First Financial Bancorp (FFBC) 2017 Q4 法說會逐字稿

Good day, everyone, and welcome to the First Financial Bancorp. Fourth Quarter 2017 Earnings Conference Call. (Operator Instructions) And please note that today's event is being recorded.

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

Thank you, Will. 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 2017 financial results. Participating on today's call will be: Claude Davis, Chief Executive Officer; John Gavigan, Chief Financial Officer; and Tony Stollings, Chief Banking 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 statements disclosure contained in the fourth quarter 2017 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, 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 fourth quarter and for the full year 2017. Before I turn the call over to John to discuss our results in greater detail, I'd like to recap the progress we made this year, largely driven by the outstanding effort of our talented associates.

2017 was an exciting and transformational year for First Financial. We made great strides toward achieving our goal of consistently and responsibly producing top quartile results. We announced the pending merger with MainSource Financial Group, which will better position both banks to serve our clients, communities and shareholders.

Additionally, we announced a 5-year $1.7 billion community investment plan to solidify our commitment to serve clients and organizations in our footprint, focusing on the areas of lending, economic development and philanthropy. Our full year 2017 results reflect solid loan growth despite weaker-than-expected credit demand across the industry, steady deposit growth as well as continued improvement in credit quality. Overall, 2017 was an outstanding year and enabled us to achieve full year operating earnings of $1.59 per diluted share, a 1.15% return on average assets, a 14.36% return on average tangible common equity and a sub-59% efficiency ratio when adjusted to remove nonoperating items.

On a GAAP basis, full year 2017 earnings were $1.56 per diluted share, resulting in earnings growth of 9.3% over the prior year. As shown on Slide 3, our fourth quarter results were exceptionally strong and marked our 109th consecutive quarter of profitability.

Previous performance improvement efforts around operating efficiency, visible distribution and deposit pricing contributed significantly to improve overall results and improvement in the net interest margin. The primary drivers for the improved margin include elevated loan prepayment fees, deposit pricing changes and favorable impacts from asset mix and recent rate movements.

As John will discuss in more detail, fourth quarter results were impacted by the passage of the Tax Reform Act in late December. This tax legislation is a significant positive for First Financial and all of our stakeholders. A more efficient corporate tax framework that results in a 21% rate is a welcome and appropriate change.

Our initial actions were to reward our associates and our communities. First, we increased our entry-level wages to a minimum of $15 per hour, which will provide a significant increase in compensation to over 200 of our team members. In addition, we made the contribution to our foundation to support our communities.

We will also evaluate franchise investments we need to make as we complete our merger in order to invest in the future growth of our company. Finally, as is appropriate, the majority of the tax reduction will accrue to the benefit of our shareholders through improved earnings and book value growth going forward. As we do each quarter, the board will evaluate our dividend policy and capital allocation strategies when we meet next week.

With that, I'll now turn the call over to John to discuss more details on our results before I come back and provide an update on our merger integration activities.

Thank you, Claude, and good morning, everyone. Slide 3 provides an overview of our quarterly performance. Net income was $24.8 million or $0.40 per diluted share for the quarter with a return on average assets of 1.13% and a return on average tangible common equity of 14%.

Turning to Slide 4. We provide a comparison of reported earnings to adjusted earnings, highlighting items we believe are significant to understanding our fourth quarter performance. We recognize that our results include a number of significant moving pieces this quarter, particularly around expenses and income taxes, and we hope this information provides additional clarity.

On the expense front, we've adjusted our reported expenses to include -- to exclude the write-down of a significant historic tax credit investment, merger-related costs, a write-down of our FDIC indemnification asset, the charitable contribution Claude mentioned earlier as well as branch consolidation costs during the period.

I'll note that the tax credit write-down is accounting geography and should be viewed economically as a component of income taxes. Additionally, the impairment of the indemnification asset resulted from a preliminary agreement to early terminate our FDIC loss sharing agreements during the quarter. The termination agreement is subject to final certification and is expected to settle early this year.

Excluding these items, noninterest expense totaled $54.5 million for the fourth quarter, ahead of our $50 million quarterly projection as a result of higher incentive compensation and a 401(k) contribution based on full year performance.

Specific to taxes, we've adjusted income tax expense to exclude the tax effect of the items I just discussed as well as the revaluation of our deferred tax liabilities and low income housing tax partnerships as a result of the tax reform legislation signed in late December. Additionally, we've excluded the after-tax impact of the $11 million historic tax credit write-down that we excluded from noninterest expense, essentially netting the historic tax credit down to the $1.1 million after-tax benefit we mentioned last quarter.

