First Financial Bancorp (FFBC) 2022 Q3 法說會逐字稿

Hello, everyone, and welcome to today's First Financial Bancorp third quarter 2022 earnings conference call and webcast. My name is Victoria, and I will be your operator for today. (Operator Instructions) I'll pass over to your host, Scott Crawley, Corporate Controller, to begin.

Thanks, Victoria. Good morning, everyone, and thank you for joining us on today's conference call to discuss First Financial Bancorp's third quarter and year-to-date 2022 financial results. Participating on today's call will be Archie Brown, President and Chief Executive Officer; Jamie Anderson, Chief Financial Officer; and Bill Harrod, Chief Credit 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'll 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 third quarter 2022 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 September 30, 2022, and we will not be updating any forward-looking statements to reflect facts or circumstances after this call. I'll now turn it over to Archie Brown.

Thanks, Scott. Good morning, everyone, and thank you for joining us for today's call. Yesterday afternoon, we announced our financial results for the third quarter. I'm very pleased with our performance, which was highlighted by strong loan growth, stable asset quality and exceptional earnings. Adjusted earnings per share increased approximately 9% from the second quarter due to record revenue, which was driven by an 18% increase in net interest income. For the quarter, we achieved adjusted earnings per share of $0.61, a 1.4% return on average assets and a 23.12% return on average tangible common equity. A recent rate increases continued to positively impact our asset-sensitive balance sheet.

Our net interest margin expanded in the third quarter by 53 basis points as yields on assets increased much more rapidly than deposit costs. Credit trends remained stable across the portfolio with slight reductions in nonperforming loan and net charge-off ratios. Even with these improvements, our loan loss reserve grew modestly to account for loan growth and the intermediate economic outlook. We're very pleased with loan growth in the third quarter. Loan balances increased by $377 million or 15.9% on an annualized basis. Growth in the quarter was again broad-based and was driven by increases in C&I, consumer and residential mortgage. Given our expectations for the economy in the near term and moderating loan pipelines, we expect loan growth to ease in the coming months.

Noninterest income was once again negatively impacted by rising rates and changes made to our overdraft program in the second quarter of this year. We also experienced an expected decline in foreign exchange income from a record second quarter and mortgage activity weakened further. Fee income continues to reflect the strength of our diversified businesses, and we expect a modest increase in the coming quarter as our leasing business grows. With that, I'll now turn the call over to Jamie to discuss the third quarter results in more detail. After Jamie's discussion, I will wrap up with some additional forward-looking commentary. Jamie?

Thank you, Archie. Good morning, everyone. Slides 4, 5 and 6 provide a summary of our third quarter financial results. The third quarter was highlighted by an expanding net interest margin, strong loan growth and stable asset quality. Our balance sheet reacted positively to additional Fed Rate hikes with our net interest margin increasing 53 basis points. We anticipate this trend will continue as the Fed is expected to increase rates over the remainder of the year. However, the margin expansion will not be of the same magnitude due to expected deposit pricing pressures.

We were very pleased with another quarter of strong loan growth. Total loans grew 16% on an annualized basis with a growth widespread across the portfolio. Fee income declined from elevated levels in the second quarter, in particular, Bannockburn income met our expectations but was lower than record levels in the second quarter. As expected, mortgage banking income declined compared to the second quarter as well. As the mortgage business has been negatively impacted from higher interest rates. Additionally, service charge income declined from the linked quarter as we continue to feel the impact from changes to our overdraft program. Finally, other noninterest income declined due to higher-than-expected revenues from limited partnership investments during the second quarter. Noninterest expenses were slightly higher than our expectations due primarily to incentive compensation tied to the company's performance.

We were pleased on the credit front as net charge-offs declined to 7 basis points and nonperforming assets declined to 29 basis points of total assets. While asset quality remains strong, we recorded $8.3 million of provision expense during the period, which was driven by loan growth during the period and slower prepayment rates. From a capital standpoint, our regulatory ratios remain in excess of both internal and regulatory targets. Similar to the second quarter, accumulated other comprehensive income declined, negatively impacting both tangible book value and our tangible common equity ratio. Slide 7 reconciles our GAAP earnings to adjusted earnings, highlighting items that we believe are important to understanding our quarterly performance. Adjusted net income was $57.8 million or $0.61 per share for the quarter. These adjusted earnings account for $900,000 of losses on investment securities and $1.7 million of acquisition and other costs not expected to recur. As depicted on Slide 8, these adjusted earnings equate to a return on average assets of 1.4%, a return on average tangible common equity of 23.1% and an efficiency ratio of 58.5%.

