First Financial Bancorp (FFBC) 2014 Q4 法說會逐字稿

Good morning and welcome to the First Financial Bancorp fourth-quarter earnings conference call.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Mr. Eric Stables, please go ahead, sir.

Thank you, Dan. 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 2014 financial results. Discussing our operating and financial results today will be Claude Davis, Chief Executive Officer; Tony Stollings, Chief Operating Officer; and John Gavigan, 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.

Additionally, please refer to the forward-looking statement disclosure contained in the fourth-quarter 2014 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, 2014, 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, Eric, and thanks to you joining the call today. Tony and John will be discussing the fourth quarter and full-year results, but before they do, I would like to take the opportunity to acknowledge our great collection of associates. Without their outstanding individual and collective efforts, our success would not be possible.

As an industry we've all experienced the challenges of a prolonged low interest rate environment, and as a Company we have faced additional headwinds related to the continue runoff of the high yielding loan portfolios that we acquired in the 2009 FDIC assisted deals. The extra effort that our associates make everyday has helped create the success that we had the opportunity to discuss with you today.

Fourth quarter was an exciting period for us as we recognized the full impact of the three acquisitions in the Columbus, Ohio market. The data conversions and rebranding efforts for the three acquisitions are all now complete. All significant costs associated with the acquisitions have been recognized and essentially all of the efficiency-related opportunities identified during the integrations have been implemented.

Loan and deposit growth remains in line with our expectation. And the First Financial brand continues to gain recognition across the Central Ohio region. We continue to see good opportunities to grow our balance sheet organically with competitively priced, high-quality loans and longer duration low cost deposits through our relationship-oriented product structure. However, the recent flattening of the yield curve is concerning and depending on its duration could have an impact on the Bank's margin.

The loan pipeline remains strong as we enter 2015. New origination yields are stable and the impact from the formally covered loan portfolio will continue to be less of an obstacle as it has become a much smaller percentage of our total earning assets.

Likewise we also recognize the environment for growth through acquisition is also improving with several deals announced recently. Although will not comment specifically or speculatively on this topic, our strong capital position will support significant organic growth and consideration of additional acquisition opportunities should they develop, and even more importantly, meet our strategic objectives.

Before I turn the call over to Tony, I am pleased to report that in conjunction with the earnings release yesterday, we announced our quarterly dividend of $0.16 per share to be paid April 1. This translates into a 3.8% yield based on yesterday's closing price and remains on the upper end when compared to our peer banks. With that I'll turn it over to Tony for further discussion of our operating performance.

Thank you, Claude. For the quarter we reported net income of $18.6 million, or $0.30 per diluted share compared to $0.26 in the prior quarter. Our results for the quarter were impacted by acquisition-related expenses and other nonoperating items which reduced reported earnings per share by approximately $0.02.

On an adjusted basis, return on assets was 1.07% and return on tangible common equity was 12.24%. For the full year 2014, we reported net income of $65 million or $1.09 per diluted share compared to $0.83 for the full year 2013. On an operating basis, our full year 2014 earnings per share were $1.18.

Average loan balances increased $358 million, or approximately 8% over the prior quarter due primarily to the first quarter impact of the acquisitions and strong originations during the third quarter. Period end loans were relatively unchanged from the prior quarter as runoff of the formally covered commercial loan portfolio offset otherwise strong organic loan growth. Loan origination pipelines remain strong and in line with expectations as we enter 2015 with no unusual slippage of funding when compared to previous quarters.

With regard to asset quality metrics, you will notice a change in the presentation of the allowance from loan loss, related charge-off metrics and other credit quality ratios this period. With the scheduled expiration of FDIC loss share coverage on the majority of the remaining loan balances from those assisted acquisitions, beginning this quarter, the covered and formally covered loan portfolios have now been combined into total loans and their related reserve has been combined into the allowance for loan loss.

A more detailed explanation of these changes as they relate to net charge-offs and non-performing and classified assets was included in yesterday's earnings release. As a result of the change in presentation, the combined net charge-offs for the quarter were 27 basis points of average total loans on an annual basis compared to 7 basis points for the third quarter.

