First Financial Bancorp (FFBC) 2023 Q2 法說會逐字稿

Good morning. My name is Rob, and I'll be your conference operator today. At this time, I would like to welcome everyone to the First Financial Bancorp Second Quarter 2023 Earnings Conference Call and webcast. (Operator Instructions)

Scott Crawley, Corporate Controller, you may begin your conference.

Thank you, Rob. Good morning, everyone. And thank you for joining us on today's conference call to discuss First Financial Bancorp's second quarter and year-to-date 2023 financial results. Participating on today's call will be Archie Brown, President 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 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 statements disclosure contained in the second quarter 2023 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 June 30, 2023 and we will not be updating any forward-looking statements to reflect facts or circumstances after this call.

I'll now turn the call over to Archie Brown.

Thank you, Scott. Good morning, everyone and thank you for joining us on our call. Yesterday afternoon we announced our financial results for the second quarter. I'll provide some high-level thoughts on our recent performance and then turn the call over to Jamie to provide further details. I continue to be pleased with our performance this year. Earnings in the second quarter were once again very strong as an expected increase in deposit costs was mostly offset by higher asset yields.

Adjusted earnings per share was $0.72 which was a 29% increase compared to the same quarter in 2022. While the adjusted return on assets and tangible common equity were 1.62% and 26.46%, respectively. Net interest margin exceeded expectations during the period as our asset-sensitive balance sheet has enabled the company to successfully navigate the higher interest rate environment. We were encouraged by the stabilization of deposit balances in the last half of the quarter.

Personal, business and public fund deposits were stable to increasing from May to June, while the mix continued to shift to interest-bearing products. Our fee income largely exceeded our expectations this quarter with strong performance from mortgage banking, client swaps and wealth management. Summit Funding Group had another nice quarter in originations although the mix has shifted to a higher level of finance leases and loans. This shift has bolstered our net interest income, but resulted in less fee income during the periods.

Loan growth was in line with expectations for the quarter, while loan activity slowed early in the quarter and we experienced higher commercial line paydowns, loan pipelines have strengthened in recent weeks and we expect moderate loan growth in the second half of the year. We're pleased that asset quality remains strong during the quarter. Net charge-offs were 22 basis points on an annualized basis, after having 0 last quarter and a net recovery in the fourth quarter of 2022, while classified assets declined 13% from the linked-quarter.

Then I'll turn the call over to Jamie to discuss these results in greater detail. And after Jamie's discussion, I'll 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 second quarter financial results. Our performance was excellent, driven by solid earnings strong net interest margin, high fee income and stable asset quality. Our asset-sensitive balance sheet continued to react positively to the current interest rate environment, with our net interest margin declining only 7 basis points during the period.

We continue to anticipate modest net interest margin contraction in the near term, due to fewer rate hikes and additional pressure on deposit pricing. Total loans grew 4.5% on an annualized basis, which was in line with our expectation. Loan growth was concentrated in the leasing and residential mortgage books with relatively stable balances in the other portfolios. Fee income remained strong in the second quarter with wealth management posting another record quarter.

Additionally, Bannockburn had a solid quarter and mortgage rebounded compared to previous quarters. Summit had another strong origination quarter, although as Archie mentioned, production mix shifted to a higher level of finance leases and loans. The shift was additive to our net interest income but resulted in less fee income during the period. Non-interest expenses increased slightly from the linked-quarter due to higher employee and marketing costs.

Second quarter expenses were slightly better than we anticipated due to lower leasing business expenses and fraud costs. Asset quality was stable during the quarter. Classified assets declined $20 million or 13% during the period. Net charge-offs in the second quarter were 22 basis points, as a percent of total loans on an annualized basis compared to 0 in the first quarter, resulting in year-to-date net charge-offs of 11 basis points.

We recorded $10.7 million of provision expense during the period, which were driven by slower prepayment rates, charge-offs and loan growth. As a result, our ACL coverage ratio increased by 5 basis points to 1.41%. The capital standpoint, our regulatory ratios remain in excess of both internal regulatory targets. Accumulated other comprehensive income declined $25 million during the period. The result tangible book value increased $0.26 or 2.4%, while our tangible common equity ratio improved by 9 basis points.

