First Commonwealth Financial Corp (FCF) 2014 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the First Commonwealth fourth-quarter 2014 earnings conference call. (Operator Instructions) As a reminder, this conference may be recorded.

I will now turn the call over to your host, Rich Stimel. Please go ahead.

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. 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 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 will open the call to your questions.

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 like to turn the call over to Mike Price.

Hey, thanks, Rich, and good afternoon, everyone. We appreciate you joining us on today's call.

With the release of our earnings earlier this morning, we officially wrapped up what has proven to be a successful and important year for First Commonwealth. The execution of our strategic initiatives and the progress we've made towards our growth objectives added up to earnings per share of $0.48 for the year, up $0.116 from last year, which is our third consecutive year of double-digit earnings-per-share growth. Excluding the legal settlement that we'll discuss in a moment, earnings per share totaled $0.15 for the quarter and $0.54 for the full year.

We've generated good loan growth over the last three quarters, with the corporate banking leading the way. In particular we've experienced strong commercial real estate originations. The fourth quarter saw $47 million in loan growth, and our Cleveland business center continues to contribute meaningfully to both approved loans and loan outstandings.

Furthermore, in November and December of 2014, our mortgage loan outstandings grew for the first time in over a decade. The fact that we've hit the inflection point for mortgage loan outstandings will make consistent loan growth that much more likely.

At the same time, credit costs in the fourth quarter decreased, as the ratio of charge-offs to average loans fell to 12 basis points from 18 basis points the prior quarter. Provision expense came in at $2.6 million for the fourth quarter and $11.2 million for the full year.

Beyond our day-to-day focus on the credit discipline, household growth, cross-sell activities, and customer satisfaction, 2014 also delivered many milestones for our organization. Our mortgage business launched ahead of schedule in July. Our team worked extremely hard to get the people, products, and systems in place to make that happen.

And we continue to add talent new products to the business. We'll be actively promoting and cross-selling this line of business throughout 2015.

We also finalized our acquisition of a local commercial property and casualty insurance agency in the fourth quarter. This brought aboard an experienced sales and account management team that also expanded our carrier access and gives us new access to markets and infrastructure for greater scalability and has boosted our fee income.

In November, we welcomed David Buckiso to First Commonwealth as head of our wealth management area. David will lead strategy and execution for our trust, investments, brokerage, and financial advisory business.

And then there is our systems conversion, which has clearly set the foundation for efficiency and growth efforts going forward. We realized $1.6 million in reduced technology and operating expenses in the fourth quarter, directly attributable to the conversion.

Annualized savings are now approaching $7.4 million going into 2015, and we have at least a dozen complementary process improvement projects that we believe will result in additional efficiencies. The savings from our conversion has allowed us to make other investments in our business, including our mortgage buildout and our insurance acquisition.

Our core run rate for noninterest expense in the fourth quarter was roughly $40 million. So we are encouraged on numerous fronts, but we also recognize that there was a lot of noise in the fourth quarter that muddied the waters.

Jim will speak to many of these items in detail, but I'd like to briefly address the noninterest expense, the noninterest income, and the legal settlement regarding the Market Rate Savings IRA litigation that we had previously disclosed. First, we take the $47.4 million in noninterest expense for the quarter and adjust for conversion-related expenses, the litigation, the wire recovery, and the donated building, and we get to about $40.1 million. We were really looking for another $1.2 million or so, and that included absorbing the investment in mortgage and the insurance acquisition, which together totaled $1 million in the fourth quarter as well.

Cutting to the chase, the fourth-quarter shortfall of $1.2 million from our own expectation comes from elevated hospitalization expenses, higher debit card losses, and an OREO item. We continue, as I mentioned, to have other initiatives in the first half of 2015, which really portend well for expenses.

Second, on the noninterest income we were down $1.3 million on a linked-quarter basis. The shortfall stemmed almost entirely from lower deposit service charges and swap fees.

Post-conversion, our new system did not have service charge fees dialed in with the same risk tolerance as prior to conversion. Additionally, we waived an inordinately large number of fees to work with customers through the conversion. Both of these items are improving quickly.

Additionally, Jim will speak to quarterly adjustment on our swap. As we have shared, our mortgage effort and a re-energized wealth initiative with new leadership also are stacked against improving our fee income.

Third, the preliminary settlement we reached in January pertains to legal -- pertains to litigation that began as class action over six years. The claims arose from an IRA deposit product sold in the early 1980s, which the Bank terminated in 2008. The court dismissed the class action claim, but allowed claims by individual plaintiffs to proceed.

