First Financial Bancorp (FFBC) 2017 Q1 法說會逐字稿

Good morning, and welcome to the First Financial First Quarter 2017 Earnings Conference Call and Webcast. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Scott Crawley. Please go ahead, sir.

Thank you, Keith. Good morning, everyone, and thank you for joining us on today's conference call to discuss First Financial Bancorp.'s first quarter 2017 financial results. Participating on today's call will be Claude Davis, Chief Executive Officer; John Gavigan, Chief Financial Officer; and Tony Stollings, Chief Operations Officer.

Both the press release we issued yesterday and the accompanying slide presentation are available on our website at www.bankatfirst.com under the Investor Relations section. We will make reference to the slides contained in the accompanying presentation during today's call.

Additionally, please refer to the forward-looking statement disclosure contained in the first quarter 2017 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 March 31, 2017, 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, Scott. Thanks to those joining the call today. Yesterday afternoon, we announced our financial results for the first quarter. As shown on Slide 3, we had another solid performance, representing our 106th consecutive quarter of profitability. Our first quarter results reflect continued execution of our core strategy, including proactive balance sheet management, a stable net interest margin, targeted fee income strategies, disciplined expense management and solid credit performance.

These actions, coupled with the tax benefit-related stock-based compensation, allowed us to offset the impact from the quarter's lower average loan balances and grow earnings 22% compared to the year-ago quarter. We also achieved a sub-60% efficiency ratio, a 1.18% return on average assets and a 15% return on average tangible common equity for the quarter.

Specific to loan growth, industry data shows loan demand has slowed across the banking sector in recent months, and we have seen similar pattern in our markets. While overall conditions remain conducive to growth and client optimism remains high, activity across our markets remained soft during the first quarter. We continue to see payoffs from commercial and commercial real estate clients related to M&A and real estate transactions as borrowers took advantage of elevated purchase multiples. While loan growth was slower than anticipated, activity and pipelines did improve toward the end of the quarter, and we remain optimistic that growth will improve over the balance of the year.

Deposit results remained strong during the quarter. While average total deposits decreased $115 million, the decline was primarily driven by the intentional runoff of higher cost brokered CDs and seasonal outflows from public fund deposits. Excluding these declines, average deposit balances increased $80 million or 5% on an annualized basis on solid growth in both consumer and commercial deposits. Capital ratios also remained strong and position us well to support future growth.

As we execute on our strategic objectives, our focus remains centered on serving the financial needs of our business, consumer and wealth management clients while remaining disciplined in our approach. The company remains well positioned to continue to grow organically, but also to capitalize on other growth opportunities that meet our strategic objectives.

With that, I'll now turn the call over to John.

Thank you, Claude, and good morning, everyone. Slide 4 provides an overview of our quarterly performance, including net income of $24.4 million or $0.39 per diluted share for the quarter. As Claude mentioned, we are pleased with our results as well as the consistent earnings growth and improving profitability in recent periods.

Turning to Slide 5. Net interest income for the first quarter was $68.9 million, a decline of $1.2 million or approximately 2% compared to the linked quarter, with the primary drivers being 2 fewer days in the quarter, as well as a decline in loan fees.

Net interest margin remained relatively stable declining 1 basis point to 3.70% on a fully tax-equivalent basis as higher yields earned on loans and investment securities were offset by lower average loan balances, higher funding costs and the decline in loan fees during the quarter. Specific to the December interest rate hike, the impact on our margin was consistent with our expectations with any variances largely attributable to the mix of earnings assets.

Slide 6 details our noninterest income mix. Noninterest income totaled $17.4 million for the period, a $400,000 increase from the linked quarter. Strong client derivative activity and wealth management fees combined with gains on sales of securities during the period to outpace seasonal declines in deposit service charges and mortgage income.

Notably, on a year-over-year basis, noninterest income increased to $1.9 million or 12% with deposit service charges increasing 6%, and wealth management fees and bankcard income each increasing 9%, respectively. We are pleased with the year-over-year growth across noninterest income categories given our continued focus in this area.

