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First Financial Bancorp
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Good morning and welcome to the First Financial Bancorp Third Quarter 2019 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 like to turn the conference over to your host today Mr. 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 third quarter and year-to-date 2019 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 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 third quarter 2019 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 September 30th, 2019, 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 and thank you for joining us on today's call. Yesterday afternoon, we announced our financial results for the third quarter.
Before I turn the call over to Jamie to discuss those results in greater detail, I'd like to make a few comments regarding our quarterly performance, successful integration of Bannockburn Global Forex and other capital deployment activities.
Our third quarter results were strong reflecting continued top quartile performance and marking our 116th quarter of profitability, consecutive quarter profitability. Our performance demonstrates strength in our businesses, despite a more challenging interest rate backdrop, and was highlighted by consistent earnings, solid loan growth and strong fee income.
For the quarter, our adjusted performance metrics included earnings per share of $0.56 or 1.54% return on average assets, a 17.6% return on average tangible common equity, and a 52% efficiency ratio. Core banking trends continue to be positive with loan demand remaining strong across many of our units resulting in record origination, enabling us to grow loan balances by approximately 4% on an annualized basis. Deposits were mixed with growth and our non-interest bearing balances tempered by lower money market balances, and seasonal declines in public fund balances. Our core net interest margin remained strong and on the high end of the range previously provided, supported by disciplines deposit cost management, enabling us to mitigate some of the impacts from declining rates.
Overall, credit trends are very good and improved during the quarter as both non-performing and classified asset balances declined during the period. However, we were disappointed in elevated net charge offs, which were driven by three franchise relationships discussed in prior periods. I'll provide more comments regarding the franchise portfolio a little later in our discussion.
Our fee income performance was a highlight this quarter with growth of over 15% year-over-year, driven by continued record client derivative fees and mortgage income and the addition of foreign exchange income from our newly acquired Bannockburn unit. As anticipated, the third quarter saw 49% decline in bank card income from the linked quarter, due to the impact of Durbin. Our 52% efficiency ratio continues to be a bright spot, although we saw elevated expenses during the quarter even after adjusting for severance and merger related items, largely driven by performance based incentives, continued strategic investments and some transitory expenses. We were also pleased to complete the integration of Bannockburn during the quarter which will allow us to broaden the product offering to our middle market clients, while also enabling us to provide banking services to their extensive customer base. The addition of this experience team and its capital market offerings creates tremendous opportunities for our banks, clients and shareholders.
During the quarter, we made progress in our share repurchase program by buying 1.1 million shares. We're able to enhance shareholder value while sustaining financial strength and capital flexibility. While the acquisition of Bannockburn in the share repurchases mostly impacted our capital ratios, our continued strong capital levels provide opportunities for additional capital deployment opportunities in the future.
With that, I'll now turn the call over to Jamie to discuss further details of our third quarter results. After Jamie's discussion, I'll wrap up with some comments on our franchise portfolio, forward looking commentary and closing remarks. Jamie?
Thank you, Archie, and good morning, everyone. Slides 3 and 4 will provide a summary of our third quarter 2019 performance. As Archie mentioned, third quarter performance was solid as loan growth, net interest margin, fee income and efficiency all met or surpassed our expectations. Capital ratios remained healthy, despite declining slightly as a result of closing the Bannockburn acquisition and share repurchase activity during the quarter. Although the interest rate environment continues to be challenging, our overall profitability remained strong in relation to our peer group.
Slide 5 reconciles our GAAP earnings to adjusted earnings, highlighting items that we believe are important to understanding our quarterly performance. Adjusted net income was $55.5 million, or $0.56 per share for the quarter, which excludes $5.2 million of severance and merger related cost, and $711,000 of cost related to branch consolidations.
As shown on Slide 6, these adjusted earnings equates to return on average assets of 1.54% and return on average tangible common equity of 17.6%. Further, our 52% adjusted efficiency ratio reflects our continued ability to appropriately manage expenses, while making targeted investments in growing the business.
