First Financial Bancorp (FFBC) 2003 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Irwin Financial third quarter earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. I would now like to turn the call over to Mr. Greg Ehlinger, Senior Vice President and Chief Financial Officer. Mr. Ehlinger, you may begin.

Thank you, Kristy, and welcome to everybody. I'm joined by Will Miller, our CEO and Chairman, and

, our Chief Accounting Officer. In our presentation today and in the course of answering your questions, we'll be making statements that are forward-looking. Statement of our plans, initiatives, expectations, objectives, strategies, improvements, estimates, expected results, beliefs and similar expressions identifying forward-looking information.

These statements are not guarantees of future performance or events and our actual accomplishments of the plans we're about to discuss with you today involve certain risk and uncertainties that are difficult to predict. Therefore, actual future events may differ materially from what we discuss here today. For an explanation of the factors that may affect our future results, please look in the MDNA of our 10-K, 10-Q and the factors described in our written press release. Will?

Thank you, Greg. I'd like to start by reiterating a couple of key points we made in the press release. First, we're obviously very pleased to announce another record quarter today, with net income for the third quarter at $31.1 million or $1.03 per diluted share. This compares with net income of $8.2 million or 29 cents per diluted share during the third quarter of 2002.

We benefited in this quarter from the unusual combination of strong first mortgage originations and an increase in the value of our mortgage servicing rights. While the level of mortgage banking profits seen in the third quarter may not be repeated any time soon, we substantially increased our capital base during the quarter, which will support future growth of the company.

In addition to a record quarter for mortgage banking, we achieved another quarter of record net income in commercial banking, which increased 71% over last year.

We've also seen improvements in our other credit retained portfolios. Our credit losses in our home equity business in the third quarter were modestly better than the amount projected in the residual impairment charges we took in the second quarter.

And IHE has returned to profitability, earning $.26 million during the third quarter.

I'll now turn the call over to Greg for a more detailed review of the quarter.

Thank you, Will.

Net revenues increased 82% year over year to $166 million. This reflects strong mortgage loan origination income and continued growth in our loan portfolio and related net interest income.

Our loan and lease portfolio totaled $3.1 billion at quarter end up 3% sequentially since the end of the second quarter.

Reflecting the rapid rise in interest rates in June and July and slowing of mortgage refinancing activity, our mortgage loans held for sale totaled one billion dollars at September 30. This was down from $1.7 billion on June 30, end of the second quarter.

Deposits totaled $3 billion at September 30, a $300 million decrease compared to the second quarter. Decreases in non-interest bearing deposits, particularly mortgage escrow deposits, accounted for the bulk of the decrease.

We had $414 million or $14.81 per share in common shareholders equity, a year over year increase of 23%.

And as Will noted, our risk-based capital was strong with a ratio of 14.8% at the end of the quarter compared with 13.8% at the end of June.

Consolidated, non-performing assets were $44 million or 86 basis points of total assets at quarter end up $4 million from $40 million or 73 basis points at the end of June.

We also increased our on balance sheet allowance for loan and lease losses, which totaled $64 million at September 30 and this was up $6 million from the $58 million allowance at the end of the second quarter.

Our allowance to loans and lease - our allowance for loan and lease losses increased from 190 basis points at June 30 to 204 basis points at September 30.

Net charge offs for the third quarter were $9 million, which was down $1 million since the second - from the second quarter. And it compares to a provision for the current quarter of $15 million.

Let me turn to some details by segment starting the mortgage bank. Net income totaled $25 million, a quarterly record. And income increased $17 million over the third quarter of 2002.

Our loan originations totaled $7 billion during the quarter, a year over year increase of $4 billion, reflecting increases in refinances and the opening in late 2002 of our correspondent lending channel, which accounted for approximately one-third of our production during the current quarter.

Refinances accounted for 73% of production compared with 62% a year earlier and 75% in the second quarter.

Reflecting strong production and limited sales of servicing rights, our first mortgage servicing portfolio totaled $28 billion at September 30, an increase of 87% from the prior year.