Net charge-offs related to the uncovered loan portfolio were $700,000, or 6 basis points of average total loans on an annual basis. And net charge-offs related to the covered and formally covered loan portfolios were $2.5 million, or 21 basis points.

Likewise, nonperforming assets increased by $20.7 million, or 31%. Total classified assets increased $48.9 million, or 46% compared to the linked quarter. The change in non-performing assets and classified assets is also largely related to the inclusion of the covered and formally covered loans. The $12 million of ORE generated from formally covered loans and now shown in total non-performing assets is carried at fair market value.

Due primarily to the previously reference change in presentation, the allowance for loan loss increased to 1.11% of total loans compared to 0.95% of total loans for the linked quarter. Without this consolidated view, the allowance ratio would have increased slightly to 0.96% of total loans.

In our view, a more appropriate and meaningful credit risk coverage metric for our total loan portfolio is the sum of the allowance for loan loss and the related loan marks net of the FDIC indemnification asset shown of percentage of total loans. As of December 31, 2014, this ratio was 1.51% of total loans. We believe this level represents adequate coverage for potential future credit losses and intend to supplement our future credit risk coverage analysis with this metric. You will find the detailed components of this ratio in our 8-K filing for the earnings release.

Average deposit balances increased by $443 million, or 8% over the prior quarter due primarily to the first full quarter impact of the acquisitions. End of period deposits increased by $123 million, or 9% annualized over the linked quarter as non-interest bearing deposits grew at a faster pace than interesting bearing deposits.

Capital levels for the fourth quarter reflect strong earnings, including a full quarter from Columbus and the dividend increase announced last quarter. Tangible book value per share increased 1.5% to $10.38 per share as of December 31 from $10.23 as of September 30. We ended the period with tangible common equity ratio of 9.02%, a tier 1 ratio of 12.69% and a total capital ratio of 13.71%.

Our strong capital position will support significant organic growth and consideration of additional acquisition opportunities should they develop. The impact from the expiration of commercial loss share had minimal impact on our capital ratios and credit quality metrics other than that's previously discussed. I'd like to remind you that the expiration of loss share does not change the overall accounting framework for these loans and they will continue to be revalued each quarter. With that I will now turn it over to John for further discussion of our financial results.

Thank you, Tony, and good morning, everyone. We are pleased with the quarter's results, and as Claude and Tony noted in their remarks, we continued executing on our strategy during 2014 with solid growth across our footprint, complimented by the strategic acquisitions in the Columbus, Ohio market.

Directing your attention to slides 2 and 3 of the supplement, you will see our fourth-quarter adjusted pre-tax pre provision earnings of $28.8 million, which excludes certain items related to covered and formally covered loan activity as well as other significant items, increased $1.2 million or 4% from the third quarter primarily due to a full quarter's impact from the Columbus acquisitions and the strong organic loan growth during the third quarter.

As shown on slide 3, pre-tax pre provision earnings as a percentage of average assets were stable at 1.58% on an annualized basis. Total interest income increased $3.4 million compared from the linked quarter as average loan balances increased 8% for the quarter, reflecting a full quarter's impact of the earning assets acquired in the Columbus transactions midway through the third quarter as well as the strong loan production in that quarter, most of which closed late in the period.

As anticipated, fourth quarter loan production was down from the third quarter as organic growth was offset by approximately $30 million of runoff in the covered and formally covered portfolio during the period, resulting in a period end total loan balance being relatively unchanged from the third quarter. To be clear on this point, total loans at December 31 now include approximately $165 million of formally covered loans due to the expiration of non single family loss sharing coverage effective during the period.

In addition to average balance growth, interest income also benefited from a $400,000 increase from loans returning to a cold status during the period. And loan fee income also remained strong during the fourth quarter.

While interest income continues to be impacted by the prolonged low interest rate environment and the slowly receding headwind from covered asset runoff, we continued to see narrowing in the spread between the yield on loans originated during the period and loans that paid off. This spread declined to 30 basis points for the fourth quarter, down from a 106 basis point spread during the first quarter. While it can be volatile, this marks the fourth consecutive quarter we have seen [narrowing] of this spread.