Slide 7 reconciles our GAAP earnings to adjusted earnings, highlighting items that we believe are important, understanding our quarterly performance. Adjusted net income was $68.7 million or $0.72 per share for the quarter. Adjusted earnings exclude the impact of a $1 million tax credit investment write-down, $1.7 million of costs associated with our online banking, conversion and $1 million of other costs not expected to recur.

As depicted on Slide 8, these adjusted earnings equate to a return on average assets of 1.62%. Our return on average tangible common equity of 26.5% and an efficiency ratio of 54.9%.

Turning to Slide 9, net interest margin declined 7 basis points from the linked quarter of 4.48%. We expected higher funding costs outpace increases in asset yields primarily due to a 40 basis point increase in the cost of deposits. That being said, we were pleased that asset yields increased 33 basis points due to higher rates and a more profitable mix of earning asset balances during the period.

On Slide 10, asset yields increased during the second quarter as loan yields grew by 40 basis points. Investment yields increased 7 basis points due to the repricing of floating rate investments and slower prepayments on mortgage-backed securities. Our cost of deposits increased 40 basis points compared to the first quarter and we expect these costs to increase further in reaction to sustained competitive pressures in the coming quarters.

Slide 11 details the betas utilizing our net interest increase with greater velocity in the second quarter, moving our current beta up 6% points to 27% with our improvement cycle beta estimated at approximately 40%.

Slide 12 outlines our various sources of liquidity and borrowing capacity. We continue to believe we have the flexibility required to manage the balance sheet to the expected economic environment.

Slide 13 illustrates our current loan mix and balance changes compared to the linked-quarter. As I mentioned before, loan balances increased 4.5% annualized basis with growth driven by Summit and mortgage loans. The other loan portfolios were relatively unchanged when compared to the prior quarter.

Slide 14 provides details on our loan concentration by industry. We believe our loan portfolio remained sufficiently diversified to provide protection from deterioration in particular industry.

Slide 15 provides details on our office space loans. As you can see, less than 5% of our total loan book is concentrated in office space. And the overall LTV of the portfolio is strong portfolio. While our portfolio is not immune to the general economic stress on office space, we continue to believe that lending to borrowers with Class A and B assets in primarily suburban markets within our footprint, mitigates much of our risk.

Slide 16 shows our deposit mix as well as the progression of average deposits from the linked-quarter. In total, average deposit balances declined $98 million during the quarter, driven primarily by a $287 million decline in non-interest-bearing account and $102 million decline in savings accounts. This was expected as higher interest rates have driven customers to more expensive products like CDs and money market accounts. Additionally, brokered CDs increased $214 million during the period, partially offsetting the decline in transaction accounts.

Slide 17 depicts trends that are average, personal, business and public fund deposits as well as a comparison of our borrowing capacity for uninsured deposits. While personal deposit and public fund balances were relatively stable in the quarter, business deposits continued to decline. As we discussed last quarter, this decline is primarily related to a post-COVID decline from record high balance.

On the bottom right of the slide you can see our adjusted uninsured deposits for $2.5 billion at June 30. This equates to 20% of our total deposits. We are comfortable with this concentration and believe our borrowing capacity provides sufficient flexibility to respond to any of them that would stress our larger deposit balances.

Finally, with respect to deposits, Slide 18 depicts average deposits by month. As you can see, deposit levels experienced a decline in the first part of the year but normalized thereafter. April was negatively impacted by 2 large business customers who initiated large transactions that resulted in lower deposit balances. Deposits balances were stable in the last 2 months of the quarter.

Slide 19 highlights our non-interest income for the quarter. Wealth management had another record quarter while Bannockburn continues to post strong results. In addition, mortgage income rebounded during the period. Summit had another very strong quarter, however, leasing income declined during the period due to a shift in product mix to finance leases. While the fee portion of the business was lower than the first quarter, the contribution from Summit to the net interest margin exceeded first quarter amounts.

