First Financial Bancorp's Management Presents at Barclays 2012 Global Financial Services Conference (Transcript)

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First Financial Bancorp (NASDAQ:FFBC) Barclays 2012 Global Financial Services Conference Call September 12, 2012 8:15 AM ET


Kenneth Lovik – Vice President-Investor Relations & Corporate Development

J. Franklin Hall – Executive Vice President, Chief Financial Officer and Chief Operating Officer


Matthew Keating – Barclays Capital, Inc.

Matthew Keating – Barclays Capital, Inc.

Matthew Keating and I work on the U.S. Bank’s Research team here at Barclays. Our discussion of Ohio-based banks continues this morning, and we’re very pleased to welcome First Financial Bancorp to our conference returning again this year. We believe that First Financial is a very well run organization with a sound growth strategy of transitioning its business and customer mix towards faster growing metropolitan markets within its Midwest footprint, largely Ohio and Indiana. More recently, well loan demand in its strategic market has been a bit low, its industry-leading capital levels have afforded it the flexibility to pursue acquisitions and return capital to shareholders. With the current dividend yield of over 7%, its one of the highest dividend yielding stocks in our bank universe.

With us, presenting today is Frank Hall, CFO and COO and also in attendance for the company are Ken Lovik, VP of Investor Relations & Corporate Development.

With that, I’ll turn it over to Frank.

J. Franklin Hall

Thank you, Matt, and good morning everyone and thank you to Barclays for inviting us to present at their conference. Here in the printed version of our presentation is our forward-looking statement. I’ll now turn to what many of you may already be familiar with, but I do want to remind you that we are a fairly simply straightforward bank that is conservatively managed that is known for strong execution in profitability located in the heart of the Midwest. We work diligently over the past several years to develop a strong sales culture across our lines of business, which include commercial, retail, wealth management, and franchise finance.

Our target commercial client is a small- to mid-size business located within our operating markets of Ohio, Kentucky or Indiana who have traditional deposit needs and lending needs of less than $15 million. Our retail business is supported by 122 locations primarily in metro or near metro markets. Our wealth management business manages over $2 billion in client assets and contributes approximately 25% of our adjusted non-interest income.

We have placed a recent emphasis on two more traditional product areas including residential mortgage production, and small business banking. Noted on the bottom right of this slide is a recently published ranking of the top SBA lenders in Southwest Ohio. First Financial ranks second for a number of loans originated and ranks first for dollar amount of loans originated for the top nine lenders in the year.

For those of you who may not be familiar with the details of our story, this slide presents a summary of our execution of key strategic initiatives since 2005. In 2005, we began a comprehensive plan to reposition the franchise, which included operational changes such as consolidating charters, implementing a single brand, and updating our technology platform to drive greater efficiency across the company. We also repositioned the balance sheet as we sold out non-performing assets, consolidated or sold under performing branch locations, and exited non-strategic business lines.

During this time, we actually shrunk the balance sheet from 3.9 billion of assets at the beginning of 2005 to 3.3 billion at the end of 2006. As a result of the restructuring, our balance sheet and asset quality were strong adding into the economic crisis.

We were well positioned to capitalize on FDIC-assisted acquisition opportunities early in the cycle, with less competition provided favorable financial terms that further enhanced the strategic deals we closed. The two FDIC-assisted transactions we executed in 2009 essentially double the size of our company. Subsequent to the integration of the acquired banks, we spent much of 2010 focused internally on operations as we rationalized at non-strategic operations and implemented further efficiency initiatives.

In 2011, we were able to deploy a portion of our strong capital base through two branch acquisitions where we accelerated our growth plans in Dayton, Ohio and Indianapolis, Indiana. Two metropolitan markets identified for future expansion. We also implemented our variable dividend, which has been acknowledged as one of the more innovative capital management strategies in the banking industry.

