First Financial Bancorp
NASDAQ:FFBC
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First Financial Bancorp
Earnings Call Analysis
Q3-2023 Analysis
First Financial Bancorp
The company experienced a solid third quarter with adjusted earnings per share (EPS) of $0.67, which marked a robust net income growth of 13% from the same quarter of the previous year. The company's return on assets stood at 1.49%, with a very commendable return on tangible common equity at 23.8%.
Despite higher deposit costs slightly impacting earnings, the company boasted a net interest margin of 4.33% for the quarter, comfortably at the upper end of their projections. Loans expanded by 3.6% annually, driven by leasing and mortgage portfolio growth.
Average deposit balances inched up by $73 million over the quarter, led by substantial increases in money market and retail CD accounts. These changes more than made up for the reduced noninterest-bearing and savings account deposits. The shifts in deposit types contributed to a 37-basis point rise in deposit costs, pushing up funding expenses. However, the company anticipates these costs will continue to rise but at a decelerated rate in the fourth quarter.
Fee income surpassed expectations due to strong performances across various segments, especially wealth management and equipment leasing. While there have been credit mix trends that led to a higher-than-anticipated net charge-offs, projection expenses are expected to stabilize in the fourth quarter. As for noninterest expenses, predictions place them between $121 million and $123 million, with capital ratios remaining strong and the company intending to uphold its dividend at the current level.
Looking ahead, the company forecasts moderate loan growth and a net interest margin between 4.15% to 4.25%. While credit costs should stay in line with the third quarter, the company expects fee income to range from $55 million to $57 million, and expenses excluding leasing expenditure to hold steady. With credit costs and allowance for credit losses (ACL) coverage anticipated to be similar to the previous quarter’s figure, investors can anticipate consistency in financial provisioning.
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Good morning, and welcome to the First Financial Bancorp Third Quarter 2023 Earnings Conference Call and Webcast. My name is Brianna, and I will be your conference operator today. Please note that this call is being recorded.
[Operator Instructions] I will now turn the call over to Scott Crawley, Corporate Controller. Please go ahead.
Thank you, Brianna. 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 2023 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 2023 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, 2023, and we will not be updating any forward-looking statements to reflect facts or circumstances after this call. I'll now turn the call over to Archie Brown.
Thank you, Scott. Good morning, everyone, and thank you for joining us on today's call. Yesterday afternoon, we announced our financial results for the third quarter. I'll first provide some high-level thoughts on our recent performance and then turn the call over to Jamie to discuss further details. Overall, I'm pleased with our third quarter performance, strong net interest income and robust fee income led to a 13% increase in net income from the third quarter of 2022.
In our most recent quarter, we achieved adjusted earnings per share of $0.67, a 1.49% return on average assets, a 23.8% return on average tangible common equity. As expected, higher deposit costs led to a slight reduction in earnings on a linked-quarter basis. Even so, our net interest margin was 4.33% for the quarter, which was at the high end of our expectations.
Loan growth was in line with expectations for the period, led by growth in the leasing and mortgage portfolios. We expect moderate loan growth over the remainder of the year. I am pleased by the continued stability of our deposit balances during the quarter, while the change in mix from noninterest-bearing to CDs and money market accounts continued, we experienced slight growth in total balances, and our loan-to-deposit ratio remained flat at 82%.
Our fee income continued to exceed expectations for the quarter with strong performance from wealth management, equipment leasing, Bannockburn and mortgage banking. Credit trends were mixed during the period, and we experienced elevated net charge-offs. During the third quarter, we elected to sell approximately $32 million in commercial real estate loans and incurred a $6.1 million loss on the sale. We also recorded a $6.9 million loss on a large C&I loan that was negatively impacted during COVID and has been unable to rebound in the period since.
Additionally, nonaccrual loan balances increased during the period due to the downgrade of one office loan whose major tenant vacated the space during the quarter. Last but assets remain low, and we expect provision expense to remain fairly stable in the fourth quarter. We continue to be pleased with our high net interest margin, favorable fee income trends and robust earnings. During the quarter, our regulatory capital levels strengthened, and our strong earnings helped to maintain the tangible common equity ratio despite the negative impact to AOCI from the increase in market rates. With that, I'll now turn the call over to Jamie to discuss these results in greater detail. And after Jamie's discussion, I will wrap up with some additional forward-looking commentary and closing remarks. Jamie?
