First Financial Bancorp (NASDAQ:FFBC) Q4 2016 Earnings Conference Call January 20, 2016 8:30 AM ET
Scott Crawley - Corporate Controller
Claude Davis - CEO
John Gavigan - CFO
Tony Stollings - COO
Scott Siefers - Sandler O'Neill & Partners
John Arfstrom - RBC Capital Markets
Chris McGratty - KBW
Erik Zwick - Stephens Inc
Andy Stapp - Hilliard Lyons
Nathan Race - Piper Jaffray
Good morning and welcome to the First Financial Bancorp Fourth 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 Scott Crawley, Corporate Controller. Please go ahead.
Thank you, Andrew. Good morning, everyone, and thank you for joining us on today’s conference call to discuss First Financial Bancorp’s fourth quarter and full year 2016 financial results. Participating on today’s call will be Claude Davis, Chief Executive Officer; John Gavigan, Chief Financial Officer; and Tony Stollings, Chief Operating Officer.
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. Additionally, please refer to the forward-looking statement disclosure contained in the fourth quarter 2016 earnings release, as well as our SEC filings for a full discussion of the Company’s risk factors. The information we will provide today is accurate as of December the 31, 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.
Thanks, Scott, and thanks to those who joined the call today. Yesterday afternoon, we announced our financial results for the fourth quarter and for the full year 2016. Before I turn the call over to John to discuss our results in greater detail, I'd like to recap the progress we made this year and recognize the outstanding effort of our talent associates who make our success possible.
This is the year in which we focused on execution of our core strategy with past acquisitions fully integrated we were able to concentrate our efforts on growing organically and delivering exceptional client service. We realigned our senior leadership team to bring new energy to our business line and through the efforts of our sales and support team have made great strides to deliver on a premier business bank strategy.
As shown on Slide 3, in 2016 we realized solid loan and deposit growth, stabilized net interest margin, implemented strategies to grow fee income and maintained disciplined expense management and strong credit metrics during the year. These actions enabled us to offset impacts from the prolonged low interest rate environment, declining loss share related income to grow full year earnings by 18%, and achieve a sub 59% efficiency ratio, a 107 return on average assets and a 14% return on average tangible common equity.
As shown on Slide 4, our fourth quarter results were also strong and marked our 105th consecutive quarter profitability. Proactive balance sheet management and an improved net interest margin allowed us to offset the impact of slower than anticipated loan production and achieve our best quarterly performance of the year. Capital ratios improved during the period and our fourth quarter results continue to reflect a steady credit environment and disciplined expense management.
Finally, I would like to take this opportunity to announce the First Financial's Board of Directors has increased the quarterly shareholder dividend from $0.16 to $0.17 per share. Our capital levels and earnings consistency support the higher shareholder dividend was still retaining sufficient capital to support future growth. Overall, I’m very pleased with our progress towards building a company that can consistently and responsibly produced top-quartile results.
As we move into 2017, the Company remains well positioned to continue to grow organically and execute on our core strategy. Our focus remains centered on serving the financial needs of our business, consumer and wealth management clients while remaining disciplined in our approach.
With that, I’ll now turn the call over to John.
Thank you, Claude, and good morning everyone. Slide 4 and 5 provide an overview of our quarterly performance. Net income was $23.3 million or $0.38 per share for the quarter with the return on average assets of 1.11% and a return on average tangible common equity of over 14%. Our quarterly performance improved throughout the year with the fourth quarter being our strongest. Highlights from the quarter include strong deposit growth, margin expansion, solid credit performance, stable fee income and continued expense discipline.
Turning to Slide 7, net interest income for the fourth quarter was $70.2 million, an increase of $1.3 million or approximately 2% when compared to the linked quarter. Net interest margin expanded 5 basis points to 3.71% on a fully tax equivalent basis with yield on investment securities and elevated loan prepayment fees during the period.
Slide 8 details our non-interest income mix. For the fourth quarter, non-interest income was unchanged from the linked quarter at $16.9 million. Fee income for the quarter was impacted by lower client derivative fees and mortgage revenues tied to slower loan production while loss share-related income increased on elevated prepayment activity during the period. Notably, deposit service charge income was consistent with the third quarter and up 6% from the fourth quarter a year ago, reflecting the impact of strategies implemented during the year and our continued focus on growing fee income.
