First Financial Bancorp. Q1 2008 Earnings Call Transcript

May.16.08 | About: First Financial (FFBC)

First Financial Bancorp. (NASDAQ:FFBC)

Q1 2008 Earnings Call

April 30, 2008 9:00 am ET

Executives

Claude Davis - President, CEO

Frank Hall - CFO

Analysts

Scott Siefers - Sandler O'Neill & Partners

Christopher McGratty - KBW

Operator

Hello, and welcome to the first quarter 2008 earnings conference for First Financial Bancorp. (Operator Instructions) Please note this conference is being recorded. Now I would like to turn the conference over to Mr. Claude Davis. Mr. Davis?

Claude Davis

Thank you, Amy. Before we provide some additional commentary on the first quarter of 2008, Frank Hall, our Chief Financial Officer, will read the forward-looking statement. Frank?

Frank Hall

Thank you, Claude. As we begin, I would like to remind everyone that our discussion today may involve certain forward-looking statements, which are not statements of historical fact. The first quarter earnings press release should be read in conjunction with the consolidated financial statements, notes, and tables attached and in the First Financial Bancorp Annual Report on Form 10-K for the year ended December 31, 2007. Management's analysis contains forward-looking statements that are provided to assist in the understanding of anticipated future financial performance. However, such performance involves risk and uncertainties that may cause actual results to differ materially. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to, management's ability to effectively execute its business plan; the risk that the strength of the U.S. economy in general and the strength of the local economies in which First Financial conducts operations may be different than expected; the effects of and changes in policies and laws of regulatory agencies, inflation, and interest rates.

For further discussion of certain factors that may cause such forward-looking statements to differ materially from actual result, refer to the 2007 Form 10-K and other public documents filed with the SEC. These documents are available on the Investor Relations section of our website, bankatfirst.com and on the SEC's website at sec.gov. Additional information will also be provided in our quarterly report on Form 10-Q for the quarter ended March 31, 2008, which will be filed with the SEC by May 9, 2008. Claude?

Claude Davis

Thanks, Frank. It has been another difficult quarter for the banking industry, but our strong balance sheet and capital position provides us the opportunity to grow loans prudently, price deposits appropriately, and manage credit proactively. As I noted in our discussion of 2007 results earlier this year, we continue to manage through the actions of the Federal Reserve and the aggressive interest rate reductions, now totaling 300 basis points in the Fed funds rate, since September. The pace of near-term economic growth remains an unknown, but we are committed the strategies and processes that we believe effectively manage our risk and still allow us to capitalize on opportunities and to position ourselves well for an economic recovery.

Our return on average assets and return on average equity of 0.89% and 10.63% respectively, while below our long-term expectations, do include some points which we will build upon. We continue to generate solid commercial loan growth on both a year-over-year and linked quarter basis, and our credit quality metrics remain strong. We remain significantly well capitalized from a regulatory standpoint and believe we are opportunistically positioned.

Greater efficiency and expense control are contributing in a positive way to the company's performance. While our non-performing asset level remains stable, our allowance for loan loss to loans increased from 1.12% to 1.14% from the fourth quarter of 2007. Even with stable credit quality metrics, we have a cautious view relative to current economic conditions and their potential impact on both commercial and consumer borrowers. The decision to shift from consumer to commercial-based lending, reduced our exposure to the residential mortgage and indirect auto loan sectors, and when combined with disciplined processes regarding land development and construction lending, we believe we will effectively manage our credit risk.

The challenge of balancing market pricing and growth with the customer's preference for higher yielding money market and time deposits continues, but we are making progress in growing transaction accounts, expanding client relationships, and increasing banking center efficiency. We continue to focus on our targeted markets and have new banking centers under construction in Dayton, Ohio, and Crown Point, Indiana, and plans for new offices in Cincinnati, Northern Kentucky, St. Mary's, Ohio and Columbus, Indiana in the next 12 months.

The shift in our loan portfolio mix from consumer to commercial continues with 16% year-over-year growth in the commercial portfolios. Our metropolitan markets of Cincinnati and Dayton, Ohio as well as Northern Kentucky continue to experience strong loan growth with each exceeding 30% year-over-year growth.

