First Financial Bancorp (FFBC) 2011 Q2 法說會逐字稿

Good morning and welcome to the First Financial Bancorp second quarter 2011 earnings call and webcast. All participants will be in listen-only mode. (Operator Instructions.) Please note this event is being recorded.

I would now like to turn over the conference over to Kenneth Lovik. Please go ahead.

Thank you, Denise. Good morning, everyone, and thank you for joining us on today's conference call to discuss First Financial Bancorp's second quarter 2011 financial results.

Discussing 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 for the quarter 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 second quarter 2011 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 June 30, 2011, 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.

Thanks, Ken, and thank you to those joining the call today. We reported net income of $16 million, or $0.27 per diluted common share, for the second quarter, representing a return on average assets of 1.03% and a return on average shareholder's equity of 9.05%.

Our results for the quarter clearly demonstrate our Company's ability to continue to produce recurring, high-quality earnings despite persistent economic uncertainty, both nationally and throughout our footprint. Our pre-tax, pre-provision earnings were up $3.8 million, or 13.9%, from the first quarter. Our provision for uncovered loans increased approximately $5 million from the first quarter, or $0.06 per share. Our credit profile and metrics, however, remained stable, and as a result, our allowance remained relatively flat on a linked quarter basis.

The second quarter was an exciting one for us, as we announced our first transaction since the FDIC-assisted acquisitions two years ago. We signed an agreement to acquire 16 Ohio-based branches from Liberty Savings Bank, the majority of which are located in the Dayton area, and will help to accelerate our growth plans in that key market. We are well into our integration activities and are still on track to close the transaction during the third quarter.

We are also pleased to announce that the Board of Directors has authorized up to a 100% dividend payout ratio of quarterly earnings consisting of two components -- one, a recurring dividend based on our previously stated target payout ratio of 40% to 60% of earnings, which is currently $0.12 per share; and a variable dividend that will equal the remainder of our quarterly earnings, which for the second quarter equals $0.15 per share. In total, the dividend represents a 125% increase over the most recent dividend we paid to shareholders.

Our stated capital ratio thresholds include a tangible equity ratio of 7%, a Tier 1 leverage ratio of 8%, and total capital ratio of 13%. Obviously, our current capital levels are well in excess of these amounts and are capable of supporting significant asset growth. Under the most constraining of our thresholds, we still have capacity to support more than $2 billion in additional assets.

Using the second quarter as an example, if we paid out only our recurring dividend of $0.12 per share, we would generate approximately $8.8 million of new retained earnings. Applying a leverage ratio of 8% to this newly generated capital would support $110 million of asset growth on top of the $2 billion we can already support. It is this incremental growth capacity that we are returning to shareholders.

The variable dividend is intended to provide an enhanced return to our shareholders and avoid unnecessarily adding to our capital position until we have capital deployment opportunities, such as acquisitions or organic growth, that moves us closer towards our capital thresholds.

Obviously, it is hard to foresee how long we will maintain the variable dividend, as the timing of certain capital utilization opportunities, such as acquisitions, are hard to predict. The Board will evaluate the variable dividend on a quarterly basis but expects to approve a payout ratio exceeding our recurring dividend for the foreseeable future.

At quarter end and prior to the payment of the upcoming variable dividend, our tangible common ratio was 11.11%, and total risk-based capital ratio was 21.43%. Our regulatory capital ratios did decline slightly during the quarter due to the early redemption of $20 million of trust preferred securities. However, the impact of the trust preferred redemption was offset by earnings for the quarter.

Generally speaking, credit quality was stable compared to the prior quarter, as total classified assets remained flat at $185 million. The provision for loan losses related to our legacy and originated portfolio was $5.8 million, which covered net charge-offs of $5.7 million for the quarter.

While net charge-offs increased $1.5 million compared to the first quarter, there were no significant items driving the total charge-offs for the quarter, and the activity can be categorized as simply coming to resolution on a number of credits, primarily in the CRE and construction portfolios.