Listed on this slide, what I believe there’s some often overlooked points of peer and market differentiation. Peer is defined as the KBW Regional Bank Index minus First Financial. First, our profitability on a non-risk-adjusted basis over the last 12 months is above peer median with a return on average assets 15 basis points higher and a return on average equity, 174 basis points higher than peer.

Our capital levels are also well above peer median. Our tangible common equity ratio is 9.91% relative to our peer at 8.73% and our total capital ratio, which is bolstered by the low risk weighting of our earning assets due to the covered status that what was acquired through FDIC-assisted transactions is 18.42% compared to peer median of 15.33%. It is because of this robust capital position that we have continued a total dividend payout ratio of 100% resulting in the current annualized yield in excess of 7%, both of which are substantially above the peer median payout ratio of 37% and dividend yield of 2.7%. And our quarterly adjusted return on risk-weighted assets of 1.92% is 62 basis points above peer median as our risk-weighted assets to total assets is so much lower than peer. Said in another way, we are delivering above peer median performance on a lower risk balance sheet.

I’ll now touch on some of our key performance results for our most recent quarter. Our earnings track record is marked by our 87th consecutive quarter of profitability, a rare accomplishment in light of the industry turmoil over the past several years that’s over 21 years without a reported loss.

Our GAAP earnings per share for the second quarter were $0.30. our adjusted pre-tax pre-provision earnings totaled $30.2 million or 1.92% of average assets. Total uncovered loan balances increased 6.7% on an annualized basis driven by strong growth in our commercial real estate portfolio and increased production from our specialty finance product lines.

We also continue to focus on efficiency and deploying our resources in markets that provide the greatest prospects for maximizing growth and profitability. During the quarter, we completed the consolidation or market exit of 10 locations and announced that we will be consolidating two additional Indiana based locations and exiting four Indiana markets where we have a limited presence.

Net of the anticipated impacts on revenue from deposit attrition, estimated annual pre-tax operating expenses associated with these locations is $3 million. This will allow us to channel greater resources into our metropolitan markets of Cincinnati, Dayton, and Indianapolis. well, moving closer to our targets, operating efficiency ratio of 55% to 60%. Furthermore, we have launched a detailed review of our cost structure during the third quarter to further ensure our ability to hit this target range.

Displayed on this slide is the five quarter trend of our adjusted pre-tax pre-provision earnings. The adjustments beyond taxes and provision expense include the revenue from FDIC loss share indemnification payments and the accelerated discount from early termination events on acquired loans as well as significant one-time events. This is intended to help to illustrate more of the operating results of the company.

Compared to the first quarter, adjusted pre-tax pre-provision income declined due to lower net interest income partially offset by higher fee revenue, however, adjusted pre-tax pre-provision income remained relatively strong and consistent at 1.92% of average assets.

Our net interest margin remains strong at 4.49%, declining only two basis points compared to the prior quarter. We continue to execute on our deposit pricing and rationalization strategies, contributing to the strong net interest margin as our total cost of funds declined to 64 basis points and our cost of interest-bearing deposits declined to 61 basis points.

Additionally, net interest margin continues to benefit from 11.4% yield on our $904 million covered loan portfolio. Over the five quarter time period shown here, our earning asset yield has dropped to 48 basis points and our cost of interest-bearing liabilities has dropped 40 basis points. This relative change has occurred on an asset-sensitive balance sheet, which highlights our ability to manage our liability cost proactively.

While we don’t provide specific margin guidance, we do note that we expect continued margin headwinds in light of the slow economic recovery in our markets, the low interest rate environment and its impacts on loan and investment portfolio yields and the fact that we have an asset-sensitive balance sheet.

This slide provides an overview of our commercial banking line of business. Our commercial lending business includes both C&I lending, and commercial real estate lending, for clients with credit needs up to $15 million. On the C&I side, our primary focus is on middle market clients whose credit needs are too large and sophisticated for smaller community banks, but also do not receive the requisite amount of attention from the larger regional banks.