Thank you, Archie. Good morning, everyone. Slides 4, 5 and 6 provide a summary of our third quarter financial results. The third quarter was another good quarter, highlighted by solid earnings, strong net interest margin and high fee income. Our balance sheet once again reacted positively to the interest rate environment. Our net interest margin declined as expected during the period but remained very strong at 4.33%. We anticipate net interest margin contraction in the coming periods due to continued deposit pricing pressure and changes in funding mix. Total loans grew 3.6% on an annualized basis, which was in line with our expectations.
Loan growth was concentrated in the leasing and residential mortgage books with relatively stable balances in the other portfolios. Fee income remained strong in the third quarter with solid performances in wealth management, leasing, Bannockburn and mortgage. Noninterest expenses increased slightly from the linked quarter due to higher employee costs, leasing business expenses and fraud losses. As Archie mentioned, net charge-offs were elevated during the quarter and nonaccrual loans increased. Classified assets remain low as a percentage of assets and were relatively stable compared to the linked quarter. We recorded $11.7 million of provision expense during the period, which was driven by net charge-offs. Our ACL coverage remains conservative at 1.36% of total loans.
From a capital standpoint, our regulatory ratios remain in excess of both internal and regulatory targets. Accumulated other comprehensive income declined $57 million during the period. As a result, tangible book value decreased $0.11 or 1%, while our tangible common equity ratio declined by 6 basis points. 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 $63.5 million or $0.67 per share for the quarter.
Adjusted earnings include the impact of costs associated with our online banking conversion as well as other costs not expected to recur, such as acquisition, severance and branch consolidation costs. As depicted on Slide 8, these adjusted earnings equate to a return on average assets of 1.49%, a return on average tangible common equity of 23.8% and an efficiency ratio of 57.3%.
Turning to Slide 9. Net interest margin declined 15 basis points from the linked quarter to 4.33%. As we expected, higher funding costs outpaced increases in asset yields, primarily due to a 37-basis point increase in the cost of deposits. Asset yields increased 17 basis points due to higher rates and a more profitable mix of earning asset balances during the period. On Slide 10, you can see the increase in asset yields was primarily driven by a 15-basis point increase in loan yields.
Additionally, the yield on the investment portfolio increased 6 basis points due to the repricing of floating rate investments and slower prepayments on mortgage-backed securities. As I previously mentioned, our cost of deposits increased 37 basis points compared to the linked quarter and we expect these costs to continue to increase in the fourth quarter, but at a slower pace than we saw in the third quarter. Slide 11 details the betas utilized in our net interest income modeling. Deposit costs increased in the quarter, moving our current beta up 6 percentage points to 33%.
Our modeling indicates that our through-the-cycle beta is approximately 40%. Slide 12 outlines our various sources of liquidity and borrowing capacity. We continue to believe we have the flexibility required to manage the balance sheet through the expected economic environment. Slide 13 illustrates our current loan mix and balance changes compared to the linked quarter. As I mentioned before, loan balances increased 3.6% on an annualized basis, with growth driven by Summit and mortgage loans. The other loan portfolios were relatively flat compared to the prior quarter.
Slide 14 provides detail on our loan concentration by industry. We believe our loan portfolio remains sufficiently diversified to provide protection from deterioration in a particular industry. Slide 15 provides detail on our office portfolio. As you can see, about 4% of our total loan book is concentrated in office space and the overall LTV of the portfolio is strong. We downgraded a single office relationship to nonaccrual during the quarter which increased our nonaccrual balance to $27 million for this portfolio.
Slide 16 shows our deposit mix as well as the progression of average deposits from the linked quarter. In total, average deposit balances increased $73 million during the quarter, driven primarily by a $253 million increase in money market accounts and a $119 million increase in retail CDs. These increases offset a decline in noninterest-bearing deposits and savings accounts. This was expected as the current interest rate environment has driven customers to higher-cost deposit products.
Slide 17 illustrates trends in our average personal business and public fund deposits as well as a comparison of our borrowing capacity to our uninsured deposits. While personal deposits and public fund balances were relatively stable in the quarter, business deposits increased 3.4%, rebounding some from second quarter levels. On the bottom right of the slide, you can see our adjusted uninsured deposits were $2.2 billion at September 30. This equates to 23% of our total deposits. We are comfortable with this concentration and believe our borrowing capacity provides sufficient flexibility to respond to any event that would stress our larger deposit balances.
Finally, with respect to deposits, Slide 18 depicts average deposits by month. As you can see, deposit levels increased in July and August with increases in the personal and business deposit categories. Deposit balances were stable in the last month of the quarter. Slide 19 highlights our noninterest income for the quarter. Wealth Management had another record quarter, while mortgage also performed well. Summit and Bannockburn both had very strong quarters, and we expect this to continue through the end of the year.
