First Financial's (FFBC) CEO Claude Davis on Q2 2016 Results - Earnings Call Transcript

| About: First Financial (FFBC)

First Financial Bancorp (NASDAQ:FFBC)

Q2 2016 Results Earnings Conference Call

July 22, 2016 08:30 AM ET

Executives

Scott Crawley - Corporate Controller

Claude Davis - CEO

Tony Stollings - COO

John Gavigan - CFO

Analysts

Scott Siefers - Sandler O’Neill

Emlen Harmon - Jefferies

Chris McGratty - KBW

Erik Zwick - Stephens

Andy Stapp - Hilliard Lyons

Daniel Cardenas - Raymond James

Jon Arfstrom - RBC Capital Markets

Presentation

Operator

Good morning and welcome to the First Financial Bancorp Second 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 Mr. Scott Crawley, Corporate Controller. Please go ahead.

Scott Crawley

Thank you, Allison. Good morning, everyone, and thank you for joining us on today’s conference call to discuss First Financial Bancorp’s second quarter 2016 financial results. Discussing our financial results today will be Claude Davis, Chief Executive Officer; Tony Stollings, Chief Operating Officer; and John Gavigan, Chief Financial Officer.

Before we get started, I’d like to highlight that we’ve updated the press release announcing financial results to a more streamlined format and added an accompanying slide presentation this quarter. 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 and welcome any feedback you may have on the format of the release. Additionally, please refer to the forward-looking statement disclosure contained in the second quarter 2016 earnings release, as well as our SEC filings for a discussion of the Company’s risk factors. The information we provide today is accurate as of June 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.

Claude Davis

Thanks, Scott, and thanks to those joining the call today. Yesterday afternoon, we announced our financial results for the second quarter. As shown on slide three, we had another solid quarter of results which is now 103 consecutive quarters of profitability. We are pleased with our results, which reflect continued strong loan growth across our metropolitan markets and specialty finance businesses.

Net interest margin remained stable as we managed our balance sheet mix and funding costs. We are also pleased with the rebound in fee income during the second quarter from the seasonal lows we experienced early in the year and remain focused on improving our performance in this area. Expense management remained disciplined during the second quarter as we remain focused on improving the efficiency of our businesses, while continuing to invest in strategic areas.

Finally, while the second quarter was marked by significant market volatility, resulting from global economic and political uncertainty, we continue to see solid credit demand and financial performance across our clients and prospects. We believe the overall credit outlook across our markets remains steady and conducive to continued growth opportunities. As we work towards improving the performance level of the Company, 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 meet our strategic objectives.

With that I will now turn the call over to Tony.

Tony Stollings

Thank you, Claude. I’d like to turn your attention to slide three, highlighting our second quarter performance and the key drivers of that performance.

To touch on a couple of points, GAAP earnings were $0.36 per diluted share with the return on average tangible common equity of 14.5%. Loan growth was the star of the quarter as period-end loans increased 14% annualized compared to the first quarter, primarily in the C&I and investor CRE categories. As in previous quarters, this growth was largely in our metro markets but all markets are seeing good opportunity. Credit quality is stable with metrics and loss coverage ratios trending favorably. Capital ratios remained strong but dipped slightly given the balance sheet growth.

On slide five, we provide a reconciliation of our GAAP earnings to earnings that reflect adjustments for those items that we do not expect to occur on a regular basis. Including these adjustments, earnings per diluted share were $0.35. The largest adjustment was the recognition of previously unrealized income on a limited partnership investment that was realized when the investment was redeemed in cash.

Slide six provides loan portfolio product mix with additional granularity on the CRE portfolio as well as the drivers of the linked quarter growth. While market pricing remains competitive, the weighted average return on our second quarter production exceeded our internal hurdle rates, demonstrating our ability to remain disciplined. The specialty platforms and national lending verticals had solid quarters as well.

Our asset quality metrics, as shown on slide seven, remained stable with the increase in provision expense, primarily driven by the quarter’s strong loan growth. The uptick in classified assets was driven by the downward migration of a few credits, but nothing material and no indication of broader issues at this time.

With that, I will now turn the call over to John.