Turning to Slide 7. Net interest margin on a fully tax equivalent basis declined 8 basis points in the third quarter to 3.96%. The margin was negatively impacted by lower interest rates resulting in lower asset yields. Basic net interest margin declined 9 basis points compared to the linked quarter as lower asset yields combined with additional days in the quarter more than offset a favorable shift in funding cost and mix. As we've mentioned in previous quarters, we anticipate further margin pressure given the potential for additional fed rate cuts, which will negatively impact asset yields as our loan portfolio is 59% variable rate.
As shown on Slide 8, the yield on loans declined 15 basis points and the investment yield dropped 8 basis points. We partially offset these declines by proactively managing our deposit pricing, which helped lower our cost of deposits by 2 basis points.
Slide 9 depicts our current loan mix and balance shifts compared to the linked quarter. End of period loan balances increased $83 million as ICRE and mortgage loan growth outpaced a slight decline in C&I and an intentional reduction in franchise balances. We remain optimistic regarding future loan growth potential and expect the fourth quarter to approximate the third quarter results.
Slide 10 shows the mix of our deposit base, as well as a progression of average deposits from the linked quarter. Average deposit balances declined $78 million as public fund and money market declined, outpaced increases in non-interest bearing accounts and brokerage CDs. Overall deposit cost stabilized and began to slightly decline in the back half of the quarter with a reduction in interest rates. We intend to actively manage these costs in future periods to help alleviate pressure on the net interest margin.
Slide 11 highlights our non-interest income and expense for the quarter. Fee income was bolstered by the Bannockburn acquisition, as well as continued momentum in client derivatives, deposit service charges and mortgage banking. These fees helped offset the impact from Durbin, which drove a $3.2 million or 49% decline in bank card income during the period.
Non-interest expense for the quarter is depicted on Slide 12. Higher salaries and benefits were driven by incentives tied to the overall Company performance outpacing our peer group, as well as a strong client derivative and mortgage banking income. The quarter included $1.4 million of Bannockburn operating cost. In addition, we had approximately $1 million of transitory cost, such as recruiting fees, fraud and OREO [ph] losses that we don't expect to occur in future periods. We also recognized an FDIC assessment credit during the quarter, which helped offset the increases previously mentioned.
Slide 13 depicts our asset quality trends for the last five quarters. Provision expense declined during the period, although was slightly higher than expected. Third quarter net charge offs were $10.2 million or 45 basis points of total loans, which included $6.3 million related to three franchise relationships discussed in previous quarters. Classified assets, which we believe to be the leading indicator of credit losses, declined as a percentage of total assets from 1.02% to 0.92%, which is the lowest level in over a year. This classified asset level combined with the resolution of problem credits drove the decline in the loan loss reserve balance.
Finally, as shown on Slides 14 and 15, capital ratios remained strong and are in excess of our stated targets. As Archie mentioned, we were active in repurchasing 1.1 million shares during the quarter, which reflects our intention to maximize shareholder value, while sustaining financial strength and capital flexibility. Our tangible book value and capital ratios were modestly impacted by the acquisition of Bannockburn and the share repurchase activity. Tangible book value per share declined 3.6% during the third quarter to $12.33, and our tangible common equity ratio declined 17 basis points, or 1.8% to 9.17%.
I'll now turn it back over to Archie for an update on the franchise portfolio, thoughts on our fourth quarter outlook and closing comments.
Thank you, Jamie. On Slide 16, we provide additional information regarding our franchise portfolio. As stated earlier, we incur additional losses in this portfolio during the quarter related to three relationships. Of the 6.3 million in charge offs, 3.2 is related to the resolution of the large relationship we disclosed in the first quarter, remaining 3.1 million relates to the continued work out of two relationships discussed in prior periods. Slide 16 reflects that of the current $474 [ph] million portfolio, $29.5 million is rated special mentioned or substandard nonaccrual. The three relationships mentioned above represent all of the substandard nonaccrual balances.
A few other points to make about the status of the current portfolio. The overall portfolio is performing well, 94% is rated pass. We monitor the portfolio on an ongoing basis and proactively manage relationships. Portfolio is granular. The top 10 relationships comprise 29% of the portfolio, makeup all of the relationships over $10 million, 7 of which have real estate as additional collateral in addition to all business assets and a personal guarantee of the owners.
