First Financial Bancorp (FFBC) 2012 Q2 法說會逐字稿

Good morning and welcome to the First Financial Bancorp.'s second-quarter 2012 earnings conference call. 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 Ken Lovik, Vice President of Investor Relations and Corporate Development. Please go ahead.

Thank you, Valerie. Good morning, everyone, and thank you for joining us on today's conference call to discuss First Financial Bancorp.'s second-quarter 2012 financial results. Discussing our operating and financial results today will be Claude Davis, President and Chief Executive Officer, and Frank Hall, Executive Vice President, Chief Financial Officer, and Chief Operating 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 2012 earnings release as well as our SEC filings for a full discussion of the Company's risk factors. The information we provide today is accurate as of June 30, 2012; 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.

Great. Thanks, Ken, and thanks to all of you who are joining the call today. We are pleased to announce another quarter of solid performance, reporting net income of $17.8 million or $0.30 per diluted common share. Return on average assets was 1.13%, and return on average equity was 9.98% for the quarter.

The results were impacted by two one-time items during the quarter. First, we recognized $2.2 million of nonrecurring expenses on a pretax basis, or $0.02 per share, primarily related to expenses associated with our branch consolidation plan.

We also recognized a pretax gain of $5 million associated with the settlement of litigation related to a subsidiary, which impacted earnings per share by $0.05. Earnings were also affected by the provision for loan losses related to our uncovered loan portfolio, which increased $5.1 million compared to the linked quarter.

We paid our third variable dividend during the quarter, representing a 100% dividend payout ratio based on our fourth-quarter 2011 reported earnings per share of $0.31. While not reflected in the second quarter's reported results, we paid our fourth variable dividend earlier this month based on the first quarter's reported earnings per share of $0.29.

Our next quarterly dividend will consist of a regular dividend of $0.15 per share and a variable dividend of $0.15 per share based on the second quarter's earnings of $0.30, the announced dividend results, and a current yield of 7.4% based on yesterday's closing price of $16.21. As we mentioned last quarter, we intend to continue paying the variable dividend through 2013, unless our capital position changes materially or capital deployment opportunities arise that cause our capital ratios to move toward our stated thresholds sooner than expected.

As of June 30, our tangible common ratio was 9.91%, Tier 1 leverage was 10.21%, and total risk-based capital was 18.42%. Our ratios continue to remain well in excess of our stated thresholds of a tangible ratio of 7%, Tier 1 leverage of 8%, and total capital of 13%. Our strong capital ratios still have the ability to support significant growth and, under the most constraining of our thresholds, have capacity to support approximately $1.6 billion in additional assets under current regulatory capital standards.

With regard to the NPR related to Basel III capital standards, while the proposed rules are not final, we performed a preliminary analysis under several scenarios and determined that our capital levels are still well in excess of the proposed guidelines. As we manage capital going forward, we are obviously in a wait-and-see period until the new capital guidelines are finalized. Once those guidelines are finalized, we will perform a thorough analysis to determine whether or not our stated thresholds are still appropriate.

Total classified assets continued to improve, declining for the seventh consecutive quarter, and are down $9.1 million or 5.9% compared to the linked quarter, and down $39.2 million or 21% compared to June 30, 2011. Net charge-offs related to uncovered loans totaled $6.8 million or 93 basis points of average loan balances during the quarter, a slight increase over the linked quarter.

Contributing to the quarterly total was $2 million related to the residual balances of two nonperforming credits sold to third parties. Total nonperforming loans to total loans decreased slightly to 2.76% as of June 30 from 2.79% as of March 31.

As I noted earlier, our provision for loan losses related to uncovered loans increased $5.1 million during the quarter to $8.4 million. The provision expense is a byproduct of our internal model used to estimate the period-end allowance for loan losses. The increase in the provision for the quarter was driven primarily by having to establish or add to specific reserves totaling $6.1 million in the aggregate, related to three separate larger credits in our commercial and commercial real estate portfolios.

Total loans excluding the covered portfolio increased $49.1 million or 6.7% on an annualized basis during the second quarter, driven primarily by the commercial real estate portfolio. And even though total dollar volumes are still relatively small at this point, we were extremely pleased with the growth in our specialty finance unit and its contribution to the overall growth in the loan portfolio. Our sales efforts in this area have begun to show results, and we expect continued success as we further penetrate our key metropolitan markets.

