First Financial Bancorp (FFBC) 2010 Q4 法說會逐字稿

Good morning and welcome to the First Financial Bancorp fourth-quarter and full-year 2010 conference call and webcast. All participants will be in listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions. (Operator Instructions). Please note, this event is being recorded.

I would now like to turn the conference over to Vice President of Investor Relations and Corporate Development, Ken Lovik. Please go ahead.

Thank you, Sue. Good morning, everyone, and thank you for joining us on today's conference call to discuss First Financial Bancorp's fourth-quarter and full-year 2010 financial results. Discussing our operating and financial results today will be Claude Davis, President and Chief Executive Officer, and Frank Hall, Executive Vice President and Chief Financial Officer.

Before we get started, I would like to mention that both the press release we issued yesterday announcing our financial results and the accompanying supplemental presentation are available on our website at www.bankatfirst.com under the investor relations section. Please refer to the forward-looking statement disclosure contained in the fourth-quarter 2010 earnings release as well as our SEC filings for a full discussion of the Company's risk factors.

The information we will provide today is accurate as of December 31, 2010, and we will not be updating any forward-looking statements to reflect facts or circumstances after this call.

I will now turn the call over to Claude Davis.

Thank you, Ken, and thank you to those joining the call today. Other than a high-level overview of our financial results, I'll be speaking to the strategic elements impacting our performance for the quarter and Frank will address the financial items in greater detail.

We are pleased to announce another solid quarter of performance, reporting net income of $14.3 million or $0.24 per diluted common share. For the full year 2010, we earned net income of $57.4 million or $0.99 per diluted common share, representing a return on average assets of 91 basis points and a return on average shareholder's equity of 8.68%.

During 2010, we earned $276 million of net interest income compared to $176 million during 2009, an increase of 57% demonstrating the strong revenue contribution from our 2009 acquisitions. Our net interest margin remained strong for the quarter at 4.65% and our noncovered portfolio of credit metrics continued to stabilize and in most cases showed marked improvement in the fourth quarter.

Although we did not make any new acquisitions during the year, 2010 was a significant year for First Financial as we demonstrated our ability to successfully integrate the 2009 acquisitions while remaining focused on the execution of our strategic plan.

Our primary objective is to increase earnings and shareholder value through a combination of organic growth, running our business lines efficiently, and taking advantage of strategic opportunities when they arise.

While loan growth throughout the year was challenging due to the continued economic environment, we implemented a number of strategic initiatives designed to drive revenue growth. The key component of our organic growth strategy is a strong focus on sales throughout all of our business lines. These efforts began to pay off during the fourth quarter as we were able to achieve considerable gains in certain areas of our business.

As I mentioned on the third-quarter earnings call, we have made a significant investment in our residential mortgage business. This investment began to contribute at a higher level during the fourth quarter as our still growing team of seasoned originators pursued new business opportunities aggressively and grew originations 60% over third-quarter levels.

Our commercial lenders were also committed to the sales efforts as we experienced the first linked-quarter growth in our legacy portfolio during 2010. During the quarter, originations and renewals in our commercial loan portfolio exceeded $210 million and in the commercial real estate book, exceeded $138 million. At quarter end, commercial loans were up 4.8% compared to the prior quarter.

Our sales focus was also evident on the funding side of our business as we continued to build our core deposit franchise. The strategic retail transaction and savings balances increased over $80 million or 5% compared to the prior quarter and total strategic transactional and savings accounts increased over 7%. Please note however that we achieved this growth while maintaining discipline in the pricing of our deposit products.

With regard to credit quality, our resolution efforts during the quarter resulted in significant improvement in our overall metrics as nonperforming loans decreased over 11% to $70.6 million and nonperforming assets decreased over 9% to $88.5 million. Due to our continued aggressive efforts in identifying problem credits, we were able to finalize resolution strategies on a number of nonaccrual and delinquent loans. These strategies encompassed a combination of improvements in the status of certain borrowers, cash payments and charge-offs, which accounted for the increase in net charge-offs for the quarter.

Note that one-third of our total net charge-offs were represented by one relationship, which was fully resolved and for which we received cash proceeds on a portion of the total exposure.

For the quarter, our provision for loan losses equaled nearly 100% of total net charge-offs. As a result, our allowance was essentially flat quarter-over-quarter but as previously noted, our credit ratios improved as a result of the lower nonperformers.

