First Financial Bancorp
NASDAQ:FFBC
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First Financial Bancorp
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Hello everyone and welcome to today’s First Financial Bancorp Third Quarter 2022 Earnings Conference Call and Webcast. My name is Victoria, and I'll be your operator for today. [Operator Instructions]. I will now pass over to your host, now have the pleasure of handing the call over to our host, Scott Crawley, Corporate Controller to begin. Please go ahead.
Thanks, Victoria and 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 2022 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'll 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 2022 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 30, 2022, and we will not be updating any forward-looking statements to reflect facts or circumstances after this call. I will now turn it over to Archie Brown.
Thanks Scott. Good morning, everyone and thank you for joining us for today's call. Yesterday afternoon, we announced our financial results for the third quarter. I'm very pleased with our performance, which was highlighted by strong loan growth, stable asset quality, and exceptional earnings. Adjusted earnings per share increased approximately 9% from the second quarter due to record revenue which was driven by an 18% increase in net interest income. For the quarter we achieved adjusted earnings per share of $0.61, a 1.4% return on average assets, and a 23.12% return on average tangible common equity.
Recent rate increases continued to positively impact our asset sensitive balance sheet. Our net interest margin expanded in the third quarter by 53 basis points, as yields on assets increased much more rapidly than deposit costs. Credit trends remained stable across the portfolio with slight reductions in non-performing loan and net charge-off ratios. Even with these improvements our loan loss reserve grew modestly to account for loan growth and the intermediate economic outlook. We're very pleased with loan growth in the third quarter. Loan balances increased by $377 million or 15.9% on an annualized basis. Growth in the quarter was again broad-based and was driven by increases in CNI, consumer, and residential mortgage. Given our expectations for the economy in the near term and moderating loan pipelines we expect loan growth to squeeze in the coming months.
Non-interest income was once again negatively impacted by rising rates and changes made to our overdraft program in the second quarter of this year. We also experienced a net expected decline in foreign exchange income from a record second quarter and mortgage activity weakened further. Fee income continues to reflect the strength of our diversified businesses and we expect a modest increase in the coming quarter as our leasing business grows. With that I'll now turn the call over to Jamie to discuss the third quarter results in more detail. After Jamie’s discussion I'll wrap up with some additional forward-looking commentary. Jamie.
Thank you Archie. Good morning. Slides 4, 5, and 6 provide a summary of our third quarter financial results. The third quarter was highlighted by an expanding net interest margin, strong loan growth, and stable asset quality. Our balance sheet reacted positively to additional Fed rate hikes with our net interest margin increasing 53 basis points. We anticipate this trend will continue as the Fed is expected to increase rates over the remainder of the year. However, the margin expansion will not be of the same magnitude due to expected deposit pricing pressures.
We were very pleased with another quarter of strong loan growth. Total loans grew 16% on an annualized basis with the growth widespread across the portfolio. Fee income declined from elevated levels in the second quarter and particular Bannockburn income met our expectations, but was lower than record levels of the second quarter. As expected Mortgage Banking income declined compared to the second quarter as well as the mortgage business has been negatively impacted from higher interest rates. Additionally, service charge income declined from the linked quarters as we continue to feel the impact from changes to our overdraft programs. Finally, other non-interest income declined due to higher than expected revenues from limited partnership investments during the second quarter.
Non-interest expenses were slightly higher than our expectations, due primarily to incentive compensation tied to the company's performance. We were pleased on the credit front as net charge off declined to 7 basis points and non-performing assets declined to 29 basis points of total assets. While asset quality remained strong, we recorded $8.3 million of provision expense during the period which was driven by loan growth during the period and slower prepayment rates. From a capital standpoint our regulatory ratios remained in excess of both internal and regulatory targets.
Similar to the second quarter accumulated other comprehensive income declined, negatively impacting both tangible book value and our tangible common equity ratio. Slide 7 reconciles our GAAP earnings to adjusted earnings, highlighting items that we believe are important to understanding our quarterly performance. Adjusted net income was $57.8 million or $0.61 per share for the quarter. These adjusted earnings account for $900,000 of losses on investment securities and $1.7 million of acquisition and other costs not expected to recur. As depicted on Slide 8, these adjusted earnings equate to a return on average assets of 1.4%, a return on average tangible common equity of 23.1%, and an efficiency ratio of 58.5%.
