First Financial Bancorp (FFBC) 2005 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the First Financial Bancorp fourth-quarter earnings analyst conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Claude Davis, President and Chief Executive Officer of First Financial Bancorp. Thank you, Mr. Davis. You may now begin.

Welcome to our fourth-quarter conference call. Joining me for the call today are Doug Lefferson, our Chief Operating Officer; Frank Hall, our Chief Financial Officer; and Greg Gehlmann, our General Counsel. Frank will now read the forward-looking statement. Frank?

Thank you, Claude. As we begin, I would like to remind everyone that our discussion today may involve certain forward-looking statements which are not statements of historical fact. The fourth quarter earnings press release should be read in conjunction with the consolidated financial statements, notes, and tables attached and in the first First Financial Bancorp annual report on Form 10-K for the year ended December 31, 2004.

Management's analysis contains forward-looking statements that are provided to assist in the understanding of anticipated future financial performance. However, such performance involves risks and uncertainties that may cause actual results to differ materially. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to, the ability of the Company to implement its strategic plan; the strength of the local economies in which operations are conducted; the effects of and changes in policies and laws of regulatory agencies; inflation; and interest rates. For further discussion of certain factors that may cause such forward-looking statements to differ materially from actual results, refer to the 2004 Form 10-K and other public documents filed with the SEC. These documents are available on the Investor Relations section of our Website at www.FFBC-OH.com and on the SEC's Website at www.SEC.gov. Additional information will also be set forth in our annual report on Form 10-K for the year ended December 31, 2005 which will be filed with the SEC in the first quarter of 2006.

Thanks, Frank. Before we discuss our 2005 earnings, I want to take some time to highlight what we have accomplished and where we're heading. As we've discussed in prior releases and calls, we are in the midst of implementing our strategic plan announced in March 2005 that has multiple elements. Therefore, we view 2005 and 2006 as a transition period for First Financial as we move to execute on our new strategy.

We are encouraged by the progress we've made thus far. As a reminder, the critical elements required to execute the plan are as follows -- reorganization of the Company's structure and management; the balance sheet restructure; the growth of our business; and improvement in our efficiency.

Our operating performance for the fourth quarter of 2005 was $0.07 per share after the inclusion of several nonrecurring items. These items included the securities impairment charge of $6.5 million or $0.10 per share, the restructuring costs of $0.04 per share, an additional provision expense of $0.02 per share due to the charge-offs related to the consumer bankruptcy law change, a gain on the sale of mortgage loans of $0.01 per share.

These per share numbers are based on fourth-quarter 2005 average shares, which have not yet reflected the share repurchase we completed in early December. As a reminder, we repurchased 3.25 million shares or approximately 7.5% of our outstanding shares.

Our financial performance is currently a reflection of where we are in the development of the Company and the implementation of the strategic plan. We do not provide earnings guidance, but as stated in our strategic plan, our Company goal is to improve in the near-term to earn at the median of our peer group or in the 12 to 14% return on equity range, and long-term, to earn in the top quartile of our peer group or 16 to 18% return on equity. In addition, we are working to build a Company that is focused on customer growth higher than our market area growth.

Frank will now review a few areas of operating performance.

Thank you, Claude. Our net interest margin declined by 11 basis points in the fourth quarter to 3.72% from the third quarter of 2005. The decline, in addition to being in a difficult flat yield curve environment, was also a direct result of our planned production in certain loan categories and the excess liquidity that resulted.

Our plan for improving our net interest margin includes the restructure of our investment portfolio and the prepayments of up to $200 million of Federal Home Loan Bank advances. This should result in an approximate 30 basis point improvement in net interest margin.

In addition, over time, we expect to see increased loan growth, principally in our commercial area which will change our current loan mix. We are approaching this growth cautiously from a credit quality perspective. We will also evaluate certain existing customers and loan types from the past that we may not want to continue in the future. This will create downward pressure on our loan balances.