Total net charge-offs for the quarter were at the top end of our expected range, but were negatively impacted by four large home equity loan charge-offs. Over the past eight quarters, as a percent of total home equity loans, both the ratio of non-accrual home equity loans and the ratio of net home equity charge-offs has been less than 50 basis points, excluding the first quarter 2008 volatility. Similar volatility in future quarters could occur, but we expect the bulk of the portfolio to perform as it has in the past.

We have maintained stable levels of both non-performing and classified assets for the past five quarters. Total classified assets also include loans that are still performing that may have characteristics that warrant a heightened level of attention. There are no particular concentrations in our total classified assets. And the ratio of non-performing loans to total loans was 58 basis points at the end of the first quarter, up slightly from 56 basis points at yearend.

As previously mentioned, the allowance for loan losses to total loans ratio increased to 1.14% from 1.12% at the end of 2007. Strong credit processes and procedures as well as being aggressive in the workout of problem credits, remain key tools in our staying ahead of credit quality issues.

As we have stated before, First Financial does not have a concentration of commercial loans to home developers with an existing portfolio of approximately $43 million. We limit our exposure from both the development and the spec home activities in any particular project by having strong internal policies requiring an extensive underwriting process, including providing multiple sources of repayment.

However, a protracted economic recession could cost some of our clients to experience difficulties. During the first quarter, we did experience an increased level of non-accrual loans in our residential mortgage portfolio, which is consistent with the industry and the weakness in the consumer sector.

Again, these are challenging times, but we believe that by continuing our strong emphasis on credit costs, continuing to grow earning assets in a profitable manner and maintaining strong expense management, we will return to our targeted performance levels. In addition, with a slightly asset-sensitive balance sheet, we are well positioned for margin expansion when we reach the bottom of the interest rate cycle and interest rates stabilize or begin to trend higher.

Frank will now review the highlights of the other areas of the first quarter. Frank?

Frank Hall

Thank you, Claude. There are a number of specifics I would like to highlight in our first quarter results of $0.20 per share. There were also some events from the quarter that will impact our performance going forward. And I will make some comments regarding those events in the context of our outlook for the balance of 2008.

The net interest margin for the first quarter of 3.78% on a non-tax equivalent basis remained relatively stable with the fourth quarter of 2007 of 3.79%. Despite the negative effect of decreasing rates on the loan portfolio, the mixed shift and overall decrease in earning assets for the quarter, due to time deposit portfolio declines allowed us to maintain both a stronger margin and higher net interest income level than anticipated. This quarter's results demonstrate our ability and willingness to be disciplined in pricing our time deposits despite competitive pressures.

As noted in our earnings release, we are increasing the size of our investment portfolio by approximately $100 to $150 million over 2008, and mostly conservative agency bank securities which will improve our net interest income, but put pressure on the net interest margin. We have estimated our full-year margin to be between 3.67% and 3.75% on a non-tax equivalent basis. There will be a more pronounced second and third quarter decrease in our net interest margin as our liabilities continue to re-price slower than our assets, though we expect to have a stable and increasing net interest income throughout the remainder of the year.

Loan growth continues in the commercial and commercial real estate sectors. This is a consistent point of emphasis as we shift our asset mix from a consumer heavy weighting to one of commercial. We have experienced over 16% growth in average commercial, commercial real estate and construction loans, since the first quarter of 2007. We are still seeing opportunities for growth, but will continue to emphasis quality first.

Total deposits on an average basis have declined only slightly on a linked quarter basis. Transactional deposits have grown modestly and our commercial deposit product is beginning to gain momentum. Time deposits however, are the driver of the approximate $30 million linked quarter decrease. $20 million of the $30 million decrease is in the brokered and public funds CD product, which will normally experience some volatility as it is more wholesale in nature and is utilized in a context of the overall funding strategies of the bank, not as a core banking product.