Non-interest expense for the quarter is outlined on Slide 20. First expenses were lower than we initially expected. However, they were a slight increased compared to the first quarter. This increase was driven by elevated employee costs and higher marketing costs. These increases were partially offset by lower fraud and leasing business expenses.

Turning now to Slide 21. Our ACL model resulted in a total allowance, which includes both funded and unfunded reserves of $161 million and $10.7 million of total provision expense during the period. This resulted in an ACL that was 1.41% of total loans which was a 5 basis point increase from the first quarter. Provision expense was driven by slower prepayment speeds, net charge-offs and loan growth.

Overall, asset quality remained relatively stable. Net charge-offs increased from $0 in the first quarter to $5.7 million, or 22 basis points of total loans on an annualized basis. While this amount is higher than the previous 2 quarters, we believe a 11 basis points of net charge-offs here today is a reasonable amount. Classified assets decreased 13% to $139 million. However, nonaccrual loans increased during the period due to the downgrade of 2 relationships. We continue to expect our ACL coverage to increase slightly in the coming period as our model responds to changes in the macroeconomic environment.

Finally, as shown on slides 23, 24 and 25, regulatory capital ratios remain in excess of regulatory minimum and internal targets. During the second quarter, tangible book value increased $0.26, or 2.4%, and the TCE ratio increased 9 basis points due to our strong earnings. Accumulated other comprehensive income declined $25 million during the second quarter and continues to impact our TCE ratio. Absent the impact from AOCI, the TCE ratio would have been 8.76% in June 30 compared to 6.56% as reported.

Slide 25 demonstrates that our capital ratios remain in excess of regulatory targets, including the unrealized losses in the securities portfolio. Our total shareholder return remains robust with 33% 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?

Thanks, Jamie. Before we end our prepared remarks, I want to comment on our forward-looking guidance which can be found on Slide 26. As I mentioned earlier, loan pipelines strengthened in recent weeks, and we expect Summit to remain a significant contributor to grow for the rest of the year. We continue to be more selective in certain segments, but we expect overall growth to stay in the mid-single digits in the near term.

Regarding securities, we will continue utilize the portfolio cash flows to support long growth. We expect the positive balances to grow modestly in the near term as repricing strategies continue to gain traction. There's still some uncertainty around Fed rate management, loan demand and deposit pricing competition. Our assets-sensitive balance sheet has helped us offset much of the positive pressures thus far in the cycle.

We continue to expect modest contraction of the third quarter with our net interest margin and a range between 4.25% to 4.35% based on an additional anticipated July interest rate increase. Specifically, credit we're still in a period of uncertainty regarding inflation and the impact of higher rates to the economy our customers. For the third quarter, we expect continued stability in our credit quality trends and ACL coverage to be slightly higher.

We expect fee income to be stable in total in the third quarter and in the range between $53 million and $55 million, including the leasing business. Specific to expenses, we expect to be between $117 million and $119 million, which includes depreciation expense from the lease portfolio. Excluding leasing expense, we expect expenses to be stable in the third quarter. Lastly, our capital ratios remain strong and we expect to maintain our dividend at the current level.

We are certainly pleased with our second quarter results, position of our balance sheet, strong net interest margin, consistent long growth, robust income and stable asset quality expected to sustain our performance in the back half of the year. Additionally, our earnings power strong and increasing capital levels and high reserve levels provide additional support in the event of a downturn in the economy.

With that, we'll now open up the call for questions.

(Operator Instructions). And your first question comes from the line of Daniel Tamayo from Raymond James.

Maybe just starting first on the margin guidance. If you could just let me know what the assumptions baked in there for non-interest-bearing degradation or declines going forward are? And then just -- let's start with that.

Dan, it's Jamie. So what we're looking at here, we obviously saw the mix shift in the first quarter to the second quarter like many are saying. We expect, generally, that same type of mix shift to continue on in the third quarter and essentially the same level of deposit cost increase maybe slightly more than what we saw in the second quarter. So we had a 40 basis point increase from 1 to 140 linked quarter here in the second quarter. And we expect that to continue around that same level and with that same general level of mix shift that we saw in the second quarter to continue on in the third quarter.

