First Financial Bancorp (FFBC) 2004 Q2 法說會逐字稿

Good afternoon ladies and gentlemen, and welcome to the Irwin Financial Corporation second quarter earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session. Please note that this conference is being recorded. 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 Mrs. Dalla, and welcome to everybody. In our presentation period today and in the course of answering your questions we will be making statements that are forward-looking, statements of our plans, initiatives, expectations, objectives, strategies, arithemats, expected results, beliefs and similar expressions are identified as forward-looking information. These statements are not guaranteed to future performance or that's in our actual accomplishments of the plans were about to discuss with you today involve certain risks and uncertainties that are discussed by us today. Therefore actual future events may differ materially from what we discuss here today. For an explanation of the various factors that may effect our future results we encourage you in our 10-Q that was filed this morning and the factors described in our written press release. I like to turn the call over to Will Miller our Chairman.

Thank you Greg, I going to just start by reiterating the key points we made in the press release. First, commercial loan and commercial finance originations grew nicely in the second quarter with an 18% annualized growth rate in those lines of businesses. Second, our credit cards continued to decline with year-over-year charge-offs declining 54%. Third, we continue to make good progress in increasing the percentage of our total fundings sourced from core deposits. These improvements enabled us produce good balanced earnings notwithstanding the significant decline in first mortgages originations nationally due to the rise in long-term interest rates and the very competitive conditions that have resulted.

Our earnings per share were $0.60 was a 33% year-over-year increase compared with the second quarter of 2003. Although 10% less than in the first quarter due to the mortgage banking environment. Earnings from the first half of this year have totaled $38.3m, or a $1.27 per diluted share compared to $25m, or $ 0.86 per diluted share during the same period in 2003. However, we've seen the environment in the first mortgage business though from record level from 2003 to a lower volume and fiercely competitive market today. Production volumes have dropped as expected but margins are much thinner than we anticipated. As we would expect with our balance revenue model, the increase in interest rates we saw in the quarter materially increased the value of mortgage servicing portfolio, offsetting to a degree this slowdown in production-based income. As we look forward to the remainder of the year, if rates rise is predicted by nationally recognized mortgage economists, we would expect an increase in the value of our servicing portfolio, and improved margins in our commercial and consumer portfolios to offset lower mortgage origination volumes and reduced margins. As such we would expect full year earnings to modestly exceed those produced in 2003. However, should long-term rates not rise as expected, we would anticipate continued price competition in the mortgage markets, but little or no increase in servicing value. In this case we would anticipate that portfolio loan growth and improving credit quality would likely produce earnings for the year in narrow range around those produced in 2003 during the mortgage refinance boom, notwithstanding the difficult environment for our first mortgage originations today. And now I'll turn the call over to Greg for a more detailed review of the quarter.

As we all know that, we are pleased with the good performance we had in each of our segments this quarter, we had a nice balance with good contributions from each of our principle lines of business. Net revenues increased 4% on a sequential-quarter basis, or 16% annualized to $139m. Net revenues increased in each of our credit portfolio lines of business, which successfully offset a decline in net revenues in mortgage banking. On a consolidated basis, our loan in this portfolio totaled $3.2b as of quarter-end, which is unchanged from the end of the first quarter, but up 5% from the year-over-year. Our first and second mortgage loans held for sale totaled $1.2b at quarter-end, up 20% from March 31. Now this moderate increase in portfolio loans but a strong increase in loans held for sale reflect our decision to sell our $205m home equity portfolio during the quarter. Deposits totaled $3.4b on June 30, unchanged from the total from year-over-year but the composition changed meaningfully reflecting an increase core deposits. Average core deposits was $168m during the quarter and annualized rate of 43% and has increased $343m, up 21% in the last 12 months. I am pleased to report the consolidated non-performing assets was $40m or 74 basis point of total assets as of June 30, this is down 11% from $45m or 87 basis points at the end of the first quarter.

Our on balance sheet allowance for loan and lease losses, totaled $54m as on June 30, down $10m from the end of March. The allowance declined during the quarter largely as a result of the re-classification of home equity loans from portfolio to low income from sale. Loans, I mentioned a minute ago that were sold in the home equity segment. Net charge-offs for the second quarter was $4m down $4m of 45% from the first quarter. We had $469m or $16.60 per share in common shareholders' equity as of June 30. Our tier one capital ratio and total risk base capital ratio was 11.5% and 14.8% respectively compared to 11.8% and 15.3% at the end of the first quarter.

