First Commonwealth Financial Corporation (FCF) Q3 2018 Earnings Report, Transcript and Summary

Good day, and welcome to the First Commonwealth Financial Corporation Third Quarter Earnings Conference Call. [Operator Instructions] Please note, today's event is being recorded. I would now like to turn the conference over to Ryan Thomas, Vice President of Finance and Investor Relations. Please go ahead, sir.

Thank you, Rocco. 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 a slide presentation on our Investor Relations page, with supplemental financial information that may 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 phone call to your questions. For that portion of the call, we will be joined by Jane Grebenc, Chief Revenue Officer and President of First Commonwealth Bank; Brian Karrip, our Chief Credit Officer; and Mark Lopushansky, our Chief Treasury Officer. Before we begin, I would like to caution listeners that this conference call will contain forward-looking statements. 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. Today's call will also include non-GAAP financial measures. Non-GAAP financial measures should be viewed in addition to, and not as an alternative for, our reported results prepared in accordance with generally accepted accounting principles. A reconciliation of GAAP to non-GAAP operating measures can be found on top of Page 13 of today's slide presentation. And now I'd like to turn the call over to Mike Price.

Thank you, Ryan. Net income for the third quarter of $25.1 million produced earnings per share of $0.25, a return on assets of 1.3% and efficiency ratio of 57.8%. 2018 year-to-date financial performance through September, as compared to the same period in 2017, is up impressively in virtually every key line item and performance indicator. So include a 31% increase in pre-tax net income to $100.2 million. Jim Reske will elaborate further on the financial picture, with a few brief thoughts on the third quarter follow. Although the stated net interest margin quarter-over-quarter dropped 3.67%, the one-time items that Jim Reske illuminated last quarter point to a margin that we expect will remain buoyant in a rising interest rate environment. Deposit betas, up 20% in the third quarter, improved from the prior quarter. At the same time, we had another good quarter of deposit growth. Loan production is at record levels in both the corporate bank and the consumer categories and will easily top $2 billion in 2018. However, commercial loan payoffs are up appreciably, resulting in modest organic loan growth for the year. These payoffs are largely attributed to activities in our corporate C&I and commercial real estate portfolios. Private equity firms are eager to put capital to work and M&A activity has ticked up, they both resulting in several commercial clients finding new ownership structures. While this has certainly curtailed our net loan growth this quarter, we're particularly pleased with the loan and deposit traction we're seeing in the more granular and lower end of our commercial banking and small business segments. This has been an area of focus for us in recent years, and it was very encouraging to see these commercial segments be able to come back to large payoffs we saw this quarter. By way of geography, most of the volume came for our new markets in Ohio, which are proven to be very receptive markets for a business-friendly, community-focused bank of our size. By having completed four smaller Ohio acquisitions in the last 3 years, the team and I are also pleased with our initial deposit retention and now growth in our northern Ohio, Columbus and Cincinnati markets. Our community Pennsylvania market has been resilient and growing as well. First Commonwealth banks core depository has provided a nice low-cost source of funding through this economic expansion, consider some 40% of core deposits are from our community PA market, which is comprised of rural geographies in smaller towns where customers have been very loyal. In fact, this market is the largest single-deposit we're in the company. A relatively large percentage of deposits at 25%, are from noninterest-bearing checking accounts. Our bank has a strong commercial depository with 66% of our noninterest-bearing checking in business categories. And with $809 million in CDs, First Commonwealth has only 14% of deposits in time categories, which we believe is low for a bank of our size. FCB maintains customer-friendly feed positioning with our deposit products, so it's not a nickel and dime a predominantly working-class customer base, building customer loyalty and retention. The team is clinical with deposit pricing and will often test price elasticity with specials that have volume limits. As the team and I put together our three-years contingent plan, we're focused on continuing a trajectory of strong earnings per share growth to which our investors have become accustomed over the last four to five years. Continuing areas of focus will be continuing to build core funding, particularly on the business side of the equation; building a more granular high-yielding, lower-risk loan portfolio; building competitive digital capabilities that meet the needs of younger households and contribute meaningfully to financial outcomes. Delivering our mission to our business customers and consumers that is, to improve the financial lives of our neighbors and their businesses. With that, I'll turn it over to Jim.