So -- and maybe again, on the cost side, with the pressure that we're seeing maybe even a little bit more of an increase on the deposit costs than we saw in the second quarter. We're just seeing those ramp up pretty significantly but again, that's baked into our forecast of the margin range that we gave in the outlook there.

Great. And then maybe help me think about post-rate hikes. Obviously, you guys have really seen asset yields come through nicely as rates have risen. Once we get into that rate hike timeframe potentially in the fourth quarter, how do you think the overall margin reacts at that point? I mean, are you expecting more or budgeting for more deposit increases and the asset side to stay relatively flat at that point?

Yes, I mean, as we get towards the end of the year, I think we'll still see some deposit -- increases and deposit costs coming through. But I mean, if you look out maybe even a little bit farther and assume then that the Fed, let's say the Fed pauses for a little while, our margin -- we think our margin stabilizes somewhere around 390 to 4 in the middle of next year.

And that assumes again -- that assumes that the Fed, increases here in July and pauses, at a minimum there in the first half and the first part of 2024. But then mid next year, looking at a margin kind of stabilizing before the rate cuts, if fed those do come somewhere in that 390 to 4 range.

Your next question comes from the line of Brendan Nosal from Piper Sandler.

Maybe on the leasing piece. Can you walk through the mix dynamics within leases this quarter between operating and financing and kind of how that progresses from here and how that kind of factors into the fee and expense guide?

This is Jamie again, Brendan. So, in the second quarter, we did see a pretty significant change. So first of all, it can bounce around a little bit from quarter to quarter. It's not necessarily always the same consistent mix quarter-to-quarter. So in the second quarter, we saw a pretty dramatic shift of production and it was virtually all finance leases with a small -- virtually all finance leases and all of the lease -- virtually all of the leases, 90% to 95% of the leases were held in the portfolio as opposed to we'll have some quarters well, where we will sell some leases out into the secondary market and produce some fee income.

So a combination of those two things, a high finance lease production quarter, a high quarter where we're holding most of releases, you are going to see that leasing income contract a little bit. Going forward, we typically see tiniest leases in that 60%-70% range but we are holding the vast majority of the leases going forward. So you may not see that the leasing income line growing as much as we were seeing in the -- when we first had the division.

So when we look at it, we had about $10.3 million in leasing business income down in the fee income section and we see that growing by about a $1.5 million each quarter here for the next couple quarters. And that's probably as much of a (inaudible) that we have into at the moment. And then the -- and so typically what we see is the ratio on the fee income side to the expense side is about 1.5 to 1. So then we see the expense side growing by about a $1 million. So we had right about around $7 million in leasing business expense. So we see that part growing by about a $1 million each quarter for the next couple quarters.

Maybe one more from me. Can you guys offer a little more color on what drove the increase in NPAs this quarter as well as the charge-offs that you experienced? I guess kind of where they both driven by the same 2 credits you noted in the release. And if so, how do you feel your reserve for those at this point?

This is Bill Harrod. The increase in the non-performing assets, as we talked about earlier, was really driven by two borrowers, one on the CNI space, one on the CRA space, which, when looking at them we don't consider them systematic across our portfolio, very unique circumstances. And we're obviously working through resolutions on both. The C&I credit was really related to management issues and the CRA credit is a small office that's been having challenges with their lease rollover. We have the charge-offs were driven mainly by the write-down of our CRE loan in the non-accrual to bring it down to appraised values and we are properly reserved on the other.

(Operator Instructions) Your next question comes from the line of Chris McGratty from KBW.

This is Nick Moutafakis on for Chris McGratty. Maybe just on deposits. If you bifurcate commercial and retail on the -- at least on the non-interest side and the mix as a whole, maybe you can make a comment on how those two segments have bifurcated the dynamics between commercial and retail. Are you seeing -- commercial is already -- you've already seen the outflows in commercial and maybe there's a catch-up in retail or maybe you can make a comment on that.

