First Financial Bancorp (FFBC) 2006 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Irwin Financial first quarter results conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. I will now turn the call over to Mr. Will Miller, Chief Executive Officer of Irwin Financial. Mr. Miller, you may begin.

Thank you, Tatiana. Good afternoon, I am joined today by Greg Ehlinger, our CFO, and Jody Littrell, our Controller. Before we start our presentation, I want to make you aware of important cautionary disclosures in connection with the forward-looking statements we'll be making on this call. The cautionary disclosures are in our written press release and at the beginning of item 2 of part 1 of our report on Form 10-Q for the first quarter of 2006, which was filed last night.

Since the beginning of the year we've announced two major strategic decisions we've undertaken to address the challenges we face in our consumer segments -- Irwin Mortgage and Irwin Home Equity. As important as these difficult decisions were, they should not overshadow the fine performance over several quarters now of our two commercial segments, Irwin Union Bank and Irwin Commercial Finance.

We had another record quarter of net income from our commercial finance line of business, and our commercial banking segment's net income was 24% about the same period a year earlier. Both commercial segments continue to experience good loan growth, expanded market share, and good credit quality.

The home equity segment performed below our expectations in the first quarter with net income of $1 million. The bulk of the shortfall came from the results in our retail channel. As previously announced, we have taken meaningful steps to improve the performance of our home equity segment by restructuring this retail channel. This will allow us to focus on the two production channels, which have been consistently profitable for us, broker and correspondent. We believe this step will have meaningful positive effect on the segment's results by late in the second quarter.

The excellent performance and good growth prospects of our commercial segments and the actions taken to restore good performance of home equity reinforces for me the decision we made earlier this year to focus our capital and growth on these lines of business. In total, net income from continuing operations for the first quarter of 2006 was $8.5 million, or $0.29 per diluted share, up 16% from $0.25 per share in the first quarter of 2005 and unchanged from the fourth quarter. Return on equity from our continuing operations was 6.6% compared to 5.8% a year earlier.

We are continuing to make progress in our effort to sell our mortgage segment, and we are engaged in discussion with potential purchasers, but we have not reached a point where we have anything we can announce.

So, in summary, in the first quarter of this year we believe we made good progress in our multi-step process of reducing the volatility of our earnings while continuing to move our capital and resources into higher growth and more predictable segments of the banking business.

Now I'd like to turn the call over to Greg Ehlinger, who will discuss our lines of business in more detail.

Good afternoon, everyone. Throughout our 10-Q and in our press release, we've made a distinction based on accounting guidance in FAS 144. Reporting as continuing operations those segments which are supportive of our forward strategy and reporting the first mortgage segment as discontinued operations. We call the mortgage operations "discontinued" for accounting purposes, even though they were, in fact, still running in a business-as-usual mode during the first quarter as we worked on the sale of the business.

As I will note again in a moment, outside of the required accounting classification, there was little discontinued about the mortgage operation, as it was able to produce $2.2 billion of new loans during the quarter. However, as we anticipate the sale of the mortgage segment and focus on the forward strategy and operations of the corporation, we have followed this accounting distinction in our reports for the quarter.

Consolidated net revenues for continuing operations, which includes commercial finance, home equity lending and commercial banking increased on a sequential quarter basis, although revenues were down modestly as compared to a year earlier due to a reduction in loans sold to the secondary market and consequently lower gains on the sale of loans.

Our consolidated loan and lease portfolio for continuing operations was $4.7 billion as of March 31, a 22% annualized increase compared to the fourth quarter reflecting approximately equal increases in both our commercial and home equity portfolios.

At March 31, deposits totaled $4.1 billion, up $200 million from the end of the fourth quarter as certain public fund deposits, which had been allowed to run off at year-end, will replace the fund loan growth. Core deposit balances averaged $2.4 billion in the quarter, down 3% from the end of 2005 as we encountered greater price-based competition.

We had $528 million, or $17.76 per share in common shareholders equity at the end of the quarter, and at quarter-end, our tier 1 leverage ratio and total risk-based capital ratio were 10.5% and 12.7%, respectively, compared to 10.3% and 13.1% at the end of 2005.

During the quarter we called $52 million of convertible trust-preferred securities, the IFC Capital Trust III. Approximately $20 million was converted to common stock. The remainder was redeemed and refinanced into tier-1 eligible 30-year non-convertible trust-preferred stock with a coupon set for the first five years at 6.69%, thereafter floating at three-month LIBOR +1.49%, and these new securities are callable after five years at par.

