First Financial Bancorp (FFBC) 2004 Q3 法說會逐字稿

(OPERATOR INSTRUCTIONS). 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, Sandra, and thanks everybody for joining us. Will Miller, our CEO and Chairman is with me today, as is Jody Littrell, our Controller. In our presentation today and in the course of answering your questions, we will be making statements that are forward looking. Those statements about plans, initiatives, expectations, objectives, strategies, estimates, and expected results, belief and similar expressions identify forward-looking information. These statements are not guarantee to future performance or events. And our actual accomplishments of the plans we are about to discuss with you today involve certain risks 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 various factors that may affect our future results, we refer you to the MD&A in our 10-Q that was filed this morning and the factors described in our written press release. I'd like to turn the call over to Will Miller, our CEO and Chairman for a few opening comments.

I would like to start by reiterating the key points we made in the press release. First, we continued to experience good growth 21 percent annualized in our small business, commercial loans, and lease portfolios in the third quarter. We also enjoyed a significant increase in the year-over-year profitability in our Home Equity and Commercial Finance lines of business in a large part to improve credit quality in both these portfolios.

Second, we continued to make good progress in increasing the percentage of our total funding that comes from core deposits. Average core deposits increased at an annualized rate of 36 percent in the third quarter and had increased to $437 million or 26 percent in the past year. The growth in our credit portfolios and increased core deposit funding should help fuel our growth in coming quarters.

Third, while not meeting both of our long-term financial goals, we were able to achieve good consolidated earnings in the third quarter despite a very difficult period for our Mortgage Banking operation. Return on equity for the quarter was 14.1 percent and year-to-date it is 15 percent, meeting our first financial goal of earning returns above our cost of capital.

Our second goal is to grow earnings per share at double-digit rates over the long term, which we measure in rolling 5-year periods. Obviously, we will have to do better next year to continue to meet this goal. Mortgage rates unexpectedly declined during the third quarter impairing our servicing asset. Typically, when this occurs, we see a pickup in production income; however, given the size of the refi market last year and the over capacity in the market today, the decline in mortgage rates during the quarter was insufficient to fuel strong originations. As far as we know as of today, the decline in our mortgage company's originations appears to be in line with that of the industry.

Last year this time, when reporting our third quarter 2003 results, we told you that those results were unusual. We got the double benefit of strong mortgage origination income and an increase in the value of our servicing portfolio in the same quarter. This year, the third quarter was exactly the opposite of our mortgage bank Our third quarter 2004 earning per share of 57 cents was a 5 percent decrease compared to the second quarter of this year and a 45 percent year-over-year decrease compared to the record results we had last year when we noted at the time was unusual and should not be expected as the norm. Year-to-date earnings have totaled $55.5 million or $1.84 per diluted share compared to $56.1 million or $1.89 per diluted share during the same period in 2003. Looking ahead, the forward rate curve has flattened considerably since the end of the second quarter and as such we are now less confident than we were 90 days ago when interest rates were revised meaningfully through the end of the year.

We will be lower in the fourth quarter than in the third and our net income for the year as a result fell short of the results we produced in 2003. As I noted however, we believe we are in a transitory period for Mortgage Banking. We expect servicing values will improve if rates raise next year as the forecast implicit and the forward curve suggests and we expect origination margins in the mortgage business will normalize in the long run as we and other mortgage companies adjust our cost structures to lower production levels. These improvements coupled with the good goals we have had in our credit portfolios in 2004 should cause net income in 2005 to return to level commensurate with our historic performance based on what we know today. Gross net income in 2005 to return to levels commensurate with our historic performance based on what we know today. I'll now turn the call over to Greg for more detailed review of the quarter.

Reflecting the continued slow down of mortgage banking from earlier periods and that revenues declined on both a sequential quarter basis when compared with the year earlier quarter. Decline in each period occurred almost entirely in our Mortgage Banking segment. Mortgage banking revenues declined $6 million or 9 percent from the second quarter of this year, principally reflecting reduced recovery of mortgage servicing impairment, net of hedge costs. On a consolidated basis our loan and lease portfolio totaled $3.4 billion as of September 30, up $200 million or 6 percent from the end of the second quarter. And our first and second mortgage loans held for sale totaled $1.0 billion at quarter end, down 19 percent from June 30. As we noted, we have made continued inroads in originating more core deposits.