The preliminary settlement agreement resolves the claims of 36 individual plaintiffs as well as the rest of the class. The settlement remains subject to court approval and other conditions.

The expense of the settlement is reflected as a legal reserve in the fourth quarter. While we are obviously disappointed about the impact this had on our fourth-quarter earnings, we're glad to put this issue behind us.

Lastly, we also announced this morning a new $25 million buyback program that we hope to have completed in the first half 2015.

Looking forward, we are seeing ongoing progress in our core performance, the expense control efforts, and credit costs and we're excited to build on this in 2015. So with that I'll turn it over to Jim Reske for a deeper dive at the numbers. Jim?

Thanks, Mike. As Mike mentioned, 2014 was a very successful year for the Company on a number of fronts: double-digit EPS growth, solid loan growth, lower credit costs, the successful core system conversion, geographic expansion into Cleveland, launch of a new mortgage initiative, and the completion of an insurance agency acquisition. In short, it's been quite a year.

What I'd like to do now is cover each element of the income statement in turn, providing some observations on the Company's performance that I hope you will find helpful. First of all, net interest income has held up as well as might be expected in the current low rate environment, $47 million for the fourth quarter as compared to $47.4 million for the prior quarter. This was driven in large part by our continued ability to grow loans.

The net interest margin, however, contracted by 4 basis points in the fourth quarter to 3.23%, as a 6 basis point decline in yield on interest-earning assets was only partially offset by a decrease of 2 basis points in our cost of funds. Replacement loan yields continue to come in at lower rates in the fourth quarter. This is due in part to a change in the mix of commercial loan originations, reflecting a preference in our commercial customers to lower-yielding adjustable-rate loans as opposed to term loans.

For the year as a whole, the net interest margin was 3.27%. Over the course of 2014, we were able to protect the margin somewhat by increasing average non-interest-bearing deposits by $88.3 million; by the runoff of $97.9 million in higher-cost time deposits; and by a reduction of $33.4 million in long-term borrowings, which together helped lower our cost of funds over the course of 2014 by 6 basis points.

Like all banks, the low rate environment has certainly had an effect on our ability to earn interest income, so let me take a moment to describe our rate sensitivity, since we've had a number of questions about this in the past. We remain asset-sensitive. That is, our analysis indicates that our net interest income would increase in a rising rate environment.

However, we have taken note of the general frustration in the analyst community over the relative lack of comparability among banks as to their disclosure of interest rate risk. Some banks, like us, use a ramp analysis while others use a shock analysis. Therefore, starting with this year's 10-K and going forward, we will include both a ramp and a shock analysis in our SEC disclosures.

I don't believe this is very common among our bank peers, but we believe it is a step forward in transparency. And it's worth noting that we are asset-sensitive using either method.

Noninterest income of $13.9 million in the fourth quarter included $500,000 in securities gains related to a partial recovery on a previously written down trust preferred security. Excluding this gain, fee income was down by $1.6 million from the linked quarter.

Three items account for most of the quarter-to-quarter difference. Trust income was down about $300,000; but about half of that was due to the timing of revenue recognition on one large trust account.

Service charges on deposits were down about $500,000, due mostly to the lingering effects of the system conversion. Deposit service charges are, however, relatively flat when compared to the prior year.

And swap income was down about $0.5 million, due almost entirely to the normal quarterly mark-to-market of our swap positions. This item shows up in the line item Other Income.

On a year-to-year basis, another item that's buried in Other Income is a decrease in fee income of $1.1 million for the year that was associated with the investment management business that we sold in January of 2014. This was more than offset by a $1.2 million gain on the sale of that business.

Compared to last year, fee income from insurance and brokerage commissions was up by $478,000 in 2014. Going forward, our fee income should benefit from both our insurance agency acquisition and our investment in our mortgage initiative.

Note, though, that when we started the mortgage initiative we had expected to sell about 90% of our originations, but our early experience indicates that we will likely retain between 20% and 30%. This will reduce our expected growth in gain on sale fee income slightly, but serve to benefit the margin.

Turning to noninterest expense, the most significant item is the $8.6 million legal contingency reserve that Mike described earlier. This was partially offset by a recovery on a 2012 external fraud, which reduced noninterest expense by $2.1 million in the fourth quarter and by $3 million for the year.