As presented on Slide 7, noninterest expense increased $900,000 or 2% from the linked quarter to $51 million. The linked quarter variance was primarily driven by OREO activity with higher compensation costs and state intangible taxes being offset by lower marketing and other noninterest expense. While expenses were in line with expectations and our efficiency ratio remained within our target range at 59.2%, we continue to review opportunities to further improve our operating efficiency in 2017 and beyond.

Turning to Slide 9. Credit performance was solid with declines in the allowance and corresponding provision expense during the quarter, reflecting lower net charge-offs and classified asset balances. Nonperforming assets increased during the period, primarily driven by the downgrade of 2 relationships, 1 ag credit and 1 franchise credit. While these borrowers demonstrated continued operating weakness that facilitated the downgrade to nonaccrual, both relationships were previously classified and our exposures are well secured. Overall, our credit metrics remain at historically low levels, and our outlook remains stable.

Finally, as seen on Slide 10, our capital ratio strengthened further during the first quarter. We also announced the initiation of an at-the-market equity offering program, which gives us additional flexibility with respect to capital planning and future growth. While we were not active through the ATM program during the first quarter, we remain well positioned to capitalize on organic growth as well as other strategic opportunities that may arise.

This concludes my remarks, and I will now turn the call back over to Claude.

Thanks, John. Keith will now open the call up for questions.

(Operator Instructions) And the first question comes from Scott Siefers with Sandler O'Neill and Partners.

Claude, with something you could sort of expand upon your comments on the pipeline having improved towards the end of the quarter. I guess, one, if you could maybe start by just going through what your customers are saying and feeling what it would take for them to indeed become more active in drawing lines or seeking new financing? And then two, as you look at the slightly tempered guide on loans, in your mind, was that more a function of just the first quarter shortfall? Or do you also end up kind of tempering the forward-look as well?

Scott, it was predominantly the first quarter shortfall on the last question as it relates to kind of activity. And activity was slower than we anticipated. We mentioned on the fourth quarter call that we had some loans or some deals carryover to early the first quarter, which those did happen and closed. But the pull through activity of other deals just didn't happen at the same pace that we expected. We did see, as I had mentioned in John's reference, some higher payoffs, again, because of a lot of M&A activity that we've seen. But I think in terms of clients, what I would tell you is predominantly anecdotal, I wouldn't call it statistical in any way, but it's I think a part of it is we're still in a slower growth but still growing economy. I think our clients are generally more conservative and then a lot of policy uncertainty that we all know exists would be, I would say, the primary drivers. All that said though, we did see some nice activity pick up late in the quarter in pipeline activity and planned closings. And we haven't seen as much anticipated kind of payoff activity as what we saw in the first quarter other than at normal commercial real estate payoff activity as projects go to the secondary market. So it's a mixed bag there but I would say we're -- we do feel good about where we are going into the second quarter, but we're still cautious.

Yes. Okay, then that's good color. I appreciate it. Then just second, same question, John, for you on the margin in the outlook's line on Page 11. And I think you'd said both stable margin outlook and then expanding 2 to 3 basis points. Just want to get a finer point, if possible, on what exactly you're thinking on margin and NII?

Yes. Sure, Scott, and I apologize if we weren't clear enough on the slide there. But our expectation on balance for 2Q is that we would see margin expand 2 to 3 basis points given the rate hike in mid-March there. And that's the combination of higher yields on loans and securities, offsetting modestly higher deposit costs, largely tied to our index deposits. We always give the caveat that, that the production mix and loan fees can create some volatility in either direction there, but those, yes, those will be the drivers and that's our expectation. And I would just also mention relative to the first quarter here, recall that our margin increased 5 basis points in the fourth quarter. So coming in relatively flat, down a basis point here in first quarter was consistent with our expectations and what we guided to, that we felt that the bump in fourth quarter margin was sustainable given the December rate hike.

And the next question comes from Kevin Reevey with D. A. Davidson.

So going back to the 2 credit downgrades, one you mentioned was an ag loan and the other one you had mentioned was a franchise credit. Can you talk about as far as the collateral underlying those credits, the loan-to-value ratios and if the borrowers have any personal guarantees on those credits?