Total deposits totaled $3.5 billion at September 30, up 15 percent increase from a year earlier. And importantly average core deposits rose at an annualized rate 36 percent during the quarter and have increased $437 million or 26 percent during the past year. Consolidated nonperforming assets were $43 million or 79 basis points of total assets as of September 30, up from 40 million or 74 basis point of total assets at the end of the second quarter. The increase principally reflects the deterioration in a portfolio of group of leases associated with a single vendor in our Commercial Finance .

We believe we are adequately reserved against these nonperforming assets. Our on-balance sheet allowance for loan and lease losses totaled $ 48 million as of September 30, down $6 million since the end of June. The allowance declined during the quarter largely as the result of a reclassification of home equity loans from portfolio to loan held-for sale they are now carried at fair value. This transfer was precipitated by the sale of approximately $150 million of loan that we sold in October to respond to secondary market demand and to relief the balance sheet of certain higher risk home equity loans. Net chargeoff's for the third quarter were $4 million, unchanged from the previous quarter that's a 48 percent year-over-year decline reflecting improvements in overall credit quality. The amount of 30-day and greater delinquencies increased modestly in each of our on balance sheet credit portfolios.

Our consolidated loan and lease provision totaled $2 million this was unchanged in the second quarter reflecting good trends in credit quality and a $3.5 million reversal in loan losses provisions related to the reclassification of home equity loans, I noted a moment ago. This was done to give our net carrying value to mach market value. Without this reclassification gross provision in this quarter would have been $5 million compared to actual chargeoff's of $4 million. We had $486 million or $17.16 cents per share in common shareholders' equity as of September 30. Our Tier 1 Leverage Ratio and Total Risk-based Capital Ratio were 11.2 percent and 14.6 percent, respectively, compared to 11.5 percent and 14.8 percent at the end of second quarter.

I will turn it to some detailed about segment starting with Mortgage Banking, where net income declined 27 percent, compared to the second quarter reflecting difficult competitive conditions and lower recovery of servicing impairment valuation allowance net of hedge costs. Loan originations of $3 billion represented a 20 percent decline compared with the second quarter. Refinances accounted for 40 percent of production in the current period, margins remain very slim. As we noted, comparison against the third quarter of 2003 a significantly worse, giving the record proportions of the market year-ago, when we originated over $7 billion of loan and had the unusual coupling of great production with a gain on servicing in that quarter. With the benefit of wider spread between mortgages in the

that we see historically we reported diluted gains of $5 million in excess for the servicing and impairment during the quarter. Servicing asset in this line of business had a carrying value of $345 million at September 30 or 120 basis points of underlying loan balances compared with 125 basis points at the end of June.

September 30 or 120 basis points of underlying loan balances compared with 125 basis points at the end of June. As we start the fourth quarter, we have not seen a meaningful change in the origination market. We believe there is still over capacity in the mortgage banking industry. Our Commercial Banking segment's revenues increased 4 percent sequentially from the second quarter, reflecting loan growth at a 16-percent annualized rate. Net income declined by 8 percent, however, to $5.5 million, principally related to personnel expenses related to increased incentive compensation due to higher return on equity, expansions to new markets in Milwaukee and Sacramento, and additional support staff.

Net interest margin was 3.74 percent during the quarter, up from 3.64 percent during the second quarter. And our 30-day and greater delinquencies in our commercial banking line of business remain low, totaling 0.24 percent as of September 30, compared with 0.19 percent at June 30. Our home equity lending business continues to see improving credit quality as a result of $8.3 million during the quarter, up over 3 times from the $2.6 million they earned a year ago. Loan originations totaled $397 million, a slight decrease in originations of $404 million in the second quarter, and we sold $405 million of loans for a net gain on sale of $8 million. This gain was small on a percentage basis than recent sales, due to product mix and resulting coupons. Our residual assets totaled $69 million at September 30, down from $73 million at the end of June. The actual cash flow we received from our residuals totaled $12 million during the quarter, a $4 million positive variance to our June 30 models, primarily due to actual losses that were meaningfully lower than our June 30 loss projections.

