First Commonwealth Financial Corp (FCF) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the First Commonwealth Financial second-quarter 2014 earnings conference call. (Operator Instructions).

I would now like to introduce your host for today's conference, Mr. Rich Stimel. You may begin.

Thank you. As a reminder, 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've also included a slide presentation on our Investor Relations page with supplemental financial information that will be referenced throughout today's call.

With me in the room today are Mike Price, President and CEO of First Commonwealth Financial Corporation; and Jim Reske, 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'll be joined by Bob Emmerich, our Chief Credit Officer; and 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 welcome, everyone. First I would like to welcome Jim Reske, our new CFO, who is with us this afternoon for his inaugural earnings call with First Commonwealth. He joined us in early May after the retirement of Bob Rout. He will provide some commentary on our second-quarter financial performance in a few minutes.

Second-quarter earnings of $0.13 per share are the same as the first quarter. This includes a $2.6 million second-quarter charge associated with our core conversion, which we have named Operation: Excellence. I would like to give some additional time to Operation: Excellence this afternoon, given the strategic importance to the Company.

In the fourth quarter of 2013, we shared that this project would require a $10 million to $12 million investment, and result in some $6 million to $8 million of annual savings which would begin to accrue in the fourth quarter of this year. The project has unfolded as we had hoped, and we are slated for our conversion in August. Besides the financial benefits, this will enable better solutions for our clients, better integration of our systems, and improved speed to market with products and services.

As you think about the financial impact the last several quarters, the charges associated with this project have totaled $4.6 million in the fourth quarter of 2013; $2.4 million in the first quarter of 2014; $2.6 million here in the second quarter of 2014; and another final charge in the third quarter of approximately $2 million, for $11.6 million total.

Starting in the fourth quarter of 2014, we will expect to realize the financial savings we have outlined of at least $1.5 million per quarter. Having these one-time charges in our rearview mirror, coupled with realizing the savings outlined in the fourth quarter, it will have a palpable impact on our core earnings and our ROA. This is an exciting time in our Company. We began this IT journey two years ago, and have been thoroughly engaged with the majority of our employees the last eight months.

The task has been monumental. We have completed four tests and two mock conversions over six separate weekends over the last two quarters. This is the IT and operational platform that will run this Company for years to come, and we've laid a solid foundation for our future.

Now, onto some other important items. First, since the fourth quarter of last year, we've invested in de novo mortgage as well. We took our first purchase money mortgage loan application this month, and that's the first one in almost 10 years. This is a core offering for any community bank. As I've shared, we do not have any delusions about mortgage and the current mortgage outlook. However, a mortgage offering will bring a younger, creditworthy consumer household to our bank.

These same households will tend to have a checking account, a debit card, and other services. This will be good business, and fill a gaping hole in our product offering. We expect mortgage to yield approximately $6 million in 2015 fee income, which after roughly $4 million in associated expense, would add about $2 million to the Bank's pre-tax income.

Second, we were pleased to see $82 million of growth in period-end loan balances in the second quarter, with $23.8 million new loan outstanding balances coming from our new Cleveland office alone. However, a good portion of these loans came on the balance sheet toward the end of the quarter, and so the second quarter net interest income did not receive the full benefit of this growth.

As you can see from page 7 of our supplemental earnings presentation, roughly half of the second quarter's loan growth was in C&I, with the remainder fairly evenly split between commercial real estate and auto loans.

Third, I want to give some brief color and coverage to expenses. Despite the linked quarter optics, we believe our core second-quarter expenses are below the $40 million figure we had previously discussed, when adjusted for $2.6 million in conversion-related charges, and certainly the $700,000 write-down of an OREO property. This obviously precedes the realization of the savings in conjunction with Operation: Excellence.

Fourth, credit metrics improved in the second quarter, with nonperforming loans falling by $9.9 million to $46 million, or 1.07% of total loans. This is the lowest level of nonperformers since 2006. Provision expense was flat with the prior quarter. Charge-offs of $7.1 million were elevated by a $5.8 million write-down on an oil and gas servicing company. Most of that write-down was covered by a specific reserve assessed in the first quarter. That charge-off contributed to a decrease in the ratio of total reserves to total loans. But the ratio of general reserves to non-impaired loans stood at 1.04%, which was relatively unchanged from last quarter's 1.05%.