Thanks, Mike. Mike has already provided brief summary of our quarterly earnings, so my remarks will focus on trying to provide additional clarity on the margin in the announced stock buyback. Our net interest margin in the third quarter was 3.67%. As we explained on last quarter's call and in our earnings release, the second quarter stated NIM of 3.78% benefited by a 9 basis points worth of unusual items. That implies that on its face, our NIM contracted by two basis points. Since our previous margin guidance was for slow, steady NIM progression based on asset-sensitive balance sheet, that of course, begs a question of whether our balance sheet is asset-sensitive as we previously expected it to be. In short, we believe the answer is yes. As we described last quarter, the subordinated debt that we issued is only outstanding for a partial quarter and so the net drag on NIM for the sub-debt last quarter was only three basis points. This quarter, the net drag was six basis points, so that accounts for three basis points of NIM compression. In addition, as previously disclosed, the benefit of accretable yield from previous acquisitions phases out at a rate of approximately one basis point every quarter. These two items together accounts for four basis points of NIM compression. So in light of the two basis points of aggregate decompression that we experienced in the quarter, that means that the margin for the rest of the balance sheet actually expanded by two basis points in the quarter, which is consistent with our past guidance of moderate NIM expansion. To be abundantly clear, these two things do not constitute one-time items that can be adjusted away. The sub-debt was a long-term strategic capital decision, and accretable yield will continue to fade out on schedule. But since the margin impact of these two items are relatively stable and the rest of the balance sheet remains asset-sensitive, we reiterate our previous guidance of moderate quarterly NIM expansion in the 3.65% to 3.75% range. There were several other developments with regard to our NIM in the third quarter that are encouraging and worth pointing out. First, the cost of our non-maturity interest-bearing deposits were only rose by five basis points, from 35 basis points to 40 basis points, equating to a deposit beta of 20% in the second quarter. This is consistent of our previous guidance at some of the rate increases that were put into place in the second quarter constituted a sort of quarter-on-quarter catch up in deposit rates for public funds and that we didn't expect to see such rate increases continue in the ensuing quarter. Second, through the Fed's tightening cycle so far, the cost of non-maturity interest-bearing deposit accounts has increased by only 26 basis points in total, from 14 basis points in the fourth quarter of 2016 to 40 basis points this quarter during a period, which the Fed funds target rate has increased by 200 basis points. That equates to a cumulative beta through the cycle so far of only 13%. Third, the commercial NIM to our balance sheet has continued to drive growth in noninterest-bearing deposits, which grew by $16.9 million this quarter. In fact, when you include those deposits to the equation, our total cost of deposits only increased by four basis points in the third quarter. And finally, loan yields increased by 10 basis points in the quarter, exceeding the pace of growth in the cost and deposits. This is driven by continued positive replacing yields in nearly every loan category in the quarter. Beyond the margin, the other significant financial item this quarter is the announcement of a $25 million share repurchase authorization. Our growing earnings per share – our growing earnings power has resulted in significant capital generation, such that our tangible common equity ratio was 9.3% at the end of the third quarter. Our capital philosophy is to manage capital in such a way that the bank is neither underleveraged nor undercapitalized. Our preference is always to deploy excess capital into organic growth or accretive acquisitions and we've done so in the past and will continue to do so in the future. We are also mindful keeping our dividend yield and payout ratio in an acceptable range commencing with peers and hope to be in a position to maintain steady year-over-year dividend increases for many years to come. Along with dividends, we view the buyback as an efficient way to deploy excess capital to our shareholders. Fortunately, the issuance of subordinated debt earlier this year contributed to an increase in our total risk-based capital ratio to 15.1% at September 30th, making the repurchase of common stock possible and giving us the ability and flexibility to manage our tangible common equity ratio into an acceptable range. Finally, the timing of the repurchase program will depend on movements in our stock price. But ordinarily, we would have expected to complete this program over the next few quarters. If our trading range today persists, we could even see completing the program in the fourth quarter of this year. And with that, we will take any questions you may have.

[Indiscernible], operator?

Yes, sir. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Steve Moss of B. Riley FBR. Please go ahead.

Hi, good afternoon everybody. This is actually Zach Weiss filling in for Steve today. Thanks for taking by question. So quick follow-up on the buyback decision, I'm just curious if you all could talk about the rationale of just kind of the decision tree there on thinking about ultimately choosing the buyback as opposed to dividend or saving that capital for M&A?

Yes. I mean, M&A -- this is Mike Price, is been episodic. We've been very thoughtful and careful. We've probably looked at two dozen opportunities and just done four, so that needs are pretty high litmus test for us in terms of earnings accretion and being minimally dilutive to our tangible book value and they're just -- there may or may not be something available, and we want to put the capital to work. Jim, other comments?