We carried the first mortgage-servicing asset at $295 million or 104 basis points of inert, underlying servicing portfolio balance. And this compares to a weighted average servicing fee on that portfolio of 33 basis points. We continue to build the servicing portfolio in anticipation of rise in interest rates and lower mortgage loan productions. Our commercial banking line of business earned a record $6 million in the third-quarter, an increase of $2 million or 71% year-over-year. It's also $100,000 increase compared to the second-quarter of this year.

Our commercial loan portfolio grew to $2 billion at quarter end, a 10% year-over-year increase and a 15% annualized increase over the second-quarter of 2003. Included in the third-quarter net income was a $1.5 million provision for loan and lease losses, a year-over-year decrease of $1.1 million reflecting an improved outlook for our commercial loan portfolio. Net charge-offs totaled $1 million during the quarter or 20 basis points of average loans on an annualized basis compared with an annualized rate of 25 basis points during the second-quarter.

We ended the quarter with delinquencies in the commercial portfolio of 72 basis points up from 33 basis points at the end of June. Net interest of margin in the quarter was 382 compared with 3.98% in the third-quarter of '02 and 3.87% in the second-quarter of '03. Our average core deposits totaled $1.7 billion during the quarter and this was up 16% on an annualized basis compared with the prior quarter. As Will alluded to, our home equity line of business earned $2.6 million during the quarter compared to income of $400,000 in the third-quarter of 2002 and a loss principally due to credit impairment in the second-quarter of this year of $14 million.

As I noted, improvement was principally the result of reductions in credit related impairment. The actual credit performance or residuals in the third-quarter was modestly better than the assumptions we had assumed in our evaluations at June 30. Loan origination volumes for the third-quarter totaled $268 million, an 8% year-over-year decrease compared with the originations of $291 million a year earlier and $299 million in the second-quarter of '03. We sold $218 million of whole loans during the quarter for a net gain on sales $8 million compared with loan sales in the second-quarter of $242 million, a net gain also of $8 million.

Our managed portfolio totaled $1.5 billion at the end of the quarter compared with $2 billion a year earlier and $1.7 billion at the end of June, but our on-balance-sheet portfolio totaled $822 million at 930. Capitalized residual assets have declined to $78 million at 930 compared to $168 million a year earlier and $93 million at June 30 of 2003. Net charge-offs for our on-balance-sheet portfolio totaled 2.45% on an annualized basis and this was down from 2.58% during the second-quarter.

Our allowance for loan and line credit losses totaled $30 million or 4.17% of outstanding loans and lines. Our 30 day and greater delinquency ratio for the on-balance-sheet portfolio increased on a sequential quarter basis to 3.29% up from 2.7% at June 30. This rise in delinquency is factored into our reserve analysis. Our commercial finance line of business broke even during the third-quarter compared to a loss of $700,000 during the same period in '02. Portfolio growth and an improvement in credit quality accounted for the bulk of the year-over-year change. Loan and lease fundings in this line of business totaled $62 million compared to $58 million a year ago and $66 million in the second-quarter. The portfolio now totals $423 million, a sequential quarter increase of $24 million.

Credit performance for our franchise portfolio and the majority of our small ticket portfolio continued to meet our expectations. We did record a specific credit provision for the

of a loan to a remarketer of small ticket diagnostic equipment during the quarter. A secured creditors meeting for this load will be concluding on the credit restructuring details later in the fourth quarter and our third quarter provision for this credit reflects our best estimate of the outcome of these negotiations.

Our allowance for loan and lease losses for this line of business totaled $11 million or 2.51% of outstanding loans and leases compared with annualized charge-off during the quarter of 1.97%. And finally, Irwin Ventures earned $65,000 during the quarter compared with a loss of $1.7 million a year earlier. The loss in the earlier period reflected portfolio evaluation adjustments. We carried the investment portfolio at $4 million at the end of the quarter. It's unchanged from June 30 and it's about 1% of consolidated equity capital.

In summary, we had record earnings of $31 million or $1.03 per share. This compares with net income 8.2 or 29 cents per share during the third quarter of '02. These results were principally achieved due to record quarters from mortgage banking and commercial banking, but we also saw a substantial improvement in our home equity portfolio and net income for that segment improved meaningfully as the company earned $2.5 million during the quarter.