Chargeoffs in the residual portfolio continue to decline coming in at a annualized rate of 3.19 percent in the current quarter, compared with 4.25 percent in the second quarter, nearly half of the 6.23 percent rate a year ago. The delinquency of our on-balance sheet portfolio rose slightly from 1.45 percent at June 30 to 1.87 percent at September 30. The 30-day delinquency rate on our residual portfolio also rose during the quarter from 9.92 percent to 10.78 percent, reflecting continued shrinking of the portfolio. At this level, delinquency is in line with our expectations.

Finally, our commercial finance line of business had strong operating results with net income of $1.1 million, although down slightly compared to the $1.3 million we earned in the second quarter. Reduced secondary market sales of franchise finance loans accounted for the bulk of the sequential quarter decline. Loan and lease fundings reached new quarterly high of $91 million, reflecting strength in each of our channels. Our loan and lease portfolio in this segment now totaled $560 million. The 30-day and greater delinquency rate for this line of business was 0.95 percent at the end of September, compared with 0.88 percent at the end of the second quarter, and its net interest margin was down modestly at 5.52 percent, down from 5.62 percentage in the second quarter, principally reflecting changes in yields and product mix.

So, in summary, we are encouraged by the fact that we continue to experience good growth in commercial loans and leases, during a period of relatively slow economic growth. We continue to see significant increases in the year-over-year profitability in our home equity and commercial finance lines of business. And we continue to make good progress in increasing our percentage of total fundings sourced from core deposits. While it has been a difficult period for our mortgage banking operation, we believe the improvements in all other lines of business bode well for our future profitability.

I'd like to open the call up to questions. And I'd like to note that I believe that I was describing the net interest margins in the commercial finance line of business -- dyslexia had slipped in -- and net margin for the quarter was 5.25 percent, I believe I'd said 5.52 percent. Then, we'd open the call for questions please

(OPERATOR INSTRUCTIONS) Ross Demmerle, Hilliard Lyons.

Three simple question, the core deposits amounting where -- what part of the country power growth is coming from? Secondly, I don't know if you mentioned dollar amount of servicing that were sold? And then finally, as far as interest rates go, and what that's going to do to revenues related to your servicing asset? I don't know if you can be more specific enough as to say if the 10-year Treasury is at 4.10, 4.05 or 4.50? I would say at the end of the year what that's going to do to your revenue, specific revenue line related to servicing asset. And those are my 3 questions, thanks.

Ross, thank you. Let me start with the question about core deposits. Ross I don't have in front of me that specific quarter-to-quarter, year-over-year growth by each of our 40 markets. I can give you a couple of indicators with regard to what we've seen on a month-by-month basis, as we have been working with that line of business. Two in questions, one is we were getting both of our growth in markets where we have very low share of market, dual markets that we've gone into in the last couple of years, where we recall we started in those markets with a credit in lending front. And began only recently to emphasis the cash management, deposit gathering services, those added headcount in those areas principally in the new market. That said one of the score cards that Will and I have looked out over the last several quarters. That does indicate that we're continuing to grow our market share even in this market by forming

for 130 years.

Over the last year, 3 and 5 years, we've been able to expand our market share, that reflects the leadership that we put into the commercial bank to focus on deposits just as much as we do on commercial credits, and the strike range and the work and the growth path in that area. How much servicing we sell during the fourth quarter, and whether we do such service in the fourth quarter, it really depends, as you know, on where interest rates move. We are now the low with the interest rates where they are right now, and looking that and you make credit coupon of about 5 and 8, we were below in most of our risk with the lower cost and market caps in our portfolio. We would not likely sell much servicing except for small portfolio management services when we are below that cost GAAP. The cost GAAP is approximately 25 basis points, it depend on what index you're looking at about where our current rates are. We would like to have to get through that 25 basis point ceiling on accounting GAAP before we'd entertain selling servicing. We would like to be able to produce quarter after quarter after quarter of smooth accounting earnings, and that's less important to us then they can show that we get the right economic targets that we set up for ourselves. And the changes in interest rates in our mind are not anything that we can directly obviously influence in the short term.

