First Financial Bancorp. (FFBC) Q3 2016 Earnings Report, Transcript and Summary

Good morning and welcome to the First Financial Bancorp Third Quarter 2016 Earnings Conference Call and Webcast. 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 Scott Crawley, Controller. Please go ahead.

Thank you, Kate. Good morning, everyone, and thank you for joining us on today’s conference call to discuss First Financial Bancorp’s third quarter 2016 financial results. Participating on today’s call will be Claude Davis, Chief Executive Officer; Tony Stollings, Chief Operating Officer; and John Gavigan, Chief Financial 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 will 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 2016 earnings release, as well as our SEC filings for a full discussion of the Company’s risk factors. The information we provide today is accurate as of September 30, 2016, 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 Claude Davis.

Thanks, Scott, and thanks to those joining the call today. Yesterday afternoon, we announced our financial results for the third quarter. As shown on Slide 3, we had another solid quarter, which is our 104 consecutive quarter of profitability. Consistent with our performance through the first half, the third quarter reflects continued focus on the execution of our core strategy, including solid loan growth, stable net interest margin, positive impact from fee income strategies, disciplined expense management and a steady credit environment. Through the efforts of all of our associates we have experienced an 18% growth in earnings through the first nine months as compared to 2015. In the third quarter we achieved a sub-60% efficiency ratio, a 1.09% return on average assets, and a 14% return on average tangible common equity. End of period loans increased approximately 60% on an annualized basis compared to the linked quarter. While production mix varies from period to period this was a quarter where we experienced strong CRE lending, but also saw elevated prepayments in the C&I portfolio. As we start the fourth quarter we are working hard to build on the momentum in the first three quarters. Though not at that levels we saw during the first half of the year, our lending pipelines remain solid and we expect to achieve our full year loan growth target of high single digits. We continue to see solid credit demand and financial performance from our clients and prospects and expect fourth-quarter production will be biased towards C&I lending. We believe the overall credit outlook across our markets remain steady and conducive to continued growth opportunities. During the quarter we also announced some strategic changes to our senior leadership team. We are confident that these leadership changes will bring impression, size and energy to our business lines and enable us to build upon our track record of success. As we close out 2016 our focus remains centered on serving the financial needs of our business consumer and wealth management clients, while remaining disciplined in our approach. Overall, the company remains well-positioned to continue to grow organically and execute on our core strategies. With that I will now turn the call over to John.

Thank you, Claude and good morning everyone. Turning your attention to Slide 5, we provide a reconciliation of our GAAP earnings to adjusted earnings, which exclude items we do not expect to occur on a regular basis. For the third quarter, adjusted earnings equaled GAAP earnings at $0.37 per diluted share as gains on sales of investment securities were offset by the combination of severance costs, gains related to branch consolidation activities, and a legal recovery during the period. Turning to Slide 6, net interest income for the third quarter was $68.8 million, an increase of $1.7 million or approximately 3% when compared to the linked quarter. Higher interest income from loans more than offset a decline in interest income earned on investment securities and modestly higher funding costs during the period with the decline in income from securities, primarily driven by a lower average portfolio balance as we continue to redeploy cash flows to fund loan growth. Additionally net interest margin was 3.66% on a fully tax equivalent basis, down 1 basis-point from the prior quarter as the shift in our earning asset mix largely offset a modest decline in the yield earned on investment securities and a slight increase in funding costs. Slide 7 details our non-interest income mix. For the third quarter, non-interest income totaled $16.9 million, a $3.2 million or 16% decline compared to the prior period. This decline was primarily driven by lower loss share related income, as well as the decline in other non-interest income, as the second quarter included a $2.4 million gain from the redemption of a limited partnership investment. Excluding these items, non-interest income increased modestly compared to the linked quarter with higher deposit service charges, mortgage revenue, and gain on sale of investment securities being the primary drivers. Of note, we were particularly pleased with the almost 14% increase in deposit service charges during the quarter. This increase was primarily driven by higher commercial deposit fees and reflects our continued focus on growing fee income. Turning to Slide 8, non-interest expense increased $1.7 million or 3% from the linked quarter to $51.1 million. Third-quarter expenses included approximately $800,000 of employee exit costs, $200,000 net benefit from branch consolidation activity, as well as adjustments to compensation accruals based on our year-to-date performance. Excluding these items, non-interest expense was inline with our $50 million quarterly run rate and our efficiency ratio remained in line with our targeted range of 55% to 60%. Slide 9 depicts the loan portfolio product mix as well as the drivers of our linked quarter growth. As Claude mentioned, loan balances increased 6.2% annualized during the period with growth coming primarily in the investor CRE space. Given the recent regulatory focus on CRE lending, I will note that we remain well below the 100% and 300% regulatory thresholds. As shown here, our loan portfolio remains well-balanced and we will continue to manage below those thresholds going forward. Turning to Slide 10, credit quality remained stable. Provision expense declined during the quarter on slower loan growth and lower net charge-offs, while nonperforming assets and classified assets declined modestly and the allowance increased slightly. Overall we remain pleased with the performance of the portfolio and the efforts of our credit team. On Slide 11, our capital ratios remain robust and benefited from another solid quarter of earnings. Finally, on Slide 12 we provide an update on our thoughts regarding the balance of 2016, including fourth quarter and full-year loan growth in the high single digits, continued stability in our net interest margin consistent with our year-to-date performance, non-interest expenses are expected to remain flat at approximately $50 million and a full year effective tax rate of approximately 32.5%. This concludes my remarks, and I’ll now turn the call back over to Claude.