Sure. We don't get too specific, Kevin. In terms of some of the specifics, I'll give you a kind of high-level of color. The biggest part of the move was the ag credit. That was the more significant kind of part of the increase, and it's predominantly land secured. We think well marketed -- well marketable in terms of it's value as well as some livestock. The franchise credit -- with most franchise credits and we've talk about this in the past, we only do national QSR concepts and so a lot of the value in those are in their franchise or enterprise value. And we think, in this case, it has good enterprise value, and allows us to secure the loan amount. We do also have guarantees in almost all credits we do, not all but most, we get personal guarantees. So that's kind of the high-level view of those 2 credits.

And then my last question relates to the trust fees that was up a lot sequentially. How should we think about that line item going forward? Was there just some unusual activity in the first quarter, which will be slower in the second quarter?

Yes, Kevin, I would look at the year-over-year comparison. First quarter is generally up because of tax preparation fees that come through. So I'd really look at the year-over-year comparison, where we still had nice growth there. So I think we're pleased with some of the successes we're having in looping our wealth management business into our commercial sales team.

And the next question comes from Jon Arfstrom with RBC Capital Markets.

One of the things I want to ask about, in your release, you talked about some of your strategic initiatives in fees and efficiency. I guess maybe give us an idea of how it's going on the fee side. And then on the efficiency side, John, if you could maybe touch on -- I think you did fine on expenses but you talked about maybe some more opportunities. So maybe give us an idea of where you're spending money and where you're finding some opportunities.

Yes, sure, Jon. On the fee side, I think we've got a couple additional initiatives kind of following on our efforts from last year that are in various stages at this point. I think our hope is that you'll start to see some of those come online in the second half of '17. On the expense side, we continue to manage that and look for opportunities. We're looking at, really, capacity across the board in all areas of the company. And I think we still have some opportunity there but probably not far enough along to give any kind of range or anything there, but we continue to work on that front.

And what I would add as well, John, this is Claude, that I think what we're trying to do is really benchmark ourselves against what we view as some of the best-in-class competitors and really look where we may be both heavy in expense as well as have opportunities on the fee side, which we think comes from both the consumer businesses and the commercial businesses.

Okay, and most of the $10 billion in asset threshold expenses, they're probably in the run rate, is that fair?

Jon, this is Tony. We're doing some of that. We're certainly -- your question also had the -- did you ask about where we're spending money? Data management is one area where we're continuing to invest. So we are making progress at the right pace around the $10 billion, but we're not going over the top here right now being -- given our asset size and what we think the future looks like for us.

Okay. So the 2% to 3% is just kind of natural pressure in the business would really be it?

Yes, natural pressure and then some investments mainly on the data side, as Tony mentioned, and a little bit on the system side, both of which are preparing us as we think for future growth.

Okay, okay. And just a follow-up to Scott's question on the loan growth. Your -- it's not that dissimilar to other companies but some others, quite frankly probably grow single-family residential and their loan growth looks a little bit better. But it seems like you're feeling pretty good about the outlook. But maybe talk a little bit, give us some examples of the size of some of these payoffs that have come through? Because it seems like that's really been the big headwind. So maybe give us some idea of the magnitude with some of that?

Yes, it has been the big headwind, Jon. I think, as an example, we had close to $20 million in payoffs right in the last 2 weeks of the quarter on a couple of large commercial deals. Some you, you just see those throughout, as well as you have, it's just the natural turn in the commercial real estate portfolio of both scheduled amortization as well as with the cap rates in that business. A lot of our investors just see good opportunities to market their properties that in traditional normal times, we hadn't seen. You're right, we are predominantly focused on growing our commercial portfolios and that's been the area that's been still a little bit slow as it relates to new activity if you look across the banking sector. We have not been aggressively growing our first mortgage portfolio nor are we in the auto lending business, which had been 2 of the areas where we've seen others growing their portfolios. So that's been the color on the headwind. I think why we're still optimistic is that our clients continue to perform well. The economy still is growing. We do think that -- we hope there'll be some policy stimulus here sometime this year. But one of the real positives that a lot of our clients talk about and certainly we see is while we may not see deregulation yet, at least we're not seeing a lot of new regulations. And I think we all know that, that was a real kind of issue and challenge for all the economy, not just banking.

And the next question comes from Chris McGratty with KBW.