Nonperforming loans to total loans declined to 2.65% from 2.90% as a result of the net charge-offs, as well as other resolution strategies. Total nonperforming assets declined $5.2 million, or 5.4%, during the quarter. And as of June 30, total nonperforming assets to total assets equaled 1.50%, continuing the modest downward trend experienced over the last four quarters.

Loan demand continues to be soft within our strategic markets, as both average and period-end total uncovered loan balances remained essentially unchanged compared to the first quarter of 2011. However, our focus on building out our commercial lending platform began to show results, as average C&I loan balances increased 6.8% compared to the second quarter of 2010.

Within our commercial and CRE portfolios, we experienced substantial growth in originations and renewals during the quarter, particularly during June, where the quarter totaled almost $240 million, or 62%, over first quarter volumes.

Furthermore, our C&I and CRE pipeline at the end of the quarter was at its highest point in months. We are cautiously optimistic that this activity is perhaps a signal that sustainable economic improvement within our strategic markets is on the horizon.

In closing, we were very pleased with our results for the quarter. The growth in pre-tax, pre-provision income, strong profitability, and net interest margin, stable credit performance, in addition to continuing to lower our strategic operating costs and continuing our growth in average core deposit balances, were all a very positive aspect of the quarter.

Furthermore, the introduction of the variable dividend and the announced acquisition are both prudent uses of our capital that will provide our shareholders both a short- and long-term catalyst to enhance their return on the investment in our Company.

I will now turn the call over to Frank for the 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. We have also provided supplemental information, furnished separately, that is available on our website, bankatfirst.com, in the Investor Relations section, or in the 8-K we filed last night. As in previous quarters, this supplement is crucial to establishing and maintaining a clear understanding of our reported results as well as the concepts that have a material effect on our current and future performance.

As many of you know from following our Company, our operating results are materially impacted by unique accounting and reporting requirements and the strategic distinctions we have made related to our 2009 acquisitions. However, to aid in a clearer understanding of our strategic activities, we will focus primarily on the ongoing or strategic aspects of our business on this call.

Our earnings release and our supplemental information should provide sufficient information and transparency into the purchase accounting details and the impact of non-strategic components of our results. These complexities have also been discussed at length in our previous earnings calls and the technical accounting call that we hosted on February 4 of this year. This information is also available on our website.

Second quarter 2011 GAAP earnings per diluted share were $0.27. Net income available to the common shareholders for the first half of 2011 increased 20.6% compared to the first half of 2010, and adjusted pre-tax, pre-provision income increased 13.9% compared to the linked quarter.

As Claude mentioned, the most significant item affecting our earnings for the second quarter as compared to the prior quarter was a $5.1 million increase in our provision for uncovered loan losses, or approximately $0.06 per share. This increase was not due to degradation in credit quality, but rather is at a level indicative of our stabilized expectations following a 10-basis-point decline in the reserve from last quarter.

The reserve level overall remains stable at 1.92% of ending loans, while nonperforming loans declined by $6.6 million during the quarter. Our operating results are better summarized on the pre-tax, pre-provision income slide, which is page 3 of our earnings supplement.

Net interest income on a fully tax equivalent basis for the second quarter was down only slightly on the linked quarter, due largely to an 8.8% decrease in our average acquired loans. Our net interest margin remained strong at 4.61% as we continued to redeploy liquidity through securities purchases and higher-cost retail and brokered CDs continued to run off, helping to offset the impact of a declining covered loan portfolio.

As in prior quarters, we put our excess liquidity to use, purchasing almost $250 million of agency mortgage-backed securities during the second quarter. If loan growth remains challenged, we will continue to deploy additional liquidity resulting from the combination of our strong earnings, core deposit inflows, and acquired loan paydowns. We also used our liquidity to redeem $20 million of floating rate trust preferred securities.