We were also pleased with our ability to capitalize on the strong commercial and commercial real estate pipeline at the end of the first quarter, as second-quarter originations and renewals were up almost 30% quarter-over-quarter. The impact of this increased activity was affected, though, as we experienced payoffs on some larger credits during the quarter. The pipeline at the end of the second quarter was strong, and we are optimistic that we will convert a significant portion of it to actual fundings.

From an operating and efficiency perspective we continue to review our banking center network for growth, expansion, and consolidation opportunities to ensure that our resources are appropriately focused on markets providing the greatest prospects for growth and profitability. During the quarter, we completed the consolidation or market exit of 10 locations and announced that we will be consolidating two additional Indiana-based locations and exiting four Indiana markets where we have a limited presence.

Net of the anticipated impact on revenue from deposit attrition, estimated annual pretax operating expenses associated with all of these locations, $3 million. This will allow us to channel greater resources into our metropolitan markets in Cincinnati, Dayton, and Indianapolis, while moving closer to our target operating efficiency ratio of 55% to 60%. Furthermore, we will be launching a detailed review of our cost structure during the third quarter to further ensure our ability to hit this target range.

In closing, we were satisfied with our core operating results for the quarter. Excluding the nonrecurring events, the most significant items impacting earnings were the decrease in net interest income and the increase in the provision related to uncovered loans.

Going forward, we are focused on net interest income and are optimistic that the combination of our deposit strategies and our ability to capitalize on loan growth opportunities will help to mitigate the impact of historically low interest rates and nonstrategic loan attrition. I will now turn the call over to Frank for further discussion on our financial performance.

Thank you, Claude. We have provided supplemental information that 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. Unique accounting and reporting requirements and the strategic distinctions we have made related to our 2009 acquisitions materially impact our reported operating results. So to aid in better understanding our strategic activities, I will focus primarily on the ongoing or strategic aspects of our business.

Our second-quarter 2012 GAAP earnings per diluted share were $0.30. The quarter's earnings were impacted by several nonrecurring items that Claude has already touched on, so I will speak briefly to the major components of our operating performance in the quarter.

Our adjusted pretax pre-provision earnings as shown on slide 3 and 4 of the supplement, were $30.2 million for the quarter or 1.92% of average assets. Adjusted pretax pre-provision earnings, which excludes certain items related to covered loan activity as well as significant nonrecurring items, were down quarter-over-quarter due to a decline in net interest income which was partially offset by higher fee revenue.

Total interest income was down $3.2 million compared to the linked quarter, due primarily to lower interest income earned on loans resulting from a 6.9% decline in the average balance of covered loans outstanding and, to a lesser extent, a decline in the yield earned on the uncovered loan portfolio. Total interest expense declined $1.3 million compared to the prior quarter due to lower interest expense on deposits. As a result, net interest income on a linked-quarter GAAP basis decreased $1.9 million.

We were pleased with our ability to maintain a strong net interest margin during the quarter, which declined only 2 basis points to 4.49%. We continued to execute on our deposit pricing and branch rationalization strategies, which contributed to the strong net interest margin and decline in interest expense.

During the quarter, the cost of funds related to interest-bearing deposits declined 7 basis points to 61 basis points. The total cost of deposit funding decreased 8 basis points during the quarter to 49 basis points.

Related to our rationalization strategies, total time deposits declined $159.4 million or 10.7% during the second quarter. The majority of this amount consisted of single service CDs and other time deposits representing non-core relationships. Additionally, since the end of 2011 total time deposits have declined over $320 million.

As of June 30, our total balance of time deposits was $1.3 billion with a cost of funds of 1.6%. While we have most likely dropped our cost of funds related to nonprime deposit products as far as we can take them, we still feel we have room for continued improvement related to our CD balances. Over 30% of the total time deposit balance represents single service relationships with a weighted average rate of 1.82%.

Since the fourth quarter of 2011, our experience with maturing single service CD products has resulted in approximately 58% of the balances rolling off and 42% being retained at rates no higher than 20 basis points. Even if our retention rates were to increase, the cost of funds differential is great enough to have a significant impact on the all-in cost of deposit funding.

There is also the additional impact of repricing the existing strategic CD book with core relationship clients, which again would be re-priced at significantly lower rates for those balances that are renewed. So as you can see, we still have a few levers to pull going forward that should help offset the impact of a decline in covered loan balances and any potential decline in new loan origination yields related to net interest income and net interest margin.