Turning to slides 9 and 10. Net interest margin increased 53 basis points from the linked quarter to 3.98%. Once again, this increase was primarily driven by an increase in asset yields during the period, resulting from rising interest rates. The increase in asset yields was partially offset by a slight increase in funding costs. As a result of rising rates, asset yields surged during the period with loan yields increasing 89 basis points. In addition, investment yields increased due to higher reinvestment rates and slower prepayments on mortgage-backed securities. Our cost of deposits increased 11 basis points compared to the second quarter, and we expect these costs to increase further in reaction to competitive pressures from an increasing rate environment.

Slide 11 details the asset sensitivity of our balance sheet. We remain well positioned for the expected rate increases as approximately 2/3 of our loan portfolio reprices fairly quickly. Slide 12 details the betas utilized in our net interest income modeling. And while we haven't realized aggressive increases in costs at this point, as additional rate increases occur, we expect our deposit beta to be approximately 30% over the full cycle. Slide 13 outlines our various sources of liquidity and borrowing capacity. We believe our liquidity and borrowing capacity sufficiently provides the flexibility required to manage the balance sheet through the expected economic environment. Slide 14 illustrates our current loan mix and balance changes compared to the linked quarter. As I mentioned before, loan balances increased 16% on an annualized basis with every portfolio growing compared to the linked quarter. The largest areas of growth were in the C&I, retail mortgage and consumer portfolios. However, we were also pleased with the trajectory of the ICRE and Summit books.

Slide 15 shows our deposit mix as well as the progression of average deposits from the linked quarter. In total, average deposit balances declined $167 million during the quarter, driven primarily by a $77 million decline in public funds, a $58 million decline in retail CDs, a $49 million decline in money market accounts and a $47 million decline in noninterest-bearing accounts. Slide 16 highlights our noninterest income for the quarter. Overall fee income declined from the second quarter, driven by declines in foreign exchange, service charges, mortgage and other noninterest income. Bannockburn met our expectations for the quarter. However, their total income was lower in the third quarter following record output in the second quarter.

Also consistent with our expectations, deposit service charge income declined in the third quarter as we realized the impact from overdrive program changes. Consistent with the second quarter, mortgage demand was light due to higher rates and record production in prior years, and we continue to expect further pressure on this business for the remainder of the year. Finally, other noninterest income normalized during the period, which was higher in the second quarter due to elevated income from limited partnership investments. Noninterest expense for the quarter is outlined on slide 17. Like the second quarter, the third quarter was relatively quiet on the noninterest expense front. On an operating basis, and excluding Summit, expenses increased $2.6 million compared to the linked quarter, due primarily to additional incentive compensation tied to the company's performance.

Turning now to slide 18. Our ACL model resulted in a total allowance, which includes both funded and unfunded reserves of $141 million and $8.3 million in total provision expense during the period. This resulted in an ACL that was 1.27% of total loans at September 30. As I mentioned previously, the provision expense was driven by our strong loan growth and slower prepayment speeds, which increased the duration of the portfolio. Despite the increase in provision expense, credit quality remained stable. Net charge-offs as a percentage of loans decreased slightly to 7 basis points on an annualized basis, while nonperforming assets declined to 29 basis points of total assets. In addition, classified assets declined $4.6 million during the quarter. Our view on the ACL and provision expense remains unchanged. We expect our ACL coverage to remain stable or increase slightly in the fourth quarter as our model responds to changes in the macroeconomic environment.

Finally, as shown on slides 20 and 21, regulatory capital ratios remain in excess of regulatory minimums and internal targets. During the third quarter, tangible book value and the TCE ratio continued to decline due to a drop in accumulated other comprehensive income. Absent the impact from AOCI, the TCE ratio would have been 8.1% at September 30 compared to 5.8% as reported. Our total shareholder return remains robust with approximately 40% of our earnings returned to our shareholders during the period through the common dividend. We believe our dividend provides an attractive return to our shareholders and do not anticipate any near-term changes. However, we will continue to evaluate various capital actions as the year progresses. I'll now turn it back over to Archie for some comments on our outlook going forward. Archie?