We do think that the balance revenue model that we'd set out does work over longer periods of time, and if those interest rates don't go up in the next 60 days, we would expect that overtime before our curve is correctly will go up and it might be in the 90th day. That's more of our short-term call and it's not one that we're in a condition here at the end of October to make. But again, we wouldn't sell servicing who can get us a sale in their management portfolio. We'd turn the call over question over to Jody here to answer your second question, which was how much servicing we sold during the quarter, and -- a question, which was how much servicing we sold during the quarter. And before I do, let me remind you that we do sell a fair amount of servicing. In current periods, we haven't done a fair amount of servicing in the current period, manage the size of the investment on our balance sheet is done. And Jody gives you the number of how much servicings we sold; it will include servicing that we sold on a flow basis that continue given the size of the asset relative to our Tier 1 capital we don't want to continue to meaningfully increase the size of the servicing assets. And I think Jody has got that number up.

In the 10-Q, in the mortgage banking line of business section, we disclosed that we have sold $4.5 billion worth of servicing. For the third quarter that was $1.3 billion.

First number was year-to-date?

Year-to-date, 9 months, it's $4.5 billion.

And in the third quarter, and so we said 1.3 --?

That actually made up of about roughly a billion of these conventional flow servicing sales that Greg is talking about and then the rest would be loans that we actually originate but broker out, but it is not a product that we want to keep the servicing on.

I think you were trying to answer the last question I had about interest rates and then some of your comments basically said if rates don't go up in the fourth quarter here, our revenues are basically going to be lower than they were in the third quarter and I don't know if you can, just sort of, give us an idea of how much more those rates have to go up for -- you to get back to where you were this quarter.

I don't think we can make it so precise, that we would be comfortable publicly stating a particular amount of interest rate rise that would sort of make the fourth quarter more comparable over the third. The point we are trying to make is the -- forward curves all suggest that rates are going to rise. The question is when. And if they rise in the fourth quarter, in time to make it economically attractive sale of servicing, if possible we will do it in the fourth quarter. But if they don't rise until the first quarter of next year then the results won't be booked until the first quarter of next year. If rates don't rise at all, if the forward curves are all wrong and rates turn around and start going back down, then we are not likely be selling servicing but at some point we are likely to be getting the pick up in the production side. So to us this is essentially a timing issue. We don't think the balance revenue model is ineffective, it's just -- we have said for many years it's not going to work perfectly quarter to quarter.

Bill Roy, Jacob Asset Management.

The cash rate, the loan sold about 3.039 billion, I just wanted to confirm if that number was correct.

Shipments -- are you talking about first mortgage business?

Yes.

Shipments were about 3.1 billion.

3.1? To have your gain on sale running at 1.29 percent of loans sold, which is meaningfully higher than second quarter and actually only slightly below the average of all of 2003 when margins were really high, could you talk about was there anything peculiar happening in the quarter, and do you think that this is sustainable in the fourth quarter?

Yes, The biggest change that we saw in the third quarter over the second quarter actually relates to an unusual item in the second quarter that we talked about 90 days ago and it's dropped in the second quarter of 10-Q related around the industry adoption of SAB 105. Let's remind you has the effect of delaying, potentially for one accounting period, certain things that are generated in the origination and sale of the mortgage loan. So those were not in the second quarter numbers and everything just sort of shifted forward and that the gain that you if you had absent SAB 105 had seen in the second quarter not coming into the third quarter and have it real forward with the gain that we had a lot of servicing in third quarter will show up in the fourth quarter. So the one time of that option thing the SAB 105. The other part of the margin index -- we have not seen much pickup, we think, in the overall secondary margin. There are some values that have seemed to have stabilized a little bit. They were running -- when there is going to be a comparison against 2003 or sort of conflicting courses there -- in 2003, the pricing gains or losses they over just

obviously we are running very favorably because in large part most mortgage banks were using pricing as a governor to how much product they wanted to bring in over the threshold, and be able to control the back-room operations, dealing, pricing and help to add to some margin. But, sourcing values last year, obviously, were a lot lower. And so I think this year what we're seeing is a slight improvement in servicing value, but margins that 8aren't what we think as long-term normalized margins.

Shifting gears onto the Home Equity, and a read in that in the 10-Q that you are planning to sell in October the 03-1 Home Equity aspect security, which was $150 million. You already booked reversal of the loan loss provision, but I was wondering if there is any gain associated with the sale of that or do you expect any gain associated with the sale of that security?

The bulk of that gain will come in the form of retention of the servicing that we have on those loans. The marked-to-market as it was, the gain on the underlying loans is what gets one to prove the allowance that occurred in the third quarter, and then we'll have a gain on the servicing.