In closing, we have made a transformative investment in our IP and operations infrastructure that will be a foundation for years to come. This will make us both more efficient and easier to do business with. Over the last 12 months, we have also made a transformative investment in a mortgage offering to serve a loyal customer base and capture younger, creditworthy households. And then lastly, our asset quality continues to improve, and we believe that our credit function will provide a source of strategic advantage for our Company.

With that, I will turn it over to Jim Reske. Jim?

Thanks, Mike. First of all, since this is my first earnings call with the Company, let me say how happy I am to be joining First Commonwealth at such a strategic time, especially with the IT conversion, the new mortgage initiative, and expansion into new markets such as Cleveland. It is certainly a very exciting time for the Company, and I'm delighted to be a part of it.

I'll start with a few broad statements about the Company's second-quarter performance, and then provide some detail that I hope will be helpful to you. Overall, the Company's financial performance in the second quarter could be characterized as one of stability when compared to the previous quarter, and strong improvement when compared to the same quarter a year ago.

Earnings per share came in at $0.13 in the second quarter, unchanged from the prior quarter, and up strongly from $0.06 a share, a year ago. In comparing to the second-quarter to the linked quarter, a few things stand out: loan balances experienced solid growth; credit quality continued to improve; fee income expanded; and expenses, on an adjusted basis, remained under control.

First half performance as a whole is particularly impressive, in light of the $5 million headwind of one-time expenditures related to our IT conversion. Now, let me take each element of the income statement in turn.

First of all, net interest income came in at $46.2 million in the second quarter, which is down by about $300,000 from the first quarter, a decrease of less than 1%. The net interest margin did contract somewhat over this period, from 3.33% to 3.26%. However, approximately 10 basis points of the first quarter's margin was due to repayment penalties, compared with 4 basis points in the second quarter.

Like most banks, our loans continue to reprice lower in the current rate environment. On the funding side, we continue to benefit from growth in average non-interest-bearing deposits, which were up by nearly $100 million in the second quarter of 2014 from where they were a year ago. Over the same period, average time deposits were down by roughly the same amount, bringing total cost of deposits down 4 basis points to 0.30% for the second quarter.

On a linked quarter basis, total deposits were down $187 million, but $106 million of that decline was in broker deposits, as we consciously shifted to cheaper short-term borrowings. Overall, the Bank remains very well positioned for a rise in rates, which I'll return to in a moment.

As Mike shared, we were pleased to see $82 million of growth in period-end loan balances in the second quarter. However, average loan balances are relatively flat, as a good portion of these loans came onto the balance sheet toward the end of the quarter. And so second-quarter net interest income did not receive the full benefit of this growth.

Noninterest income came in at $17 million in the second quarter. However, to be fair, in order to properly understand the change from the prior quarter, the one-time gain of $1.2 million on the sale of our Registered Investment Advisory business in the first quarter should be taken into account, as should a $2 million gain on the sale of a single OREO property in the second quarter.

Beyond those items, we did experience an increase in a number of fee income categories in the second quarter. Deposit service fees were up $300,000; insurance and retail brokerage commissions were up $200,000; and interchange income was up $200,000. Swap fee income, which is contained in the other income line, also increased by $400,000 in the second quarter.

As Mike mentioned, we re-entered the mortgage business in July. We understand that the mortgage refi industry has experienced a downturn in the current rate environment, but there is still upside for us in being able to do purchase money mortgages for our customers. We expect that this business will begin to make a contribution of approximately $0.5 million of fee income in the fourth quarter this year. But, because we continue to invest in that business, the bottom-line impact to net income will be negligible in the fourth quarter. We continue to expect that we will sell most of our fixed loan production in the secondary market.

Turning to noninterest expense, the one-time expenditures related to our IT conversion are the biggest story by far. These expenses totaled $2.6 million in the second quarter, up $200,000 from the first quarter. As Mike described, the first quarter also benefited from a $900,000 insurance recovery; while, conversely, the second quarter was impacted by a write-down of $700,000 related to a single REO property.

By way of note, at June 30, OREO balances were down to $7.8 million, with only two properties valued at over $1 million. Nevertheless, taking all of these items into account, on an operating basis, second-quarter noninterest expense remained relatively aligned with the linked quarter; below our previously announced target of $40 million per quarter; and well below last year's levels.

We continue to expect that our IT conversion will result in expense reductions of at least $1.5 million per quarter, beginning with the fourth quarter of 2014. However, before we get there, we are still incurring expenses related to the conversion, which we expect to come in at approximately $2 million in the third quarter. In addition, our continued investment in the mortgage business will result in about $600,000 in expense in the third quarter before we start to see positive net income from fees in the fourth quarter.

