First Financial Bancorp (FFBC) 2005 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Irwin Financial third quarter earnings conference call. [OPERATOR INSTRUCTIONS]. Later we'll conduct a question and answer session. I'll now turn the call over to Mr. Greg Ehlinger.

Thank you, Justin, joined today by Will Miller our CEO and Jody Latrelle our controller. I want to remind there are important cautionary and forward-looking disclosure our written press release in our 10-Q filing that apply to this conference call you can find these on page 22, of the 10-Q, for the third quarter, that we filed yesterday with the SEC. All the year-to-date figures, we'll be discussed and will reflect the affect of the restatement that we discussed last week due to a change in the accounting treatment for incentive servicing fees through the second quarter of 2005. I'm going to turn the call over to Will for a minute, for some summary comments.

Thanks, Greg. I would like to start by reiterating the key points in the press release. We entered the third quarter with net income $18.5 million or $0.61 per diluted share. As compared with net income of $16.3 million in the third quarter of 2004, and a $3.4 million loss in the second quarter of this year. All of our segments had improved sequential-quarter net income and good loan origination growth. Our capital remains strong and we have the capacity for on going growth. We're encouraged by the positive turn around in our consolidated results we achieved in the third quarter and believe these will continue. The quarter-over-quarter improvement was fueled by the turn around in mortgage banks and our improved mortgage servicing right and servicing hedge performance.

We are experiencing continued steady growth in our commercial segments, commercial banking and commercial finance, both reported record quarterly income this quarter. Last week, we announced a change in the way we record revenues from our home equity incentive services fee, and as a result, we will restate our financial statements from 2004 and the first half of 2005. We want to remind you that the ISF change is an accounting correction at our home equity segment only and does not impact the underlying economics or cash flows of that business. It simply changes the timing of when we'll be recognizing income from these assets.

Additionally, the ISF accounting correction will not impact the results of our other lines of business. I would like to conversation over to Greg Ehlinger, who will discuss our lines of business in more detail and explain further the accounting change for our incentive servicing fees.

As Will mentioned, consolidate net revenues increased on a sequentially quarter basis, although they are down on a year-over-year basis due to reduced secondary market-margins on mortgage loan sales.

Our consolidated loan and lease portfolio was $4 billion as of September 30, a $51 million decline as compared to the second quarter of this year. This decline was attributable to the reduction in held for investment portfolio in the home equity segment, resulting from a strategic decision to sell more home equity product in future quarters and therefore, $200 million of loans were reclassified to hold for sale classification. Our two commercial portfolios increased $205 million or 29% on an annualized basis. Reflecting good loan originations and the reclassification of the home equity loans, I mentioned a minute ago. Our loans held for sale total $1.6 billion, a $ 0.5 billion sequential quarter increase.

At the end of the quarter, deposits totaled $4.1 billion, up 34% on an annualized basis from June 30. Institutional non-brokered CD sales, contributed to the majority of the deposit growth, which offset 137 million or 19% decrease in mortgage escrow deposits, which naturally declined as mortgage servicing rights were sold to reduce our market-to-market valuation risk. We had $508 million or $17.78 per share in common shareholders equity at the end of the third quarter and at quarter-end our tier 1 leverage ratio and total risk-based capital ratios were 10.3 and 13.1% respectively, compared to 11.1 and 13.8% at the end of the second quarter.

Consolidated non-performing assets, which include other real estate owned of $13 million, were $50 million or 77 basis points of total assets as of September 30, up in dollars from $47 million but the same 77 basis point of total assets, as at the end of the second quarter. Our on-balance sheet allowance for loan and lease losses, total $54 million as of September 30, and this was up $3 million from the end of the second quarter. Our ratio of on-balance sheet allowance for loan and leases losses to non-performing loans and leases, was 147% at quarter end, compared to 154% at June 30. Our consolidated loan and lease provision totaled $6 million, down $3 million in the second quarter and it compared favorably to quarterly charge-offs, which total $3 million. Our 30-day in greater delinquencies were largely unchanged on a sequential quarter basis and included in our third quarter loan loss provision and other reserves our estimates total $1.7 million pre-tax, to cover losses in our two consumer mortgage segments, as Hurricanes Katrina and Rita.