The other significant item in the fourth quarter was a donation of a building to a local university, resulting in a $700,000 increase in noninterest expense. The donation of this building allowed us to donate unused office space to the benefit of a valued local partner. But from a financial perspective, it will pay for itself over time through lower overall operating expense, including lower maintenance and property taxes.

We know a number of banks are reconsidering their approach to real estate in the current environment. And for us, this donation was a big first step in looking at our utilization of real estate and how we can best rationalize underperforming assets.

Adjusting for these nonrecurring items, plus about $100,000 in left-over conversion costs that hit in the fourth quarter, noninterest expense came in at an adjusted $40.1 million for the quarter, up from last quarter's core expense of $39.3 million. We had previously disclosed that we expected approximately $1.6 million per quarter in lower expense following the conversion, with approximately $800,000 recognized in the third quarter. So it would have been fair to expect core operating expense to come in closer to $38.5 million in the fourth quarter.

However, as Mike mentioned, three items hit expense in the fourth quarter, each of which cost approximately $400,000. Our hospitalization expense was up due to timing; debit card losses were elevated; and OREO expense is up due to two properties. These three items increased noninterest expense by $1.2 million in the fourth quarter.

Looking past these three items, we incurred approximately $200,000 in additional expense related to our investment in our insurance business following the agency acquisition, and $700,000 in continued investment in our mortgage business, though we consider these to be investments that will more than pay for themselves and not nonrecurring items.

We understand that we've had a number of nonrecurring items in the fourth quarter and in 2014 as a whole, and that it can be difficult as an investor to cut through this noise. So we've laid these items out in tables starting on page 18 of the earnings supplement that is available on our website starting today.

Looking at 2014 as a whole, adjusting for the noise of the conversion, the legal reserves, the building donation, and other nonrecurring gains and losses that are all listed in the supplement, total operating expense in 2014 was $156.3 million. We are pleased that our operating expense is down by $3.9 million compared to last year; but this figure is even more impressive when you compare it to operating expense in 2010, which was $167.7 million.

That means that the Company has been able to take $11.4 million out of annual operating expense in just four years. Obviously, any time we talk in terms of nonrecurring items and operating expense, these are non-GAAP concepts; and a full reconciliation to GAAP figures can be found in the supplement.

In other news, our effective tax rate was 28.5% at the end of the fourth quarter. We expect it to be 29.1% in 2015.

With that, we will take any questions you may have.

(Operator Instructions) Bob Ramsey, FBR.

Hey, good afternoon, guys. Appreciate you all spending a little time identifying some of the unusual items in the expense base this quarter. Just curious; as you think about 2015 do you think that you all are still on a path to get to an efficiency ratio that's in the 50s at some point in 2015?

It will be close, Bob. I think we could get under the wire in the fourth quarter. Our budget is actually just right (technical difficulty) that.

Okay. Then thinking about revenues, I know you all pointed out that on the deposit fee side things are light this quarter; some of that was fee waivers and so forth. What is the right way to think about deposit fees next quarter? How much of that do you think bounces back next quarter?

I think a good portion of it. I think a lot of it was waived fees from customers as it related to post-conversion issues and just working through the issues with clients.

I mentioned dialing in our risk tolerance. I'm sure you're wondering what that means. That really gets to just good decisioning and making sure our decisioning post-conversion with our new system is exactly the same as it was prior, in things like pay/no pay decisions for checks and so forth.

So we just had a little bit more tinkering than we thought we would. But I think we get at the same run rate relatively quickly here in the first quarter.

Okay, all right. That's helpful. Last question and I'll hop back out, but wondering how you all are thinking about, without any change in rates, the direction -- or maybe more than direction, how you're thinking about the magnitude of changes in net interest margin as we go through 2015 prior to any movement at the short end of the curve.

Bob, it's Jim Reske. I'll be as frank as I can about this. Our internal models would suggest that there isn't a whole lot of compression from here; although I would say I caution that the internal models do not account for the unpredictable changes in the shape of the yield curve.

So I would say that there is some compression that could happen from this point going forward, despite what those models say.

Yes. And just as it relates to the NIM, in the third quarter we really put on a lot of higher rate commercial real estate. And then, for whatever reason, in the fourth quarter we had very good production, a lot more C&I at variable rate off the LIBOR.

So when you looked at the replacement yield or the actual rate, it really fell a bit in the fourth quarter. So I think a lot of it also is dependent on the mix of loans that we book in a given quarter.

That's exactly right. And the other caution we've given in the past is that the part of this that's very hard to predict is the runoffs and the payoffs. So if higher rate loans got payoff, we get those, those are -- they come in and that will end up lowering the NIM.