While we feel cautiously optimistic about credit heading into 2011, we also recognize that complete economic recovery is still a longer-term event and the timing of a key driver of economic improvement, higher employment levels, is still hard to predict.

Once again, our capital levels remain strong and well above regulatory minimums for well-capitalized status and well above our peers. We remain committed to deploying our capital in a manner that most benefits long-term shareholder value. As part of that commitment involves a return of capital to the shareholders, we are pleased to announce the Board of Directors has decided to increase the quarterly dividend by 20% to $0.12 per share.

Our earnings power and consistency over the past several quarters provides the capacity to support a higher payout ratio to our shareholders. Despite the higher dividend, we still feel comfortable that our capital levels going forward will provide sufficient ability to take advantage of strategic opportunities while also ensuring that we are well-positioned to manage uncertainties surrounding any potential changes to regulatory capital guidelines.

While organic growth remains our top priority, we are receptive to transactions, either traditional acquisitions, FDIC-assisted deals, or branch acquisitions should they meet our specific, strategic, operational, and financial criteria.

Before I turn things over to Frank to further discuss our performance, I want to reiterate a few things regarding First Financial as we head into 2011. First of all, due to regulatory requirements and financial reform legislation, we expect that the combination of higher cost of compliance and restrictions on consumer fee revenue will put pressure on earnings in future periods.

Furthermore, we have seen competition heat up in our markets and as a result, we expect the banking environment to be extremely competitive as the economy recovers and the survivors pursue growth opportunities. In order to be well positioned to compete, we remain keenly focused on expense control and have initiatives under way to ensure that we are managing our business as efficiently as possible.

Additionally, we are constantly evaluating strategic opportunities, both transaction-oriented such as the third-quarter prepayment of Federal Home Loan Bank advances and market-oriented such as the market changes and branch consolidation plans we announced during the fourth quarter to ensure that our resources are being deployed appropriately and in any shareholder-friendly manner.

Finally, I want to remind everyone that our balance sheet risk still remains low. We still enjoy FDIC loss share coverage on 35% of our loan portfolio and less than 50% of our balance sheet consists of 100% risk-weighted assets.

As previously announced, we made improvements in our asset quality during the fourth quarter and our metrics compare even more favorably to our peers. As we head into 2011, we remain confident that our client-focused banking model and disciplined approach to managing our business will allow us to take advantage of growth opportunities going forward while also maintaining the high level of performance our shareholders have come to expect.

I will now turn the call over to Frank for further discussion on our financial performance.

Thank you, Claude. I will start by providing a few comments on some of the operating results of the quarter and the major components of performance, making reference at time to the supplemental information that was furnished separately and is available either on our website, bankatfirst.com in the investor relations section or in the 8-K we filed this morning.

As in previous quarters, this supplement is crucial to establishing a clear understanding of our reported results as well as the concepts that have a material effect on their current and future performance.

Fourth quarter 2010 GAAP earnings per diluted share were $0.24. The most significant items affecting our earnings for the fourth quarter as compared to the prior quarter excluding the Federal Home Loan Bank prepayment penalty and the gain we recognized in conjunction with the sale of franchise loans during the third quarter were a higher provision for loan losses and lower income from the accelerated discount associated with covered loans.

As we discuss our results, we remain sensitive to the fact that when reading our earnings release, it is easy to get lost in the details of the accounting for acquired loans and the impact that our non-strategic operations have on our overall performance. We continue to try to simplify such concepts as best we can and I would summarize our underlying strategic performance for the quarter as consistent with our expectations.

One particular area of complexity is the impact of the accelerated discount on earnings and whether or not there is any way to reasonably forecast what the effect will be in future periods. As we have previously discussed, we can reasonably estimate what the total impact will be over the expected life of the covered loans, but we cannot predict the timing of accelerated discount quarter-to-quarter as the majority of this revenue is driven by prepayments which are client-driven and each loan has a different discount percentage based on its underlying characteristics.

Whether the recorded discount is recognized through acceleration associated with prepayments or accreted over time through net interest margin, both are accretive to tangible book value.

Looking at page 4 of the supplement, you'll see a quarterly progression of pretax, pre-provision income that excludes accelerated discount as well as certain other nonrecurring items. After backing out the volatility of the accelerated discount, you will see that we have produced a fairly consistent run rate over the past five quarters and earned $28.7 million of adjusted pretax, pre-provision earnings in the fourth quarter. This table does not exclude all the nonrecurring items listed in table 9, which further supports our conclusion of stable trending results.