In the last half of 2005 we were successful in adding several experienced commercial bankers. While it takes time for them to develop their pipelines and ultimately close loans, we are encouraged by the early results in the development of the pipelines. Also, several of our lenders have nonsolicitation agreements that are still in place from former employers thereby restricting their ability to contact previous customers. These agreements begin to expire in 2006.

We also continue to expand our branch network in our higher growth markets. In 2005, we opened three new offices in northern Kentucky and northwest Indiana. Our plan is to open four new offices in 2006, with three of those being in southwest Ohio and one in northwest Indiana. In 2007, we are currently planning to open four to eight new offices in the southwest Ohio and northwest Indiana markets.

Some of our credit quality measures worsened during the fourth quarter, principally our nonperforming asset levels and our net charge-off rate. Our charge-offs rate was at 37 basis points, primarily due to higher consumer bankruptcies as a result of the change in the bankruptcy laws. We expect this to be a timing issue that may extend into the first quarter of 2006. However, we have already seen a significant decline in new bankruptcy filings in December and January.

With the consolidation of our banking charters and the significant improvement in the talent and depth of our commercial credit group, our recent loan reviews have resulted in a few rating downgrades to some commercial loan relationships. Our credit, staff, and lenders are working with our clients to make improvements in loan structure and performance, and ultimately improve the related loan grades.

On a positive note, our past due levels have not increased, and our charge-offs are still in an acceptable range and, excluding the change in the bankruptcy law, are consistent with our expected range. In addition, we have continued to provide a reserve levels that is commensurate with our current loan quality ratios.

Excluding the securities impairment charge, our non-interest income increased 9.1% for the fourth quarter 2005 over the fourth quarter in 2004, and 0.2% for the full year 2005 compared to 2004. We continue to see an opportunity to expand our business in this area through continued growth in our wealth management business and service charges in our deposit business.

As outlined in our earnings announcement, we believe we need to make a significant improvement in our efficiency ratio. A critical part of this process is to see a reduction in our expense levels based on our current level of revenue.

This will be accomplished through several steps. We will complete the position reductions related to our operational consolidations. We have engaged Sandler O'Neill to assist in our branch evaluation. And now that our organizational restructure is almost complete, we will be evaluating every area of our operations for improved efficiency. I encourage you to read our earnings release for more detail on these topics, and will now turn it back over to Claude.

Thanks, Frank. I will wrap up our comments by noting that while we have accomplished many aspects of our plan, we have several others yet to accomplish. However, I'm very optimistic about our ability to completely execute the plan and return First Financial to a high-performing, growth-oriented company.

This concludes our prepared comments. And at this time, I will open the call for questions with Doug, Frank, Greg, and myself.

(Operator Instructions) Brian Hagler, Kennedy Capital.

Just a few questions. One, Doug, how much did excess liquidity impact your margin of the 11 basis points?

This is Frank. Of the 11 basis points, the excess liquidity is 11. It is the full 11.

Oh, okay -- so it's all 11 basis points. And as you get that reinvested, obviously, that would help?

That's correct. And that will be in conjunction with the balance sheet restructure that we announced as well. So that will be incorporated into that analysis.

Okay. And then Claude, can you review what your efficiency ratio goals are?

The efficiency ratio goals that we have discussed is -- if you look at our peer group, which we think we should be able to be in that range, is approximately in the 59 to 60% range -- and that we would expect to at least get to that level over time.

Because I guess I tried to back out all the one-timers that you had this quarter, and kind came up with an upper 70s type ratio. And then even backing out the 5 million or so that you're hoping to get from your expense program, that still only gets you kind to the mid 60s. Is there more to go, or do you think that the branch review will get you kind to that 60 target?

