First Commonwealth Financial Corp (FCF) 2013 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the First Commonwealth Financial Corporation fourth-quarter 2013 earnings conference call. (Operator Instructions).

I would now like to turn the call over to Rich Stimel.

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. We have also included a slide presentation on our investor relations page, supplemental financial information that will be referenced throughout today's call.

With me in the room today are Mike Price, President and CEO of Commonwealth Financial Corporation, and Bob Rout, Executive Vice President and Chief Financial 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 Bob Emmerich, our Chief Credit Officer; Mark Lopushansky, our Chief Treasury Officer; and Norm Montgomery, Executive Vice President Business Integration.

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 forward-looking statements.

Now I would like to turn the call over to Mike Price.

Thank you, Rich, and good afternoon everyone. Thank you for joining us on today's call.

Overall we feel good about the quarter and its implications for 2014 although undoubtedly there is still a ways to go to become top-performing.

We reported net income of $9.3 million or $0.10 diluted earnings per share compared to net income of $8.7 million or $0.09 per share in the fourth quarter of 2012. If you factor out the unusual expenses associated with our core technology conversion and the liquidation of two of our trust preferred securities, our operating earnings per share comes in at $0.14 for the quarter. We are seeing progress across several areas of strategic focus namely credit, organic growth, our technology conversion and organizational efficiency.

First, building a culture of operating excellence starts with credit discipline. We feel we laid the groundwork over the last two years that will make us very competitive along this critical dimension for years to come. Nonperforming loans are trending down nicely having fallen 45% from 2012 levels. Our criticized loans continue to decline as well down from $289 million in 2012 to $162 million in 2013.

We did see an increase in net charge-offs year-over-year from $15 million to $32 million but that increase was concentrated in two large legacy credits in the first and second quarters and we expect that number to moderate in 2014.

Second, fourth-quarter loan growth of $43.8 million was encouraging and exceeds 4% when annualized. And looking at the past year, our retail bank performed well in loan originations while our corporate bank contended with some challenges. Over the year, we selectively pruned well over $80 million in corporate credits that slowed in the latter part of the year and at that time we also saw a nice pickup in corporate lending activity in the fourth quarter that really provides nice momentum into 2014.

We also announced last year a business center in Northeast Ohio and we are already seeing traction with that initiative and over $65 million in approved loans coming from Ohio.

On the mortgage front, we filled key leadership roles in operations and sales. We have identified an origination system and we continue to build out our policy procedure and compliant structures. Undoubtedly we missed the unprecedented first mortgage run-up over the past several years but this is a core business for which we have an immediate market and a lack of a first mortgage offering has added to the challenges we faced from a noninterest income, loan growth, and net interest margin perspective. So mortgage remains a strategic priority.

Third, we mentioned last quarter that we had begun our IT systems conversion in partnership with Jack Henry and Associates. This conversion process entails replacing an expensive core IT system and simultaneously transforming operating models to drive efficiency, integration and the ease of doing business with First Commonwealth. As I mentioned earlier, we realized a total of $4.5 million of technology restructuring charges in the fourth quarter with $2 million of those expenses related to accelerated depreciation of hardware and software and the $4.5 million figure equates to $0.03 per share.

Beyond the associated cost, we anticipate $6 million to $8 million in annualized savings going forward with core conversion savings already beginning to show in the run rate. We are roughly one-third of the way through the conversion and currently on schedule with key project milestones.

We have conducted our parameters setting, data mapping and product design activities. Some testing will begin in February and will continue through the quarter and into April and May. The conversion of our IT systems is an important part of our efficiency efforts but it is just one component of those efforts. We continue to look for every opportunity across our organization to improve processes, reduce costs and enhance the delivery of financial solutions to our client base.

Encouragingly, salaries and staffing levels continue to decline as noninterest expense fell from $177.2 million in 2012 to $168.8 million in 2013 and I believe we are well positioned to achieve our goal of reducing our noninterest expense below a $160 million annual run rate.

When you look at our quarterly figure of $45.3 million, subtract out $4.5 million for the conversion, we are left with about $827,000. Bob will talk about that but we have some medical shot claims that caught us a little bit by surprise in 2013.

We will remain focused on our strategic priorities of lower credit cost, successful execution of our IP systems conversion, continuous efficiency enhancements and growing our revenue. We believe successfully executing on these priorities will deliver long-term value to our shareholders.