To provide additional solutions for our C&I clients, over the last 18 months, we have built on our specialty finance product set including asset-based lending and equipment finance. Our leasing portfolio has grown ahead of our initial projections and the asset-based product allows us to capitalize on providing structured financing for growing companies in our operating markets.

As highlighted on the graphs, our commercial portfolio is diverse in terms of both geography throughout our footprint as well as composition between owner-occupied real estate and C&I and investment real estate. With regard to consumer lending, we originate a variety of loans through the retail channel for the strong focus on home equity and installment loans, and residential mortgages. The revenue contribution from these products resembles the composition of the retail portfolio, but with a somewhat larger contribution from business banking and credit cards due to the highest rates earned on these products.

Unlike the commercial portfolio, the consumer portfolio is relatively diversified throughout our footprint. This table presents our investment portfolio as of June 30. As you can see, the portfolio represents a sizeable portion of our balance sheet. The portfolio has grown over the past year as a result of cash received in connection with the branch acquisitions we did in 2011 as well as continued pay down of the non-strategic portion of our covered loan portfolio.

You can also see that the portfolio is comprised primarily of mortgage backed securities, all of which are agency MBS. As a result, we have minimized the credit risk in the portfolio albeit at a yield that trails the peer group. With regard to increased prepayment speed and premium risk resulting from the low interest rate environment, we have partially mitigated the refinancing and premium risk by capping the premium at which we have purchased securities and by selectively purchasing agency MBS collateralized by assets less subject to refinancing.

That said, we do feel we have some continued margin opportunities related to deposit pricing and structure. This slide tracks our cost of interest-bearing deposits relative to the peer group median. Over the past several quarters, our cost of deposit funding has converged with the peer group as a result of our pricing and rationalization strategies, initiated during the third quarter of 2011.

Related to our rationalization strategies, total time deposits declined $159.4 million or 10.7% during the second quarter. The majority of this amount consisted of single service CDs and other time deposits representing non-core relationships.

Additionally, since the end of 2011, total time deposits have declined over $320 million. As of June 30, our total balance of time deposits was $1.3 billion with the cost of funds of 1.60%. While we have most likely dropped our cost of funds related to non-time deposit products as far as we can take them. We still feel we have room for continued improvement related to our CD balances. Over 30% of the total time deposit balance represents single service relationships with a weighted average rate of 1.82%.

Since the fourth quarter of 2011, our experience with maturing single service CD products has resulted in approximately 58% of the balances rolling of, and 42% retention rates at rates no higher than 20 basis points. Even as our retention rates were to increase, the cost of funds differential is great enough to have a significant impact on the all-in cost of deposit funding. There is also the additional impact of re-pricing the existing strategic CD portfolio with co-relationship clients, which again would be re-priced at significantly lower rates for those balances that are renewed.

So as you can see, we still have a few levers to pull going forward that should help offset the impact of a decline and covered loan balances, and any potential decline in new loan origination yields related to net interest income and net interest margin.

Excluding other comprehensive income, our capital structures comprised solely of common equity. Our capitalization levels remain strong relative to our peer group, and can support a significant amount of additional assets under our stated capital thresholds, and current regulatory guidelines.

Additionally, with regard to the NPR related to the Basel III capital standards, we performed a preliminary analysis under several scenarios and determined that our capital levels are still well in excess of the proposed guidelines. As we manage capital going forward, we are obviously in a wait-and-see period until the new capital guidelines are finalized.

This slide provides details on our variable dividend, which has been recognized as an innovative capital management strategy in the industry. Our Board has approved another quarterly variable dividend of $0.15 per share, which is additive to our existing and recurring quarterly dividend of $0.15 per share.

Our recurring dividend is intended to be sustainable and represents between 40% and 60% of our earnings. The variable dividend represents the balance of our quarter earnings. This variable dividend will continue for the next five quarters or all dividends paid through 2013 unless our capital position changes materially or capital deployment opportunities arise that cause our capital ratios to move towards our stated thresholds sooner than expected.