I'm not sure we calculated in the mid to high 70s in terms of the net of those items. But regardless, we are short, but we are not yet to where we need to be, even with the operational consolidation savings. We have more to go in the way of cost reduction and revenue improvement to get to that 59 to 60% level. And that's a part of what we call our Performance Improvement Plan that we've undertaken -- in terms of looking at all areas, not just the branch environment, but also looking at all other areas of the Company for efficiency improvement.

Okay. And then I guess what kind of efficiency ratio did you guys come up with, and could you give any more timing or sense of timing on the branch review?

The branch review is currently underway, and as we complete that, we will certainly announce the results of it. We're saying probably the first half of 2006 (multiple speakers) with respect -- in terms of timing. We don't -- I don't know, Frank, do you have a --?

No, we didn't recalculate that in the earnings release. But we can take a look at that.

The efficiency ratio?

Yes. We didn't show what a core efficiency ratio is (multiple speakers). We tried to back out the components so you could isolate what core and noncore items --

Right, right. I guess my upper 70s number was a little high, so I was just wondering kind of what you guys had in mind. Did you come up with lower 70s or --?

As I said, we did not include that in the earnings release.

Fred Cummings, KeyBanc Capital Markets.

A couple of questions -- one with respect to the pipeline for commercial loan growth. Claude, can you talk about what's happening there? I know it's been a pretty challenging commercial loan origination environment for a number of mid-cap banks in Ohio.

Sure. Our pipeline is building, as we stated. We obviously have not yet seen that translate itself into significant loan growth in terms of closings. The work now is to get those loans to close.

You're right; I think it is a comparatively slower time than maybe it was earlier in '05 or '04. But we still see some good activity, so we're encouraged.

Okay. And then you talked about the plans to maybe expand your branch network. Where do you stand in regards to hiring more commercial loan officers? What are your plans on that front?

You know, we had a strong push as we outlined in the release, Fred, in terms of especially the last half of '05. And in total, with the hiring of the 16 commercial bankers, we continued to look to add to our commercial team, especially in the Cincinnati market and in the Dayton market and really throughout southwest Ohio and northwest Indiana. And so we would expect to see additional recruiting efforts, especially in those two markets that we think are the most vibrant commercial markets for us.

Okay. And then Frank, one question for you. With respect to your headcount, I think at the end of the third quarter, 1,434 FTEs is the number I have. Where do you stand at year end? And then as we look out to '06, I know -- excluding the planned divestiture of branches, do you think you'll be down in '06 versus where you finished the year in '05?

We're at about a 1,460 for year end on headcount. And yes, I would fully -- excuse me, FTE is at 1,460.

As far as '06, yes, given the plans that we've announced, I would expect that number to decline.

Okay. Then one last question -- as it relates to managing the other portions of the loan portfolio, should we anticipate additional whole loan sales in the mortgage area similar to what you did here in the fourth quarter?

What that particular loan sale related to was -- they happened to meet a risk profile that was no longer consistent with what we were looking for. They had an extreme rate risk movement scenarios. We ended up with risk characteristics that we didn't care for.

So the short answer to your question is probably not. However, it is something that we review periodically. And if we end up with a piece of the portfolio that just has unusual risk characteristics, we would probably look at something again. But given the fact that we are selling most of our mortgage loan production into the secondary market, I would not expect to see any more movement in the current mortgage loan portfolio.

Brad Ness, FBR.

Is it safe to assume that the cost-saving assumption of that 4.8 to 5.2 million -- none of that has occurred yet as of the fourth quarter?

No, I wouldn't say none of it has occurred. We expect -- and that's an annualized number. We expect to be sort of at that rate in the first half of '06.

Okay. If you had to project how much has occurred annualized during 2005, what would you guess? Would that be half of it?

Boy, I hate to guess on that. I think what you can look at, though, is our estimated costs associated with the restructuring and gauge it relative to how much of that total cost estimate that we've actually incurred. And I think it's 3.8 estimated total cost, and we've incurred 3.2 million of that. But I wouldn't say that that is precisely correlated there.

