First Financial Bancorp (FFBC) 2020 Q1 法說會逐字稿

Good morning. Welcome to the First Financial First Quarter 2020 Earnings Conference Call and Webcast. (Operator Instructions) Please note that this event is being recorded.

I would now like to turn the conference over to Scott Crawley, Controller. Go ahead.

Thank you, Kate. Good morning, everyone. And thank you for joining us on today's conference call to discuss First Financial Bancorp's first quarter 2020 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 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 2020 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, 2020, 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 today's call. Yesterday afternoon, we announced our financial results for the first quarter. To say the events of the last few months are unprecedented seems like an understatement. While the first half of the quarter was marked by strong financial performance, March was characterized by economic and logistical upheaval and uncertainty. There are very few areas of our client base, our associate base or our operations not impacted by the COVID-19 crisis in some way.

In a rapidly changing operational and economic landscape, we successfully mobilized our teams with thoughtful changes to maintain the performance and service of our customers and shareholders that they've come to expect and we are pleased that pre-provision financial results exceeded our expectations despite a 150 basis point drop in interest rates. We began monitoring the COVID-19 pandemic early on, preparing in the event it affected our markets. As can be seen on Slides 19 and 20, we immediately activated our pandemic response plan and our Executive Committee shifted to crisis management, working to develop plans and products to assist our clients, communities and associates in a meaningful way. Our guiding principles in managing this crisis have been prioritizing associate and client safety, preserving the continuity of our business, assisting our communities and ensuring the safety and soundness of our company.

Across our client-facing teams, including our banking centers, we have updated protocols to protect both our associates and clients, enabling us to provide virtually all banking services to our communities. Over 96% of our banking centers have remained open by utilizing drive-through capabilities. Our sales associates, support teams and management have transitioned to working remotely with approximately 60% now working from home. I've been exceptionally pleased with our ability to rapidly adapt and function at a high level despite the challenges. Additionally, we've also rolled out various associate relief programs for those associates experiencing financial hardship.

For our customers, our planning efforts developed into our COVID-19 relief program, which provides comprehensive assistance to clients across all segments through payment deferrals, fee waivers for our loan and deposit clients and suspension of vehicle repossessions and residential property foreclosures, to name a few. It's been a busy quarter, and we've accomplished a great deal to support the evolving needs of our retail business and governmental clients. We continue to actively monitor the actions of federal and state governments and are proactively assisting our clients to ensure that they're aware of every program of financial assistance available to them.

Lastly, we've also been working to enhance our remote, mobile and online processes to seamlessly support a bank anytime, anywhere environment. Since the passage of the CARES Act, the entire bank has mobilized to launch the historical client relief programs that are part of this legislation. We conducted a significant level of cross-training and redeployment of associates to rapidly meet the influx of client requests. Our implementation of the U.S. government's Paycheck Protection Program has gone well overall. To date, we've received over 5,700 loan requests, representing more than $1 billion and secured SBA funding for approximately 3,600 loans, representing an excess of $750 million. Feedback from our clients has been overwhelmingly positive, and I'm proud with the way our associates have responded as the embodiment of our corporate strategic intent to support the communities in which we work and live. Additionally, we contributed $1 million to help fund COVID-19 relief efforts in the communities throughout our footprint, which will put funds directly into the hands of agencies supporting relief efforts.

The results for the first quarter were substantially influenced by the COVID-19 pandemic across net income -- net interest income, fee income and most significantly, credit costs. Overall, we recorded adjusted earnings of $0.31 per share, a 0.85% return on average assets, a 10.41% return on average tangible common equity and a 58% efficiency ratio when adjusted to remove nonrecurring items.

I'll now turn the call over to Jamie to discuss the details of our first quarter results. And after Jamie's discussion, I will wrap up with some comments on specific areas of focus within our credit exposures and forward-looking commentary.