Thank you, Jamie. Before we end our prepared remarks, I want to comment on our forward-looking guidance, which can be found on slide 22. Loan demand remains solid, pipelines are beginning to ease, and we expect growth to moderate to high single digits over the fourth quarter. We expect total deposit balances to remain flat or decline slightly over the near term. Our asset-sensitive balance sheet continues to benefit from rising rates. And although there are many variables that impact magnitude and timing, we expect the margin to continue to expand to a range of 4.3% to 4.45% in the fourth quarter based upon anticipated interest rate increases. The competition for deposits is increasing, and we expect the margin expansion to moderate as we get further into 2023.

Regarding credit, much uncertainty remains regarding inflation and the impact of rate hikes to the economy and our customers. Over the fourth quarter, we expect continued stability in our credit quality trends, and ACL coverage to remain stable to slightly higher. We expect fee income to be between $44 million and $46 million in the fourth quarter, with continued strength in our diversified fee-producing businesses. Specific to expenses, we expect to be between $105 million and $107 million, but incentive expenses could fluctuate with fee income performance. As our operating lease portfolio grows, we will see corresponding depreciation expense growth of approximately $1 million per quarter, which is included in our range. Regarding Summit, our outlook is unchanged, and we expect the acquisition to have a minimal impact on overall 2022 earnings and provide approximately $400 million in annual originations. Lastly, our capital ratios remain strong, and we expect to maintain our dividend at current levels.

Overall, we had a really nice quarter, and we're optimistic that we can sustain the momentum over the remainder of 2022 and into the new year. Our strong balance sheet is well positioned to continue to benefit from rising rates with a loan deposit ratio under 80%, strong liquidity and positive credit trends, we believe we are well situated to manage a potential economic downturn. We'll now open up the call for questions Victoria?

(Operator Instructions) Our first question comes from Scott Siefers at Piper Sandler.

Thank you, morning guys. How is everybody doing? I guess, Jamie, maybe first question for you. So it kind of feels like at almost every turn in the tightening cycle, you guys have been maybe a little more asset sensitive than you had modeled. It sounds like we'll get another big lift in the fourth quarter. Archie, you had noted moderating mentioned into 2023 as deposit costs sort of keep up. But after we get to a point where the Fed stops raising rates, maybe just some thoughts on how much further could you expand the margin? And can you sustain NII positive NII momentum after the Fed stops raising rates?

Yes, Scott, this is Jamie. So yes, we do expect to see another pretty sizable increase here in the fourth quarter, in the margin. It's just -- I mean from the pace of the interest rate hikes and how these are coming on. We expect to see that lift here in the fourth quarter as well. And then even into the first quarter, if you look at -- based on the Fed fund futures and what we're expecting in terms of rate hikes going in for the beginning of next year. But then -- so we expect the margin to peak. So if you were to ask me maybe 6, a few months ago, where our margin was going to peak I would have said maybe in that 420 range. But just given the way things have changed, I think it is -- the peak is a little bit higher. So the peak is probably somewhere in that -- in the first quarter of next year and where the peak is going to be a little bit higher and somewhere in that 440 to 450 range into next year. And then as the Fed stops and on the back side of that, the deposit side starts to catch up. I mean we just had no time for the deposit side to really ramp up to where it should be, that's going to happen more on the backside when the Fed stops. So you'll then start to see the margins start to come back down and moderate in the middle to the back half of next year.

Yes. Perfect. All right. Thank you for that color. And I guess, just given that we're getting closer to the end of the tightening cycle, hopefully. Have you guys given any thought to sort of moderating our asset sensitivity to protect against the turn in rates? And a lot of guys are putting on swaps out to do so. What -- if so, what would be the best in your mind?

