First Commonwealth Financial Corporation (FCF) Q1 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the First Commonwealth Financial First Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, there will be a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, today's call is being recorded. I'd now like to turn the conference over to your host, Rich Stimel. Sir, you may begin.

Thank you. As a reminder, a copy of today’s earnings release can be accessed by logging on to fcbanking.com and selecting the Investor Relations link at the top of the page. We’ve also included slide presentation on our Investor Relations page with supplemental financial information that will be referenced throughout today’s call. With me in the room today are Mike Price, President and CEO of First Commonwealth Financial Corporation; and Jim Reske, Executive Vice President and Chief Financial Officer. After brief comments from management, we will open the call to your questions. For that portion of the call, we'll be joined by Bob Emmerich, our Chief Credit Officer and Mark Lopushansky, our Chief Treasury Officer. Before we begin, I’d like to caution listeners that this conference call will contain forward-looking statements about First Commonwealth, its business, strategies and prospects. Please refer to our forward-looking statements disclaimer on Page 2 of the slide presentation for a description of risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. And now, I’d like to turn the call over to Mike Price.

Hey. Thanks, Rich, and good afternoon and as always thank you for investing some time with us today. With me today is Jim Reske, our CFO and who'll be speaking to you in a moment. Our net income of 14.2 million for the first quarter of 2015, translated earnings per share at $0.16 and represents a good start to 2015. Our lower credit costs, stronger wealth management revenue, lower systemic non-interest expense and a special FHLB dividend drove earnings and created nice tailwinds for the quarter. Conversely a slower fees for institution funds and overdrafts weighed on our non-interest income. Some other important observations include, we had solid average quarterly loan growth of $48.2 million, which helped drive net interest income, a more robust NIM at 3.35% helped us as well. The growth in loans stemmed largely from a flurry of commercial loan activity at year end. Our asset quality continued to improve and resulted in a provision expense of just 1.2 million. Third, our non-interest expense dipped to 39.9 million for the quarter, which includes well over $1 million in unbudgeted expense due to unusual snow removal cost and debit card losses that carried over from fourth quarter of 2014 related to several national retailer card breaches. We continue to tighten our operations environment and the rate of those losses has abated. Non-interest income of 14.2 million was stronger than the previous quarter at stronger wealth management fees and commercial loan fees overcame lower, deposit service charge income and a slower than forecasted ramp up in our mortgage business. As we reflect on the last 12 to 24 months, we've really had our shoulder to the wheel on at least four fronts to position our company. Mainly and first I would mention our core conversion last year where we remade the IT backbone of our company beyond the cost structure, this has really enabled a myriad of 2015 initiatives designed to enhance the customer experience and drive value for the bank. And I'll just give you a flavor for some substantial things in the offing this year at First Commonwealth. A refresh of our online banking and our fcbanking homepage, a valuation of the credit card product to support our customers' online buying preferences, the launch of opening act here in May and online account opening option for our customers and prospects, the launch of an outbound call center to introduce customers to our capabilities, a wholesale emphasis on helping our clients navigate their financial future as measured by referral activity between our professional partners at the bank, our consistent deployment of a powerful new customer relationship management tool, the introduction of a home construction loan product for our mortgage customers, introduction of data scan, a product that will help us grow our dealer floor plan business and also an introduction of chip card and Apple Pay here later this year. That’s a lot and that has really been enabled by our core conversion here a year ago. Second and as long as we're talking about some of the things that impact customer experience, I would also note that we've been focused on our penetration of mobile banking and internet banking which are tracking satisfactorily and really above our industry standards, conversely our bill pay penetration is really just at the median of our peer group and represents opportunity for improvement. Continued traction in these digital measures in the ensuing months and years to come will really be vital to move ahead and be competitive. Third, as I mentioned earlier our mortgage initiative is slower than we forecasted out of the gate in 2015, however we remain excited about the prospects for incremental fee income and the potential for acquisition of younger credit or the household. Last thing I would mention before turning it over to Jim, it's been one year since we launched our Cleveland loan production office, our three lenders there have generated over $130 million in loan commitments with roughly two-thirds of those being commercial real estate and one-third C&I commitments. These strategic forays were really enabled by our core system and resulting simpler operating environment. With that I'll turn it over to Jim and let him dig into a few of the details around the numbers.