Thank you, Archie, and good morning, everyone. Slides 4 and 5 provide a summary of our first quarter 2020 performance. Although the first quarter was an eventful one, the company's fundamentals and core operating performance remain solid as loan growth, fee income and efficiency all met or surpassed our expectations. The adoption of CECL and the impact of the pandemic resulted in $25.5 million of provision expense and reduced overall earnings. However, our earnings power and balance sheet strength has put us in a position to absorb elevated credit costs while maintaining capital in excess of internal and regulatory targets. We were pleased with net interest margin, which declined only 12 basis points on an FTE basis compared to the prior quarter. Foreign exchange, trust and client derivative income were all strong during the quarter and offset an otherwise flat expense base to result in a sub-60% efficiency ratio. We believe we are well positioned from a regulatory capital standpoint as these ratios remain relatively flat on a linked quarter basis. Our tangible common equity ratio declined 82 basis points in the first quarter due to the adoption of CECL and share repurchases.

Slide 6 reconciles our GAAP earnings to adjusted earnings, highlighting items that we believe are important to understanding our quarterly performance. Adjusted net income was $30.7 million or $0.31 per share for the quarter, which excludes a $1 million contribution to fund COVID relief in our footprint and $1.5 million of other nonrecurring items, such as branch consolidation costs and certain other COVID-related expenses. As shown on Slide 7, these adjusted earnings equate to a return on average assets of 85 basis points and a return on average tangible common equity of 10.4%. Despite the slight increase during the quarter, our 58.2% adjusted efficiency ratio remains strong and reflects our diligent approach to expense management.

Turning to Slides 8 and 9. Net interest margin on a fully tax-equivalent basis was 3.77% for the first quarter. The 12 basis point decline since year-end was better than we anticipated, given the 150 basis point reduction in interest rates during the quarter. The decline in our net interest margin was primarily related to fewer loan fees and lower purchase accounting accretion during the period. While asset yields dropped by 16 basis points during the quarter due to the Fed rate cuts, we were able to offset this by proactively managing our funding costs, which declined by 13 basis points during the period.

The impact of the recent Fed actions are further shown on Slide 9, as declining interest rates, lower loan fees and purchase accounting caused the yield on loans to decline by 29 basis points, and the investment yield dropped by 12 basis points due to lower reinvestment rates. In response to these declining yields, we aggressively lowered our cost of deposits 10 basis points during the period.

Slide 10 depicts our current loan mix and balance changes compared to the linked quarter. End-of-period loan balances increased $106 million, which was primarily driven by ICRE originations. The remainder of the portfolio was relatively unchanged from year-end. Archie will provide additional details on various aspects of the loan portfolio later in the presentation.

Slide 11 shows the mix of our deposit base as well as the progression of average deposits from the linked quarter. In total, average deposit balances were relatively flat during the first quarter as interest-bearing DDA and noninterest-bearing deposit growth, combined with brokered CD balances to outpace a decline in retail CDs, money market accounts and public fund balances. As I previously mentioned, we were able to successfully manage deposit costs, resulting in a 10 basis point reduction to 64 basis points. Over the near term, we will continue to monitor deposit pricing and make any necessary adjustments based on market conditions and funding needs.

Slide 12 highlights our noninterest income for the quarter. First quarter fee income was positively impacted by a 65% increase in foreign exchange income, record wealth management fees and continued momentum in client derivatives and mortgage banking income.

Noninterest expense for the quarter is shown on Slide 13. Higher salaries and benefits were driven by seasonal increases in payroll taxes, elevated health care costs and incentive compensation related to the aforementioned strong foreign exchange and client derivative income. In addition, noninterest expenses included a $1 million contribution to fund COVID relief efforts in our footprint and approximately $1.5 million of other costs not expected to recur, such as merger-related and branch consolidation costs.

Next, I'll turn your attention to Slide 14, which discusses our allowance for credit losses and related provision expense for the quarter. As you can see, we made the decision to adopt CECL as of January 1, and our day 1 impact was in line with what was disclosed in our 10-K. Our first quarter model resulted in a total ACL, which includes both funded and unfunded reserves of $158 million and $25 million in total provision for credit losses. The model utilized the Moody's baseline economic forecast released at the end of March and included considerations for both COVID and the government stimulus. It's worth noting that substantially all of our first quarter provision expense was related to the expected economic impact from COVID.