Yes. Thanks for the question. Historically, we have preferred to do acquisitions and deploy the capital through that inorganic growth as opposed to share buybacks. And if you look at that last buyback that we have authorized, we had it authorized and then started buying back shares and then we quickly shut that program off when the opportunity to acquire the divested first rates became available. So when those opportunities arise, we prefer to deploy capital that way. So this is really decision to deploy excess capital and part of decision as well is to have an authorization in place for a date like today, in stock price and opportunistically, we can go back and return some shares at a reasonable price.

Okay. That's helpful.

That being said, we're still committed to a dividend payout ratio that's in the range, we've tended to be on the higher end of that range probably over the last five years or so.

Got it. That's helpful context there. And then, in terms of expenses, just curious how we should think about that heading into the fourth quarter and into 2019?

We -- this is Mike. We have been extraordinarily mindful of expenses over the last five or six years and moved our efficiency from 67 to 57 in that time period, and we're just beginning a three-year planning cycle. We'll be very mindful of operating leverage. And I think there's and we have added Cincinnati this year. Jim, there's one item there that's a bit unusual and I'll let you explain it.

Yes. So I just think it's worth clarifying. We mentioned this in our earnings release, but it's probably worth spelling out a little bit. It relates to mortgage banking and related hedging expense, and bear with me for a moment just to clarify that. We got back in the mortgage business in 2016 and have been ramping up production fairly steadily ever since. A few quarters ago, we felt that our mortgage originations had really reached a point where we should be getting a mortgage pipeline hedging program. And the hedging program is relatively recent and it's still getting up to speed to catch up our mortgage portfolio originations. So what you saw in the quarter, the linked quarter was a $1.1 million swing at expense from the second quarter to the third quarter, and that is unfortunate, but that represents kind of volatility that you might expect to see in the early days of a hedging program is stop. From an accounting perspective, the line item actually reflects changes in the combination of the value of both the mortgage pipeline that remains unsolved and the value of related hedges. I believe that would actually the case for any bank that has a mortgage pipeline and a hedging program. Year-to-date, the whole net gain loss for that programs only $78,000, so we think the program is on track. So it just a portion unusual items that affected the expense comparison for the quarter. To get at the core of your question about expenses and our belief, we remained committed to efficiency ratio of 55% or lower. So we are realizing [indiscernible] a little bit in the quarter, but a sub-55% efficiency ratio remains our goal.

Thanks for the question.

Yeah, thank you very much.

And our next question today comes from Russell Gunther of Davidson. Please go ahead.

Hey, good afternoon guys.

Good afternoon.

I wanted to start with some loan growth questions here. Just give us your thoughts heading into the fourth quarter, you mentioned the record pipeline, but how do you think about what that pull-through would look like in the face of some pay-down headwinds?

I think our guidance historically has been mid-single digits. I think that will come to pass hopefully for the year. We're seeing nice traction in the commercial segment, particularly in a group that we call commercial solutions for about $0.5 million dollars loan up to several million dollars. Our payoffs are happening with much larger loans. We also have some nice momentum in small business. Our mortgage and our branch and consumer lending has really turned the corners. So we like what we might see in the next four or five quarters as we look out. We're also seeing a nice pattern of growth in our newer markets that's been pretty pleasing.

And then can you guys touch on expectations for the auto portfolios specifically?

Yes. The auto portfolio has really hovered in this range for probably the better part of four or five years. If anything, over the last two or three years, we've sacrificed volume and really pointed to get the margin of the portfolio up, that's been a focus of ours. I think it might have grown $15 million or $20 million in the last quarter. So that's also been a pretty clean portfolio for us over the last decade really, even through the last cycle. So we really haven't had credit concerns with predominantly our Western Pennsylvania core customer.

Yes. And then ask in terms of balance that portfolio stability, it will be -- we hope a contributor to the targeted loan growth percentage, but it's not in one-off mode, it's also a lot in high-growth mode. Some of the growth we saw actually this recent quarter just communicates that we have a little more pricing power in that portfolio than we have thought.

Okay. Great. I appreciate the color there. And just switching gears to the margin guidance, that sort of 365 to 375 range you guys are recommitting to, could you just flush out for us what is baked in there from a rate perspective?