With regard to our investment portfolio, since the end of the third quarter of 2010, the duration of the portfolio has increased from 1.1 years to 1.8 years at the end of the second quarter of 2011. While we have extended the duration, albeit from a very low starting point, we continue to manage the overall performance of the portfolio to provide a stable and predictable revenue stream across a variety of interest rate scenarios and market conditions. This is consistent with our intent to remain in an asset-sensitive position while providing a suitable balance of quality and diversification.

Non-interest income earned in the second quarter 2011 was $15.4 million as compared to $14.9 million in the first quarter of 2011 and $14.5 million in the second quarter of 2010. The increase compared to the linked quarter was primarily driven by higher service charges on deposits, bank card income, and client derivative fees, offset partially by lower gain on sale from residential mortgage originations and trust and wealth management fees.

Additionally, we recognized a gain of $429,000 resulting from the sale of approximately $9.3 million of loans originated by the franchise finance unit. Consistent with prior sales of franchise-related loans, the sale was conducted to lessen credit and geographic concentration risk within the franchise portfolio.

Non-interest expense in the second quarter 2011 was $43.7 million as compared to $45.7 million in the first quarter 2011 and $47.7 million in the second quarter 2010. The decrease in non-interest expense of $1.9 million, or 4.3% compared to the linked quarter, was primarily driven by lower salaries and benefits, occupancy costs, and FDIC assessments, offset by an increase in data processing and professional services expenses.

At the end of the second quarter, we completed the early redemption of our remaining trust preferred securities and recognized an early termination fee on a related interest rate swap of approximately $600,000.

We have disclosed a tremendous amount of detail about the balances, yields, and quarterly valuation results of our loans accounted for under SOP 03-3, which should aid in evaluating our acquired loan portfolio. But as I mentioned earlier, we will not discuss the details of purchase accounting-related items. Overall, the credit performance of the acquired portfolios continues to exceed our initial estimates, and the quarter-to-quarter changes continue to be positive.

I will now turn it back over to Claude.

Thanks, Frank, and we'll now be happy to open the call for questions.

Thank you. (Operator Instructions.) Jon Arfstrom, RBC Capital Markets.

Just a conceptual question for you. I like the concept of the variable dividend, so don't take this question the wrong way. But how do you weigh the variable dividend concept against the concept of a buyback?

Sure, John, it's a good question. Obviously, as you would imagine, as we contemplated that, that's an issue we discussed, and I'll provide a couple of thoughts, and then Frank can add to it if he would like. But as we evaluated it and thought about it in context of both our price well above book value and being sensitive to book value dilution as one issue, a second being the, I would call it economic and regulatory uncertainty, but also what we viewed as a shareholder-friendly way to return capital and reward our shareholders, we felt like the variable dividend did that, but also retained flexibility for us, should that opportunity come along to deploy the current earnings, if you will, that we're using in the variable dividend. So that was the balance of items we considered as a Board as we made the decision to go the dividend route as opposed to a buyback.

But I don't know, Frank, if you would add anything to that.

Yes, those really are the key considerations. On a buyback, there's always the debate as to whether or not it's a good price to buy your shares back. And, as Claude said, the flexibility of this approach, we think, is well suited for the regulatory environment that we're in and the uncertainty of the growth environment as well.

All right. And then just a question on the lending environment. I would characterize all of you as reasonably cautious over the last few quarters in terms of the outlook, but you're stating in your release a bit more optimism on the commitments, and I guess, is there anything you can attribute that to -- what you're hearing from your clients or other things that you might be seeing? And then the second part of that is, has the momentum continued into July?

Sure. And we are, and I think what you read into our comments are true, is that we have been more optimistic in the last two to three months about what we're seeing in terms of loan demand and our ability to win the business. And it really picked up late in the second quarter, and I would say as a result of two things. One is our sales staff has done a great job of being out, actively calling, really, throughout the whole crisis and ongoing, and we've really stepped it up in the last year. And so the first thing I would attribute it to is a great team who's been out aggressively pursuing good business.

Secondly is it's always a function of demand and clients' willingness because of their own revenue picture to make commitments. And I think that's what we saw as an improved change late in the second quarter. And so those pipelines have continued to build.

