First Financial Bancorp (FFBC) 2007 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. Mr. Miller, you may begin.

Thank you. Good afternoon and thank you for joining us. I am joined today by Greg Ehlinger, our CFO.

Before we start with our presentation, I want to make you aware of important cautionary disclosures in connection with the forward-looking statements we will be making on this call. The cautionary disclosures are in our written reports -- excuse me, our written earnings press release today and in our recent SEC reports, including our report on Form 10-Q filed this morning.

Results in the first quarter were very disappointing. Today we announced a loss of $6.1 million, or $0.22 per diluted share from continuing operations. Three primary factors contributed to that loss -- weak home equity results due to the disruption in the secondary market, a single impaired commercial credit in Michigan, and slower than planned loan and deposit growth in Commercial Banking. We have taken action to address each of these issues.

The primary impact on us of the adverse conditions in the secondary mortgage market was that investors were bidding prices that were not reflective of the underlying value of our loans, in our opinion, in the first quarter. Accordingly, we used some of our liquidity and strong capital base to move products into portfolio.

Most were originated to third party guidelines that produced riskier loans than we target for our portfolio. Transferring them caused us to add meaningfully to our provision, reflecting the mark-to-market and additional reserve requirements for our portfolio.

To reduce this secondary market risk in the future, we have made significant product modifications and pricing changes, including halting production of loans without acceptable pricing and liquidity in the secondary markets.

We believe these changes, in addition to the restructuring we undertook last year have put us on the path to return this segment to profitability. How long this will take depends on the speed with which secondary markets return to normal. Although we're beginning to see some encouraging signs of this, we cannot predict how long it will take. Mortgage markets are cyclical. On the other side of this shakeout, we think competitive conditions will improve and our products will be much more competitive and attractive to borrowers.

During the first quarter in our Commercial Banking line of business, we discovered we were victims of an apparent misrepresentation of collateral in one large loan. In response, we have increased our credit risk management review process and procedures for collateral review. We have now evaluated the root causes of our losses in Michigan, changed some personnel, and began an in-depth credit review of all major exposures in the state.

Absent this issue, underlying credit quality continues to be strong in this segment. Annualized charge-offs in the first quarter, associated with all loans other than the one with the apparent fraud, were only 10 basis points. This continues a longer-term trend, where on a quarterly basis over the past six years, we have averaged an annualized 18 basis points of credit losses.

In response to slowing deposit and loan growth, we have redoubled our sales and calling efforts, made modifications to our incentive plans, and filled some important open positions in our senior sales group. We believe these steps will enhance both deposit and loan growth in coming quarters.

We saw regional differences in our commercial banking growth, with the midwest market generally flat or slightly declining and the majority of our western markets growing nicely. This geographic dispersion continues to pay dividends for us.

Now, obviously none of us is pleased with the financial results we have delivered over recent quarters. I continue to believe, however, that our strategy of investing in differentiated products and services remains the best way to compete against commodity players in the banking business. Our commercial lines are strong and growing, and we plan to continue to invest in them with a focus on core deposit generation. When the mortgage markets normalize, we believe the balance of our three lines of business will help return us to double-digit EPS growth and earning an ROE above our cost of capital.

And now I will turn the call over to Greg to discuss our financial results in greater detail.

Our net loss from continuing operations for the quarter was $6.1 million or $0.22 per diluted share, down from net income of $0.35 per share and $0.30 per share in the fourth and first quarters of last year, respectively. Combining these results with those of the discontinued operations, the Corporation had a consolidated net loss of $10.1 million or $0.36 in the first quarter.

Consolidated net revenues for continuing operations, those of Commercial Banking, Commercial Finance, and Home Equity, decreased on both a sequential quarter and a year-over-year basis, reflecting increased loan loss provisions and credit based mark-to-market adjustments made on loans moved into our held for investment portfolio from held for sale. Net interest income was $66 million, which is flat on a sequential quarter basis but up 7% year-over-year.

Our consolidated loan and lease portfolio grew to $5.4 billion at the end of the quarter, up 3% from year end due primarily to the transfer of $167 million of consumer mortgage loans from the held for sale to the held for investment classification. As the result of the reclassification, mortgage loans held for sale declined to $45 million at the end of the quarter, down from $238 million at the end of 2006.

At quarter end, deposits totaled $3.4 billion, down from $3.6 billion at the end of the year, reflecting the delivery of mortgage escrow deposits associated with the servicing rights, which were sold in late 2006.