With regard to capital ratios and EPS calculations, the FASB's emerging issues tax force recent decision to review treatment of contingently convertible bonds should not affect IFC. As we indicated in our SEC filings, our convertible bonds are continuously not contingently convertible at the option of the holder and the effect of the bond has been included in our fully diluted EPS calculation since we issued the bond in 2000. We'll turn to some segment detail, and our stock at the mortgage bank. Net income declined 43% compared with the first quarter reflecting reduced secondary market margins due to rise in interest rates and competitive conditions, loan originations totaled $3.7b which was down 49% in the second quarter 2003 during the mortgage revive boom. Loan shipments totaled $3.4b for the quarter.

We estimate the application of SAB 105 to the interest rate locks we had in effect at quarter end reduced revenues by $2.2m or $0.04 per share during the quarter. This impact is a one-time delay in the timing of the recognition of income and will not affect the ongoing economic value of the business. We recorded a $71m reversal of servicing impairment and recognized $58m of derivative losses associated with the service in asset resulting in a net recovery of $13.5m during the quarter. Servicing fee revenue for the quarter was $26m compared with amortization expense of $24m for a net spread of $2m. Our mortgage-servicing asset in this line of business had a carrying value of $366m on June 30 or 125 basis points compared to a 102 basis points at the end of March. Due to rise in the interest rates during the quarter, the economic value of the portfolio had significantly surpassed its GAAP carrying value. Due to an independent third party price survey, our estimate of the June 30 economic value of the servicing rights is $424m or $58m in excess of our GAAP carrying value.

The commercial banking line of business earned $5.8m in the second quarter, a 6% sequential quarter increase reflecting loan growth and improving credit quality. Compared to last year, the second quarter was down a $100,000 due to a decline in mortgage loan activity in the local markets served by this business. Net interest margin was 3.64% during the quarter down from 3.79% during the first quarter and reflects strong core deposit growth we had. These liabilities have not yet been fully deployed into term assets, but are strategic important to our growth and we're pleased that the core deposit growth was as strong as it was during the quarter. Margins from this line of business should increase in the second half of the year as short-term interest rates rise and as we are able to deploy the deposits into longer-term assets.

30 day and greater delinquencies in our commercial line of business totaled 19 basis points at the end of June, down from 29 basis points at the end of March. Our home equity lending business continues to see improving credit quality and as a result earned $8.9m during the quarter. Loan originations totaled $404m, a $97m sequential quarter increase. Our residual assets totaled $73m at June 30, up from $69m at the end of March reflecting valuation adjustments and the reacquisition of residuals we had sold between 1999 and 2001. Actual cash flows from all of our residuals totaled $11m during the quarter. This is a $4m positive variance compared to our March 31 valuation assumptions. Year to date cash collections from the residuals have out stripped modeled assumptions by $7.5m, nearly a 60% positive variance due to improved collections and the strengthening economy. 30 day and greater delinquencies in the entire home equity managed portfolio continue to drop. To 5.87% at year-end and 4.72% on March 31, to 4.16% at June 30. The delinquency rate on the on balance sheet portfolio, a sub set of the whole managed portfolio dropped from 2.46% at March 30, to 1.45% at June 30. The 30-day delinquency rate on a residual portfolio did increase during the quarter from 8.65 to 9.92%, reflecting a shorter collection mark in June relative to March, and our residual reacquisition. However, we did see continued improvement in the seriously delinquent bucket of 90 days past due from 3.73% at March 31 to 3.48% at June 30. Our gross no-loss provision in this line of business prior to transfers of reserves to our loans held for sale valuation accounts due to the portfolios I described earlier was $6.8m, compared with quarterly charge-off's of $2.6m. Our commercial finance line of business had strong operating results with net income of $1.3m, compared to a break even performance a year earlier. Loan in these fundings reached a new quarterly high at $89m, reflecting strength in each of our channels. A 30-day rated delinquency rate for this line of business remained low at 88 basis points, and our margin was down modestly at 5.62%, compared with 5.74% in the first quarter. And finally our venture capital subsidiary lost $200,000 reflecting portfolio valuation adjustments.

In summary, despite very competitive conditions in the mortgage banking market, we had a good quarter across each of our lines of business. Commercial loan, and commercial finance originations grew nicely in the second quarter. Our credit cost continues to decline with year-over-year charge-off's down 54%, and NPAs declining 11% on a sequential quarter basis. And finally we continue to make good progress in increasing our percentage of total fundings sourced from core deposits. Now Will, Tony Watt our Controller, and I would like to open the call to questions. Marcella are there questions today?

