First Financial Bancorp
NASDAQ:FFBC
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First Financial Bancorp
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Good morning, and welcome to the First Financial Bancorp First Quarter 2018 Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded.
I now would hand the call over to Scott Crawley. Please go ahead, sir.
Thanks, Keith. Good morning, everyone, and thank you for joining us on today’s conference call to discuss First Financial Bancorp’s first quarter 2018 financial results. Participating on today’s call will be Claude Davis, Executive Chairman; Archie Brown, President and Chief Executive Officer; Jamie Anderson, Chief Financial Officer; John Gavigan, Chief Administrative 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 statement disclosure contained in the first quarter 2018 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 March 31, 2018, 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. Good morning and thank you for joining us on today’s call. On April 1, we successfully completed our merger with MainSource. We are pleased and excited to be here with you for our first earnings call for the combined First Financial. Today, Archie and I will provide some opening comments, and then we’ll turn the call over to Jamie and John to discuss first quarter results. Finally, we will wrap up with Archie discussing the combined bank outlook, and I will provide and update you on the integration progress.
We see this merger as a significant milestone in our company’s history and one that positions us well for future growth and success. We expect to benefit from the strong complementary mix in our footprints, operational strengths, strong asset quality and cultures. Over the last several quarters, we’ve been working diligently to integrate management, sales and support teams to position the combined franchise for continued growth. Our commitment to provide value for our clients, communities and shareholders remains our top priority. And by joining together, our expanded First Financial team will continue providing superior service and exceeding expectations for all of our constituents.
Yesterday afternoon, we also announced our financial results for the first quarter. Our first quarter results were exceptionally strong and marked our 110th consecutive quarter of profitability. We are extremely pleased with our top-quartile level performance and anticipate the merger will provide a continued growth and success.
With that, I’ll now turn the call over to Archie to provide further thoughts before John and Jamie discuss the first quarter financial results.
Thanks, Claude. I’d also like to echo Claude’s excitement about the completion of the merger and strong financial performance at both banks during the quarter. Although we’ve been working closely over the last several quarters initially to formally to bring the two banks together to fully focus on a smooth transition and system conversion, we continue to look for opportunities to maximize performance between our two institutions, both having already demonstrated the capability to independently produce industry-leading returns.
Providing two like-minded and community-focused financial institutions provides our clients with greater financing options and extended product offerings, while our associates can continue to deliver high-quality and personal level of service. We’re now well on our way to integrating two strong companies, and we remain steadfast in our commitment to exceed expectations for our clients, communities and shareholders.
At this point, I’ll have to now turn the call over to John and Jamie to discuss our first quarter results in more detail. I would then – Claude and I would provide an update on the combined bank outlook and merger integration activities. John?
Thank you, Archie, and good morning, everyone. Slide 3 provides an overview of First Financial’s standalone first quarter performance, which included net income of $30.5 million or $0.49 per diluted common share. As Claude mentioned, we are extremely pleased with our first quarter results, highlighted by strong earnings growth, margin expansion and improved efficiency, in addition to solid loan growth and stable credit quality.
Turning to Slide 4, we provided a reconciliation of our GAAP earnings to adjusted earnings, highlighting items we believe are significant to understanding our quarterly performance. Adjusting primarily for merger-related expenses and costs related to the final settlement of our FDIC loss-sharing agreements, net income was $32.4 million or $0.52 per diluted share for the first quarter, with an adjusted return on average assets of 1.49% and adjusted return on average tangible common equity of 18.2%.
Further, we continued to see solid expense management across our business, as reflected in our adjusted efficiency ratio of 53.8% for the period. Turning to Slides 6 and 7. Net interest income for the first quarter was $75.8 million, and the net interest margin increased 2 basis points from the linked quarter to 3.84% on a fully tax equivalent basis. The increase in our net interest margin was primarily driven by higher earning asset yields, as we benefited from rising interest rates, the termination of our loss-sharing agreements and two fewer days in the quarter. These factors more than offset declines in loan fees and a tax equivalent adjustment as well as higher funding costs due to rising rates and shifts in our funding mix during the period.