I'll now turn to detail by segment; starting with the commercial bank, which Will noted recorded a record quarterly net income of $7.6 million, a $2 million increase over the second quarter of this year and a $2.1 million increase from the third quarter of 2004. This year-over-year increase reflects increases net income interest from the portfolio growth, that we had, and a modestly improved net interest margin. Average loans outstanding during the quarter were $2.6 billion, increasing on a sequential quarter basis by an annualized rate of 35%. Net interest margin was 3.83% up from 3.80% during the second quarter and credit quality continues to be strong. In the commercial banking segment 30-day and greater-delinquencies declined to 12 basis points as of September 30, compared to 15 basis points at the end of the second quarter and our loan and lease provision of $1.4 million compared favorable to charge-offs of only $600,000.

Our mortgage-banking segment reported net income of $5.9 million, compared to a second quarter loss of $9.2 million and prior year earnings of $4.1 million. As Will stated the improvement primarily reflected results in the hedging of our services asset. Net services and hedging impairment of $1 million in the third quarter compared favorable to net impairment $27 million in the second quarter of this year. Loan -- Mortgage loan production of $3.2 billion increased 21% as compared to originations of $2.6 billion in the second quarter. In each of our three distribution channels, wholesale, retail, and correspond dent had sequential quarterly increases in originations.

However, margin pressures remain as the gain on sales loans, as the a percentage of loans sold, were 57 basis points in the third quarter, compared to 66 basis points in the second quarter. We continue to reduce our mark-to-market valuation risk through bulk servicing sales totaling $1.8 billion during the third quarter. From this sale, we recognize an $8.6 million gain and reduced our mortgage-servicing portfolio to $18.5 billion; this is a $10 billion year-over-year decline. At this juncture in the fourth quarter, our servicing hedge is holding up well. Our commercial finance line of business earned $2.5 in the third quarter, a $1.1 million increase as compared to the second quarter of 2005, and also quarterly record for net income for this segment. Loan and lease funding totaled $119 million during the quarter compared to $110 million in the second quarter. Both income and level of loan originations, as I said, were quarterly records for the segment.

The loan and lease portfolio now totals over $.75 billion, a $60 million or 9% increase from the end of the second quarter. Net interest net income totaled $9 million; a $1 million sequential quarterly increase and the gain on sales loaned totaled $1.5 million compared to $100,000 in the prior quarter. Reflecting loan and lease growth, the provision in this segment totaled $1.5 million, up modestly from 1.2 million in the previous quarter, and net charge-offs declined to $1.1 million from $1.4 million in the second quarter. Our 30-day and greater delinquency ratio increased slightly to 57 bas -- 59 basis points, at the end of September.

Net income in our home equity lending business totaled $2.2 million, this is up from a restated $0.5 million loss during the second quarter. Loan sales gains and lost provision in this segment were influenced by the low level of loan sales, relative to production, and credit quality, which continues to meet our expectations. Loan originations totaled $444 million in the third quarter, down 11% from $ 0.5 billion, in the second quarter. Loans sales totaled $151 million during the quarter, about one third of the quarter's originations.

As I noted earlier, the Company reclassified about $200 million of loans held for investment, to loans held for sale during the quarter. Reflecting a modification strategy with regard to future balance sheet growth.. We recognized $300,000 of trading gains on our residual asset during the quarter, the carrying value of the residuals at September 30, was $24 million compared to $38 million at the end of September 2004. And the home equity segment recognized $900,000 in revenues from cash collections, attributable to incentive servicing fees, up from $700,000 in the second quarter. As we describe in more detail in note 2, to the financial statements in the 10-Q we filed yesterday, and in consistent with the revised accounting for these assets. The restatement has caused us to eliminate the capitalized, asset we had been reflecting, and will be recording income on the incentive servicing fees, on a cash received, cash due basis, in the future.

In summary, we're pleased with the result this quarter with the combination of turn around in our mortgage banking and steady progress of our two commercial segments. We continue to see strong loan growth and credit quality in our commercial segments, and those two segments each announced record quarterly net income. A strong capital base in the capacity for ongoing growth has us well positioned going into the end of 2005. Jody, Will, and I would now like to open the call up for questions. Justin if you would open us, please.

[OPERATOR INSTRUCTIONS] Our first question comes from Ross DeMerle from Hillard Lyons, please go ahead.

Good afternoon.

Hi, Ross.

First -- well I have a could .of questions on the home equity lending side you talked about a change in strategy, and it looks like you're going to start selling a lot more of our loans if you could possibly elaborate a bit on that strategy. And secondly, on the mortgage banking side with the services portfolio, I -- I have always had a sense that that is -- that business improves with economies of scale, and is there a point where, -- that -- being in that business is no longer profitable, and are you -- I mean for as much as that servicing portfolio has come down, is that -- you considering getting out of that?