We also understand how important a component of value the dividend is to our shareholders. With that in mind, we announced an increase in the dividend from $0.06 per share to $0.07 per share earlier today. We know there is still a lot to do but we are unwavering in our commitment to getting it done and we see tangible proof from our financial performance, from our sales metrics and from our customer satisfaction measures that our community banking value proposition resonates in our market.

We are on a clear path to continue to improve the operating performance of First Commonwealth and build for the future.

So Bob Rout is here to discuss how execution of these strategic priorities impacted our fourth-quarter financials. Bob?

Thank you, Mike, and good afternoon everyone. As Mike mentioned, we were real pleased with the ongoing improvement in our financial performance again this quarter, solid loan growth, a stabilizing margin, ongoing improvements in credit quality and the kickoff of an IT conversion initiative that we believe will be transformative with respect to both customer experience and operational efficiencies.

We still have a long way to go to achieve a high performance financial status but the direction and the momentum are highly encouraging. We had two unusual issues that occurred this quarter that blurs that core performance slightly. We reported a $4.5 million or $0.03 earnings per share charge related to our IT conversion that is currently scheduled for the third quarter. Most of this charge was related to accelerated depreciation for hardware and software that will the abandoned at conversion, also include charges for early termination of existing maintenance contracts on that hardware and software, professional fees, and accruals for severance cost and retention bonuses for employees that maybe displaced by more efficient operations.

We have previously disclosed that expected total charges related to this conversion will range between $11 million and $12 million; therefore, we can expect the remainder of those charges to trickle in over the next three quarters in the $2 million to $3 million range per quarter. Again, most of these charges will the relating to accelerated depreciation on hardware and software of 39 different systems that are being replaced.

The second unusual issue is a $1.3 million realized loss on securities fueled by trust preferred investments that had some unique default language in their documents. It appears that smart hedge fund figured this out, (inaudible) controlling senior position, liquidated their collateral and crammed the mezzanine holders such as First Commonwealth. None of our other holdings have similar language.

Walking through the income statement starting with net interest income, the core net interest margin was actually fairly stable on a link quarter basis. You will recall that we had an unexpected payment to one of our other [TruPS] investments that added $1 million to net interest income and about 7 basis points to 8 basis points to the net interest margin for that third quarter.

Our $44 million of loan growth in the fourth quarter was primarily the result of good commercial activity being fairly well balanced among C&I, construction and commercial real estate categories. A good quarter for provision expense is reflective of the ongoing credit quality improvements here too. We have a ways to go until we can claim this area as a strategic competitive advantage.

Noninterest income before security gains and losses increased $600,000 or 4% on a year-over-year quarterly comparison. Swap transactions and the restructuring of our deposit accounts has been very helpful in this area. In preparation for our upcoming IP conversion, we have converged a hodgepodge of different deposit products into a more consolidated and more manageable menu of deposit product offerings.

Incrementally we continue to chip away at core noninterest expense. This quarter and for the year we had some unusual medical expense patterns that Mike was referring to earlier. Typically with a self-funded medical plan of our size, you will see one to three shot claims in a typical year and then every five, seven years you get a year of high claims. This was our year. Hopefully those elevated claims will be somewhat of an anomaly going forward.

We also saw an increase in reserve to unfunded commitments related to a $19 million increase in construction loans this past quarter. We always get questions on the of effective tax rate. Ours was 26.8% for the fourth quarter.

So with that, we will open up the line for any questions. Thank you.

Thank you. Questions, operator?

(Operator Instructions). Bob Ramsey, FBR.

Good morning, guys. A quick question. I know you highlighted the medical expense piece but how much was the differential or the unusual piece of expenses this quarter?

On a linked quarter, Bob, I believe we had to adjust the cost about $700,000.

Okay, great. Thank you. And then this also was a nice quarter in terms of loan growth was a little bit better, your margin on a core basis was pretty stable. How are you guys thinking about the opportunity for net interest income growth as we go through 2014?

I think, Bob -- this is Mike. We have shared in the past probably mid-single-digit loan growth and our margin is stabilizing. So we are hopeful that equation is beginning to change from the last several years. We did a nice job this past quarter -- four or five credits $15 million to $20 million, $25 million. Nice local companies and so the C&I and the commercial real estate picked up nicely.

And when you talk about margins stabilizing, do you think we have actually hit the bottom and are onward and upward or do you think there could be a modest amount of compression early that you sort of earn back later? Just curious how you think about the trajectory?

Bob, this is Bob Rout. I think there will be continued pressure on the net interest margin but it is so highly dependent upon what is happening with the Fed and the interest rate environment and today we are just seeing a whole bunch of volatility in all of the markets because of what is happening with some of the emerging markets and their interest rates. So the spread (inaudible), they are going to be highly dependent.