Non-performing assets were $55 million, or 0.8% of total assets at quarter-end, relatively unchanged since the end of December. Our allowance for loan and lease losses totaled $64 million at March 31, and this was up $5 million from the end of 2005. The ratio of allowance for loan and lease losses to non-performing loans and leases was 177% at quarter-end compared to 160% at December 31. In our consolidated loan and lease provision from continuing operations totaled $9.2 million, up slightly from the fourth quarter. The provision compared favorably to quarterly net charge-offs, which totaled $4.5 million.

On an encouraging note, our 30-day and greater delinquencies decreased in each portfolio.

I'll now turn to some segment detail beginning with commercial banking, which earned net income of $6.8 million, a $1.3 million increase over the first quarter of 2005 reflecting increases in net interest income from loan portfolio growth.

We continue to see strong loan growth as our new markets reach scale. Loans outstanding at quarter-end reached $2.8 billion. This is a 14% annualized growth during the quarter, and 21% growth over the past year. Net interest margin was 3.98 %, up from 3.81% during the fourth quarter as excess liquidity that we had sold internally during 2005 was redeployed within this segment, and we currently expect similarly strong net interest margin in the second quarter.

Credit quality continues to be strong. Thirty-day and greater delinquencies in the segment totaled 10 basis points at March 31, compared to 13 basis points at the end of the fourth quarter, and our provision for loan and lease losses in the commercial banking segment of $1.5 million compared favorably to net charge-offs of only $600,000 during the first quarter.

Our commercial finance line of business earned net income of $2.9 million in the first quarter, an increase of $2.2 million and $100,000, respectively, compared to the first and fourth quarters of 2005. And as Will noted earlier, this was a record quarterly performance for the segment fueled principally by the loan and lease portfolio, which now totals $900 million. This was a $200 million, or 33% increase over the past year.

Net interest income totaled $9.7 million, a $500,000 sequential quarter increase. Net interest margin expanded modestly during the quarter, rising to 4.67% from 4.65% during the fourth quarter, and our loan and lease fundings totaled $120 million during the quarter compared to $83 million a year earlier.

Our loan and lease loss provision in the segment totaled $1.2 million, down from $1.4 million in the previous quarter, and despite the rapid loan growth we've had in the last year, net charge-offs declined to $700,000 from $900,000 in the fourth quarter of 2005, and, as we saw in the commercial bank, 30-day and greater delinquencies declined. In this case by 19 basis points in the commercial finance segment to 0.47% at March 31, down from 0.66% at the end of the year.

Our home equity lending business earned $1 million during the quarter compared with a loss of $1.5 million during the fourth quarter and earnings of $2 million in the first quarter of 2005.

This quarter, higher servicing fees and pipeline hedging gains helped result in the sequential quarter improvements, and credit quality continues to meet our expectations. Loan originations totaled $284 million in the first quarter, down 11% from $318 million in the fourth quarter and $430 million a year earlier.

The decline in origination volume was primarily the result of the retail channel which, as Will noted, we are in the process of significantly restructuring due to its higher origination cost and lower lead-to-close pull-through rates as compared to the more profitable broker and corresponding channels.

We saw lower delinquencies in this portfolio as well. Thirty-day and greater delinquencies on our on-balance sheet portfolio declined to 1.9% from 2.23% at year-end. Our loan loss provision in the quarter increased on a sequential quarter basis from 6.1 million in the fourth quarter of '05 to 6.6 million in the current quarter. Approximately $2.9 million of the current period provision related to the acquisition of $20 million of seasoned loans in conjunction with clean-up calls of previous asset-backed securitizations.

Net charge-offs were $3.2 million during the first quarter compared to 900,000 during the fourth quarter. This was reflective of losses incurred from the increase in bankruptcy filings that we saw in October as well as shipping product mix, loan seasoning, and normal seasonality. Notwithstanding the increase in bankruptcy-related charge-offs, the percentage of our customers who have taken personal bankruptcy but remained current on their obligation to us remains at a historically high level.

Finally, also included in results from continuing operations was a loss of 2.2 million for the parent and other consolidated operations compared to a loss of $1 million in the first quarter of 2005. The increased loss related principally to a $1.1 million write-off of debt issuance costs associated with IFC Capital Trust III, which, as I noted, was called during the first quarter.

The discontinued operations that our conventional mortgage banking segment recorded an after-tax loss of $10.3 million in the first quarter compared with an after-tax loss of $9.8 million a year earlier, principally reflecting mortgage servicing right hedge losses in excess of GAAP-based MSR impairment reversal. The hedge structures employed during the first quarter of '06 were designed concurrent with the decision to exit the segment, and they were intended to hedge the economic rather than the accounting value of the portfolio in order to optimize potential sale proceeds.