Slide 8 depicts the loan portfolio of product mix as well as the drivers of our linked quarter growth. Loan balances increased $89 million during the period or 6% annualized as a result of strong originations late in the quarter as well as funding of prior-period construction commitments. Linked quarter growth was primarily in our investor Commercial Real Estate, Commercial Finance and construction portfolios. While we’ve seen some pockets of growth across our footprint, many businesses have yet to fully embrace the current economic environment and continued to utilize cash reserves rather than seeking debt financing.
Finally, on Slide 9, credit performance remained strong, with a stable allowance, both in dollars and as a percentage of total loans. Classified non-performing asset balances were relatively flat, while first quarter provision expense approximated net charge-offs, which increased to 13 basis points on an annualized basis as a percentage of average loans.
I’ll now turn it over to Jamie to discuss MainSource’s first quarter results.
Thank you, John, and good morning, everyone. Slide 11 provides an overview of MainSource’s standalone first quarter performance. All results included in the slide are adjusted for merger-related activities. Similar to the First Financial results, we are very pleased with first quarter performance, highlighted by strong earnings per share, a stable net interest margin, improved efficiency and excellent credit quality. Net income was $16.4 million or $0.63 per diluted share. Profitability metrics include a return on assets of 1.45%, a return on equity of 12.6% and a return on tangible common equity of 17.6%.
Net interest income was $37 million for the first quarter of 2018, which was a slight decrease on a linked quarter basis and primarily related to fewer days in the quarter. Net interest margin on a fully tax equivalent basis was 3.71% in the first quarter of 2018 compared to 3.78% during the fourth quarter of 2017. As a result of tax reform, the lower FTE adjustment negatively impacted the net interest margin by 10 basis points.
Non-interest income was $12.5 million in the first quarter of 2018 compared to $13.8 million in the previous quarter, due to seasonally low overdraft and debit card interchange income and the industry-wide decline in mortgage banking activity. Non-interest expense, excluding merger-related expenses, totaled $30 million in the first quarter of 2018, which declined $1.4 million from the linked quarter and resulted in an efficiency ratio of 59.3%.
From a balance sheet perspective, loan balances declined by $59 million during the first quarter of 2018. The first quarter for MainSource has historically been a slow-growth quarter, and the first quarter of 2018 reflects a similar pattern. While commercial loan production was approximately 7% higher than the same quarter a year ago, a larger number of CRE loans paid off during the quarter, and they were refinanced into the permanent market.
In addition, seasonal line paydowns and problem loan resolutions also contributed to the decline for the quarter. Credit quality remained excellent for the first quarter of 2018. Net charge-offs increased during the quarter to $3.7 million related to relationships that were substantially provided for in prior periods. As a result, non-performing loans declined by $4.3 million and represented only 47 basis points of total loans as of March 31. Classified and non-performing asset balances also declined significantly during the quarter. Similar to the First Financial portfolio, our overall credit metrics were historically low levels heading into the merger.
Now I’ll turn it over to Archie to discuss the merger and our outlook for the next year.
Thanks, Jamie. As can be seen on the combined company outlook on Slide 12, we are well positioned for continued success over the remainder of the year. In regard to the loan portfolio, we continue to target mid-single-digit growth on a percentage basis for the remainder of the year, excluding the impact of divestitures and loan markets. Additionally, we do not expect to see a significant deposit attrition other than what is related to the branch divestiture and market exits.
We expect the net interest margin to be in the range of 3.85% to 3.90%. This estimate is based on the current interest rates, includes the impact of purchase accounting adjustments and excludes the impact of tax equivalent adjustments, which is estimated to be approximately 7 basis points.
We’re providing a range as the margin could fluctuate depending upon loan prepayment activity and production mix, deposit pricing pressures and growth trends and market rate movement. Our combined balance sheet projects to be slightly asset sensitive. Our realized benefits could be muted if there’s any catch-up in deposit pricing driven by market competition.