Thanks John. And, Kate, we’ll be happy to open the call up for questions now.

[Operator Instructions] The first question comes from Scott Siefers of Sandler O’Neill. Please go ahead.

Good morning guys.

Hi Scott.

Good morning Scott.

Claude is there something you could just expand a bit on your thoughts on the overall lending environment, you suggested [Indiscernible] correctly, lending pipelines are still good, just not as robust as what we have seen earlier this year, which sounds pretty consistent with what we are hearing from others, by the same token no real change to the overall guidance except maybe just a little softening, just curious if you can kind of expand upon the thoughts you offered in your prepared remarks.

Sure Scott. No, I think the - your commentary there describes it pretty well. I mean the first half of the year was very strong. We had a second quarter growth rate of close to 14%, which as we said then we didn't expect to continue at that level. Third quarter was a little softer, but still at 6% in our mid to high single-digit expectation of what we see long-term, I think as we go into the fourth quarter, as I have mentioned and you described is solid, John talked about high single-digit for the fourth quarter and full year, which is what we are thinking. And we are seeing obviously a good steady growth across the product lines. The one thing I would just note on the environment is we have seen both during the second quarter and third-quarter, and we expect to continue in the fourth quarter some prepayments on the C&I side, mainly due to acquisition. We are seeing a lot more M&A activity in the private company space. So, when that occurs with one of our clients, it is ggood for them, but obviously we see a loan pay down. We also expect over time and the fourth quarter is probably one of those, where we see similar activity on the commercial real estate side, where projects stabilize and our borrowers then tend to liquidate or sell or go to the permanent non-recourse market. So all of those things are going on right now. We still view it as a very healthy lending market, but absolute growth rates will vary from quarter-to-quarter.

Okay. That is helpful color. I appreciate it. And then maybe switching gears there just a little to the margin [Indiscernible] increased - that rate increase I should say in the fourth quarter, I imagine probably not much movement one way or the other, and not much impact one way or the other to the margin, but maybe you can just sort of refresh your thoughts on what the company’s rate sensitivity looks like and how you repositioned it for if that does more later on this year?

Sure Scott. This is John. I will take that one. Based on our modeling, we are currently estimating approximately $2 million to $2.5 million annualized increase to net interest income from a 25 basis point rate hike. I will note there that assumes we hold the line on managed rate deposits, which we would expect to do.

Okay. That is perfect. Thank you very much.

Thank you.

The next question is from Jon Arfstrom of RBC Capital Markets. Please go ahead.

Hi, thanks. Good morning everyone.

Hi Jon.

Good morning Jon.

Just maybe a follow-up to Scott’s question on loan growth, and more on the CRE side, thanks for pointing out the concentration piece of it, but maybe if you could touch on commercial real estate pricing because we have heard some different things. Some say it is getting a little bit better as other heavily concentrated banks back off, others say it is still tight, maybe comment on that and then just in terms of your overall appetite to keep CRE growing?