As I mentioned in the first quarter, we've been proactively managing this portfolio to improve its overall risk profile since late 2016. Since year end 2018, the portfolio has declined by 15% as we've exited relationships that we determined did not fit our risk profile or that have had material deterioration and performance. We estimate the portfolio will decline another 10% to 15%, due to the intentional slowing of origination activity, and the workout of special mentioned and substandard loans.
Before we end our prepared remarks, I want to comment on our forward outlook as shown on Slide 17. We remain optimistic in our ability to maintain loan growth given the continued strength in our loan pipelines. We expect loan balances to increase in the low single digits on an annualized basis for the fourth quarter. Long term, we continue to target mid to high single digit growth given the investments we've made in talent, our core operating market center conference of product offerings. Regarding the net interest margin, projections will be largely dependent on the path that the fed takes moving forward. Assuming no further cuts, our outlook is at 3.65% to 3.70% margin excluding purchase accounting. As always, the net interest margin can fluctuate depending on a variety of factors and we actively work to mitigate downward rate pressures on the asset side through discipline deposit pricing management.
As stated earlier, credit quality is stable with a normalized provision covering charge offs and accounting for loan growth. Our individual loans can have a transitory impact from time to time. We expect fee income to increase to the range of $34 million to $36 million over the next quarter, including the full quarter impact of Bannockburn, which represents approximately $6 million of income.
With respect to expenses, we continuously focus on efficiency, even while making strategic investments to support the long term success of our business. We expect expenses in the range of $84 million to $86 million including the $5 million full quarter impact of Bannockburn.
With regard to taxes, our outlook for the fourth quarter is 17.5% and includes a 2% reduction for the expected recognition of tax credits. With Bannockburn close and integrated our strong capital levels, earnings power and consistency provide flexibility for continued capital deployment strategies. Replaced with the strengthen performance of our company, we believe this strength positions us well for managing in the current environment and pursuing growth opportunities that meet our objectives.
At this point, this concludes the prepared remarks. We will now open up the call for questions. Keith?
Yes. Thank you. We will now begin the question-and-answer session. [Operator Instructions] And this one is first question comes from Scott Siefers with Sandler O'Neill.
Good morning, guys. Thank you.
Hey Scott.
Hey Scott.
Hey. Just first question on the franchise finance portfolio. Archie, just curious about your thoughts on any additional loss content within the portfolio and why we didn't see a need to reserve for any of those? And I guess, first the question is back in the second quarter, I think we've discussed a couple of the credits, but it didn't look like there was going to be any charge off related to them at that time, if I recall correctly. So just curious how sort of the thinking projected between then and now?
Yes, Scott, on the first part of the question, we did in the prior quarter, have a higher increase resolve related to the one that was resolved this quarter. And then there was a charge against that, was not a full charge, but the charge against that reserve this quarter. So that's the $3.2 million piece, I believe. With respect to the other two, there's been some further deterioration in the credits. I think the one came up last quarter in a question because I believe it was, had moved to accruing TDR status. And at the time when we looked at the overall value, enterprise value of the stores involved, we believed we had adequately valued. What's ensued since with respect to that one is that, that franchisee had two store concepts. And in fact, what's occurred is one of those concepts has now been sold. And as part of that sale, there were some loss that we recorded. So that's that one. With respect to the third one, there has been a longer term problem probably for two and a half years or more. And we had sale – we thought we had a sale worked out with that credit, and for multiple quarters have been an ongoing due diligence and that sale fell apart. And as we started to evaluate the current performance of the stores, we believed it was appropriate to, you know, take a partial charge down. That one now is again in negotiation with another party for sale.
Okay, perfect. Thank you. But I guess ultimately it seems safe to while maybe this handful of credits has maybe taken longer and cost a bit more than we thought, it seems like it is indeed isolated to these couple, it's not the broader franchise portfolio. Fair enough assessment?