Noninterest expense for the quarter is outlined on Slide 20. Core expenses were a bit higher than we initially expected. The increase was driven by elevated employee costs and leasing expenses, which are tied to fee income as well as higher-than-expected fraud losses. Turning now to Slides 21 and 22. And our ACL model resulted in a total allowance, which includes both funded and unfunded reserves of $162 million and $11.7 million of total provision expense during the period. This resulted in an ACL that was 1.36% of total loans, which was a 5-basis point decrease from the second quarter.
Provision expense was driven by $16.4 million of net charge-offs, which increased to 61 basis points of total loans in the quarter. As Archie mentioned, during the quarter, we elected to sell approximately $32 million in commercial real estate loans and an attempt to derisk the portfolio and charged off $6.1 million in the process. We also recorded a $6.9 million loss on a large C&I loan that was negatively impacted by the COVID pandemic. In other credit trends, nonaccrual loans increased during the period due to the downgrade of the office relationship I previously mentioned, while classified asset balances were relatively flat quarter-over-quarter. Our ACL coverage is 1.36% of total loans. We have modeled conservatively in prior quarters to build a reserve that reflected the losses we expect from our portfolio. We expect our ACL coverage to remain relatively flat in the coming periods as our model responds to changes in the macroeconomic environment.
Finally, as shown on Slides 23, 24 and 25, regulatory capital ratios remain in excess of regulatory minimums and internal targets. During the third quarter, tangible book value decreased $0.11 or 1%, and the TCE ratio decreased 6 basis points due to a $57 million decline in accumulated other comprehensive income. Absent the impact from AOCI, the TCE ratio would have been 9.07% at September 30 compared to 6.50% as reported.
Slide 24 demonstrates that our capital ratios will remain in excess of regulatory targets, including the unrealized losses in the securities portfolio. Our total shareholder return remains robust, with 35% of our earnings returned 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 26. As indicated earlier, we expect loan growth to be moderate through the remainder of the year. We continue to be more selective in certain segments, but we expect overall growth to be in the mid-single digits in the near term. For securities, we expect a modest decline in balances as we utilize the portfolio cash flows to support loan growth and we expect total deposit balances to grow modestly over the near term.
Regarding the net interest margin, we still see some uncertainty around the Fed rate path, loan demand and deposit pricing competition. We expect modest margin contraction in the fourth quarter with our net interest margin in a range between 4.15% to 4.25% with no further Fed tightening expected. Specific to credit, we're still in a period of uncertainty regarding inflation and the impact of higher rates to the economy and our customers.
Over the fourth quarter, we expect our credit cost to be similar to the third quarter and ACL coverage as a percentage of loans to remain stable. We expect fee income to be in the range between $55 million and $57 million, including the leasing business. Specific to expenses, we expect to be between $121 million and $123 million, which includes the depreciation expense from the lease portfolio. Excluding the leasing expense, we expect expenses to be stable in the fourth quarter.
Lastly, our capital ratios remain strong, and we expect to maintain our dividend at the current level. We're pleased with our results thus far in 2023 and continue to be encouraged by the higher net interest margin, favorable fee income trends and overall earnings performance. As we close out the year, we believe we're well positioned to navigate the current economic environment and continue to deliver strong results. We'll now open up the call for questions. Brianna?
[Operator Instructions] Our first question comes from Daniel Tamayo with Raymond James.
Maybe we start on the credit outlook. I'm just curious, given the elevated net charge-offs in the third quarter and then the guidance in the fourth quarter for a similar level, if that's -- if that should be considered a more normal number now? Or if not, how we should be thinking about what net charge-offs might look like next year?
Danny, this is Archie. Maybe I'll start, and either Jamie or Bill can pick up on my thoughts. We think in the near term, I think we're seeing things from a credit cost, or we expect to be somewhat stable. You've seen our nonaccrual trends move up slightly. We think there's some resolution to some nonaccruals in Q4. There may be some charge-offs related to that. So that's kind of where we have things stable. As we look further out, things look like they moderate back down or if you will call them back down. So I think right now, what we're saying for provision kind of where we've been in a range, it feels like it's pretty stable there.
Okay. That's helpful. And then I guess, specific to that office loan that was downgraded in the third quarter. I was wondering if you could tell us if that was suburban or urban and if possible, what city that was located in?
Yes. That was suburban located in north of Cincinnati and the Blue Ash area, which is a very commercial district.