As noted in Table 1 of the earnings release, operating non-interest income earned in the second quarter increased $1.1 million to $16.4 million from $15.3 million for the linked quarter. The increase was primarily driven by increases in service charges on deposits, client derivative fees, and gain on sale from mortgage originations to franchise loan sales, partially offset by lower trust and wealth management fees.

As noted in Table 2 of the earnings release, operating non-interest expense in the second quarter was $49.2 million as compared to $48.7 million for the first quarter. The modest increase in non-interest expense compared to the linked quarter was primarily driven by higher data processing costs, uncovered ORE, and other miscellaneous expenses, partially offset by lower occupancy costs.

Finally, I will briefly comment on the performance of our covered loans during the second quarter. Net credit losses on covered assets for the quarter were $2.1 million, as highlighted on page 10 of the supplement, which discloses the individual components of credit and FDIC related items associated with covered assets.

As can be seen on the graph on page 10 showing the prior four-quarter trend, actual credit losses can be somewhat volatile from quarter to quarter and are affected by actual charge-offs as well as changes in both the timing and amount of cash flows, in addition to the continued mix shift as the covered loan portfolio matures. Overall, the performance of the covered loan portfolio continues to exceed our initial estimates.

I will now turn it back over to Claude.

Thanks, Frank. And Valerie, we will now be happy to open up the call for questions.

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

Morning, guys. I guess the first question I wanted to ask is on the efficiency analysis you guys are going to be embarking on. I was just looking for a little more color, I guess, maybe in terms of what the overriding goal of that will be.

Just to the extent that you have already rationalized geographies, so what are the main things you're going to be focusing on? Then maybe your top-level thoughts on timing. We know when the start will be, but when you would hope to be finished with the analysis, the process you are going through, how you will communicate the results to people like us, etc.

You bet, Scott. Yes, the first stage of it we wanted to complete was the branch consolidation plan, which as we mentioned we did the first 10 of those at the end of the second quarter, and then the other six will be happening in the third quarter. So the impact of those have not yet been seen in our results. So we should begin to see that start to show up in the third-quarter numbers.

The analysis we will be doing should be substantially complete by the third-quarter call when we will at that point give an update as to where we are at and the impact of those changes. The process we are going through, in addition to what we have already disclosed on the branch consolidation plan, is to literally look at every part of the Company.

The way we are looking at it is we have developed what we call key performance indicators for all parts of our business which really focus on, for lack of a better term, capacity management and making sure that the business that we are doing justifies the expense base that is dedicated to each part of our business. So now that we have these KPIs as we call them in place, in most parts of the business, we will be going through that capacity management analysis, determining where we have excess cost, and then coming up with a plan to reduce it.

That is process we will go through, and that is the part of the process that we should be able to disclose substantially all of that work by the third-quarter call.

Okay. That's perfect. I appreciate the color there. Then, Frank, had a question for you just on Basel III.

Now, Claude, you mentioned it at a top level, still comfortable with how you look under Basel III. But I was wondering if you might be able to put any more specifics around it.

And then, Frank, I guess specifically for you, I was wondering -- I guess there is a little bit of an impact to your guys' capital ratios with the expiration of the loss-share agreement next year, I believe. Does that factor in any differently under Basel III versus Basel I? And how are you guys thinking about that dynamic?

Sure. Scott, with -- I would say our analysis took a very conservative view across all areas of the balance sheet. I think as you can appreciate, not all of the points that are addressed in the NPRs are necessarily readily available for analysis for many financial institutions. So we took a very conservative view, and just assumed the worst as far as treatment on any area of the balance sheet, and reached the conclusions that Claude articulated.

Including the loss share.

Yes.

Okay. All right.

You had mentioned next year. Actually ours expire in mid 2014.

That's right.

Okay, sorry. Excuse me. Okay, good; I think that does it. Thank you very much.

Chris McGratty, KBW.

Good morning, guys. Frank, with the improving loan growth this quarter, can you just help us on the thinking about the size of the investment portfolio going forward?

Sure. You know, I would say that the investment portfolio is largely going to be driven by what we see on the funding side of the deposit portfolio in particular. We have given ourselves a boundary, if you will, around our overnight borrowings position, to support the investment portfolio because there is some seasonality in our deposits, as you saw this quarter with public funds.