The only concern we would have, I would say, at this point, Jon, would be we felt the same way late in the fourth quarter of last year. We saw a nice surge in December and then it trailed off. We didn't expect that this time, other than, I think, all of the hysteria that's going on in Washington around the debt limit and what that might do to the economy would be our primary concern or caution. And does that mute GDP growth going forward and cause some of our clients to pull back?

The other piece is it's still a very competitive environment. Everybody's got the same issue around loan demand and loan growth, so we're certainly seeing competition that's been more aggressive than we've experienced in a long time. So I'd say those two things are the only governing factors to our optimism. But we did feel good about the late second quarter surge.

Okay, great. Thank you.

Scott Siefers, Sandler O'Neill.

I wanted to follow up with a couple of quick questions on the dividend as well. Can you just talk about, at a very top level, the discussions you went through with regulators and everything? I imagine they, at the least, didn't object to the new policy, but I think we're all looking for the green light to have had a more substantial portion. So how did that back-and-forth go?

And then additionally, Claude, I noticed in your prepared remarks, you said, "up to 100% payout," when you were talking about the variable dividend -- or the cumulative dividend. But the release says it's going to be 100% payout. So is 100% of earnings the policy, or are you guys keeping some wiggle room in there as well?

Yes, it's a good question, Scott. The first is we're very sensitive to our regulatory relationships, and so we don't disclose either the content or the back-and-forth that we have with them. I think to that point, though, I think we feel like our balance sheet is more fortress-like than at least anybody we look at, and I think with our capital levels and liquidity levels at both the bank and the parent company, we feel like we're very much in a position to have an outsized dividend, if you will.

And just as a reminder for those on the call, if you look at our balance sheet, we're almost entirely deposit-funded. We're solely common equity capitalized. We have capital ratios that are probably in the fifth percentile of the industry. And at the parent company, the strength of the parent company is we have almost $100 million of cash and no debt. So that was the combination of factors that we said, "Look, we're in a position to do this."

In terms of the payout ratio, I did say, "up to." And the intent of the variable dividend, until we have opportunities, is to pay out the 100% payout ratio. But the point is, or as we've been real clear about always on dividend policy, our Board does do a quarterly valuation. And so to say it as an absolute would be inappropriate, because our Board needs to evaluate it on a quarterly basis.

But the intent of this program is to pay out 100% of earnings until we have capital deployment opportunities. I don't know if that helps or answers the question, but that was the intent.

Yes, it does. It does, so I appreciate that color. And then separately, Frank, I was hoping you could maybe -- I know the purchase accounting noise always, just adds some wrinkles into the numbers. But I wonder if you could talk at a high level about some of the trends you're seeing that might affect purchase accounting adjustments.

I ask because a lot of companies have done deals. We've started to see some of that increase in the margin tail off very quickly, which I think has made a lot of investors nervous about longevity of purchase accounting benefits. So maybe if you can discuss things like pre-payment trends on purchased loans that just might give us a sense for how things are trending in there, that might be helpful.

Sure. Yes, there's really nothing that we're seeing that's outside of our expectations as far as any behavior there. I would say that, as you think about yields on a covered loan portfolio, there are more moving pieces than there are in an originated portfolio and that you're doing the quarterly estimations of expected future cash flows. So it's not as simple as taking a coupon and impacting a portfolio. There are more moving pieces there. And as I've looked at some others in the industry, I would say that's probably more the dynamic there than anything.

But the portfolio that we've acquired continues to behave, say, in line with our expectations. Occasionally you may see some -- I can't think of a better word than "spikiness," if you will -- to some of the credit. But that's more a timing-related element than anything, and it will be reflected in the provision expense for the covered loans with that offset on the FDIC indemnification income.

But overall, really no surprises. And I think if you look at the supplemental material, there's some good information on the trend in the yields on the covered loan portfolio and the yields on the indemnification asset as well, and then also the details on the credit losses for the covered assets.

Yes, okay. Good. Thank you very much.

Chris McGratty, KBW.

