Tom O'Malley – IR Officer
Paul Greig – Chairman & CEO
Bill Richgels – EVP & Chief Credit Officer
Terry Bichsel – EVP & CFO
Scott Siefers – Sandler O'Neill
Sweety Dickens – JP Morgan
FirstMerit Corporation (FMER) Q1 2010 Earnings Call Transcript May 4, 2010 2:00 PM ET
Good afternoon. My name is Patrick, and I will be your conference operator today. At this time, I would like to welcome everyone to the FirstMerit first quarter 2010 earnings conference call.
All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session.
(Operator instructions) Thank you, Mr O’Malley, you may begin your conference.
Thank you, Patrick, and good afternoon everybody. I am Tom O'Malley, Investor Relations Officer for FirstMerit Corporation. Welcome to our first quarter 2010 earnings conference call. Joining me today are Paul Greig, our Chairman and CEO; Bill Richgels, our Chief Credit Officer; Terry Bichsel, our Chief Financial Officer; and Mark DuHamel, our Treasurer. Following our prepared remarks, we will conduct a question-and-answer session.
I will now turn the call over to Paul Greig.
Thank you, Tom, and good afternoon everybody, thanks for joining our call. I am pleased to report that we had solid performance for the first quarter of 2010. Financial highlights reflect healthy and strong results on many fronts, including core deposit growth for the tenth straight quarter, an $8.4 million decrease in net charge-offs, continued net interest margin expansion, and a robust tangible common equity level at 7.93%. Additionally, we increased gross revenues by 5.7% over the prior year quarter after adjusting for one-time items.
The quarter reflected the positive impact of our hard work throughout the company, and it also marked several events beneficial to FirstMerit’s future stability, profitability, and long-term growth. Before I go into detail on those events, let me recap the quarter.
For the first quarter of 2010, FirstMerit reported earnings of $0.21 per share compared to $0.17 per share last quarter, and $0.33 per share for the year-ago quarter. Net income for the first quarter was $18 million compared with $14.5 million last quarter, and $29.4 million for the first quarter of 2009.
I believe the improvement in linked quarter results and the encouraging anecdotal signs we are getting from a number of our commercial customers, are indicative that the worst period in the economic cycle is past. We cannot control the timing or magnitude of economic recovery but we are positioned to grow and serve our customer base.
We are now open for business in Chicago. Over the February 19 weekend, we completed our conversion of 24 Chicago area First Bank branches and also acquired the 4-branch George Washington Savings Bank from the FDIC. The George Washington branch is complemented by other Chicago area locations, providing a platform of 28 branches and establishing a solid presence in the vibrant Chicago market.
These acquisitions are the results of a disciplined growth approach. They also are only possible due to the strength and stability of our financial position coming out of this recession. Today, we stand in an optimal position to explore future acquisitions that meet or exceed our strategic and financial M&A criteria. We remain actively engaged in the FDIC resolution process throughout the Midwest with a particular focus in the Chicago area. With the two recent acquisitions, we have ample capacity to add to our presence there.
While I will not comment on individual FDIC transactions, I will acknowledge that we have been on a number of institutions and expect more resolution opportunities to materialize. We will not win every bit nor will we sacrifice our financial and strategic discipline. We do however expect to remain active in this process going forward yet at the same time be mindful that our core markets in Northeast Ohio remain disrupted and provide ongoing opportunities for organic growth.
Our balance sheet remains strong. We maintain ample liquidity and have increased reserve levels this quarter. The foundation of our healthy franchise partnered with our proven Super Community bank model positions FirstMerit for growth in our new and core markets.
We raised $80 million through an at-the-market offering during the quarter. This action supports our commitment to maintaining solid capital levels and provides us the ability to explore growth opportunities. These noteworthy events took place during our 44th consecutive quarter of profitability. The fact that we have kept this streak uninterrupted during the financial crisis is a true testament to our fundamental banking policies on wavering credit procedures and the dedication of our employees.
Our net interest margin expanded for the fourth consecutive quarter increasing to 3.72% compared with 3.64% in the fourth quarter 2009, and 3.53% in the year ago quarter. A large driver of this margin expansion is our continued emphasis on core deposit gathering, and shifting our deposit mix away from higher priced CD products.