So, I would say barring any significant changes in our deposit portfolio, I would expect to see the investment portfolio stay about the size that it is, and maybe decline if we are successful in seeing some good solid loan growth.

On that point on the growth, can you update us on where pipelines are today? I think you maybe said they were stable; but any additional color about back half of the year growth expectations for loans?

Sure. Yes, as we have talked about, and we talked about it in the last quarter's call, we saw a nice pipeline increase at the end of the first quarter which translated into 30% higher 2Q originations. With that level of origination, in the second quarter we saw the pipeline decline some, as you would expect with those fundings. But still very strong.

So at least at this point, we are optimistic. But we are also concerned and cautious related to just all the economic news that is out there.

So I think our sales team is doing a great job of being out aggressively pursuing new clients and retaining existing clients. So we are still cautious but optimistic.

Great. On the investment portfolio, one more for you, Frank. What are you buying in terms of duration and yield? Just if we are to keep the portfolio flattish, what are you buying to offset the maturing cash flows?

Sure. Right now the duration is right around -- just under 4 years, about 3.8. And then the yield is in the -- is about 1.5%.

Okay. Last, what is the tax rate we should use going forward?

I would say it looks similar to what we've experienced in prior quarters. This quarter was an anomaly due to an adjustment, but should be probably best-case maybe 20 basis points lower than it has been.

Great, thanks.

Jon Arfstrom, RBC Capital Markets.

Good morning, guys. Just a follow-up on the pipeline or loan growth question. Specifically on commercial real estate, it is one of the better quarters, maybe the best quarter I have seen in quite a while. Is there anything specific going on there? Anything that drove those balances in the quarter?

I wouldn't say -- I mean it was a combination of some good wins. It is certainly an area that we remain cautious in, just because of what has gone on in the economy. But, Jon, we have seen some nice opportunities there to do some very high-quality deals, and we were able to get those closed and funded in the second quarter.

So it's I wouldn't say anything out of the ordinary. But we are beginning to see, especially for good cash flow supported deals, more interest by buyers in that market. So yes it's -- I would say in general we are seeing some improvement there.

Okay. The term cautious comes up periodically in the dialog here. What is the borrower mood like? Has it changed at all? Is some of the negative macro news impacting the borrowers, in your view?

I think it is. It just seems like it stops and starts as it relates to mood and attitude, which is kind of reflective of the overall economic mood. So I would say that tends to be more of what impacted to the negative is more the macroeconomic.

Many of our clients are still doing well. I think there has been some softness that has happened in the second quarter; but in general I think it is more just macro news and environment that has caused it, I would say, more than anything.

Okay. Then just a quick credit question on the three separate commercial and commercial real estate credits. Obviously, without that $6 million additional provision, the numbers would be a little bit better here.

But is there anything specifically, or is there a story in terms of what drove that? Was it some kind of a portfolio review? Or are these just three larger credits that experienced some difficulties at the same time? Just some more color there would help.

Sure. Yes, Jon, one of the credits was just a classified credit that just got to a place where we pushed for some change in action that caused the further downgrade and reserving. The other two, I believe, are more valuation adjustments related just to ongoing appraisals that we do on troubled credits. So, no; no unusual events related to portfolio reviews other than just our normal process.

Okay, thank you.

Emlen Harmon, Jefferies.

Good morning. Just a quick one tied into loan growth. Did see the legacy or the noncovered loan yields drop a good amount this quarter. Could you help give me a sense of how much of that is due to you guys being more aggressive on growing that book and going out there and pricing aggressively, versus just general repricing in the portfolio? And whether we should expect declines of the same magnitude going forward as you guys stay aggressive on loan growth?

I think we are -- I would say we are more aggressive. Certainly yields or rates have come down in the last two months. As we all know, the 10-year has come down substantially. So yes, I think market rates have come down on loans, so that that is a part of what you're seeing reflected.

It is also just ongoing renewals that occur that when they occur they tend to, if they're -- especially term loans will adjust in pricing. But other than that in terms of our approach to the pricing models and other things, we have had no change.

So it is just more the current rate curves and just repricing of loans. So no change other than that from a policy perspective.

Got you. So it feels like the degree of decline that we saw this quarter, maybe you get a couple more quarters of that as the book just reprices down through the year.

Yes; I think the whole industry is going to have some of that.

Yes, yes, fair. Okay. Thanks, appreciate it.

Bryce Rowe, Robert W. Baird.