Kristy, Will, Joey and I would like to open the call up now to questions, please.

Thank you. We will now begin the question-and-answer session. If you have a question, you will need to press star, one on your touch-tone phone. You will hear an acknowledgement that you have been placed in queue. If your question has been answered and you wish to be removed from the queue, please press the pound sign. Your questions will be queued in the order that they are received. If you are using a speakerphone, please pick up the handset before pressing the numbers.

Once again, for any questions, please press star, one on your touch-tone phone. Our first question comes from

from

. Please go ahead.

Hello?

They've disconnected. Our next question come from Joe Sieber from Stifel Nicolaus. Please go ahead.

Hi, guys. First of all, good quarter. Greg or Will, can you help me out a little bit? You wrote up the value of the MSRs in the quarter, which is what everybody's doing right now. But you also had a

that you also had hedge losses that, you know, were of a relatively decent magnitude.

And I'd have to think that or could you tell us a little bit about the dynamics? Because I think most people - I have to guess that your hedge losses were probably a little bit higher than what somebody might normally anticipate and probably shouldn't be that high going forward. So can you go ahead and try to comment on that? I know it was a pretty complex quarter, but thanks, guys.

Joe, thank you. Let me try to address the question. We did have gross recovery in our MSR asset of $42 million. That leaves us with $158 million in our impairment reserve at the end of the quarter. So our gross asset currently is about $450 million, about $160 million of impairment valuation allowance still left on the balance sheet and our carry-in value at the mortgage companies -- $295 million.

So our gross recovery was $42 million. Our net recovery was $14 million. We had net derivative gain losses in premiums of $28 million. And, in fact, that probably was, if you simply look point to point, end of June, end of September, a fairly high level of derivative losses or premiums relative to the 36 basis point increase in the Fannie Mae rate that we made note of in the press release.

It is, in fact, more expensive for us to hedge any of our assets and servicing rights include in a very volatile interest rate environment. And we made note in the press release that the Fannie Mae coupe rate went up 120 basis points from the beginning of the quarter to its peak in August and then retraced the majority of that such that the point to point change was only 36 basis points.

We set up our hedge structure for servicing assets in a way that I think protects us over with a reasonable amount of hedge expense and premium expense over a fairly wide range of expected rate movement. If you look at historic movements in the interest rate curves that we look at.

The move that went from July 1 to the middle of August was again somewhat off the map. And when we started getting up in the late July and August at levels that were 110, 120 basis points over what the gain in quarter amount was, it meant that we needed to add more derivatives to our position, pay more premium, and restructure our derivative position.

We would expect under more normal interest rate movement periods, for example we've seen rates drift up about 30 basis points thus far this quarter. They've been up as much as in the low 40s. They're back down to about 30.

In those types of environments, it is less difficult to hedge and less expensive to hedge. And so you did see a relatively high level of hedge expense, but it was directly related to the fact that we had a relatively volatile interest rate environment during that period.

Thanks, Greg.

OK.

Our next question comes from

from JEM Partners. Please go ahead.

Hi. Good afternoon.

Hello.

Can you, do you have the loans that we actually sold in the quarter versus the $7 billion or origination?

In the first mortgage business?

Yes.

We basically sell all of our production to, from a credit point of view to Fannie Mae or Ginne Mae or Freddie Mac.

How about with servicing retained? I'm trying to get to the gain on sale.

We're on a call.

The amount of shipments during the quarter slightly exceeded the number of closings in the quarter. So closings in the quarter were just over $7 billion. Shipments were in the 7.3 range.

OK. And do you have the any held for sale balance on the mortgage?

Again, first mortgages?

Yes, first mortgages.

Loans held for sale were $900 million.

OK. So you said - that would explain some of the difference that you're at a billion five. You got $600 million coming off the held for sale and your shipments were $300 million more than your origination. It's close enough. I'm not going to haggle over that.

And our consolidated loans held for sale, remember also include home equity loans.

Oh, right.

And our home equity segment that we've tagged for sale in the near term.

Got it. Got it. That probably explains the difference.

Yes.

