First Commonwealth Financial Corp (FCF) 2015 Q4 法說會逐字稿

Good day, and welcome to the First Commonwealth Financial Corporation's fourth-quarter 2015 earnings release conference call and webcast.

(Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Mr. Ryan Thomas, Vice President of Finance and Investor Relations. Please go ahead.

Thank you, Diosa. 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've also included a slide presentation on our Investor Relations web 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 for 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 will contain forward-looking statements about First Commonwealth, its business, strategies, and prospects. Please refer to our forward-looking statement 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.

Thank you, Ryan. Welcome to our fourth-quarter earnings call. We sincerely appreciate your interest and investment of time in First Commonwealth. Joining me on the call this afternoon is Jim Reske, our CFO.

This morning, we reported earnings per share of $0.11 for the fourth quarter. Although this is a decrease of $0.03 earnings per share over the prior quarter on a GAAP basis, the core earnings capacity of the Company was in line with the previous quarter and we believe it will be stronger in 2016 than it was in 2015.

I would like to address some important items impacting the fourth quarter up front, relating to one-time charges and credit. First, regarding the one-time charges, we had $2.1 million of severance costs to evolve the structure and approach of our consumer, or retail, bank. The payback on the severance should be under a year.

There was $900,000 in one-time charges associated with the closing and conversion of First Community Bank in Columbus, Ohio, our first bank acquisition in a number of years. The banking presence, small as it is, has enabled our recruiting of talented residential and commercial lending talent to help build out those platforms in an attractive market.

We incurred $600,000 in charges associated with the disposal of two branch locations, both of which were former corporate headquarters buildings. This, too, should pay for itself in about one year. Excluding these one-time charges, core operating earnings for the fourth quarter were $0.15 per share, which was in line with the previous quarter.

Operating expenses continued to be well controlled and came in below our $40 million per quarter targeted run rate. We were particularly pleased with this result, given the investments we've made over the past two years to include mortgage, the corporate banking build-out in northern and now central Ohio, the acquisition of an insurance agency, and additional investment in digital technology for our clients.

The second impactful item to the fourth quarter is credit. Provision expense of $6.1 million represented an increase of $1.5 million from the previous quarter and, obviously, was a disappointment. We recognized $5.3 million in specific reserves on two commercial credits that moved into non-performing status during the quarter. The larger of these two was tied to the oil and gas industry. We've shared similar information before, but our loan outstandings to the oil and gas industry at year end totaled $65 million to some 30 borrowers.

All but three of these borrowers are currently pass-rated credits. The three non-pass-rated borrowers had outstanding loan balances totaling $16.8 million at year end. Although oil and gas exposure has certainly impacted the last two quarters, we have a detailed understanding of the names and circumstances, borrower by borrower. Jim will elaborate further on the numbers in a moment, but we expect the steps we have taken in 2014 and 2015 to set us up for improved earnings in 2016.

Let me explain our perspective. Operating expenses should remain flat to down, as you've seen over the last year. Net interest income is expected to grow, due to a relatively stable margin in growth in commercial lending. In fact, loans in our corporate banking group grew organically at an 8.2% annualized rate for the quarter. Our northern Ohio loan production office contributed to that growth, and we expect Columbus to follow a similar pattern. Our brand in commercial lending is strong as we are privileged to do business with some of the better businesses and developers in our markets.

Non-interest income is up year over year. And the fourth-quarter slowdown was largely caused by a change in the broker-dealer platform in our wealth management area in October and a seasonal slowdown in mortgage.

With credit, we acknowledge the specter of a multi-year price trough in oil and gas or other commodities. However, our exposure is limited as we have been disciplined in our loan portfolio concentration limits, which in turn limits the overall downside to the Bank.

Before handing it off to Jim, just one more topic. Like many banks, we are continually rethinking the evolution of our retail bank and branches in particular. We're taking some big steps this quarter. The fact is, our monthly branch transaction volume has dropped appreciably over the last four years. The good news is, the number of retail customers who do business with our bank continues to grow, as does non-branch transaction volume in areas like card, ACH, mobile, online, P2P, and wires over the same period. Our customers are simply banking differently.

Consequently, we're continuing to reshape our branch cost structure to closely match our branch transaction volume; hence, the severance charge in the fourth quarter. But we are also investing to better serve our clients. A couple things we've done. We've reorganized and thinned the retail bank structure. We're embracing the notion of solutions-oriented bankers within our branches who can help our customers manage their money, borrow wisely, and prepare for the future. In short, we need to help our customers improve their financial lives.