We had $513 million, or $16.92 per share in common shareholders equity as of quarter end. Our Tier 1 leverage and Total Risk-based Capital Ratios were 11.3 and 13.5% respectively, compared to 11.5% and 13.4% at year end. During the first quarter we repurchased 325,000 shares of common stock at an average purchase price of $21.57. We anticipate being in the market for additional shares during the second quarter.

Non-performing assets were $63 million, or 1.05% of total assets as of March 31. And this is up from $58 million, or 0.93% at the end of December, reflecting weakness in some of our midwest banking markets.

Our allowance for loan and lease losses totaled $85 million as of March 31, up $10 million from the end of the year. The majority of this increase, approximately $9 million, reflects additional provision taken at the home equity segment, about $6 million of which was related to the transfer of $167 million of loans from warehouse into portfolio. The relationship of on balance sheet allowance for loan and lease losses to non-performing loans and leases was 1.79% at quarter end compared to 199% as of December 31.

Our consolidated loan and lease provision from continuing operations totaled $23.2 million in the first quarter, up from $9.9 million in the fourth quarter reflecting the increases in the home equity and Commercial Banking segment.

I'll now turn to some detail by segment beginning with Commercial Banking, which earned net income of $3.2 million, a decrease of 53% from the first quarter of 2006. This decrease was primarily the result of an increase in loan loss provision, and increased operating expenses associated with new branch expansion. As we noted in the release, these new offices in the West are already providing returns for us through better credit quality, better margins, and by helping to offset weak loan demand in the midwest. The segment's loan portfolio remained flat from year end. Loans outstanding at the end of the quarter were $2.9 billion.

Net interest margin was 3.99% in the quarter, down from 4.24% during the fourth quarter, reflecting lower than planned loan growth combined with excess funding. We expect the margin to be in the 4% range in coming quarters.

Provision for loan and lease losses increased to $4.6 million during the first quarter compared to a provision of $1.5 million in the same period in 2006. The increased provision relates primarily to the charge-offs with the impaired credit in Michigan that we've discussed before. We took a charge-off of $4.1 million related specifically to this loan during the quarter. And as Will noted, charge-offs associated with all our loans in this line of business totaled 10 basis points during the first quarter.

Our Commercial Finance line of business earned net income of $2.6 million in the first quarter, down from $3.5 million in the fourth quarter, reflecting an increase in provision towards small ticket lease portfolio. The segment's loan and lease portfolio ended the quarter at $1.1 [billion], unchanged from year end. Loan and lease fundings totaled $129 million compared to $164 million in the fourth quarter, and $120 million a year earlier. For portfolio management purposes, we sold $27 million of loans and participations of $25 million.

Although we had an uptick in charge-offs and provision, underlying credit quality in this segment remains in a range in which we are comfortable. Our loan and lease provision totaled $3.5 million during the quarter, up from $2.1 million during the prior quarter. Net charge-offs increased to $1.9 million from $900,000 in the fourth quarter of last year.

The increases reflect elevated losses and delinquencies in the domestic lease portfolio. The bulk of the credit costs have come from originations through a small number of vendors in the automotive sector. We ceased originations through these vendors in the fourth quarter and our total exposure to this stream accounts for less than 0.5% of our consolidated loan and lease portfolio.

Thirty day and greater delinquencies totaled 0.64% at March 31, up slightly from 0.60% at the end of December.

Our Home Equity Lending business lost $10.1 million during the first quarter compared to earnings of $1.2 million in the prior quarter. Loan originations totaled $189 million, down from $254 million in the fourth quarter. This decline reflects the changing and challenging conditions in the secondary market where intermediaries to whom we sell loans changed their underwriting guidelines throughout the quarter, which inhabited the loan origination process.

This portion of the production strategy, originating to third party guidelines, drove the loss for the quarter. Due to the disruption in the secondary markets, we chose to pull back from sales and into an illiquid market. We reclassified $167 million from held for sale to the held for investment classification.

This caused two significant credit hits. First, we recorded a mark-to-market valuation adjustment of approximately $7 million prior to moving the loans to held for investment classification. Once in portfolio, we took a $6 million provision to add to our allowance for loan and lease losses.

In the other side of our strategy, originations intended for portfolio, credit performance continues to meet our expectations. Delinquencies decreased modestly on a quarter-over-quarter basis as we would expect seasonally. Thirty day and greater delinquencies in our on balance sheet portfolio decreased to 2.95% from 3.16% at December 31 and it includes those loans transferred to the portfolio during the quarter.

