First Commonwealth Financial Corporation (FCF) Q4 2018 Earnings Report, Transcript and Summary

Good day, and welcome to the First Commonwealth Bank's Fourth Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. Ryan Thomas, Vice President of Finance and Investor Relations. Please go ahead.

Thank you, Sean. 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 Web site 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. Now, I'd like to turn the call over to Mike Price.

Thanks, Ryan, and good afternoon everyone. In the fourth quarter, core earnings per share of $0.27 reflected margin expansion of 3 basis points to 3.70%; and loan growth was strong at $115 million or 8.1% annualized; core return on assets improved to 1.39% in the fourth quarter; the core efficiency ratio of 57.45% improved as well but was somewhat higher than our sub 55% target; improved credit quality led to provision expense of only $1.5 million. Looking back on 2018, I wanted to begin by highlighting several themes. First, 2018 represents First Commonwealth's sixth consecutive year of double-digit core earnings per share growth. In 2018, even adjusting for the change in the tax rate security gains, core earnings per share was up double digits again year-over-year. Second, our deposit franchise continues to be a strength of the Bank and provides stable low cost funding. Additionally, as interest rates increased over the last 12 months, our deposit franchise proved resilient as a commercially anchored base, loyal consumers and disciplined pricing kept our deposit betas under control. Third loans grew 6.7%, including the Cincinnati acquisition in 2018, but there is a little more to the story. Simply put, our portfolio has become more granular and our key credit quality metrics are at the best levels in over a decade. Fourth, our noninterest income was upset substantially year-over-year. Our few businesses for next year of strong note to include SBA, mortgage and wealth. Fifth, on the heels of four successful Ohio acquisitions, we've built a capable commercial banking franchise and engine for future growth in each market. We are seeing strong traction in Northern Ohio, Columbus and Cincinnati in both loans and deposits. Building on several of these 2018 themes with a little bit more detail, for the full year of 2018, net income of $107.5 million was a record for First Commonwealth and produced core earnings per share for the year of 110 and the core ROA of 1.44% and the core efficiency ratio of 57.15%. Loan growth of 6.7% occurred despite significant larger loan payoffs. Loan growth was balanced in 2018 between commercial and consumer loans. I was coming through our 2019 forecast prior to the call and the largest single growth category in 2019 is C&I lending. But also mention that provision expense for loan losses totaled $12.5 million in 2018 as key measures of credit quality, including delinquency, non-performing loans and classified loans were among the lowest year-end figures at the Bank in over a decade. For example, over the four quarters of 2018, the ratio of non-performing loans to total loans declined steadily from 1.06% to 0.81%, to 0.70% and finally, to 55 basis points at the end of the fourth quarter. Similarly, our classified loans failed from 10.89% of risk-based capital at the end of the first quarter of 2018 to 4.49% at year end. Just a few other noteworthy items for 2018. Yesterday, we announced an 11.1% increase in the dividend from $0.09 to $0.10 per share. In May, First Commonwealth Bank issued 10 year and 15 year subordinated debentures notes each totaling 50 million. And the Bank received an investment grade rating from S&P during that process. During the fourth quarter, we also announced and completed $25 million stock buyback. Lastly, our mobile banking Bill Pay and online utilization at the end of the 2018 were all above the 75th percentile of our peers in penetration. In summary, we are pleased with company's progress to a high-performing bank and are excited about our prospects in the years to come. Catalyst for earnings growth in recent years have included four well executed acquisitions, aggressive cost takeout and subsequent reinvestment in talent, digital and new platforms for growth and also the build-out of a strong independent credit and enterprise risk platforms. We believe First Commonwealth is well positioned to fulfill our mission and to grow and prosper as an organization, and we're even more excited about the next five years than the last five years. And with that, I'll turn it over to Jim.