We are also realigning how the small business segment is organized, again to be more solutions oriented. We're also investing heavily in better technology to serve our customers. And just a couple examples: EMV chip-enabled cards; Apple Pay; online deposit account opening, followed by online consumer lending in 2016; an enhanced mobile remote deposit capture app; new functionality to our mobile app; and an account-aggregation tool.

With that, I'll turn it over to Jim Reske.

Thanks, Mike. As Mike described, the fourth quarter's results were impacted by the specific reserve of $5.4 million and its three unusual expense items. Mike already touched on these items, but I'll take a moment to provide a little more color on each of them.

The first expense item was for the recognition of a $2.1 million one-time charge related to the realignment of our consumer businesses. We expect to redeploy the cost savings from this initiative into other revenue-producing lines of business and expect that this will help us to keep overall expenses flat. Second, the $900,000 in one-time merger-related expenses actually came in a little under our original $1.3 million projection, due to lower contract termination charges and lower severance payouts than had been expected.

Third, we experienced one-time costs of approximately $600,000 related to the disposition of two bank facilities as we continue to work down our total square footage number. These two transactions represent the last anticipated dispositions of former branch headquarter buildings within our system for the foreseeable future, and they should help lower operating costs by approximately $600,000 per year. Again, we expect this will help us to keep overall operating expenses flat.

Excluding these unusual items, on an operating basis, our total expenses were $38.5 million in the fourth quarter, which is consistent with our $40 million quarterly expense target as we continue to find ways to pay for our new investments and hit our goal of keeping expenses flat to down.

Turning to the revenue side of the equation, net interest income on a fully taxable equivalent basis increased $1.6 million on a linked-quarter basis. This was the result of an increase in average earning assets of $181 million over last quarter, which was driven by $73 million in organic loan growth, $60 million from the acquired First Community loan portfolio, and $47 million of growth in investment securities.

We sold approximately $75 million of low-yielding agency securities in the fourth quarter and exchanged them for higher-yielding mortgage-backed securities, increasing the securities portfolio yield. The transaction resulted in a loss on the sale of $285,000 in the fourth quarter, but will add approximately $1.4 million in pretax income in 2016. Higher-investment yields, together with lower-deposit costs and positive commercial loan replacement yields, helped the NIM improve by 1 basis point to 3.26%.

In terms of fee income, on a linked-quarter basis, total non-interest income excluding securities gains and losses was essentially flat. However, non-interest income benefited from a $1 million improvement in the mark-to-market adjustment on our swap positions, which was negative last quarter and positive this quarter. So, on an adjusted basis, our total fee income dropped as a result of pressure on several fronts.

First, our gain on sale of loans decreased $600,000, but this change was driven by a $400,000 gain on the sale of a commercial loan in the prior quarter combined with the seasonal slowdown in mortgage lending. Secondly, our trust unit is coming up pretty strong third-quarter results, due to tax preparation fees. And, finally, our brokerage unit suffered a temporary slowdown in sales due to a conversion to a new broker-dealer platform, as Mike had mentioned. Given the building momentum in brokerage income this year, we expect the setback to be temporary.

Taking a step back for a moment, let me share with you our outlook for 2016 so that you can better understand where our Company is going. We see mid-single-digit loan growth in 2016, driven primarily by commercial loans. The securities portfolio isn't expected to grow or shrink.

We expect the earning asset mix to improve in 2016 as loans grow and the securities portfolio remains relatively constant at approximately $1.3 billion. The profits are expected to grow in 2016, as well, though not as much as loan growth. Yes, this will put some pressure on the margin but within a manageable range. We still expect net interest margin to be relatively stable in the 3.20% range in 2016.

The loan-to-deposit ratio ended 2015 at 112% and is expected to stay under 115% for the year. The optics of our loan-to-deposit ratio have been affected by our decision to run off $198 million in higher-cost brokered time deposits over the last year in favor of lower-cost borrowings.

Net interest income should improve slightly due to higher-earning asset balances and a stable net interest margin. There was some benefit from the December rate hike, but it was nominal, less than 1 basis point of margin.

Our net interest income expectations are based on the assumption of two rate increases in 2016. We would acknowledge that the rate outlook is increasingly uncertain but, as we have said previously, our models indicate that the Bank's interest rate risk profile is neutral in the first year with greater asset sensitivity in the outer years. As a result, we estimate that the entire difference between a flat scenario, versus a scenario where rates rise 4 times in 2016, is less than $2 million in net interest income for 2016.