Thanks. Yes, I just wanted to follow up on Emlen's question there. Was there an interest reversal in the quarter related to the three credits that you provided for?

There was. We don't have that number --

Yes, on a couple of the credits, yes. But it would not have a material impact.

Okay. Then, Frank, the $2.2 million of nonrecurring expenses, was it spread out across the expense line items? Or was it concentrated in salaries or occupancy?

Yes, most of the number is salary and benefit. But it is spread out, as you would expect --

Some occupancy.

-- across all categories including occupancy. But the bulk of it, yes, was in salary and benefit.

Okay. Then last question, I guess the six branch consolidations/exit, can you guys tell us which ones they are? And that is being offset, if I remember correctly, by a couple new branches coming on line in Cincinnati.

Yes. Of the six that we are closing, four are in-store locations in markets in Indiana, where we have no other presence. Then two others are consolidations in existing markets where we will continue to have an ongoing presence.

And you are correct in that we opened up a small downtown location in Cincinnati that would be more akin to an in-store type expense level. Then we also opened up early in the second quarter, or I guess mid part of the second quarter, an office in a suburb or a part of Cincinnati. So part of those -- that expense for that office would have been in the second-quarter results.

Okay. So no more planned openings for the balance of the year?

We have one other location on the east side of Cincinnati that we are planning, but we have not yet started construction. So my guess is that would come on in the first quarter of '13.

Okay. Thank you. Appreciate it.

(Operator Instructions) Kenneth James, Sterne, Agee.

Hi, good morning. I wondered if you could touch on maybe the retention rate of acquired customers in the covered portfolio.

And then just about the pace of runoff this quarter, a little faster than it had been; and I am just wondering. I would think as those portfolios mature and the bad stuff gets worked out in the early period, that the rate of runoff would slow towards something like normal amortization. So I was just curious if you could give some color on that.

Yes, I would say that on the covered loan portfolio, we have, I would say, been fairly successful in retaining those relationships.

That we view as strategic.

That's right, that we view as strategic. We haven't disclosed an absolute dollar amount, but it has been successful. If you'll recall, we do differentiate between strategic and nonstrategic, nonstrategic being those that are in markets that are outside of our Ohio, Kentucky, Indiana footprint and also those that are credit challenged.

But no, we have been very pleased with those retention rates. And I would say as far as a rate of change, the rate of change has certainly slowed within the last six, eight quarters.

Okay. Was there some out-of-market strategic stuff or I guess credit-challenged stuff in the covered portfolio that got worked out this quarter, or moved out, I guess?

Yes. And there are prepayments and contractual activity and we disclosed that in one of the tables. But yes, I would say some behavior is difficult to predict in that covered loan portfolio. But as far as what we want to keep in that strategic portion, we have had good success there.

Okay. If you get a maturity and you get a renewal, does it automatically go into your regular? Or while there is a loss-share agreement in place, can you actually keep that covered?

Yes. There are some very strict conditions that we need to adhere to, but it is possible to renew and maintain coverage.

Okay. Then lastly, would you say generally your borrower base has -- would you say that they are in the aggregate still deleveraging? Or have reached neutral and just haven't thought about releveraging yet as far as, like, the loan growth demands?

Sure. I would qualify my statement I am going to make by saying this is more anecdotal than statistical in terms of we do not look at it that way in terms of the portfolio. I would say in general, from an anecdotal perspective, I would say people are either staying static or continuing to delever.

We can look at that by our line utilization rates, as one kind of indicator, as an example, and just other discussions. But our line utilization rates, as an example, on our commercial lines has actually gone down in the last couple of quarters. So --and still at levels that we have not -- are historically low levels.

So just based on a couple of those data points, yes. I think they are staying static or delevering more than leveraging up at this point.

And lastly, can you refresh me on maybe the utilization rate? Is it low 40s, high 30s?

It's more in the -- it's obviously [on] the product type; we look at it across all of ours. But it would be more in the mid 40s, what I would call core commercial.

Okay. All right. Thanks a lot, guys.

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

Yes, thank you, Valerie. We appreciate it. I just want to make one other comment, before we conclude. And that is, that if you are not already aware, we will be hosting our first investor day on the afternoon of August 15 in Cincinnati. The event will be webcast, and we will be distributing details soon through a press release.

If anyone has any questions regarding the event, please feel free to contact Ken Lovik. His information is listed in our earnings release and on the investor relations portion of our website. So, thank you all for participating.

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