Our near-term credit outlook is stable with no systemic credit issues. However, [indiscernible] credits can negatively impact results from time to time. On a combined basis, we expect non-interest income will be in the $29 million to $31 million range per quarter, but it will fluctuate depending upon seasonality, loan production and wealth management market values. Mortgage, in particular, has seen recent headwinds due to market conditions, both by a combination of modest rise in rates and tight housing supply, and continues to be a potential risk as we move forward.
Our estimates include non-revenue synergies, which approximately offsets lost revenue related to divestitures. Through the execution of our strategy, we expect to continue to grow fee income across all sources. We see our expense base settling in at – in the $75 million to $77 million range per quarter once all cost-saves are phased in. Second quarter expenses are expected to be approximately $80 million, excluding one-time and merger-related expenses.
We project a fully phased-in efficiency ratio of 50% to 52%. Long-term, we remain focused on efficiency while also continuing to make strategic investments to support the continued success of our business. All capital ratios are anticipated to exceed current internal targets. We continue to maintain our targeted dividend payout ratio of 35% to 40%. And on taxes, we expect an effective tax rate of approximately 19.5%.
With that, I will now turn the call back over to Claude to discuss the integration progress.
Thanks, Archie. As I mentioned earlier, we were pleased to have closed the merger as scheduled and to be able to stay on our integration planning time line. As detailed on the merger integration update on Slide 13, we continue to see the necessary progress with our integration activities and remain on target for a system and brand conversion at the end of May. Our executive management teams are now fully in place and have transitioned to the new responsibilities, while the new combined Board of Directors is also in place.
Phase 1 of our integration plan, which is all technology, organizational and staffing assessments, is now complete, and Phase 2 is well underway. Our integration action teams are actively engaged across all areas of the organization, and vendor reviews, contract negotiations and contract terminations are mostly complete. We also expect to conclude the divestiture and de-conversion of the previously disclosed five branch locations in Columbus, Indiana and Greensburg, Indiana by the middle of May.
As Archie mentioned previously, the vast majority of our cost saves are expected to be phased in over the coming quarters and be fully realized by the end of 2018. Our loan marks are estimated to be approximately 1.25% to 1.75% for credit and 2.25% to 2.75% for rate. While the core deposit intangible is projected to be approximately 1.75% to 2%.
With regards to our branch network, in addition to the five branches being divested, 21 banking centers will have been consolidated by conversion, with a potential for additional consolidations prior to year-end. As the combined First Financial Bancorp, we are excited about the scale and reach we have to successfully execute our strategy, deliver exceptional service to clients and provide solid returns to shareholders. We look forward to spending the rest of the year positioning the combined company for a continued success in the years to come.
This concludes the prepared comments for the call, and we’ll now open the call up for questions. And since there are a few of us here in the room, we – they’re making multiple individuals to answer various questions. But Keith, we’ll open it up for questions now.
We will now begin the question-and-answer session. [Operator Instructions] And the first question comes from Scott Siefers with Sandler O’Neill.
Good morning guys.
Good morning, Scott.
I guess the first question is just broadly on the breakdown [indiscernible] of the combined companies. I appreciate the margins on [indiscernible] about being modestly up that [indiscernible]. I’m trying to get a sense for order of magnitude of your [indiscernible] controlled corporate balance to discount can you hope for. So how has the [indiscernible] are you guys then [indiscernible] for the margins? How many, if any interest rate hikes [indiscernible]?
Yes. Scott, this is Jamie. It’s a good question. So if you look back historically at the two companies premerger, MainSource was slightly liability-sensitive and First Financial was slightly asset asset-sensitive. So when you put the two balance sheets together, we are positioned still as slightly asset-sensitive, so we expect to see a modest margin expansion if rates move higher two to three basis points, potentially there.
In addition, we expect to see some benefit in the second quarter as we get the full quarter effect of the March rate hike. The wildcard, I guess, being what happens on the deposit side. With deposit betas, we’ve been modeling deposit betas historically of those companies essentially in that 50% to 60% range. Obviously, it has not seen that. Through the most recent rate hikes, it’s been more in that 20% range.