I can tell you that we remain asset sensitive. Upward movement in the rates have a more beneficial affect for us than downward rates so we are hopeful that that will be the direction of interest rates going forward.

Okay, great. Last question and I will hop back out but in terms of credit, great to see the level of net charge-offs this quarter. I mean it gets even well below where you guys have talked about kind of a normalized level of losses. I am curious as you think about 2014, do you think that credit trends are more or less normal or do you think it is a year where losses run below average or above average?

We feel they will continue to improve and objectively, we just look at the run rate of criticized and classified assets which we have disclosed in decks before and I am just looking at the sheet right now, just a few years ago our criticized assets were $598 million; end of 2011, they were $302 million and then $288 million last year and down to $162 million. So really the pipeline of things that will create problems has certainly decreased although credit is credit and in any given quarter something can happen but we feel really good about those trends and we think they are pretty solid and portend well for the future.

Okay, great. Thank you very much, guys.

John Moran, Macquarie Capital.

So maybe just a quick one on OpEx, Mike. If I heard properly or correctly in the prepared remarks, it sounds like some portion of the $6 million to $8 million in cost saves that you expect from the conversion are already starting to show up in the run rate. Is it possible to tease out how much of that is already there and what we might expect going forward or is that $6 million to $8 million kind of incremental once everything is converted?

Yes, it is a little bit of both. I think it is about 10% of that is we are beginning to see on a linked quarter basis and I think we have the majority of it, 75% plus, identified so as the team works over this next critical phase of the project, they have done a lot of the data mapping and field selection and product design and those types of things, that is where we really get at the core processes and really flush out how operating procedures will be different before and after.

And I think there is a lot of proof there and we are pretty enthused about that and not just from an efficiency standpoint but just from an ease of doing business both internally and with our customers. We are also pretty excited about perhaps some good uptick in capability that customers will see.

That is helpful. I think if I am thinking about it correctly, the $40 million run rate that you guys have had out there as a target might end up being a little bit conservative actually once we get into the back part of 2014 and into 2015. Is that fair to say?

It is and in fairness, John, we have said that we really expect to dip below that upwards of $1.5 million per quarter.

Got it, got it. That takes care of one of the questions there for me. The other one just kind of circling back on credit following up on Bob's question, when I look at reserve to loans sitting at still I guess [131] in the quarter whatever somewhere in between there and the recent charge-off history anyway second quarter's experience of last year and notwithstanding, it seems that there is probably room to continue to work that a bit lower and maybe have provision not quite cover charge-offs for the next little bit here. Is that fair to say and how are you guys thinking about where you want to be reserved?

Mike, Bob Rout here. I think the best way to quote it is we are comfortable where it is at today and secondly, given our history with credit issues, we had a tendency to maybe skew a little bit more on the conservative side and that is where we are going to (technical difficulty) until we are absolutely sure that this credit cycle has sufficiently gone behind us.

Understood and well put, Bob. If I'm not mistaken, this might be your last rodeo with respect to conference calls. So congrats on the retirement.

Thanks very much.

Collyn Gilbert, KBW.

Thanks. Good afternoon, gentlemen. Just to go back to your commentary on the expenses and I apologize for beating a dead horse. I just want to make sure I understand this. So, Mike, when you said the $160 million annual run rate which obviously implies $40 million a quarter, when did you think that that would start to then kick in?

After the conversion is complete and perhaps a quarter or so after.

So that would be the end of the year?

End of the year, first quarter of 2015.

I just want to make sure. So we are going still be above that and then it will drop off below that by the end of the year?

Maybe just to clarify, if you take out our expenses here through the fourth quarter and back off the IT conversion cost and maybe adjust for close to $1 million of medical costs and elevated costs, we are pretty close to that $160 million (inaudible).

That is why I was kind of (multiple speakers) .

The $6 million to $8 million then would become further reductions to that $160 million.

Okay, okay. I apologize for being confused on that. And then, Bob, just your commentary around the NIM. If we assume -- obviously it is unknown, it is volatile, but let's just assume interest rates don't move the short end and the long end don't move this year, what -- just given the a normal churn of the balance sheet -- where do you see that NIM going?

Downward.

Okay. And that is a function still of loan origination yields being lower than what is rolling off work or --?

Yes, but certainly not to the extent that we experienced in prior quarters.

This is Mike. Just looking at the trend of the new volume rate and that -- it appears to have stabilized and doesn't certainly have the downward pressure we have had in past quarters and also in 2012 and early 2013.