Now from a methodology standpoint, and I'm looking at gain on sale, should I be - should I be dividing the gain on sale by loans originated or loans sold with servicing retained?

In the - you want to look at the margin against shipments.

OK. So the 7.3 billion is a ...

Yes.

OK. Because it looks like your gain on sale came down pretty significantly as it has for some mortgage banks during the quarter.

It did come down significantly, especially on a sequential quarter basis.

That's what I'm talking about.

The conditions in the second-quarter I would say were unprecedented. There was far too much demand in the second-quarter relative to supply and we and probably a lot of other mortgage bankers began to price in May in a way that tried to control the amount of supply that was coming over our doorstep in order to manage resources and to be able to appropriately put the operational expertise and credit underwriting expertise on to the loans that came over the

and so the result of that is that in our pricing structure during the second-quarter, we priced in a way so it's to try to control volume to make sure that we had the right through-put in the underwriting and closing and shipping departments.

As volume has subsided of course, then I think everybody in the industry is gotten a little more price competitive because they weren't at the over capacity run-rate.

Right, but two of the three months during the quarter, volumes were spilling over from the second-quarter and very strong. I would argue -- I mean, I would agree with you that that might occur in the fourth-quarter but it sounds like the margin falloff was due to some one time things that were happening in the third-quarter of what ...

We also had some product mix ships that may have affected the second-quarter where some of the products that we originated in higher volume in the second-quarter had higher margins on them.

Right. Well, your correspondence

has a lot lower margin.

That's part of it. We were also earlier in the year running a special product for

that they withdrew from the market.

OK. How much price competition are you seeing in the market today relative to what you've seen in past cycles when, you know,

at the

of the downturn?

It's not yet as severe as it was in the last downturn.

But there is price competition.

Certainly.

OK. So would the margin then, do you think, go up from the second -- the third-quarter given kind of what happened in the third-quarter? I know it's hard to compare apples to apples but I hear some positive things going on in the fourth-quarter that happened in the third-quarter but I won't say some negative things in terms of price competition.

No, I would expect that margins in the fourth-quarter will be lower than margins in the third-quarter because a lot of the pricing of the product that was shipped in the third-quarter was priced in the second-quarter and the shipments in the fourth-quarter are largely going to reflect pricing decisions that were made in September, October, November, et cetera, and conditions starting in late July started to get more competitive as lenders had more capacity. This capacity backup that I talked about in May and June was beginning to go away by the end of July. That's when we started to see pricing margin changes.

OK. I'm switching gears quickly. The impairment reserve. I have it at about -- I'm sorry, $129 million. Is that about where it is?

No, it's about $158 million. The gross assets - 453 million. The net assets - 295 million.

Right. OK. I'll have to -

. But anyways, what's your - the methodology that you're using toward reversing the impairment? In the past, you've tended to sell servicing as interest rates have gone up. Are you more inclined during this cycle to reverse the impairment as opposed to selling?

Well, that will depend on a variety of factors including the mix of servicing in the portfolio. We, in essence, have to manage the overall portfolio, not unlike a bond portfolio with thoughts about duration and exposure to refinances and all of that. But another major factor is as long as the value of the servicing is below the original amount we booked it for - the gross amount on the balance sheet - we don't have to sell it in order to write it up. It's only when its value goes above that, where GAAP requires you to value it at the lower of cost or market, and therefore, if cost is lower, you stop writing it up, would we be in a mode of selling in order to realize the value.

So in an environment where you reverse the entire - we're going to be gaining 158 million. You basically write the MSR up to its cost.

Net of the hedge costs that we ...

Right.

... do to protect ourselves from a following ...

We might also

the portfolio management decisions we make. We also look at concentration ratios and we have a MSR concentration ratio relative to our Tier 1 capital that would also cause us to sell servicing - may or may not be at a gain, as Will explained. We might sell servicing that we've already written up, so it would be purely a balance sheet and capital management question.

And even within the portfolio, if we begin to get over concentrated in certain segments, we may do portfolio management sales that may or may not result in a gain.