In other news, our effective tax rate was 28.4% in the second quarter compared with 28.3% in the first quarter. And our stock buyback program continues, with $17.4 million of our $25 million authorization remaining as of June 30, 2014. We have changed our approach slightly, to purchase shares more aggressively on price dips, while still pursuing a goal of completing the repurchase program by the end of this year.

Finally, there's no mention of our interest rate risk methodology in the earnings release, but it will come up in the 10-Q, and so I wanted to mention it here. With the help of a third party, we have done a closer examination of the stickiness, for lack of a better word, of our demand and savings deposit base. We found that they are quote-unquote stickier than we had previously contemplated, meaning that they are less likely to run off in a rising rate environment.

As such, the weighted average duration of our deposit base has increased. This means that in the upcoming 10-Q, you will see that our interest rate risk calculations show that we are more asset-sensitive than was the case in the first quarter, and it's a direct result of this change in our methodology.

And with that, we'll take any questions you may have.

Operator, questions?

(Operator Instructions). Bob Ramsey, FBR Capital Markets.

Really a nice quarter for loan growth. It's nice to see, on an end-of-period basis, those balances start moving higher. I know it's something you guys have been focused on for a long time. You highlighted contribution from the Cleveland commercial business center. Is something -- $20 million, $25 million a quarter -- is that a good run rate out of that office? Or was there anything unusually strong this quarter? Or what's the expectation from that branch?

I think we got off to a really strong start, but the $23.8 million is really with probably in excess of $70 million of approvals, so those are just beginning to fund. We'll continue to monitor that kind of pipeline, but it continues to look pretty strong. And it's pretty split between commercial real estate and C&I.

Okay, great. And then in the growth that you saw in the rest of the portfolio, was it more some of the -- I guess less of a drag from loan sales and loan runoff this quarter? Or was it stronger originations? Or what was in the rest of the book, the factors and the growth?

Yes, I wish I could say that runoffs had -- and our episodic de-risking had come to a close, but it hadn't. And we probably -- there was another creditor, too, that were a little larger. But we had a pretty good production quarter, probably in excess of $0.25 billion of loan production. And that was pretty equally split between commercial real estate and C&I.

Okay. And then -- so I guess you're doing a little more production. Do you have the sense that borrowers are a little more confident? And is this something that you expect to continue?

You know, I wouldn't go there yet. (laughter) I was just looking at the spreads, and I think I've shared some of these spreads before. I don't know that I need to do that. But I'm looking at 2012, 2013, and 2014, and there continues to be downward pressure on these spreads for the quality credits. It's really that simple. And that obviously -- you see that in the margin.

Yes, okay. Shifting to fee income, I know you guys highlighted that strong interchange income was one of the factors this quarter. What is driving that? Has there been any sort of push to get people spending on debit card, to your debit cards, or is it --? Yes, I'm just curious for any color there.

Yes, it's really just a continued growth in consumer households and the interchange associated with that. It seems paradoxical, given the leakage in our deposits, particularly on the savings and the time deposit side. But on the time side, the bulk of that -- I think it was $133 million downdraft -- was [seeders]. And we have gotten pretty stiff when it comes to promo rates. We haven't done a promo rate, I think, now, for almost a year.

And everybody hangs a rate. Now, part of that was our margin; and honestly part of it was just, we have this conversion. And it just makes the product mapping less complicated when we get to the conversion here in August. So that was a little bit of the thought process as well.

We've driven out a lot of the households that just come in and shop rates. There's literally -- there's not really a lot of vehicles for them other than some exception pricing that could happen on a discrete basis, branch by branch, but that's pretty rare.

So the benefit is, you see it in the rate, in the downdraft, in the funding cost, but we're somewhat pleased that the households continue to grow. And you can see that obviously in the deposit service charges, and not just the interchange. We're growing households, but we're losing that single-service rate shopper.

Now, in fairness, that single-service rate shopper will become important to us at some point, and we'll want to bring them back into the house. And we'll begin to experiment with some promo rates, I'm sure, on the other side of the conversion, Bob.

Okay. A last question and I'll hop back out. But it looked like most of the margin compression this quarter really related to the drop in prepayment fees that were really strong last quarter. Do you guys think you're getting closer to a trough in the margin?