As shown on Slide 15, credit quality was fairly benign in the first quarter as we had $900,000 of net recoveries for the period and a slight increase in nonperforming assets. The increase in NPAs was driven by a single specialty finance credit that was modified during the period and classified as a TDR. Classified loans increased by $35 million during the period as 3 large relationships, including the previously mentioned TDR, received risk rating downgrades during the period.

Finally, as shown on Slide 16 and 17, capital ratios remain strong and are in excess of regulatory minimums. During the first quarter, we repurchased 880,000 shares before suspending the program on March 13. Our regulatory capital ratios remained relatively flat and exceeded internal targets. Our tangible common equity ratio declined by 82 basis points during the period due primarily to the adoption of CECL. We expect our dividend will remain unchanged in the near term. However, we will continue to evaluate various capital actions as the economic impact of the COVID pandemic develops.

I'll now turn it back over to Archie for some commentary regarding our loan portfolio and our outlook. Archie?

Thank you, Jamie. Given the current economic circumstances related to the COVID-19 pandemic, we've added Slides 21 through 25 to highlight specific areas of focus within our loan portfolio. In the very early stages of forming our strategic response to the pandemic, we thoroughly conducted a review of all asset classes that we would expect to be most directly impacted, including restaurants, hotels and retail commercial real estate. That review included conversations with every borrower of a certain size to assess the immediate impact of COVID-19 on their business operations.

As of the end of the first quarter, our franchise portfolio was $455 million or 5% of total loans. Our review of the portfolio subsequent to the broader implementation of stay-at-home orders indicated that approximately $138 million of loans to clients with either strong delivery expertise or that utilize a carryout model will be minimally impacted or potentially see improvement in revenues. Fast casual concepts with drive-throughs, which totals approximately $162 million, have seen material revenue declines. Lastly, the sit-down casual dining segment, which totaled $155 million at March 31, have seen severe impacts to revenue streams. 93% of the franchise portfolio was pass-rated pre-pandemic. A significant portion of franchise customers are taking advantage of relief programs, including payment deferral, the PPP program, rent relief and franchiser relief as mitigants to revenue disruptions.

Our hotel book had outstanding balances of $401 million or 4% of total loans as of the end of the first quarter. The entire hotel industry has been substantially impacted by declining occupancies though most of our portfolio is concentrated in Midwest metropolitan markets reliant on business travel, which has fared better than other locations. Our portfolio is quite diverse with limited-service hotels representing approximately 80% of our exposure. Pre-pandemic, 100% of this portfolio was pass-rated and has an average loan-to-value of 61%. Again, almost all of these customers have taken advantage of relief options or the PPP program.

The retail CRE portfolio had outstanding balances of $846 million or 9% of total loans as of March 31. Loan-to-values range from 60% to 70% across most of the portfolio. The bank has focused on strong locations with adequately capitalized sponsors. This is essential in rightsizing deals that do not rebound to precrisis levels or in cases where market demand will decrease over the next 24 months. Pre-pandemic, 100% of this portfolio was pass-rated. The majority of this customer segment has also taken advantage of relief or PP options with us.

Given the challenging environment and uncertainty over the rest of the year, we are adjusting our guidance this quarter. Slide 26 shows the key factors that we expect to impact our performance moving forward. Loan growth is expected to be in the low single digits, excluding the transitory impact of the PPP program. Core deposit growth is expected to be in the mid-single digits. With the dramatic Fed rate cuts in March and a gradually declining LIBOR rate, we expect to see further net interest margin compression. The net interest margin is expected to decline 6 to 8 basis points for each 25 basis point cut to rates. We've been very proactive in our deposit cost management and expect costs to rapidly come down in the next quarter and then to continue to gradually fall as higher cost time deposits mature.

Current economic forecast indicate a high likelihood of credit stress over the back half of 2020. Therefore, we expect elevated provision expense in the near term. Fee income is expected to increase in the next few months due to higher mortgage revenue, driven by refinance activity. We anticipate headwinds across deposit overdraft service charge and interchange revenues, which will largely be dependent upon the length of stay-at-home orders and the time frame required for spinning to return to more normal levels. Wealth, foreign exchange and derivative fees are uncertain due to business disruptions and market volatility.