Turning to Slide 9, non-interest expense declined $900,000 or 2% from the linked quarter to $50.2 million. Fourth quarter expenses benefited from higher gains on sale of OREO properties and lower state intangible taxes, but we're also impacted by higher performance based compensation and marketing expense during the period. Overall, expenses were in line with our expectations and our efficiency ratio remained within our target range at 57.6%.
Slide 10, depicts the loan portfolio product mix as well as the drivers of our linked quarter changes. Fourth quarter loan production was impacted by slower business activity across our business lines and elevated prepayments, as well as our efforts to remain disciplined with respect to credit concentrations and loan pricing. Despite these crosswinds, we were pleased with our ability to proactively manage our balance sheet and offset the impact to earnings through higher income from investment securities during the period.
Turning to Slide 11, credit quality remained stable. The allowance in corresponding provision expense increased during the quarter on higher net charge-offs while non-accrual loans, nonperforming assets and classified assets all declined, reflecting the continued efforts of our credit team. The modest increase in the reserve balance is consistent with the mix of higher net charge-offs, but otherwise improving credit quality during the period. Overall, our credit metrics remain at historically low levels and our outlook remains stable.
On Slide 12, our capital ratios are robust and strengthen further during the fourth quarter. Overall, we’re extremely pleased with our fourth quarter and full year 2016 results and in particular our ability to grow revenue and earnings through the combination of strong organic growth, proactive balance sheet management, solid credit quality, core fee income strategies, and a continued focus on efficiency.
Turning to Slide 13 and our outlook for the year ahead, I'll note that while we are optimistic about the prospects for higher interest rates, infrastructure spending, tax reform and regulatory relief, we do not project any of these in our planning process. With that said we believe that we have positioned our company for continued success and are excited about the opportunities ahead in 2017.
In regard to the loan portfolio, we continue to target mid-to-high, single-digit loan growth on a percentage basis for the full-year consistent with 2016. With regard to net interest margin, we expect the margin to remain relatively stable through the first quarter though, as always, it could fluctuate a couple basis points in either direction depending on prepayment activity and production mix.
On interest rates, as I've said we do not project future rate changes in our planning process; however, I will note that we remain asset sensitive under slow and modest short-term rate increases. On fee income, we remain optimistic about opportunities to grow fee income across all sources and will continue to devote time and resources toward this effort.
With respect to expenses, we believe that a 2% to 3% increase represents a reasonable expectation for 2017. We will remain focused on efficiency, while also continuing to make strategic investments in people, processes and technology to support the continued long-term success of our business. And on taxes, we expect an effective tax rate between 32% and 33% for 2017.
Finally, I will note that the first quarter is typically impacted by a number of seasonal factors that affect both income and expenses for the period.
This concludes my remarks, and I will now turn the call over to Claude.
Thanks, John. Andrew, we’ll open the call up for questions now.
[Operator Instructions] The first question comes from Scott Siefers of Sandler O'Neill & Partners. Please go ahead.
Claude, I was hoping to ask just about loan growth, thoughts on the fourth quarter and outlook. Maybe if you could expand on those printed comments on slower business activity in the fourth quarter. I guess as I sort of put things together from the last couple of quarters I remember you guys suggesting on the third quarter call that maybe the pipeline, while it was good, maybe not as strong as in the first half. And then I think the fourth-quarter total growth maybe a little lighter than anticipated, but conversely it looks like the outlook is still pretty good for 2017. So, maybe if you could just speak at a top level about the puts and takes you see, what's going on with overall activity, demand, et cetera?
Yes, Scott. It's a few things, right, we did say I would say from August on just slower activity with our clients in the markets then might be what we had seen kind of pre-that. It's hard to know whether that was the election or just a pause after a strong first half. But that part, it was a little disappointing to us. That said on the activity front, we're really seeing that pickup we saw that starting late in the year in terms of just planned activity. Now, we all know that needs to come to fruition in closed loans, but we are encouraged by that which is what guides the 2017 guidance that we gave.
The other two pieces which caused fourth quarter to be a little bit lighter than what we had expected on the third quarter call. One was some elevated prepayments, and I would -- what I would tell you on those, none of those were -- and in a significant way related to what we look at as lost clients where someone took share from us. It was more related to two major factors. One being some larger commercial real estate projects that had come out of construction and went to prominent market as well as an M&A activity where we had some larger clients who were acquired and as a result paid-off their loans with us.