Yes. Our latest forecast, we actually purchase from an outside vendor, does not call for a rate hike in the fourth quarter, although the figures market seems to be pretty accretive that would happen, so there's odds there. But we also in that rate forecast, we are pretty seeing it's 0.44 rate hikes next year.

Okay. Great. Thank you. And then just last one for me, it's a bit of a ticky-tacky question here, just expectations for the fourth quarter and to the extent you could 2019 on your outlook for the tax rate?

Fourth quarter effective tax rate was 19.1%, and we don't expect particularly a bit that we change very much the next year.

Okay. Great. Thanks so much for taking my questions. That's it for me.

Thank you.

And our next question today comes from Collyn Gilbert of KBW. Please go ahead.

Thanks. Good afternoon, guys.

Good afternoon.

Just Jim, back to the NIM -- your NIM guidance of that 365 to 375, that is I just want to clarify, that's for the fourth quarter or that's for the full year for '18?

That's for the fourth quarter and the foreseeable future. So it's just because we update our guidance every quarter, as we see going outside that range, I'll update it in the next call.

Okay. Got you. And then just more broadly, how are you seeing and I know it's -- they're still just early into the franchise, but just kind of the betas within the foundation franchise, legacy foundation versus what you guys are seeing, any big variances there?

There's a little bit different deposit strategy, a little higher rate. However, Collyn, if you look at Page seven of our supplemental deck, we're just the cost of deposits in the black line, which is really the total cost of noninterest-bearing in time, 13,29 and 33 basis points on a linked quarters and the cost of interest-bearing DDA and savings, just there are a lot of disciplined there. We're not chasing CDs at higher money market rates. We just feel like we have a small business in the commercial piece of our depository, which is about 66% of the noninterest-bearing. Really present a nice position for us as a company. But nothing undue with -- although we didn’t anticipate with either foundation or Central Ohio, we've been in Central Ohio now for going on two years and Northern Ohio about the same.

Okay, okay. That's helpful. And then, Jim, I'm guessing, any change in your outlook or any thoughts on the credit side for how you're seeing things migrating or perhaps, we're now again with foundation on the fold. How you may be seeing future reserves or purging?

Not particularly. I thought it's a fairly ordinary credit quarter. We are actually very pleased that most all of the asset quality metrics improved over the quarter. So that's part of a long-term trend that's very helpful, but nothing in particular. Mike, I don't feel if you want to add anything to that.

I just think we're probably have taken the volatility out of it, since you first came acquainted with this management team. We're taking larger chunkier credits, working them down to maybe 25% or 30% of what they were at the peak and really replace them with now small business, commercial solutions, more direct lending certainly and I just think that pretense well for the credit picture. And we're really focused, Collyn on how will do through the next cycle and that's important to us. In fact, our Chief Credit Officer has done a terrific job and we've asked him to present regularly on that very topic to our Board and that will be a telltale task for all of us.

Okay, okay. That's helpful. And then, just one final thing on targets. Jim, I know you indicated you continued to look at that 55% efficiency ratio or lower as a target. Is there anything else that you can offer us for targets for 2019? I mean, if we just kind of flow through some of what you're saying, it looks like kind of more of a flat earnings year perhaps in 2019. I'm just curious if that's sort of what you guys are anticipating given some of the market dynamics, are there certain offsets there that you think you can really sort to sort of reaccelerate the earnings growth?

No. I guess probably provide a little more specific guidance the next call, which has been kind of our tradition as we start of the year. I'll give you category by category. But I'll tell you, in a general sense, a lot of the guidance, we think, a lot of the way we think of the company is fairly steady progression. We realize it's always not a straight line, it's not always steady quarter-on-quarter. We have some businesses that we're starting up like SBA, that are getting momentum and things like this hedging the mortgage pipeline that caused the near-term volatility. But overall, we see fairly steady growth in the margin, we see fairly steady growth in fee income, fairly stable decline in credit costs. So our loan growth guidance is continuously mid-single digits and if we can achieve that deposit growth, commensurate with that to keep loan-to-deposit ratio under 100%. So that's probably the same kind of story you can hear when I give you more specific guidance next quarter.

And we also like the traction that we have in each market in Ohio, both on the loan and deposit side and the pipelines. We also feel we're reenergized in community of Pennsylvania with good deposit growth this year. And also a good loan growth in the commercial side on the smaller end and I think, I just like the increase in the productivity and the way we're working because functionally as a company, better than ever before, quite frankly.

Okay. That's great. That's helpful color. Thank you guys.