John Gavigan

Thank you, Tony and good morning everyone. Turning to slide eight, net interest income for the second quarter was $67.1 million, an increase of $600,000 or approximately 1% when compared to the linked quarter. Higher interest income from loans and modestly lower funding costs more than offset a decline in interest income earned on investment securities 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.

Net interest margin was 3.67% on a fully tax equivalent basis, down 1 basis-point from the prior quarter as modest declines in the yields earned on loans and securities were largely offset by lower funding costs and a shift in our earning asset mix during the period.

Slide nine details our non-interest income mix and trend. For the second quarter, non-interest income totaled $20.2 million, a $4.7 million or 30% increase over the prior period. As Tony mentioned, non-interest income included $2.4 million of previously unrealized income from the redemption of a limited partnership investment as well as $200,000 of losses on sales of securities during the quarter. Excluding these items, non-interest income increased $2.5 million as compared to the linked quarter with higher client derivative fees, mortgage revenues, bank card, and loss share related income being the primary drivers.

Turning to slide 10, non-interest expense declined $1.3 million or 3% from the linked quarter to $49.4 million including approximately $200,000 of expenses related to branch consolidation activity. Primary drivers of the linked quarter decline include lower occupancy costs from branch consolidation activities and lower professional services expense from seasonal tax services associated with our wealth management business.

As Claude noted, our second quarter results reflect the continued efforts of our associates to improve the efficiency of our operating platform while allowing us to continue investing in strategic priorities.

Slide 12 provides an update on our thoughts regarding the second half of 2016 including full-year loan growth trending toward high single digit and possibly low double-digit growth, continued stability in our net interest margin over the near-term with potential fluctuation in either direction depending on production mix and prepayment activity. Additionally, I’ll note that our interest rate risk profile continues to trend toward higher asset sensitivity that we remain positioned to be no worse than neutral under flattening yield curve scenarios. And finally, we expect non-interest expense to remain flat through the second half of the year.

This concludes my remarks, and I’ll now turn the call back over to Claude.

Claude Davis

Thanks John. And, Allison, we’ll open the call for questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions] And our first question will come from Scott Siefers from Sandler O’Neill. Please go ahead.

Scott Siefers

Tony or Claude, I was hoping that one of you could expand upon Tony’s comment from the beginning on the credit cards specifically and then I guess the increase in classified. I mean it’s down like there is just a handful of things but if there was one delta relative to what I was looking for was that the provision came in higher. So, one, any expanded thoughts you can give on sort of deterioration you are seeing in the classified piece? And then, two, and more broadly, just your thoughts about kind of how are you thinking about the credit environment and provisioning levels? And I think mostly, my best guess is there is no real deterioration but you guys are just kind of looking at things with a more conservative lens, particularly in light of such strong balance sheet growth. So, I guess I’d just be curious to hear your thoughts.

Claude Davis

Sure. I’ll start Scott and then, let John or Tony fill in. On the classified piece, that was the one move up in terms of absolute dollars. And you know that it was a handful, predominantly C&I credits where we saw some deterioration in performance also and almost all of those cases we expect that our clients -- and believe our clients have plans in place to improve performance that we’re monitoring it closely. Anytime if credit goes substandard, you want to be cautious and manage appropriately. But this one, we don’t see that it’s any kind of systemic issue or broader portfolio concern or question, and we feel good about our overall portfolio, if you look at all the other metrics, very solid. Provision was predominantly driven by the growth in the loan portfolio being usually strong. So that was really the main driver of that. I don’t John, if there is anything you’d add on the provision piece.

John Gavigan

No, I think you covered the key components there with the two drivers being the very strong loan growth we saw during the quarter as well as the modest stuff taking classified to some of the reserving that was associated with that.

Scott Siefers

And then, maybe if I could switch gears to fees for a second, just curious your thoughts, I know fees have been a more recent area of focus and it seem to have shown through in the second quarter. Just as you look at things, how much of that was just the natural seasonal improvement and then how much was related to some of your more recent efforts?

Claude Davis

Yes. I would say Scott, certainly the -- we do see a seasonal uptick after the first quarter which we always see is unusually low. So that would be the biggest part of that improvement and what I would call the core fee income. We certainly are focused on trying to improve it. We’ve been looking at pricing as well as just volume increases and sales whether that’s in mortgage trust and investment, consumer DDA; treasury management. Those are all of our kind of key focus areas. And that’s the one area I would say that we continue to feel like we’ve got opportunity to improve more significantly than even other areas.

