First Financial Bancorp (NASDAQ:FFBC)
Q4 2012 Earnings Call
January 30, 2013 09:00 am ET
Claude Davis – President & Chief Executive Officer
Tony Stollings – Executive Vice President & Chief Financial Officer
Ken Lubbock – Vice President, Investor Relations and Corporate Development
Scott Siefers – Sandler O’Neill
[John Barr] – KBW
Good morning and welcome to the First Financial Bancorp Q4 and Full Year 2012 Earnings Conference Call and Webcast. (Operator instructions.) Please note that this event is being recorded. I would now like to turn the conference over to Mr. Ken Lubbock, Vice President Investor Relations and Corporate Development. Mr. Lubbock, please go ahead.
Thank you, Keith. Good morning everyone and thank you for joining us on today’s conference call to discuss First Financial Bancorp’s Q4 and full year 2012 financial results. Discussing our operating and financial results today will be Claude Davis, President and Chief Executive Officer, and Tony Stollings, Executive Vice President and Chief Financial Officer.
Before we get started I would like to mention that both the press release we issued yesterday announcing our financial results for the quarter and the accompanying supplemental presentation are available on our website at www.bankatfirst.com under the “Investor Relations” section. Please refer to the forward-looking statement disclosure contained in the Q4 2012 earnings release as well as our SEC filings for a full discussion of the company’s risk factors. The information we will provide today is accurate as of December 31, 2012, and we will not be updating any forward-looking statements to reflect facts or circumstances after this call. I will now turn the call over to Claude Davis.
Thanks, Ken, and thanks to all of you for joining the call today. We were pleased to report Q4 net income of $16.3 million or $0.28 per share and full-year net income of $67.3 million or $1.14 per share. Return on assets was 1.03% and return on equity was 9.06% for the quarter and 1.07% and 9.43% for the full year representing a slight improvement compared to our results for 2011. Included in the results for the quarter were approximately $1 million of pre-tax expenses related to the execution of our efficiency plan, or $0.01 per share. These were offset by $1 million of gains related to the sale of investment securities during the quarter.
With regard to the efficiency plan we announced on the Q3 earnings call, our implementation plans remain on track as to timing and realization of the $17.1 million in annualized cost savings. I would like to reiterate that we do not view this initiative as a one-time event. We continue to review our operational cost structure for additional opportunities, and more importantly are working to build a culture of efficiency within the organization that leaves us well positioned to be a high performing company over the long term.
In January we paid our most recent variable divided based on the Q3 earnings per share of $0.28 and the Board has declared our next variable dividend to be paid in April based on Q4 earnings of $0.28. Based on yesterday’s closing price of $15.25 this represents a yield of 7.3%. During Q4 we began to buy back shares in connection with the share repurchase plan we announced last quarter. In November and December we repurchased approximately 461,000 shares at an average price of $14.78, and bought back an additional 84,000 shares during January at an average price of $14.83. When you combine the share buyback with the regular and variable dividends paid during the year, we returned in excess of 110% of full-year earnings to our shareholders during 2012.
We also announced that we expect to repurchase about 1 million shares annually under the plan, so as you do the math you can see that we are ahead of schedule on timing as we were able to take advantage of price weakness in the shares. Given that we are still planning on paying the variable dividend through 2013 we expect future purchases to be more consistent with our 1 million share annual target, as the total return of capital to shareholders will continue to exceed 100% through the year.
As we disclosed on the Q3 call, our intent is to return 60% to 80% of the capital we generate to shareholders in the form of dividends and share repurchases on a long-term basis following 2013. We continue to expect to maintain capital ratios in excess of our stated target thresholds, current regulatory requirements and the proposed capital requirements under Basel III while still preserving a sufficient level of excess capital to support growth initiatives. As I have highlighted in the past, this capital management plan will be subject to change if our capital position changes materially or capital deployment opportunities arise that result in capital ratios moving towards our stated thresholds sooner than expected.
We experienced our third consecutive quarter of growth in our uncovered loan portfolio as balances increased $113 million or 14.7% on an annualized basis driven by the C&I, commercial real estate, specialty finance, and residential mortgage portfolios. I would like to highlight that Q4 was the first time since the Irwin transaction in September of ’09 that growth in the uncovered portfolio outperformed the decline in the covered portfolio, as total gross loan balances increased over $35 million.