Net interest margin increased to 4.65% for the quarter due to lower funding costs that helped to offset the impact of continued pay downs in amortizations of acquired loans. As in prior quarters, we put our excess liquidity to use, purchasing over $362 million of agency mortgage-backed securities during the fourth quarter.

However, a vast majority of those purchases did not settle until the latter half of the fourth quarter with a sizable portion settling during the last two weeks of the quarter. Had those investments been purchased at the beginning of the quarter, our fourth-quarter net interest margin would have additionally benefited by approximately 9 basis points.

As noted earlier, provision expense related to our legacy portfolio was one of the key drivers influencing the change in earnings relative to the third quarter, increasing 55%. Provision nearly equaled total net charge-offs for the quarter. Our ending allowance for uncovered loans remained flat and is reflective of our overall credit view as many borrowers are still under stress. Our allowance represented 2.03% of total loans and almost 92% of nonaccrual loans.

Non-interest income for the quarter remained flat on an adjusted basis. However, we began to see what we can assume were the effects of financial service reform on fee revenue as service charges on deposits declined approximately 9.6% quarter-over-quarter. Non-interest expense also remained flat after adjusting for acquisition-related items and other items not expected to recur.

We did experience an increase in acquisition-related costs during the quarter accounting for the overall increase in non-interest expenses after excluding the Federal Home Loan Bank prepayment penalty. The drivers of this increase include the impact from both lease and contract termination fees, minor subsystem conversion costs, several property valuation adjustments, as well as wind down expenses related to acquired subsidiaries.

We do expect additional acquired nonstrategic operating expenses during 2011 due to our exit of the Michigan and Louisville markets and continued acquired subsidiary activity.

I also want to discuss today our fourth-quarter revaluation of certain acquired loans, the results of which we highlight in table 1 of the earnings release and on page 3 of the supplement.

Before I get into the details, I want to point out that it is difficult to compare the balances of loans with improvements and loans with impairment on a quarter-to-quarter basis due to the nature of the valuation procedures in the accounting treatment for loans with improvement versus loans with impairments. Also impacting the comparison is the amortization of prepayment of acquired loans.

During the fourth quarter, our credit expectations have improved on loan pools totaling $691 million or 51% of the revalued portfolio. Loans with improved credit expectations include both those which have solely experienced improvement to date as well as loans which were determined to be impaired during a prior valuation and have since improved, recapturing prior impairment. The value of impairment recaptured by these loans totaled $4.4 million for the quarter and is recorded as an offset to provision expense.

Total improvement for the quarter equaled $17.3 million, which is recognized prospectively as an upward yield adjustment as shown in the table on page 3 of the supplement. Going forward and until our next periodic valuation, these loans will have an approximate yield of 9.94%.

Loans with previous impairment incurred $14.6 million of additional impairment as a result of the quarter's revaluation. However, this was partially offset as certain of these loans pools experienced some improvement, recapturing $5.3 million of prior impairment. When combined with the $4.4 million of improvement discussed above, this resulted in a $5 million fourth-quarter net impairment and was recognized as provision expense on covered loans.

Actual net charge-offs for the quarter totaled $9 million resulting in total provision expense on covered loans for the quarter of $14 million. Two important items of note, first, the yield on the portfolio with impairment will have no change in yields due to revaluation. And second, a significant amount of the covered loan provision expense is offset by FDIC loss share income shown in non-interest income.

Though it may seem unusual, lower FDIC loss share income is desirable as it is derived by relating credit losses in the covered loan portfolio. In other words, the FDIC loss share income will always be overshadowed by a higher related amount of provision expense on covered loans as we only receive an 80% indemnification from the FDIC.

The prospective yield on the entire revalued portfolio will be 10.41% until our next periodic valuation. Revaluation procedures related to the FDIC indemnification asset indicated a continued decline in the expected future cash flows, which is a byproduct of improved cash flow expectations on the covered loans. This results in a prospective negative yield of approximately 76 basis points.

On a combined basis, the revalued portfolio and the FDIC indemnification assets weighted-average yield is expected to be approximately 8.84% until the next periodic valuation.

