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First Financial Bancorp
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Good morning, and welcome to the First Financial Bancorp. Second 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 would now like to turn the conference over to Scott Crawley, Corporate Controller. Please go ahead.
Thank you, Drew. 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 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; and Tony Stollings, Chief Banking Officer.
Both the press release we issued yesterday and the accompanying slide presentation are available on our Web site 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 second 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 June 30, 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 all for joining us on today’s call. Yesterday afternoon we announced our financial results for the second quarter. We are pleased to be here with you marking to close our first quarter for the combined First Financial Bancorp. Today I’ll provide an update on our successful integration and then turn the call over to Archie and Jamie for comments on our second quarter results. Finally, we will wrap up with Archie discussing the combined bank outlook.
On May 29, we opened our door with a fully integrated bank having successfully completed our system and brand conversions. Building upon prior efforts to integrate management sales and support teams, we worked diligently during the quarter to integrate systems and business processes to position us for continued growth. We also successfully completed the divestiture and de-conversion of the previously disclosed five branch locations in Columbus, Indiana and Greensburg, Indiana.
We made substantial progress on our cost save activities during the quarter as we completed the consolidation of 41 banking centers in addition to the five that were divested. Additionally, we are approaching our targeted staffing levels. Further cost saves will continue to phase in over the coming quarters and are expected to be fully realized by the end of 2018.
These milestones were important steps and enable us to successfully execute our strategy, deliver exceptional service to clients and provide solid returns to shareholders. Our work over the preceding quarters will better position us to be a high-performing community bank that successfully meets the lending economic development and financial needs of the communities that we serve.
With that, I’ll now turn the call over to Archie to provide further thoughts before Jamie discusses the second quarter financial results.
Thank you, Claude. As shown on Slide 3 of our earnings presentation, our second quarter results were exceptionally strong and marked 111th consecutive quarter of profitability as benefits from the merger are fully realized.
Our second quarter results reflect top quartile performance enabling us to achieve earnings of $0.57 per share, a 1.6% return on average assets and a nearly 21% return on average tangible common equity and a sub 52% efficiency ratio when adjusted to remove merger-related items. Our strong earnings and profitability demonstrate the emerging potential for the combined company.
The second quarter was also highlighted by margin expansion, stable credit quality and strong capital levels. Loan growth fell short of our expectations as a result of lower loan originations and higher payoff activity. However, we anticipate our loan growth trends will gradually improve in the second half of the year. We believe we are well positioned to capitalize on the earnings momentum generated during the second quarter to close the year on a strong note.
At this point, I’ll now turn the call over to Jamie to discuss our second quarter results in more detail before I provide an update on the combined bank outlook.
Thank you, Archie, and good morning, everyone. Slide 3 provides an overview of our second quarter performance which included net income of $36.4 million or $0.37 per diluted common share.
As Claude and Archie mentioned, we are extremely pleased with our second quarter results and the first quarter as a combined company. The quarter was highlighted by strong earnings, margin expansion and improved efficiency in addition to stable credit quality.
On Slide 4, we’ve provided a reconciliation of our GAAP earnings to adjusted earnings highlighting items that we believe are significant to understanding our quarterly performance. As you might expect with the closing of the merger in the beginning of the second quarter and the system conversion mid-quarter, the period contained a bit of noise.
Excluding merger-related items, net income was $55.6 million or $0.57 per share for the second quarter which equates to a return on assets of 1.6% and return on tangible common equity of 20.9% as shown on Slide 5. Further, our adjusted efficiency ratio of 51.7% for the quarter reflects cost synergies realized from the merger with MainSource and diligent expense management.
Turning to Slide 6. Net interest margin for the second quarter increased 31 basis points from the linked quarter to 4.15% on a tax equivalent basis. The increase in our net interest margin was primarily driven by the impact from purchase accounting in addition to higher loan fees and earning asset yields which were driven by increased interest rates and a restructuring of the investment portfolio.
These factors more than offset higher funding costs resulting from rising rates and shifts in funding mix as well as the initial margin dilution from acquiring the MainSource balance sheet.