Well, and Frank, when you say most of that during the fourth quarter --

That's correct. Does that help?

Yes, absolutely does. I appreciate that. And with regard to your residential mortgage loans, it looks as though you guys are more aggressively selling that portfolio. Is that both fixed and ARMs, and should I assume that eventually, this portfolio could dwindle down to a de minimus as far as its portion of your balance sheet?

Yes, right now, the real estate mortgage portfolio is about 54% of our total portfolio. And we are selling both fixed and adjustables into the secondary market.

We feel that the current mix is weighted a little too heavily toward real estate mortgage loans. There is an optimal level. We're not there yet. But I would expect to see it decline to a certain point -- plus we're hoping to offset that mix with some growth in the commercial portfolio as well.

So we're looking to achieve a mix shift in our loan composition in two ways -- one, a reduction of the mortgage loans, and two, the increase in the commercial loans.

But that would not be reduced to a de minimus. (multiple speakers) It would still be a significant percentage of our portfolio, but just lower than it is today.

Okay. And lastly here, do you have any mortgage [servicing rights] gain or impairment in the quarter?

No, none in the quarter.

Eric Grubelich, KBW.

I've got a bunch of things for you here. The first one is -- with respect to the mortgage portfolio, would it be the proper assumption that the portfolio -- if you looked at the decay rate on it, if I looked at what it did this past quarter, is that a good decay rate, with the exception of the loans that you actually sold out of the portfolio? In other words, if you're not going to retain anything that you originate anymore, is it just going to slowly burn off at the rate of -- you know, pick the [PSA speed], but something like that?

I'd hate to say that it will continue on that linear path, as you mentioned with your PSA comment. There are a lot of assumptions in there.

And Frank, I would add that it shouldn't take -- as we tried to state in the press release, we are selling a majority of our mortgage loan origination in the secondary market, but not all. And that percentage may increase and decrease over time, depending on the type of product we originate. But we wanted to make sure you were aware that we are selling more into the secondary market than previously, but there will be additions to the portfolio.

Okay, but your intention is to take it down from the -- I know on an average balance basis it was about 54%

Right.

Your intention is to reduce that with hopefully the intention of increasing the commercial and commercial real estate lending?

That's correct.

That's fine, good. Now, the other thing that I'm having a little bit of a tough time is the comment about the net interest margin going up 30 basis points or $0.05 a share -- and I know that was in the release from February 1, if I'm not mistaken. If you take 30 basis points on your balance sheet as it is, that's a heck of a lot more than $0.05 a share improvement. So I guess what I need to factor in is the securities that are being sold 200 million or up to the 200 million aren't coming back, and other net liquidations in the near-term will bring that only to a $0.05 improvement?

That's right. And we'll detail this when we actually execute the transaction. Much of that margin improvement comes from the fact that we are shrinking the balance sheet. So the --

By the up to the 200 million.

By up to the 200 million, that's correct. That's the margin improvement.

That must have been in a not-so-great carry margin, I guess, right?

It was at a negative (laughter), so yes, not so great.

That's fine, good. The other question I had was you mentioned in the press release that you are replacing your data processing system. And I don't recall if it said what the timing was on that. But will there be any incidental costs to affect that implementation? And I'm not referring to just the capitalized costs or whatever you're installing that you're going to write-off over time, but something else -- consulting fees, professional fees, whatever that is going to be involved with getting that new system in? And how pervasive is that replacement?

I guess in a scenario there could be -- we haven't disclosed any, and quite frankly, the timeline is still being established on that. So there are a lot of variables there. But if there are material costs associated with that, we will be sure to disclose those.

Okay, that's fine. And then the other thing was your mortgage banking in the quarter obviously had the gain from the sale of the portfolio loans. If I backed it out correctly, it looks like you made maybe 400,000 or so in regular core mortgage banking gain on sale. Does that sound right?