Turning the Slides 9 and 10, net interest margin increased 53 basis points from the linked quarter to 3.98%. Once again, this increase was primarily driven by an increase in asset yields during the period resulting from rising interest rates. The increase in asset yields was partially offset by a slight increase in funding costs. As a result of rising rates, asset yields surged during the period with loan yields increasing 89 basis points. In addition, investment yields increased due to higher reinvestment rates and slower prepayments on mortgage-backed securities. Our cost of deposits increased 11 basis points compared to the second quarter and we expect these costs to increase further and reaction to competitive pressures from an increasing rate environment.
Slide 11 details the asset sensitivity of our balance sheet. We remain well positioned for the expected rate increases as approximately two-thirds of our loan portfolio re-prices fairly quickly. Slide 12 details the betas utilized in our net interest income modeling. And while we haven't realized aggressive increases in cost to this point, as additional rate increases occur we expect our deposit beta to be approximately 30% over the full cycle. Slide 13 outlines are various sources of liquidity and borrowing capacity. We believe our liquidity and borrowing capacity sufficiently provides the flexibility required to manage the balance sheet, through the expected economic environment.
Slide 14 illustrates our current loan mix and balance changes compared to the linked quarter. As I mentioned before, loan balances increased 16% on an annualized basis with every portfolio growing compared to the linked quarter. The largest areas of growth were in the CNI, retail mortgage, and consumer portfolios. However, we were also pleased with the trajectory of the ICRE and Summit books. Slide 15 shows our deposit mix as well as the progression of average deposits from the linked quarter. In total, average deposit balances declined $167 million during the quarter driven primarily by a $77 million decline in public funds, a $58 million decline in retail CDs, a $49 million decline in money market accounts, and a $47 million decline in not interest bearing accounts.
Slide 16 highlights our non-interest income for the quarter. Overall fee income declined from the second quarter driven by declines in foreign exchange, service charges, mortgage, and other non-interest income. Bannockburn met our expectations for the quarter, however, their total income was lower in the third quarter, following record output in the second quarter. Also consistent with our expectations, deposit service charge income declined in the third quarter as we realized the impacts on overdraft program changes. Consistent with the second quarter, mortgage demand was light due to higher rates and record production in prior years and we continue to expect further pressure on this business for the remainder of the year.
Finally, other non-interest income normalized during the period which was higher in the second quarter due to elevated income from limited partnership investments. Non-interest expense for the quarter is outlined on Slide 17. Like the second quarter, the third quarter was relatively quiet in the net interest expense front. On an operating basis and excluding summit, expenses increased $2.6 million compared to the linked quarter due primarily to an additional incentive compensation tied to the company's performance.
Turning now to Slide 18, our ACL model resulted in a total allowance which includes both funded and unfunded reserves of $141 million and $8.3 million in total provision expense during the period. This resulted in an ACL that was 1.27% of total loans at September 30th. As I mentioned previously, the provision expense was driven by a strong loan growth and slower prepayment speeds, which increased the duration of the portfolio. Despite the increase in provision expense, credit quality remained stable. Net charge offs as a percentage of loan decreased slightly to 7 basis points on an annualized basis while non-performing assets declined at 29 basis points of total assets. In addition, classified assets declined $4.6 million during the quarter. Our view on the ACL and provision expense remains unchanged. We expect our ACL coverage to remain stable or increased slightly in the fourth quarter as our model responds to changes in the macroeconomic environment.
Finally, as shown on Slides 20 and 21 regulatory capital ratios remain in excess of regulatory minimums and internal targets. During the third quarter tangible book value and the TCE ratio continued to decline due to a drop in accumulated other comprehensive income. Absent the impacts from AOC -- the TCE ratio would have been 8.1% at September 30th compared to 5.8% as reported. Our total shareholder return remains robust with approximately 40% of our earnings return to our shareholders during the period through the common dividend. We believe our dividend provides an attractive return to our shareholders and do not anticipate any near-term changes. However, we will continue to evaluate various capital actions as the year progresses. I'll now turn it back over to Archie for some comments on our outlook going forward. Archie.