We continued to see market pricing that is well outside our range of profitability. Rates paid by our competition in certain markets, has had an effect on our retention rates, but we have held our expected margin on the deposit portfolio with disciplined pricing. Our strong liquidity position and our available wholesale funding capacity have provided us the luxury of making prudent deposit pricing decisions, while still maintaining the flexibility to pursue the previously mentioned investment portfolio growth.

Non-interest income on a linked quarter, excluding the effect of the $1.6 million gain on the redemption of Visa common shares and the $5.5 million fourth quarter 2007 gain on the sale of the merchant portfolio, decreased primarily due to a seasonal decline in service charges on deposit accounts and lower trust and wealth management fees, offset slightly by higher bank card income.

Our first quarter success in the wealth management area was muted by the market performance of the underlying assets under management. With approximately one-third of our total non-interest income coming from management fees, we are well positioned to benefit from an overall market recovery.

The seasonality in the service charges on deposit accounts was more pronounced to this quarter. We are actively reviewing both the performance and recovery strategies to ensure that this is not indicative of a long-term trend. Management expects and has early indications that the first quarter levels of NSF fees are low due largely to some seasonality. Our overall outlook for non-interest income remains unchanged with flat to modest growth on a full-year basis.

Non-interest expense for the linked quarter, excluding the effects of the pension settlement charge were down slightly. Salaries and benefits expense were up slightly on a linked quarter basis, due in large part to the seasonality of certain payroll taxes. Our overall staffing and salary levels remain disciplined with some opportunity for improvement. Expense control remains one of our priority items this year with planned though modest expense cuts expected in 2008.

Credit quality was diluted somewhat this quarter with an annualized net charge-off level for the quarter of 40 basis points. As Claude mentioned earlier, approximately 8 basis points were due to 4 large home equity loans. We continue to support our 2008 outlook of between 30 and 40 basis points in net charge-offs.

We remain mindful, however, of the possibility of unforeseen credit events. The risk of these events is elevated in difficult economic times and is addressed in our allowance for loan losses model and is the driver of the two basis point increase in our allowance. As of the end of the first quarter of 2008, we believe our allowance coverage to non-performing loans and non-accrual loans of 195% and 202% respectively, is adequate and yet another point of differentiation from our peers in these difficult times.

Capital remains strong. Total capital exceeding the minimum regulatory requirement has averaged approximately $100 million, since the end of the first quarter of 2007. During the first quarter, First Financial did not repurchase any shares and does not expect to repurchase any additional shares in 2008 at this time.

In conclusion, the volatility in the financial markets has had a near-term negative effect on our net interest income, margin and our wealth management fee income. It is important to note however, that we are well positioned to be significant beneficiaries of any recovery either in increasing interest rates or increasing equity values.

It is important to note however, the First Financial has remained disciplined in credit underwriting, asset and liability pricing, expense management and capital management as these are the fundamentals of managing a strong and healthy financial institution. We are well positioned for the future.

We appreciate your interest in our company. And this concludes the prepared comments section of the call. We will now open up the call for questions. Amy?

Questions-and-Answers Session

Operator

(Operator Instructions) Our first question comes from Scott Siefers at Sandler O'Neill.

Scott Siefers - Sandler O'Neill

Good morning, guys.

Claude Davis

Morning, Scott.

Frank Hall

Hi, Scott.

Scott Siefers - Sandler O'Neill

Let's see. I guess, Frank, the first couple of questions might be for you. It's just on the increase and potential increase in the securities portfolio. I guess, if I look at the end of period numbers, the available for sale portfolio is up fairly substantially though the average numbers were down. So is it, I mean, fair to say that, you guys already started the strategy to increase that? And do you see this as something that occurs sort of evenly throughout the course of the year? Or would you front end load the timing of adding the $100 to $150 million?

Frank Hall

Sure. We have started the purchase of the $100 to $150 million. We had approximately $20 million settled by the end of the quarter. And we do expect to front end load it. I expect most of these purchases to happen during the second quarter.

Scott Siefers - Sandler O'Neill

Okay. And can you give us a sense for typical yield on the kinds of instruments you're buying and the kind of costs to fund that as well?