Thanks Mike. Fourth quarter financial results were favorable, but fairly uneventful. I do, however, have a few minor technical things to note. First, as Mike mentioned, the margin expanded by 3 basis points consistent with our previous guidance of gradual quarter over quarter margin expansion. Non-maturity deposit betas remained in control at 20% in the fourth quarter and 25% for the full year. And loan replacement yields are positive across the board for an effective loan beta of 60%. Purchase accounting contributed 5 basis points to the net interest margin in the fourth quarter, unchanged from the prior quarter. Second, we not that non-interest income, excluding securities gains was up appreciably year-over-year. There was a change in revenue recognition accounting rules that affected the whole industry in 2018 that in our case suppressed non-interest income by approximately $3.4 million in 2018, $2.5 million of which hit the insurance and retail brokerage line. Now, the accounting change depresses non-interest expense by the same amount, and so it's a wash to the bottom line but it does affect the year-over-year comparisons with fee income. After adjusting for this accounting rule change and for securities gains and even for gains on the sale for non-performing loans in the second and fourth quarters, non-interest income was up by $6.7 million over last year as the fee businesses contributed significantly in 2018. Third, our fourth quarter results reflect $1.7 million relief of specific reserves related to the successful resolution of the C&I credit in early January. I would note that because the C&I payoff came in the first few days in January, we were able to true up the reserve to 12/31 and release $1.7 million in excess specific reserves in the fourth quarter that have been provided for in previous quarters. But the loan remained on the books at 12/31 with a balance of approximately $6 million. That loan balance is, therefore, included in the 12/31 non-performing loan totals and asset quality ratios. The full balance will be deducted from non-performing and non-accrual loan balances and reserve coverage ratios in the first quarter. Finally, hospitalization expense was up by $1.3 million from last quarter. Our hospitalization expense tends to run about $2 million per quarter and it was $3.4 million in the fourth quarter. We often see a spike in hospitalization expense in the fourth quarter after deductibles are met and on top of that we have some additional shock claims in the fourth quarter. As is our custom in the first part of the year, I would like to take a moment to provide a little bit of guidance for you as to the financial trends we expect to see for the year ahead. First and most importantly, in terms of the net interest margin, we reiterate our guidance that we expect to see slow and steady quarterly improvement. For some time now, the Bank has been markedly asset sensitive as we position the balance sheet to take advantage of the rising rate environment. Our interest rate risk position for 2019, however, means more toward neutrality or mild asset sensitivity rather than strong asset sensitivity. The reason for this is a mortgage platform that we launched several years ago, which is now at speed and generating longer-term asset, about half of which are sold and about half of which are made in our portfolio. Not only does this create a barbell counter weight to our short-term LIBOR-based commercial and variable loans, but it also adds an incremental layer to the balance sheet that is very liability sensitive, which is enough to move the entire balance sheet to neutrality. In fact, when we’re preparing our budget toward the end of 2018, our third-party rate forecast were still calling for rate hikes, and we noticed that our projected financial results were almost completely unchanged when we ran our models with no hikes at all. For the record, our third party rate forecast now calls for two hikes in the second half of 2019, which seems to have to be much more reasonable. Beyond the margin, I will quickly mention a few other items that you may find useful. We continue to expect loan growth in the mid-single digits and are optimistic that a slowdown payoffs compared to 2018, combined with some measure of mortgage retention will contribute to our ability to achieve that growth. We expect deposit to be commensurate with loan growth consistent with our recent experience. In terms of deposit betas, we are forecasting increased deposit betas compared to our recent experience and that assumption contributes to our asset neutrality. We have been fortunate to hold the line on beta to this point and at some point in the cycle, it's reasonable to think that the pace of betas will pick up if rates continue to rise. Of course, if rates don’t rise at all, beta assumptions will be in a relevant concept. But we believe that market competition for deposits is likely to persist for sometimes even without rate increases, putting pressure on the margin that could blunt the impact of positive loan replacement yield. Operating expense that is non-interest management expense less intangible amortization should be in line with the fourth quarter at about $49 million to $50 million per quarter. The increased revenue from the slowly expanding margins should bring the efficiency ratio down below our 55% target by the end of 2019. Fee income is expected to grow modestly at approximately 2% to 3% over adjusted 2018 levels. Mortgage gain on sale is expected to increase only modestly as we continue to retain approximately half of our mortgage projection on balance sheet in 2019. We expect SBA gain on sale to continue to build momentum, while swap income is actually expected to decrease slightly as fewer customers take advantage of the opportunity to lock in fixed rate in the higher rate environment. We expect credit expense to be in line with long-term averages as reduced expense reflecting our improving asset quality is offset by provision expense to loan growth. And finally, our effective tax rate stands at 19.2%. And with that, we will take any questions you may have.