The level of early payoffs in the portfolio did remain elevated as some clients continued to deleverage during the quarter. Additionally, consolidation activity among our clients driven by tax planning and healthcare cost concerns, particularly in the franchise finance segment impacted payoffs as well. However, we experienced one of our strongest quarters in terms of new originations and renewals as we continued to capitalize on our unique position in our key metropolitan markets, which more than offset the early payoffs.
As we mentioned in the earnings release we had a particularly strong December resulting from new business in our traditional commercial lending business as well as in our franchise finance business, which had its strongest month of the year. Our commercial and consumer lending teams ended 2012 on a very positive note, and we feel optimistic that this momentum will carry over into 2013 as the pipeline of new business opportunities remained strong at the end of the year.
I want to take the next few minutes to address some of the achievements we have accomplished over the past year in terms of confronting some of the headwinds we face. We recognize that our declining covered loan portfolio presents near-term challenges for generating earnings growth which are exacerbated by the current interest rate and economic climates. Our goal as it always has been is to execute on our strategic plan of building long term, sustainable franchise value.
Over the past several years we have made significant investments consistent with this plan, including the branch acquisitions in Indianapolis and Dayton during 2011, the build out of our specialty finance product set, refocusing on the mortgage business, and investments made in our online and electronic banking platform.
As a result of our increased presence and marketing efforts in the Indianapolis and Dayton markets, these acquisitions are beginning to produce tangible results in terms of asset generation as the two markets contributed almost 45% of the annual growth in uncovered loans during 2012. The full earnings impact of this growth has been muted due to the interest rate environment but we have strong, growing commercial and retail sales teams in place that are well positioned to have continued success. Furthermore, the deposit relationships we added in those markets contributed to the 9.6% increase in service charge and bank card revenue we realized during 2012.
To better penetrate our metropolitan markets, increase market share and adapt to the changing needs of our client base in an uncertain economic environment, we began to build out specialized product sets in our commercial line of business including asset-based lending and equipment finance. During 2012, balances in these product lines increased 83% year-over-year and represented about 24% of the annual growth in uncovered loans.
After exiting the mortgage business prior to the financial crisis, we reentered the business once the dynamics of the industry returned to a more risk appropriate level. We are still early in our growth plans for this product line but have begun to experience success as originations increased over 67% and fee revenue increased 51% during 2012 compared to the prior year.
And finally during 2012 we made significant investments to upgrade and expand our electronic banking options. We continue to see a shift in client banking habits and preferences and we invested in enhancements to products and services to meet these changing needs. Throughout 2012 we experienced a significant increase in the number of clients using various electronic banking features and expect this growth to continue as we develop and roll out even more robust offerings.
Going forward, these products and services will be a key factor in retaining and growing core deposit relationships in a cost-efficient manner. These are just a few examples of strategic initiatives we have executed on and we remain focused and committed to further opportunities while we continue with our plan to build long-term franchise value for all stakeholders of the company.
I want to conclude my comments with some thoughts on the M&A environment as we enter 2013. While M&A activity has yet to take off in the banking sector, and I am not speculating as to exactly when it will take off, I feel more optimistic about the opportunities for M&A than at any time over the past couple of years.
We are all aware of the current challenges facing the industry and the increasing regulatory and compliance requirements for institutions, both large and small. And with margin compression and a hyper-competitive environment, and as more and more laws and regulations are implemented, we believe even the most well-run community banks are finding it difficult to run their companies efficiently with their focus being diverted from the core business of generating loans and deposits.
At some point we believe many of these institutions will come to the conclusion that it makes sense to partner with a larger institution that has the infrastructure in place to handle the regulatory burden and allow the decision makers to get back to the business of serving clients’ needs. We believe we are in a good position to be an alternative for these community banks in our market area.
Finally, this month we announced a management change including the appointment of Tony Stollings as our CFO. I’m excited about the experience Tony brings to the role and his knowledge of our company, and his more than thirty years of banking experience. Tony will be an integral part of the management team in our ongoing financial management, organic growth, and M&A strategies of the company. I’d now like to welcome Tony to the call and turn it over to him for a further discussion on our financial performance.
Thank you, Claude. Our adjusted pre-tax, pre-provision earnings as shown on Slides 3 and 4 of the supplement were $28.6 million for the quarter or 1.81% of average assets on an annualized basis. Adjusted pre-tax, pre-provision earnings which exclude certain items related to covered loan activity as well as significant nonrecurring items increased approximately 17% quarter-over-quarter as a result of positive trends in most of the major categories of income and expense.