Core deposits grew by $692 million or 12% over the fourth quarter of 2009, and by $1.5 billion or 29% compared with first quarter 2009. Net charge-offs were down quarter over quarter. In the first quarter of 2010, they were $22.8 million or 1.36% of the average loans, compared to $31.2 million or 1.79% in the fourth quarter of 2009, and $15.6 million or 0.86% of average loans in the first quarter of 2009.
In a few moments, Bill Richgels, our chief credit officer will provide some context around that decrease as well as context around the increase in nonperforming assets we experienced this quarter. I do want to point out that the primary driver of this NPA increase is set backs for well collateralized companies within the commercial and real estate portfolio due to economic pressures. Due to the stabilizing overall business environment we are seeing, we expect limited loss content in the new nonperforming assets.
Earlier, I commented on our balance sheet, which remains one of the strongest in the industry. While our tangible common equity level of 7.93% decreased from the prior quarter, due to the impact of our recent acquisitions, we have strengthened our tangible common equity position from the year-ago quarter level of 7.6%. Our reserve levels remain robust currently at 1.82% at March 31, 2010 that is up from 1.77% at December 31, 2009, and 1.53% at March 31, 2009.
We have come through, what I believe, as the worst of the financial crisis as a stronger organization. We have capitalized our numerous opportunities to fortify our position as a bank of choice in our core markets and to establish a new presence in the Chicago area. We also continue to strengthen our company by attracting top banker talent as an employer of choice in the midst of an industry-challenging environment. We continue to take the right steps building and strengthening our company to generate profitable growth in the months and years to come.
At this time, I will turn the call over to Bill Richgels, our chief credit officer. Bill?
Thank you, Paul, and good afternoon. As we reported our charge-offs for the quarter ending March 31, 2010 totaled $22.8 million or 1.36% of average loans, which is down from $31.2 million or 1.79% on a linked quarter basis. These charge-offs are in line with our guidance. Our consumer retail portfolio had a $13.9 million share of these charge-offs. This level of retail charge-offs is in line with our expectations and up modestly $700,000 on a linked quarter basis.
Within this $2.7 billion consumer portfolio, our direct and indirect portfolio charge-offs were relatively unchanged from the prior quarter, and HELOCs were down $246,000 from $2.1 million. Credit card charges were up $630,000 from $3.1 million, and mortgages up $365,000 from $1.3 million the quarter before. While consumer charge-offs are elevated at these levels, these results were in line with our expectations in the normal seasonal cycle.
On a very positive note, overall delinquency rates in the retail book are down running 2.42% versus 2.97%. Additionally, early stage delinquencies are down on a linked quarter basis in every category. Most are down on a year-by-year basis including credit card, this is a repeated encouraging sign. I want to further comment that the commercial early-stage delinquencies are also down on every category. That coupled with 90-day (inaudible) loans down from $35 million to $21 million gets further equaling [ph] of stabilization.
Nonperforming loans including OREO rose $22 million from fourth quarter of last year to $123 million or 1.87% of loans. Driving the increase this quarter, we had several well-collateralized credits filed bankruptcy. We expect that these judicial proceedings will result in the sale of their various properties sufficient to repay our outstandings. This is supported by appraisals, letters of intent, and should occur over the next two trailing quarters.
In general, our NPAs have been charged down as appropriate or have reserves or are carried at book value if the collateral is sufficient to retire our outstandings supported by appraisals or valuations. The takeaway here is that we do not have high levels of loss content in these credits Over the next few quarters, we continue to expect NPAs and OREO balance to remain elevated reflecting the broader past economic stress, but we believe that inflows will slow over the course of 2010.
Our OREO book increased to 69 properties at quarter end versus 51 properties on a linked quarter basis. It still remains modest to peers at roughly $11.2 million and we continued to clear properties at our expected values. On a positive note, the total homebuilder portfolio continued to reduce nearly 10% down to $69 million.
Finally, our criticized and classified asset buckets increased $80.7 million to $424 million this quarter, primarily in the first level of the classified asset bucket of special mention. As Paul has commented, we saw a number of C&I credits weaken over the trailing two quarters and we aggressively moved to improve our position, take additional collateral or provide increased scrutiny given the elevated risk in the intended risk rating change.
Although not concentrated within any particular industry, a number of these companies are starting to see revenue growth necessary for improved prospects and successful operating results. Based on a C&I order books filling, widening margins, sufficient liquidity, and balance sheet of our customer bases, we are viewing as positive our opportunity to experience significant upgrades outweighing downgrades over the next several quarters.
