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First Commonwealth Financial Corp (NYSE:FCF)

Q2 2008 Earnings Call Transcript

July 17, 2008 2:00 pm ET

Executives

Rich Stimel - Communications Manager

John Dolan - President, CEO

Ed Lipkus - Chief Financial Officer

Mike Price - President First Commonwealth Bank

Analyst

Steve Moss - Janney Montgomery Scott

David Darst - FTN Midwest

Kim Brasilia - KBW

Operator

Hello and welcome to the First Commonwealth Financial Corporation Second Quarter 2008 Earnings Conference Call. All participants will be in a listen-only mode. There will be an opportunity for you to ask questions at the end of today's presentation. (Operator instructions). Please note this conference is being recorded.

Now I would like to turn the conference over to Mr. Rich Stimel Communications Manager at First Commonwealth. Mr. Stimel, you may begin.

Rich Stimel - Communications Manager

As a reminder a copy of today’s earning release can be accessed by logging on to www.fcbanking.com and clicking on the Investor Relations link at the top of the page.

Before we begin I’d like to caution listeners that this conference call will contain forward looking statements about First Commonwealth, its business, strategies and prospects. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward looking statements. These risks and uncertainties include a variety of factors, some of which are beyond our control. These forward looking statements speak as of today and you should not rely on them as representing our views in the future. We undertake no obligation to update these forward looking statements to reflect events of circumstances that occur after this call.

Please refer to our SEC filings including our most recent Annual Report on Form 10-K for a more detailed description of the risk factors that may affect our results. Copies of these documents may be obtained from the SEC or by visiting the Investor Relations section of our website.

Now I would like to introduce to you, the President and CEO of First Commonwealth Financial Corporation, Mr. John Dolan.

John Dolan – President, CEO

Thanks Rich and good afternoon everybody. I appreciate you all have taken the time to join us today to discuss the second quarter earnings. What we continue to see is the execution of our strategic plan is bringing us wins in our market place. Probably the most important component of this strategy execution is a relentless focus on partnering within our corporation. The result of which has been an affective client acquisition and retention strategy. Bottom line as we continue to build on the momentum from the first quarter.

With me to discuss what we seen and why we are seeing it is Ed Lipkus our Chief Financial Officer; and Mike Price, President of First Commonwealth Bank.

To touch on the financials briefly, our second quarter net income was $1.4 million almost 12.5% over the same quarter of last year. This increase is largely attributable to the expansion in the net interest margin and an increase in our earning assets just shy of 8%.

We remain committed to growing earnings to support our historical strong dividend and in the second quarter we did just that. And I believe Mike and the rest of our banking unit will continue to strengthen this foundation for long-term growth. Thus far in the current credit cycles First Commonwealth has benefited from the aggressive mistakes made by the national financial institutions. Through a disciplined business approach we manage to grow earnings north of 7% year-to-date.

We avoided the subprime mortgage loan and subprime collateralized debt obligation marketplace. Thus avoiding the risk, exposure of the risk associate with him. Our view is that it comes down to the fundamentals, building and maintaining relationships and taking advantage of prudent opportunities. To maximize on these opportunities we are partnering across the lines of business in order to expand and deepen the relationships we have with our clients.

We have seen strong loan growth combined with growth and core deposits. Total loans increased $220 million from a 6% over the last quarter. While savings and demand deposits have grown a little over 8.5% year-to-date.

Our effective partnering within the organization also allowed us to take much more aggressive approach to going out and getting the business. Our client acquisitions strategies now take more holistic view to the client relationship. And we have used recent product campaigns to raise awareness and engage interaction in an effort to build these more comprehensive relationships.

We are also seeing good results from our sales blitz initiatives, during which we visited more than 1600 businesses in the last four months that’s a only blitz a month. All these things are coming together to form a community bank focus, focused on the services that provides to the customers, but with the resources to compete with the larger institutions on versus the community banks can't.

And now I would like to turn it over to Ed Lipkus for more comprehensive review of the financials.

Ed Lipkus - Chief Financial Officer

Thank you, John and good afternoon everyone. I will start by quickly reviewing our net income results for the quarter, then I am going to followup with some additional information regarding the loan growth and assets quality.

We have had a good quarter from several perspectives. Net income was up appreciably over the first quarter driven by strong loan growth and an improvement in net interest margin. Excluding our security gains and losses non-interest income increased and non-interest expense was flat despite increased incentive accruals related to net income growth.

We are extremely pleased with our loan growth both in year-over-year and from the 2008 first quarter. Loans to individuals increased at their 5 consecutive quarterly decreases due to stronger than expected growth in both direct and indirect portfolios.