Sure Jon. First of all, I would say pricing has moderatedall and I think with the regulatory focus on it we think we can do better on pricing. So, I would say it is stable to kind of upward in terms of the possibility, but every deal stands on its own because of the quality of the sponsor. In terms of growth rate as we put here, I would just describe our strategy right now as we have moderated our construction lending. We feel like the concentration levels we are at are a good level to maybe even over time seeing those declines on the construction side. Not because we are worried necessarily by credit quality, but we have seen a shift there where we see more deals go from construction to permanent market much faster, and when we see that the profitability for the bank is not nearly as high. So, construction lending I think you will see moderate to possibly decline. Now it will jump around from quarter-to-quarter because of withdrawal rates and funding rates of our existing commitments, but in terms of new origination that is what I would expect. On the overall CRE portfolio, as we pointed out here, we are at about 227% of total capital. We think we have still got some room to grow that, but we will be well below the 300 and will grow at what we think what are the right sponsors and the right projects.

Okay that is helpful. And then just on the - back on C&I, would you say - is it more about the pay downs or is it just kind of a change in mood or cautiousness overall, does that make sense? I know you touched on it a bit with Scott, but is there one side that is tipping the scales more than the other?

Yes, it is a good question Jon. I would say it is - we saw in the third quarter less activity overall. So, in the first and second quarter it was very active, so we saw some slower activity, but what impacted the fact that we were relatively flat in C&I were some larger prepayments. The other thing I would point out is that there are some seasonal activity there, so as an example, Oak Street is more heavily dominated in the fourth quarter activity versus especially second or third-quarter activity. So that tends to be a slower period for them. Finally I would say that I think we have seen some slower activity through the summer months, and it is hard to know whether or not that - what that was related to because of such a short period of time, some say maybe the election, maybe it is just such a strong second quarter that we saw a lot of that front-loaded, so it is really hard to tell. I'm anxious to see how the fourth quarter and the first quarter activity shapes up. I would put all that though in the context that our clients continue to perform well. So their business is good, profitability is good. So on that context I feel - I am optimistic but we want to see the activity come back.

Okay. And then just one quick one for either Tony or John, we have talked about this in the past, but how much more room - just thinking about overall balance sheet growth, how much of that earning asset mix shift room is left on the balance sheet, kind of out of securities and into loans?

Yes, Jon, I think as we have talked about in the past, the securities portfolio today I think it is just under 22% of assets. We will vary that over time depending on the opportunities we see on the loan side, but, probably target range, we generally like to see it 15% to 20%, so we will continue to manage it somewhere around that range just depending on the opportunities we see on the loan side?

Okay. Thanks guys.

Thanks Jon.

The next question is from Erik Zwick of Stephens. Please go ahead.

Good morning.

Hi, Erik.

Good morning Erik.

First just on the loan-loss provision, last quarter you suggested that the provision would be reflective of loan growth and potential credit developments, given that the third quarter provision was quite a bit lower than the second quarter, can you just talk about the factors that went into determining the provision this quarter?

Sure Erik. I think if you look at the loan growth we had in 2Q versus the loan growth here in 3Q, you see that was certainly a factor in the decline in the provision expense, and then also in 2Q we talked about the increase in provision expense during the quarter. It was really roughly equally driven by the strong loan growth we saw that period as well as the increase in classified assets. So here in the third quarter, classified assets ticked down modestly. So really it was a function of slower loan growth, net charge-offs were very low, and we did not have a similar increase in classified assets there. So there was relatively little to no impact to provision there.

Got it, and then looking at your capital ratios after declining for a number of quarters, they ticked up slightly in the third quarter. What are your thoughts on the appropriate level of capital today and also deploying capital for growth versus returning it to shareholders via dividends or buybacks?

Yes, this is Claude. I will make a comment and then let John kind of fill anything in. We have talked about before that we have kind of three target ratios that we look at. The two most significant though are the tier 1 to total that we target. This is not a minimum or a maximum. We target [2.5] and at [10.20] in the third quarter we are slightly below that level. Total capital we targeted 12.5. We are slightly above that ratio. So, the combination of that we feel pretty good about where our ratios are at. Obviously our dividend is still at a high 2%, 3% type yield, which we feel like is also a good fair return to shareholders, but as a board we look at that dividend level every quarter and evaluate it. I don't know John if you would add anything to that or not?