Thanks.

Thanks, Collyn.

[Operator Instructions] Our next question comes from Frank Schiraldi of Sandler O'Neill. Please go ahead.

Hi, good afternoon.

Good afternoon.

Just – let's say I guess, I just wondered if you guys could give I mean, you spoke to credit sort of broadly and just wondered if you could speak specifically, give a little bit of any color you could give on the loans you call out in the release in terms of the C&I credit that was partially charged off? And then the downgrade of the two commercial real estate credits. Just any color, any story there that you can provide might be helpful.

Well, the two credits that I would mention was a Pittsburgh-based technology company that we had a charge in the second quarter -- first quarter. A portion of that was sold and is beginning to work itself out. And then, another one was a manufacturing company in Western PA areas as well, probably the two of the larger ones, Jim?

Yes. And similar are just part of the successful resolution we are able to take these and sell them off and some maybe so happening in the [LLL], we had specific reserves previously set aside against these credits and we're able to use this to offset the charge. And then that just reduces the amount of specific reserves [LLL], which then we replaced the credit provisions. So but I guess, what I would suggest a note from Mike's comments, there's a local credits very different than some of the problems looking back over the years that had banks like us out in market lending is low cost EMI credit.

All right. Okay. But I there were couple the decree credits were downgraded in the quarter or was that [indiscernible] or did that happen previously?

Brian, could you patch that? [indiscernible].

Yes. We moved credits in non-performing, there's receivers in place and we're working out of those two credits. And the C&I credit is a Pennsylvania bank-based distributor. Companies underperformed and we elected to move forward with that credit and move out of it.

Okay. But it sounds like, just in general, again, on credit you guys aren't seeing stress. You feel pretty good. And I think, Jim you even mentioned thinking about stable to slowing credit cost here going forward?

That's right way to think about. We -- let me be clear, we think it's a growing company. We'll always be setting aside provision expense for growth in loan portfolio and then replace charge-offs. So I wouldn't think of it as an absolute decline dollar amount provision. It might -- it will be commensurate of the size of the company and the size of the balance sheet.

Okay. And then, just one other on the TC ratio. I think you mentioned it Jim, I hope I don't mischaracterize, but I believe you might even mentioned on this call that you guys look to be in the 8% to 9% range, if I'm correct? And just kind of thinking about as you accrete capital here to earnings, you obviously have some uses in all of the buyback obviously. But as we see accretion through just regular earnings, should we think about you getting to that -- those sort of levels in the near-term or do you run -- do you think about running a little bit higher here for things like Cecil?

Well, yes and yes. So we generally and do think about capital common equity ratio 8% to 9% range, but I would be clear to characterize that as an informal target. It's not a regulatory target, obviously. It's not a target that is set by our Board of Directors. But our generally feeling as a management team is set, if we were to fall below that range we feel that undercapitalized. And when you start getting above that range, we feel like we're underleveraged and obviously, you would see the impact on our ROCCE ratio. We are thinking very carefully public issue capital to absorb whatever hit comes from a seasonal permutation. So most industry is thinking about that, but I do want to be very mindful that we have a capital in place to do that. We think very particularly about the stock buyback as a use of excess capital as there is only few ways to deploy excess capital, we don't want to accelerate leverage in the balance sheet or doing the kind of synthetic leverage program if we have excess capital. We generally don't see a benefit in special dividends. We want smooth, steady increase to the regular dividend and so that doesn't leave a whole lot of other options in terms of deploying excess capital. We’re ready to absorb Cecil like you said, and then we can stock buyback program just makes a lot of sense for us.

And just if you look at it over the course of the last several years, I mean, regular dividend increases, we've done buybacks regularly and been in the market and we've done smaller, tight M&A with a little cash on the table that's been -- so we expect to continue [was] in the water with all three of those.

Yes. That's right.

Okay. Great. Thank you.

And our next question is from Russell Gunther of Davidson.

Hey, guys. Thanks for taking my follow-up here. Actually, Frank, just hit it on the capital target so I'm all set. Thank you.

Good.

And ladies and gentlemen, that concludes the question-and-answer session. I'd like to turn the conference back over to the management team for any closing remarks.

I always say this, and I mean. I do appreciate your sincere interest in our company and the opportunity to get together with a number of you from quarter-to-quarter. It's important to us. And thank you for all you do for First Commonwealth.

Thank you, sir. Today's conference has now concluded. And we thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day. END