Thanks Mike. We are off to a very good start in 2015, I will pick on some of Mike's themes that have driven our performance, including a strong net interest margin, lower credit costs, fee income growth and lower operating expense. I will encourage you to take advantage of the earnings release supplement presentation that has available on our website, which has been completely revamped this quarter to provide investors with some useful information that expands on the earnings release. First of all, net interest income was $48 million up by $1 million from the linked quarter and up by $1.5 million in the year ago quarter. The first quarter benefited from $1 million special dividend from the Federal Home Loan Bank, but even adjusting for this dividend, we were pleased to have maintained spread income at the same $47 million level of last quarter given that there are two fewer days in the first quarter, which otherwise would have lowered net interest income by approximately $900,000. Annualized growth and average loan balances of 48.2 million due to strong commercial loan originations at the end of the last year helped drive first quarter net interest income. End of period loan balances were down slightly for the first quarter as growth in commercial and industrial loans in the first quarter cannot offset run off in direct installment consumer loans. But loans are up $192 million or 4.5% since last year. Our interest margin extended by 13 basis points from 3.22% in the fourth quarter to 3.35% in the first quarter. To be fair, 7 basis points of this expansion is directly attributable to the $1 million FHLB special dividend. However, in a reversible last quarter, positive commercial loan and placement yields contributed to 3 basis point increase in the yield on loan portfolio. Lower funding cost also contributed 2 basis points to the margin as we continue to run off higher cost broker time deposits and grow demand deposits and saving deposits. Our total cost to deposits is now down to 19 basis points. Non-interest bearing demand deposits increased by $15.9 million or 5% in the first quarter and clearly comprise 24.2% of total deposits. Savings and interest bearing demand accounts were up by another $52 million in the quarter or 2.1%. In order to further protect the bank from potential effects of a prolonged low rate environment, the bank entered into another $100 million macro swap in the first quarter. This swap is in addition to the $100 million swap we executed in the third quarter of last year. Like that swap, this swap also effectively extends the duration of another 100 million of our 1.3 billion in LIBOR based commercial loans into three and four year maturities. So if short term rates remain low and in fact even if they rise slightly, this swap will add approximately $1 million of pre-tax income on an annualized basis in the first year resulting in approximately 2 basis points of protection in net interest margin. The bank still remains asset sensitive in the second year of a rising rate scenario, but we have endeavored to maintain a relatively neutral position in the first year in order to avoid the high short term opportunity costs associated with asset-sensitivity. Lower loan loss provision expense contributed strongly to our improved performance in the first quarter. It's important to note that we did not release reserves in the first quarter, rather we added $1.2 million to reserves in the first quarter, so this significant investment provision expense in prior periods. This was driven by continued fundamental improvements in asset quality as a percentage of non-performing loans continues to decline. During the first quarter, the bank charge off $6.5 million in loan but these charge offs largely represented the charge offs of specific reserves that had been satisfied against these loans in prior periods. The replacement of these specific reserves with further general reserve was not warranted in the first quarter due to the bank's improved credit history. The banks ratio of general reserves as a percentage of non-incurred loans improved slightly in the first quarter to 0.98% up from 0.97% last quarter. Turning to non-interest income, exclusive of non-recurring gains under sale for securities and other assets, non-interest income improved by $600,000 compared to the prior quarter and compared to the same period a year-ago. Going forward our fee income should benefit from both our insurance agency acquisition and our investment in our mortgage initiatives. As Mike mentioned the mortgage ramp up was slower than expected in the first quarter, but continues to build momentum. We’re in $122,000 of spread income and $440,000 in non-interest gain on sale income from mortgage in the first quarter. That’s a nice contribution, but the non-interest expense associated with the mortgage initiative totaled $740,000 in the first quarter and so the business is still not yet operating on a breakeven basis. However, we were out of the first mortgage business for a decade and a precise pace of our reentry has always been difficult to predict. We are still building a business that is on track to make a meaningful contribution to fee income in 2015. In terms of non-interest expense, the quarterly and yearly comparison is strongly affected by a number of non-recurring items including the $8.6 million legal reserve that we satisfied last quarter. These items are described in detail in our earnings release and are itemized in a table on page 9 of our earnings release supplement. All of these items represent real gains and losses and obviously anytime we talk in terms of "non-recurring items and/or operating expense" these are non-GAAP concepts and a full reconciliation to GAAP figures can be found in the supplement. But in order to better understand our business we look at operating expense on a core basis before any of these items. And on that basis operating expense decreased by $500,000 compared to last quarter from 39.1 million in the fourth quarter to 38.6 million in the first quarter. Operating expenses came down despite absorbing $700,000 in increased snow removal and utility costs and 300,000 in increased expense to satisfy reserves for increased unfunded loan commitments. Compared with same quarter last year, core operating expenses up by 800,000 largely reflecting increased costs associated with our insurance agency acquisition and our mortgage build out. The company is committed to creating culture of continued ongoing improvements in operations and efficiency. For example, as we have previously announced in our local markets we will be officially closing three branches on April 30, which is tomorrow. We expect this will save us approximately $350,000 in operating costs on an annual basis. In other news, our effective tax rate was 30.1% at the end of the first quarter. And in terms of capital management, we completed $18.6 million of our $25 million stock buyback authorization in the first quarter, ahead of schedule, due to the purchase of several large blocks of shares. And with that we will take any questions you may have.