Yes, I would agree with those comments. We think we are at or near our capital targets. We are managing accordingly. I do think over time we would like to see our tier one capital ratio kind of rebuild a little bit higher up towards our target there. And when we saw some of that this quarter and the other thing that I would just say, as Claude mentioned, it is a discussion we have with the board every quarter. But it is a balance between retaining capital to support future growth opportunities versus the dividend and we make that evaluation on a regular basis.

Great. Thanks for taking my questions.

You bet Erik. Thanks.

The next question is from Andy Stapp of Hilliard Lyons. Please go ahead.

Good morning.

Good morning.

Good morning Andy.

Was the increase in commercial deposit service charges driven by a pricing increase?

Andy it is Claude. We have updated our pricing which we do annually, and one of those was an increase in some commercial pricing as well as we continue to see new account growth.

So is that - is Q3 level a good run rate?

Yes, I think Andy, we are happy with the performance we saw this quarter on deposit service charges and some of the fee income strategies we have talked about in the past. We still think we have some opportunity here and we have some additional strategies that are under evaluation, but it is going to take some time for things to play out and demonstrate sustainability in run rate. But again we are pleased with the early returns we are seeing there.

Okay. And is the 32.5% guidance for the Q4 tax rate a good run rate for 2017?

Andy we are in the middle of our 2017 planning currently. So we will come out with some more guidance on 2017 in our January call and we will speak to that then.

All right, and how much of the - how much was the incentive comp adjustment in Q3?

Andy, we don't give a number on that. I would just - the point I was trying to make in my earlier comments was just that given our year-to-date performance through the first three quarters there was true up for the first half of the year there to a higher level there. And if you exclude that as well as the other non-operating expenses that we called out on Slide 5 we were right in line with our $50 million guidance.

Okay. That is helpful. Thank you.

Thanks.

The next question is from Chris McGratty of KBW. Please go ahead.

Hi, this is actually Kelly Motta on for Chris McGratty. Thanks for taking my question. I think most of my questions have already been asked, but I guess turning back to capital and priorities - capital deployment priorities, I was just wondering given where your trading up two times tangible book, I was wondering how - where strategic M&A fits in with your capital priorities and if you are seeing any increase in conversations or interest? Thank you.

Sure Kelly. Thank you. We think about M&A really not in the context of so much stock price as we do our focus on first strategic fit and does it make sense for us and our long-term franchise value. Second is it operationally feasible and does it make sense for us to be able to execute on a deal, and then third we look at the financial elements, and that is really where our current stock price comes into play, as well as what the target we maybe expecting, what our earn back period is et cetera. So, it is one piece of one factor that we take a look at. As I have mentioned I think in last quarter’s call or maybe the one before, right now we are predominantly focused on organic growth because we feel good about the operating leverage that we are getting from organic growth. We continue to look at opportunities and certainly if the right strategic one comes along we won't be afraid to - as we have done in the past to pull the trigger. So that is how we think about it. Our focus on the capital side is really first on supporting organic growth as a company.

Thank you.

[Operator Instructions] The next question comes from Daniel Cardenas of Raymond James. Please go ahead.

Hi, good morning guys.

Hi, Dan.

Good morning Dan.

Just - maybe some - your quick thoughts on the competitive nature on the deposit side, and then maybe where do you kind of see your loan to deposit ratio maxing out?

Yes, on the competitive nature Dan, we are not really seeing any competitive pricing pressures in the market right now. I would say if anything for us the focus is just on making sure that our deposit growth keeps pace with our asset generation. Right now we are roughly at 92% loan to deposit ratio. We have talked about in the past; ideally we would love to see that right at 95%. So, we will continue to manage along those lines.

Okay, great. Thanks, all my other questions have been asked.

Great. Thanks Dan.

Thanks Dan.

There are no additional questions at this time. This concludes our question and answer session. I would like to turn the conference back over to Claude Davis for closing remarks.

Thanks Kate. And again, just thank everyone for their interest in First Financial, and we will look forward to the fourth quarter call. Thank you.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.