So if we get some catch-up with the next couple of rate hikes, essentially, what we pick up on the asset side might subsidize that what we have to – the market pressure that we might see on the fund deposit side.
Okay.
And we assume zero interest rate hikes in our outlook, Scott. Yes.
Okay, perfect. All right thanks guys. And I just wanted to ask also something down to efficiency. When you talk about the 50% to 52% fully phased-in ratio, is that sort of a 4Q 2018 number? Or does that get pushed back in 2019? And then just if you look forward, do you see opportunities to get down ultimately below that 50% to 52% rate?
Yes, Scott. This is Jamie. So yes, that 50% to 52% range, we expect to get there by the end of this year so in 4Q of 2018. And then going from there, expecting to get down to the low end of that range as we head into 2019.
Okay. All right, perfect. Thank you guys very much.
And the next question comes from Chris McGratty with KBW.
Hey, good morning everybody.
Good morning Chris.
Maybe just a question on the balance sheet with the merger. Any thoughts to repositioning the investment portfolio, given tax law changes moving the rates, reinvestment opportunities? And also, kind of the size of the investment portfolio? I think, John, you guys have been keeping your investment book relatively flat. But is the $3 billion number about right?
Yes. Chris, this is Jamie again. So a couple of things on the repositioning side, we are doing, I would say, a modest restructuring of the investment securities portfolio. But what – I think what you’ll see is that we really won’t see a major impact going forward to the income statement of that move. We’re going to pick up some yield on the securities side, but what we are planning on doing then with that increase in yield is moving out on the liability side to make that – make the balance sheet again more asset-sensitive as we move forward here.
So I would expect that the income statement impact to be marginal but position the company to be slightly more asset-sensitive going forward. And in terms of the size of the securities portfolio, so a combined portfolio of $3 billion to $3.2 billion would remain roughly flat as we move forward.
Great. And when you think – in terming out, are suggesting putting some borrowings on, locking out longer-term borrowings or putting down CD campaigns? What are your thoughts there?
Yes. It’s mostly on the wholesale side. So moving out some borrowings from overnight to – in that 2 to 5 year range.
Okay. Great. Thank you for that. And then just maybe a couple modeling questions. You talked about capital levels. I’m interested in pro forma capital levels, make sure I got the share count right and then I need the timing of the merger charges.
Yes. So pro forma opening and what we’ll report there at the end of the second quarter from a TCE standpoint, in the low 8. Some of those will be – will get refined as we get further down the road on the valuation and purchase accounting adjustments. But expect TCE to fall out somewhere between 8 to 8.2. And then on the regulatory side, Tier 1 to be around 11%, and the total capital to be 12.5% to 13%.
Okay, great. And maybe if I could sneak one in. Claude, would you guys have been opportunistic when others in your market have been doing consolidation to the higher lenders? I’m wondering if you could speak to retention and any opportunities to – or have you seen any kind of departures that you weren’t planning for? Thanks.
Yes. Chris, I’ll briefly talk about that, then I’ll turn it to Tony Stollings, the Chief Banking Officer. He can talk about it. I think for the most part, we’ve been pleased with our retention as well as the integration of the two culture and teams. Like any time, we do see some changed transitions that we may have initiated others that individuals may have. So on balance, we still feel good about the overall team and our ability to execute. But Tony, how about do that?
Yes. Just we’ve done a lot of work pre-integration and in the last few months with the teams and worked hard on retention and strategy, education, if you will. So certainly, we had some turnover that I would call regrettable but all manageable. And we got everybody aligned strategically, and that that’s a good spot to be in.
Great. Thank you very much.
Thank you. And the next question comes from Kevin Reevey with D.A. Davidson.
Good morning. Claude or Archie, I was wondering if you could give us some color as far as how we should think about revenue enhancements, if any, in 2018. I’m assuming these numbers do not include that.