We'll create a mortgage servicing right in the fourth quarter that in effect will be another increment to income.

Will it be somewhat similar to the one that you've taken in the third quarter -- actually in the second quarter?

The contractual servicing right would be the same.

They will be proportional though. It's not that this --

Right. As a percentage. And finally, can you just

the methodology used for selling servicing in this cost cap of 25 basis points. I didn't quite understand what is it that you are saying -- if you can just run through one more time, I'll appreciate it.

That was another question there. It was followup. I think it was followup to the third question of the first questioner, which was how much will rates need to rise for us to do a servicing sale that would add meaningfully to revenues in the fourth quarter. The 25-basis points that I made reference to was a rough estimation of the degree to which current coupons in the

and government mortgage markets are below where the lower cost of market cap is in our servicing asset on an aggregate strata basis, not at individual strata basis. And so, my point was to create any gain at all above the lower cost of market cap on that asset, we would need to see at least a 25-basis point increase. Now, we can recapture some of the value between 0 and 25 basis point in increasing rights in rates through normal reversal of

. Of course some of that would be netted out against the derivative positions that we have that currently protect or intended protect us with declining rates, but obviously we have a cost in doing that net cost in a rising rate environment. Did that help?

Joe Stieven, Stifel Nicolaus.

I'd say most of my questions here have been answered, but let's go back to the mortgage-banking environment for a second. I guess it was 6 quarters ago when you guys had successfully brought on a whole group of people; I believe it was from Washington Mutual. And in this environment, right now, a lot of the mortgage bankers are complaining how tough the environment is -- environment is, are you guys actively -- can you just talk about the chances of or your plans for trying to look at bigger operations to bring people in, and just sort of the thought process you guys are going through? Thanks guys.

Sure Joe. First of all, condolonces on the

but-

I was trying that to bring that up a little. We are mourning.

Yes, I could understand why. You are right. It was about 2 years ago that we brought on correspondent lending group in Monroe, Louisiana that Brauwerman had purchased from their companies; their talent is a factor. And that volume has been very helpful as the 2 years of unfolded bid, of course, sort of put us even higher up initially because we -- post-refinement environment didn't come as quickly as we originally anticipated it would. But it has also helped to keep our volume a little more robust here as overall repurchase on our way. We are always, as you know, looking in a sort of temporary way to -- if there are really good people available. There is not a specific plan to try to add a certain number of offices in a certain time. We also, however, after

, we take very seriously the need in an environment where the earnings from the entire line of business are going down as rapidly as they are to be looking at cost containment and rationalization of the production system we currently have internally. So, it's a difficult period in the sense that you try to simultaneously play defense and offence. You can't take your buy off of the need to get our costs in line and rationalize the existing system. While we are always open to the opportunistic chance if there is a really good office somewhere that becomes available in this environment.

Fair enough. Okay thanks a lot.

(OPERATOR INSTRUCTIONS). (Stone Miles, KeyBanc

.

Yes. Good afternoon. Can you elaborate at all on the new disclosure in your Q1 in NorVergence matter just to give us some sense of materiality to this?

Yes. The NorVergence -- that is in the low single, I'll call it NorVergence generically, it's not with NorVergence it's with Lomburger

that used a product that NorVergence's sold, and I think, of the top of my head, we have about 160 individual leases that totaled to a credit that is capsulated in this NorVergence's issue in the low-single digit millions of dollars, geographically spread throughout the country. We don't have any geographic concentration, but obviously we have a vendor with concentration in it.

Beyond the credit aspect to it, can we get a sense of the materiality to the remaining litigation beyond the credit?

Yes. It's in very early days, so it is very hard for us to size that. We've actually put it in the press release largely because even though we are one of the very smallest lenders that are tied up in this thing, there are much larger, in fact tens of larger lenders than we are that are in the same position we are. But because there are public documents being filed with our name on it, we felt it was appropriate to disclose it so that an investor or shareholder might come across that in another venue wouldn't be surprised by it.

(OPERATOR INSTRUCTIONS)

Sandra, there aren't any others. We thank everybody for their time and attention and I appreciate your interest in our stock. We intend to do it again on January 25 for the release of our fourth quarter and annual earnings. Thank you.

Thank you. Ladies and gentlemen this concludes today's teleconference. Thank you for participating and you may now disconnect.