First Commonwealth Financial Corp (FCF) 2017 Q3 法說會逐字稿

Good day, and welcome to the First Commonwealth Third Quarter Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Ryan Thomas, Vice President of Finance and Investor Relations. Please go ahead, sir.

Thank you, Rachel. 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 have also included a slide presentation on our Investor Relations page, with supplemental financial information that may 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 will open the call up to your questions. For that portion of the call, we will be joined by Brian Karrip, our Chief Credit Officer, and Mark Lopushansky, our Chief Treasury officer.

Before we begin, I would like to caution listeners that this conference call will contain forward-looking statements about First Commonwealth, its businesses, strategies and prospects. Before we turn 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 would like to turn the call over to Mike Price.

Okay. Thanks, Ryan, and good afternoon, everyone. Our third quarter 2017 net income of $21.3 million was the highest quarterly total in the history of First Commonwealth, producing a return on assets of 1.14% and earnings per share of $0.22. The efficiency ratio improved to 57.9% for the third quarter. The successful integration of the FirstMerit branches in Northern Ohio in December of 2016 and of Delaware County Bank in May of 2017 has boosted revenue to record levels, thus enabling operating leverage. The team has been able to retain core deposits, loans and critical talent through both acquisitions as well.

Let me walk through a few financial highlights before turning it over to Jim. First, we had a modest increase in average loans of $40.7 million, coupled with a (inaudible) margin to 3.61%, and this propelled net interest income to $60.7 million, which was up nicely on a linked-quarter basis and year-over-year, given a bigger balance sheet with the 2 integrations. Our commercially oriented balance sheet has benefited from 3 rate hikes since December of 2016. We continue to have traction in commercial lending and mortgage while facing some headwinds in other consumer lending categories. We've been able to keep our deposit costs low, given the commercial complexion of our deposit mix and our relatively low reliance on CDs.

Second, provision expense for the third quarter of $1.2 million stayed low and is reflective of only 12 basis points of annualized charge-offs year-to-date. Reflecting on several key credit indicators for the quarter, total delinquency at 18 basis points, nonperforming loans of $38.8 million or 72 basis points and total criticized assets of $125 million were all at the lowest levels in the past decade.

Third, noninterest income swelled to $19.7 million. The drivers include a bigger base of households stemming from the FirstMerit branch acquisition and the DCB acquisition as well as improved performance in key noninterest income categories like wealth, deposit service charges, gain on sale of mortgage and interchange income, which you can readily see in the year-over-year comparisons.

Fourth, we told you last quarter that we expected the core efficiency ratio to come back below 60% before year-end. And as expected, the ratio was 57.96% in the third quarter. Although our core efficiency ratio fell, we believe we still have some work to do on this important dimension of performance.

We did glean the cost saves from the acquisition, and the tale of this opportunity is still not fully realized. However, we have also invested in our lending teams, particularly in our Ohio markets. We're also building out a regional SBA lending platform. All of this adds cost, but we should have a near-term and long -- longer-term payback. Nevertheless, we do recognize that we need to do appreciably better than our current efficiency figure over the long term.

The team has accomplished a lot in the last 4 to 5 years, but we must continue striving to grow revenue and improve efficiency in order to be -- become a top-performing bank. Some of our priorities as we look to the next year include really enabling breakout performance in Ohio across all of our lines of business. We've acquired and recruited a high-caliber group of people in Ohio, and we believe this team is poised to deliver strong revenue growth in the coming years. Also, we need to continue investing in our technology platform to decisively move towards the digital future. We need to leverage our strong enterprise risk and credit culture to drive growth and also have credit costs that outperform peers through the next credit cycle. We're also refining and automating our key processes to create efficiency and support the growth of our business. And we'll also need to leverage the SBA platform to drive loan and fee income growth in desirable markets.

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

Thanks, Mike. Mike has already hit the financial highlights, so I will briefly provide some additional color on the numbers, and then we'll move right into the Q&A.

The company's record earnings performance in the third quarter was not only strong in the fundamentals but also relatively clean. And by clean, I mean that there were no significant nonrecurring items to adjust for in third quarter results. We continue to report core profitability figures for consistency with past periods, but the core figures were essentially the same as the GAAP figures in the third quarter.

Mike mentioned core EPS and ROA, but I would also point out that core return on average tangible common equity of 14.01% is up nicely from 11.82% for the same quarter a year ago.

Earnings certainly benefited from the relatively low provision expense, which, at $1.2 million, was well below our trailing 12-quarter average of $3.8 million per quarter, which is a figure that is adjusted for the large recoveries that we reported in the second quarter of this year and the fourth quarter of last year. Similarly, our net charge-off rate in the third quarter of 8 basis points of total loans was well below the trailing 12-quarter average of 34 basis points, again, adjusted for the large recoveries.

We continue to reiterate our guidance that, given some of the volatility in our provision expense in the recent past, the best way to understand the credit performance of our company is to look at the long-term historical trends rather than the provision expense of any given quarter. Now to be completely fair, a 12-quarter look back period includes some negative credit experience from the last energy cycle. So the truth is probably going to be somewhere in between that historical average and our current experience. In any event, our long-term goal is for our credit costs to converge with and eventually exceed that of our peers, and we are pleased to see progress towards that goal in the third quarter.