Yeah, I think if you look at the industry, you know, there's some challenges, you know, labor costs and some other things overall, but when we look at our operators, especially with some of the winnowing we've done in the portfolio over the last year plus, Scott, we feel like you know, the operators we have are high quality operators and performing, if you look at the overall portfolio performing well.
Yeah. Okay, perfect. And then separately, Jamie question on the margin, just so understanding perfectly, we've got, we're looking for basic margin of 365 to 370, or at least margin before purchase kind of investments 365 to 370. But if we did get another rake up by the fed here at some point in the very near future, that would imply most of the quarters' worth of impact for an additional 6 to 8 basis points of reduction. So if we do get a cut, presumably it would come in below this 365 to 370, right?
That's correct. Yeah. So the 365 to 370 assumes no further rate cuts. And then so we were kind of trying to set it up for you and your colleagues to be able to then assume, because we know you guys assume when you know cuts a different time, so basically 365 to 370 with no further cuts, and then a 6 to 8 points kind of 6 to 8 points drop with each 25 basis point cut.
Yeah. Okay.
I'm looking delay in the timing of that however you see fit.
Perfect. Alright, thanks a lot, guys, appreciate it.
Thanks Scott.
Thank you. And the last question comes from Christopher McGratty with KBW.
Hey, good morning.
Hey Chris.
Hey Chris.
Jamie, another margin question for you. You shrunk the investment portfolio by about 300 million on a period basis. I'm interested in kind of thoughts on the balances of that portfolio going forward. And also kind of as you kind of take a step back, if the margin is going to be under pressure like most banks, you know, are earning assets, how do we feel about fourth quarter earning assets and net interesting income? I think that's what people are really focusing on is the revenue. Can you just maybe add some color there? Thanks.
Yeah. So just with, you know, the shape of the yield curve we did throughout the third quarter reduce the investment portfolio by 300 million. I think on average, it was down about 120 million for the third quarter, but we'll get the full effect of that in the fourth quarter. So, what we did, we essentially sold securities that had an average yield of about call it around 250 and then reduced short term borrowing. So, the spread on that was relatively low, was very low. And so, we just essentially delivered a little bit and reduced the portfolio. So, our intent for the short term is that we will keep the portfolio basically right at that $3 billion. So at the level that we ended the third quarter will keep the portfolio at that level. And then the earning asset growth would be the growth that we see in the loan portfolio.
Okay, great. And kind of thinking out, you know, if we stay in this environment, you do have some borrowings on the balance, I mean, it just kind of a strategy that might be considered more into 2020 just kind of shrinking and building a little bit capital and then you know recycling and then buyback, is that kind of what you're thinking?
Yeah. That is exactly what we were taking that. You know, we are, you know, based on where our stock prices, we would be, you know, in the market buying shares like we did in the third quarter and, you know, reducing the balance sheet and increasing the capital ratios in order to essentially subsidize the share repurchase program. We would continue that if given the yield curves thing is same.
Understood. Okay, great. And then maybe if I could stick with it on the deal. I think when you announced that you said it was going to be around a $30 million annual revenue plus about 15% annual growth. I think the guide says 6 million for the quarter for Q4. Is that – is there seasonality in the business or revenues a little bit less than what you might have thought initially?
Yeah, Chris, this is Archie. There is some seasonality. You know, you take during an integration, there's just a little bit of noise and attention on working through the deal. But as we look at Q4, I think we're seeing approximately 6 million. And then if you look at next year, we would still think that we're going to see, you know, probably a more like an 8 million a quarter, and it won't be linear, but it'll be you know, kind of an average of that, you know, throughout the year. So you're talking in the low 30s in terms of revenue next year.
Okay, great. And just the final one if I could. The tax rate that you've pointed out Jamie in the fourth quarter, that's just a one quarter event, right, it goes back to what 19.5 next year?
That's correct, yeah. We're looking at getting some tax credits in the fourth quarter assuming a new market tax credit project goes into effect.
Okay. And same with the FDIC assessment, right, that'll go back, assuming you don't get another refund?
That will bounce back. Now, the fourth quarter will still be a little bit lower, because we have some credits still to eat up, but it will go back to kind of normal levels. It'll go back, I would say it's about half normal levels in the fourth quarter, and then first quarter back to 100%.