As detailed on the graphs on Slide 4 and reflecting the adjustments I just described, net income totaled $27.7 million or $0.45 per diluted share with a 1.26% return on average assets, a 15.5% return on tangible common equity and a 58% efficiency ratio for the fourth quarter.

Turning to Slides 5 and 6. Net interest income for the fourth quarter was $75.6 million, increasing $5.1 million or 7%, while the net interest margin increased 25 basis points compared to the linked quarter to 3.82% on a fully tax equivalent basis.

Slide 6 details the drivers of the margin increase, including a significant increase in loan fees, interest recapture from nonaccrual loans and a more favorable asset and liability mix during the period. Additionally, as we have previously discussed, we implemented targeted strategies late in the third quarter intended to lower deposit costs, and we recognized the full benefit of those efforts here in the fourth quarter.

Turning to Slide 8. Credit performance was strong during the quarter, with a modest decrease in the allowance, driven by a 16% decline in nonperforming loans, a 7.5% decline in classified assets and annualized net charge-offs totaling 2 basis points of average loans.

Our credit metrics remain at historically lower levels, and as such, we recorded $200,000 of provision recapture or negative provision expense during the period. Overall, we are extremely pleased with our fourth quarter and full year 2017 performance, and in particular, our ability to grow earnings and tangible book value through the combination of solid organic loan and deposit growth, strong credit performance, a continued focus on efficiency and disciplined tax planning efforts.

While results fell short of our expectations earlier in the year, we adjusted course along the way, and our strong fourth quarter and full year performances are a direct result of those efforts.

Turning your attention to Slide 10 and our outlook for 2018. We believe that we are positioned for continued success in the new year. In regards to the loan portfolio, we are targeting mid-single digit annualized growth on a percentage basis consistent with 2017.

We expect the first quarter net interest margin to be between 3.7% and 3.75% on a fully tax equivalent basis, reflecting more normalized loan fee and interest recapture activity, 2 fewer days in the quarter and a smaller tax equivalent adjustment due to the lower corporate tax rate in 2018.

With respect to expenses, we're targeting a $51 million quarterly expense base excluding onetime costs. We remain focused on efficiency while also continuing to make strategic investments to support the continued long-term success of our business.

On credit, our outlook is stable, but we do expect that loan losses will ultimately migrate upward toward historical levels over time.

And finally, on taxes. We expect an effective tax rate of approximately 21% for 2018, reflecting the lower statutory corporate rate, the elimination of certain deductions and reduced impact from state taxes, tax credits and tax-exempt income. We will continue to evaluate and update you on the impact of tax reform as implementation guidance becomes more available.

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

Thanks, John. In addition to our exceptional fourth quarter performance, we continue to be excited about our pending merger with MainSource Financial Group. Together, we continue to make progress in working through the regulatory approval process and integration planning as detailed on Slide 11.

The 2 companies each received shareholder approval on December 4, and we continue to be pleased with integration planning to this point. And we remain on track for the first quarter close and a technology conversion in mid-to-late second quarter.

As we move into 2018 and form the new First Financial bank, we are excited about the scale and reach we will have to successfully execute our strategy, deliver exceptional service to clients and provide solid return to shareholders.

Finally, I want to take the opportunity to thank our associates for their efforts in 2017. As the embodiment of our organizational values, the work they do every day drives our ability to exceed client expectations, serve our communities and deliver First Financial's current and future success.

That concludes our prepared comments for the call, and we'll now open it up for questions, Will.

(Operator Instructions) And our first questioner today will be Nathan Race with Piper Jaffray.

Question on the deposit product changes in the quarter. Obviously, you had some changes in product based on the changes in pricing that you guys implemented last quarter. So just curious, how much of the change in product type was driven by that versus perhaps some promotional activity that you guys enacted during the quarter?

Yes, Nate, this is Tony. What you see here is directly related to those strategies that we implemented late in the third, early in the fourth quarter. The key has been the retention of those deposits. The retention rates have been well inside anything that we modeled in terms of net outflows, so it's been a very, very big positive. I think there's 2 reasons for that. One, is that it's still a very competitive-priced product in the market. And also our sales teams have done a tremendous job in all of their client conversations and explaining the changes, and you can see their efforts reflected there. The primary takeaway is that we now have a significant amount of our deposits, and their pricing back in our control. And that's where it ought to be.