Fee income is expected to grow as our mortgage initiative bears fruit in 2016. Starting from scratch a few years ago, we ended 2015 with a complete mortgage product menu, which sets us up to convert more loan opportunities in 2016. Our full secondary-market capabilities, complemented by a commitment to quality portfolio lending, has resulted in an ability to hire top-performing mortgage professionals.

Non-interest expense should be relatively flat as we pay for continued investments in revenue-producing mortgage and commercial loan production, with savings from other areas such as the consumer business realignment mentioned earlier. Our target remains under $40 million per quarter, and we expect to realize the benefits of positive operating leverage by ending the year with an efficiency ratio under 60%.

Provision expense should cover net charge-offs, plus cover anticipated loan growth, all while keeping our allowance as a percentage of total loans relatively stable in 2016. We expect provision expense in 2016 to be in line with 2015 or slightly higher.

This outlook reflects moderate strain in the commercial and consumer portfolios from weak energy and metals prices, but assumes that the broader US economy will continue to grow at its current pace. We do anticipate some quarterly volatility in our provision expense, as we have experienced in the past.

In other news, our effective tax rate was 29.4% at the end of the fourth quarter and we expect it to be in the range of 29.6% to 29.9% in 2016.

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

(Operator Instructions)

Our first question comes from Bob Ramsey with FBR. Please go ahead.

Hey, good afternoon, guys. I appreciate all of the guidance for 2016. The expense number looked really good this quarter.

I know you said you expect expenses next year will be relatively flat, and talked about some of the new pieces, but should we think about it flat in total to operating expenses this year of $155 million? Or are we thinking flattish in terms of a $38 million, $39 million quarterly run rate? What is the right way to think about that?

The latter.

Sub $40 million.

Okay. Got it. Thank you. And then on the margin guidance, I know you guys said you think the margin will be more or less flat. And I think you said 3.20% for the year. Or did you say mid 3.20s%? I just missed whatever detail you said.

I said in the 3.20% range, which is 3.20% to 3.30%. Mid-3.20s%.

Got it. Thank you. Can you give a little bit more detail maybe on the energy credits this quarter that you had the specific reserve?

There were two credits that tipped and the larger one was an energy-related credit. That particular credit, I think in the press release, was $7.5 million, and we have a specific reserve of probably 55% of that credit. It is really, in the call codes they're a servicer.

Okay. Can you share what type of business the servicers are in or any more detail? I don't know how much you can or can't say.

Just their fortunes are tied to rig counts and as rig counts have fallen off. They're not in the maintenance of wells, they're in the drilling of wells. So, that's impacted them.

Got it. Perfect. I think those are the real questions. I'll ask, as well, on the capital front about share repurchase appetite. I know you don't currently have an existing authorization but your stock has certainly come in quite a bit over the last couple months. Just curious about appetite for share repurchase this year.

We're looking at that and discussing it. We do have and really do recognize the value of returning capital to shareholders in the form of buybacks over time. But nothing to announce at this time.

Okay, thank you, guys.

The next question comes from John Moran with Macquarie Capital. Please go ahead.

Thanks for taking the questions. The three that are non pass to the energy book, I understand that it's a small concentration for you guys and managed well, but are those also services credits or is there some reserve based in there, too?

One is exploration and production, another one is tanks and water, and the other one is oilfield services.

Okay. And then the provision guide for 2016 at the same levels as 2015, maybe slightly higher. That would incorporate some additional -- I don't want to say hooking credits but some additional migration into adverse grades in that book -- granted, again, small concentrations.

We do have internally, we do expect a little bit more strain this year than the past year in our projections but that doesn't dissuade, we feel, the ability to still grow the earnings per share of the Company.

Okay. That's helpful. And then just switching gears over to mortgage, and sorry if I missed this, but is that expansion now at this point hitting profitability? Certainly it would seem like it's expected to this year. But just curious if it was in the last quarter and, if not, when it would hit profitability.

We've been, I think, past the breakeven point for several quarters now and just really ramping up to a rate we think is commensurate with our market share as a community bank, which is probably on a trajectory to be 50% to 100% more over the next year than it has been in the past.

50% to 100% more and then just we'd see regular seasonality in that business now that it's in the process of ramping.