Thank you Jamie. Before we end our prepared remarks I want to comment on our forward-looking guidance which can be found on Slide 22. Loan demand remains solid, pipelines are beginning to ease, and we expect growth to moderate to high single-digits over the fourth quarter. We expect total deposit balance to remain flat or decline slightly over the near-term. Our asset sensitive balance sheet continues to benefit from rising rates and although there are many variables that impact magnitude and timing, we expect the margin to continue to expand to a range of 4.3% to 4.45% in the fourth quarter based upon anticipated interest rate increases. The competition for deposits is increasing and we expect the margin expansion to moderate as we get further into 2023.
Regarding credit, much uncertainty remains regarding inflation and the impact of rate hikes to the economy and our customers. Over the fourth quarter we expect continued stability in our credit quality trends and ACL coverage remains stable to slightly higher. We expect fee income to be between $44 million and $46 million in the fourth quarter with continued strength in our diversified fee producing businesses. Specific to expenses, we expect to be between $105 million to $107 million but instead the expenses could fluctuate with fee income performance. As our operating lease portfolio grows, we will see corresponding depreciation expense growth of approximately $1 million per quarter, which is included in our range.
Regarding Summit, our outlook is unchanged and we expect the acquisition to have minimal impact on overall 2022 earnings and provide approximately $400 million [ph] in annual origination. Lastly, our capital ratios remain strong, and we expect to maintain our dividend at current levels. Overall we had a really nice quarter and we are optimistic that we can sustain this momentum over the remainder of 2022 and into the New Year. Our strong balance sheet is well positioned to continue to benefit from rising rates with a loan deposit ratio under 80%, strong liquidity, and positive credit trends, we believe we are well situated to manage potential economic downturn. We will now open up the call for questions. Victoria.
[Operator Instructions]. And our first question comes from Scott Siefers at Piper Sandler. Please go ahead. Your line is open.
Thank you. Good morning guys and how's everybody doing?
Good.
Hey, I guess Jamie maybe first question is for your, so [indiscernible] at almost every turn in the tightening trend that you guys have been maybe a little more asset sensitive than you had modelled. It sounds like we'll get another big lift in the fourth quarter. Archie, you had noted moderating branches [ph] into 2023 as deposit cost sort of keep up but, after we get to a point where the Fed stops raising rates maybe just some thoughts on how much further could you expand the margin and can you sustain NII -- positive NII momentum after the Fed stops raising rates?
Yeah Scott, this is Jamie. So we do expect to see another pretty sizable increase here in the fourth quarter in the margin. From the pace of the interest rate hikes, understand how these are coming on. We expect to see that lift here in the fourth quarter as well and then even into the first quarter if you look at based on the Fed fund futures and what we're expecting in terms of rate hikes going in to the beginning of next year. But then -- so we expect the margin to peak. So if you were to ask me maybe six -- a few months ago where our margin was going to peak, I would have said maybe in that 420 range but just given the way things have changed, I think it is -- the peak is a little bit higher. So the peak is probably somewhere in that -- in the first quarter of next year and with a peak it is going to be a little bit higher and somewhere in that 440 to 450 range and into next year. And then as the Fed stops and on the backside of that, the deposit side starts to catch up and we just had no time for the deposit side to really ramp up to where it should be. That's going to happen more on the backside when the Fed stops. So you'll then start to see the margin start to come back, come back down and moderate in the middle to the back half of next year.
Yes, perfect, alright, thank you for that color. And I guess just given that we're getting closer to the end of the tightening cycle and hopefully, have you guys given any thought to sort of moderate asset sensitivity to protect against it by turning rates and a lot of guys are putting on swaps out to do so, what -- if so what would be the best in your mind?
Yeah. So we're looking at several things, it was kind of I would say evaluating. We haven't done anything yet I would say material. May be the only thing we've done at this point is some slight rebalancing in the Investment Portfolio to maybe extend some duration there on the Investment Portfolio. But that I would say that's on the fringes. But I mean I would tell you that we're evaluating various options to kind of to protect the NIM on the downside and reduce that asset sensitivity. We were looking at conference callers, we are looking at building in some floors and what not. But haven't done anything yet but expect to do so here in the next -- within the next quarter.