Yes. This is Archie. Think we show on the one slide, I think it's 18. You can look at the -- it's a balanced trends there by month and you'll see pretty much the stabilization that's occurred during the quarter really for each of our segments so personal, public funds and business. So I mean, at this point, as Jamie said, we're going to continue to see some mix shift going forward. But we feel like we're in a place now where deposits are going to grow and we're kind of in more, I guess, more normal operating cycles with businesses.

So they're still -- they still have some liquidity. Even this past quarter, we used some of that to pay some lines down. So we'll probably see a little bit of pressure on the business in ID balances like we've seen. But generally, they're going to grow overall and maybe a little more tick up in the interest-bearing side. Jamie's got another comment.

Nick, this is Jamie. The other thing on the personal side, so I would tell you, as we've seen the last few months, we're seeing the average balance per account come down. But we are growing the number of accounts, net new accounts, and it's helping to offset that. But we are seeing pressure just on each individual account, the average dollars that are sitting in those accounts coming down, which is what we expected just given the large increase in the -- throughout '20 and '21 during Covid and the large increase in deposits. But we're offsetting a good portion of that with the fact that we are adding accounts.

Great. Maybe, I don't know if it's in the slide deck or if I missed it too. But just the -- as far as the CD growth, maybe the duration of the CD portfolio as a retail broker or…

Yes. All of that is relatively short. I mean, we're putting on our specials would typically run either in like 7 months or 11 months, but it's all less than 12 to 15 months. Brokers would typically be in that 6-to-12-month range.

Your next question comes from the line of Terry McEvoy from Stephens.

Maybe let's start with a question or 2 on the loan portfolio. Could you just talk about what you're seeing and hearing from your customers in commercial and small business banking, maybe pipelines and what are their kinda concerns given some of the macro headlines out there?

Terry, this is Archie. We saw, especially at the beginning of the quarter, some softness and I think it had a lot to do with some of the turmoil that had occurred at the latter part of the first quarter in the industry. So pipelines certainly softened, activity slowed, and then somewhere around mid-quarter, it just shifted and we're seeing much stronger and better activity at this point. And say that I'm talking about primarily on the commercial banking side, probably middle market side, in particular.

With respect to commercial real estate, it's sort of mixed. I mean, there's opportunities, but certainly the industry and we are being more selective or a little more defensive in the areas we're targeting. And we are seeing relative to quality in that space, we're seeing a lot better structures, more equity into projects and things like that when we do them. So C&I side much better demand in the back half of the quarter; CRE side, there is demand, but we're just much more selective so it's a little -- I'd say it's just a little slower activity because of that.

Appreciate that. And getting back to the discussion on Summit and some of the moving parts. Are the economics different at all to the bank, whether it's run through fee income or net interest income? And I'm just thinking about the capital that goes with the holding it in the loan portfolio?

So this is Jamie. It's relatively, marginal on either side from an economic standpoint. And if you think about the capital side of it from a risk-weighted asset standpoint, whether it's sitting in that -- I think they are -- so they're both 100% risk-weighted whether they're sitting in other assets or whether they're sitting in the loan book. So from a capital allocation standpoint, they're both at a 100% but the economics -- I mean the timing of it moves a little bit, but the economics are virtually the same.

Great. And maybe one last one. Is the company considering selling any loans going forward in order to either reduce concentration in the portfolio or de-risk a certain asset class?

Yes. And Terry that is part of our normal operating rhythms to periodically go out and test the market getting pricing discovery on various tools and we take a look at that to get a lens and what's happened in the market and then we're under no obligation to execute. But we will take a look in business case make sense, we'll do it.

And there are no further questions at this time. Mr. Archie Brown, I'll turn the call back over to you for some final closing remarks.

Yes, Rob. Thank you. I want to thank everybody for joining the call this morning. We're glad that you were on with us hearing more about our quarter and our story. We look forward to talking to you again next quarter. Have a nice day.

This concludes today's conference call. Thank you for your participation. You may now disconnect.