Commercial loan portfolio grew 207 million or about 9.5% from March 31st, and increased about 521 million or 28% from the same period last year. The growth in commercial loans in the second quarter this year was equally spread in three main categories; 30% in commercial and industrial, 32% in commercial construction loans, and 38% in commercial real estate.

The growth in the commercial portfolios is across all sectors and its not concentrated. And about 95% of our construction growth was related to commercial real estate. And Mike is going to provide us additional color around some of our loans successes and associated programs we are getting in that growth.

We are seeing some improvements in our asset quality, non-performing loans as a percentage of total loans was 1.24% at June 30th, down from 1.26% at March 31st. And down from year end 2007 at 1.47%.

Loans pass due in excess of 90 days still accruing at June 30 decreased 5.9 million from the prior quarter end and were only 2.5% greater than in the same period last year.

Total non-performing loans at June 30 did increase 2.1 million from the prior quarter end and was 3.2 million greater than the comparable period last year. These increases were due mainly to an addition of one, $5 million commercial construction loan which is collateralized by real estate. Now that was partly offset by the successful work at a several smaller credits.

The provision for credit losses for the second quarter of 2008 increased 2.9 million from the same period last year primarily as a result of growth in the commercial loan portfolio as well as aforementioned the aforementioned construction loan going into non-accrual.

We continue to monitor the EFI loans and are presently in talks with P&C. As of June 30 we had 3.4 million in balance is down from 4.1 million on March 31, of which 2.4 million is in non-accrual. There were no additional losses on this portfolio in the second quarter.

Turning to investments, our mortgage-backed securities are all AAA rated and they are pretty well seasoned. These securities are backed by Freddie and Fannie and we do not presently have any equity holdings in these governments sponsored entities.

We did have some other than temporary impairment charges totaling 541,000 on two financial equities. Our present portfolio of financial equity is about 21 million in total. There has been some recent focus on trust preferred, we are presently holding about 130 million in trust preferred of which 81% are common pooled securities structured from financial trust preferred. To date all of these pooled securities are of investment grades and 99% carry a Moody rating of 83 or better.

We believe the recent volatility in the financial equities market is temporary. However, we will continue to monitor the banking sector and our related holdings for any additional impairment. And that wraps up my comments on our quarterly financial results. I would like to turn the call over to Mike to discuss his focus on our lines of business and our opportunity that lie here in.

So with that said it is my pleasure to give you Mike Price, President First Commonwealth Bank.

Mike Price – President First Commonwealth Bank

Thanks Ed. On last quarter's conference call John talked about winning in the market place. Our vision is to be first choice for our customers and to become the best community bank in Pennsylvania.

You know, I think our second quarter results show are beginning to win on several fronts, although there is a lot more work to do. As you heard from John and Ed our commercial services, our cooperate banking group has certainly led the way from a balance sheet perspective, but we have made good strides in our consumer and wealth management businesses as well.

If I were asked to summarize why we are getting the improvement, I would say we are doing more of the little things right. We are executing better than we have in the recent past. Let me just give you a few examples. We have clear expectations and a score card now for almost every front line facing position. We have developed new goals and incentives that are more line of site and they are align with growing earnings and creating shareholder value. We have a solid sales infrastructure that includes weekly reporting on results sales blitzes as John mentioned and really a heightened level of the accountability.

Now let me share some specifics and begin with our consumer services line of business or retail banking. Well I think we had and we continue to have the most opportunity for improvement. In consumer landing we grew our branch base consumer loan portfolio for the first time in several years on the back of a successful home equity campaign we call success is [brilliant]. We finished at 133% of a $97 million, 20 week campaign goal. Over 90% of these loans were in our A tier range for FICO scores over 700. So we felt really good about credit quality and we trended that year-over-year and we actually see an improvement.

There were lots of contributing factors towards success here. Things like clarifying goals, training and new and well conceived product offering, coordinated marketing by weekly teleconference to celebrate success. However one encouraging trend developed in this best practices was disseminated in every successful branch we felt like we had engaged the tellers to discuss the promotion with customers and make referrals that was common theme.

Similarly on the consumer positive side we are pleased with our progress. In June we kicked off a new, sweat and a checking products with the fun theme and internal campaign and titled it Catch The Way. Last month we averaged 20% more checking account openings in the same period last year we saw no dilution of average balances either. Not surprisingly we like the trends we are seeing with our growth.