With the variable dividend, we are choosing to return to our shareholders, all of our incremental earnings, so as not to compound already high capital levels. And as I stated earlier, based on our recent stock price, this represents a dividend yield exceeding 7% on a stock that has strong underlying fundamentals and a track record of success.

We’ve noted in the past, the low-risk nature of our balance sheet. Due to the meaningful balance of loans on our balance sheet that are covered by FDIC loss share agreements, only 48% of our total assets are comprised of 100% risk-weighted assets significantly lower than peer group median.

Furthermore, our distribution of assets among risk ratings produces the risk-weighted assets to total assets of 59.5% relative to the peer median of 67.5%. However our return on risk-weighted assets significantly exceeds the peer median illustrating that we have a lower risk profile yet still generate better returns than peers.

Our credit quality has continued to improve with classified assets coming down almost $40 million or 21.2% over the prior year. Our credit metrics have remained relatively consistent over the last five quarters. And generally speaking our, overall credit performance through the cycle has held up well, the economic conditions or mix that we remain cautiously optimistic about our credit quality.

Our track record for deploying capital through acquisitions is outstanding as previously mentioned we completed two FDIC-assisted acquisitions in 2009 and announced during 2011, the acquisitions of 16 Ohio-based banking centers, 12 of which are located in the Dayton, Ohio market and 22 Indiana-based banking centers, 18 of which are located in the Indianapolis area.

Our acquisition philosophy is conservative, exhaustive and due diligence and has targeted to produce superior returns to an organic growth only strategy. We first evaluate opportunities for strategic fit, then assess our ability to integrate and operate, then finally price the deal to achieve predetermined hurdle rates of return. We do not feel that we need any transactions and will adhere to our time tested approach in targeted evaluation.

In summary, our operating fundamentals are strong, and we continue to generate better than peer performance. We have tremendous capital levels. Our variable dividend approach creates a dividend yield exceeding 7% among the highest in the industry. Our balance sheet is one of the lowest risk in the peer group. The credit outlook is stabilizing and presents us along with others in the industry, the opportunity to get back to normalized provision and charge-off levels with somewhat greater predictability.

We have improved our market share position in our primary operating markets, both organically and through low-risk branch acquisitions. And we have built a solid platform for commercial lending growth in our key metropolitan markets and are building scale in our specialty financed business lines as we round out our product offerings.

And with that, I’ll now be happy to take questions.

Matthew Keating – Barclays Capital, Inc.

Okay. The first question is if you currently don’t own shares of FFBC or are underway to stock, what might cause you to change your mind? One, faster deployment of its excess capital; two, in extension of its 100% available dividend payout beyond the end of 2013; three, a loan growth acceleration; four, greater comfort with a competitive environment, and it’s for Ohio market or five signs of progress on its announced efficiency initiatives, it’s targeting to 55% to 60% efficiency ratio? Okay. Well, choice three, an acceleration in loan growth certainly seems to be the top concern among investors. Frank, maybe you could comment several banks have explained, and have talked about a slowdown between the second quarter and third quarter in loan growth at this conference over the past few days. Are you seeing similar dynamics in your market?

J. Franklin Hall

Yeah, Matt. I would say it’s – I wouldn’t say, we have meaningfully different results from some of our competitors, but I wouldn’t say that we have noticed a significant up tick in the new products that we’re starting to offer to really round out the product set, and while the growth figures on a percentage basis are impressive. The dollar amounts obviously can start from a very low base. I would say that’s consistent with what you’ve heard from others, there’s an overall slowdown. but again, given our relative market position, we do have opportunities to grow. And because our internal lending limit is only $15 million, the size opportunity that we’re looking at sometimes is ignored by some of our larger competitors. So it’s really through market share gains that we would hope to see differentiated growth relative to some of the larger cap names that may have previously commented.

Kenneth Lovik

Next question, please.

Matthew Keating – Barclays Capital, Inc.