Perfect, alright, good. Thank you guys very much for taking the questions.
Thanks Scott.
Thank you very much Scott for your question. Our next question comes from Daniel Tamayo at Raymond James. Please go ahead. Your line is open.
Thank you. Good morning, guys. Maybe we just start on the fee guidance, the decline there, if we could just talk through some of the puts and takes in terms of what drove that and maybe if we could just talk a little bit about what your expectations are for Bannockburn in particular going forward that would be great, thanks?
Yeah, Daniel I'll start. This is Jamie. So kind of just going through the various line items like so the first one like we just closed, I think a few months ago, we made some changes to our overdraft program that is the impact. The impact was what we expected. It's not any different than what we expected. But that did drive that service charge revenue down in the third quarter. So that impacted that line item. In terms of mortgage I mean, so as you expect, I mean our mortgage rates are up 400 basis points or so from a year ago. So, in terms of that activity has fallen off dramatically. So obviously, seeing an impact there. On the wealth management side, with a lot of those fees are based on market values of the portfolios of the assets under management. So, getting impacted by the downturn in the market and then offsetting that a little bit, we are still seeing strong income on the foreign exchange side. So, we were down a little bit this quarter, but coming off of what was a record quarter for them and that's -- and they have a base of income and then there are some quarter-to-quarter fluctuations. But when we look at that income at this point, there's somewhere in that $12 million a quarter range so about 48 million is on an annual basis of revenue at Bannockburn. And we going forward, expect that to increase in that 5% to 10% range on an annual basis for the near term.
Okay, great, that's helpful Jamie, thanks. And then I guess a similar question, but on the expense side, in particular it looks like the guidance for the fourth quarter is similar to what you put up in the third quarter. And then you call that specifically the million increase in leasing expenses. Just curious how we should be thinking about kind of growth rates from there if that's just a unique situation in the fourth quarter where expenses should be roughly stableish and also if that million is included in the guidance that you've given? Thanks.
It is, yeah. The million is included in that guidance and that's just obviously as we put operating leases on the books, that line item there it is going to -- is going to continue to grow. But I mean absent that I would tell you it's really just the pressure that we are seeing is really on the employee cost side. So outside of that I would just call it inflationary pressure on employee cost. Other expenses are relatively flat. And so you got -- essentially you have that increase on the Summit side every quarter kind of just ramping up and then some pressure there in wage cost, healthcare costs, and what not that is impacting the employee cost line. But outside of relatively flat.
Hey Dan, this is Archie. Jamie you are relying [ph] on the corresponding size as that leasing business expense goes, you are also seeing corresponding benefit in the P side.
Yes, correct, the operating leases, yeah.
Alright, thanks for all the color, guys, that's all for me.
Thank you for your question Daniel. Our next question comes from Terry McEvoy at Stephens, Inc. Please go ahead, your line is open.
Good morning, this is Brandon Rud on for Terry. My first question is about deposits, non-spring deposits pre-COVID and the 2019 were about 26% of total deposits. In this last quarter, they were about 32.5%. You think they can return back to that pre-COVID level the next year, year and a half or so?
Hey, this is Archie, certainly there's some money that's surged into demand deposit accounts during COVID and you would expect over time so that will work its way back out as businesses and individuals spend some of that or start to put some of that money to work. So I don't know if we will be able to hold it at the low 30s but I think we believe just given our strategy and focus on growing our business sector particularly we think that number will probably be higher than where it was pre-COVID.
Okay, perfect, thank you. Next one here is, you mean sectors or regions across your footprint they are expecting to drive your loan growth going forward?
This is Archie again. I mean, I think it's across the -- it's across -- Cooper's pretty tight, think about where we're located for four hours, four and half hours across the whole footprint. So it's becoming really from all of those marks. We will also have -- as you know we have some national businesses with Oak Street and Summit and even in some of our more regional and commercial real estate. So all those areas will help drive some of that growth as well.