In the context of your comments on the dividend, can you just talk about any changes you're seeing in several of your markets from the acquisition front? Obviously, the pace of closure has been slow, but maybe you could just comment on that relative to a few months ago, and maybe opportunities you may see on the unassisted front and which markets you're most interested in.

Sure. Yes, we continue to have our primary interest be in Ohio, Indiana, and Kentucky. And we still, even in the context of the Liberty branch deal in Dayton, still feel like we have the capacity and ability, both financially and operationally, to do additional deals if they present themselves.

And in terms of the conversations or activity, as we've always said in the past, we don't go into individual discussions. But it is one that we, like many, continue to expect the M&A activity to pick up. But it's still, obviously, tepid, mainly, in my view, because of separation between buyer and seller expectations around price and, I think, continued conservatism around credit.

So I think the M&A will be slow for a while. But we remain positioned to be able to take advantage of it if the right opportunity presents itself.

Right. And your comment on the possible assets you could add -- is there a preference for fewer larger deals or multiple smaller deals?

I'd say the first, Chris. We focus on strategics. So if it's a smaller deal that it's perfectly aligned in a strategic market for us, we'll take a look at that. You always have a general preference for, if you think, on average, a larger-than-average versus a smaller-than-average deal, only because of the operational resource constraint that any deal gets to you. So I wouldn't want to target an amount or a preference. But we're going to look at any opportunity that we think strategically fits what we're trying to accomplish in our market area.

Okay. And then just one final question on C&I pricing. Maybe you can just talk about where new production's being put on today versus, say, six months ago in terms of spread.

Yes, this is Frank. There really hasn't been, I would say, any material change to what we're seeing as far as origination spreads.

All right, thanks a lot.

Joe Stieven, Stieven Capital.

Scotty Siefers sort of got my question, but I'm going to rephrase it. Basically, you guys have just got anointed to do something that no other bank's got, whether it be JP or Wells or US. You've all wanted to start paying out much more, and I know you won't answer it because you just talked about you ain't going to talk about the regulatory side, but I will just tell you congratulations. You guys did a great thing, and that's it. Thank you.

David Long, Raymond James.

Just to follow up on some of the C&I questions that we've heard -- most of my questions have been answered -- but regarding any particular industries, have you seen any industry stand out where you may be seeing more demand from?

Sure. Yes, I would say the manufacturing sector has really been the one sector that stayed strong throughout the cycle and, I think, was better capitalized to continue once the crisis was over. So that's continued to be a stronger side, an element. And then the rest is a variety of industries, from some small healthcare, agribusiness, to some of the other sectors that are, I'd call them more service-oriented. So it's been a mix. But if there's one that stands out, I think it's manufacturing that's been the stronger of the industries that we lend into.

Okay. And are the opportunities you're seeing, is it more client wins, or is it more line utilization?

No, I'd say it's been more client new origination activity. I think some increased line utilization. I don't have those numbers in front of me, but that's always one you're wanting to see, especially for good clients, for them to use their line. But what I spoke to was more around new activity. And some of that new activity was existing clients, but new activity, both existing and new clients.

Great. Thanks, guys.

Matthew Keating, Barclays Capital.

Core expenses appeared to rise about -- or fall, rather -- about 4% this quarter. Just wondering whether we should expect any pickup in your run rate in second half '11, mainly associated with the transition to the new corporate headquarters at the Chemed Center.

Sure. No, that should not, because it's in effect a replacement for existing facilities that we're already in. And so comparable costs to -- we're consolidating two facilities into one in that new headquarters facility, and so it should be a comparable cost impact to us.

And we've been working very hard as a team. We continue to become more efficient and reduce costs, and that included not only, I would call it ongoing operational saves, but we also announced some branch closures that have helped and will continue to help us on a go-forward basis in terms of improved cost structure.

Got you. Thanks. It's helpful. Then lastly, you saw a modest pickup in home equity lending this quarter. Just wondering if you think that's the start of any trend there or, it just was sort of interesting in light of the decline in residential mortgage lending. So just any other color you could offer on the home equity lending environment would be great.