As I mentioned earlier, excluding the impact of the accounting treatment related to certain acquisition-related items, our performance was in line with our expectations. While our credit costs were higher compared to the past two quarters, they were in part driven by the finalization of resolution strategies related to nonperforming credits and the result is a stronger credit profile as we remain focused on executing our strategic plan heading into 2011.

As to 2011 performance, we will not offer specific earnings guidance, nor specific information on any of the key drivers. We will however continue to offer insights and additional information about the key drivers so that each of you can reach your own conclusions.

As Claude previously mentioned, we are beginning to see improvements in both our sales activity and in our overall credit picture and as such, expect 2011 to be a year of organic improvement.

Before I turn the call back over to Claude, I would like to announce that First Financial will hold a technical call next week in order to provide greater clarity on the issues surrounding acquired loans and FDIC loss share coverage. We will go into greater detail on these complex issues and discuss how they impact earnings, our balance sheet, our capital, and our future performance.

If there are topics or specific questions you would like to have addressed in that call, please email Ken Lovik in investor relations and we will be ensure to include them. Additional information about this call will be made available later this week.

I will now turn the call back over to Claude.

Thanks, Frank. Sue, we are happy to now open the call up for questions.

(Operator Instructions). Scott Siefers, Sandler O'Neill.

Good morning, guys. I guess first, just on the dividend raise, Claude, can you remind us what sort of payout ratio you guys are targeting?

Scott, we have communicated in the past the payout ratio we've targeted is 40% to 60%. Obviously that can vary based on the current economic conditions and earnings level, but that's been our stated level.

Okay, perfect. Frank, you gave a pretty good color on a number of those -- the items both particularly on the fee side I guess -- the items that are labeled items likely to recur. I guess on the expense side, just in past calls I recall you making comments such as XYZ would decline to something over the next several months or several quarters. Are you able to make any qualitative comments like that just so we can get a sense for at least some of these numbers where we should be expecting them to trend over the next few quarters?

You know, as far as anything forward-looking, no, just in general if you are looking at table 3 from the release, if we are looking at acquisition-related costs, as we indicated, those are likely to be a little choppy, though. Again, the further into the acquisition integration we are, the less you would expect to see there.

Other items expected not to recur, the increase on a linked-quarter there relate partially to the Michigan and Louisville exit and some other items there. But again, the deeper end of the integration that we get and the further into the workout or disposition of the nonstrategic components of the business, you would expect to see those eventually make their way to zero. But over what time horizon, I couldn't say.

Okay, and then that acquired nonstrategic operating expenses which I think got kind of hit because of the announcement that -- market exit announcement from early in the quarter, would that similarly just be expected to trend down pretty steadily?

Yes.

Okay, and then final question just on the margin, you had mentioned the nine additional basis points of improvements that you would have gotten had there been some timing differences in there. Are you feeling like otherwise the margin was pretty stable and therefore we could expect some kind of high single-digit improvement going forward?

I would say absent the item that I noted there, it was relatively stable. But again, you've got the same drivers impacting our margin going forward as you have historically in that we have a very high yielding acquired loan portfolio that continues to shrink. So again, I wouldn't want to give guidance but there have been no significant changes in any of the drivers.

Okay, perfect. Thank you very much.

Jon Arfstrom, RBC Capital Markets.

Thanks, good morning. Just a follow-up on that one, Frank, what were the average yields on the [MDS] purchase just generally?

Sure, the weighted-average yields on the purchases was 1.85%.

Okay. Claude, maybe a question for you. In the release and in the prepared comments, you talk about demand for loans remain slow, but you actually had I think a decent loan growth quarter particularly in your two largest categories. Just curious where that demand is coming from and how you feel about the pipeline in your core business?

Sure, no, actually the fourth quarter was a more encouraging sign, Jon. I think the commercial business is one that we continue to be very active in and had a sustained calling effort in. And I think in the fourth quarter, we began to see more just general activity from our clients, some new prospects that we were able to convert over to First Financial. And especially later in the fourth quarter, we were really pleased with some of the closing activity.

So I think it was a good first step as it relates to organic growth. We felt good about it going into 2011, but it's one of those where I am still a bit cautious. I want to see two or three quarters of good, solid origination improvement before I can declare that we're going to see that on an ongoing basis. But at least for one quarter I feel good about the sales activity and clients' optimism.

Okay, also in your prepared comments you talked about competition increasing. Is that something you are seeing already or something that you are expecting to happen?