Interest income from investment securities was down modestly from the third quarter, as average balances declined $53 million. This decline reflects normal amortization which was not invested back into the portfolio, as well as $74 million of sales during the period. The impact from the decline in securities balances was partially offset by a 3 basis point increase in the portfolio's yield during the quarter.

Additionally, the overall duration of the investment portfolio declined to 3.4 years as of December 31 from 3.7 years as of September 30. As we discussed on last quarter's call, the decision to shrink the investment portfolio was intentional as we continue to balance loan demand, other balance sheet dynamics and the interest rate environment. We are comfortable with the current size and duration of the portfolio and will continue to manage the portfolio within a range as a percentage of assets depending on loan demand, fee and spread income levels going forward.

Total interest expense increased approximately $600,000 compared to the linked quarter, driven by a full quarter's impact of the deposits acquired during the third quarter. As the integrations are now complete, we have started implementing strategies to more actively manage the cost of these deposits while continuing to focus on core deposit growth and rewarding deeper client relationships. Regarding our overall core deposit strategies, we continue to see these efforts bear results and are pleased with our deposit generation (inaudible) heading into 2015.

Net interest margin increased 1 basis point to 3.67% from 3.66% for the linked quarter. Excluding the benefit from the previously mentioned interest income recaptured during the period, net interest margin was 3.64% for the fourth quarter.

Moving now to non-interest income, excluding covered loan activity and other items as noted in table 1 of the earnings release, non-interest income declined $600,000 from the linked quarter to $15.2 million. The increase was driven by lower fee income from our client derivative program as well as lower deposit service charges and bank card income during the period partially offset by higher trust and wealth management fee income.

Non-interest expenses for the fourth quarter, excluding covered expenses and other items as noted in table 2 of the earnings release, totaled $47.6 million, a $900,000 increase from the linked quarter primarily as a result of a full quarter's impact from the Columbus, Ohio operations. We are pleased with the disciplined expense management effort across the Company during 2014 and remain focused on maintaining a scalable and efficient operating platform going forward.

Our fourth-quarter results represent a strong finish to a productive year. Turning our attention to 2015 we look forward to the challenges and even greater opportunities that lie ahead. In regards to the loan portfolio, we are targeting mid to high single-digit loan growth for the year. With respect to expenses, we expect to maintain a stable expense base for the year and believe a modest increase to the adjusted non-interest expense total from the fourth quarter as noted in table 2 of the release, represent the reasonable indication of our quarterly operating expense base for 2015.

With regard to net interest margin, we expect the margin to remain relatively stable with the fourth quarter through the first quarter of 2015 that we could see a 1 or 2 basis point change in either direction depending on interest rate movements and loan payoffs during the period. Loan growth and to a lesser extent runoff from the higher yielding covered and formally covered loan portfolio remain the major drivers of variability, and for that reason we are focusing on the first quarter of 2015 only.

And finally, I will note that the first quarter is typically impacted by numerous seasonal factors that affect both income and expenses and that should be considered in establishing quarterly estimates. This concludes my remarks and I will now turn the call back over to Claude.

Thanks, John. As we reflect on 2014, we're proud of our accomplishments and the success of the Company. As we look to 2015, we are excited about a future that includes both continued organic growth throughout our metro centric footprint and additional strategic opportunities that meet our strategic, operational and financial criteria should they arise. This concludes the prepared comments for the call. And Dan we'll now open it up for questions.

(Operator Instructions)

Our first question comes from the position of Scott Siefers, Sandler O'Neill.

Tony or John, maybe this first question is most appropriate for you. And I have a couple on the covered loans and the credit impact given the expiration back in October. So the covered loan portfolio came down very, very rapidly in the fourth quarter, more so than has typically been the case. Can you spend just a second discussing anything you may have done, for example given the expiration? Did you maybe blow stuff off to get rid of it completely or really, what drove that decline?

And then the related question, given the impact it had on all your credit metrics, how should we be thinking about charge-offs going forward? In other words, was the 25-ish basis points, was that a catch up number, or is that the run rate going forward? Or is it somewhere in that much lower 7 to 10 basis points you guys have had the last couple of quarters? How should we think about that?