Our buildout has occurred primarily in Ohio where the mortgages are a little larger in the communities that we're working in. We've been able to attract some talented mortgage loan originators and that is a nice opportunity for us. It's really about the talent you can attract. We've been able to get some good people in Columbus and Northern Ohio.

Okay. That's helpful. And then maybe just a quick update on First Community opportunities that you're seeing there. How are things going?

The team did a terrific job. We had a flawless execution, really. Hit our milestones in terms of the conversion, not a lot of customer disruption. Typically you see 5%, 10% deposits run off. Amazingly, we didn't see that. They were actually up a little bit since the legal close in October.

But what it becomes, albeit small, it's just a chassis for good branches with some good people in them, a market presence, and that really, surprisingly, has allowed us to attract probably better talent than we would otherwise. But we put some costs on top of that with a couple commercial lenders from some larger institutions and also three or four mortgage loan originators in some pretty thriving Columbus markets.

So we've added some costs. Jim, do you know the numbers on how that's running? I think we gave some guidance in the past. How are we doing versus that?

It's coming in line with our expectations from before. Really, overall impact to the Bank's financial performance is going to be immaterial. It's not going to move the needle appreciably in aggregate. It's really more about the buildout of the platform, as you described, Mike.

But it's revenue positive and actually slightly positive to the net interest margin at this point. Not even 1 basis point, but in the right direction.

Great. But a good beachhead then. Thanks very much, guys.

The next question comes from William Wallace with Raymond James. Please go ahead.

Hi. Good afternoon. I apologize if I missed it but did you give guidance on fee income for the year?

We just said fee income is expected to improve because of the mortgage buildout.

So, everything else should be relatively flattish?

Expenses flat. We expect net interest income to continue to grow.

I mean on the fee income, the various fee income line items. The only driver of growth is going to be mortgage. Everything else --.

No. Thank you for asking the question to clarify. Mortgage is a primary driver of growth in fee income. We do expect other fee income items to grow, as well. I think I mentioned in the comments that the brokerage unit has really had a great trajectory throughout the year and we expect that to grow. So, mortgage is not the only driver of fee income growth but going to be the primary driver in 2016.

And we've seen some nice traction in debit card and interchange income, as well.

And insurance. Because of the insurance agency acquisition we did last year, insurance is up year on year and that's trending nicely, as well.

Okay. And then you call out about $3.6 million in expenses in the quarter that could be considered one-time. I'm just wondering, are those spread out? I'm just struggling to find one line item that I can back them out of. For example, the $2.1 million in severance, was that in the salary line, so was your salary down?

Yes, that was in the salary line.

When did the severance or when did the changes occur?

The severance was accrued for in the fourth quarter, the $2.1 million, and the changes are taking place in the first quarter.

So the realignment was done at the end of the year, the beginning of the quarter?

The realignment was paid for at the end of the year by accruing the severance amount. The actual realignment will be taking place starting in the first quarter and continuing in 2016.

Starting this month.

Okay. And then I'm curious if you have noticed in your markets any kind of ancillary impacts to low gases. Are you seeing lower vacancy at any of your hotels, weakness at any restaurants, things like that? Just maybe give us a sense of the markets you guys are operating in based on your anecdotal evidence.

This is anecdotal and it mostly comes through -- our people are extremely involved in community chambers of commerce, nonprofits, United Way, hospital boards, those types of things, and just a lot of family, friends, dozens of people that we probably know in the oil and gas industry. A lot of those have been impacted, and really in the last quarter and a half. So, that's very anecdotal but I think it's real. So, we're looking for the impact of that in local business.

A lot of these towns, though, the economies are relatively diversified. There's a lot of colleges and universities, hospitals, healthcare. That infrastructure preceded, really, Marcellus, so perhaps it will be muted. These aren't oil and gas towns. This is a relatively new phenomenon that has been additive. I don't know if that's helpful or not, Wally.

I appreciate that. Of the 30 credits that are direct to energy, 3 are not pass grade. Are you seeing migration of the other 27 to lower pass ratings? Should we be cognizant of a potential for that migration to continue in that portfolio?

I think it could happen, depending on the length of the cycle. We have 30 names at $65 million. Most of the names are small business. There's only 12 borrowers over $1 million. So we're watching those closely. We have four or five that we have our eye on and just watching them closely.

Some of them, probably the largest exposures, Wally, the largest two don't borrow and really never have. They really fund their operations with equity partnerships. It's an interesting lot. But we're going to follow that closely.