My point here with both our HELOC or home equity loan and our checking campaign in this early success is that execution matters. And we feel like we are improving our execution continually and every day. For the quarter and year-to-date we have nice growth in what we call core or DDA and savings balances, which is well in excess of an aggressive budget and in fact is over 10%.

We have led higher cost CDs and in particular jumbo CDs runoff. In our estimation bigger banks seem to be going places with rates that are not prudent for us to follow. In our second line of business wealth management we are showing improvements there as well. We have realigned here under a single sales leader and we are excited on the cost of the some innovative product launches. We have also aligned the investment and brokerage businesses more closely with our branch distribution channel. Results here are encouraging and we are up some 20% in both revenue and net income year-over-year through 6 months and well head of our plan.

Our revenue through our investment representatives alone that are aligned with our branches is up some 111% year-over-year and is obviously one of the key drivers. Third and perhaps most importantly in our commercial services or corporate banking line of businesses capitalized on market disruption to driver our corporate banking portfolio up to $2.1 billion and about $400 million that’s end-to-end I think John and Ed were given you average balancing increase.

Here we have laid a solid foundation with good strategic discission over the last few years and we have build a corporate finance capability in a stronger commercial real estate offering. We also have a team of season lenders who have a long standing relationship with the (inaudible) clients.

Let me give you a little bit more color commentary here and Ed alluded to some of this. About two-thirds of our loan growth came from within our market and about one-third came from outside of our market. And to just give some of the detail, as we look for some granularity at the one-third outside of our market, we are really following existing clients where they were in contiguous markets adjacent to ours where we had develop some loan production offices over the years.

Also I would add about two-thirds of our loan growth came from our poor regional lending business from middle market business and the other third came from participations. And if you look at that one third that came from participations, about 60% of these are participations within our market and about 40% are outside of our market. So I am hopeful that helps a little bit.

Our spreads seemed to be winding slightly, we also see better fee income and better cross selling by our commercial relationship managers as well. I might add that we are using the same methodology we have had in place for years where we look at our average credit rating and this is an internal measure. And as we look at that, its improved on this book of business since last fall. So we are encouraged by that as well. So despite some encouraging trends that I have outlined the last two quarters, I still think we have lots of opportunities to continue to the grow our earnings.

You know, a couple things that I would mention here, our branches in Pittsburgh have historically underperformed the rest of our network, but we are keenly focused on reversing that trend and we feel like we have some early traction here just in the last few months. Similarly we have not performed in our ten or so de nova branches, I think commencer with our investment the last few years. And I feel like we have good traction on turning that around as well.

Our business franchise in our estimation is languish relative to the opportunity. And as we get that going, I think it will be great engine to grow our deposit faster and be an engine for nice new households in our retail banking, our consumer services business.

In corporate banking we really have good relationships and people that have been loyal to us for years. And I think we can build and provide more solutions to these customers by enhancing our cash management capabilities and product offerings.

In closing, given the disruption in the market, I think it’s a good time to be our size. I think we play it big in many important areas, but I also think, we can may remain true to our community bank heritage and really deliver locally and out flank some of our larger competitive. I am genuinely excited about our future and I think we are begging to get some traction.

And with that, I will turn it back over to John to make some closing remarks. John?

John Dolan: Chief Executive Officer

Thanks Mike, and thanks Ed. We made solid and steady progress in the past few quarters, despite the distraction happening in our industry. Our conservative lending practices, prudent growth strategies and business plan execution allowed us to achieve earnings growth.

The couple of significant loans that moved into non-performing status the last couple of report periods were not originated during the times in which we have had significant loan growth. As pointed out by Mike, that we have actually had improvement in our credit quality of those loans that we are originating.

We couldn’t achieved this performance improvement without the dedication and enthusiastic support of all of our employee base. Again, I want to thank them for their efforts and support. And as we continue the transition First Commonwealth into high performance community bank.

We continue to identify solid growth opportunities in the current industry environment and in the markets we serve. We will aggressively pursue the available growth opportunities caused by current market disruption and position our company to take advantage of these and other growth opportunities in order to strengthen our long-term market position. To identify strong opportunities, to expand our wealth management, corporate banking, and consumer services business.

Our success will be determined on our ability to execute the banking basics. Leverage the existing and perspective customer relationships and introduce new innovative products and provide unmatched quality in our services. We remain under penetrated as Mike said in the Pittsburgh market and have excellent potential to expand our sales campaigns in corporate banking and small business relationship. And we can further improve our internal partnership, collaboration, our cross selling activities.

In closing, I will say that we are stronger and better positioned today than we were one year ago. We remain confident about our long-term business prospects because we have continued to see favorable near and long-term growth opportunities and believe that this will be a successful year for our First Commonwealth.