No, we are seeing it already. With especially the banks that have raised capital or are already well capitalized and I think what all of you see as analysts, I think the fact that we have had either declining loan balances or anemic growth I think everybody is interested now in really pursuing, especially those really good clients. And so that has increased competition and we would expect it only to get more intense as we move forward.

And then just two more things. Frank, we've all talked to you about the complexity of the numbers here and I just want to try to simplify what you said, the credit assumptions that you are making on your covered assets.

Just generally you are saying that the credit assumptions are coming in better than your original expectations. Is that a simplified way of saying it?

That's correct. Overall, the covered portfolio is having performance better than original expectations and past expectations as we continue to reevaluate it on a periodic basis.

Jon, the one other point I guess I'd want to keep emphasizing as well and Frank spoke to it in his prepared remarks is that we continue to remind people that as you do a loan pool by pool or a valuation, impairment are recognized immediate; improvements are over time.

And that, Jon, actually is a topic that we will cover in that technical call in greater detail as well.

I understand that, and I understand the timing is obviously something that isn't always in your control.

The last thing is you touched on regulatory reform, Claude. Is there one or two things that we should be aware of that you think are the largest headwind that we need to think about in a little more detail, specific to your Company?

I don't think there's anything specific to our Company, Jon. I think my concern is really just what I would call the attack on consumer fees, both legislatively and from the regulatory perspective. And so that's -- if there's an area that we remain cautious about it is in that area, whether that's further changes to overdraft programs and expectations. Even though we think ours is conservative and complies, that seems to be an ongoing focus of the agencies as well as while we are under $10 billion and technically the Durbin Amendment doesn't apply to us, we are as concerned as any bank out there that competitively it may end up impacting us.

And so those are the two biggest areas that are known today but I think the environment is just one that we are cautious about what other impact that may be a result of the Dodd-Frank legislation.

Okay, all right, thank you.

Justin Maurer, Lord Abbett.

Good morning, guys. I appreciate the clarity and attempt as best you can to segregate this confusing issue to another call.

Just one quick question on that, though, the NIM relative to the expectations, you have the two buckets that will flow through NIM, the third bucket being indemnification asset, which flips to a negative. That's in the other income or expense, is that right?

No, that is also in net interest margin.

It is, okay. So prospectively all three of those items -- so 9.01% -- on page 3, 9.01% dropped to 8.84%. That also flows through NIM?

That's correct.

Okay. Secondly, just thoughts on the provision. Claude, I appreciate the color on -- you guys have certainly been cautious all along relative to your borrowers and the migration, this quarter we've certainly seen most -- maybe not of all banks start to under provide relative to charge-offs -- in fact, one even I am sure you saw did a negative provision which raised some eyebrows.

But if you are class -- you guys mentioned in the press release I believe classifieds are down. Obviously NPAs are down. I suspect as a result your kind of general reserve against those loan pools would be down or would have the potential of being down. So give us some kind of color on thoughts of moving -- bumping the provision up a bit linked-quarter.

Sure. It is a fair question, Justin. Obviously we have a model that we follow that kind of guides our provisioning and allowance. I would say from a qualitative management perspective, we've seen our NPAs stabilize throughout most of '10 and then in the fourth quarter, as you pointed out and I put out my prepared remarks, did decline.

I'd say it's similar to my comments on the organic sales growth that we are pleased to see that improvement and we are just a bit cautious because it's one quarter decline. And with unemployment continuing to remain, I would say stubbornly high and commercial real estate being still choppy, it's one that we think our approach this quarter was prudent.

Now as we get into 2011, we will see how the model plays out in terms of what it suggests. But from a management perspective, that's our view right now.

Okay, was there any movement at all more into CRE even though the overall blended number was down? Was there some shifts kind of to some more severity types of buckets that that's what causes it or just more again -- just general cautiousness?

No kind of specific severity issues. We obviously don't disclose the details of the allowance model, but I don't know, Frank, if you would add any additional color.

Yes, Justin, I would to say that our view of each of the different asset classes is reflected in the model, but as Claude said, no dramatic changes in our view.

You mentioned the regulatory issues and so on and Durbin that you guys don't apply. So -- and the Reg E issue would have been kind of fully baked, right, as in -- for the fourth-quarter kind of run rate. So are there other things you guys are thinking about kind of actively that are potential depressants to fees or is it just the overall risk, like you said, the industry kind of under attack that leaves the door open for potential?