[Operator Instructions] Our first question is from Bob Ramsey of FBR Capital Markets. You may begin.

Hey, good afternoon. It's great to see a little bit of margin expansion. I know you guys broke out what was from the FHLB, but it looks like there was a couple basis point benefit from higher low yields, too, which is unusual in this environment. Just curious whether there was any benefit in they are from shifts on the nonperforming loans, or whether it was the day count, or whether there were some higher-yielding loans that were put on the balance sheet this quarter. What drove up the yield on the loan book quarter-over-quarter?

Bob this is Mike and thanks for joining us today. Just looking at the complexions of the loans that were approved, I just think they were a little higher yielding. In terms of the types of credit, one was a rehab or occupational therapy type business, in other words a custom products molded business and some other things that just had higher yields, but I don’t know if that’s sustainable but the texture of the loans is just a little higher yielding.

Bob I'll just add to that a little bit, if you look at the mix of commercial loan originations in the first quarter, the mix tended to favor investment [indiscernible] which tends to be term loans of the adjustable rate LIBOR base comps, so that is up a little bit. But also the rate on loans we're paying off was lower as well, so that contributed to the positive replacement yield just a little bit.

Then as we think about the net interest margin headed into the second quarter, I guess the FHLB dividend benefit of like 7 bps goes away. So is it right to think that we start 7 basis points lower and then maybe there is a little bit of core impression? Is that directionally fair?

Yes in a broad sense, Bob I think it is directionally fair. It may have been newer but one of the other analysts who mentioned this on a call a while ago, but as an expectation we now have that our margin is going to bounce around a little bit of the range. So quarter-on-quarter we -- two quarters where we had positive replacement yields, last quarter that wasn’t the case, this quarter it’s the case again. So rather than just saying we're on secular trend long-term trends worth margin depression, I think it's fair to say we're going to bounce around range a little bit.

Okay, great. Shifting gears a little bit to loan growth, just curious: thoughts on loan growth this quarter. Obviously your balances were down pretty modestly, but they were down. I think last quarter you guys had talked about expectations for 2015 being something in the mid single digits. Just curious if that is still good guidance and what you guys are seeing in the pipeline.