Okay. Ross, the -- the strategy to sell more home equity loans really is a reflection on the fact in the first two quarters of this year we sold substantially less product than we typically could against our originations. We -- we have for several quarters made note in the 10-Q and I believe it's in there again this quarter that our long-term expectation given the product breadth that we want to provide to the market on one hand, and our return requirements on -- on -- on capital, and our credit quality requirements with regard to what we want to believe on balance sheet would typically have us selling over 50% of what we produce and in fact, I think the number we used in the Q might be 60 to 70%. So, what we have seen in -- in the year-to-date figures is the fact, that we had a -- a substantial balance sheet capacity to hold on to loans earlier this year, I'm reminded that our cap it will -- total capital ratio several quarters ago was approaching 16%, so, as we have been evolving the product strategy at Irwin Home Equity we have been taking advantage of the opportunity to put some loans on the balance sheet and use the balance sheet leverage. Going forward I think you'll see us get closer to a number that's north of 50%.

On the mortgage servicing side -- and I suspect that you are talking and the first mortgage servicing side, most of the studies that we have seen on economies of scale suggest that the economies are pretty strong among the first billions of dollars that you service, and that they -- the economies then are slower to come when you get over $10 billion in servicing portfolio size. We're 180% of that size right now, and we have not seen meaningful decline in our efficiency ratio that we used to measure scale economy at the mortgage bank. We -- we have incurred some slightly higher cost in the last year, and some of those ratios have gone up, some of the efficiency metrics have gone up in the last year. Some of that is due to the decline in the portfolio, some of it is due to the fact we have been selling a substantial part of the portfolio, and the increase process of shipping the loans and the servicing out have disrupted some of the efficiency gains that we typically could get. So, we believe that with the portfolio in the mid-teens, it's a type of the business where you can make money.

Although, the studies I've seen are not directly addressed the point I'm about to make, I personally infer from the studies I've seen that above the 10 million -- billion range, things like being locate Indianapolis, Indiana have a bigger affect than the actual size of the portfolio on your servicing cost.

Okay. And then one other question, in light of all of the -- the bankruptcy filings that have recently occurred this month and the types -- or some of the older home equity lending that you have done, I guess how do you think that might impact some of the old loans that you have made? I know your credit quality looks good now, but are you concerned about those in any way?

Ross, we don't think the change in the bankruptcy law in the last month will have a significant impact on us. We have for many years observed that the bankruptcy laws give home equity lenders more protection than other consumer lenders, and it's obviously one of the reasons why we're in that business and not in the unsecured business. Our bankruptcy customer -- customers who have declared bankruptcy with whom we have a home equity loan, their -- the percentage of those customers who remain current on their account even after declaring bankruptcy has actually risen in the past year, in large part due -- due to some of the changes and improvements we have made in our servicing operation.

That's a very high percentage that we have got of those customers that are current on their -- on their loan with us, even though they have declared bankruptcy. So, we just don't see much impact on it. We will probably, if we see any we should see it in the near-term, and it will probably steel some losses that we might otherwise see out of '06, as folks probably move to declare their bankruptcy before they typically would have under the natural flow if the law hadn't changed.

We also incorporate the latest information we have on our own customer's bankruptcy filings and the -- our best modeling estimates of what effect that will have on our cash flows into our quarterly review of the loan lost reserves and -- and other valuation techniques. So, if we begin to see some effect, which we haven't yet, it -- it's not expected to be huge, and it would be reflected right away in the way we set up our reserves.

Okay. Thanks.

Next question comes from Gerard Cronin, Jr. Sandler O'Neill & Partners Please go ahead.

Thank you. Hey, Greg. Hello, Jerry. Could you tell me where on the income statement the bonds issuance right off cost would be the 1.9 million?

The controller will answer.

Yes, Jerry it's in the margin. It's included in the net interest net income.

Okay. It is. Okay. Which leads to my second question, what would you have, if you exclude the 1.9 million, you folks do in aggregate average balance sheet, so if you exclude the bond issuance costs, what would the -- would you have calculated for your third quarter consolidated net interest margin?

Jerry, we have not run that number.

You have not.

No.

Okay. Okay. And lastly, on the -- you mentioned in the Q that you called or you redeemed your trust preferred in September and you issued 52 million of trust preferred in early August. Could you disclose what the rates on -- what the rates on those two securities were?

Well, Jerry, the one that we called was a -- a public deal. RFC Capital Trust 2 and it had a nice rich 10.5% coupon.

Okay.