Kevin, this is Archie. They actually do include a little bit. We, I’d say, we probably got about approximately $5 million of revenue enhancements that are probably already were reflecting in here, and they really are going to offset some of the impact from revenue loss of the divestitures. So maybe it’s just we’ve got enough to do that already. We’ll continue to look for other opportunities across all of revenue lines. But service charges, some fee income, slot fee income are quite the two main areas we’ve seen some benefit so far and get enough to offset some of the revenue impact from the divestitures.
And then how should we – as far as the deposit realignment strategies, is that pretty much completed? Or is there still a little bit more work to do?
Well, yes, Kevin, this is Tony. The deposit books fit together pretty nicely. They’re very complementary. And we don’t see in our product mapping, in our integration work to be significant shifts or alterations that we need to make. We are more – the products are aligned. We’re much more focused on getting the pricing and understanding the competition in the go-forward book.
And then lastly, how should we think about the impact of Durbin on your 2019 card income interchanging?
Yes. So that’s baked in to the back half of our guidance. And in the beginning of the third quarter in 2019, and it’s about $3 million. So $12 million annualized reduction. So $3 million a quarter comes off our interchange income starting with the third quarter of 2019.
Great. Thank you.
Thank you. And the next question comes from Nathan Race with Piper Jaffray.
Hey guys. Good morning. I want to start on the provision line. Just curious kind of what would you expect for the magnitude of the increase in provision as some of the acquired loans renew over the course of the next few quarters here.
Yes. So in terms of provision going forward, I mean, right now, we are projecting provisioning spend to cover charge-offs and cover loan growth at roughly 80 to 100 basis points of loans. And then as we – as the loans – the main – the legacy MainSource loans start to renew, those obviously go into the calculation related to the internal model of the loan loss reserves. So we will see how those go, how they perform relative to the credit market.
Okay. Got it. And then, Claude or Jamie, just curious with some updated thoughts on loan pricing. I think you alluded to on the slides deck, the competitive dynamics have now become a little more acute recently. So just curious to hear if you’re seeing any term or pricing or other competitive environments based on what we saw through the back half of last year.
Yes. This is Tony. You know what? I’d say things are relatively calm at the moment. We’re not – there’s a little bit of pressure maybe because certain sectors are falling a bit out of favor, so it’s putting pressure on others. But overall, I think loan pricing is hanging in there. We haven’t seen a lot of customer demand or had a lot of conversations about repricing loans or lines of credit. So we’re in pretty good shape there.
I’d just add – this is Claude, that our quarter-over-quarter pricing spread have really been holding solidly, even the rates have gone up or spread over the curve and stayed pretty consistent quarter-to-quarter, which always is a good sign that we look at to make sure we’re not seeing any pricing pressure.
Got it. Appreciate guys for taking the questions.
Thank you. And the next question comes from Jon Arfstrom with RBC Capital.
Thanks. Good morning.
Good morning, Jon.
Same question but on deposit pricing. All right. Obviously, there’s a pretty big focus on deposit retention but talk about any emerging pricing pressures on deposits.
Jon, this is Tony. Yes, they’re emerging for sure. We see it building. But to this point, it’s been mostly in some of the seasonal categories like public funds or from companies where their loan-to-deposit ratios are pretty high. But to this point, we’ve been able to really handle some of the pricing pressure, more one-off than having to do broad-based repricing changes. But it’s definitely built.
Okay, Good. Maybe a bigger picture question on loan growth. It sounds like, from both of your comments, maybe C&I activity is maybe a little bit higher. But you still suffer from some of these Commercial Real Estate paydowns. And maybe first touch on the C&I environment and if there’s anything else do you think might slow the CRE issue.
Yes, this is Tony again. On the C&I, I’d say we’re – we keep saying this, but I think we’re really starting to see some of our efforts pay off here. Those sales cycle on the C&I side are pretty long, but we’re really starting to see some things coming due in the clear view across a number of sectors. So C&I hasn’t been what we would hope it would have been in the last few quarters when we see it picking up.