So we could see some compression from this point forward. I don't expect it to be inordinately large, but there could be some compression.

Okay. Then thinking about when you all say could be some compression, not a lot, does that mean maybe a couple basis points a quarter? Or do you think that there could be volatility around loan mix but then you really in the end -- I won't say in the year, because maybe rates move -- but that you don't really see a continued direction either way?

I'm not sure I understand exactly what you're asking, but I don't --

I'll rephrase it. Sorry. I guess I'm just asking if not a lot of compression but some from here means that you do continue to trickle lower from this level; or do you think it's more a question of you bounce around a little bit but there is not a real clear direction? It just will depend on loan origination mix and so forth?

Yes, it's really a combination of those. There is definitely going to be some bouncing around within a range based on quarter-to-quarter originations and payoffs and replacement yields.

If rates stay where they are -- even if rates stay where they are, there could be a little bit of compression just going forward.

Okay, all right. Thank you, guys.

Collyn Gilbert, KBW.

Hi; good afternoon, guys. Just a quick question on your comments about changing strategy a little bit here on the mortgage business. What -- how should we think about the net mortgage banking line for 2015?

I had in my model, which I'm assuming maybe came from guidance you all had provided, but about $1.5 million on a quarterly run rate basis for mortgage banking. I don't know if that's accurate. If not, or if it is, like, how should we think about a reduction in that line item?

Sure. Hey, Collyn, it's Jim. I can give you updated guidance on that. Yes, we've previously talked about getting $6 million of fee revenue from the mortgage business after $4 million expenses, dropping $2 million to the bottom line.

To refine those numbers for you slightly, we are now thinking -- because we're going to retain a little bit more on mortgage production -- getting about $5.7 million of fee income. And then the cost of that will be more like $3.3 million, not $4 million.

Okay.

So the net will actually tick up a little bit.

Okay, okay. Good. That's all I had for right now. Thank you.

John Moran, Macquarie.

Hey, guys. Just to follow up on the mortgage one, the decision to portfolio 25% to 30%, or retain it, what is driving that? And presumably that's going to be 5/1, 7/1, kind of stuff, right?

Yes, in general our preference would be exactly what you're describing, which would be to sell the fixed and retain the variable. But there are other things that come into play as well.

When we built the platform originally, we did not build a platform that was a traditional mortgage banking platform where you have to use -- originate only conforming loans and sell them all off. We built a platform that could do mortgages like jumbo mortgages that we might want to retain in the portfolio.

And so part of it was when we set up the model originally, we had just predicted the kind of mortgage origination business that we would get, and it's coming in a little bit different than we predicted.

Yes, part of is, John, simply -- been a little surprised by the business owners and the kinds of properties that they've brought to us. There's been some larger loans than we expected, a little chunkier. Really better credit, quite frankly, and that's been a bit of a silver lining.

Okay, got it.

So we retain those mortgages that are nonconforming.

Got it. All right. That makes sense; thanks. Then the other one that I had, just with energy and oil prices and everything -- I realize that you guys are sitting in a place that's more gas focused -- but just wondering if you're seeing anything there in terms of second-order flow or knock-on impacts or whatever.

And then if I'm remembering correctly, you guys had brought in an energy lender. I'm not sure how big that business had gotten, but any kind of update that you might have on anything that you are seeing on that front I think would be helpful for folks.

Yes, John, hey, let me just take you briefly soup to nuts on that. As of 12/31, we had about $56 million in outstandings in oil and gas, about -- that's with $149 million in commitments. We have a limit or a concentration limit in that segment of about $160 million.

And as we look at the exposure -- so that's about 3% of our overall exposure at the Bank, so not a lot. And that might surprise you. We see more in terms of the ripple effect of energy and gas as opposed to -- obviously this is not a lot of loans.

We put anything into the oil and gas exposure if it has 40% or more of its sales revenue from exploration and production companies. So that's -- and then if you look at down into the portfolio, we probably have about $47 million of that $149 million in exposure is in exploration. It's a smaller portion.

But just to give you a feel for that, the bigger credits there, public companies and large independent oil companies, they don't borrow. They haven't borrowed for five, six, seven years. They tend to be net depositors.

And then you really get into the supply chain, and that's really where you see a lot more activity with tank companies and valve manufacturers and people like that. I'll tell you right now, all of our credits are pass-rated, with the exception of the one service company that's I think been on our nonperformers since 2012. So pretty good performance so far in that portfolio.