It's just the overall environment. It is related to even Jon's comment. It's really more just the environment and I think the sensitivity in the legislative and regulatory areas around consumer fees specifically and certain types of fees that we just want to point that out as the area of caution for investors. I can assure you that we continue to look, as many other banks have announced this quarter, that if certain fees get reduced we are looking at other opportunities for revenue improvement or cost reduction in that business to try to offset it. But I feel like we would be not completely transparent if we didn't disclose the fact that just the environment itself concerns us.

Okay, fair enough. Thanks a lot, guys.

Eileen Rooney, KBW.

Good morning, everyone. Most of my questions were already answered, but I'm sorry, Frank, if I missed this in your comments. The charge-off that you took this quarter, that one credit, was that already on nonperforming? Can you just give us a little bit of color on what that charge-off was?

Sure, it was on nonperforming and as far as the industry, Richard Barbercheck, our Chief Credit Officer, is here and he can speak to general description.

That was a -- it was a credit into a marketing and servicing firm that we had had for a number of years that had gone through several different strategies of [work] (inaudible). And we finally found resolution to that, to Claude's point. In his comments that brought back actually cash recovery into the transaction, although we obviously had charge-off in conjunction with that.

It would have been classified in the C&I category, Eileen.

At it wasn't nonperforming previously.

Thanks, and then I know we have kind of covered this a little bit, but I'm just thinking about your loan yield going forward. You had a nice increase this quarter but it sounds like credit spreads are probably going to come under some pressure just have you been talking about the competition in the market? Should we expect that you might have some trouble holding that where it is now?

I think, Eileen, as you look at the headwinds on loan yields, certainly the competitive environment could impact it and as you look at the yield on the covered loans, as that begins to diminish, I would say those are two headwinds there. Certainly.

Okay, and then partially offset by the MBS that you bought at the end of the quarter?

That's right, yes, so the overall margin will certainly enjoy the benefit of that and also the lower funding costs.

Okay, that's helpful. All right, thank you, guys.

Matthew Keating, Barclays Capital.

Thank you, good morning. I just wanted to follow up on the Michigan and Louisville exits. Are those still on track for March 31?

Yes.

They are, and the expense savings associated with those is about $5.3 million, thereabouts. I guess there was also seven branch consolidations. Could you size sort of the expense savings associated with those seven branch consolidations in Ohio and Indiana?

We have not disclosed that specific number.

Okay and then I guess just broader strategy speaking, I was somewhat surprised on the Louisville exit. Could you talk to your broader strategy in Kentucky and why sort of exiting that Metro market made sense for you at this time?

Sure, Matthew. If you recall, that was a location that was acquired as part of the Irwin transaction. It was one location that was relatively small in scale. It had not been originating new loan volume for the past two to three years roughly. And the conclusion on our end was that while Louisville is an attractive market, in our view certainly fits within our franchise footprint, having one location there without sufficient scale just did not make sense to us. So Louisville would be one of those markets in the context of an acquisition opportunity or other opportunities to reach scale that we would consider.

And we didn't find that our current operation there would be helpful to us in the event that an acquisition opportunity presented itself, so that was the reason for that decision. It's not a statement about Louisville per se.

But as we look at our organic growth investments, in other words those areas where we will be investing in new banking center or branch growth, that will be focused at least for now in our current metro markets, Cincinnati, Dayton, Indianapolis, and our other market areas where we need additional infill. So we didn't see the opportunity to allocate additional capital to Louisville to get to the scale we thought we needed there long-term.

Great. Thanks for the color.

Bryce Rowe, Robert W. Baird.

Thanks, good morning. You guys touched on the competitive landscape getting -- or intensifying a little bit here. I don't know if you guys talked about this, I might've missed this with Jon's question, but are you seeing a higher level of competition for C&I credits versus CRE credits and do you kind of see that as a potential opportunity?

Yes, I would say the areas of greatest competition right now are in C&I and small business credit. CRE I would say is still a little bit tepid in terms of people's interest in that. Obviously we continue to look at commercial real estate opportunities, both owner-occupied and investor. But we are cautious, as most banks are currently.

So yes, I think the greatest competition is in the C&I and small-business sector.

Okay, and then I guess from an M&A perspective obviously you've got the dividend increase here today and you're still sitting on plenty of excess capital. Can you speak to -- I'm sure you're having some level of conversations with potential targets. Can you speak to what thoughts are on pricing today and kind of how you approach some of the increased pricing for M&A transactions we have seen over the last couple of months?