Hey, John, maybe just start with you on the margin. Hoping you could give a little bit of color on the move in to securities and loan yields. I'm wondering what the delta might have been for premium A.M. and also whether the move in loan yields of 7 basis points was all kind of new originations or better spreads or is there a bump in accretion?

Sure, Chris. On your last question there, there was no bump in accretion there driving the loan yields. In fact, covered and formerly covered loans in the fourth quarter was 5 basis points on our margin, that's 4 basis points here in the first quarter. So a bit of a drag there. You know I'd say it's was a combination of higher new origination spreads, as well as about 60% of our loan portfolio is variable rates, so the impact of the December rate hike, you really wouldn't see much, if any, impact from the March hike just given the repricing dates on a lot of those loans. On the flip side, the deposits, that's generally a pretty instantaneous impact. So a little bit of an impact from the March rate hike on the liability side in March there. Sorry, on the investments, I'd say given the slow pace of loan growth, we have added some credit exposure in the securities portfolio to enhance yield there. But we generally stay at the top of the capital stack and continue to manage duration risk as well. So I'd say purchases in recent months have been about half agency mortgage-backs, CMOs, some other government-guaranteed securities and then the balance has really been a mix of private MBS, some asset backs, some tax-exempt munis and some floating rate CLOs there. But overall, portfolio duration remains relatively short at about 3.2 years.

And the move in premium A.M., did that help at all? I'm just wondering because the tenure's back at 2.25%?

No, it didn't hurt us in the quarter where it was a drag in fourth quarter. So I'd say prepaid fees were benign through the first quarter, so we didn't have a negative impact. We'll see how 2Q plays out.

Could I ask another one on the index deposits or the higher betas portfolio? How much, John, how much of the deposits are kind of tied, kind of one-for-one to market rates? And how much of the core portfolio -- I mean, have you adjusted rates on the core portfolio at all?

Sure, Chris. Yes, the index deposits is about 20% of our total deposits. In terms of the rest of the deposits, we really haven't moved rates, I would say, other than in the public fund sector, that's where we probably see a little more competition.

And then CDs move, CDs will move based on current either specials or activities. But other than that, none of the core moved.

So if I kind of put it together, a little bit of expansion next quarter and assuming we get hike again, midyear, is the assumption like every 25 is a couple of basis points. Is that the right way to think of kind of the sensitivity?

Yes, I think we've talked about it on prior calls, 25 basis point rate hike. Based on our modeling, we should benefit by about $2 million to $2.5 million annualized there, which would equate to that 2 to 3 basis point kind of range on margin.

That's assuming we don't see significant core deposit pricing pressure.

Correct.

Correct, John.

Maybe last one, Claude, for you on the capital. Obviously, I think when you did the atm [ at-the-market equity ], you said there wasn't a necessarily an imminent use for it and obviously, you didn't draw on it in the quarter. Are you having more conversations with potential parties from an acquisition perspective now that kind of valuations have I guess, permanently resettled a little bit higher?

Yes, I wouldn't say more necessarily, Chris. I'd say we're always open and interested in what are the growth opportunities. As we've said in past calls, we're primarily still focused on organic growth, but as John and I pointed out, both of us in our scripts, we're certainly open to other strategic growth opportunities. And to your point, valuations are at a good place for that.

Is there a preference on size or market, if you were to do a deal?

Yes, I wouldn't say preference. I think we've -- obviously, at $8.5 billion, we have the $10 billion issue that still exists. And so we have to be mindful of that and strategically think about if we were to look at opportunities, what would make the most sense. So, and we all know that going right to 10 doesn't -- isn't probably the best strategy. So we're very mindful of that in terms of what our strategy is around growth.

And the next question comes from Nathan Race with Piper Jaffray.

A lot of my questions have been answered but just one last one. The decline in classified assets, obviously, hit a new low this quarter since this cycle. Any additional color in terms of the drivers, in terms of each segment that resulted in that decline? Or was it pretty broad-based?

I would say, Nathan, it was pretty broad-based. It's a mix of -- across loan types and asset classes and just various workout strategies that played out through the quarter.

And is it fair to kind of assume the reserve goes out from here assuming growth kind of picks up in terms of the guidance that's been provided?