Thank you all and we will entertain questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instruction). Our first question comes from Steve Moss from Janney Montgomery Scott. Please go ahead

Steve Moss

Good afternoon guys.

John Dolan

Hi Steve.

Steve Moss

What is still offer the loan growth, I am sorry, if I miss heard Mike, was it -- correct me that one-third of loan this quarter came from participations or within market?

Ed Lipkus

That’s year-to-date one-third came from participations.

Steve Moss

Okay.

Ed Lipkus

Those participations some end markets some or not?

Steve Moss

Okay. And what are your expectations here for loan growth going forward?

Ed Lipkus

The expectation for loan growth going forward, Mike you want to take it? Run at that?

Mike Price

You know, I would like to think we could sustain this, but I think that will be hard to do. I think we will continue to grow loans from both consumer and the commercial side at a pretty nice pace and probably out flank a lot of our great competitors.

Steve Moss

Okay. And sounds good. And with regard to the construction books growing pretty nicely here. What's the mix between residential versus commercial?

Mike Price

I think that its predominantly commercial, but let Ed address that.

Ed Lipkus

Steve, I would say out of the mix maybe 3 million is residential and the rest is commercial, I can give you kind of a flavor. Its across the board here we got about 32% office, 23% student housing, 20% major flagship hospitality, 10% retail, 10% healthcare and 5% other. And I sure hope that will adds up to 100%. But that kind of gives you across the boards spread on how we are diversifying our risk here within that portfolio.

Steve Moss

Okay, that's helpful. Thank you. And just the color on the trust was helpful was that the reason for the swing and other comprehensive incomes this quarter?

John Dolan

Yeah, I believe that’s the primary explanation but Ed do you want to address that.

Ed Lipkus

That is substantially all of the swing.

Steve Moss

Okay.

Ed Lipkus

And you are probably seeing that in the lot of other financial institutions or CI.

Steve Moss

Yes, and last but not least that I want to take up all the questions here but what is good tax rate going forward?

Ed Lipkus

I think annualizing - if I had if I used this in the model Steve I probably just take our six month run rate and annualized it. I don’t see any significant changes happening for the rest of the year.

Steve Moss

Alright. Thank you very much guys.

John Dolan

Hey Steve, thanks.

Operator

Our next question comes from David Darst from FTN Midwest. Please go ahead.

David Darst

Good afternoon.

John Dolan

Hi David.

David Darst

The $5 million construction loan where is that located?

John Dolan

I don’t believe we are going to get into any specific details of the customers, David. But….

David Darst

Geography or is it a participation?

John Dolan

It is a participation.

David Darst

Okay. Then could you give us an idea of what the new loans yields are on the construction portfolio relative to the overall portfolio yield?

John Dolan

I don’t know that I can give you that information right now. But we do a lot of variable rates on both sides Ed may be as if can give any input on that.

Ed Lipkus

Yeah generally we see the spreads are higher on and in this type of portfolio 250 to 350 probably good range. Over the LIBOR.

David Darst

Okay. And then how much of the CD book do you expect to reprise in the third or fourth quarter confirmed multi grates?

Ed Lipkus

Now I will give it you the first comment and turn it over to Mike, but the CDs we haven’t been very aggressive with them because some of the larger competitors who have problems with raising funds have been trying to do it through there CD pricing. So we haven’t been as aggressive and I think that we have seen some of that roll up, but I think there are core customers who are able to take care off. And the lot of that the jumbo CDs or hub money is what's left. So Mike lets you take if you want to refine that?

Mike Price

The only think that we add is when we look at the run off about CDs certainly disproportion about 80% of it is jumbos which is purchase money with school district and public Candies and thinks like that. When we monitor those very closely just to make sure that there single service household and its not reaping away of the fabric of a strong consumer household. And we are pretty satisfied there.

David Darst

Okay. Are you looking for any acquisitions opportunities?

Mike Price

Yes. We are always looking for the right, the appropriate transaction so we are still in the market.

David Darst

Do you think things will come to market this year?

John Dolan

I think there is been over slowdown and you probably have seen it more than I have but there is been slowdown and transactions and I think it would have to see work checks out last half the second half of the year ago.

David Darst

Okay. Thanks a lot.

John Dolan

Sure David.

Operator

Our next question comes from Kim Brasilia from KBW. Please go ahead.

Kim Brasilia

Hi good afternoon guys. Thank you for taking my question.

John Dolan

Yeah.