Thanks, Mike. I appreciate the commentary. I'll hop out.

The next question comes from Matt Schultheis from Boenning.

Good afternoon. Really quickly, with regard to the retail delivery restructuring that you've announced, for the actual restructuring that you've announced this quarter and that's getting executed in January, are we looking at actual branch closures or are we looking at simply staff who are not going to make the successful migration to a universal banker model being migrated into a career change?

It's more the latter. We've done some pruning with branches. It's more of a focus on delivering broader product and services and less of the historical bifurcation of the platform and the tellers. So, blurring that distinction, having a more robust professional.

And then we just need probably fewer professionals in each of the offices. And we're working around a lot of operating procedures on how we can run branches just with a little leaner staff and more flexible staffing. So, a lot of moving parts. It's tough stuff. These are really good people that have worked for us for a long period of time but really a lot of change there.

Right. And then you mentioned branch foot traffic. So, with regard to looking out towards the second half of 2016, is it possible that we will hear about branch, actual physical locations, closing, the branch consolidation?

You could, but our focus is really on the inside of the branch and the customer experience, more so. We think that's where we really need to get it right.

And then certainly as transaction counts change -- and we track them pretty closely, everything from card to over-the-counter to ACH to checks to bill pay -- we have to adopt our cost structure to match how our customers want to do business with us. It's really pretty simple.

And we've taken, as Jim outlined, in terms of the larger offices, headquarter offices, where we have more cost and more exposures, we've addressed those over the course of the last three or four years, and there's been probably three or four or five of those that have leaped in and erupted from time to time. But this is more the inside of the branch and our good people that deliver to the customers versus a brick and mortar. I think that will come. I hope it will come. It will probably come also with investment in different types of offices that our customers find more appealing.

Okay. And then, lastly, just to make sure I heard right, I think Jim said that this was the last of the former headquarter buildings that we should hear about as far as you guys getting rid of them. Is that correct?

Yes, that's the last anticipated disposition that we have, really, for the foreseeable future. And I phrase it that will because there is still some former headquarters buildings from the history of acquisitions at the Bank over the past, but there's nothing really anticipated in a change or disposition of any of those offices at this time.

Okay, thank you very much.

The next question comes from Collyn Gilbert with KBW. Please go ahead.

Thanks. Good afternoon, guys. Just two quick questions. Just on the credits, the two non-performing credits that popped up this quarter, were they on the watch list in the third quarter?

Yes. Actually there's three that I'm looking at. But the two -- let me check. Yes on the larger one. And on the second one I'm not sure what the grade was. It was either watch -- I don't think it was classified yet.

Okay. And was there anything in particular that pushed the oil and gas credit, other than saying the obvious, but more in particular from your internal perspective that moved it to nonperformer this quarter?

No, just the lower rig counts, the precipitous drop over the course of the last 12 months, and then the protracted effect of that with the larger company.

Okay, that's helpful. And then, if you covered this, Jim, I apologize but did you say -- what was it that drove the asset yields higher on a linked quarter basis?

A couple things. We had positive commercial loan replacement yields, which is nice. I mentioned on previous quarters, that's fluctuated from quarter to quarter but this was a quarter which was positive. And then the bond exchange we executed took the overall securities portfolio up, our yields up, which helped the yield, as well. Deposit costs actually came down slightly over the quarter. All that worked together to help the NIM.

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

(Operator Instructions)

And we have a follow-up by Bob Ramsey with FBR. Please go ahead.

Thanks for taking the follow-up. You may have answered this when Wally asked it, but I know, Mike, you said that looking at credit this year you do expect a little bit more strain. And I'm just curious if, outside of energy, you're seeing anything that gives you pause or is maybe more of a flag today than it was six months ago.

Just one, it would be probably a commodities related. Every community has a scrap dealer, people that make their living with metals and things like that. We bank a few of those families, and we have for years. So, we're seeing a little strain there. That's things like aluminum, copper and just the basic scrap business you see in almost every large community.

So, that's commodities related. That's probably the big one. We're really not feeling any strain in investment real estate. That's probably about it. And then this oil and gas here the last couple quarters.

Okay. Thank you.

This concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Mike Price for any closing remarks.

Just, as always, we sincerely appreciate your interest in our Company. Jim and I are available if you have questions or follow-up questions from time to time and you want to clarify things. Thank you sincerely for your time today.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.