We’re continuing to think that our outlook on Commercial Finance, Commercial Real Estate as well as the – several of our specialty finance businesses, they had a good first quarter, and we think that they’ll continue that throughout the year. And we’ll be able to complement that with some C&I there that we haven’t seen in recent quarters.
Okay. Maybe last one for you, Archie. Louisville is probably the one market where the big market where there’s the potential for disruption. Talk a little bit about how it’s gone so far and the messaging that maybe some of your commercial customers in retail. Any surprises there? And is there a potential to maybe do more there with a bigger balance sheet?
Yes. Jon, this is Archie. Right, Louisville is a very good market. And you’re right. There is some disruption in the market. We’ve seen – from our first capital acquisition, the MainSource first capital acquisition last May that really getting into retail model going in that market has been pretty successful for us. Commercial made it worked through a few clients that probably didn’t fill our credit appetite or risk appetite in the middle or latter part of 2017, but the core balance is there. We’ve been able to start to see some further activity and growth.
We’ve got a pretty solid team there overall. We want to make some additional investments in some commercial bankers in the market. We’re going to be adding, as a result of the merger, some other capabilities, primarily around wealth in the market. And certainly, again, with some disruption, we think it’s a good opportunity, a good market, a good economic climate with – there’s a lot of opportunity. We do have one new – I guess, a branch we’re relocating into a much nicer market area on the southern Indiana side of Louisville. So we feel optimistic about it. Just really getting a few more bankers is really the big thing we need to do.
Okay. Thanks for the help guys. Good luck with everything.
Thanks, Jon.
Thank you. And the next question comes from Andy Stapp with Hilliard Lyons.
Good morning. Just wondering how much cost saves are remaining from the merger.
Yes. Andy, this is Jamie. So I would tell you, I mean, overall, we feel good about the progress that we’ve made on cost saves. And we are expecting to achieve the $48 million of cost savings that we announced back in the back half of the year there when we – when it was updated. So when you look at the run rate in the outlook, the $75 million to $77 million, that run rate that is the fully phased-in expenses. And it reflects the $48 million of savings, but time has passed now obviously.
It also – so it also includes some strategic investments in new branches going over $10 billion, the compliance costs related to that with CECL and DFAST. And then there is some additional incentive comp based on the better-than-expected performance. So we still have a couple of – I would say, a couple of big events coming here in the next few months related to cost savings. We have the system conversion, brand conversion over Memorial Day weekend, which will strip out a lot of costs going forward in the run rate.
And then in terms of the branch consolidations, we closed 15 branches that – in the beginning of this year and the first part of January, we have another 26 that will be closed, last consolidated with the system conversion. So really those two events drive a lot of those cost savings. So to say we’re 30% of the way there is a little bit difficult to say with those events still coming in the future. But we are – both companies in the first quarter, we are seeking those cost savings – some of those cost savings in our numbers already as we leave positions open and as we are winding down some of the systems and whatnot.
Okay. And what do you expect merger-related expenses to be in Q2?
In Q2, so listen – so to give you just a complete update on the merger-related costs. So we now announced cost of a total of $63 million. We’ve incurred about half of those so far. With the remaining half – the majority – the vast majority of those will hit in the second quarter and some will trail out potentially into the third quarter. And then the one thing to update on that, I guess that will – where we will reduce that $63 million is with the branch divestiture and the gain that we take in selling those branches in Columbus, Indiana and Greensburg.
Okay, all right. Thank you.
Yes.
Thank you. [Operator Instructions] we have a follow-up question from Chris McGratty with KBW.
Yes. Thanks for the follow-up. I may have missed a bit. Do you – can you provide the pro forma share count, given the movement in the stock?
Oh, yes. I left that off when you asked it. So the pro forma share count is 97.7 million.
Got it, perfect. Thank you.
Thank you, Chris.
Thank you. And as there are no more questions at the present time, I would like to return the conference back over to Claude Davis for any closing comments.
Thanks, Keith. And once again, thank you all for joining the call today and your interest in First Financial. And we look forward to continuing to report a good financial results as we go forward. Thank you all very much.
Thank you. The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.