We also saw a few deals that were larger as well pushed from 2016 to 2017, and we've seen a few of those deals actually already closed. Some were M&A related, most likely related to tax planning expecting maybe lower rates, this year given the new administration. So, there was a combination of factors that caused the fourth quarter to be a little bit lighter than what we had expected than what we talked about on the third quarter call. But as we look forward and we've said it in the past, and I think it's what we showed for '16 is that while quarter-to-quarter things maybe a bit bumpy. We're still pretty positive and bullish on the expectations for '17 round that mid-to-high, single-digit growth rate.
Okay. That's perfect. I appreciate the thoughts there. Then, John, maybe if you can just address the margin a little, I was pleasantly surprised to see the benefit. I can obviously see what the drivers were at a very top level with the improved securities portfolio yield, for example. But just curious to hear your thoughts on, as you look at it, what allowed the margin to come in so well in the fourth quarter.
Yes, sure Scott, I think to your comments there, fourth quarter the drivers as I mentioned were primarily the securities portfolio yield as well as some of the prepayments that Claude mentioned. We saw elevated prepayment fees in the quarter and there's the silver lining there to that activity. The securities portfolio the yield increase we saw there that's really a continuation of some of the reinvesting we’ve done over the past over the past couple of quarters and the back half of the year.
Some of that was offset in the third quarter by prepayments speeds impacting overall portfolio yield, but we feel good about where the yield came in for the fourth quarter and are optimistic that opportunities going forward especially with the December rate hike there. So I think on our near term outlook, we expect the margin to remain relatively stable with the combination of the December rate hike in higher yield on investment securities, offset modestly by higher deposit cost tides or floating rate deposits.
The point I'd make there, Scott is we have been more conscious about trying to move up some of our loan pricing, which I think is begun to yield the positive benefit.
The next question comes from John Arfstrom of RBC Capital Markets. Please go ahead.
Claude, you may have just started to touch on this, but just following up on the loan growth commentary, the third bullet on the Q4 loan growth impacts, you talk about continued focus on profitability and limiting credit concentration. Could one of you maybe expand on that a little bit and help us understand that?
Yes, so John what we really took a look at was just kind of where we were at in some different kind of loan concentrations. One example being certain parts of the commercial real estate portfolio specifically construction, and we do this with all of our asset classes. Look at what we want that concentration to be and then begin to either pare back proactively or look at pricing adjustments, which we did both of in the third and fourth quarter. So, we -- which we know typically has a near term impact on volume though we feel like that's the right long term call.
And then in general, we've been encouraging all of our markets and lines of business to continue to price appropriately, and I'm sure that's impacted some volume where we may not have been as aggressive as some of our competitors were. But again, we feel like on the overall margin and yield and portfolio that was the right call.
Okay. Do you see anything out there that gives you pause or maybe doesn't make a lot of sense or do you feel like all your competitors are pretty rational at this point?
Yes, there's nothing of significance that I would say is giving us pause right now in terms of any major asset class or any what I would call systemic type issues. I think for the most part people are quite disciplined. I think what we’ve seen, which is continued in a commercial real estate space is some competitors, still doing a long-term fixed rate without swaps or hedges in place, like we tend to approach things. So, that’s probably been the one surprising piece to us, but that’s not moderated some just given the likelihood of the increase in rates.
Okay. Good. And then you all deserve a lot of credit on expense management and with your guidance, maybe Tony or John, where do you plan to spend money this year? What needs attention and where are you finding further opportunities on efficiency?
Yes, John this is I can take that and Tony can chime in it, if he has anything to add. I think overall our expense performance in 2016 was really a mix of targeted investments in the business on the regulatory front, on technology and process there, offset by our continued efforts to identify efficiency and cost saves elsewhere to help, and able us to continue reinvesting in the business, and I think 2017, we expect to be continuation of that.
The only thing I would add there John is that we do continue to invest in the $10 billion model and what that looks like. But I will describe that as a very appropriate pace based on our other asset planning models.
And John, there is last thing I would add is, one of the real things we’re focused on and post the Columbus acquisition and Oak Street acquisition is to really focus on strong operating leverage, and really getting that growth to reasonable level, maintaining the margin, fee income strategies while holding down expense. And we feel like getting operating leverage that way is capital efficient and manageable from a future credit risk prospective.
The next question comes from Chris McGratty of KBW. Please go ahead.
John, maybe we can start with you. Given the dynamics of the balance sheet growth this quarter and the outlook for loan growth to improve, how should we be thinking about the investment portfolio? Is that just going to be a source of liquidity? Should we assume there is growth with earning assets? How would you help us with the investment portfolio?