Total interest income increased $1.3 million compared to the linked quarter due primarily to higher interest income earned on investment securities and loan P income during the period, including a $2.2 million prepayment fee related to the early payoff of a commercial credit. Net of the prepayment fee, the decline on interest income on loans was primarily the result of an 8.3% decrease in the average balance of covered loans outstanding, and to a lesser extent a decline in the yield earned on the portfolio.
The impact of interest income on the covered loan activity was partially offset by a $78 million or 2.6% increase in average uncovered loan balances on a linked quarter basis. However, the impact to interest income continues to be muted as loan originations during the quarter were recorded at an average yield of 4.05% or approximately 70 basis points lower than the average yield on loans that paid off during the period. Excluding the impact of the prepayment fee, the yield earned on the uncovered portfolio during the quarter was approximately 4.73%, a three basis point increase compared to the linked quarter.
Higher interest income from investment securities resulted from a $141 million or 8.8% increase in average balances compared to the linked quarter, partially offset by a ten basis point decline in the portfolio yield primarily due to the current reinvestment rate environment. We continued repositioning our investment portfolio during Q4, purchasing over $564 million of securities with a weighted average yield of 1.55%, an average duration of 3.1 years, and with characteristics that we expect will help mitigate prepayment and premium risk.
These purchases were offset by normal amortization and pay downs as well as the sale of approximately $152 million of lower yielding agency mortgage-backed securities, sold in order to further reduce liquidity, interest rate cap, and prepayment risks in the portfolio. We recognized a pre-tax gain of $1 million on the securities sales during the quarter.
During Q4 a portion of the investments we purchased were funded by wholesale borrowings under a strategy to prefund the portfolio based on its estimated runoff over the next twelve months. At year end the quarterly increase in short-term borrowings of about $250 million approximates the amount of borrowings used under this strategy with a weighted average cost of funds of 17 basis points for the quarter. We expect to continue using this strategy throughout 2013 in order to maximize interest income generated by the investment portfolio.
Total interest expense continued to benefit from the impact of the bank’s deposit pricing and rationalization strategies, declining approximately $800,000 compared to the prior quarter. The cost of funds related to interest bearing deposits declined eight basis points to 49 basis points during the quarter, and has declined 42 basis points since Q4 2011. Total time deposits continued to decline, decreasing $131 million or an end point 9% during Q4. Compared to one year ago, time deposits have declined $586 million or 35.4%. The majority of these amounts consisted of single service CDs and other time deposits representing non-core relationships.
As of December 31, our total balance of time deposits was $1.1 billion with an average cost of funds of 1.40%. We feel there is still room for improvement related to CD balances as about 30% of the total time deposit balances represent single-service relationships with a weighted average rate of 1.61%. During Q1 2013, maturities of these deposits are expected to be approximately $70 million with an associated cost of 1.66%. For the full year 2013, approximately $215 million of these deposits will mature with a current cost of funds of 1.62%.
Additionally, within our entire CD portfolio approximately $715 million are expected to mature during 2013 with a cost of funds of 1.48%. Our current rates on CD products and renewals are no higher than 35 basis points on a weighted average basis. Our retention rate experience with maturing single-service CD products has been approximately 41% of the balances while we have retained approximately 50% of maturing time deposit balances overall.
When you include non-interest bearing deposits, our total cost of deposit funding declined seven basis points to 38 basis points for the quarter. As we continue to reduce the balance of higher cost, non-core relationship deposits we have significantly improved the quality of our deposit base as total non-time deposits now comprise almost 78% of total deposits compared to 71% one year ago and non-interest bearing deposits have grown almost 17% year-over-year. This improvement is another tangible example of our ongoing efforts to create long-term franchise value, the significance of which will increase substantially when interest rates begin to rise.
Net interest income on a GAAP basis increased $2.1 million to $62.0 million from $59.9 million for the linked quarter. Similarly, net interest margin on a GAAP basis increased six basis points to 4.27% from 4.21% over the linked quarter. Excluding the previously mentioned prepayment fee, net interest margin was 4.11%, a decline of ten basis points compared to the linked quarter and in line with our expectations.
Looking forward into 2013, we expect further net interest margin compression due to two primary factors: first, the continued decline in our high yield and covered loan portfolio; and second, continued pressure on earning asset yields from the ongoing low interest rate environment. Our future net interest margin and ability to grow net interest income is going to be highly dependent on our success in continuing to increase uncovered loan balances.