Well, when you break the charge-offs, now I'll take that piece of it, Scott, we would expect the legacy portfolio to remain fairly consistent with what we've seen across 2014. Whether it'll continue to be as low as 7 as has been the last couple of quarters, it's hard to say. But certainly we don't see significant credit issues on the horizon out of that portfolio.

On the covered piece, that's a little harder to judge. Those loans are still under 033 and give value to each quarter, and there's a lot of timing that takes place there. We still have about, a little under $300 million of loans that are under that accounting framework. So, it's hard for me to say right now what those could look like because of the volatility.

I will say, though, and John can speak more to the numbers here, that we're very comfortable with where we landed on the commercial side of the house with the loss share expiration. We were under $40 million of what the best way to frame it would be to say the criticized and classified portfolio out of all of that. And again, that's all -- there's the allowance. It has marks, so we're very comfortable with where we landed going forward.

Okay.

Hey, Scott, this is John.

On your first question around the balances, just to be clear, the covered loan balances as of September 30 were approximately $330 million. The balance of the covered and formally covered loans, which would include the loans that lost coverage during the fourth quarter, was about $300 million at December 31. So the runoff was about $30 million during the fourth quarter.

On our disclosures and on the balance sheet, we've highlighted in our footnotes there the balance of the loans that remain subject to coverage for five more years, that's the $135 million figure noted on the balance sheet there. So want to be clear there on what the runoff was and that the biggest change -- or biggest driver in the change in the balance there from September 30 to December 31 was really the expiration of the loss sharing coverage on the commercial assets.

Okay that makes more sense, because I was obviously looking at the $135 million versus the $332 million. So that color is helpful. And then I know you don't want to go out past the first quarter on the margin, but maybe more broadly if you're comfortable, could you -- I mean you've got very good loan growth and the outlook is still pretty good, would the goal be to generate positive NII growth throughout the year regardless of what happens to the margin? How are you thinking about that dynamic?

Yes, I think we're going to -- obviously, and we've been doing this for a number of quarters now, we're going to defend the net interest income dollars very, very aggressively. It's difficult to do, but we think that with our metro centric approach we'll be able to do that.

Competition is fierce, to say the least. Clients want longer term, fixed-rate product, so we're staying creative there and doing a pretty good job in managing the product. But I think that we will continue to focus very hard on growing the dollars.

Okay. That's perfect. Thank you very much.

Our next question comes from Chris McGratty, KBW.

Claude, if you think about some of Scott's questions in the context of the efficiency ratio you've got, you have done pretty good historically on getting costs out from deals and you've gone organically to your expenses a couple times. But given the flattening like you alluded to and likely the pressure on the margin for everybody, is the right way to think about the efficiency ratio now that the loss shares expired, are we going to still stay a little over 60, or is something in the high 50s still aspirationally or maybe is a little bit pushed out because of the curve. Maybe some guidance on the efficiency?

Yes, certainly high 50s is I would call it aspirational, Chris. I think to your point on the yield curve and where we're at on the rate cycle, I think where we've been is probably more what we would expect.

As Scott asked, what we're looking for is NII growth and positive operating leverage overall as the covered portion becomes less of a factor in the overall earning asset base. But to get significant enough operating leverage to move that into the 50s is certainly aspirational. We'll keep grinding forward, but I think it would be challenging.

Okay, that's helpful. Claude, maybe on capital deployment, you have the big dividend. You've done three deals, it seems like the cost saves are in. You are a couple -- either a couple smaller transactions or one transaction away from $10 billion. Can you talk about how you're thinking about that, when you might think any sense to jump the $10 billion and what kind of size opportunities M&A you're looking at?

Sure. We -- I think all of us that are above $5 billion start thinking about the $10 billion and the ramifications of what that means. And we're continuously, I think, to the first point of operational planning, thinking about what are the impacts from a stress testing compliance, other regulatory management perspective and continuing to evolve our systems to be able to handle it should we exceed that $10 billion level, Chris.