As shown on Slide 7, loan and deposit mix were relatively unchanged post merger. Purchasing accounting resulted in higher loan yields while overall deposit costs declined on a combined basis due to the lower MainSource cost of deposits.
Slide 8 depicts our end of period loan and average deposit progression from the first quarter. As shown on the left-hand part of the slide when adjusted for merger and branch divestiture activity, loan balances declined modestly compared to the first quarter as originations were lower than expected and prepayments accelerated.
On the deposit side, again excluding merger and branch divestiture activity, average balances increased due to higher brokered CD balances. Archie will discuss our outlook for loan growth later.
Slide 9 details our non-interest income and expenses. Overall, both non-interest income and expense levels approximated our targeted amounts. Second quarter non-interest income was largely in line with expectations although changes in mix and expected over the remainder of the year as certain income streams are subject to seasonal variance.
Total non-interest expense of $102.8 million included $24 million related to the merger. We are committed to maximizing synergies between the two legacy companies and we’ll continue to identify opportunities for future efficiency.
On Slide 10, overall asset quality remains excellent. Asset merger activity, classified and nonperforming asset balances increased slightly but remained low compared to historical norms and were flat or declined as a percent of assets.
Net charge-offs increased to 18 basis points as a percentage of loans primarily driven by a single credit in the ag portfolio. Provision expense approximated net charge-offs resulting in a relatively stable loan loss reserve balance.
The allowance as a percentage of loans predictably declined due to purchase accounting requirements. However, there was approximately $33 million of credit mark associated with wired loans at the end of the quarter.
Finally, with respect to capital ratios as shown on Slide 11, I’ll note that following the merger all ratios remained in excess of stated targets with further expansion expected on the quarter.
I’ll now turn it back over to Archie for some comments on our outlook for the rest of the year.
Thank you, Jamie. As can be seen on Slide 12 regarding our outlook, we’re well positioned for continued success over the remainder of the year. As I said earlier in the call, we fell short of expectations with regard to loan growth.
Originations in the commercial banking group were lower than we anticipated for the quarter as we work to build the team to the levels we believe we need to drive expected growth.
We also experienced higher than normal payoff levels primarily related to our construction lending portfolio. We anticipate that the higher rate of payoffs will slow as we approach the end of the year.
We expect the third quarter to have low-single digit growth on an annualized basis with gradual improvement to more normalized levels as we approach the end of 2018. Additionally, we do not expect to see material deposit attrition.
We expect the net interest margin to be in the range of 3.95% to 4.05%. This estimate is based upon current interest rates and includes both the impact of purchase accounting adjustments and the impact of tax equivalent adjustments.
We’re providing a range as the margin could fluctuate depending upon the loan production mix and prepayment activity, deposit pricing pressures and growth trends and market rate movement.
Our combined balance sheet projects that these slightly asset sensitive 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, individual credits can negatively impact results from time-to-time.
On a combined basis, we expect non-interest income will be in the $28 million to $30 million per quarter but will fluctuate depending upon seasonality, loan production and wealth management market values.
Mortgage in particular has seen recent industry headwinds due to market conditions caused by a combination of a 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 loss revenue related to divestitures. Through execution of our strategy we expect to continue to grow fee income across all sources.
We see our third quarter expense base in the $76 million to $78 million range, excluding one-time and merger-related expenses before finally settling in, in the $75 million to $77 million range once all cost saves are phased in.
We project a fully phased 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 target dividend payout ratio of 35% to 40%. And on taxes, we expect the effective tax rate to approximately 19.5%.
With the majority of merger-related activity behind us, our focus is on maximizing remaining synergies and implementing strategic initiatives that produce top quartile returns while continuing to deliver the value and service that our clients and communities and shareholders have come to expect.
We look forward to spending the remainder of the year executing our strategic objectives with a disciplined approach and focusing on the financial needs of our business, consumer and wealth management clients.
This concludes the prepared comments for the call. Drew will now open up the call for questions.
We will now begin the question-and-answer session. [Operator Instructions]. The first question comes from Scott Siefers of Sandler O’Neill & Partners. Please go ahead.
Thank you. Good morning, guys.
Hi, Scott.