With respect to expenses, we believe the run rate to be consistent with the last 2 quarters. We follow a disciplined approach to expense management and have paused on most planned hiring, discretionary expenditures and significant investments, except where critical, to support current operations.

Regarding the PPP program, we will see transitory loan growth and incremental revenue from the $750 million in approved loans with average fees of approximately 3%. We anticipate some incremental expenses related to the program. For 2020, without taking into consideration the impact of PPP loans, we expect our pretax pre-provision income to be in the range of $220 million to $240 million assuming that consumer and business activity ramps back up over the second half of the year.

In conclusion, First Financial has weathered many tough times during the bank's 156-year history. This is another of those moments, and it's certain to be added to the history books. Every challenging event is filled with great moments to work together as a company, community and a nation. I said earlier how proud I am of the First Financial family and it bears repeating these events will likely be transformational for the industry and society, but the challenges will also provide unique opportunities to build and strengthen customer relationships, improve the digital client experience and evaluate our standing in the communities we serve -- or elevate our standing in the communities we serve. As we move forward, we will continue to be diligent stewards of the company while providing exceptional service and support to our customers and maintaining the well-being of our associates.

This concludes the prepared comments for the call. We'll now open up the call for questions.

(Operator Instructions) Our first question is from Chris McGratty from KBW.

Jamie, can I start with the -- just the margin? I just want to make sure I understand the slide. So if you look at the first quarter, it was partial reflective of the 6 cuts by the Fed. So is the message that you're trying to tell on the core margin that we still have multiple 6 to 8 basis point impacts coming as margins reset in the next couple of quarters?

Correct. Yes. So I mean eventually, our margin should settle out. So if you think about it, we had -- as we've guided in the past, our margin gets affected by 25 basis point rate cuts. It goes down 6 to 8 basis points. So if you use the midpoint, at 7, when you think about it, essentially towards the end of the first quarter, we had 6 of those 25 basis point rate cut. So our margin will eventually settle down from the first quarter, roughly 40 basis points. And that -- and Chris, the one thing to keep in mind, I think we kind of tipped it in the outlook slide, is that the -- that assumes then that 1-month LIBOR comes in line, I guess, with the Fed funds rate. Right now, you're seeing a 45 to 50 basis point differential to where -- between Fed funds and 1-month LIBOR. So that assumes that, that comes back in line.

Okay. Got it. And then maybe a follow-up, Jamie, on the margin. So if I'm doing the math on the PPP loans, right, you're going to get, on the loan fees, 3% of $750 million, so call it $22 million assuming these loans. I know you have to amortize it. But assuming they come back in the next quarter or 2, that $22 million should be flowing through margin over the next 6 months. That's the math, right?

Yes. That's the -- so I mean obviously, when we set these up, we will set up that 3% fee upfront. It will amortize over the life of the loan. So we'll take in 1/24 of that fee every month until it pays off. We're expecting the -- a large percentage of those to pay off within 6 months, but there could be some that extend out beyond that as well.

Okay. Got it. And then maybe...

So you'll see a pop, Chris. So you'll see -- what you'll see then is when they pay off, obviously, you get -- you'll pull all that into income and you get a pop during that time frame.

Exactly. Yes. I got it. And then, Archie, maybe just a question on the comments. I think you said it in your prepared remarks the dividend is steady for now but you'll evaluate, I think, capital actions. Can you just elaborate on that? Is that suggesting potential coming to market for capital or shrinking the balance sheet? I mean can you just talk through what you're messaging there?

Yes. Well, I think -- maybe I'll just make a high-level comment and maybe have Jamie just walk you through kind of how we're concluding this. But yes, our view is that we feel good about being able to continue to pay the dividend based on what we know at this time. We'll get, later in the year, our outlook. It's always dependent upon what our outlook is going forward. But at this point, we feel -- I think we feel pretty good about it. Maybe Jamie will talk about how are we going to...

Yes. So Chris, when -- so when we did our stress testing, we looked at several different scenarios of stress tests on the loan portfolio. But I mean when you look at kind of a common -- look at the DFAST, severe case, which we think is one of the more severe cases, apply those losses to our portfolio, we come up with approximately $500 million in losses over a 2-year period using that methodology. So when you -- under that scenario, looking at our excess capital that we have, our pretax pre-provision income even a conservative number over that 2-year period and keeping the dividend flat, we still remain above regulatory capital ratios, above those regulatory minimums. So that's kind of how we triangulated it.