FFBC is on pace to close 15% of its branches, around 10% of its branch network this year, how would you best characterize these actions? Choice number one, probably enough in the near-term; two, a good start with more closures are probably going to be needed; or three, this is too much reduction. Okay. so it seems like the majority of the investors believe that, your recent branch closings are enough for the near-term. Frank, perhaps you could comment on are the closures this year simply a function of doing a few branch deals in 2011 and looking at some low-hanging expense save opportunities or is it more of a function of just an over branched, over banked Midwest market.

J. Franklin Hall

Yeah. Matt, the way that I would describe it is a continuation of a discipline that we started several years ago, which is annually evaluating the branch network against various performance metrics and making our decisions in that context, because we did acquire a number of offices that we did not originally open or select locations for, I think the opportunities this year were magnified a little bit, but this really is part of our ongoing process that we’ve developed over time.

Kenneth Lovik

Next question, please. Is there a third question or is this all that we have?

Matthew Keating – Barclays Capital, Inc.


Kenneth Lovik

Okay. So, let’s go back to the traditional Q&A format. First, I’ll check to see if there’s any questions in the audience.

Question-and-Answer Session

Matthew Keating – Barclays Capital, Inc.

Okay. Well, people get their talks together, I have a few more. You commented earlier in the presentation that you believe there’s about 1.6 billion under current capital resumes; you think you have the capability to engage another 1.6 billion in acquisitions. Under the Fed’s NPR, how does that metric change in your view, I know you’re probably still evaluating some of the dynamics there, but if you could provide any color, it would be helpful?

J. Franklin Hall

Yeah. We haven’t provided a specific update on that particular metric in light of our evaluation. but again, we are still above with those stated thresholds would be. so I would expect that’s certainly to be able to support our organic growth strategy certainly as if you look at the end of ‘13 with the end of the variable dividend retaining enough earnings to support organic growth. But we haven’t provided a specific number on that.

Matthew Keating – Barclays Capital, Inc.

Okay. Switching gears a little bit, obviously you guys put a lot of effort into differentiating between acquired strategic and acquired non-strategic loans. I think as of the second quarter you have identified about 11% of your loan book as non-strategic run-off, but you have a greater 23% of loans covered under FDIC loss sharing agreements.

J. Franklin Hall


Matthew Keating – Barclays Capital, Inc.

What is your historic track record in terms of identifying this non-strategic are those, I guess acquired non-strategic loans from strategic loans, are they generally trending in line with that categorization?

J. Franklin Hall

Yes, just to remind everyone that the difference in classification there is due to when we acquired Irwin back in 2009, they had operations well outside of our footprint, all the way out to California, Arizona, Las Vegas. And so we early on distinguished non-strategic loans as those that are outside of our footprint, and those that were of poor credit quality. So our performance on those loans from a credit perspective has certainly been better than expected. And I would say, the retention of loans or this slowness, if you will for those loans to exit, has been somewhat consistent with our expectations. The remaining loans that we acquired that were in footprints and of good credit quality, we certainly were to retain those.

So what you will see happen overtime is that even though the covered loan balances may decline, we will for those that are in footprint and of good credit quality treat them no differently, irrespective of the loss share coverage. So we may actually lose loss share coverage on that loan, but still retain it in the uncovered portfolio.

Matthew Keating – Barclays Capital, Inc.

Speaking of your loss share coverage obviously, I think most of those expiring in 2014.

J. Franklin Hall

That’s correct.

Matthew Keating – Barclays Capital, Inc.

What type of impact should investors expect on your capital position once that expiration comes?

J. Franklin Hall

Sure. A couple of different impacts there; one the risk-weighting of the covered loans moves from 20% risk-weighted assets to 100% risk-weighted asset. And then the credit quality metrics if you will, will have the impact of no longer excluding them because of loss share coverage. Between now and then roughly 80% of the covered portfolio, the non-strategic portfolio has a maturity of then to or something that should help its exit. But we are looking at a range of solutions there to deal with those circumstances. And as we look at our five-year plan, we of course make the adjustment to the risk-weighting, when we do our capital projections.

Matthew Keating – Barclays Capital, Inc.