Sure, Chris. Honestly, I think if you look at 2016, it’s pretty good illustration of how we view the securities portfolio and manage it right now and it really, I hesitate to give you any kind of target portfolio size because it really is depended on the opportunities we see on the loan growth side. If we see a higher growth than anticipated as we did through the first half of 2016 and into the third quarter, I wouldn’t be surprised to see us let the securities portfolio cash flow and help support that growth. On the flipside you saw us here in the fourth quarter go back into and actively reinvest cash flows and grow the size of the portfolio, modestly there is loan growth tapered off. So, we’ll continue to actively mange that going forward.
And Chris this is Claude. I would say that to John’s point, we’re doing it in the context of a couple of key things we’re trying to manage and that is really the overall duration of the portfolio, which is still around three years as well as our overall interest rate risk positioned, which continues to be, as John pointed out in this comment, solidly asset sensitive. So, if the combination of all those factors that of how we’re looking at that part of the balance sheet.
Okay. That's helpful. In the quarter your investment yields went up. I think you alluded to some purchases you made. Was there a notable shift in premium am or should we expect any kind of bleed from the first quarter?
Actually, the premium amortization went against us in the fourth quarter. So, there was no benefit there.
Do you have that number? Because the first quarter should be a benefit, right?
Hopefully, I don’t have that exact number in front of me Chris. We can get back to you on that.
Okay. That's okay. And maybe one last one on rates. Can you remind us what the mix of fixed and variable rate loans are on the balance sheet, the limitation of floors, and what you might need if we do get rates before you see more material mix expansion?
Yes, in terms of the overall portfolio, we're right around 60% floating rate loans. But I will say that's been growing modestly as our production over 2016, and I would expect it to continue in 2017 has been heavily biased towards floating rate.
Okay. If I could ask one last one on capital, obviously we've seen in couple of market given where stocks are and evaluations are. How are you guys thinking about external capital as it stands here? And maybe frame the answer in the context of potential M&A opportunities. Thanks.
Yes, Chris, it's something we are always look at similar to the dividend discussion with our capital plan every quarter look at evaluate dividend, evaluate capital position and making sure that we do have the capital capacity. If the right strategic deal comes along, we will pursue it. We certainly are aware everybody's prices are up. If you need capital, it's a good time to raise it. At the same time, we feel the responsibility to shareholders that will only raise it, if we feel like either the organic growth or acquisitive growth opportunities are clearly there. So, that's the equation we look at and evaluate and try not to do it just on opportunistic price movement.
Okay. And are there more opportunities postelection to have a conversation with a partner?
I think there is always opportunities, I would say we're optimistic about the economy and growth rates, and certainly are very pleased to hear the new administration and Congress talking about a lot of good policy shift that we think is way overdue and well needed. And so that's on I think the positive side, on the M&A side, we're always in those conversations. But on day-in and day-out basis, we are really focused on our core growth organically, and we feel like we've really built the engine, the product mix, the business lines that growing organically with good disciplined expense management is going to get us the operating leverage to have good strong year-over-year EPS growth, which is really what we're trying to accomplish.
The next question comes from Erik Zwick of Stephens Inc. Please go ahead.
Maybe first on your goal to grow and diversify noninterest income, are you able to quantify your expectations and maybe provide any commentary around which businesses present the best opportunities for growth?
Yes, Erik. I would hesitate to give you a number because as you saw in 16 some of these strategies take time to manifest. We're really focused on all the areas, but I'd say in particular on the commercial deposit service charges it's an area that we're targeting, and we saw some success there in 2016, and we think we still have opportunity ahead in 2017.
The other one, Erik, this is Claude. I would add is that we're really trying to ramp up our capacity and capability on the commercial wealth side or private banking from the standpoint that one of the things we've seen in the private company market over the last specially two to three years is very active M&A, and so we're seeing a lot of our clients having liquidity of that. And we've had a few wins lately and hope to expand that and our ability to then to help them invest those assets. So, it really does come across service charge, mortgage fee and wealth management sectors are the biggest fee opportunities for us.
Next, maybe with regard to the loan loss provision, as I attempt to balance your outlook for mid to high single-digit loan growth and the recent decline in NPAs and classified assets, how are you thinking about the 2017 provision relative to the, we'll call it, $10 million reported in 2016?