Got it, and just changing gears and thinking about loan growth. I appreciate the guidance for 2018. Just curious in terms of line utilization trends in the quarter. And obviously, you had some good -- C&D growth in the quarter as well. So just kind of curious on some of the drivers there by geography and asset class as well.

I think overall -- again, this is Tony. Overall, it's been fairly flat.

The line utilization.

Yes, the line utilization. Our overall growth is -- the fourth quarter was pretty representative of the full year. It's in our metros, it's in Oak Street franchise and it's some of our specialty lending lines. So fairly consistent there. The portfolios have stayed fairly balanced on a year-over-year basis; a little bit of uptick in the service side; office, a little bit; a little bit in hotel, but that's coming off of a very small base. So it's been spread around pretty well.

And on the C&D side, Tony, a lot of that, I think, was just [fund] off of previously committed construction loans. We'll see that, and then, it will begin to plateau.

Right.

And the next questioner today will be Jon Arfstrom with RBC Capital Markets.

Just on loan growth. Claude, you made a comment that industry-wide loan demand has been a little bit weaker. Are you seeing any more -- any signs of optimism from your borrowers?

In the fourth quarter, late fourth quarter, we actually did. I would say, we've gone into '18 with a better pipeline across really all asset classes than we did in 2017. So I think that, that's a reflection of better activity, one. Two, I think we are beginning to sense more optimism across different industries of different clients. You can see that in a lot of the business confidence indexes, and I think we see it as well in our client base. So we're hopeful that reflects a solid 2018. As we've talked about though, Jon, in past quarters, we've actually had decent origination activity. We've just seen elevated prepayment, which, on one hand, you can tell in fourth quarter was a positive when you look at the prepayment fees -- really jumps. So parts of our business where we have prepayment penalties included, the reason for that is in the event of elevated payoffs. So it's a little bit of a mixed bag there. But yes, I think the answer to your direct question, we see more optimism, more activity at this point, this year, than we did last.

Okay. Just on that prepayment fee topic. It seemed like you did a little better than expected on the margin. And maybe, Tony, that goes to your comments on doing a little better on your deposit strategy. But is there anything else you'd attribute the margin strength to if you set aside the loan fees? Is it just better execution on the deposit plan?

Jon, I think, on the margin, kind of the reverse of maybe what we saw earlier in the year, particularly in the second quarter, where you always have some volatility and different factors that can impact the margin. And generally, in any given period, some go in your favor and some go against you, and they net to something smaller later in the year. We had a number of factors that all moved against us at the same time. And I think you're seeing here in the fourth quarter where most of those same things moved in our favor here in this period. It's the -- fees came in, obviously, very strong for the quarter. Interest recaptured [during] in the period. I think we hit on the high end of our range in terms of execution on the deposit pricing strategies. Some favorable mix on both sides of the balance sheet and a little bit of lift from the December rate hike as LIBOR -- 1-month LIBOR had really started to move in anticipation of that.

Okay, just a little better than we thought it was going to be. And obviously, the guidance is a little better as well, so that's the reason for the question. And then I guess, John, as long as you have the mic, the "losses revert to historical levels in terms of credit." I think what you're saying is longer term, you're not saying any kind of big snapback in the provision in the near term?

That's correct.

And our next questioner today will be Chris McGratty with KBW.

Claude, maybe a question for you. Given the comments on the near-term expense guide of around $51 million, when we think out post-integration and you get the cost saves in, how are you thinking about running the company from an efficiency perspective? Is this something where the combined scale post $10 billion can run 50% or better? Or can you maybe opine about that and also kind of the investments you might need to make with the cross of $10 billion and then kind of in anything offsetting the tax windfall that you have?

Yes. Well, first off, Calvin -- Chris, on your point, what we've tried to assume in light of the cost-save estimates that we've provided is kind of reflective of some of the investments that, we think, we'll need to make. So we've tried to look at that net cost save number of $48 million to be inclusive of those items. Traditionally, we've guided to a 55% to 60% efficiency ratio at First Financial standalone, which we've achieved. We think that will improve pretty significantly on the combined company. I wouldn't say sub-50%, but I think, in the low to mid-50s is, I think, where we've looked at it John, is that correct?

Yes, I would agree with that.

Okay. And maybe if I could, John, as a follow-up, the $51 million of expenses post -- I guess, near term. Is it fair to assume kind of you get the cost -- I guess, when do you assume the full cost saves will be in?