I've kind of had that perspective before, so I'll stop short of reiterating that. So, I just -- hope is not a strategy. But there is still downward pressure on the C&I side of the business.

Okay. Great. Thank you, guys.

Collyn Gilbert, KBW.

Just wanted to ask about the net charge-off that came in this quarter. I presume that that was somewhat unexpected. Just wanted to better understand the circumstances around that. And then also to -- if you guys could provide any color on the direction of the reserve.

Yes, I have Bob Emmerich with us, and I'll turn to Bob for the question.

Yes, Collyn, that was an oil services company that was hurt by -- obviously by the decline in gas prices and the reduction in drilling activity. On top of that, both the CEO and the CFO became ill very close to each other, within about six months of each other, and left the Company. So there was a vacuum in leadership at the Company while the market was going down. And so that really hampered them being able to work their way through it. In terms of that one specific credit that we -- where we took the charge-off.

Okay, okay.

And we took a specific reserve in the first quarter, and then charged it through here in the second quarter.

Yes.

And then in terms of the direction of the reserve -- the reserve, as you know, has been going down for the last few quarters. And it's down from last quarter, where it was at 128. And a lot of this has been in reduction in specific reserves for impaired loans. And that was really -- the reduction this quarter was really from that one large charge-off we took, where we took the specific reserves in the first quarter.

And as Mike mentioned in his comments earlier, the general reserve for the non-impaired loans has been pretty consistent at 105, down to 104.

Okay. Okay. Okay, that's helpful. And then just on the loan growth, Mike, I know you said it was fairly evenly split between CRE and C&I, and Cleveland had been driving a lot of that. Was there anything in there that was out-of-market or were other loan participations? Or was all of this in-market originated, and you guys carried the bulk of the projects?

Yes, I'm looking at the list right now, Collyn. And I would say if you're just including Ohio as an adjacent state, I would say that the vast majority of this is either Western PA or Ohio, and particularly Northern Ohio or Central Ohio. And we've got a pretty good toehold in Ohio right now. I think we have about $238 million of loans. And about $80 million of that is C&I, and the remainder of it is commercial real estate, and some nice projects in Columbus. So I think that's the bulk of it.

As you know, we have done some SNCs and some participations in the past, and there are a few of those in here, as well.

Okay. Okay, that's helpful. And I think you may have just covered it, and I apologize. Your outlook for the NIM, or more specifically on the loan yield trajectory, how are you guys thinking about that from here? Assuming we don't see any kind of change in rates, and certainly not for the rest of this year.

Collyn, this is Jim Reske. I think what we're seeing is something that we see a lot of other banks experiencing, which is that the new loans coming on are at slightly lower rates than the loans that are rolling off. And so we expect that to continue for a little while here, until rates eventually rise.

,

Okay. Okay. And anything more to do on the funding side, in terms of cost reduction, or are you bottoming there?

When your total cost of funds is down at the 0.30% level, getting closer to cost of borrowing overnights, it's hard to see that getting a lot lower than it is now.

Okay. Okay. Good. That was all I had. Thanks, guys.

Matthew Breese, Sterne, Agee.

I just wanted to drill a little bit down into noninterest income, specifically the gain on sale of assets line. Given how much credit quality has improved, should we expect that line item to dwindle quite a bit over the next few quarters?

This is Jim Reske. Yes, actually, we did actually provide in the supplemental presentation some non-GAAP disclosures that will help you with that. But, yes, some of that was just the recovery of an OREO property, a $2 million being on sale in the second quarter.

The other part of that -- and if you look in the back of the supplement, it's really -- it's not stated on a quarter-by-quarter basis; it's stated on a first-half basis -- so you'll see a gain on sale of assets of $3.7 million. $2.3 million was that covering OREO I just mentioned, but $1.2 million is the gain on the sale of our Registered Investment Advisory business that we sold in the first quarter.

So if you're adjusting and looking at adjustments to make, those would probably be proper adjustments.

Right. So all things aside, we shouldn't expect much of a contribution from that line item going forward?

No. I wish we could sell -- gain of piece of OREO property every quarter for $2 million, but probably not going to happen again.

Okay. And then turning to the swap side of things, what would be a more realistic run rate on swap income, versus that of what you put on the books this quarter?

Yes, the swap income is up nicely. And I really -- and saying those numbers in my prepared remarks, don't want to overstate the case. I think these items like the swap income, and some of the other items as well, are moving in the right direction. The fee income is going up; it's all positive. But they're really relatively minor variances, so I wouldn't put too much attention on that as a growth trend.