You had, what -- a little under $800,000 of gain from the portfolio, and I think the total mortgage banking line was 1,124,000?

I think it's a little south of that number there.

Okay. So I guess the question is is that a reasonable run rate? Was the fourth quarter weak, or what do we expect going forward from that line of business?

I don't think our experience is too vastly different from others in the industry. I think many have seen volumes slow, but --

Is there anything with the spread on what you sold? Because there were a few banks this past quarter that got hammered on a gain on sale spread.

The margins were compressed. I mean, it was a much more difficult pricing environment.

Okay. I've heard it sorts of reflated in the January time period -- but okay, that's fine. And then -- oh, yes, you also mentioned in the release that you had a buyout of, I guess, some computer leases? Am I reading that correctly that that was a one-shot, onetime benefit? There's not a recurring benefit from that going forward, right?

We bought the leases out so we no longer have the lease expense. So to the extent that we continue to use those computers, there is no additional expense associated with it.

Okay. So that would be -- like linked quarter, your premises and equipment was down, it looks like about -- call it 250, $300,000 something like that. Again, you disclosed what the amount of that savings was. So that really does affect the run rate going forward, then? It wasn't just a one-shot reduction this quarter, and then it pops up next quarter?

That's correct.

Okay. I wasn't sure whether to interpret that as like a gain on a lease buyout or just a net reduction in cost. You're telling me it's an improvement in the run rate then to some degree?

Yes.

Okay, good. And then a little bit more of a mundane question -- we all know what you did with the accelerated buyback and what the price was, but the extra stub of regular buyback -- do you know what the average share price was for those securities, the common equity that you bought?

I don't have that number in front of me, but we'll be sure to disclose that in the K.

Okay. And then one last thing, Frank. Someone asked earlier in the call about the liquidity portfolio, the investments in your other earning assets. You know, that popped up on an average basis quite a bit. You did make mention to the fact that with some of the proceeds, I guess, from the loans that were sold and other liquidations -- when I look at that number, it was close to 750 million for the quarter. Notwithstanding what you'd plan to do with the portfolio, that level is up well over 100 million from the last couple of quarters. Do you intend to use that or -- keep the way it is, or use some of those funds to pay back FHLB in excess of what you plan to sell out of the portfolio, the securities portfolio?

We are considering that liquidity in our overall balance sheet restructure analysis.

Brian Hagler, Kennedy Capital.

Just a couple of quick follow-ups. One, can we get a little more detail on the nonsolicitation agreements? Remind us how many commercial lenders you hired last year, and how many were impacted by that?

We hired about 16 bankers in the southwest Ohio area, southeast Indiana, which is where we concentrate a lot of our recruiting. We didn't disclose and don't disclose kind of individual agreements or how many. I would say there were several, but that's the extent of it. We've chosen not to disclose the individual details.

And how long were those agreements -- six months, a year --?

They varied. But those we hired in 2005 all expire in 2006.

Okay. And then I guess lastly, you mentioned expanding de novo in the metro markets I guess, and looking at strategic acquisitions. Can you talk about what type of acquisitions you're looking for, and why you feel like you're ready to maybe do such a transaction?

The comments we have made about strategic acquisitions are kind of obviously over time. And it's one we continue to look at in terms of strategic acquisitions -- would be in those markets where we believe we already have a significant presence, where we'd like to have a significant presence, and where we think the growth prospects are good. You know, we probably wouldn't comment at this point whether we're ready right now or not. But that's the long-term plan.

So it would just be in markets where you're already at?

Or those where we see a significant growth opportunity.

Fred Cummings, KeyBanc Capital Markets.

Can you give us an update as to how successful you've been in terms of attracting these commercial deposits? I think you said you were at least going to hire some deposit specialists. Can you give us some update on that initiative?