Our first quarter first mortgage loan production of $2.2 billion decreased 5% as compared to originations of 2.4 billion in the fourth quarter. The ratio of gains on sales loans sold in the secondary market was 0.68%, only a modest increase over the fourth quarter as we continue to see signs of intense price competition.

We had no bulk servicing sales during the quarter, and the servicing portfolio totaled $18.4 billion at March 31, up modestly from 18.3 billion at the end of '05.

So in summary, our commercial lines of business continue their steady progress and produced very good results in the first quarter. Second, credit quality remained strong and delinquencies declined in each segment. We achieved a 16% year-over-year increase in EPS from continuing operations and, by reallocating our resources to focus on our commercial and home equity segments, we believe these three segments focusing on growing niches, which are aligned with our strengths, will enable us to grow in a more predictable, less volatile manner over the next several years.

Tatiana, Will, Jody, and I would like to open the call to questions, please.

Thank you. We will now begin the question-and-answer sessions. [OPERATOR INSTRUCTIONS] Edward Hemmelgarn, Shaker Investments.

Just a couple of questions -- one, could you talk a little bit more about the nature of -- or the structure that you had for your hedge -- I guess you were hedging the servicing and then mortgage banking operation.

You'll remember under accounting requirements, we are still subject on the MSR to the lower of cost or market cap. So historically we have entered into hedge instruments that were aimed at hedging the amount of value that was at risk that would show up in our accounting statements rather than the entire economic value of the MSR portfolio, because if you started off with a portion of the portfolio well above the LOCOM cap, and its value changed, that change in value would not show up in our accounting statements, but the corresponding gain or loss on the hedge instrument would. And that could create accounting mismatches that we avoided.

However, when we made the decision to exit the mortgage banking line of business knowing that we would sell the entire MSR portfolio sometime this year, we changed our strategy so that we would be hedging the entire economic value of the MSRs in anticipation of the sale and not just the accounting value. Does that make sense?

Yeah, I guess -- you know, going back over, like, your presentation you made back in '05, you know, where you described one of your ideas was is that -- and it makes sense as the reason why you have the servicing portfolio is to be allowed to rise in value when interest rates are rising.

Sure, but there's also the potential that in between the time when we decided to sell and the time we actually got the portfolio sold, interest rates might go down. So we were trying to -- we didn't hedge it 100% as a target, but we did want to preserve the economic value we had in the MSR as we contemplated the sale of the entire portfolio.

Okay. I guess, then, the other question gets at -- I mean, obviously, you're selling at a very low price to book value now -- that's one of the things that structured my interest here, but what -- you're also way over-capitalized, and that's one reason why you're selling at a very low price to book, given your potential earning assets relative to your capitalization -- and you'll hopefully generate more cash from the sale of the -- and perhaps some positive value -- from the sale of the mortgage banking unit, what do you intend to do to, I guess, reduce this over-capitalization or bring it more in line with the asset base that you've got?

That's obviously an issue that we need to turn to once we have clarity on the ultimate outcome of the Irwin Mortgage disposition, and we'll look at all the alternatives. We'll balance the competing alternatives of the stock repurchase knowing that our stock is trading close to book value with the opportunities we have to redeploy the capital and to expanding the three lines of business we have. But we're not going to make a decision on that until we know what the actual numbers are.

Okay, you know, if you had your -- what do you think is a reasonable -- or do you have any targets that you'd like to get to for capital as a percentage of assets?

We have minimum standards, but we don't have specific targets we're trying to manage down to -- if we're over-capitalized, instead we look at it -- or we will look at it, once we know what the actual numbers are.

And I think one other aspect of your question -- Will said we will weigh the competing demands of an attractive share price and a repurchase opportunity with the growth of the portfolios. But I think, you know, tied back to the strategic decision we made in January to sell the mortgage bank, what is available to us, frankly, because we've got three attractive segments, niches, which are growing very rapidly, and which were getting overshadowed by issues of the mortgage banking segment, and those portfolios, as I described, were growing at an excess of 20% rate and have been for a number of quarters now. So it will be an evaluation that we will look at the tradeoffs between the two, as Will said, when the mortgage sale gets done, and there's clarity on the amount of capital that's freed up off the balance sheet due to the mortgage operations on the balance sheet. We'll be clear in our statements about how we're going to deploy it.

Well, I guess what I'm just trying to get at -- I mean -- there's even, you know, I think you've got good growth, although I'm not so sure I see the commercial bank growing at the 20% rate, but your return on equity being around 6% is, by most standards, is very low.

We understand the issue, Ed, we're just not in a position to give you a plan until we know what the numbers are.

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

Okay, thank you, Tatiana, and thank you all for joining us. We look forward to talking with you again around the end of July with our second quarter results. Appreciate it.

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