As Claude mentioned earlier, we realize we face earnings headwinds. From a net interest margin and net interest income perspective, we feel we have a few opportunities to help defend against margin compression. First, we have rounded out our credit product set. We have diverse channels to pursue loan growth and we are not solely dependent on traditional C&I and CRE lending. Second, as I mentioned earlier, we still have some opportunities to lower funding costs throughout 2013 as CD balances mature and re-price at much lower rates. And finally, we are actively monitoring our cash balances to ensure that the maximum amount of resources are deployed into earning assets while ensuring that we can meet short-term liquidity needs.
Moving now to non-interest income, excluding nonrecurring items, reimbursements due from the FDIC, and other covered loan activity as noted in Table 1 of the earnings release, non-interest income earned in Q4 increased approximately $800,000 from the linked quarter to $16.7 million. The increase was driven by various items, none of which were individually meaningful. In Q4, non-interest expenses excluding nonrecurring items, [pertinent] FDIC and covered asset expenses, and other non-strategic operations- and transition-related items as noted in Table 2 of the earnings release, were $49.4 million as compared to $50.3 million in Q3. The decrease in non-interest expenses compared to the linked quarter was primarily driven by lower uncovered OREO and collection expenses partially offset by higher data processing and professional services expenses.
Finally, I will briefly comment on our credit performance during Q4. Total classified assets continued to improve, declining for the ninth consecutive quarter and are down $4.3 million or 3.3% compared to the linked quarter, and down $33.3 million or 20.5% compared to December 31, 2011. Net charge-offs related to uncovered loans totaled $5.3 million or 68 basis points of average loan balances on an annualized basis during the quarter, a slight decrease over the linked quarter.
Contributing to the quarterly total were $1.1 million of charge-offs related to the cumulative implementation impact of recent guidance from the OCC for consumer borrowers in Chapter 7 bankruptcy proceedings. This OCC guidance relates primarily to homeowners whose mortgage debt has been discharged in bankruptcy but who continue to live in the home and perform on the loan.
The OCC determined that a concession has been granted and that the loan should be reported as troubled debt restructuring, placed on nonaccrual and recorded at the lesser of the bank’s loan exposure or the estimated fair value of the home. Excluding charge-offs resulting from the OCC guidance, Q4 net charge-offs would have approximated 54 basis points of average loans on an annualized basis.
Total nonperforming loans to total loans decreased slightly to 2.39% as of December 31 from 2.41% as of September 30. Nonperforming loans were impacted by $2.3 million of additions resulting from the aforementioned OCC guidance as well as the addition of a $7.0 million commercial relationship where we believe the total exposure is collateralized substantially in excess of the outstanding loan balance.
Provision for the loan losses related to uncovered loans increased slightly to $3.9 million for Q4 and is a byproduct of our internal model used to estimate the period-end allowance for loan losses. Excluding the $1.1 million of charge-offs related to the OCC guidance, Q4 provision expense equaled 91.6% of net charge-offs.
Turning briefly to covered assets, net credit costs on covered assets for the quarter were $1.4 million, as highlighted on Page 10 of the supplement which discloses the individual components of credit and FDIC-related items associated with covered assets. While actual credit costs can be somewhat volatile from quarter to quarter and are affected by actual charge-offs, changes in both the timing and amount of expected cash flows, and continued mix shift as the covered loan portfolio matures, our net credit costs on covered assets have declined for three straight quarters and we remain pleased with the overall performance of the covered portfolios.
Now I’ll turn the call back over to Claude.
Great, thanks Tony, and Keith will be happy to open the call for questions now.
Yes, thank you. We will now begin the question-and-answer session. (Operator Instructions.) And the first question comes from Scott Siefers from Sandler O’Neill.
Scott Siefers – Sandler O’Neill
Good morning, guys. So the first question, Claude, I just want to make sure I understand what you’re saying clearly on the share repurchase outlook. So obviously this was a pretty aggressive quarter, Q4, for share repurchase. So it sounds like it might be a little more evenly spaced out going forward, so was it just taking advantage of price as opposed to something that we should expect to be consistent with that level going forward?
Yes, that’s right Scott; that is, if the Q4 level continued we would be significantly more than the 1 million share annual number. So what you should expect at least, and we look at it quarterly as a Board. And so at least at this point what you should expect is something that’s more consistent with an annual run rate of 1 million shares.
Scott Siefers – Sandler O’Neill
Okay, perfect. I thought that was the case but I appreciate you clearing it up. And then Claude, either for you or Tony, I just was hoping you could chat in a little more detail or give a little more color on exactly what the strategy’s going to be with the securities portfolio and then the base of short-term borrowings as well which jumped up a little here in the quarter.