Frank Hall

We're seeing, I would say in the high 4's approximately on the yield on those securities.

Scott Siefers - Sandler O'Neill

Okay. And then on the cost of funds?

Frank Hall

We're looking at the funding strategies right now. Overall, I would just say that to paint this picture correctly for you, we're expecting -- we call it around 200 basis point spread on the leverage strategy.

Scott Siefers - Sandler O'Neill

Okay. And then switching gears down to fee income, for a second. You made some comments on, I think it was the service charges just being, I guess unusually weak due to a couple unusual items. What are the kinds of things that give you confidence that those numbers will jump back up as we look through the remainder of the year?

Frank Hall

Sure. As we said that, the seasonality is one that we've experienced before, but we're always a bit skeptical to make sure that it is just seasonality. And we do have early indications that the number of occurrences of the NSF fees are starting to come back out. So, that's what gives us confidence that seasonality is happening yet again.

Claude Davis

And Scott, this is Claude. Really the one area where we have typically seen it, we're seeing-- we saw it again this first quarter was in the NSF fee area. Other service charges have been stable and in the commercial area they've actually been up slightly because of the decline in the earnings credit rate. So as we can continue to grow our commercial deposit base, we would hope to continue to see increases in that category.

Scott Siefers - Sandler O'Neill

Okay. And then if I can just jump back to the margin for one second. I guess there's a growing sentiment that we'll get some sort of an extended pause if the fed cuts rates today. What kind of interest rate forecast have you guys baked into your own modeling for the remainder of the year?

Frank Hall

Yeah. At this point, we've accounted for the most recent rate changes.

Claude Davis

Stable from where we're at.

Frank Hall

Right.

Scott Siefers - Sandler O'Neill

Okay. Perfect. Thank you very much.

Claude Davis

Thanks, Scott.

Operator

Our next question comes from Christopher McGratty at KBW.

Christopher McGratty - KBW

Good morning. Just a quick question on your margin guidance, I think you said 3.67 to 3.75. And if I convert that to an STE, I'm coming up with like 3.74 to 3.82. Is that about right for the full year?

Frank Hall

Again, our margin guidance is on a non-tax equivalent basis. So I'll stand by the numbers that are in there.

Christopher McGratty - KBW

Okay. And in terms of the net interest income, in terms of next quarter, you said it's going to stabilize. Does that mean grow from first quarter or are we going to see a decline in the second quarter before rebounding?

Frank Hall

Stable or flat.

Christopher McGratty - KBW

Okay. And then my last question is on credit. You guys maintain your charge-off guidance. But in terms of home equity, can you maybe discuss what happened this quarter? You know, charge-offs were a lot higher than they were the last few quarters. I'm just wondering if this is a concern or if any parts of the portfolio, you guys are concerned about at this point?

Claude Davis

Chris, this is Claude. As we mentioned in the release, the spike we saw on home equity this quarter was related to four specific home equity loans all in excess of $100,000. And as we pointed out and I mentioned in my comments, the rest of the portfolio is actually continued to perform as it has in the last several quarters. So one of the things that we're evaluating is certainly, being mindful of the whole portfolio but also being sensitive to look at larger balance home equity loans to make sure that we're managing those effectively. But the balance of the portfolio has performed as expected.

Christopher McGratty - KBW

Thank you.

Operator

(Operator Instructions) Mr. Davis, it seems we have no further questions.

Claude Davis

Okay. Amy, I thought I'd just kind of end with a couple of key points for us that we feel like are important to emphasize as to where we are focusing as a management team. First is in credit management, we're continuing to manage that effectively being mindful of our pricing discipline and hopefully growing and maintaining our funding base, a strong capital position, managing expenses effectively, and most importantly positioning ourselves well for an economic recovery, while still growing the business. And we feel like if we execute on those key points, we'll return to our targeted return levels.

But we appreciate everyone's interest in our company. And we look forward to next quarter's call. Thank you.

Operator

Thank you for attending. You may now disconnect.

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