The pipelines in the commercial side Bob look good, on the consumer side a little thinner. The consumer side particularly the branch portfolio is the one that's leaking a little oil and -- just there isn’t a refinance activity that we've seen in prior years. Commercial real estate is robust, I think it's -- when we look at the last year from the first quarter 2014, that's about 192 million or 4.5%, I think that's the real estate. Particularly when you add in the Cleveland LPO in some of our other works and other markets particularly in Ohio, Columbus, and how they've helped us. So I think that's still the guidance that we would stick with.

Thank you. Our next question is from Will Curtiss of SunTrust. You may begin.

I thought maybe we would start on the fees. I think you mentioned in your prepared remarks a little disappointment in the progress on the mortgage business to date. Just curious if you can provide some additional color on the business and maybe your thoughts on why it might be a little behind where you expected.

I think the primary reason is behind us, we've been out of the business for over ten years and perhaps we were -- the ramp up was a little aggressive in terms of the forecast, I think that -- the business is running at about half the volumes that we have hoped honestly. And I think the challenge has been -- we've been able to get the quality of producers having been out of the business. And I think we just -- we feel like we've kind of got to a tipping point where we've begun to get some better producers here after a quarter or two. But I think it's really the talent and people understanding how committed we are in the business, but mortgage loan originators are really true professionals in any communities they live in and they make a living by how well they do, and they want to be aligned with partner or bank that is competitive and committed to the business and I just think as that becomes clear we will have some more good people join us.

I think we're fortunate and we're very happy to have the professionals that we have with us now, we're just looking to add more and in fact we have had some talent acquisition in the first quarter that's going to help to really build the business [indiscernible] in the quarters going forward.

Thank you. Then on service charges it looked like the quarterly drop was pretty consistent with what we've seen historically. Just curious if there was anything else maybe that impacted that this quarter. And if not, should we expect a rebound like we've seen previously?

Honestly, the bounce in our non-interest bearing DDA is less the function of activity and more a function of people keeping more money in their account. And consequently -- so I belief it's just not overdrawn as much and so we're seeing the incidence rate of the overdrafts menace to fall, and that's really where it's starts to -- it's $0.5 million hole in our income statement.

Yes, this quarter. And I think that -- when we first noted that happening, we do internal investigation to understand why that was happening and then we had heard anecdotally that other banks were experiencing now that the others of our peers have [indiscernible] and few others have noticed a same kind of effect. In higher customer balances, less overdraft is a result [indiscernible]

Thank you. Our next question comes from John Moran from Macquarie Capital. You may begin.

I just want to follow up on the mortgage banking stuff. It sounds like about $750,000 or so in OpEx is not quite breaking even. Jim, I think in your prepared remarks you said that you expect that to still be a solid contributor to fee revenue this year. Is the expectation still that it would be EPS accretive and chipping in on the bottom line, too? Or is this going to run as a breakeven business this year and then chip in, in 2016?

I'm sorry for not being clear. I think it will be net income positive by the end of the year, just going slower than you thought this quarter.

That's helpful. Then just wanted -- wondering if you guys -- on the OpEx run rate it sounds like there was some wintry stuff that went on there and maybe some additional provision for unfunded commitments. So if I am reading you right, it sounds like you think you can chip away at that run rate; and then you've got some help from branch saves coming in here too. Just wondering if you could put a finer point on that for us.

I think that’s fair, John you are from Boston, right?

Well, I grew up in New Jersey.

A month ago we still had three inches of ice on the lakes around here. So it was kind of long and tough sledding.

Yes that was very expensive at $700,000 snow removal, this was a headwind, obviously one more months won't have that headwind. But the other piece what you are mentioning is we have increase lines in that increase utilization, so that’s just an aspect we make every quarter. So reserve is a bit expense because we not sponsor expense but it's representing good trends of underlying so that’s all positive.

The other housekeeping one that I had was just if you had an update on the energy book. I know that there was some movement in the one that was the one larger one that was hanging around. But I think last quarter small and healthy with round numbers, $60 million in loans outstanding or something like that, and $150 million in commitments. Any update on that?