We will now begin the question-and-answer session [Operator Instructions]. Our first question comes from Frank Schiraldi with Sandler O'Neill. Please go ahead.

Jim, you mentioned the margin. You talked about how many rate hikes are baked into it. But it sounds like it doesn’t really matter all that much how many we get so your guidance for slow and steady quarterly improvement. Is that still would you say along the lines of 3 bps a quarter?

Yes, that’s about right, Frank. 2 to 3 bps a quarter seems about right to us. In any given quarter, it's hard to predict it with perfection but that's what we expect.

And is that core to the purchase accounting offsetting any of that?

Not much. The purchase accounting like I said was 5 basis points, last quarter it's 5 basis points this quarter. I did actually look at the exact number this quarter, it declined by a grand total of $68,000 quarter over quarter out of Bank that has several hundred million of spread income. So it has almost no effect out of that number, there's almost no effect.

So on a linked quarter basis, you expect the variance there to be pretty small it sounds like?

Yes, I think it ends up being around to less than 1 basis point of margin of per quarter of NIM fade out.

And then just lastly just obviously nice to see the dividend increase and you completed, sounds like from Mike's comments the buyback that you just put in place. So how do you think about buybacks from here? How do you think about additional authorizations and the stock level here for buybacks?

I think we'd like to be in the market with the buyback to be opportunistic from time to time. But our first preference to deploy capital is organic growth and then other as we have demonstrated in the past smaller accretive opportunities that are both strategic and accretive in the first year of the acquisition.

That's exactly right. We see smooth steady increases in the dividends and returning capital to shareholders in the form of buybacks to be an effective way to manage capital. But as Mike mentioned, our first preference is always organic growth or acquisitions we just can't -- plan the acquisitions as they come when they are available.

And our batting average on acquisitions is we probably have looked at 25 to 30 things Jim to do before, so we are pretty picky.

I mean, as you certainly got pretty aggressive on the buyback in the fourth quarter. So is it fair to say if prices got back down to where we saw in December that you would get again more aggressive on the buyback?

No, I don’t know. First of all, we don’t have any buyback in place and nothing to announce in that speaking hypothetically about buybacks and our philosophy in the future. The fourth quarter was a real opportunity given the reaction to the third quarter earnings releases, so we saw that as a real buying opportunity. And of course that helps our -- getting the shares out of circulation, helps our share count and our earnings per share for both the fourth quarter and the full year 2019. But I think we would probably be a little less aggressive on future buybacks if we go down that road in the future at some point. It’s a little bit like you are saying Frank being really having some dry powder at some point to be able to buy on stock bps, that’s what if the price were to go down from here, you would want some authorizations so you could buy on that but again, speaking clearly hypothetically. I would note by the way just for the record our pricing which we did to repurchase for the fourth quarter was $13.56 average price and I think that’s actually a little less than we're trading for that.

Our next question comes from Steve Moss with B. Riley FBR. Please go ahead.

This is Zach Weiss from Steve's team. Thank you for taking the question. I guess first one on the loan to deposit ratio. Just curious how high you all are willing to take that if we end up getting loan growth in excess of deposit growth, and would funding for that come from securities or wholesale funding in your mind? Thanks.