Okay. And I mean, any read-throughs from that you mentioned it was a large tenant that pulled out. I mean is that something you feel like provides any kind of clarity into any other offices in that same type of bucket? Or is that feel like a one-off to you?
Yes, it feels like a one-off. I mean that area is very robust. There's already interest in leases on that, that we're trying to work through. But yes, I mean, the area is very good. We feel confident where we're at. We don't think it's systemic over rest of our office book.
Got it. Okay. And then lastly, just changing the subject here, looking at the expense base. Just curious if -- I'm sure we'll get into more of a conversation on the revenue side here after I jump off. But if the revenue environment is pressured next year, how you think about your ability to pull out some expenses in an environment like that?
Yes. Danny, this is Archie again. Some of the revenue, if there's pressure, some of that's going to come maybe on the fee side, which a lot of our expenses are tied to -- they're more variable in nature tied to the fee performance. So if we see pressure there, that by itself will come down some. And we continue to look, I guess, on a continuous basis for opportunities where we can cut costs or use attrition not to replace staff when they leave. So there'll probably be more effort in 2024 to do that as we as we see how revenue plays out.
Our next question comes from Terry McEvoy with Stephens.
I apologize for a little bit late on the call. So just a couple of questions. Maybe, Jamie, the forward curve has some rate cuts. Is there anything to suggest that the deposit and loan betas that you experienced in, was it '19 to '21 are not a good proxy for us to use today as we kind of incorporate the prospects of lower rates?
So you're talking specifically about the deposit beta, like on Slide 11, we show kind of our historical betas in that '19 to '21 cycle, we're showing a through-the-cycle beta in that time period of 33%. I think -- yes, so given -- no, I don't think there's anything at this point right now that would tell us we would expect anything different in that down rate cycle. Obviously, they are going to have the -- we'll have to react to the competition in the market. But at this point, no. I mean, we would expect that to be similar in that down rate scenario in that in that low 30s range.
Okay. And again, this may have been discussed, but did you have a reserve already in place for the CRE loan sale, which is a $6 million charge-off and the C&I loan, that $7 million charge-off. And I guess I was a bit surprised to see the ACL decline quarter-over-quarter, but I'm guessing there was some allocated result.
Yes, there were some. But I mean, we had -- over the past few quarters, we had built the reserve up in the -- at the end of the second quarter, it was 141 basis points of loans, which when we looked out at the peer group, it was about 20, 30 basis points higher. So we were conservative coming in, maybe a little bit ahead of the group in terms of building that reserve. And I mean the loan sale, essentially, if you think about the loan sale just accelerated some of those charge-offs that might come down in the next 2, 3, 4 quarters, we accelerated all of those into that current period.
So that and coupled with the charge-off that we had on the one C&I loan, charge-offs can be a little chunky from quarter-to-quarter. And -- but we are -- we feel like with our reserve at 1.36% of loans, we feel like our reserve is still so conservative, and we're in a good spot here going forward.
Okay. Maybe one last one, if I could. Just the size of the balance sheet or size of earning assets over the next kind of 2, 3 quarters is flattish. The best way to think about it is kind of cash -- the securities portfolio comes down to fund loan balances. Or would you expect some growth?
Yes. I would say over the next couple of quarters, that's a good assumption in terms of earning assets. I would say after that, the earning assets will -- we're going to keep the securities portfolio at that point, at least the plan is at this point, obviously, to look at the deposit flows. But after a couple of quarters of still letting the securities balances run down a little with that cash flow, the balance sheet will grow with the growth in the loan portfolio.
Our next question comes from Jon Arfstrom with RBC Capital Markets.
Just a couple of margin questions here. Jamie, what kind of margin expectations do you have beyond the fourth quarter, assuming the Fed is done, and I know you're saying it's a little bit uncertain, but one of the key questions is when do you think NII and the margin start to bottom up?
Yes. So when we look out in the '24, I mean we see the margin bottoming out in the second quarter of -- again, assuming no other Fed actions, we see the margin bottoming out, leveling off in the second quarter of next year, call it in that 3.95% to 4% range. And then, again, as we start kind of what Terry asked, as we start to increase the earning asset base, you'll start to see at that point then, as we get into the third quarter, you start to see the dollars of net interest income start to grow again.
Okay. Helpful, very helpful on that. Slide 17 and 18, I think, are good slides. And I just wanted to ask on the business deposits. It looks like they bottomed out in kind of MASH time frame. What do you think is driving that increase again? Is it confidence? Is it rates from you guys? Is it businesses not having the opportunity to invest or being cautious? Is there any way to put a thumb on that?