The strong net interest margin drove improved spread income, which was up by $1.8 million over last quarter despite loan balances that were essentially flat for the quarter, as 3 large commercial loan payoffs totaling approximately $38 million masked growth in commercial loans. I would add that one fortunate consequence of this is that because annualized deposit growth of 3.74% outpaced loan growth in the quarter, the loan-to-deposit ratio came down ever so slightly from 97.1% last quarter to 96.8%. That's a very small change, but it does reduce funding pressure at the margin. And of course, it's a vast improvement from the 109% loan-to-deposit ratio of a year ago.

Finally, our effective tax rate was 30.29% in the third quarter.

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

Operator, questions?

(Operator Instructions) The first question comes from Steve Moss with FBR.

This is actually Kyle Peterson on for Steve today. Just wondered if we could start a little bit (inaudible) on the margin. It looks like you had some nice expansion on the loan yields this quarter. Was that all from recent rate hikes? Or were there any recoveries in there? Just how should we think about that moving forward?

This is Jim. I'll take that. There's a combination of several factors. One is the loans that came over from DCB, even though they were marked where it's slightly higher yields than our own, so there was a slight lift from that. But the replacement yields have come in very nicely. We have seen positive replacement yields in the loan portfolios. This quarter, it was not consistently positive across every portfolio but, in the aggregate, it was quite positive. And so there's been a real lift from the replacement yields. And then, of course, the other thing, as you alluded to, is the increase in the variable rate portfolios from 2 Federal Reserve interest rate hikes.

Okay. Yes, so I guess, just do you guys have an estimate of kind of what new money yields are on loan production now?

Yes. Some of the new production coming on this quarter had an unadjusted yield of around 4% coming on.

Okay. And just a quick reminder about how -- what percentage of your portfolio kind of reprices off of some of the short-term rate increases?

Right about 42%. There's an additional piece of the portfolio that will reprice over time, but not immediately. But in the first month after rate hike, about 42% of the portfolio would reprice.

About 42% reprices immediately, but 62% is variable.

Correct. The other 20% will reprice over the ensuing year or 2.

Okay. And I guess, just last one for me, and then I'll step out. It looks like it was a good quarter for trust fees. Seasonality looks like it might have played a role in there as well as the acquisition. But just I wanted to see if we can get any more color on trends you guys are seeing in that or how we should view that moving forward?

We have hit on a couple of the key things. Obviously, the market is up. But we also acquired really a nice team with Delaware County Bank, and that's really added to our business. We also see, in our core business here in Western Pennsylvania, really nice new business pipeline in the trust and wealth businesses.

Okay, great. And is there a -- I guess, is there any kind of metrics, whether it's AUM or kind of size of the team, that -- how big is that, that came over from DCB?

I don't recall specifically.

I don't know if we just have the number off the top of our head or disclosed that in the past, but that's certainly additive to the business.

The next question comes from Daniel Cardenas with Raymond James.

A couple questions. In terms of your fixed rate loans, what percentage of those are broken through the floor? And for those that have -- through any floors that they may have and those that haven't, how much more in rate hikes do you need to see before you get through 100% of your portfolio with no floors [write-down]?

Yes, it's a great question, Dan. So we've done some work trying to understand the impact of floors on the portfolio. And essentially, it varies loan to loan. But in the aggregate, the floors have almost no effect right now. So it's not like we are waiting for -- that there'll be some portion of an interest rate hike that will not affect our variable-rate portfolio. We're at the point now, in aggregate in the portfolio, where it's a direct translation from rate hikes into the portfolio.

Perfect, perfect. All right, and then just in terms of loan growth. I mean, maybe some color as to how your pipelines look right now. I mean, it looks like paydowns and payoffs had some impact on third quarter growth. But as you look into 4Q, which can be [seasonably] soft, what's kind of the outlook for growth in that quarter?

Yes, I mean, I'll just take you through the portfolio. So on the consumer side, we're really seeing a nice year-over-year pickup in our home equity and our installment lending through our branches. And we also have nice tailwinds with our indirect auto has begun to grow in the second half of the year. And so that's really positive. Mortgage as well. We had a record quarter in mortgage in terms of production. We portfolio-ed about 35% of that, mostly construction and variable rate loans. So those all provide tailwinds, and that was a portfolio that was kind of leaking oil and moving away from us. And that's really stabilized. So that's really positive. On the commercial side, we still have some momentum in commercial real estate, although it's getting a little tighter. You're right, the payoffs in the third quarter impacted results. It was a little soft in the third quarter. But our pipelines look good, and the guidance we've given around loan growth is really mid-single digits and really trying to keep the credit quality top-notch.

Okay. All right. Good, good. And then, Mike, alluding to your comment about, I guess, there's constant need to reinvest in the franchise, as we look at operating expenses, and it sounds like there's a number of fronts that you want to potentially attack, but are you kind of including that in your thoughts for 2018? I mean, how should we be thinking about -- I guess, about operating expenses as we look forward?

As we think about efficiency ratio, we really have to leverage the expense base that we have. But we also really need to be moving towards 55% efficiency ratio and past that, quite frankly. As a commercially oriented bank, we've made great strides the last 4 or 5 years from the high 60s, quite honestly. But we still have a lot of work to do. We do a lot of peer comparisons through some consultants, and we're really trying to close the gaps kind of by each business unit and line of business with enhancements to productivity and so forth. And those will play out, really, over 6 months, a year or more. But we're focused on that, and we think that efficiency is really vital to the reinvestment it will take with digital banking in the years in front of us.

(Operator Instructions) At this time, there are no further questions. So I would like to turn the conference back over to Mike Price for any closing remarks.

We just sincerely appreciate your interest in our company, the opportunity to meet with each of you from quarter-to-quarter. Jim and I are always available when you have questions. And thank you very much.

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