We look to keep pace with loan growth through deposit growth. We haven't been extraordinarily aggressive with CDs and time deposits, so we have that a bit in our pocket. Our time portfolio is probably undersized relative to our peers. We have a nice commercial base of deposits and that's really where we are focused on growing.

And then on credit, I may have missed it when you touched on this. But how should we expect the loan loss reserve to trend from here in 2019 and maybe the incremental credit costs from the provisioning if we’re going to get outsized C&I growth in the upcoming year?

It'd probably trend a little higher. And I mean it dipped somewhat but as Jim mentioned, we had some clean up in credit in the fourth quarter. And our numbers like a reserve coverage and other lead indicators look as good as they've looked in a long time.

Our next question comes from Russell Gunther with DA Davidson. Please go ahead.

Wanted to circle back to the margin discussion, I appreciate your thoughts on the outlook for '19 and hear you loud and clear on some of the mortgage retention, but as you think of that mid-single digit growth. Could you share with us your thoughts on the mix of that growth be it C&I, CRE throughout the portfolio? Thank you.

As we look at our plan that we put together and just presented to the board a month or so ago, probably the largest proportion of that growth mid single digit is on the commercial side and the largest proportion of that is C&I lending. And that’s really across the board it's everything from a dealer floor plan, SBA. The smaller end of C&I up through what we call middle-market. So that’s our focus and that’s really been our focus as we build commercial franchise and a chassis on top of the acquisition opportunities in Ohio. And we also on the other side of the ball on the retail side will do, I think we'll do a job again in mortgage and our branches have really made terrific progress with their loan productivity and what used to be running away from us in a little negative, a bit right at the ship there. And it's neutral to growing slightly, so that's pretty much the whole gamut.

And then on the fee side, the 2 to 3% growth off of adjusted. I saw that the SBA was up a little this quarter. If you could you share with us what the dollar amount was in 4Q18 and what you're expecting within that vertical from a fee perspective?

Yes, I'm looking at the origination number I’m not looking at the income numbers. So forgive me.

We may have to get back to you on the question. I am not sure I have the actual breakout exactly right now.

And then just last one for me on the expense side of things. I want to make sure I heard you, the $49 million to $50 million a quarter excludes intangible amortization expense. Correct?

That’s correct.

And then the 55% to core efficiency target is something you would expect to reach by the end of '19, or would we be able to post 2019 full year 55%? Just how should I think about that?

The former, not the latter.

Yes, by the end of…

Okay, great…

So just to be clear, by the end not [Multiple Speakers]…

Our next question comes from Collyn Gilbert with KBW. Please go ahead.

Mike, if we could just talk a little bit more about the favorable C&I growth that you're seeing and the optimism that you have surrounding that segment. How much of your anticipated growth in '19 is from current customers coming back into the fold or new customers? And I know you offered that Ohio, you're seeing some good opportunities. But are there any other geographies too that are driving some of the favorable results that you are expecting this year?

We are just seeing pretty good pipelines and growth that built throughout the year in Ohio. We also saw nice growth unusually in our community PA markets, particularly on the smaller end of the C&I portfolio. And just this is more tactical, I think Jane Grebenc and team are just doing a lot of things like blitzes, calling, it's fairly tactical I think in terms of how we are getting results and winning on both the deposit and the loan side. I don’t know if that’s helpful, Collyn.

It is helpful. And then also, I don’t know Jim if you have a dollar amount of commercial loan pay downs that you guys saw throughout '18 or even in the fourth quarter.

Yes, I don't know if we did it, I would disclose the exact amount. But I can tell you for commercial loans with little bit a crescendo in the third quarter and then it came down in the fourth quarter. And I'll rattle off these numbers for you. This is the quarterly progression in commercial loan pay downs going quarter to quarter; 241 in the first quarter; 190 in the second quarter; 311 in the third quarter; and then now to 262 in the fourth quarter. So slow down on pay and commercial payouts really did help enhance our loan growth rate in the fourth quarter.