Kim Brasilia

My question is and regards to other reserve. You guys have had some nice loan growth primarily within CNI, your construction real estate while at the same time year-over-year the reserve has actually gone down from let's say 1.8 to 1.08. Do you guys see those building in the future or are you comfortable with that at these levels?

John Dolan

Again I will take the first comment and then turn it over to Ed, but we have a disciplined process as the banks -- all banks do and it's a -- there is judgment involved, but there is a lot of mathematics involved and good analysis done for the allowance. So we use that measure as a percentage -- allows as a percentage as an indicator but that’s not how we monitor our reserve and we believe that any movements you have seen has been directly proportional to the risk that’s in the portfolio. That’s going to drive it going forward as well. So Ed, do you want to add anything to that?

Edward Lipkus

Kim, I would probably just be repeating what John said. It's a rigorous model. There is no magic number that we provide to and that it certainly is directionally correct as far as the risk that we are taking.

Kim Brasilia

Okay, thank you. The next question is in regards to your margin. There is some nice expansion this quarter and I know here in your release you are saying that about 12 basis points of that was regarding prepayment fees. Is this a good run rate going forward, the 340, 342, is that a good run rate going forward or…?

John Dolan

Well, I would say that the major reasons for the improvements, shifting some investments into loans and also the deposit mix changes have been favorable to us. So I think that we have a strong base going forward and I don’t see a lot of volatility there. But Ed is there anything you want to add to that?

Edward Lipkus

I think that we have had some good pickup both in favorable deposit repricing as both John and Mike have pointed out, but also we have gotten some small pickups in the spreads and so I would say that don’t expect any substantial changes to that next six months.

Kim Brasilia

Okay, perfect. Thank you for your time.

John Dolan

Great, thanks.

Operator

(Operator instructions). Joining again is David Darst from FTN Midwest. Please go ahead.

David Darst

Okay. I have some more questions. Was the 130 for the first deferred, is that your market value? Can you give us the book value?

John Dolan

Ed, do you want to add anything to that?

Edward Lipkus

Yeah, hold on for a minute, Dave. I would say that you could probably easily compute the book value by just -- hold on for one second. The 130 Mark, we have Mark (inaudible) here he is our Treasurer and the 130 million that I threw out was that…

John Dolan

That is the book value.

Edward Lipkus

That is the book value.

John Dolan

We have a book value right now of throughout the corporation of 130,566,000 as far as the current market we have it 104,326,000.

Edward Lipkus

So as we indicated earlier, Dave, most of that swing in OCI came from this portfolio.

David Darst

Okay. And Mike, maybe you could give us an idea of where you are gaining the most market share and where you are seeing the most disruption relative to consumer, small business or within corporate business?

Mike Price

Just looking at our household growth and kind of just stack ranking where the growth is the greatest, I think corporate households and wealth management households have been at the top of the list and have been double-digit. Small business households are 5 to 6 and of course we have a couple of hundred thousand consumer households and although the number is relatively modest, we are very pleased with the number because a lot of our markets are flat to a slight decrease in population. So hopefully that helps you calibrate a little bit.

David Darst

And would you say that the corporate growth is coming from the lack of willingness to lend or the larger banks not sending behind their customers?

Mike Price

I think that’s part of it. I also think that the average experience of our lenders is well in excess of 15 years and I just think we have a lot of loss long standing relationships with customers and prospects. So I think we want to prospect picks up the phone and you know maybe needs to the lease a piece of equipment and borrow some money that you know where on the shortlisted of two or three people they might call?

John Dolan

Yeah, I think that David and in addition to that we have developed relationships over the years and some of the business may have been going elsewhere that we are getting a short at, this is not just because the other banks are not getting into the mix, but we had to be there, and be ready. And we had (inaudible) and we have been able to step in and provide what they are looking for. We do have a three lenders in addition to what we had year ago. So I think that the all those things are coming together at the right time to provide that growth force.

David Darst

Okay. That sounds good. How about for the month of July for a specific (inaudible) have you seen any change in deposit growth or deposit fronts from consumer that might be moving from larger banks?

John Dolan

Yeah, I thinks its too early to tell what’s going on there and I think that there is just a lot of disruption in the market. So really not comment on the third quarter yet.

David Darst

Okay, Thanks a lot.

John Dolan

Sure.

Operator

(Operator Instructions). Gentlemen, there seems to be no further questions at this time. I would like to turn the conference over or back over to Mr. Dolan for any closing comments.

John Dolan

Okay. Well the only thing I would say is that I am excited about where we are headed and you know, what the momentum we are picking up here. And thank you all for participating on the call.

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