Yes. Thank you. We'll now begin the question and answer session. If you have a question, you need to push star one on your touchtone 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. The questions will be queued in the order that they are received. If you are using a speakerphone, please pick up your hand set before pressing the numbers. Once again, if you have any questions or comments, please press star, then the one on your touchtone phone. Thank you. Our first question comes from Joe Stevenson from Stypho Nicholas. Please go ahead

My name just got changed actually little bit. That's okay. Couple of things. First of all on the asset quality front. I mean in general the asset quality did really well in the quarter, I mean -- but you had the one thing that with three days on your home equity, you said went up a little bit, and you gave a point of rationale. Can you go through that again because everything else has been charge-off's in the 90-day and the non-performance were down but 30 days bump only in the one segment there of home equity? That's question number one. And then question number two is on the commercial bank side, your traditional banking side. Talk a little bit about loan and deposit growth sort of what your seeing the

I tell you that our feeling in the field regarding the economy? Thanks guys.

Joe, asset quality at home acquisition, first question. I give you a mouthful in describing that 30-days delinquencies for the managed portfolio in which we have credit risk, did decline over the course of the quarter, and ended the quarter at 1.45 for the unbalanced sheet portfolio. What I described as a increase, was an increase in the subportfolio of the old residuals, which went from 8.65% to 9.92% in the course of the quarter; still down from 10.2% at year end. Within that same subcomponent of residuals, the serious delinquent bucket moved from 4.15% at year end to 4.73% at the end of March. I am sorry 3.73% to 3.48% at the end of the quarter. With those residuals in our collection average, we obviously focused our attention on the most seriously delinquent accounts first in our collection efforts. And with June being a short month with regard to collection dates, our focus is as in most months looked on them more seriously delinquent accounts.

90 days.

Yes, the 90 days and that came down in line with all the other performance metrics that we have been seeing in the Home Equity Company. Last month due to the shorter month was the 30-day and the shorter end of the capital accounts.

Okay.

And all the other numbers are correct.

Yes. And then the residuals that have been reacquired, it is about $5m residuals, the delinquency rate on that point was higher than the overall delinquency rate, that added about 70 basis points for that 30-day past due or above it.

Okay.

Okay, but again on the entire managed portfolio where we have credit risk, the rate did go down the new account on balance sheet and accounts to residuals off balance sheet, the rate has moved exactly where we wanted to it move from 587 at the end of the year to 472 at the end of March, and then down to 460. So, the overall credit risk that we are seeing in that Company is moving down nicely.

Okay.

Okay. Now what we are seeing in the commercial banking market, much as we've been saying throughout the last year, obviously the Midwest markets Michigan, Indiana and Kentucky, Missouri have been hit, more of it much more severely with a recession and we are starting to see long growth come back in those markets but again the Western markets was not only didn't suffer quite as much slow down in the last three years that the growth is a little bit stronger out there. But we are not seeing -- I don't think that the same level of difference between Western markets versus Midwest markets as we did six months ago. We are seeing nice steady growth in most of our markets right now. On the deposit side, we made good progress there generally in the last year and a half, asking our commercial bank colleagues to put an emphasis on deposit raising in that time period and pretty more effort for in terms of resource deployment and staff in the field and it's beginning to show it's positive effects in terms of -- raising the core deposit liabilities, it does have some short-term drag aspect to it in terms of head count expense that are putting sales down in the market and have short-term drag on the commercial banks net interest margin that I made reference to, but we feel those are very short-term needed investments to be able to improve our deposits and by body structure.

Okay. Thank you guys.

Yes.

Thank you. Your next question comes from Bill

from Jacob Asset Management. Please go ahead.

Hi guys. Have a ten number of questions and kind of random order here. To start, do you have the loans that were actually sold in the Single Family business in the second quarter?

You want to give us all your questions are you want us to do one at a time.

I will do one at a time. Some are really quick but I do feel one at a time.

So, you want to know the loans sold in the post mortgage business?

Right.

Our total shipments during the second quarter totaled $3.8b.

$3.8b?

$3.8b.

Okay great. Second question.

Just to clarify, Greg had mentioned the number during his prepared comments of $3.4b of shipments. The difference there is $400m of brokered loans

.

So, in terms of gain on sale, look at the $3.8b.

Correct.

Okay. And on the MSR, did the fair value exceeding your booked cost of $366m?