So Chris, what we modeled and what we've communicated is that we would expect 75% of the cost saves to be realized in the first 12 months post-close, and then 100% of cost saves would be in the run rate 1 year after close. So assuming, as Claude said, that we expect to close here in the first quarter, we would expect 100% of those cost saves to be in the run rate beginning in Q2 of 2019.

And if I could, sneak one -- go ahead.

I'm sorry, Chris. This is Claude. You mentioned something about the tax issue. I want to make sure we didn't kind of blow through that question, if you had one.

No, I would just assume -- in trying to estimate -- we're all trying to estimate how much of the gross savings from lower taxes will actually flow to the bottom line versus setting aside a portion of it to invest in the company.

Sure, sure.

The -- maybe a follow-up for John. On the securities portfolio, any meaningful alterations in kind of how you're thinking about it given the move in yields and post taxes? I think, combined, if you just put the 2 companies together, it would suggest around a $3 billion portfolio. Is that about -- or maybe, as a percentage of earning assets, low 20s? Is that how you're thinking about it or should we think maybe a little bit of a delever in the close?

No, in terms of the size of the combined portfolio, I think you're right on, Chris. And I really don't think our strategy post-merger changes much and that ultimately, the size of the portfolio will depend on the opportunities we see on the loan growth side. And if loan growth is stronger and we have opportunities to deploy capital, that's certainly our preference, and you would see the portfolio come down over time and a bit of a deleverage as you mentioned there. If loan growth stays in this low to mid-single-digit-type range, then you'd probably say that -- see the portfolio either be more flat or even, potentially, grow some.

But no planned delever at close, Chris.

Right.

And the next questioner today will be Kevin Reevey with D. A. Davidson.

So Claude, where are you guys as far as your deposit strategy initiatives? Are you pretty much done? Or are you probably in the sixth or seventh inning? And should we expect more benefits from that to accrue as we move into the first and second quarters of 2018?

No. I mean, we've implemented the strategies that we intended. And I think the ongoing strategy that we've always talk about is growth in DDA and core transaction account. And we saw some good progress on that in the fourth quarter, which aided our margin. But in terms of the major change that we talked about, third quarter, that's been implemented in, and you saw the 6 basis point improvement related to that. The other part that we're in the process of doing as we're working through our integration, planning activities with MainSource. The whole point of that from the beginning was to look at a best of both model. And so we're going through product mapping and product planning with both organizations trying to take the best of both. And to the extent that we see opportunities as a result of that, then we'll announce that after close and in the opportunities or the impact of that. But that's really the next major, I'd say, deposit initiative that we'll undertake. I don't know, Tony, if there's something you want to add?

There's only one thing I'd add to that is the strategies -- as Claude said, the strategies are implemented. The position that we're in now is that we're in control. And the consensus is that there will be 3 increases across 2018. We believe that we are positioned right now with a competitively priced product, but also have the control now across those rate increases to manage our cost much more effectively.

And then once you close the MainSource deal, kind of how are you thinking about acquisitions going forward? Are you solely focused on the integration? Or are you kind of looking -- doing -- looking at focusing on the integration at the same time as you're -- having discussions? And then what kind of institutions would you be looking at post close?

Sure. This is Claude. I'd say, throughout '18, Kevin, we're going to be focused on integrating the 2 companies. And really, to the earlier question on efficiency and your question on deposit, we see a lot of great opportunities just bringing these 2 companies together to make sure we execute it appropriately, get the cost saves. But we see some real revenue opportunities that we have to look at and really try to realize here. So that will be our first and focus primarily in 2018. As we've always done and I know as MainSource has done, we'll look at acquisitions when they make good strategic sense. And as we bring the 2 boards together into the new First Financial bank board, that will be one of the first things we look at is what's the corporate strategy, both around organic growth but also acquisitive growth. So yes, we'll continue to look, continue to talk, but 2018 will predominantly be focused on the integration.

And the next questioner will be Erik Zwick with Stephens Inc.

First, with regard to noninterest or fee income, what are your expectations for fees in 1Q '18? Is the $18 million and change result from the fourth quarter a good starting point for the quarterly run rate?

Erik, this is John. I think, fee income in 2018, I'd say similar to trends in '17 and '16. We continue to kind of chip away, if you will, in incremental growth across a couple of different fee lines there. In recent years, you've seen kind of a tail-off of covered loan income that ran through those fee income lines. So maybe in the bottom line total fee income, you maybe didn't see significant growth there. But I think '18 will largely be a continuation of that. We've seen good progress, certainly, on our client derivative fees here in 2017. Wealth Management fees had a good year. Cards and deposit service charges, offset a little bit by some slower fee income on the mortgage area there. So I think '18 will largely play out similar to '17.