Jon, this is Archie. I mean, we have been competitive with rates and certainly have seen a mix -- some mix shift, but you're right that they have balances of strength. And then interestingly enough, they've strengthened even while so we have seen also businesses with liquidity, take that liquidity and pay down lines. We saw a lot of that in the quarter. So I think businesses are by and large, liquid, not all but many. And so they're either bringing more of that in because the rates are a little better on some of the products we're offering or they're using some of that to pay down pay down their lines. So yes, I think they're pretty healthy right now overall.
Okay. Okay. And then just one for you, Jamie. I don't know if you have this or not, but Slide 23, the bottom right graph, also good because you're just showing us the numbers. But any idea of how much of the unrealized losses in the securities portfolio burn off over the next, call it, 4 or 5 quarters. So if we're sitting here at the end of '24, how much of that just naturally burns off?
Yes. So we were actually talking about this yesterday. So the overall loss in the portfolio and the AOCI impact in equity, call it, somewhere around that $350 million to $400 million range and about -- over the course of the year, about 20% of that will burn off. That's maybe a little bit conservative, but around 20% of that would burn off just naturally. I mean, obviously, there's a lot of variables in rates given no other rate movement, right?
Yes, absolutely. So that's over the next 12 months. Okay.
Our next question comes from Christopher McGratty with KBW.
Great. Archie, maybe -- maybe, Jamie, a question on the margins for you. Just it feels like you've got this higher margin starting point in part because of the mix of your assets which should have a little bit of credit volatility, but overall, good credit adjusted margins. How do we think just about normalized credit costs? I think somebody asked about it before, but is it fair to assume that you'll have a little bit higher credit cost to peers because you have a higher margin?
Yes. I think that's fair to say over the long term that if you look at the rest of the industry. And if you just want to say what I've always used in my career when you're looking at overall credit losses, if you say credit losses are, give or take, 30 basis points over a long window, I mean to say ours could be 10 basis points higher than that, 10 or 15 basis points higher over that long term consistently. That could definitely be the case.
But again, when we look at it from a risk-adjusted return, our loan yields and overall asset yields are -- again, over that long term are significantly higher than the peers as well. So that's a trade that we're willing to make. It's just -- there's times when -- again, like this quarter, where we had a slightly elevated charge-offs. But again, when we look at our margin, our margin is between 100 and 110 basis points above the peer median. So I think we're going to have that just given the makeup of the portfolio.
Yes, completely see that. On the -- just a question on the securities book. Your yield is a bit higher. I assume you have floaters in there, but interested just kind of competition of that, whether put anything in place to hedge downside risk or also any contemplation of adjusting anything in the bond book given where rates have moved?
Yes. We do have -- it's about between 15% and 20% of the investment portfolio that is in -- that we have in floaters. So that's obviously helped the securities yield quite a bit over the last year. And in terms of hedging strategy, what really -- nothing specifically against the securities book. But overall, we are building in some protection on the downside. And I would call it more on the extreme downside where we are -- we want to -- we put in place so far around some macro hedges that are around $600 million in total notional amount. But we want to get to about $1.5 billion or so, potentially $2 billion of downside protection.
Again, I would call it extreme downside protection where we're putting in some floors that are in that 2% to 2.50% range just to protect us because -- I mean, if you remember, when our margin got -- where we got hurt the most was, call it, March of '20 and forward there when rates went to plummeted, and we -- our margin went in that 3.20% range. So what we're trying to do is build in some protection on that the extreme downside.
Okay. Maybe just one more. The 2 charge-offs in the quarter, the $32 million loan sale, I guess, it was like -- it looks like about a 20% loss. What was the sub-asset class within CRE? And then second, the C&I loss, what was the balance of that? I'm just trying to back into like loss rates on the relationships.
Yes. The loan sale included loan hotel loan office and loan health care deal. And the commercial credit was a consumer retail company that had as a multilevel marketing that changed their model after COVID when the party circuit kind of went down after having very robust pre-COVID and covidiers and the model couldn't be changed ultimately.
Okay. And that $6 million, what was the size of the principal, like what kind of loss rate was that on the second one?
Yes. I mean it was a total of about $10 million.
[Operator Instructions] Seeing no further questions, I will now turn the call back to Archie Brown.
Thank you, Brianna. I want to thank everybody for joining today's call and following our story. We look forward to talking to you again next quarter. Have a great day.
This concludes today's conference call. Thank you for your participation. You may now disconnect.