If you take the difference of $59m and divided by the servicing portfolio, it looks like you are up about a 20 basis point gain on the existing portfolio to the extend you sold everything, obliviously you are not. But the gain that was produced in this quarter on servicing sale that we go was about $2.4b, turned out to be about 8 basis points. My question is, going forward is the 20 basis points, is my math right and should the gain produced on future sales did extend that rates, don't fall from here but stay where they are on these 20 basis points more accurate reflection of gains on future service in sales.

Well, Bill your math is right. It needs an explanation as to a reminder perhaps that the excess -- the economic value over GAAP value of $58m comes about from the totality of the traunches that we have traunched the service and asset into and there are certain traunches that are not above GAAP. But certain traunches that are in the $58m in the representation of the amount that

. Generally, those that economically we have above GAAP is the loans that we originated probably on to most of 03. The eight basis point of gain that you have calculated by looking at our current period sales those are for more current compound originations we effectively

so I would call January through March conventional per product, January through March '04 conventional product during the second quarter in a mini bulk slash flow sale and so the combined differential is such that put the quarterly gains eight basis point to substantially lower than sort of the embedded economic gain that we have got some order coupon.

That answered my second question. And I mean what kind of reserve, which kind of enters the previsions one. How can be the share value can be of the MSR 425 exceed the cost of 366 and there is still be in permanent reserve. My understanding that the impairment reserve would be first be exhausted and then the value could rise above the cost first question. And then second question, what does it mean in terms of the existing impairment reserve and is it harder to recapture all of it and does it take a much higher upward movement in reach to recapture the remainder of that. That's it.

Well at least I would be - - if you restate that question because I am not sure I follow what you are asking.

Okay. Do you have any impairment reserve?

It is $27m plus point.

Great. And you are using cost of market. Okay as long as the impairment reserve exists because of the share value be previously the share value of your MSR was below that what you had booked the MSR.

I think what's been missing here is that Greg mentioned earlier that he has to divide the entire servicing like portfolio in to the series of traunches and some of the traunches are still below the low comp cap and therefore couple of the traunches have an impairment reserve associated with them.

Okay.

And that's where you get the $27m from.

Okay then does the 425-share value include, does that include the impairment reserve. I'm trying to think it, can you recapture impairment reserve and still self-servicing at a gain. Well that's what I am trying to get at.

Well if rates stayed exactly where they are, then if we sold out of the traunches that are above the low comp cap we would have a gain.

Okay.

If we sold out at the traunches but below the low comp cap and with their fair value and carrying value are the same. Then we wouldn't have a gain.

Okay.

If interest rates rise further the traunches that are below the low comp cap have the potential to be written up to the $227m with out a sale.

Got it.

Before they hit the low comp cap.

Okay. That answer

Just one more final point on it you just referred to the 425 is the fair value. The 425 is the amortized cost basis. The fair value is the 450, the 400m plus the 56m economic value on top of that.

Okay I made that

Our part of the difficulty is we generally talk about the servicing value of the mortgage, first mortgage business and then when you start asking specific numbers question I think you have points are consolidated.

Yes I was.

Which includes the small mortgage portfolio of a commercial bank and a so slightly different mortgage service and asset at our home equity company and it is differed in that it is embedded with a lot of prepayments.

Do you break out the single family? The kind of we have a cost for family but

did you discloses the fair value of the single family.

Well what he means is the Irwin mortgage.

Yes that is the number that I made reference to earlier. The 450, no it is the one from the press release.

Okay that's fine I will go back don't worry real quickly at the reduction of the -- in the 10-Q, which is -- that you -- from servicing sales, the reduction in the MSR, if the reduction of servicing sales is at $20.1m for the six months. Now that includes home equity, does it? This is on the consolidated --

That's right. We don't and have not done

by the home equity company. Again it's just really not a different type of asset. Billy it is, we don't have it in the previous, sort of confusion about the numbers, about one set of them of being just the conforming first mortgage business, we refer to us only mortgage and the second set of numbers being consolidated. This quarter there is an unfortunate coincidence of numbers that consolidated amortized cost basis is $425m and the sale value of the conforming first mortgage portfolio is $424m.

Okay. So the cost, all right, the fair value of one is close to the cost of the other.

Yes. And really the fair value, the economic value of all the amortized cost value, the vast majority of that is in the first mortgage line of business. So, if you want to look at a consolidated asset, you look at the growth in MSR net of amortization of $425m and then on top of that you would add the other $56m, $57m of economic value above the amortized cost we've at that segment. You with me?

Yes. Got it.

Sorry about that. This just gives us more opportunity to clearly indicate

.