As it relates to just more the industry and taking a step back, natural gas prices tend to move independent of crude oil prices. They are more weather related in terms of the factors that drive them.

But just to give you a sense, I think -- and I looked at it this morning. In 2012 gas was about $2.75 an Mcf; in 2013 it was $3.72; and then last year, $4.39 average price for the year; and now we're sitting at $3.00.

You might say: well, gosh, can companies still make money at that level? And the answer is yes, because it just got a lot more efficient on the well site, and they can be profitable really at that level or even a little bit lower.

And they tend to have hedging programs in place that get them out about six to eight months in the pricing. So that will give you maybe a sense.

We looked at the rig counts here in the last week, and just comparing them with the same period last year, there was probably 56 rigs here first part of 2014, and it's about 52 in this region right now. So maybe that is helpful to you.

Definitely helpful. So maybe a little bit of a slowdown, but nothing that you are seeing really material now.

And then obviously, the poking hole part of this is more labor-intensive and has more involved than the ongoing production. Just -- I guess from your comments, what you are saying is basically you are not really seeing a material slowdown in any activity at this point that would be cause for concern.

Not yet, but we monitor these credits closely. And the portfolio is small enough that I can really look at all the names here on one page in front of me. So it's a lot harder to monitor maybe other segments of the portfolio, quite frankly.

Sure, sure. Hey, I appreciate the detail.

(Operator Instructions) Matthew Breese, Sterne Agee.

I was hoping for a little bit of color on what you think loan growth in 2015 could look like, especially in light of your change in strategy on the mortgage front.

Yes, I'd just -- I think I've talked about mid single digits. If you just look at our deck, I think the last year was about 4%, 4.3% or so.

And one of the things you'll notice in the mortgage category -- and I don't have it right in front of me unfortunately -- there's about $1.2 billion there. About half of that is first mortgage. That ran off at about $34 million, $35 million.

So if you just -- the fact that that has now stabilized will just add at least 1% to our run rate. And then if we begin to grow that at all, it will add 1.5% to 2%. So in this past year, we were growing at about 4%, so maybe that's a little bit of guidance into the mid single digits or a little higher.

So that's been a little bit of a headwind. The headwind was probably $60 million to $70 million several years ago, and it's probably dissipated to about $35 million to $40 million the last few years.

Okay. Then with that, if loan growth is set maybe to pick up a little bit, in light of some modest margin compression, do you think net interest income can grow in 2015 versus 2014?

We do.

Okay. Any idea to -- would you frame that a little bit, or is that enough?

Yes -- no, I mean the loan growth -- even the loans that we are putting on now, even adjustable rate loans that are at lower rates, are higher-yielding loans than our securities portfolio and other alternative assets. So the loan growth definitely helps increase our nominal interest earnings.

Okay. Then hopping on back to the expenses, what would you say is a good run rate per quarter in 2015, now that the systems conversion is completed?

We believe that looking forward into 2015 we will be able to keep our noninterest expense below $40 million a quarter.

Okay. Then my last question is really around nonperforming assets. We had a tick out this quarter; looked like there was a single project or a single loan that went nonperforming.

Could you give some color around that? What was the type of project, and what happened?

Yes, it was a construction company that really specialized in wastewater and water treatment facilities for municipal entities. They were doing a local project and -- just the kind of thing that haunts construction companies: change orders and disputes.

The bonding company came in, and the bonding company hired our contractor to finish the project. We're really going to find out where we're at over the next four to five months as the project comes to completion. And we'll probably -- that company will probably go through a liquidation now.

And it's a company that we put a specific reserve of $2 million against our exposure here. And I think -- and that event will really begin to play itself -- we felt very comfortable with that, and that will play itself out probably in the second quarter on the equipment side and probably in the third or fourth quarter on the real estate side of the collateral we have there.

Okay. Was this entirely your loan or was it any sort of participation?

No, this was a C&I loan and it was somebody that we had done business with for quite some time.

Okay. That's all I had. Thank you, guys.

Thank you. I'm showing no further questions at this time. I will now turn the call back over to Mike Price for closing remarks.

Hey, well, just thank you for your continuing interest in First Commonwealth and your questions. And as questions arise maybe as you move through your modeling, don't hesitate to call Jim and I. We look forward to seeing a number of you over the course of the next quarter or so. Thank you very much.

Thank you, ladies and gentlemen. That does conclude today's conference. You may all disconnect and everyone have a great day.