I'd say, certainly, loan growth would be a catalyst for additional provision expense there. It's tough to say provision expense is a product of the allowance model, and there's always multiple contributing factors there. But I would say this quarter's decline in provision really was on balance, driven by probably by three things: the decline in classifieds; the migration to nonaccrual of the 2 well-secured credits that we previously discussed, both of which would have been in higher rate general reserve buckets previously; and then we also saw decline in the reserve on our covered and formerly covered loans during period. So I would say those were the three drivers here. And we'll continue to see how it plays out, to your point, loan growth would be a catalyst for additional provision.

And the next question comes from Andy Stapp with Hilliard Lyons.

What do you expect the effective tax rate to be for the balance of the year, including the impact of new stock-based accounting standard?

Sure, Andy. We updated our outlook, our full year effective tax rate outlook, I believe it's on Slide 11. For the full year, we dropped it down to 31.5% to 32.5%, down from 32% to 33% and the driver there was really the first quarter impact of the new accounting guidance.

Okay. And you had about $1 million in construction loans that went on nonaccrual status during the quarter, could you just talk about that?

I don't have detail on that. John, do you? Sorry, we'll have to get back to you on that one, Andy.

Okay, and lastly, could you talk about your exposure to retail?

The retail commercial real estate?

Yes. Retail loans in general, either C&I or CRE?

Okay. So you're talking about more of the commercial impact?

In terms of asset quality, with the exposure that a lot of retail companies have to the Internet?

Sure. Yes, our retail, commercial real estate portfolio, which is the primary area where we would have any exposure to that sector, we don't do much on the C&I side. There is, I think, between $300 million and $400 million as we disclosed on our last investor presentation. As of 4Q, we've done a review of that portfolio in some depth. I would -- I could tell you that we don't have any significant exposure to any of the major retailers that have either gone into bankruptcy or have announced significant store closings. We certainly have some exposure in areas where they maybe kind of nearby or tangential to that -- to one of those retailers, but they're typically with strong sponsors, lower loan-to-values and good debt service coverages. So we feel -- we actually feel good about our retail portfolio.

(Operator Instructions) And the next question comes from Daniel Cardenas with Raymond James.

Most of my questions have been asked but just a couple of quick questions. Given your comments about kind of slower growth and slow-but-steady economies, could you maybe talk a little bit about what you guys -- or how you guys interpret the risk tolerance in your major metropolitan markets right now? And more specifically, your risk tolerance in those markets?

Yes, I think you have to break it by type, right? So talking about commercial real estate first. I would tell you, I think, in risk tolerance of the market, our clients in our markets, I would say we'd be balanced from the standpoint that I don't think it's overly aggressive nor overly conservative. Commercial real estate investors see opportunities and they're taking advantage of it. We're trying to be very careful and evaluate all of the perceived hotspots as it relates to our risk tolerance. So we're doing detailed reviews of what I was just describing on the last question around whether that's retail commercial real estate. We've done a deep review of our multifamily exposure and those projects, as well as the sponsors, as well as we've done a deep review of any portfolio we have in like the senior credit area. As well as just all commercial real estate relationships above $5 million, we've done a deep dive into those as well. So I would say, our risk tolerance is also moderate to balanced, but we're cautious in that, we're really evaluating those portfolios and new client requests. We've mentioned in past calls that we've become, I would say, less aggressive on the construction side as we want to see some of these asset classes in the new projects come online and see how they lease up. On the C&I side, I would say it's slightly different from a client or market perspective. I think those clients in general are more between conservative and moderate in that, they are more cautious about new investments. And I think that's been that case really since the crisis. Our risk tolerance there is still probably more moderate in that, for good clients and good underwriting, then we're willing to take that risk. So I'd say it's a balanced market and what we need to see happen is just some more activity, especially on the C&I side with both our clients as well as new opportunities.

Good. And then just maybe if you could just remind me on your net interest margin outlook, as you look to the remainder of '17, how many more rate hikes do you guys have built into your model?

Dan, we don't project future rate hikes, there's just too much uncertainty around the pace or timing there. So we don't incorporate that into our budgeting or forecasting.

And as there are no more questions at the present time, this concludes the question-and-answer session. I would now like to turn the call back over to Claude Davis for any closing remarks.

Great. Thanks, Keith. And again, thanks, everyone, for your interest in First Financial. Thank you.

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