Yes. So we're looking at several things, kind of, I would say, evaluating. We haven't done anything yet, I would say, material. Maybe the only thing we've done at this point is some slight rebalancing in the investment portfolio to maybe extend some duration there on the investment portfolio. But that's -- I would say that's on the fringes. But I mean I would tell you, we're evaluating various options to kind of to protect the NIM on the downside and reduce that asset sensitivity. I mean we're looking at costless collars and looking at building in some floors and whatnot, but haven't done anything yet, but expect to do so here in the next -- within the next quarter.

Perfect. All right. Good. Thank you guys very much for taking the questions.

Our next question comes from Daniel Tamayo at Raymond James.

Thank you, good morning guys. Maybe we just start on the fee guidance, the decline there. If you could just talk through some of the puts and takes in terms of what drove that? And maybe if we could just talk a little bit about what your expectations are for Bannockburn in particular going forward, that would be great.

Yes. Danny, I'll start. This is Jamie. So kind of just going through the various line items like -- so the first one, like we disclosed, I think, a few months ago, we made some changes to our overdraft program that is impact -- the impact was what we expected, it's not any different than what we expected. But that did drive that service charge revenue down in the third quarter. So that impacted that line item.

In terms of mortgage, I mean, as you expect, I mean, our mortgage rates are up 400 basis points or so from a year ago. So in terms of that activity has fallen off dramatically. So obviously, seeing an impact there. On the wealth management side, a lot of those fees are based on the market values of the portfolio and of the assets under management. So getting impacted by the downturn in the market. And then offsetting that a little bit, we are still seeing strong income on the foreign exchange side.

So we were down a little bit this quarter, but coming off of what was a record quarter for them. And that's -- and they have a base of income and then there are some quarter-to-quarter fluctuations. But when we look at that income at this point, they're somewhere in that $12 million a quarter range, so about $48 million-ish on an annual basis of revenue at Bannockburn. And we, going forward, expect that to increase in that 5% to 10% range on an annual basis for the near term.

Okay. Great. That's helpful Jamie, thanks. And then I guess a similar question but on the expense side, in particular, it looks like the guidance for the fourth quarter is similar to what you put up in the third quarter. And then you called out specifically the $1 million increase in leasing expenses. Just curious how we should be thinking about kind of growth rates from there? If that's just a unique situation in the fourth quarter where expenses should be roughly stable-ish. And also if that $1 million is included in the guidance that you've given? Thanks.

It is. Yes. The $1 million is included in that guidance, and that's just obviously as we put up operating leases on the books. That line item there is going to continue to grow. But I mean, absent that, I would tell you, it's really just the pressure that we are seeing is really on the employee cost side. So outside of that, I would just call it inflationary pressure on employee costs, other expenses are relatively flat. And so you got -- essentially, you have that increase on the Summit side every quarter kind of just ramping up and then some pressure there in wage costs, health care costs and whatnot, that is impacting the employee cost line. But outside of that is relatively flat.

Dan, this is Archie. Jim, the other item on the corresponding side as that leasing business expense goes up, we're also seeing corresponding benefit in the fee side from the operating leases.

Yes, correct.

All right. Thanks for the color guys. That's all for me.

Our next question comes from Terry McEvoy at Stephens Inc.

This is Brandon Rud on for Terry. My first question is about deposits. Noninterest bearing deposits pre-COVID in 2019 were about 26% of total deposits. In this last quarter, they were about 32.5%. Do you think they could return back to that pre-COVID level in the next year, year 1.5 years or so?

This is Archie. Certainly, there's some money that's surged into demand deposit accounts during COVID, and you would expect, over time, some of that will work its way back out as businesses and individuals spend some of that or start to put some of that money to work. So I don't know that we're going to be able to hold it at the low 30s. But I think we believe, just given our strategy and focus on growing our business sector, particularly, we think that number will probably be higher than where it was pre-COVID.

Okay. Perfect. Next one here is do you have any sectors or regions across your footprint that you're expecting to drive your loan growth going forward?

It's Archie again. I mean, I think it's across our footprint, our footprint is pretty tight if you think about where we're located. 4 hours, 4.5 hours across the whole footprint. So it's coming really from all of those markets. What we also have -- as you know, we have some national businesses with Oak Street and Summit and even in our -- some of our, more regionally, commercial real estate. So all those areas will help drive some of that growth as well.