No, real movements there and obviously one of the credits that we had some charge offs on was the one standing company we talked about that’s really, that shallow well servicer and we have charge offs against that account this year or this quarter that we previously reserved.

Okay but no real movement in terms of concentrations or commitments or anything like that?

I don’t believe so no.

Okay, last one from and I'll leave you guys alone. The LPO success in Cleveland, do you guys intend to maybe take that and put it into other markets and if so is there places with that kind of soft circle?

Yes we like to do that and we've looked at Columbus market, it’s just the market we are familiar with and we know well. And we've done a couple of loans there on the commercial real estate side. So we have nothing for certain but we're looking in that market. The talent is more important than the timing.

[Operator Instructions] Our next question comes from Collyn Gilbert with KBW. You may begin.

Just wanted to follow up on some of just the movement in credit this quarter. So the 5.6 million, I guess, if we think about it for the energy credit in terms of the charge-off and then the previous reserve that you had set aside, what was the original balance on that loan?

That credit was well north of 10 may be $12 million.

Okay and then the same question on the credit that you have now 3 million that you've got ready to sell. What was the original balance on that credit?

5 million.

Okay. And just in general how should we think about the reserve from here? You guys obviously released some this quarter, do you that can continue or how should we be thinking about that over the next few quarters?

I think in general if you think about reserves, we wanted to get to a place where we have a real run rate where we are just replacing a charge off with reason. So if we get our credit quality and a peer standard in the 20 to 30 basis points range then if get production expense that will approximate that kind of level quarter-on-quarter book. Obviously that's not the actual map that calculation be triple 0 and if you have a quarter that's lumpy, as we see this quarter that’s some of the credit coming to reserve chart that set aside against some trial period and it is going on. But if you want to think about long term kind of rate, we want to get that kind of credit metrics lined up, and that kind of peer level and then the provision expenses for the quarter.

And if you already said this Jim I apologize. But can you offer sort of may be some guidance on where you think an ongoing run rate will be on expenses obviously having come in a little bit better this quarter.

Happy to, last quarter there was going to be split of change that we had 40 million benchmark, we wanted to keep that south of 40 million. And this quarter with even on adjusted basis it came through below, we give that all kinds of detail and all the adjustments you can make it achieve two with operating number in the mid 38 or midpoint this quarter which we are pleased with. But south of 40 million is what we are looking at.

So still that same guidance.

That’s correct.

Our next question is a follow from Bob Ramsey of FBR. You may begin.

Just quick question on the two large credits that you have charge offs on this quarter. The one that was moved to loans held for sale. Is there an agreement or commitment in place to sell that yet and I guess similar question, the energy credit yield took a large charge on, is it still on your balance sheet and sort of what is the timeline to resolution look like on that credit?

On the first credit, we do have an agreement to sell that credit. And then on the second credit the shallow wells driller, just really working through that’s a long time customer of the bank. And just working through that credit closely with that borrower and just making sure that their cash flow can match the amortization we have [indiscernible].

And then shifting to capital, you guys as you mentioned were even a little more active than sort of expected on the share repurchase front. I'm guessing that you still anticipate completing the existing authorization this quarter, and I'm just curious if you all are successful in that regard whether that sort of gets you done for the year or whether you all would evaluate another authorization in the back half of the year?

I think it’s the latter, so I think that clearly we will finish that authorization here in the second probably pretty early in the second quarter, so that will help the average total shares for the quarter, and then going forward we'll just going to take a look at our capital, evaluate whether or not we should use more or we have better use for the capital?

I am showing no further questions at this time. I would like to turn the call back over to Mike Price for closing remarks.

As always thank you for your interest in the company. We look forward to see you in the next quarter. And Jim and I are a phone call away if we can be helpful to you in any way. Take care. Bye-bye.

Ladies and gentlemen this concludes today's conference. Thank you for your participation and have a wonderful day.