OK. That made sense. And one final question. The impairment - can you explain, conceptually, if rates continue to go up in 40 basis point increments, let's say, over the next four quarters - the third quarter had a 40 basis point upward move in the 10 year. Let's assume we have a, you know, the same upward movement over the next three quarters. Is it linear the way that you bring back the impairment reserve or do you get your biggest kick during the first upward move because coupons go back to, you know, the strike price on your servicing or your average, you know, weighted no rate on your servicing portfolio?

It's non-linear.

It's non-linear meaning you get more of a kick during the first 40 to 80 versus the latter 40 to 80?

Yes.

OK. Thank you.

Our next question comes from Fred Cummings from McDonald Investments. Please go ahead.

Yes. Good afternoon. Greg, can you touch on the falloff in volume in the home equity side, on the origination side? Does that reflect competitive pressures? Does that reflect a change in the underwriting that you've implemented? I'm looking at just a link quarter decline there, Greg.

Yes. It is probably a combination of both, Fred. I think that we have seen a larger number of regional, super regional banks start to turn to their home equity product to make up for the beginnings of production declines in their first mortgage product.

So it's a little bit of that.

It still is a little bit of introducing our channels and our distribution agents, whether they're direct, our direct sales folks or our accounts reps on the indirect side to the new product offering.

I'd say that it's probably almost a year now since we introduced some of the product changes. So that is starting to go away but there's still a little bit of education that's required on the distribution side, so a combination of the two.

You know, I don't know that we - we don't expect production to expand at a large rate off the 270 that we did in the quarter. But I'd say in the range that you've seen over the last several quarters is what we would expect to do over the short-term.

And there also some seasonality effects that make the link quarter comparisons a little plus back. For instance, the fourth quarter around Christmas time is traditionally a low point and then the first quarter, as people begin to manage their debt after Christmas time becomes a traditionally a stronger quarter.

OK. And then related to that, my understanding the business model here. I was assuming that your goal was to sell approximately 50% of the production. And looks like the numbers are much higher than that. Have you changed how you plan on running that business from that perspective?

Fred, I think that a few things. I think, you know, 50% is a round number and you'll see it fluctuate every quarter. And we're not tied to a model that says 50%.

The second observation is that we did have a meaningful amount of first mortgage loan sells included in that $220 million on the order of about 15-18% of that sale volume this quarter was first mortgage loans. We don't, we intend, actually to sell 100% of those loans that are produced at the home equity company.

So you've got that factor as well.

And again the last piece is on the guidelines that we've provided to our investors about what our plans are, again, they're really not meant to be taken on a quarter-to-quarter basis. They're meant to be taken over time. And so you will some quarters that are below what we sold this past quarter.

OK. Then lastly, Greg, jumping back to the traditional mortgage business, what gave vice to the negative loan servicing fees and when will you - when do you expect that to turn positive?

Negative $7.3 million we saw here in the third quarter. Was it a real function of pre-payment activity being high during the quarter and you guys having to have a high level of intangible amortization?

Yes.

Intangible amortization ...

Yes, Fred. Amortization was close to $30 million in the quarter. Directly tied to pre-pay activity. And as we, if you buy an interest rate forecast it suggests that re-fi activity is going to come down, stay down, that amortization will slow up meaningfully in coming quarters.

And can you give us kind of your gross servicing fees that the portfolio produced?

Twenty-two million dollars.

OK. And then, what about if you throw, kind of delinquencies and charge-offs into that? Because I would expect those to increase as rates increase as well.

In the first mortgage business, we don't bear the credit risk. We sell the first mortgage loans ...

Right.

... off to Fannie and Freddie and Ginny Mae. Delinquencies will indirectly affect us because they cause us to spend more money servicing because we are responsible for collecting the payments from the - on behalf of the investors. But we also tend to collect late fees. People get behind and sometimes that's a net benefit. It's hard to predict.

OK. Thank you.

Once again, for any questions, please press star, one your touch-tone phone. At this time, we have no additional questions. Do you have any closing comments?

No, Kristy - don't - we don't. Thank you very much for - everybody, for joining the call.

Yes. We appreciate your interest.

Thank you. This concludes today's teleconference. Thank you for participating. You may all disconnect at this time.