Got you. I'll ask 2 here kind of go hand in hand, talking about credit. Can you talk about how your restaurant franchise borrowers are managing the current environment? And also, can you (inaudible) to your exposure to office, hotel and retail CRE is kind of how you stress those portfolios for the higher interest rates.

Yes. This is or Jim, I'll start, but I'm going to turn it to Bill to kind of get into the tails. On the restaurant book and hotel book, just to let you know, we have -- that those books are much smaller than they used to be. So I think the restaurant portfolio is now under $300 million. So it's about half of what it was 4 years ago, and the hotel book is down about 40% from where it was 2, 2.5 years ago. So I think it's a little bit over $300 million or so. So they are much smaller, but we'll have Bill Harrod, our Chief Credit Officer talk about what he's seeing in those portfolios as well as, I think you said the retail CRE portfolio.

Yes, sure. As far as the office and the retail books and the hotel books. Those are actually performing very, very good. Hotels have rebounded nicely and up to, in some cases, exceeding pre-pandemic levels. And so we're very happy with that portfolio, and it's this progress. On the franchise book, they have some cost headwinds as far as labor and inputs, but we're also seeing rises and prices across a lot of the platforms to help mitigate that. They still have good volumes compared to 2019. And so we feel pretty bullish there as well.

On the office, we continue to monitor that portfolio very diligently, including stress testing not only on the interest rate environment, one thing about our vertical book in the real estate side, the vast majority of that is swapped and so have interest rate hedges on it. So we feel pretty good about that. That said, we do run through our models, including not only interest rate shocks as well as rent rolls and looking out short-term, midterm and long-term expiries to try to read think the risk and attack it quickly and before it becomes a potential issue with (inaudible). So we do that across our real estate books. Hopefully, that helps.

Got it. Yes. That's very helpful. I appreciate you taking my questions. Thank you.

(Operator Instructions) And our next question comes from Chris McGratty at KBW.

Great, thanks. Hey guys. Jamie, a question on the just spot rates. Do you have the spot deposit -- interest-bearing deposit in the spot loan yield?

So like for September, is that what you're asking?

Yes, (inaudible) the quarter exactly.

Yes. So our cost of deposits in September was 27 basis points. And hang on here, we go back into it in our loan yields, for September -- let's see here, was around $540 million.

Okay. Thank you. And the 30% beta you cited, was that total? Or is that (inaudible)? Just to make sure I'm clear?

It's total. And obviously, I mean, Chris real quick on that. I mean, we haven't really seen a whole lot so far in the cycle, but we're starting to see some pressure. And it's just we're seeing that here starting out a little bit in the fourth quarter, some competitive pressures. And obviously, that beta is going to start to move up here. And then on the back side, again, like I said, the -- that data moves up pretty substantially on the backside of the rate hikes. So...

Great. I guess maybe on the loan yield outlook, I mean, if they price -- if they continue to reprice higher, I mean you're going to have -- your borrowers are going to be paying north of 6 -- maybe mid-6s on a loan. At what point does the pressure on the borrower become more acute with related to credit?

Yes. I mean it's hard to look at that on a global basis. But when we look at credits and underwrite credits, we have built in shocks. And those built-in shops go out in duration and size depending on the deal. But we test them to really ensure that they're bending and not breaking. And then on -- and also a lot of our book is hedged on the loan side, both in commercial and on the ICRE. Now that's waned a little bit just with the rising rate environment that we're in right now, people are going to hold off a little bit. But overall, the book is protected that way. But it's really through our downside, base case downside and severe cases that we prove that they don't bend. Now of course, any expense, it's an increasing and pressures and they'll figure other ways to deal with it.

Yes. Chris, this is Archie. I think this is part of the case for where we're seeing a little bit of softening in the pipeline and slowing down growth is that we know, especially in our ICRE group, certain projects are being postponed or put on hold and just waiting for the environment to get a little bit better. So that is driving some of the -- some of our outlook around loan growth.

At this time, there are no further questions. And now I would like to pass back over to Archie Brown for any final remarks.

Thanks, Victoria. Thank you all for joining us on today's call and hearing, hear more about our story in the third quarter. We're excited about the fourth quarter and 2023, and we look forward to talking to you again next quarter. Have a great day.

Thank you, everyone, for joining today's conference call. You may now disconnect.