Great, thanks.
Yep.
Thank you. And the next question comes from Terry McEvoy with Stephens.
Good morning, guys.
Good morning, Terry.
Thanks for the details on page 16. I guess the annual review that you do on the portfolio, when's the last time you've kind of reviewed the portfolio specifically those top 10 really relationships as well as that largest relationship? Was that done in the quarter, earlier in the year or last year?
Hey Terry, this is – I'm going to have Bill Harrod, our Chief Credit Officer, jump in here and talk about, you know, the process we use for ongoing reviews.
Absolutely. We do a quarterly review of all the franchise transactions, including covenant reviews, et cetera. Then we do a full pass review on everything above $5 million. The next one for that review is going to be in November. We have – we do touch anything above really above the $5 million level on the common test on a quarterly basis. So we do a full deep dive twice a year and we do a little bit lighter of a touch every quarter.
Thank you. And then as a follow-up question, I guess any CECL less than three months away, any thoughts on CECL, as we think about 2020? And then did you guys disclose the loan mark that will flow into the reserve on January 1 in connection to CECL just so we're modeling out the reserve as accurate as we can today?
Right. So, the second part of that question, the amount of the mark that will flow into the reserve is very low, just given the fact that we didn't have by the purchase impaired loans. There was very low compared to for the acquisitions. So the – on the CECL side, you know, at this point, we are not disclosing the range at this point. I'd say at this point, we are in the, where we are kind of tweaking kind of the models that we have. We've had a couple of dry runs and then a parallel runs that would be based on our data. And really, we're just working through final assumptions and our internal controls. So we're in good shape to be ready to go. January 1, we got our model validated, but we are not at this point prepared to disclose what that range is. Now, keep in mind with our CECL reserve, our reserve is going to go up, I would say, at a higher percentage than most of our peers, just given the fact that we have a fairly large percentage of acquired loans that are sitting in our loan portfolio that currently have no reserve. So it's going to go up by a bigger percentage, but we're not at this point prepared to disclose that.
And will that be something in your 10-Q, something you'll talk about in January? When do you expect to have some final numbers around CECL?
Yeah, we're still evaluating that whether we're going to put that in our Q or whether we would follow-up with that later.
Okay. Thank you, guys.
Yep, sure.
Thank you. And the next question comes from Nathan Race with Piper Jaffray.
Hi guys. Good morning.
Good morning, Nathan.
Going back to last question on the deal. You know, I think when you announced the transaction, you guys are targeting a pre-text margin around 40%. And the guidance you guys provide for fees and expenses tied to Bannockburn implies a little lower margin for the fourth quarter. And Archie I appreciate your comments that the fee should ramp as we move into next year. But just any color in terms of if you guys still think that 40% pre-tax margin is doable? Or if maybe there's no upside just the cost side of the equation?
Now we think the margin that we disclosed before is really kind of an EBITDA margin that you know they were tracking to. We still think that type of a contribution is similar to what we had shared with you before.
Okay, got it. And then if I could just ask one kind of housekeeping question on the purchase account accretion. I think in the past, Jamie, you've suggested that it should decline by a basis point or so in each subsequent quarters. Is that still a right way to think about the decline?
Yeah. So we are – based on our prepayment assumptions, the fourth quarter is between 19 and 20 basis points of purchase accounting accretion, and then again that goes down. You got it right, it goes down call it a basis point and a half each quarter.
Yeah, perfect. I appreciate you guys taking the questions.
Yep.
Thank you. [Operator Instructions] And the next question comes from Jon Arfstrom with RBC Capital Markets.
Hey, good morning, guys.
Hey Jon.
Hey. Just one follow-up and then I just want to talk about loan growth as well. But Archie, you talked about the franchise finance longer term plan to bring balances down a bit more 10% to 15%. What kind of time period are you thinking about on that?
Yeah, I think if we look at – Jon, we've been kind of looking ahead, and that's probably four to five quarter period. As we're looking out, that's probably what you'll see, it'll just trend down from this point, probably to the end of 2020.