I would tell you, though, that we still think we've got a ways to go unless we would do a big deal. And so I think it's at least on the horizon, we've got some time before we would cross that threshold. And certainly I think as most people in our situation do, unless it's clearly compelling to cross it, it's not worth while to do so. So you need to really be prepared, ready and thinking about going much bigger if you go above the $10 billion. So we think we've some run way here before we get there, but we're certainly planning for it and the eventuality that it happens.

As it relates to size of deals, we don't either have a minimum or a cap, although we're sensitive to too small and the resources that it constrains. And we've talked before about the $200 million and $300 million and up size is our preference. Doesn't mean we wouldn't go below that, which we did in 2014.

And on the high side, again no cap. But you're certainly always sensitive to what the disruption is to the organization organically. So, we just always consider those factors as we look at opportunities.

That's helpful. Thank you very much. The last question, what should we use for an effective tax rate for 2015?

Yes, Chris. As we noted in the release there, it can fluctuate quarter to quarter, and especially when you have tax rate changes in different states. But we see it really in that 32% to 34% range for 2015.

All right. Thanks a lot.

Our next question comes from Emlen Harmon, Jefferies.

Claude, you noted the volatility in the yield curve and it can have an impact on the margin. How do you go about quantifying the impact on the NIM from movement and the middle to the longer end yield curves, like the 5 to 10-year range. What's the assets -- what's the sensitivity if you have 25 or 50 basis point moves one way or the other?

Yes. Emlen, I'll give you a couple high level points and I can -- Tony or John can fill in any details they'd like. But at least to this point, we've not seen a material change in loan pricing.

And we're very sensitive to how we price loans and making sure that the spread there is appropriate given our cost of funds and that we hit a certain hurdle rate of return, which our teams have done a great job continuing to achieve as evidence by our fourth-quarter yields.

I would say the biggest impact on the long end is how you reinvest on the investment portfolio side and the impact of the portfolio yield, which is one of the reasons why we took the opportunity to sell some securities in the fourth quarter and reposition the portfolio a bit, shorten the duration. So it's really more, at least to this point, and I emphasize to this point, on how the yields we see on the investment portfolio has not yet infected, if you will, the loan yields, per se.

But the longer it persists, the more I worry that competitively that could happen. I don't know, Tony or John, if there's anything you could add to that?

Yes, I'd add our bias continues to be neutral to asset sensitive and we manage all of our products with that in mind. We have good diversity on the loan side with some of our specialty businesses, equipment finance franchise and that that help us in our placement along the yield curve. But our bias continues to be neutral to slightly asset sensitive.

Got you. With where say the yield curve is today, any kind of cash flows coming off the securities book. Are you able to keep that yield flat today, or is there potentially just some natural compression there?

No, there is about $15 million to $17 million of cash flows coming off the portfolio today. And I feel pretty good about our ability to keep that yield relatively flat.

Got you, okay. And then a quick question on the runoff portfolio and against your guidance for mid to upper single-digit loan growth, what's your expectation for what is left to run off from some of the acquired books?

Yes. As you've probably seen, the pace of runoff and the covered and formally covered loans is certainly slowing down and we expect that to continue as the mix of the portfolio shifts more toward the consumer loans with longer terms. So, we think the pace of runoff there is going to slow. We saw it slow in the fourth quarter and we think that's going to continue.

The other thing I would add, Emlen, on that, this is Claude, that as you can imagine, we were pushing very hard to resolve and continue to resolve those that are in the that classified bucket. So we saw some pretty good reductions during 2014. And with the likely to exit number being much smaller, it's more to the point of John, we see that runoff slowing down into 2015.

Got it. Okay, thanks.

Our next question comes from Jon Arfstrom, RBC Capital Markets.

Emlen just took one of my questions, but to put a finer point on it, the $135 million that's still covered, the resi stuff, that probably hangs around a bit longer. Is that correct?

Yes, I would say that's accurate.

Okay. And in turn -- so going back to the pipeline, Claude, in terms of the mid to high single digits, you do have a little bit of runoff, so maybe the real core number is a bit higher than that. What is the message from the clients in terms of the borrowers. Are they more confident? I know it ebbs and flows a little bit, but what's the mood today?