Tony Stollings

I’d just add to that Scott. Probably and as we said on the call last quarter, we are taking a much more strategic and intentional plan of action on fees related to deposits. But, you’re likely to see more of just an increasing trend there than any kind of a step increase. These things take time. So we would expect that you’d see just more of an upward trend.

Scott Siefers

And just one final point, whoever was responsible for the format change in the release, I think probably deserves a raise. I like it quite a bit. So, please keep that up.

Claude Davis

Thank you. We appreciate it. We were looking for feedback on the approach change. We thought it would be a bit more understandable and straight forward. So, I appreciate that comment.

Scott Siefers

I agree. So, thanks again.

Claude Davis

You bet.

Operator

Our next question will come from Emlen Harmon of Jefferies. Please go ahead.

Emlen Harmon

Just one more question I guess on the provision. You guys did have particularly strong end of period loan growth this quarter. I mean, with similar levels of -- where you to see similar levels of loan growth going forward. Is the reserve build in this quarter kind of representative of what we should expect going forward or just, how should we think about what you’re actually quantitatively putting aside for the loan growth portion versus what was the classified though?

John Gavigan

Yes. Emlen, this is John. I think certainly, if we continue to see strong loan growth, you should expect to see the reserve build and provision associated with that. Now, it’s not -- obviously we’re putting on past rated [ph] loans. So, those aren’t going to be -- our allowance ratio as a percentage of total loans is 99 basis points, it’s not going to be kind of dollar-for-dollar, point-for-point there. The reserve rates on past rated credits are generally lower than that. But we would expect to build provision and the allowance in lockstep with loan growth there. And then, outside of that, you’ve got couple other moving pieces with classified trends and any credit migration you’re seeing and those -- obviously as they move down the credit spectrum, they are going to get higher general reserve rates; if they go nonaccrual, they flip over into specific reserves and you can be a little more granular there. As well as just macroeconomic conditions and some of the qualitative factors that go along with it. So, it kind of depends on the facts and circumstances where we are in those future periods. But absolutely, we would expect to build a reserve along with loan growth.

Emlen Harmon

Got it. Thanks. That was helpful. Sorry to kind of to labor that point. And then, interesting to see the commercial real estate as the driver of growth this quarter; are you seeing any better opportunities there as a result of the regulatory environment in that products?

Claude Davis

Yes. Emlen, this is Claude. I wouldn’t say anything better. We’ve seen strong commercial real estate markets in our metropolitan markets mainly Cincinnati, Columbus, Indianapolis. This quarter, we saw more growth in that category than we did in C&I. However, I think if you look at the chart on slide six, you’ll see that as a percentage of the total portfolio, we’ve seen about a two-point pick up in construction and CRE versus the four-point pick up in C&I. And as we think about the balance of the portfolio with about 47% in C&I and owner occupied CRE in about 35 and the ICRE categories, those are right relative mixes with the plus or minuses a few points. We think there is no trend there other than I think over time you’ll see the construction bucket plateau. We saw some usually good construction deals over the last year, year and a half. We don’t expect to see the same level of growth in construction that we had during that period.

Operator

Our next question will come from Chris McGratty of KBW. Please go ahead.

Chris McGratty

Hey, good morning. Thanks for taking the question. I had a question on the balance sheet. You guys have been remixing the maturities in the bond book into the loans. I am wondering how we should be thinking about not only the level of securities going forward, but is this -- on a proportional basis, is this going about 20%? It feels like that’s kind of directionally where we’re headed, Claude, but any help on the size of the bond books?

John Gavigan

Chris, this is John. I think you’re correct. As conditions stand today, we expect the securities portfolio to continue to migrate down similar -- through the second half similar to what you saw in the first half. And we don’t have a hard peg or target on the securities portfolio; it’s really dependent on what we see on the loan production side and what our opportunities are there. But I will saw in the last few years, the securities portfolio has probably been higher than we generally would prefer it to be, probably peaking up somewhere around 25%, 26% of assets. Ideally, we probably prefer to see that 15% to 20% of assets but again, it depends on the opportunities we see on the loan side.