Sure. That initiative is, I would say, going slower at this point than we would like, principally because we've not focused as much recruiting time as we hoped to going forward. That is a significant part of our plan for '06 is to be more aggressive. We have hired -- I think it's two or three -- actually, three deposit sales specialists. And they are still early in their building of the pipeline. So that's a 2006 initiative.

Okay. Then one last question, Claude. With respect to how the Board is reviewing management's performance, would you say -- in '05, did you come in in line with what you had expected to do; did you fall below plan, or were you on a core basis above? How did you look at your performance in '05?

Well, we obviously don't disclose the Board's expectations or budgets. But the Board's focus, as management's is as well, is on the development of the plan and putting in place the core infrastructure and the elements of the Company we need or think we need to grow the Company going forward and to achieve the kind of financial results that I outlined in my comments.

And as I said, we feel good about the steps that we've taken in 2005, the successes we've had. Certainly it wasn't without challenges as we've talked about. But we feel good about where we are at currently.

(Operator Instructions) Eric Grubelich, KBW.

A couple more for you. Just on the number of lenders that you hired, the 16, what was sort of your average -- or as you approach the end of the year, without those 16, what was the core lending staff at the bank? How much did you increase it with the 16 people?

You know, in --

And I don't mean like the admin and the credit analysts -- just like the guys out there that are hustling the loans (multiple speakers)

I don't have an exact number. It is north of 60.

That's fine, Claude. That's close enough.

It's probably a 20% add, or in that range.

Okay. So it was a pretty decent -- if you added 16 on top of 60, that's a lot.

It was a significant add.

Okay. And then I wanted to make sure I understood you correctly, whoever made the comment, that you said you were going to open four offices in 2006; is that correct?

Correct.

Okay. And are those standard branch? Is there anything different in terms of -- are they going to be larger, bigger, cost you more to operate, or are they going to be smaller average branches than what you have?

Two are standard retail offices. The other two are the headquarter offices, if you will, of Cincinnati and Dayton. And so those would include commercial lenders --

Sort of like a hub office?

Sort of like a hub office. They both, though, are in leased facilities.

Okay, and those are not open yet, correct?

That's correct.

Okay. Do you have any idea as to the timing of those four?

The two retail will be late in 2006. The Cincinnati will be late first quarter. Dayton will be first quarter as well, although the staffing -- we're still in the recruiting phase of Dayton. The staffing will ramp up throughout 2006.

Okay. So there needs to be more headcount for that. But it sounds like the Cincinnati operation is staffed already?

Yes, principally. Back to Fred Cummings' question, we are continuing to recruit commercial bankers in both Dayton and Cincinnati. So as we find strong salespeople, we will look to recruit and hire those individuals.

Brian Hagler, Kennedy Capital.

Last one. Just on the branch review, can you tell us what the average deposits are in some of your rural branches, and possibly how many are slightly profitable, breakeven, or unprofitable?

The average branch size for -- and this information is available on the FDIC web site -- some of the more rural offices, depending on where you're looking -- I'd say the smaller offices, if you were looking for an average, it's going to be 15 million and below. I don't know if that helps.

Our overall average is 27.

Right.

Okay. So overall, 27; rural is closer to 15. And what does it take to break even in some of the rural markets?

That depends on a lot of factors. I know the old banking rule of thumb is $12 million in deposits. But of course, that depends on the composition of loans and deposits.

And staffing levels (multiple speakers) [hours], and part of our branch evaluation are all of those factors.

Okay. And then how many of the 105 would you consider more rural?

We have not kind of cut it that way.

Is that roughly half or --?

I'd say it's probably more of a 60-40 split. You can look at the offices in the southwestern Ohio and northwestern Indiana and sort of draw your circles around those offices and look at everything beyond that. I'd say it's probably a 60-40 split.

Gentleman, I show no further questions in queue at this time.

Well, we appreciate everyone joining us for our call. And thank you, Joy.

It was my pleasure. This concludes today's conference call. Thank you for your participation.

Thank you.