Just quickly moving on, the $4.6m, I'm sorry, in the first quarter you revalued the home equity residual up by $4.6m due to a better prior performance. In this quarter in the same line, which is trading gains you have $6.688m, is that also due to the credit performance?

The vast majority of it was credit performance. There is additional noise in there with regard to things like LIBOR strategy, prepayment companies that are pledged to the trust are referring to the servicing asset, but the vast majority of it was from credit performance.

Okay. And three quarters in a row, is this something that -- is there anymore recurring? Going forward, does it sound like in the first quarter there is more of a one-timer now? You have got two straight quarters of this.

Yes. This is a fair value asset and we have got loss assumptions baked into that assumption. The economy continues to improve at a pace and credit quality improves at pace better than our loss assumptions than you would fear that the economy doesn’t than you won't fear.

Okay.

In fairness of the economy drift on the other way and our losses come more quickly than we currently modeled in, then we could have to write them back down.

Right.

You have to make that assessment every single quarter.

Got you. And other income was pretty much non-existent in '03, but in '04 it's actually become meaningful at about $2.8m, what is this other revenue category in the home equity segment?

Thank you. Our next question comes from

That was down the tip of my tongue, we will find out and before we end the call, we will get back to you.

And gain on sale of home equity, can you tell me how much was -- this is my last question, how much was due to price competition versus execution, because it really dropped 1.36%?

Let me address that -- I don't know how does that rate price competition versus execution because I think they are one in the same -- in the marketplace, but 1.3% is sort of a confusing number and it has to do with the discussion that I had during the opening of the call about the provision that we had during the quarter. You are doing straight math by looking at gain on sale of loans about $3m over $224m of loans so and I think it's about 140 basis points. If you look at the amount of provisions that was relieved to get the assets to mark-to-market to the buyer

loans held for sale. That was that $7m item that I made reference to in the provision and you are getting sort of an economic gain of about 4.2%. And again, what we did is we provided at a rate of about $7m in that segment during the quarter against charge-offs of $2m, but we had to immediately relieve some of that allowance, move that allowance into the loans held for sale evaluation adjustment, and then that when we went to sell the loans, we came part of the economic gain in the books.

Okay, that makes sense. Good day.

Thank you.

George, I think you can address your other income in the home equity segment.

The majority of the increase in other income relate to hedging activities at the home equity line of business and those are discussed in detail in the derivative section in the back of the 10-Q.

, do we have any other questions?

Yes we do sir. We have a question from Marcello Martino from Key Bank Capital Markets. Please go ahead.

Hello, Marcello.

Hi, good afternoon. Just a quick question in relation to the $6.3m in reversal in provision. What are you viewing as a core EPS number in light of that or how are you viewing that?

Marcello, that's is actually the cumbersome mix of GAAP. We view our core EPS number $0.60 a share. All we did was originate loans like we do every quarter, and depending on -- because we sold loans that we have prior to that point had in portfolio as suppose to selling loans that we currently produce that have loans held for sale, then at the GAAP treatment side, gain on sales provision needs to be different, but the NOI activity was exactly the same and the net

as we just discussed with Bill brings the net gain on sales in economic basis out to some other term line to what we have seen in the previous quarter, so now review core earnings $0.60 a share. We originated loans as we always do and we sell loans as we always do. There is nothing non-core about that. This seems to have create a little confusion and unfortunately, it's required to be presented this way by GAAP. When we took the Irwin home equity loans that we decided to sell, how are the portfolio, one of the things you have to do is remove the loan loss provision associated with those loans from your total reserve when you go to sell them, and that's why the loan loss provision dropped, because it includes this removal of provision held against the set of loans that we are selling. What's missing in just looking at the net number is that all new production and on the portfolio that we continue to hold, we did provide in the normal course. What was it Greg, about $6m?

Yes, the gross provision at $6.8m.

So, that was associated with the normal activities, and that's why we consider these to be core earnings. But we didn't really under provide or reduce our provisions. What we did is when we want sell our portfolio loans, we will require to backout the provision associated with the loans that are no longer on our balance sheet.

Just market into market.

Okay. Thanks for the clarification.

Thanks.

Thank you. Again, if you have any questions or comments, please press star one on your touch-tone phone.

Well,

, I think we are all set.

Yes sir. We have no questions.

We appreciate everybody's attention and interest, and we will be doing this again on October 29. Hope you will join us. Thank you.

Thank you.

Thank you. Ladies and gentlemen, this concludes today's Irwin Financials Corporation's second quarter earnings conference call. You may all disconnect, and thank you for participating.