Yes, Erik. Honestly, I think given the improvement throughout the year in our credit metrics and overall, we're sitting at historic lows and a pretty benign credit environment, and we don’t really see anything out on the horizon in the near-term that changes that. So, I would expect 2017 to be relatively similar to 2016. It could be up or down modestly, but relatively in line would be my expectation.
Maybe finally one for Tony. With the announcement this morning that you are assuming the role of President of Consumer Banking, anything we should expect, any reviews or changes to the way that business line is run?
I don't think so, just hopefully a little more intensity, a little more production and execution. I think it ties nicely into John's comments about our fee opportunities. He highlighted commercial, but I would say that anything related to the deposit product and the sales products is fair game here, and we really hope to drive a lot of that performance into fee growth, so no strategies to talk about today, but just a lot more intensity and focus on execution.
The next question comes from Andy Stapp of Hilliard Lyons. Please go ahead.
A number of banks we talk to have talked about balloon pricing improving even before the Fed rate hike. Do you guys see this?
Andy, it’s Claude, we have seen some modest improvement in just market pricing, and I would say better rational thoughts about it. We've also tried to improve and we’ve seen that come through in our originations yields over the last two quarters continue to move up even though we are predominantly originating variable rate product, which I find very encouraging from just an overall margin and growth standpoint. As I mentioned on one of the earlier questions, we see specific deal situations where we have a few competitors that still will do long-term fixed rate financing. But I would say that's more of the exception than the rule, so yes, overall I think it has improved.
Okay, good. And I might have missed this but could you talk about the sequential increase in net charge-offs and provisioning?
Sure, Andy. The net charge offs really was a combination moderately higher charge offs coupled with lower recoveries during the period. Multiple small, I would say to mid size loans in various work out situations. There was really no one asset class or individually significant contributor here in the quarter. Overall, with respect to provision, provision expenses is a product of the allowance model which incorporates multiple factors including the charge offs, loan growth, risk ratings, economic conditions and outlook. So, I would say the primary driver there was the higher charge off figure during the quarter although I used that term higher loosely as 17 basis points, there is still historically low charge off rate.
[Operator Instructions] The next question comes from Nathan Race of Piper Jaffray. Please go ahead.
Just going back to the loan growth discussion from earlier, I appreciate all the color around the various puts and takes there. But I was just wondering if you could expand a little bit on maybe the opportunities and challenges within the specialty finance asset classes that you guys operate in as you look into 2017.
Yes, we see -- first talk about the commercial finance space which includes our kind of Oak Street business line and the franchise group. So, a couple of thoughts there I think on the -- on one side is we see a lot of activity around M&A in both the insurance agency space as well as in the franchise space. And that presents both an opportunity and a headwind, headwind if one of your clients gets acquired which we saw a few of those occur in fourth quarter and opportunity if your client is a consolidator, and we've seen some of those as well. So, I think that would probably be the most dominant factor. I think beyond that both of those asset classes continue to be strong, good opportunities. Franchise space is one where we’ve seen continued new entrants and competitors into the space.
So that's a more competitive space so that creates its own kind of bit of challenge. But cutting through it all, I think both of those areas we see as real opportunities for us to grow in 2017. The other specialty finance areas we have are in business capital or asset based lending and equipment finance. And those continue to both do well, kind of hit their growth targets. But we’ve seen in the C&I space, I would say more competitors being willing to do, asset based lending type deals that we would structure as an asset based loan, more on a standard senior credit facility, which creates a different level of competition that we’ve seen, maybe pre 2016. But all that said again, we think both of those asset classes as well have an opportunity to grow in 2017.
Got you. That's very helpful. And then one other quick question just in terms of deposit pricing -- any thoughts on potentially changing the product type or mix? I would imagine you guys would have an ability to lag deposit pricing relative to peers, when we get a couple rate hikes this year. Just any updated thoughts on that in 2017 would be helpful.
Yes, this is Tony. We do have a pretty popular index product that will move with rates. But outside of that, we’ve not seen significant movement in rates in the markets yet. Fill like that we do have some, some pretty good capability to lack. So, we’re not ready to start change in our deposit basis or anything like that. So, we think it’s going to be relatively stable environment in the near term.
This concludes our question-and-answer session. I would like to turn the conference back over to Claude Davis, CEO any for closing remarks.
Thanks, Andrew. And again thank all for your interest in First Financial, and appreciate your participation on the call. Thank you.
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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