First question I wanted to ask was just on the margin guidance. Archie, I think when you were – in your prepared comments you suggested that the 3.95 to 4.05 GAAP is – that’s also in FTE margins. Is that correct?
Yes, so I’ll have Jamie expand here on the margin if you like?
Yes, that’s correct, Scott. That’s on a tax equivalent basis.
Okay. So then excluding the 23 basis points of purchase accounting benefits I guess it would suggest the core in a range of like 3.72 to 3.82. I guess I’m just curious since you start with the 3.86 core margin in the 2Q, what would cause – I think it’s about 9 basis points of erosion in the core margin in the 3Q given the assets onto the balance sheet.
Scott, this is Jamie. A couple of things affecting that that we are forecasting there in the third quarter compared to the second quarter. So two of the big things. One is we’re forecasting lower loan fees and that’s affecting the margin by 3 basis points. So we had the second quarter and we just don’t forecast those. They could come in. They’re just lumpy. So in the second quarter we had some higher loan fees, some prepayment fees in the commercial finance line of business and we’re just not projecting those going forward. So that’s 3 basis points. The day count actually has an effect there in the third quarter compared to the second quarter. That’s 2 to 3 basis points. And then we are projecting just on the core margin still a shift in the funding mix that would bring down the margins slightly as well.
Okay, all right. And then would you guess it sort of stabilizes after that or would there be reasonably – that there would be further erosion as we go forward?
No, we would think then at that point that the margin would stabilize.
Okay, perfect. Then if I can switch gears a bit. So by the fourth quarter we’ve got the anticipated expense range of 75 million to 77 million and I think Archie you had said that the cost savings should be done by the end of the year. I’m just curious as you look at the dollars of expenses in the fourth quarter and then the fully phased in 50% to 52% efficiency ratio, is there room for improvement on both of those as we get into early next year or will fourth quarter of this year be the trough for dollars of expenses in the efficiency ratio?
Scott, this is Archie. I think we’re saying we’ll have the expenses related to the merger will be through all of the effects of that by the end of the year. So that trough happens sometime end of the fourth quarter, early first quarter is kind of when we’ll see that base line kind of on a run rate basis occurring.
Okay. So maybe some additional leverage as we look into the first quarter of next year to I guess ideally have the low for expenses be early next year as opposed to fourth quarter this year?
Probably early part of first quarter, yes.
Okay. All right, perfect. Thank you very much.
The next question comes from Kevin Reevey of D.A. Davidson. Please go ahead.
Good morning.
Good morning.
My question relates to your ability to continue to reduce your deposit cost with the addition of MainSource now in the fold. Do you see further opportunities as you head into the third quarter and fourth quarter?
Kevin, this is Jamie. Just to be clear, when you look at our deposit cost on the slide where we’re showing our deposit cost from quarter-to-quarter, they’re going down from 60 basis points to 57 basis points. That is showing FFBC standalone in the first quarter and then obviously the combined company in the second quarter. So our deposit cost when you look at it on a combined basis in the first quarter was around 51 basis points on a combined basis. So our deposit cost went up 6 basis points from quarter-to-quarter when you look at it when blending in the MainSource balance sheet. So we still expect that deposit cost will increase from quarter-to-quarter in a similar fashion depending on market pressures and whatnot.
And then related to customer and talent retention post merger, can you give us some color as to what you’ve seen there? I know it’s only been a few weeks since the transactions closed.
Kevin, this is Tony. I’d say that it’s been about what we would expect for the trailing period of the transaction. We have been very intently focused on client retention. The number one driver of client retention is retaining our relationship managers. So I will put both of those as very, very high priorities. So we’ve had some success. We’ve had some regrettable turnover I’d have to admit, but we feel good about where we are and we continue to build the teams as we work with a larger company and move up market.
Now that you passed the $10 billion asset threshold, how should we think about the impact of Durbin in 2019?
This is Jamie again. So the impact of Durbin will hit us starting in the beginning of the third quarter of '19. And our estimate of the impact is that interchange income will be reduced by $3 million a quarter.
Great. Thank you very much.
You’re welcome.
The next question comes from Jon Arfstrom of RBC Capital Markets. Please go ahead.