Sure. I would not view it as a trend, certainly not until the housing industry begins to become stronger. We are always, for our better clients and certainly our higher FICO score clients, trying to solicit new business. And I think, with some of our retail clients being perhaps more conservative about move-ups into new homes and maybe more doing remodels, that's always a good environment to do home equity lending.

The challenge with it is really appraised values and making sure you have enough value in the home to do a safe home equity deal. So we saw some nice trends there, but I wouldn't be ready to call it a trend that would continue in the future.

Thank you.

(Operator Instructions.) Kenneth James, Sterne, Agee.

Following up on potential capital deployment opportunities, I assume you guys would rather be doing M&A deals and growing the franchise than paying out 100% of earnings. So could you just talk about, I would assume the biggest impediment between buyers and sellers is what the credit market implies the bank is worth to the seller. And just given the improvement in credit generally across the industry and even in your FDIC-acquired portfolio, are we seeing any indications that those marks in an M&A scenario are starting to come down at all?

Yes, this is Frank. It's really hard to say. There's a qualitative aspect that goes into any credit due diligence as well. I'm going to say qualitative, not credit quality, but loan file quality and the risk associated with that aspect. So I haven't seen any what I'd call material changes in what those valuation estimates look like. But to your earlier observation, yes, we'd prefer to have earning asset growth and capital deployment opportunities in that way.

Okay, thank you.

Bryce Rowe, Robert W. Baird.

Just to follow up to Kenneth's question there, on the M&A front, Claude, are you getting more incoming calls from prospective sellers that are tired of boards, tired of dealing with the environment? Has that picked up at all?

We try not to comment too much on activity levels in terms of one quarter to the next or one period to the next on that. We're always having conversations, because we view it as a part of our role and responsibilities, good stewards. The incoming calls tend to go in waves, and I think they are continuing to occur, but it's an environment where, even when we find people are going to be looking or seeking opportunities, they still have a price expectation. And it's that price expectation that has to be brought together between buyer and seller. And this isn't just First Financial related. I still think there is a gap out there that exists that -- I don't know what's going to be the catalyst to move it together, but it still exists.

Okay. And then a question for Frank. Frank, any thought on what to expect from that core expense base with the addition of Liberty in the third quarter?

Sure. The expectation is that we would manage it to a cost structure that is very similar to our legacy franchise. So while there may be what I'd call an interim elevated level, we would expect that to be temporary in nature and would taper off.

Okay, all right. Thank you.

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

Frank, I just wanted to try to delve into a bit more detail that the covered provision, which was a bit more elevated than I thought this quarter, if you can maybe review what's keeping that elevated, and more importantly, going forward, what are the main dynamics that would keep it up toward this level or allow it to drift back down more toward where it was a couple of quarters ago? I know there are the offsets that occurred in other geographies of the income statement, but if you can just run through those briefly, I'd appreciate it.

Sure. Again, it all stems from expected future cash flows, and we're continually refining the model to make sure that our expectations around certain exit or renewal events are accurate. So it's a combination of factors that go into that.

And there's also, keep in mind, too, that we have 26 different valuation pools. And each of those valuation pools, if there is net impairment in one of them, you have to take the impairment regardless of whether or not there's improvement in another pool. So I would call it a combination of mix shift within each of the valuation pools and some level of refinement in event expectations and their impact on the future cash flows. But it's a difficult line item to predict, but it's something we'll just continue to give you good visibility into.

Okay, all right, perfect. Thank you.

And, ladies and gentlemen, showing no further questions in the queue, this will conclude our question-and-answer session. I would now like to turn the conference back over to Kenneth Lovik for any closing remarks.

Actually, this is Claude Davis. Yes, I would just close by thanking everyone for their ongoing interest in First Financial and what we believe was another, a good quarter. And hopefully, we'll continue to provide good visibility into our future earnings capability. So we appreciate the interest, and thank you very much.

The conference has now concluded. Thank you.