Okay. So if you were to -- if that scenario were to play out, you'd still feel that you wouldn't have to come and do anything inorganic with the capital? Is that the right message?

Yes. I think that's right, Chris. Now having said that, I would say that we are in a really uncertain environment. And Jamie and I, a bunch of us, we're here 12 years ago. And when you get that kind of market dynamics in an uncertain time, it is good to have capital flexibility. So we've looked at Tier 2 off and on. We'll continue to evaluate it in this environment with -- a 60 basis point, 10-year, low-cost total capital does seem prudent to consider at some point. So I'm not sure what we're going to do or when we will do something if we do it but with rates this reasonable, it really doesn't seem to have any downside in an environment like this.

(Operator Instructions) Our next question is from Scott Siefers from Piper Sandler.

I guess first question I wanted to ask is just on the PPP loans. And maybe, Jamie, if you could expand upon the comments on how rapidly some may pay off and how some might extend. I mean my understanding is if all kind of goes as planned, they can pay off as little as something like 10 weeks. I'm just curious given the fluidity in the situation, I guess sort of the lack of really concrete rules on a lot of them or known rules, under what circumstances you guys feel that they would be forgivable versus kind of stick around on the balance sheet for a little while?

Yes. I mean like I mentioned, I think conservatively, we are expecting, call it, between 50% and 75% of these to be relatively short. But just given the low rate and just the unknown, there could be some that extend beyond that. So Bill, maybe you want to add anything?

Yes, absolutely. As we look at the request and we process them through the system, obviously, one thing that's important is the number of employees to be maintained during the 8-week period. As this draws on, we'll get a better lens into how many companies are able to maintain that same level as they went into it as they apply for the loan. That's really going to dictate what the carry is going to be. And then based upon the rate of that carry and the interest rate on the PPP loans, we suspect that will be paid off within the 2-year period but, on average, shrink that back about 12 months or so just because the cost of capital is low enough that a borrower will probably string that out a little bit.

Yes. Okay. That makes sense. I appreciate the color there. And then separately, just as you guys look to the loan modifications, I guess I'm specifically referring to the business side, the roughly $950 million in modifications to date. Can you sort of walk through what the thinking will be as we go through those forbearance periods? I think this is becoming kind of unchartered ground for a lot of us. And just how will you kind of go through the thought process of, okay, it looks like once we get through this modification period then where this guy is going to be fine or this one might have some stress. How will that sort of re-due-diligence process go in your guys' minds?

Scott, this is Archie. I'll start and we'll have Bill really walk you through the guts of how we're thinking about it. But for the first deferral is primarily through our conversations. If the borrower had impact and requested a deferral, we were going to give them that deferral. And in some cases, we will -- in many of those, we'll give them a second deferral for another 90 but under -- and many -- there will be certain industries we'll look at maybe a little bit differently or borrowers. Maybe Bill, describe what that kind of things we would think about for the second deferral.

Yes, absolutely. And so as we look at the second deferral, it's really about the time and the individual situation. What I mean by that is the longer that the current shelter-in-place lockout continues, the more likely that we're going to -- it's going to be necessary for us to grant additional 90 days on a more systematic or more global perspective. But then we'll also dive into the individual situations as businesses will take a little bit longer -- certain business will take a little bit longer to revamp or get back up to normal. It's about pacing. And so one of the key things we did on the front end was have our customer outreach program so we can kind of get a lens. This first 90 days will come -- we're monitoring to see how it flows. The second 90 days is going to be a little bit more deal-specific insomuch that we'll start to craft and tailor credit products and/or relief to their individual needs.

(Operator Instructions) At this time, we have no questions so this concludes the question-and-answer session. I would now like to turn the conference back over to Archie Brown for closing remarks.

Thank you, Kate. I want to thank everybody for joining us today and just ask you to be safe and healthy through this trying and unprecedented period, and we look forward to talking to you again soon. Have a nice day.

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