Chris McGratty

Great, that’s helpful. Just on the margin, if I could. Do you happen to have the dollar amount of accretable in the quarter?

John Gavigan

I don’t have that off hand, Chris, but I can tell you that the covered and formally covered loan accretion that contributed about 7 basis points to our overall margin.

Chris McGratty

Okay. And does the guidance for stability -- I assume that it assumes a ratable amount of accretion in the back half, is that right?

John Gavigan

Yes, I mean, I think we’ve talked about it in the past. Just the mix of that portfolio being a little more biased towards the consumer assets now than it once was; we expect it’s going to be a slow and gradual burn down.

Chris McGratty

Great, maybe one last one, Claude, on capital. You obviously had pretty good strong loan growth. What’s the updated thought on M&A at this point?

Claude Davis

Yes, Chris, the way we’re approaching M&A is as we said on slide 12, we’re predominantly focused on organic growth. We feel really good about the combination of markets, business line and what’s that producing in terms of growth. So, we don’t feel the need to do M&A for growth purpose unless we find a deal that’s strategically compelling. So, I would assume that we’re predominantly focused on organic unless we find that right deal in that right market, then we’ll take a look at it but otherwise, it’s predominantly focused organically.

Operator

Our next question comes from Erik Zwick of Stephens. Please go ahead.

Erik Zwick

First, maybe on the margin and the second quarter performance as well as your outlook for stability going forward is very strong, I guess kind of relative to the low interest rate environment and the flattening yield curve with many other banks that I look at experiencing compression. Can you talk a little bit about -- you talked about the asset sensitivity but maybe more in terms of the competition you’re seeing in your markets; is there just really strong loan demand that’s allowing you to be more selective in the loans you add to the book or kind of maybe, what’s driving some of the stability from that perspective?

Claude Davis

First thing, and it’s Claude, is I think what helps us is that ability to remix. So, as -- we put on loan growth having that come from investment securities, is providing next opportunity, one. I think two has been the mix of our business that we’ve been doing, combination of solid C&I in terms of core C&I, some of our specialty platforms that may have higher yields as well as even on the ICRE side, we’re really trying to hold pricing. Tony referenced in his comments that we monitor all of our production versus internal hurdle rate. And we had a good strong quarter this last quarter. So, it’s the mix of business; it’s the remix of the balance sheet. All that said, it is competitive especially for the best clients. And we’ll just have to see if the yield curve flattens even more, kind of what that holds for loan pricing. But to this point, we’ve not seen a degrade to where it goes below our hurdle rates.

Erik Zwick

That’s helpful. And then, in terms of deposits in past quarters, I think you talked about some core DDA growth initiatives that you have in place and it looks like that non-interest bearing growth was just pretty strong here in the second quarter. Is that reflective of those efforts or anything else that played during the quarter?

Claude Davis

Well, a couple of things. I think one is our team continue to do a good job of focusing on the core deposit business. We also see some seasonal change, first quarter being low and we see some improvement in the second quarter; so, some of that was seasonal as well.

Erik Zwick

And maybe the last question, I believe the FDIC deposit insurance fund is nearing the 1.15% level, which would trigger lower deposit insurance rates for banks with assets below $10, it looks like potentially early as the third quarter. Are you able to quantify what those potential savings would mean to your expenses?

John Gavigan

Yes. Erik, this is John. I don’t have the exact figure. We’ve taken a look at it with some of the guidance that the FDIC has put out there. We expect it to probably be a couple of hundred thousand dollar per quarter type benefit to us. But that, I just note that that’s included in my guidance on our non-interest expense levels for the second half of the year.

Operator

Our next question will come from Andy Stapp with Hilliard Lyons. Please go ahead.

Andy Stapp

Could you provide some color on the linked quarter decline in loan yields?

John Gavigan

Andy, I think that’s just a function of the production mix.

Andy Stapp

Okay. Do you expect to see continued erosion in yields on loans?

John Gavigan

I think in recent periods, our loan production has been pretty heavily biased towards floating rate loans. So that’s kind of put some pressure on the overall portfolio yield. But to Claude’s earlier comments, we’re hoping to offset that. We’ve seen stronger growth out of our specialty finance businesses, which are higher yields, generally. So that helps. And then, the earning asset remix out of the securities portfolio and into loans should help as well.