Swap income -- a $400,000 increase from the first quarter, which is healthy. It's good. Some of that might actually come down a little bit. I think there's expectations maybe to do a little less swap activity going forward, so that might come down a bit.

And then on the overall expense side, Mike, you noted a $1.5 million per quarter reduction in overall expenses. So, as we think about that and this quarter's operating expenses, should we just basically subtract $1.5 million from this quarter's run rate and that will be the new expenses, post-conversion?

I think we've been taking you there, to the $40 million number, less $1.5 million for the last few quarters. I think that's fair.

Okay. Okay, that's all I had. Thank you.

(Operator Instructions). John Moran, Macquarie.

I wanted to circle back on this mix, real quick. Is the result of the annual review incorporated in this print, or are you guys still -- is that kind of ongoing?

It's in this print.

It is in this print? Okay, great. The next question -- just if I'm looking at this wrong, flag me here -- but as I look at the year-on-year growth, a lot of that has been driven out of commercial. And then if we tease it out in dollar terms, you are up year-on-year about $110 million in the total commercial portfolio. The SNCs are up $107 million, so it's kind of 97% of that growth, if I'm thinking about it right.

And I guess what I'm driving at here is, SNCs -- and I appreciate that more of these are being done in footprint -- but SNCs was part of what drove a whole lot of credit sins of the past.

So maybe it's a question for Bob. What's changed? And can you give an update on the Company's approach to how we should think about this business, or how you guys think about this business?

Yes, in comparison to how things were in the past, I think they are a lot different than they were in the past. I think we're a lot more selective about who we have as an agent bank. And also, a lot of the transactions I'd really classify as club deals, where we know a bank reasonably well and we share in exposure there, and rather than a broad syndication. And we're doing that both on the C&I side, and also on the real estate side.

And we had a situation here -- maybe it was in the first quarter, whereas it was a large real estate transaction here in the city of Pittsburgh, and we were trying to win the agency. And we didn't win it. Another bank here locally won it, and we ended up splitting the deal. And so we do have a fair number of either participation in loans, or syndication of loans, that fall into that category as well.

And in addition to just being more careful about the agent banks and the kind of transactions we're getting into, as you know, we've also been more careful about the size of credits we got into, and trying to keep the portfolio very granular.

And John, this is Mike. Let me just add to Bob's comment. I think if you looked at -- if you tracked $0.25 billion of credit cost over four years that came out of that 2004 to 2007 timeframe, the vast majority -- and underscore the word vast, probably 85% -- would be -- come out of the construction portfolio and participations in speculative development lending. And we're not doing participations in speculative development lending, so now you're talking about a C&I credit that, quite frankly, performed pretty well through the cycle. And it wasn't the credit that bit us in the backside.

The other thing I would say is that we underwrite all of these loans, and we're not buying these loans in the aftermarket. A good portion of these loans, we have other relations with them in terms of either depository; cash management; a branch in their corporate headquarters, you name it -- and so just a little different. Again, speculative development and participations -- that's what hurt this Company, and these aren't those types of deals.

Got it. That's actually really helpful. If I can just do two quick follow-ups on that. One, back to Bob, how large was that CRE credit that you referenced in Pittsburgh that came in in first quarter, where you guys trying to be agent and it ended up -- it sounds like you got second place?

I think the total credit was probably around $40 million, something like that.

Okay. And then maybe a just a second quick follow-up to Mike. You mentioned that you guys have another relationship of some sort with a whole lot of these guys. Do you know offhand what the percentage would be, where either it's a deposit relationship or some other kind of product relationship, versus just a physical branch in the building?

I think the fact that they are in our backyard -- I'm going to speculate. It's probably one-third to one-half, but I will get back to you on that.

Okay. So one-third to one-half that you guys would have some sort of other relationship with. And then do you know, or have handy -- and I think you guys used to disclose this -- but how many you were actually lead on?

The number where we'd be lead on would just be a handful, and there's probably about 70 credits or so would be in this bucket.

I got it. I really appreciate all the detail. Thanks very much, guys.

At this time, I am showing no further questions. I would like to now turn it back over to management for any further remarks.

We appreciate your interest in our Company, your questions. And we invite your questions at any time, and either Jim or I will be helpful; and suspect we'll get to see a lot of you before our next earnings call. So, thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect.