First Financial Bancorp (FFBC) 2008 Q3 法說會逐字稿

Good afternoon ladies and gentlemen. Welcome to the Irwin Financial Corporation Q3 conference call. All participants are in a listen-only mode. Later we will conduct a question and answer session.

I will turn the call over to Will Miller.

Good afternoon. Thank you for joining us. I am joined today by Greg Ehlinger, our CFO, and Jody Littrell, our Controller. Before we start with our presentation, I want to make you aware of important cautionary disclosures in connection with any forward-looking statements we may make on this call. The cautionary disclosures are in our written earnings press release and our recent SEC filings.

In addition I also need to note that since a Registration statement related to the Corporation's shareholder rights offering has been filed with the SEC, but has not yet become effective, we are in a quiet period. For these reasons, we would like to limit the questions we take in the Q&A session to the information in our Q3 earnings press release, and other previously reported information. I am not permitted to answer questions related to the rights offering, other capital raised related areas, or other forward looking areas, with any information not already in the Registration statement we filed, until our Registration statement is declared effective by the SEC.

This morning we reported a Q3 loss of $54 million, down from a $107 million loss in Q2. Losses were primarily attributable to restructuring costs of approximately $30 million, additions to loan loss reserves of approximately $16 million, and valuation reserves for deferred tax and other assets of about $10 million. We have made substantial progress on our strategic restructuring during Q3, we successfully exited the small ticket leasing business, and continue to shrink our exposure to home equity, We securitized 85% of our remaining home equity whole loans with nonrecourse funding, thereby capping our credit exposure on these loans. Our home equity portfolio is now in run-off mode.

We made progress on our plans to strengthen capital base as well. We filed a Registration statement with the SEC relating to a $50 million rights offering to shareholders. Last week we received shareholder approval to increase our authorized shares, which provides us the flexibility to pursue our rights offering for other capital raising activities.

I am pleased to announce that we have secured additional commitments from standby purchasers for the planned rights offering, increasing the total commitment from 31 million to $37 million. So now we have 74% of the anticipated offering already committed.

We are making steady progress on our restructuring to focus on small business and community lending. As as example of the success of this renewed focus in the third quarter, we expanded our loan portfolio in Columbus, Indiana, our headquarters location, in fact, we are pleased that in Q3, Irwin Union Bank was the leading producer of consumer residential mortgage loans to our neighbors in the community, producing 44% more residential loan volume than the next largest competitor locally.

I believe that through our strategic restructuring, we will return to profitability by simplifying our business, and returning to the core strategy driven that has driven our success for the past 137 years, serving small businesses and consumers in our branch communities.

Now I will turn the call over to Greg to discuss results in greater detail.

Good afternoon. Net interest income of $48 million decreased 22% on a sequential quarter basis, reflecting the sale of the equipment leasing portfolio, the securitization of $268 million of home equity loans, and a reduced level of loans. Noninterest expense increased from Q2, reflecting restructuring activities which totaled approximately $30 million during the quarter. Excluding these restructuring costs, noninterest expense was flat relative to Q2.

Consolidated net interest margin declined to 4.16%, as compared to 4.38% during the Q2, reflecting the smaller loan portfolio, and excess liquidity retained to address environmental conditions in the banking industry. Due largely to the sale of the small ticket leasing business, the consolidated loan and lease portfolio declined nearly $800 million during the quarter. The loan portfolio totaled $4.7 billion as of September 30th.

We had $8.82 per share in common shareholders equity as of September 30, at quarter end the Tier 1 ratio in total risk based capital ratios were 6.8 and 10.8% respectively. Those same capital ratios were 9.3 and 11.3% respectively at Irwin Union Bank and Trust, and the ratios were 11.2 and 12.4% at our thrift, where we have committed to the OTS to hold 9 and 11% respectively.

To address economic conditions, we substantially increased our allowance for loan losses during Q3. The allowance totaled $232 million at the end of September, up from 216 million at the end of June, and 104 million a year earlier.

Turning now to each of the segments, Commercial Banking lost $15 million during Q3, reflecting increases in loss provisions for commercial real estate related loans. The segment's loan balances declined during the quarter, as we reduced our concentration of commercial real estate loans. Net Interest margin was 3.58 during Q3, down from 3.66 during the second quarter, reflecting unsettled market conditions, and the decline in earning assets.

We added $20 million to loan loss reserves in excess of the quarterly charge-offs of $9 million for a total loss provision of $29 million. The segment's allowance for losses grew to 2.57% of loans at September 30, up from 1.75% as of June 30.

In the Commercial Finance line of business, the franchise finance channel, the part of the commercial finance business we are retaining after the restructuring, earned $3.3 million, up from earnings of $1.7 million in Q2. In total, including the $650 million equipment lease portfolio which we sold in July, the segment lost 2 million in Q3. As a reminder, we sold the lease portfolio of this segment in July, and have ceased any additional originations of equipment leases.

The Franchise finance loan portfolio totaled $611 million as of September 30. Franchise finance loan sales totaled $48 million, with net gains on sale of franchised loans of 3.2% of loans sold, in-line with other quarters. We are pleased we continue to be able to sell franchise loans at an attractive premium, even in this environment. Net interest margin for this line of business was 4.31%, up modestly from 4.24% during Q2.

The home equity segment, where we have put the credit risk portfolio in to run off, lost $24 million during Q3, 47% less than in Q2. The loss reflects the affect of a loss provision of $27 million, and $15 million in restructuring charges related to the planned exit of this segment. 30 day and greater delinquencies in the home equity portfolio increased from 6.06% at June 30, to 7.43% at the end of September. The allowance for loan losses totaled $155 million, or 12.1% of the portfolio at quarter end.

In our other bank and nonbank consolidating entities, we lost $14 million during Q3, and this loss was primarily due to a deferred tax valuation allowance of $8 million. We also recorded other than temporary impairment or $2 million, on a portion of the security portfolio which has not traded in several quarters, due to illiquidity in the secondary markets. Each of these securities which we now carry at an aggregate discount to par of about 85%, remained current on scheduled interest not withstanding this mark-to-market.

So in summary our Q3 losses were half of our Q2 loss, and were driven by restructuring charges of $30 million, loan loss reserve additions of 16 million, and valuation reserves of other assets of $10 million. Our credit exposure to home equity continues to shrink, as we completed a non recourse securitization structure during the quarter, and in the past couple of weeks, we have received additional standby commitments for our capital raise, which now totals $37 million, or 74% of the anticipated offering.

Finally we remain on our path to return to our core historical strength of small business lending and serving customers with banking services in the neighborhood where we have branches. As Will noted, we saw an example of this refocus during the third quarter, as we expanded our loan portfolio in our headquarters market here in Indiana.

John, now Will and I would like to open it up for questions please.

We will now begin the question and answer session. (OPERATOR INSTRUCTIONS). Our first question comes from Ross Demmerle, Hilliard and Lyons, please go ahead.

Good afternoon. It looks like noninterest expense at the bank jumped up quite a bit, is there anything nonrecurring in there, or in the Q it says FDIC insurance premiums, but I am wondering if there was a chance that might go down going forward?

There were some severance charges, but the FDIC insurance premiums were the major component of it.

So it sounds like that the level of experience in this quarter is a pretty good run rate going forward?

Yes. I can't forecast when the FDIC premiums would change.

Well, they are probably going to go up higher next year.

That is one of the reasons I can't forecast that change.

(laughter) Okay. Thanks.

Our next question is from [Roger Saul, Worldwide Christian Aid]. Please go ahead.

I have got a question on the 8-dollar something a share. Is that like what book value is of IFC?

Yes. That is our current book value.

Okay. Why would shares be like a quarter of that or less right now?

I can't speculate on how the market is trading. It is a mystery to me.

I mean if they broke up IFC, and distributed all of the equity out over the shareholders it would be about $8 each though?

That is the accounting figure. I think people would have different estimates of what a liquidation value on a fire sale would be. But the accounting number as presented in the books is the $8. Yes.

Okay. Like the optimal then probably, right? What is a franchised loan?

Those are loans made to people who take out franchises from major quick service and casual dining restaurants across the US, like Burger King, Wendys, Q-doba, Dunkin' Donuts. We loan money to the small business people who take those franchises and operate the restaurants.

Right. So if somebody wants to buy one of those franchises you might lend them part of the money for the franchise fee then basically?

Not just the franchise fee, but the purchase of equipment, and in some cases, construction of a building. Our target market there are experienced operators, who already have five or six units of a particular brand, and are expanding, and we have a very good mix of brands.

Is there a timeline on when the SEC is supposed to give it's okay or not, for the dilution of the shares or the issue of the additional shares?

They have I believe until the end of next week to give us comment letters, and then if they have any, we will deal with those, and then whether or not they give comments, would influence whether or not what the next deadline would be.

I was doing the math, if it says 200 million shares and they only need $50 million, isn't that like about $0.25 a share?

The authorization of shares does not mean we will use all of them. That is just the upper limit we can deploy without going back to shareholders. The pricing of the rights offering will be completely independent from the authorized shares.

Okay. That is good. Can you guys get money at 1% at the Fed window, or something like that? It seems like this is a fantastic opportunity to get cheap money. Can you access those low interest funds?

I am trying to make sure I know which ones you are referring to.

The discount rate is down to 1%.

Right. Yes.

Can IFC get money from the federal Treasury in some way at 1% interest, at least for a short-term?

We can access the discount widow, you are right in believing that the Fed wants you to keep that very short-term, and so it is not a source of funding you do a lot of your balance sheet in.

Too short to do like even loans with a three year adjustable or something?

One of the principles of good interest rate risk management is you want to match the term of your funding with your liability.

Yes. Borrow long, lend short. That is my main problems for now.

Thank you.

Our next question from Bill Chen from Barrington Partners.

Thank you for taking my questions. Housekeeping, other assets could you give a little bit more detail within there?

Bill the biggest part in our other assets is our deferred tax asset. We also have $50 million of bank owned life insurance assets in there, those are the two biggest pieces.

What was the last one?

BOLI, Bank Owned Life insurance contracts.

Right.

Those two pieces make up about 75% of what is in Other assets.

So DTA is about 75% then?

The DTA and the bank owned life insurance combined make up roughly 75% of what is in Other assets.

Got it. Okay. That is really helpful. Second thing, one thing you provided a lot of helpful information on on the last call was the construction loans. Last time around I believe you gave geography, and also a little bit of color on what was going on. That would be great if you could provide a little bit more of that again today?

Bill, if you look in our 10-Q around page 42, you can get it on our website in PDF form, you will see some detail there.

You said page 42.

That is right.

That gives portfolio information on the franchise finance forms.

Back up a few pages.

Okay. I will flip through it. In terms of the brokered CDs at IUB, from what I recall correctly, that with the OTS you cannot take on brokered CDs, or any more--?

We cannot take not brokered CDs in the thrift, which only has about 15% of our assets, we are still permitted in our state chartered bank.

I would assume that would be about 15% of the 900 million, is that about right? Is how much brokered CDs are in there?

No. The brokered CDs remain spread between the two charters, and we didn't have to do anything with the ones that were already outstanding. We just weren't/aren't allowed to issue more in the thrift. But we have plenty of liquidity in the thrift, and don't need to issue brokered CD's there, and we are not precluded from doing that in our state chartered bank.

Okay, appreciate that, that is helpful. In terms of the 37 million of the offering that has been committed, is 25 million of that coming from Cummins?

Yes. 25 million is from Cummins, the remainder are from individuals.

So the thing I am trying to understand is when I went through the documents for the Cummins standby letter of commitment, is says that Cummins can own up to about 19.9% of the stock, is that correct?

Right.

so assuming the current market capital of around 55 to 58 million, I am not getting to the full 25 million?

We also said we are working on a possible exchange of trust preferred for common, which would add some additional ownership to the company, and affect what ultimate percentage Cummins would have, and therefore how much of the 25 million they would be able to put in. Of course Cummins 25 million in total, depends on what the response from the other shareholders is.

Of course. Excuse my ignorance, and how does that work exactly? What are mechanics in terms of the preferred. When I look at this I am looking at the market cap, and trying to figure out how Cummins can put in to prevent them from getting over that 19.9%. It sounds like I am thinking with the wrong way, can you explain how I should be thinking of it?

The ultimate amount will depend on several things that we don't know yet, one is the pricing of the rights offering. Which will have to do with the number of total number of shares they ultimately receive.

Second, whether or not we convert any of our trust preferred securities to common, which we said is possible, but I we have no definitive agreements to do that yet. If that happens then that will add additional shares from that exchange to the mix, and therefore Cummins could own more shares, and still be below 19.9.

If you convert some of the preferred shares to common that would bring the stock price down, right? I don't know how it solves that problem exactly. understand that it increases the number of shares, common shares outstanding.

The share price at which we would issue the rights offering, and whether or not we convert trust preferred to common, I don't think are directly related. The way you asked the question.

Right. Okay.

You thought they were.

I think I understand what you mean then. Okay. I really appreciate your time. Thanks.

Thank you.

Next question from Stephen Geyen from Stifel Nicolaus, please go ahead.

There was a significant increase in nonperforming loans in the commercial banking business from Q2 to Q3, what prompted the increase? Was there a sudden deterioration credit quality Q2 to Q3, or did you go through a lower view process in the Las Vegas/Phoenix markets, or where did the increase come from?

I would say it is probably attributable to both. We did do a very thorough owner review process in Q3, with particular attention on construction land development and commercial real estate loans, with and particular attention on the markets you mentioned. I also think it is fair to say that particularly in commercial real estate, the credit quality deteriorated in Q3.

You said it was a partly from the review, are you pretty much through the review?

Yes. One of the important things we did mention in in the press release and the Q, to keep in mind, is that our definition of nonperforming asset is nonaccruals. Every nonaccrual in the commercial banking line of business has a specific reserve.

And so if you look at the change in specific reserves from a year ago to now, the non-performing assets are up 300 something, and the specific reserves are up 500%. So sorry, we are in the wrong numbers. 385% increase in the nonperformings and 522% increase in the specific reserves. We attempted to get all over this, and increase the specific reserves appropriately.

Okay. Thank you.

You are welcome.

Our next question from Roger Saul from Worldwide Christian Aid.

This is one I had on my list, but glanced over it mistakenly before. On the accounting on the reserves, these reserves are taken out for the potential loan losses, but maybe some of the borrowers will pull it out and they will perform, and pay off their loans.

So the things I want to know is when you take the reserves do they come off the balance sheet as of like this year's income, and then suppose they paid them off next year for example, or part of them, does that go back onto the balance sheet as income?

Sure. The loans themselves do not come off the balance sheet, when we put them, either establish a reserve for them, or put them on nonaccrual. They only come off the balance sheet when we charge them off.

When a loan is on nonaccrual, then we are no longer booking income for it in the income statement. But the loan is still on the balance sheet. We have some reserves in what is called it will FAS 5 portion of our reserving, which are for loans that are still paying us, or for which we are still accruing interest, because we expect ultimately to get paid on those. But there is a methodology for estimating in the future, what portion of those are likely to go to default, and likely to have losses, even though they are presently not representing a loss. And the reserves will include a portion of that.

Those are estimated both statistically by historic migration from our internal risk ratings to us, and then there is also on top of that a qualitative reserve, where we make judgments about the economy is getting worse, so things could be worse, so we will put in some additional reserves for stuff we don't fully know about yet, but we believe they are losses inherent in the portfolio as of the moment.

I am sorry --

You asked about what happened if in the future one of them pays off, or gets better. It will depend whether it was something we put on non-accrual, or whether we charged it off. If it was nonaccrual, and they pay off we will simply put it back on accrual, and begin booking interest income on it again. If it was something we charged off, then it becomes a recovery, which goes back in to the loan loss allowance, to provide additional cushion for future losses on other loans.

Do the reserves then, are they losses, or just money in a different place kind of?

The real losses are the charge-offs. The reserves are an accounting, that to put money aside for losses we have not yet charged off. You should understand though, that under the Federal capital rules, there is a limit to how many, how much of the reserves we can count on our capital base. We are over that limit. It is 1.25%. At the moment, adding to our reserve actually reduces our capital, as we set aside money for potential losses that haven't been recognized yet.

So that makes the balance sheet look worse, but actually that money is sort of like a security deposit kind of, and it could come back, I mean not a deposit.

No. It is a reserve.

Yes.

A valuation allowance in effect.

Okay. I do some lending to on a small basis on single family homes, and I buy them and sell them on real estate contract, and what I have done in this time with people having a hard time, is just work with them, if they are paying a good part of the loan, because eventually prices are going to be back up, and we are going to get all the money plus all the interest, even if we have to put some of it on negative amortization with the people, or add to what they owe each month, like if you they are supposed to make 2000 a month let them pay 1500, add then we add 500 to the end of the loan.

Sure. Those are often sensible loss mitigation techniques. In our home equity line of business, for instance, where we have the authority to, we do similar kind of things, work with the borrowers, try to avoid foreclosure, and help them out to work through their financial difficulties.

The other observation I would make, is those kinds of loss mitigation activities, are one of the reasons why we set up reserves, and only charge the loan off after it's clear that none of those things will work.

Okay. I would just would encourage that. We got loans, recorded down there in the courthouse, they have got to pay those off, before they can get clear title to the house for the next loan or something.

That is right, even if we have charged them off.

If you sit on them, eventually you will probably get paid plus interest.

Thank you.

Thank you too.

Our next question comes from Bill Chen from Barrington Partners, please go ahead.

I had another quick question, in terms of the data on the construction loans, I can't find it in the Q, the only thing I am finding on page 38, there are portfolio characteristic for the overall commercial banking loans, and on page 33, there is the construction real estate and land development loans at 512.9 million?

Bill, I pointed you to the Q having misunderstood your question. The Q has information on our loan portfolio by geographic region. The call report, which is on file with the FDIC would have the more detailed information about portfolio by product type. I don't have those pages memorized.

I will just follow up with you offline then, Greg.

Thanks.

Our next question comes from [Greg Somerville, Tecumseh] Capital.

Thank you for taking my question. With regard to the timing on the rights offering, assume for a moment you don't get any comments back next week, what is the likely timing going forward, and I am assuming, would you proceed, I guess sort of throw a couple of side questions in here, with a partial backstop in place, and I am assuming this is coming to some resolution with regards to the preferreds you are negotiating on as well?

Thanks, Greg. If there were no comments from the SEC, we would move ahead directly with it, but I can't really speculate on exactly the timing of that. It is dependant on too many variables.

It is our plan to proceed with the offering with the standby commitments we have in hand, if the SEC, if and when the SEC give us the go ahead. So it is not, in that sense dependant on reaching the possible agreement with the trumps.

Okay. Then additionally, have you disclosed who those additional investors are, who have come on board, or are you going to disclose who they are?

We didn't believe their identities would be material, but I would be happy to tell you. We didn't formally disclose it. They are a former Chairman, and a retired partner of Warburg Pincus in New York. They are investing as individuals.

Okay. Fine. And with regard to the preferred, I realize your comments will be limited. I will ask the [David Keer] question I guess, what is the probability you will come to some sort of an agreement there?

That is exactly what one of those forward-looking statements I am not permitted to answer right now because of the quiet period.

What are the issues that are sort of I guess, the heart of the negotiations with the preferreds right now, in terms of trying to come to some agreement?

I am sorry I have got to give you the same answer.

Okay. Is there a question that I could ask that would--?

(laughter)

Anyway, okay. In another I guess thought I guess crossed my mind given the magnitude, especially where the common is trading today of this offering, and the loss carry forwards, is there any risk of sort of change of control coming in to play here, and limiting your ability to take those losses in the future?

That was a very serious constraint prior to the change in the rules by the IRS. A month or so ago, where they took A-LLL out of the equation of what was capped, and only left in net operating losses. We do have some net operating loss carry forwards that would be capped, but it is not a material amount. So the change in the rules was very helpful to us.

The part from write-downs in loan losses you will be able to apply against--?

Even if we issue more than what how the IRS figures it, which is a very complicated formula, up to trigger the change in control, the A-LLL will continue to be deductible.

Thank you. That is all I have.

You are welcome, thanks.

(OPERATOR INSTRUCTIONS). Standing by for questions. We have no questions at this time.

Thank you John. We appreciate everyone's interest and attention, and look forward to talking to you all again soon. Thank you very much.

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