Yeah thanks. So you are different from a lot of the other banks we listened to in footprint and exposure. And I just wanted to sort of see if I can dig a little deeper to get you to comment a little more about the trends in activity you are seeing in your footprint. First is in mortgage, when you guys have never been, your footprint is not what we consider an exciting housing market, which has probably been a good thing of late. Just curious, how the mortgage trends are going. And then secondly, on the small business exposure, I was curious, if you talk a little bit more about what the recent contour has been. People talked about slowing, but where it is slowing and do you think it’s going to pickup as we move through 2013.

J. Franklin Hall

Sure. I’ll answer the mortgage question first. We’re relatively new in reentering that business. So we were a fairly good size mortgage lender exited the business, use the third party to outsource much of that activity, and now we are back into it. And I would say that the process is – our internal process is maturing and I think we are starting to enjoy the benefits of what others have seen in previous quarters. But again coming off a relatively low base, so I’d say, we should expect to see our fair share going forward on that.

As it relates to small business lending, it’s hard to really identify why there is a slowdown and I think we’ve all heard the same anecdotal observations about uncertainty in taxes, uncertainty in the political landscape. But there are pockets that we are starting, or have seen, I think some relatively strong demand in some of the manufacturing areas in particular. I think this CapEx would say, that’s just delayed upgrades, that they perhaps should have done a while ago, so a little pent-up demand there. I'm not sure and I couldn't say broadly what's driving that, but that is an area that we've seen some pickup, but beyond that I don't know that I could offer much comment.

Matthew Keating – Barclays Capital, Inc.

Frank while you've talked at your recent mid-August Investor Day about providing more specifics on your targeted efficiency, great initiative to bring the ratio down to 55% to 60% on your 3Q call. One of you could perhaps provide us a sneak peek of some of the contemplated actions that you guys are working on.

J. Franklin Hall

I’m probably getting trouble if I did, but no, I would say that our approach and our process is moving along well and the approach has reminded it to those that their lessons is to really look at the broad range of performance matrix throughout the company. Compare them to some type of a benchmark and see if there are what I would call easy opportunities for improvement. We have the ability now to look at capacity utilization in our operating units and administrative units, as we look at the stack rankings of our sales force in our branches. Some I think some relatively easy opportunities are there, I don’t want to give a number as far as range, but again we're committed to get to the 55% to 60% and feel confident that we can do that.

Matthew Keating – Barclays Capital, Inc.

Switching gears back to capital, if the M&A or consolidation environment remains fairly slow over the next few quarters, is there a possibility that as the Basel III rules are finalized, you may decide to continue with the variable rate dividend, which is obviously a differentiator for First Financial versus peers for a longer time period, beyond the announced end of 2013 timeline.

J. Franklin Hall

Yeah, Matt, that obviously is a Board decision and the conversion around capital management, has always been one that is very shareholder friendly, and certainly we evaluated every quarter and look at what the future looks like, what the regulatory landscape looks like, and our Board, I think has demonstrated a commitment to doing what's right, and what’s in the best interest of our shareholders so, wouldn’t want to say one way or the other they are, but just would want to describe more completely the Board view on capital management.

Matthew Keating – Barclays Capital, Inc.

And then just briefly on the competitive landscape, a top five player in Ohio market, recently commented that competition there has been out sized, are you seeing similar competitive dynamics in the marketplace at this juncture.

J. Franklin Hall

When that comment came out we started getting that very question, I don’t know that we're seeing what he is seeing. Now his geography relative to our geography is much broader, but we don’t see a lot of distinction in pricing among our various geographies. So Ohio pricing doesn’t look materially different than Indiana pricing. And it may just be, the comment relative to our experience may just be based on the size of opportunities, that that institution may be evaluating relative to our size of opportunities.

Matthew Keating – Barclays Capital, Inc.

Well, it looks like we’re approaching the end of our time, but please join me in thanking First Financial and there will be a breakout session in the Riverside Ballroom.

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