The one that we have recently issued is a fixed-rate for 5 years.

Yes. At a spread of -- liable plus 290-basis point spread, and the rate -- the rate at year end that was at 546 at year end. I don't have that right now.

Talking about the brand new one, Jody. Why don't we get back to that question?

Okay. Great. Thanks you very much those were my questions.

Your next question comes from the John Rodis from Stifel Nicolaus. Please go ahead.

Good afternoon, guys. Hey, Greg. Hey, Will. Hey, Greg, on the commercial bank your margin was up 3 basis points over the second quarter which kind of bucked the trend of a lot of the companies we look at. Can you just kind of talk about what you are seeing there and maybe what you see going forward for the margin at the bank.

John, we've talked for a lot of quarters about the efforts we have been putting forth to increase quarter deposit and moving off wholesale deposits, so I think there's some benefit accruing there. In that segment in particular, the way we do transfer pricing within the corporation, that segment is the one that has the deposit gathering franchise. So, they have been running at a loan to deposit ratio in that segment, less than -- significantly less than 100%. When they have excess deposits, which they do in terms of several hundreds of millions of dollars that they lend to other segments within the commercial banking enterprise. We effectively credit them at a short time overnight rate. Their loan portfolio grew very nicely between March and September, and we have effectively been putting those excess deposits into earning assets for the commercial bank. So, we're getting some expansion in that segment due to the utilization of some of though deposits that we have raised.

I think the second aspect is focusing more in -- in recent months on deposit pricing, and trying to be a little bit sharper on our deposit pricing, and we may have seen the negative of that is that our core deposits might have grown a little bit less quickly in the third quarter than we have seen in the last several quarters. Going forward, we would anticipate seeing margins, your know, in this area, we had an FED rate increase, was it last week? I think there is another one in the market. I think we're going to try to be careful about how we manage our deposit rates against those increases.

Okay. And I guess my second question related to the home equity portfolio. I noticed, I guess in our Q that the percentage of loans originated in California continued to drop. Is that kind of an intentional shift or is it something that just happened? Are you targeting a lower level going forward?

We're not targeting anything specific. I think that just reflects what the originations happen to be.

Okay so it's not by [besig]?

Our -- our overall design, of course is to have a well-diversified portfolio, and that continues, but the particular dynamics of the third quarter did not reflect a strategic shift.

Okay. Okay. Thanks, guys.

[OPERATOR INSTRUCTION] Our next question comes from David Conrad from KBW.

Hi, good afternoon. Just a quick question on the bulk servicing on the MSR's in the mortgage area. I guess it looks to me like you have got pretty good execution this quarter. I was wondering if you could give any other sort of metric, in terms of like a multiple servicing spread that you got on the bulk sales versus maybe what you were getting a couple of quarters ago. It seemed like it was a marked improvement.

David, we didn't disclose the much detail on that servicing sale in the Q, so I'm not going to do it on this call, but the bulk of the marked improvement we got simply was from the rate environment. It was a sale that we were able to execute in the right environment that existed in the middle of August, and although rates generally moved up during the third quarter, they didn't move up there in a linear manner, but we did manage to get that servicing sale done in August when rates were pretty attractive relative to the rates that we saw either in the beginning of July or early part of September.

And the net gain on it, of course was affected by in that tranche whether we were -- the degree to which we were above the cost in carrying the cap and -- and so part of the gain you saw there was because we were able to sell -- sell some product where we had been capped under GAAP with regard to the carrying value. I wouldn't say that the dynamics and the pricing and the overall servicing market have changed much other than just due to the interest rate environment, and so it's a little bit of interest rate and a little bit of the fact that GAAP has been capping our carrying cost.

Okay. Thank you.

Jerry Cronin, if I could go back to your question. I apologize I didn't have this in my head. I think you asked a two-part question about the trust preferred. The deal that we sold deal we called was an issuance that we did in 2000 when -- when yields were pretty high and the yield curve was almost flat that was 10.5% coupon on IFC Capital Trust 2, and we were able to call that with a five-year par call and we replaced wit a 30-year privately -placed issuance that has a five-year fixed period at 596, and then it will float at 3 months LIBOR plus 153 after that point, so we think pretty good economics on that one.

[OPERATOR INSTRUCTIONS]. We have no further questions at this time.

Well, thank you very much; we appreciate everyone's attendance and interest. We look forward to our fourth quarter and year-end conference call during the last week of January, and hope you'll join us then. Thanks.

Thank you, ladies and gentlemen, this concluded today's conference. Thank you for participating. You may all disconnect.