You have also saw some construction loans and some draws on existing loans that really helped and again the Ohio markets kick in.

And then, Mike, could you just give us your thoughts on the M&A environment? I mean, you guys obviously have been very active there. And how you see opportunities unfolding as it relates to M&A in '19?

We did not see a lot of add backs in 2018. It's really that simple. Just a few things, we saw some national opportunities which were not our cup of team. Ideally, it would be in our geographies and perhaps an overlap and a little bit of a takeout or a slight expansion in the contiguous market, which would be natural for us. But other than Foundation Bank in Cincinnati in the first half of the year, there didn't seem to be much out there in our backyard. Jim, anything you want to add?

No, I think that’s exactly right. It’s a continuation of our previously reiterated M&A strategy.

So it will be, I mean, the expectation is M&A will be -- you're anticipating it to be fairly quiet going forward?

It is hard to anticipate, it's opportunistic. We're looking for opportunities within our markets for our overlap acquisitions. The depositories or we could take our costs growing contiguous circles around our current markets so that we can reach to far geographically. Its consistent messaging out for a while, it just depends on those things to come up for sale.

I mean, to go and make a call on a customers, none of us need to get on a plane. We could drive and get back the same day and we know the markets and so that’s -- for better or worse that’s been a focus of ours.

And then just one last question. Have you guys seen any impact or do you anticipate any impact in the first quarter from the government shutdown?

Little bit, bear in mind that we have talked about that with some of our customers through our branch network trying to give a few individuals that might have been affected by the shutdown. But it's all anecdotal. We want to be -- that makes us responsive with those customers, but none of that affects financial results.

I don’t believe so. I think with the marketing function and the commercial functional really set up a nice hot line. And we probably had several dozen calls where we were handing consumers and businesses one by one that were impacted by the shutdown. And so we were responsive, I was really proud of the team. We watched SBA lending closely as well, because that would obviously be more impacted.

Right, some of that affects our ability to sell the SBA loans, the guaranteed portion of SBA loans during the shutdown. Speaking of SBA by the way, I know -- so let me return to that question from the earlier call about the amount of fee income from SBA loans is about $0.5 million in the fourth quarter, so that’s from zero a year ago quarter. So it's expected to grow from there.

[Operator Instructions] Our next question comes from Daniel Cardenas with Raymond James.

Really most of my questions have been asked and answered, but just want to get a sense. I appreciate the color on the non-performers and the clean up that we can potentially expect here in Q1. But can you give us maybe a little bit of color as to what you're seeing on the watch list. Are there any trends out there that are beginning to concern you? I mean credit metrics have been very good for a while and we've seen some improvement throughout the course of '18 for you guys. But is there any sense that maybe we’re hitting a tipping point in your operating markets?

I can't resist. We have our Chief Credit Officer here. Brian, any comments from you?

We continue to track, monitor and manage credit risk within the bank. Our watch list is actually down quarter-to-quarter. And we continue think our portfolio is well behaved and well marked.

And on the buyback, was that towards the end of the quarter?

No, we've actually done shortly after we came out of blackout after the third quarter earnings release. So, I think by rule we have to out of the market for two trading days after earnings release. And we are given the price drop we were in the market the third day. So it was executed in basically in the middle of quarter.

So, then as I think about a weighted average share count for you guys, what would be a good number to use?

We might have that. We will have a share for the fourth quarter.

With that full quarter number, are we good for '19, I guess is what I'm asking.

Yes, that would.

All right, thanks guys.

Let me just go back and clarify that. Really the fourth quarter average continued at but by the end of the period, you could just carry the end up period. I mean because they're no issuances or buybacks in the 2019. So just took out the fourth quarter year-end share count number for you, number for 2019.

There are no further questions in the audio queue. This concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Mike Price President and CEO.

We just appreciate your interest in our company. And Jim and I and others are a phone call away if we can be helpful on questions about our performance. Thank you very much.

The conference has now concluded. Thank you for attending today's presentation. And you may now disconnect.