Thanks. Good morning.
Hi, Jon.
Hi. A question on Slide 8. The decline in loans, good to kind of show us the stack in terms of what happened to loan balances this quarter. But you talked a little bit about some prepayments and some lower origination activity. Is this kind of merger-related do you think? Is it an aberration to see that kind of number I guess is the first part of the question?
Yes, Jon, this is Archie. I don’t think it’s unusual or an aberration. There are two real pieces to this. On the loan origination side as you think about the company or the size of the company we’ve created, there’s a lot more opportunity in the Middle Market space and we just need to build in our staff levels for that kind of talent. And so we’ve been doing methodically some of our markets [indiscernible], a fewer markets we still have to get some more Middle Market bankers. And I think as we do that it will allow us to drive originations higher. On the payoff side, it’s really for us as I alluded to it’s in the construction lending portfolio and we can look ahead here over the next few quarters and see what’s happening and it really looks like it’s peaking out through the third quarter. And then as we get into the back half of the fourth quarter, it starts to level back off. So we think we’re just in a little bit of a high level on some construction projects and then it will start to get back to a normal level.
Okay. Generally big picture, you feel good about your markets, good about the pipelines. It’s just you’ve got a little bit of work to do as you come together. Is that fair?
That’s correct. And again it’s just building out Middle Market lending teams fully for the size we are and just getting more of that talent on board.
Okay. Jamie, one for you just provision thinking. Anything in the provision this quarter that was elevated? And I think you said the mark was 34 million, so you’re just a little under 1%. Is that the preference to keep the reserve at that level?
Yes, so let me touch on the mark first. The mark at the end of June had – the credit mark had a balance of $33 million related to the MainSource portfolio. And so that’s a little higher than what the loan loss reserve balance was. That was the closing MainSource loan loss reserve balance. So we have that sitting out there. We did have during the quarter – when you look at the charge-offs during the quarter, so basically if you say charge-offs and loan loss provision expense were virtually the same, 4 million of net charge-offs and 3.7 million of provision expense. The 4 million with loan balances essentially flat. In the $4 million of net charge-offs we had one single credit that contributed to about 75% of the charge-offs, about $3 million of the charge-offs. When I think about provisioning going forward, it’s essentially approximating covering charge-offs and between 80 and 100 basis points of loan growth.
Okay, good. And then just one more on the balance sheet. You talked about the shift in mix to higher cost funding. Help us understand that a little bit more. Is that just deposit competition or is it some other type of change in your thinking on funding?
Well, it would be two things. It would be what you just said on deposit competition but then it would just also be for us on a short-term basis with the attrition that we did see from a core side. Again, this is a short-term issue with us with the disruption from the merger, just some shift in the funding mix to more higher cost funding to CDs and whatnot.
Okay.
But the attrition overall was minimal but there was – we’re always going to have some in these and we’ve build that into the projections that we had.
Okay, that helps. Good luck with everything. It looks good so far.
Thanks, Jon.
Thanks.
The next question comes from Nathan Race of Piper Jaffray. Please go ahead.
Hi, guys. Good morning.
Hi, Nathan.
A question on loan pricing. Obviously we’ve seen the short end come up higher, so just curious if you’ve seen any erosion in spreads more recently or if spreads are holding really well thus far?
Yes, Nathan, this is Tony. I’d say that they’re certainly under pressure but we’ve been able to hold the line for the most part. We might exercise a little more flexibility on current clients in making sure that we retain relationships. But overall, I don’t think we’ve seen as much pressure on the pricing side as we have the structure side.
Understood. And just of changing gears a little bit and thinking about expenses in 2019. I know we’re kind of some ways out but just curious if you guys have any expectations in kind of underlying expense growth as we get into 2019?
This is Jamie. When we look at – if you’re building off of the base from the fourth quarter, we’re really just talking about what I would consider to be normal expense growth in that 2% to 3% range.
Perfect. I appreciate the color, guys.
Thanks.
Thanks, Nathan.
The next question comes from Chris McGratty of KBW. Please go ahead.