Okay. That helps me. And then on Slide 9, you show a bit of a decline in commercial. And I think that's separate from finance, big franchise finance, because you have that down below. So maybe talk a little bit about that, you know what's happening there?
Yeah, some of this was – you know, we did make some other progress in some loans that we would, I would say we wanted to move out, we made some progress during the quarter in our commercial group in particular. I think that's a piece of it. We had – on the commercial side, we had a little bit of a lower origination quarter than we've seen in the prior quarters. We've got some decent pipelines, but for the quarter, the originations were lower than what we've seen in let's say, Q1 or Q2. So I think it's a combination those two things.
Okay, got it. And then one question on deposit costs. Jamie, I think you mentioned later in the quarter, second half of the quarter, you guys were able to bring down some deposit costs. Just curious maybe the magnitude of it, what you did, and any surprising reactions at all that customers generally expected?
Jon, it's Archie. I'll start, making Jamie can jump. We – even in the summer, we sat down with our consumer team in particular and talk about where could we, you know, make some real progress. And for us, you know, so that comes more in the money market category in particular. So we took some actions there in particular, of course, there's, you know, CD balances, we started to adjust those as well. So those are probably the areas we focused on first. You think about it in the – a lot of the interest bearing, other interest rate transaction accounts, or savings accounts, there's not a lot of room. So it's money market for us, it's CDs, it's probably public funds a little bit, so little more elastic but still weak, probably a little progress there as well. So those are the key areas that I think we focused on. And we're probably starting July-ish.
Yeah. So I mean, I would say first, Jon, we thought that are – keeping our deposit cost, just where we kind of were in the interest rate cycle coming into the quarter with you know, we would potentially see deposit costs at best, remaining flat. But I think we were able to get out in front of it a little bit. We've got not overly aggressive, but move some of our pricing down on the money market side. And, you know, we saw those costs kind of flat now in the first part of the quarter. And then we were saying, you know, a couple basis point drop in deposit cost in the last couple months of the, of the quarter. So I was – I would say I was pleasantly surprised. I thought that they would be flat for the quarter. So getting those couple basis points out of the deposit cost side was nice and help the margin.
Yep. Sounds good. Okay. Thanks a lot, guys. Appreciate it.
Thanks Jon.
Thank you. And next question is a follow-up from Christopher McGratty from KBW.
Yeah, thanks for the follow-up. Jamie or Archie, you know, you guys had a really good history of managing costs in regardless the environment. How do we think and obviously Bannockburn is going to put a little bit upper pressure on your efficiency ratio? How do we think about the bank in terms of operating efficiency you know, heading into the next, you know, several quarters a couple years if this environment? Other levers you can pull on the expenses, I mean, what's the kind of a range that you guys are targeting?
Yeah, so you know, if you look at our outlook slides, you know, you take the middle of it, we're projecting call it 85 million and non-interest expensive expense here going forward. I think, I mean, overall, I would tell you know, we will see, you know, I would call it normal kind of annualized percentage increases in that 2% to 4% range. But, I mean, we're taking a look at strategic investments on the technology side, but then on the flip side of that, we're looking at ways that we can offset that and cut costs elsewhere. So, we can reallocate dollars within the organization and you know, and make those strategic investments whether it is reducing the branch count or you know, using technology to get more efficient. So, having said that, you know, with the decline in the margin and also with, you know, with Bannockburn having you know, just a higher efficiency ratio, you will see our efficiency ratio tick up a little bit. You know, we've been in that 50% to 52% range kind of over the last three or four quarters once we got through all of the you know, I would say all of the merger and getting the cost savings out of that. But you will see that tick up a little bit you know, given the investments we're going to make, and also with Bannockburn. So you might see a tick up a couple of percentage points.
Great, thank you.
Thank you. And this time, I would like to turn the floor to Archie Brown for any closing comments.
Thank you, Keith. Thank you, everybody for being on the call today and listening to our quarter. We feel great about where we're heading as a company and look forward to talk to you again next time. Have a great day.
Thank you. The conference has concluded. Thank you for tuning in today's presentation. You may now disconnect your lines.