You know, Bryce, I will just give you our general strategy that we have articulated before on M&A, which we hope to honestly regardless of what others are doing and what's going on is in addition to the strategic fit and our ability to manage it operationally. We have always approached M&A prior to our '09 acquisitions when we had not done any but had looked at others in past to those that we did in '09 to any that we would pursue going forward, that we expect it to have an IRR certainly well above our cost of capital and we price it based on that.

Certainly depending on what we think the franchise opportunities are for revenue growth as well as cost saves obviously drives that number, as you well know. So that's really our approach and if we can successfully do a deal on those -- on that basis, we will do it. But at the same time, as we've always said, we are not going to put internal pressure on ourselves to do a deal at a price that we don't think make sense.

So yes, we watch the pricing just as you do. We know it's drifted up in a few deals, but that has not impacted our strategy.

Okay, I appreciate it. And again, thanks for all the information on the acquisition accounting.

John Rodis, Howe Barnes.

Good morning, guys. Frank, maybe just back to the loan growth real quick. Was the growth in the C&I category, was it fairly granular or were there any one or two bigger credits that you put on in the quarter?

It was granular.

Okay, and then just kind of looking at the end of period balance sheet versus the average balance sheet, it looks like the commercial real estate balance has maybe trended down a little bit towards quarter end. Can you maybe just address that?

You know, there's no specific kind of issue there. Obviously we always see some paydowns and some year-end cleanup that might occur, but nothing of significant note there. We continue to see our construction and development portfolio decline and we would expect it to continue to decline as we are not active right now in doing new originations there. So that -- nothing specific.

And the other point I would make to your other question, too, just as a reminder is even with our growth, we still have an internal loan limit of $15 million, so that's what allows our portfolio to stay relatively granular.

Okay, fair enough. Thanks, guys.

(Operator Instructions) Joe Stieven, Stieven Capital.

Good morning, Claude. Good morning, Frank. Actually almost all my questions were answered. My last one was sort of on the M&A side, but I actually do appreciate you guys trying to open up your -- the understanding of the accounting, because it is complex.

I guess my final question was you guys had talked about -- I'm assuming the Michigan, getting out of some of the Michigan stuff is sort of the same answer as Louisville that it's -- you still could find attractive markets in Michigan, but what you had there just was not what you wanted. Is that sort of the correct answer?

Joe, it is. And again, Michigan was very similar to Louisville that we had four offices in four different cities, all of those cities -- Kalamazoo, Lansing, Grand Rapids, Traverse City -- our of a size that one office is not a sufficient scale for the retail banking business that we want to do. And we did not think any of them would be necessarily helpful in the event of an acquisition in any of those communities.

So yes, again it was not a statement about Michigan or our interest in that market or any specific market. It was more about lack of scale.

Claude, on a big picture macro level on acquisitions right now, are boards of these small companies let's say the $0.5 billion companies, and maybe a little bit lower, are they starting to come around? Because if you look at a company like yours that has not only capacity but it has the professional expertise to sort of excel, are these smaller companies coming around, saying okay, I need to partner up because the regulatory burden is now so high? Or are they still delirious?

Well, I wouldn't want to make any general statements or certainly try to lead the group on to think that we have enough color to be able to make a broad statement. But I would just suggest that I think the headwinds that they are facing are even more acute than what all of us in the industry are facing as it relates to regulatory pressure on fees, regulatory compliance costs. Their probably additional burden is access to capital for growth and we think for the right markets and the right players, we offer an alternative that could be good for their shareholders and good for our shareholders, and that's our view of kind of that unassisted transaction that we talk about.

Okay. Thank you, guys.

This concludes our question-and-answer session. I would now like to turn the conference back over to Claude Davis for any closing remarks.

Thank you, Sue. Again, I would just thank everyone for participating on the call and just add a reminder that we do plan to hold a technical call next week and there will be further information provided in terms of the timing of that call.

And as Frank mentioned in his prepared remarks, if you should have any specific items you would like us to cover, please email those to Ken Lovik. And again, our objective on that call is not necessarily to introduce new information but it is to try to continue to clarify and be transparent as we think we have been on the impact of that accounting and the value of it that we see to ourselves and to make sure that our investors understand it well.

With that, thank you for joining us on the call today and we appreciate your interest in First Financial. Sue, that ends our call.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.