Got you, thank you. Well, that two here kind of go hand in hand talking about credit, can you talk about how your restaurant franchise borrowers are managing the current environment and also -- your exposure to office, hotel, and retail CRE is kind of how you stress those portfolios for the higher interest rates?
Yeah, this is Jim, I will start and then I will turn it to Bill to kind of get into details. On the restaurant book and hotel book just we have those books are much smaller than they used to be. So I think the restaurant portfolio is now under 300 million. So it's about half of what it was four years ago. And the hotel book is down about 40% from where it was to two to two and half years ago. So, I think it's a little bit over $300 million. So they are much smaller, but we have Bill Harrod, our Chief Credit Officer talk about what he is seeing in those portfolios as well as I think you said the retail portfolio?
Yeah, sure. As far as the office and retail books, those are -- and the hotel books those are performing very, very good. Hotels have rebounded nicely. And up to you know some cases exceeding pre-pandemic levels and so we're very happy with that portfolio. I mean it's been as progress. On the franchise book they may have some cost headwinds as far as the labor and inputs. But we're also seeing rises in prices across a lot of the platforms to help mitigate that. They still have good volumes compared to 2019 and so we feel pretty bullish there as well.
On the office, we continue to monitor that portfolio very diligently including stress testing not only on the interest rate environment. And one thing about our vertical book in the real estate side is the vast majority that is swapped have interest rate hedges on it. So we feel pretty good about that. That said we do right through our models, including not only interest rate shocks as well as right roles and looking out short-term, mid-term, and long-term expiries to try to break thinks risk and attack it quickly. And before it becomes potential issues with interest rates [ph]. So, we do that across our real estate. Hopefully that helps.
Yeah, that's very helpful. I appreciate you taking my questions. Thank you.
Thank you.
Thank you very much. [Operator Instructions]. And our next question comes from Chris McGratty at KBW. Please go ahead. Your line is open.
Oh great, thanks. Hey guys. Jamie a question on just spot rates. Do you have the spot deposit, interest bearing deposit in the spot loan yield?
So, like for September, is that what you're asking?
Yeah, like in the pretty end of the quarter exactly?
Yeah, so our cost of deposits in September was 27 basis points. And hang on here, I will go back into it, and our loan yields for September, let's see here, was around 540.
Okay, thank you. And the 30% beta you decided, was that total or is that interest bearing, just to make sure I am clear?
And obviously, I mean, Chris -- we are growing seeing the whole lot so far in the cycle, but we're starting to see some pressure and just we are seeing that here starting out a little bit in the fourth quarter, some competitive pressures and obviously that beta is going to start to move up here. And then on the back side again like I said, the -- that data moves up pretty substantially on the backside of the rate hikes.
Great. I guess, maybe on the loan yield outlook. I mean if they were priced, they continue to reprice higher I mean you're going to have -- your borrowers are going to be paying north of 6 maybe mid 6s on loan. At what point does the pressure on the borrower become more acute with related to credit?
[Multiple Speakers]
I mean it is hard to look at that on a global basis. But, when we look at credits and underwrite credits, we have built-in shock and those built-in shocks go out in duration and size depending on the deals. But we test them to really make sure that they have been doing that breaking and then on -- and also a lot of our book is just hedged on the loan side both in commercial and on the ICRE. Now that's waned a little bit, just with the rising rate environment that we're in right now. People will not look that far. But overall, the book is protected that way, but it's really through our downside, base case downside and severe cases that we prove that they don't bend now. Of course like any expense it's increasing in pressures and they'll figure out ways to deal with it.
Hey Chris, this is Archie. I think this is part of the case for where we are seeing a little bit of softening in the pipeline and slowing down of the growth as we know especially in our ICRE group. Certain projects are being postponed or put on hold and just waiting for the environment to get a little bit better. So that is driving some of the sort of our outlook around loan growth.
Thank you.
Thank you very much for that question Chris. At this time there are no further questions and I would like to pass back over to Archie Brown for any final remarks.
Thank you, Victoria. Thank you all for joining us on today's call and hearing more about our story in the third quarter. We're excited about the fourth quarter and 2023 and we look forward to talking to you again next quarter. Have a great day.
Thank you everyone for joining today's conference call. You may now disconnect.