Andy Stapp

Okay. And gains on loan sales came in higher than we expected. What was driving the increase?

John Gavigan

Just higher mortgage production. We saw a good quarter in mortgage, which has continued to be a building business for us, but second quarter was stronger than first.

Andy Stapp

And how much of it was refi driven?

John Gavigan

I don’t have that percentage in front of me. We are not a large refinance shop. We tend to do more purchase, just because we don’t have a large servicing portfolio. But it was a higher percentage in the second quarter than it had been previously. I just don’t have it in front of me, Andy.

Operator

[Operator Instructions] Our next question will come from Daniel Cardenas of Raymond James. Please go ahead.

Daniel Cardenas

Nice quarter. Most of my questions have been asked and answered, just a couple. Maybe some clarity on, in terms of the average size of the loans that you added this quarter; was it trending towards a little bit larger loans or was it fairly granular in terms of the growth we saw?

Claude Davis

Yes. Dan, when you look at it in terms of what moves the needle especially in a quarter like this, it’s going to be some larger deals. So, yes, I would say the average loan size was high, was higher, but I don’t know that it’s anything higher than it’s been over the last four to six quarters.

Tony Stollings

Yes. I don’t think so it was pretty typical. I think really what you saw this quarter and it speaks to diversification of the portfolio and the verticals and channels that we build. Because when you have a quarter like this where just about every channel really performs well and see this overall lift. We don’t see it every quarter. Some are really hitting and some aren’t in a given quarter. But this quarter, we had really good production out of a number of channels, if not all.

Daniel Cardenas

Okay, perfect. And then, may be just a little bit of color as to the manageable increase in your classified assets on a sequential quarter basis. Was that coming from any specific industry or was that just really kind of related may be to one or two loans.

Claude Davis

Yes. I’d say just, as I mentioned I think on Scott’s question, just a few C&I credits were really the driver of that. It was really related to some downgrading our performance, most of which we think is manageable and they have plans to improve. So, at this point, we don’t see it as a portfolio level issue. But anytime you see even a small increase in a classified category, you’re sensitive and want to manage it aggressively.

Tony Stollings

And not specific to any single industry.

Claude Davis

Correct.

Operator

Our next question will come from Jon Arfstrom of RBC Capital Markets. Please go ahead.

Jon Arfstrom

Dan covered a bulk of my questions on lending. I thought it was a good lending quarter, but seems like a big growth quarter for you. I’m just curious how are you feeling about the pipeline. I know you’re setting high single digit to low double digit but some of the strengths from Q2 as that continued into Q3?

Claude Davis

We will continue to see strength Jon; I wouldn’t expect that level of strength. As Tony mentioned, we just -- we hit on all cylinders in the second quarter. You also can see a couple of big deals hit that will move the dial a little bit. But we expect good solid growth in the second half that leads to that high single-digit low double-digit for the year that John mentioned. But second quarter was unusually strong.

Jon Arfstrom

Okay. And then, on expenses, I think John you mentioned the expense outlook was flat. I know Tony we’ve had some conversations in the past about some of the things you are spending money on. Maybe give us an idea of where the spending pressures are and also where you’re seeing some opportunities to take expenses down? Just help us understand the mix that’s going on the underneath that guidance?

John Gavigan

Yes, Jon, we’re taking expenses down through just good solid process improvement, cost control. I think you and I, we’ve talked about our sourcing function that helps to aggressively manage our vendors and suppliers. So, we are taking cost down. However, we’re also investing on a number of fronts whether it’s in the branch footprint or data management, cyber, the compliance function. I mean these are all areas that as we grow, they need to grow with us and to same scale. We think that being able to create those savings and then invest keep our overall expenses flat; that’s a very good outcome.

Jon Arfstrom

Yes, I agree. Okay. I know you got a little help from the partnership gain, but just congrats on the 110 ROA. Good job.

Operator

This will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Claude Davis for any closing remarks.

Claude Davis

Thanks Allison. And again, thanks to everyone for joining the call and your interest and support to First Financial. Thank you.

Operator

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