That's helpful. And then could you talk about how you reached your decision to terminate the FDIC loss-sharing agreement? And why now was the appropriate time?

Sure. Erik, I think, on that, it's certainly something that if you follow the headlines, you've seen a number of banks exit loss-share over the last 12 to 24 months or so. And it's certainly something that we've looked at. As with any kind of transaction like that, you've got to have both sides on the same page and a deal that works for both. And at this point, loss-share, for us, is so immaterial to our overall balance sheet. The economics here of the early termination, we had an indemned asset of about $7 million here. We've taken a $5 million impairment charge here at year-end and expect to settle the remaining approximately $2 million balance here early in '18.

All right. And then my last question, kind of turning to credit. You mentioned your expectations for, I'd call it, kind of near-term stability and then for losses to revert to historical levels over time. First, thinking about the combined franchise, with First Financial and MainSource, what would you expect the kind of average loss rate to be over a full credit cycle? And second, do you think that the positive effects of the tax reform extend this current cycle even longer?

Yes, Erik, this is Claude. It's hard to say what, kind of what normal credit losses are. I mean, we've obviously seen a very low period here through the last, really few years. But obviously, very low in '17, not only ours, but the industry. I think with most senior credit portfolios, you would typically see that 30 to 50 basis points is norm, higher end being in more challenged periods, lower end being in more normal periods. But we've all been well below that. So the hope is we continue, but I think, as John pointed out in the outlook slide, all we're suggesting is, is that reversions to means typically happen. And that's the way we think about our planning cycle is that over time, experience reverts to the mean, and we should expect that and plan for it in our own profit planning, not suggesting we see that happening tomorrow as we had in the earlier question, but it's a part of our planning cycle. And then I'm sorry -- your second question was? Say it again?

I -- it's just whether the positive effects of the tax reform could potentially extend the current cycle even longer?

Yes, I think so. If you think about most of our clients and their profitability, and most would be kind of corporate over some kind of a pass-through. So this should really benefit them. And the positive, for me, as I think about credit macro is that tax benefit will help offset, I think, what we'll see in rate increases with most of our loan portfolio being variable rate. They're going to see an increase in some of their credit costs, and this should be more than offset by their reduced tax cost. So hope is, is that we will continue to maintain the profitability that we've seen, which, with most of our client base, has been very strong.

(Operator Instructions) And our next questioner today will be Andy Stapp with Hilliard Lyons.

Most of my questions have been answered, but I do have a question on the noncore expense items. Do I assume correctly that expenses related to the shared contribution, the indemnification asset, the historic tax credit were all included in noninterest expense? And how are the M&A and branch consolidation charges allocated?

Andy, it's Claude. They were all included as noncore in terms of those specific line items.

I mean, in which line items? I mean, (inaudible) it would just help going forward.

Andy, you are correct in that they were all in our GAAP or as-reported noninterest expense. To your -- the last part of your question there, the merger-related costs, was a little bit of a mix there, primarily in the professional services line item. And I would say, it was largely -- those expenses were largely tied to technology and contract negotiations and terminations.

And our next questioner today will be Daniel Cardenas with Raymond James.

Just a quick question on branch rationalization efforts, maybe a quick update as to where you are in the process. Are you pretty much where you think you should be or a little bit ahead or a little bit behind?

Well, Dan, this is Tony. The real heavy-lifting is yet to come, but we were able -- both companies were able to accelerate some activity here in the fourth quarter we closed to combine about 15 locations. So we've got a good start, but most of that heavy-lifting will come post-close and in that probably first 3 to 6 months after closing.

Okay. And no backlash from any of the communities where some of these branches are being consolidated?

Well, I mean, there's always unhappiness, and in some cases, a bit of angst about it if you're a maybe a sole bank provider in an area. But nothing that we would say is unusual.

And Dan, if you remember, as a part of our model, we assumed up to $5 million of potential loss revenue kind of related to those closures. Obviously on the 15 that we've done combined, it's still very early in that process, but we think that's a very reasonable and conservative estimate.

And this will conclude the question-and-answer session. I would now like to turn the conference back over to Claude Davis for any closing remarks.

Great. Thanks, Will. And as always, thanks, everyone, for your interest in First Financial. And we'll look forward to our first quarter earnings call. Thank you.

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