It's still pretty good, Jon. I think we continue to see a pretty good pipeline, I think good activity. Our clients are performing well. US growth, as we've all seen, has been strong.

I think the only concern we have is just what's going on elsewhere in the world and the 24-hour news cycle and does it make them for conservative or nervous. Or, to the extent that they may supply multinationals who see a drop in activity, that could be a potential headwind. But at this point it's not showing up in activity, pipeline, conversations. So at this point we feel pretty good about where our clients are at.

Okay. Can you give us an idea of maybe early returns in Columbus? I know it's very early. And then also maybe an update on Fort Wayne, how that's going?

Sure. Yes, Columbus, we couldn't be more pleased with. I think we've been able to retain the vast majority of all the teams that we had desired to retain as a part of the deal. And their embracing of our culture and our products has just been really terrific.

With examples being their ability to do some larger deals than maybe they were able to do prior. Their embracing products like our client derivative program that they would not have had before. They've come out of the chute very strong there with some nice fee income.

And the melding of the cultures. If you think about it, there were four separate cultures that had to come into one from ours and the other three that we acquired. That has gone well. I mean, it's always a work in progress, but we couldn't be more pleased.

From an overall financial performance, they've met and exceeded our model that we talked about when we announced the deals. So we're really pleased with the team in Columbus, the leadership they've shown and their financial results.

Fort Wayne similarly, really strong team. They have continued to evolve. It's obviously with startups, so they're starting from a very different place. We've finally able to move them into their permanent location, and they have, as well, met our original objectives for the market. And as we look to add other locations in Fort Wayne and Columbus, we see both as really good growth drivers for us in 2015 and beyond.

Okay, good. And then a couple more. In the release you talked about potential for growth from strategic pricing opportunities and new products. Could you maybe cover what you mean by that?

Yes, and it's I think growth and profitability. I'd say the first run of pricing, is, if you look at the Columbus market, three small banks. Funding is always a little challenging when you're smaller and you're growing loans quickly. We've got some pricing opportunities in that market. And still it's rewarding the clients that maybe bringing down the overall cost of that deposit book.

We also see the opportunity in some of the specialty areas that we've continued to grow throughout 2014 and add some really significant and experienced talent in our asset-based lending, our cash flow mezzanine products, as well as continuing our franchise business growth. And all of those we've seen very good yields, very good credit quality opportunities. So we're really hopeful in that area we'll continue to see some nice growth as well.

Sure.

Jon this is Tony, I'd say we're floored by the economic environment in Columbus and our ability to tap into that fairly quickly. So we're very optimistic about that market.

Sure. It's not just Buckeye fever, it's real?

Well that's a 365 thing, Jon. (laughter)

I figured you'd have a comment on that. John, a quick question on expenses. I want to make sure I heard it right, the $47.6 million is the baseline that you're using?

Yes, we expect a modest increase from there in 2015.

Okay.

Mainly related just normal compensation adjustments and other inflation, Jon.

Right, okay. Good. All right, thanks.

(Operator Instructions)

Our next question comes from David Long, Raymond James.

Given your commitment to positive operating leverage, when you look out to 2015, if the revenue backdrop gets even more challenging than what we're looking at today, what specific levers on the expense side can you pull to try to offset that to still put out the cost of operating leverage?

Sure, David. One of the things we're continuously doing, we started instituting last -- about two years ago some very focused process improvement efforts. And quite honestly, whether or not we see the margins compress or not, we're going to continue to look for opportunities to be more efficient, ways to reduce costs.

So we always are looking to improve upon that expense base that John talked about and try to get that to a smaller number and improve the operating leverage. Other levers, obviously, if you're not seeing the growth in the margin expansion or stabilization, if you will, then you're going to look for what capacity do you have that you need to cut back? We're always looking at that depending on what sales results are.

Okay, great. The rest of my questions have been asked. Thanks.

At this time, it appears that there are no other questions. I would like to turn the conference back over to Claude Davis for any closing remarks.

Great, thanks, Dan, and again thank everyone for your interest in First Financial.

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