The other factor in that is the mix of the loans that we will be putting on next year. The LIBOR priced product is still pretty skinny especially in C&I and -- but there are still fairly decent yields in the commercial real estate and construction and some of the other product lines.

Some of that will be determined by the mix of the loan growth that we put on next year. All things given equal, if we have the consistent interest rate environment we have today and it doesn't change over the next 12 months, I think you will see a slight deterioration in that net interest margin.

Okay, that is helpful. Just one last question. What should we be using for a tax rate going forward?

26.7%.

Okay. That was all I had. Thanks.

(Operator Instructions). Matthew Kelly, Sterne, Agee.

This is actually Matthew Breese. I just wanted to touch on the Mortgage Banking operation build out and when do you think we can start to see some of that actually hit the income statement?

We have shared that the third-quarter of this year.

Do you have any idea to what extent we can expect an impact?

(inaudible) I mean, we believe it will be a substantial business. We tend and a lot of these small wonderful towns in Western PA, tend to be first, second or third in share and customers are very loyal and they ask us for that product and offering. So we do the math on one to two mortgages per month per branch across 110 branches, it is pretty sizable business at an average run rate. And at one time we had a mortgage portfolio that eclipsed about $600 million and that was selling a lot and that has been run down to 180, 140. So it will move the needle for us even in a tough economy.

And the intention is to sell 100% of the production?

We will probably portfolio some so you will see it mostly in our noninterest income but we will keep a portion, 5% or 10% of nonconforming. There is a lot of great credit out here particularly in half of our markets are really community markets where a nice house will have excess acreage and that is really kind of nonconforming from an FHA or a Freddie, Fannie or Ginnie or Federal Home Loan Bank standpoint and those will be very good credit risks for us.

Let me try the revenue question this way. Right now operating fee income is about 24% of overall revenues. Do you expect the Mortgage Banking income to meaningfully shift that number?

Not in 2014 but certainly in 2015. We also have some other opportunities there with some improvement in our wealth business and also just better cross-selling. We have made some progress but not nearly enough. We our cross sells and our products per household. Good traction the last year and a half or two years but certainly a lot more runway there as well.

And the expense guidance you have given which is $40 million a quarter or below, that includes the added staff from the Mortgage Banking operation?

Yes, it is already a burden. Trust me. We have really invested in some good people and already a system there.

And then maybe give us an update on some of the progress you have made on Marcellus Shale and the buildout.

Actually we are pretty comfortable with that the last few years. We hired a lender maybe three years ago and the other thing we are a little different in that we have always done shallow gas so traversing from shallow gas and the history there of 50 years of oil and gas, the Marcellus perhaps wasn't as hard for us. We do stay away from lending to drillers and we tend to do more of the supply side. The drillers that we have for customers tend to be net depositors by a long shot and they don't borrow a lot of money.

We have been in that business for a long time and just as I look at -- I am looking at the top five or six loans that were approved in corporate this past quarter, it looks like maybe 10% of them would be oil and gas related.

How much exposure do you have overall right now to the shale?

Not a lot. Bob Emmerich, our Chief Credit Officer, is very disciplined about portfolio concentration and we have a pretty modest concentration there. I think I'm looking at Bob right now, it is about $150 million to $200 million and we haven't even used up half of that, have we?

In terms of commitment, we are at about (technical difficulty)

So pretty well contained. It is really the ripple effect of that that we see tighter real estate market and really the blessing and the benefit of that shows up also in other ways.

Thank you very much, guys.

I am showing no further questions. I would now like to turn the call back over to Mike Price.

Thank you. And Mike from Macquarie beat me to the punch. But I just wanted to thank Bob Rout. I wanted to take a moment to express my appreciation to Bob for his leadership and commitment to this organization. He cares and anyone who has had the opportunity to work with him appreciates the knowledge and credibility that he brings to the role.

I believe everyone is aware that in November of last year, Bob announced his intention to retire in the first half of this year. He gave us plenty of time to navigate the transition and he has been very helpful in helping us to begin to identify a new CFO. He may very well be with us for this quarter's call in which case I will do this again, Bob. But I didn't want to miss this opportunity. He has brought with him 40 years of financial experience that has been invaluable during the last few years and some tougher times at First Commonwealth and I have thoroughly enjoyed the opportunity to work with Bob over the last few years. Thank you very much.

Operator, thank you.

Thank you. Ladies and gentlemen, that does conclude the conference for today. Again, thank you for your participation. You may all disconnect. Have a good day.