Within our commercial portfolio, we have approximately $2.7 billion of commercial real estate outstanding. Major components of this diversified books remain fairly constant with previously reported composition in that owner occupied real estate at $560 million, office medical at $443 million, multifamily at $220 million, retail at $203 million, industrial commercial construction at $322 million, healthcare at $246 million, industrial warehouse and or storage at $285 million, general income production at $282 million, and the previously referenced homebuilder portfolio.
We would like to note that this commercial real estate is within our footprint, it is not geographically remote and it does not have any concentration. In general, this book has performed to our expectation. Within the retail consumer book, average utilization of HELOCs remained stable at 43% consistent with last quarter, First lien HELOCs are 48% of that portfolio, 35% of the second lien HELOCs are related to FirstMerit first mortgages either as owner or servicer, and total weighted loan to value equals 70%, with a weighted average FICO at 746 and re-scores on that maturing portfolio slightly up, NPLs for that $766 million book equaled $2.9 million or 37 basis points.
Foreclosures for our book both mortgages and HELOCs increased slightly up 8 from 101 to 109 at March 31, 2010. As of quarter end March 2010, our allowance for credit losses was $124 million, representing 1.82% of loans and 1.11 times NPLs. This consistent provisioning is appropriate with the loss inherent in our loan portfolio. As the shrinking homebuilder housing portfolio becomes less a factor in our NPAs and you cycle in cash generation CRE or C&I credits with some measure of cash generation, we expect loss content in that book to decline.
To summarize, we are encouraged by significant recent positive signs of stabilization although we are planning for a muted economic recovery. With that, I will turn the call over to Terry Bichsel, our CFO. Terry?
Thank you, Bill, and good afternoon everyone. Our financial statements this quarter contains several new captions due to the acquisitions that deserve explanation before moving to the remainder of 2010 guidance.
On page 7 of our earnings press release, the consolidated financial highlights, $523 million of acquired loans including covered loans at 3.31 is shown. The term covered loans refers to those loans that are covered by an FDIC loss sharing agreement. The purchase accounting marks on these loans were 9.1% for the asset based lending portfolio, 8.5% for the First Bank’s acquisition, and 44.4% for the George Washington covered loans. These loans are excluded from the allowance for loan loss ratios.
On page 8 of the release, the consolidated balance sheet, covered loans including the FDIC receivables are shown at $277 million, and intangible assets and goodwill increased $53 million for the consideration paid and purchase accounting for the acquisitions. Cash increased $561 million from December 31, representing the uninvested position from cash received from the acquisitions and deposit growth during the quarter.
Page 10 describes our average balance sheet and decomposes the net interest margin. You will see that the covered loans and loss share together as one line item is included in earning assets with loan accretion at 5.65%. In other income on the income statement, page 11, a $5.1 million gain or $0.04 per share is recorded recognizing that the value of assets acquired was greater than liabilities assumed for George Washington. Offsetting this gain, expenses are elevated $2.7 million in the quarter or $0.02 per share for one-time conversion due diligence and other related acquisition costs.
Turning to guidance for the remainder of 2010, provision for loan losses are expected in the range of $24 million to $25 million per quarter covering charge-offs and loan growth with the potential for additional provisions associated with loan downgrades. Total loan growth is expected to average 4% to 4.5% on an average over 2009 including acquired loans.
Commercial loans are expected to increase 8.5% with consumer loans showing a decline of 1% to 2%. $575 million of the excess liquidity from the acquisitions was invested in short duration US agency and mortgage backed securities resulting in $3.3 billion investment portfolio with duration of 1.98 years. The remaining cash is held at the Fed to fund future loan growth, manage our interest rate risk position, and to allow opportunistic deposit pricing.
At 3.31 for 100 basis point increase in rates, our interest rate risk position was just under a positive 2%. By year-end, we expect the position to move into approximately 1.7% asset sensitive. With the acquisitions, deposit retention has been 97% for George Washington and 98% for First Banks.
Total deposits are expected to decline from 3.31 approximately 3% by year-end with core deposits increasing 2% to 3%. Over the remainder of the year, $892 million of CDs mature with an average rate of 1.77%. As a result of the balance sheet described, the net interest margin is expected to be maintained at the first quarter level.
Non-interest income strong in the first quarter versus a year ago is expected to average between $50 million and $55 million per quarter. Noninterest expenses will be elevated for the next two quarters to $98 million before moving down to the $96 million range recognizing George Washington data processing conversions and building out the FDIC loss share practice and ongoing due diligence expenses. The tax rate is expected to be 26% over the remainder of the year.