Strategy in terms of, are you looking at level or mix or…
Scott Siefers – Sandler O’Neill
Yeah, both – kind of just what you’re planning to do over the course of the next year with the securities portfolio and the base of short-term borrowings.
Sure, yeah. In terms of the size of the portfolio I don’t think we see it potentially increasing from here. You know, whether it decreases or not I think will depend on loan growth and what we see in that context. The borrowings piece we had signaled a little bit last quarter that we were going to add roughly $300 million to the portfolio and fund it with borrowings, so that was the plan. And that borrowing number will again adjust up and down depending on what deposit growth looks like over the balance of the year. We may do some laddering of the funding base just to mirror the portfolio but the portfolio has a pretty high cash run off as well. I don’t know, Tony, if you’d add anything?
No, I think those are all good points, Claude. And as Claude said we are considering laddering out some of the funding base there so you might see that 17 basis point pick up a little bit but I wouldn’t see it being considerably different than what we’ve talked about.
Scott Siefers – Sandler O’Neill
Okay, that’s perfect. Thanks a lot.
You bet, Scott.
Thank you. The next question comes from Christopher McGratty with KBW.
[John Barr] – KBW
Good morning, it’s [John Barr] filling in for Chris. Just on that point, what you’re buying on the securities book, is it different from what you have on the books right now?
It’s not really different. It’s a mix of fixed and float, predominantly fixed but we are mixing in some floaters in there as well. And it is north of 90% agency-backed so it’s pretty typical of what you’ve seen us do in the past.
Yeah, no substantial credit risk in the portfolio.
[John Barr] – KBW
Okay. And on the mortgage banking business I know you’re still ramping up. Should we expect additional costs in the next couple quarters in ’13? And also if you can talk about trends you’re seeing in that business in terms of volumes, the mix versus re-fi and purchase and gain on sale margins? Thanks.
Sure. I wouldn’t expect a substantial increase in costs. We’ve been building that really throughout 2011 and more substantially in 2012, so most of the cost run rate in that business you’ve already seen in the last couple of quarters. It’s more the fact that as you bring on a lot of mortgage loan officers it takes them time to build volume as well as it’s taken us time to rebuild our awareness so that we’re doing mortgages in the way we’re doing them again, especially in our metropolitan markets – so just building that brand takes time. And we feel good, especially in Q3 and Q4 that we’ve really begun to see that pick up in the context of volume.
One of the things we’ve tried to focus on in that business when we reentered it was to have a heavier way to purchase versus re-fi. Now, in a low rate environment like this there’s still going to be a lot of re-fi business but ours, as an example, was roughly 41% purchase, 59% re-fi; and I think if you were to look at the mortgage banker indexes, the re-fi volumes for the industry have been running in the low- to mid-70% range for the industry. So we’ve been about 10 to 15 points better most of the year of our purchase volume versus our re-fi volume as compared to the industry, and that’s what we think we need to do long term to build that franchise.
[John Barr] – KBW
Thanks, Claude. What’s a good effective tax rate for ’13?
I think it’s going to be pretty consistent with what you’ve seen for the year. I’m not anticipating any huge changes there right now.
[John Barr] – KBW
Okay, thanks. And the last question I had: Tony, I know you’re serving as CFO and Chief Risk Officer right now. I’m just wondering from a timing perspective when you’re anticipating adding an additional person for the Chief Risk Officer position and whether you expect that to be an internal or external hire. Thanks.
Certainly. Obviously it’s a process that we’re currently going through. As with any kind of search we do you don’t know timing until you identify the person that you think is right for the role. Certainly we hope it will be nearer-term versus longer-term, but we need to go through the process. And whenever we do something like this we always have a bias toward internal as a way of promoting internal talent but we’re also going to make sure we get the right person for the job. So if that’s not the right person internal then we’ll certainly do an external search. So at this point it’s still only about a week and a half in process and hopefully sometime during the quarter we’ll be able to give everyone an update on that plan.
[John Barr] – KBW
Thank you. (Operator instructions.) Alright, there are no more questions at the present time so I’d like to turn the call back to management for any closing remarks.
Great, thanks Keith. And I would just close by again welcoming Tony to the call and thanking all of you for your interest in First Financial. Thank you.
Thank you. This concludes the conference. Thank you for attending today’s presentation. You may now disconnect.
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