Hi. Good morning. Thanks for the questions. Jamie, can you remind us what the pro forma deposit base, the net work deposit based on the balance sheet, the legacy FFBC that were kind of more sensitive to the fed fund and how you work that down to the fund?
I’m sorry. Can you repeat the question?
Sure. The net work deposits or the deposits that are more sensitive, the higher beta deposits, I know in the last several quarters you’ve been working balances down. Can you just remind me where those stand kind of pro forma with the – I guess what I’m getting at is what’s left of the balance sheet restructuring on liabilities and also the securities book? Thanks.
Chris, this is Claude. If you remember last third quarter we made a pricing change on – I think you’re probably talking about the Middle Market deposits that were more fed fund rate sensitive. We actually changed that product set early in the last third quarter and those are now managed rate deposit accounts. So those are ones that we’re very happy with from a core. And actually what we did and we actually disclosed this price and we moved those to 80 basis points. So if you think about how rates have moved up, those are not that far off market today. So we’re actually happy with where we stand with those and there’s no needed additional change from what we did last third quarter.
Okay. That’s where I was going. Thank you for that. And then if I could ask a question on credit. The commentary and the charge-off in the book, can you just remind us the size of the ag portfolio, kind of the commentary you’re having with your borrowers and kind of the outlook for credit in the ag book? Thanks.
Yes, Chris, this is Archie. It’s about $360 million book for the company today. It is under stress. We do some stress testing on it. I think there’s probably – I’ll look at Jamie here and try to recall it. Was that $10 million sitting in our nonperforming category?
Yes, 10 million to 15 million.
Yes, and just a little bit more than that in our classified bucket. So that’s what we’re seeing. It’s relative to the portfolio. It’s a handful of clients. The good news about our ag clients is while they may be under a little bit of stress from a liquidity perspective, they’ve got plenty of assets. And so we’ve got a lot of opportunities to work with them as we continue to work through kind of a lower commodity price cycle.
Okay, great. And if I can sneak one more in, Jamie, on pricing of the loan book. Can you remind us with the pro forma company the fixed variable mix of the loan book and also the sensitivity to LIBOR that’s getting a lot of attention today?
Yes. So on the loan book from a fixed – we have about 60% of the loan book that would be variable when re-priced virtually within 30 days. And then of that from a LIBOR perspective, it’s about 4.5 billion to 5 billion that is – I don’t have that right in front of me, Chris, but 4.5 billion to 5 billion that is tied to LIBOR.
Got it. Great. Thanks, guys.
[Operator Instructions]. We have follow up from Scott Siefers of Sandler O’Neill & Partners. Please go ahead.
Hi, guys. Jamie, I was hoping you could just sort of walk through the scheduled accretion on the purchasing accounting benefits. I know we’ve got the 23 basis points presumably on average for the remainder of the year. As we look into '19, any sense for a sort of a rate of decline in there or how we would think about that factor?
Yes. So it essentially goes down about 1 basis point every quarter. So we have 23. And again this is – make sure we’re saying the same thing. This is scheduled accretion based on the prepayment models that we have in the valuation. So it basically goes down 1 basis point every quarter, so 22 in the fourth quarter and then proceed to still go down 1 basis point through all of '19.
Okay, perfect. That’s helpful. Thank you.
Scott, it can vary based on prepayment activity.
Yes, of course, yes definitely but that’s sort of the steady state we would anticipate. Okay, perfect. Thank you.
That’s right.
And then I just want to make sure I’m crystal clear on the margin guide just because in the release you referred to the 2Q GAAP margin as 4.10 but the FTE margin is 4.15 and then the guidance – so the 3.95 to 4.05 where you say GAAP basis that actually, however, is indeed an FTE so the 3.95 to 4.05 compares to the 4.10 in the 3Q. Is that correct?
Yes, that’s on a FTE basis.
Okay, all right. So basically the guide is 3.95 to 4.05 from the 4.15 basis in the 2Q.
Correct.
Okay, all right, got it. Thank you very much.
This concludes our question-and-answer session. I would like to turn the conference back over to Claude Davis, Executive Chairman, for any closing remarks.
Thanks, Drew, and thanks everybody for joining our call today.
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.