Amidst the issues in the industry, I am pleased to report that none of the bonds sold in the secondary market with our collateral had been downgraded by rating agencies. And additionally, on April 2, S&P reaffirmed its strong rating on our servicing portfolio with a stable outlook.

Servicing platform.

S&P's ratings on our servicing platform -- strong rating with a stable outlook.

Finally, for continuing operations, we had a loss of $1.7 million for the parent and other consolidating operations, compared to a loss of $2 million during the fourth quarter. The discontinued operations related to our conventional mortgage banking segment recorded an after tax loss of $4 million, reflecting staff and other operating costs as well as increases in reserves for future repurchases of loans. The bulk of the repurchase activity was for early payment defaults on loans made prior to the sale of the segment in 2006. Six months have now passed since the last origination was made in this segment, and as a result, we expect future activity in this area will be substantially lower. The segment has total reserves against unsold and potential repurchases of $21 million at quarter end; $1 million less than we had at year-end.

Assets held for sale totaled $41 million at March 31, compared to $56 million as of December 31 with a substantial completion of the sale of the segment's activities; but with certain remaining obligations in the segment, we expect to report a loss from discontinued operations in each of the remaining quarters of 2007. The amount of the loss is most likely to be affected by future repurchase demands and results of disposition in the secondary market. We have no material exposure to New Century's bankruptcy.

In summary, the results in the home equity segment were bad. However, we were pleased with the underlying credit quality of our core portfolio, and we believe the consumer mortgage market will be much more rational in the future when real estate prices come back to earth and competition has been rationalized.

Second, we believe we are addressing slowing of loan and deposit growth in Commercial Banking. We have put in place steps to improve our sales and calling efforts, made modifications to our incentive plans, and filled some important open positions in our senior sales group.

Third, the increases in credit cost in Michigan and in the domestic small ticket portfolio appear to be isolated events. We have taken steps to improve our credit processes in both segments.

And finally, although we're disappointed with this quarter's results, we do believe we have action plans in place to address the three issues which greatly impacted our results for this quarter.

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

(OPERATOR INSTRUCTIONS). David Konrad, KBW.

I was wondering if you could just give a little bit more color on the home equity, in terms of you talk about changing production, different loan types that you can sell in a secondary market. I was wondering if you could give a little bit more color and maybe what the $189 million represented?

And then, kind of give us a start, in the near-term at least, on what you think production and gain on sale. I think absent of the increase in reserves, gain on sale was kind of basically a breakeven. So just wondered what your near-term outlook for both production units [would be] in that business line.

Let me start with more color and Greg can comment on the near-term outlook.

What happened really throughout the first quarter, although it calmed down towards the end of it, was a series of rolling investor guideline changes almost weekly, sometimes multiple times during a week, where people were either significantly changing the underwriting standards or withdrawing products altogether from the market. As you can imagine, that created quite a bit of difficulty in the production channel where it can take six to eight weeks to close a loan and turning that pipeline -- or changing the criteria for production in that pipeline so frequently was really quite disruptive.

In a number of instances saw the products that we originated for sale to others but were not in our target sweet spot for our own portfolio were withdrawn from the market altogether. So we ceased production of those obviously, when we learned that investors wouldn't buy them. But we did, in some instances, have a pipeline of those products that made up a part of what we transferred into our own portfolio.

Because when you went out and looked for others who might buy them, the pricing we were getting was clearly, from our point of view, sort of firesale pricing that didn't make any economic sense to accept. And even though the addition of the $167 million to our loan portfolio will actually raise the credit risk profile of our portfolio modestly, due to the mark-to-market that we did to mark them down to fair market value before we transferred them and then the additional reserves that we took upon them, we think the inherent greater risk is fully provided for in what we booked.

I would also say that market conditions like this and these kind of disruptions provided some opportunity as well on our own production -- the stuff we are targeting and will continue to do. We've been raising our pricing in the higher CLTV categories, where there is now considerably less competition. It has also allowed us to tighten our own underwriting standards on FICO's and stated income programs and that sort of thing much more tightly.

And we are working to introduce a 90% LPV first mortgage and on some combination loans with first and second, at somewhat lower CLTV's than we've done in the past, like an 85/15 and a 75/25. Because those markets have had so many people pull out of them that where the pricing used to be unattractive to us, it's now getting more attractive.