That concludes my remarks, I will return the call to Tom O'Malley. Tom?
Thanks, Terry. That concludes our prepared remarks, at this time, we welcome your questions.
(Operator instructions) And our first question comes from the line of Scott Siefers of Sandler O'Neill.
Scott Siefers – Sandler O'Neill
Hi guys, how are you guys doing?
Scott Siefers – Sandler O'Neill
Just a couple of questions, I guess, the first one is for you Paul, it is just sort of on the state of competition as you look for FDIC deals, you mentioned that you have been on a number of them, I guess, I am curious as you look over the last several months, if indeed the bidding has gotten more intense from your perspective, where are you seeing you will get more or less competitive, etc?
Yes, I think the bidding has certainly become more competitive Stott. I think it will depend on the – it would be an institution specific factor as well but it certainly has become more competitive.
Scott Siefers – Sandler O'Neill
Then Terry, the next question is for you, I think I have got all of the color that you mentioned on the margin but if I understood it correctly, it sounds like you guys are going to move to a slightly less asset sensitive position over the remainder of the year. I guess, maybe if you can provide a bit more commentary on exactly the way you are managing for the rate environment?
Certainly, Scott. Typically we would manage our interest rate risk position to interest rate neutrality except for the fact that we have obtained a lot of cash and a lot of liquidity through the acquisitions and we want to preserve that cash for future loan growth and to not take duration risk within our investment portfolio at what you might call an absolute low interest rates. We are not uncomfortable with the asset sensitivity that we have at 3.31, but with the loan growth that we are anticipating and the deposit flows that we described, the asset sensitivity would come in just marginally, but still in a position for interest rate rises as they might occur with Fed funds increases and shifts in the yield curve.
Scott Siefers – Sandler O'Neill
Okay, perfect. Thank you very much.
(Operator instructions) Your next question comes from the line of Steven Alexopoulos from JP Morgan.
Sweety Dickens – JP Morgan
Hi everyone, this is actually Sweety Dickens [ph] speaking on behalf of Steve. Can you first divide the dollar amount of inflows you found [ph] to nonperforming this quarter and how that compared to last quarter?
The inflows, we measure it because we have a constant in and out but we reference the $22 million increase. I would, if you will, give some color by illustrating the concentration we had a couple of well-diversified, collateralized credits that had significant duress. The duress was brought in litigation with them on the part of matters outside of the businesses we were financing, and there was, as people do during these times, they sought some relief and comfort in a defensive bankruptcy.
The values on the properties that we have and are represented in the NPAs are substantial, and we believe that the liquidation scenario through the bankruptcy will provide us and the owners of these properties an orderly process of maximizing the value, paying us off as well as developing whatever liquidity for themselves. The actual inflow detail will be in our 10-Q.
Sweety Dickens – JP Morgan
Okay, that is helpful. And then in sort of absent those bankruptcies and those credits that moved into nonperformance this quarter, I mean is it safe to say we are reaching sort of a peak here?
I would say that we are seeing very positive signs throughout the general portfolio. You always see a peaking in the C&C and then consequently the NPAs at kind of the late stages of the cycle, and so as the cycle moves up, you will start noticing that peaks and while we are claiming the bottom, we are certainly seeing a lot of optimistic business activity, order books, and more people definitely looking to purchase assets, those would be signs of renewed activity and optimism within the general economy.
This is Paul. Let me just add, through interaction that I have had with our customers, I am hearing and seeing positive signs that we have come through the worst of the cycle. Last week, we sponsored a breakfast, an economic breakfast in Cleveland, and had attendance of over 200 commercial customers and prospective customers, and the discussion that I had with them concurred was similar customer sentiment that I have seen since the beginning of 2010, and that is that things are bottoming and we are seeing modest pick ups in the economy. I would say that view is also consistent with what we have read in the recent (inaudible) commentary on our market.
Sweety Dickens – JP Morgan
Okay, great, thank you.
And at this time, I would like to turn the call back over to Investor Relations Officer Tom O'Malley for closing remarks.
Thank you, Patrick, and thank you all for joining us on the call today. Should you have any follow-up questions, please feel free to contact us. Thanks again and have a great afternoon. Good bye.
This concludes today's conference call. You may now disconnect.