So it's kind of a mix of good and bad news in there. In terms of the short-term, certainly mostly bad, but some of the long-term elements seem to us to actually have improved competitive conditions.

And David, the other part of your question was on gain on sale. And there are some tables attached to the release that we put out this morning wherein we break out the gain on those secondary loan sales where we got about $200,000 of net gain before hedge transactions. But we had a valuation write-down due to the transfer of about $7.9 million. And that $7.9 includes both -- just shy of a $1 million of an interest rate mark and of the $7 million of credit mark.

I think we have not obviously seen a dramatic turn in the market. But we put a pull in the market in April and we were very satisfied, in fact, pleased, I would say, given recent market conditions with where those are priced. It was a relatively small package so it's not going to have any material impact on the second quarter. But it does suggest to us that what had happened in the market is a disruption of supply due to the implosion of the subprime market. But it's our sense from talking to the folks we do in the secondary market that demand is still there on the institutional side for mortgage products.

So we are anticipating in our internal projections and as we're rebuilding the home equity segment, that margins will remain very slim going forward for the rest of 2007. But it's our hope that as the subprime implosion shakes out that there will be a return of buyers to that market. And the products that Will just described to you will be products that they'd be interested in.

Just to clarify that, since we're not in the subprime market, it's the effect that they have on --

The supply of paper.

-- the supply of paper, and therefore, the collateral effect they have on our near prime paper. So even -- what we really need is for the subprime market, in my sense, to stop being a headline and getting worse so that people can focus again on the quality of our paper as different from subprime. And hopefully the pricing will rationalize.

One of the things that is more evident in the 10-Q filing -- but when we look at our vintage curves for our 2005 vintages, we've really not seen any deterioration vis-a-vis our 2003 and 2004 vintage paper. I think that's a reflection of the changes that we made back in 2003 to dramatically tighten our credit quality, number one.

And number two, the fact that in the last 24 months or so, because of competitive conditions and in market pricing, we have largely been out of some of the heated real estate markets. I was reminded the other day that our home equity concentration, so on the 1/4 or 1/3 of the balance sheet that's home equity, our concentration in California has dropped by more than half from about 23% going back about five years to about 10% today. And I think that's largely one of the factors that, combined with our underwriting changes in 2003, that's helping our 2005 and 2006 vintages look very strong at this point.

Thank you. That was helpful.

Stephen Geyen, Stifel Nicolaus.

You guys have some contracts, have purchased home equity loans from brokers. Can you explain to me just a little bit about how that works? And I was just wondering if most of those contracts kind of fully reflect the current market conditions. Or are there still some pricing issues that you need to deal with?

I'm not quite sure what contracts you're referring to?

Well, maybe contract isn't the right term to use, but you often have relationships with brokers, pre-arranged relationships, and I was wondering if those prearranged relationships that you work out with them, the pricing relationships --

In the broker channel essentially we underwrite every loan ourselves and we price daily. So while we have ongoing relationships with sources, the pricing in that channel and the underwriting guidelines, since they're ours and under our control, are very flexible and change real-time.

That's good to know. Thank you. And another question about Commercial Finance. You guys originate about $129 million but growth was fairly slim over fourth quarter. Just wondering, did you experience some unusually high payouts or is this --?

No, we didn't. You recall that portfolio late last year crossed $1 billion in size. And for some time we've been selling loans to manage portfolio concentrations. We did that again in the first quarter, so about $25 million to some investors, a group of investors that we have been selling to for some time to manage that portfolio's concentration by concept in the franchise portion of the business. The new thing we did this year in the first quarter is we also saw about -- another $25 million.

$27 million was the sales, $25 million were the participations, sorry.

So we solve participations this quarter largely as a tool that we wanted to add to the secondary market tool just to be able to provide flexibility for balance sheet growth there. So we were able to do some participations this quarter. And took the opportunity to sort of learn what was necessary for participations out of the franchise channel.

So overall the growth was still fairly strong?

We were pleased with originations, particularly in the franchise channel. They originated over $50 million in the quarter. We just sold essentially the same amount, about $52 million.

(OPERATOR INSTRUCTIONS). We have no further questions at this time.

Well, thank you all for your time and attention. We appreciate it and look forward to talking to you in another quarter with some happier results to report. Thank you.

Thank you, ladies and gentlemen. This concludes the Irwin Financial first quarter results conference call. Thank you for participating. You may all disconnect.