First Financial Bancorp /Oh/ Q4 FY2023 Earnings Call

Thank you for standing by and welcome to the First Financial Bancorp Fourth Quarter 2023 Earnings Conference Call and Webcast. I would now like to welcome Scott Crawley, Corporate Controller to begin the call. Scott, over to you.

Thank you, Mondy. 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 2023 financial results. Participating on today's call will be Archie Brown, President and Chief Executive Officer; Jamie Anderson, Chief Financial Officer; and Bill Harrod, Chief Credit Officer. Both the press release we issued yesterday and the accompanying slide presentation that are available on our website at www.bankatfirst.com under the Investor Relations section. We'll 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 2023 earnings release, as well as our SEC filings for a full discussion of the company's risk factors. The information we'll provide today is accurate as of December 31, 2023, 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 Archie Brown.

Thank you, Scott. Good morning, everyone, and thank you for joining us on today's call. Yesterday afternoon, we announced our financial results for the fourth quarter and full-year 2023. Before I turn the call over to Jamie, I'd like to provide some highlights from the most recent quarter and recap this year's record performance. I'm very pleased with our fourth quarter performance; adjusted earnings per share was $0.62, which resulted in a return on assets of 1.37% and a return on tangible common equity ratio of 22.2%. As expected, rising funding costs outpaced the increase in asset yields. However, our net interest margin remained very strong at 4.26%. Additionally, balance sheet trends were positive during the quarter with loans increasing $286 million or 11% on an annualized basis, and average deposits increasing $416 million or 13% on an annualized basis. Non-interest income and expenses were both lower than we expected during the quarter. The decline in non-interest income included a $4.6 million loss on a trade at Bannockburn. However, excluding this loss, foreign exchange income was within our range of expectations. Leasing income also declined during the period due to lower end of term fees and lease origination shifting to a greater mix of finance leases. The partnership increased interest income and the net interest margin. It resulted in lower non-interest income during the period. Non-interest expenses declined for the quarter primarily due to lower incentive compensation, which is tied directly to non-interest income. Asset quality was stable for the quarter with underlying credit trends improving. Net charge-offs were 46 basis points during the quarter, and were driven by one relationship that included a borrower fraud. This loan had been on non-accrual for most of the year and was almost fully reserved going into the fourth quarter. Additionally, non-performing assets declined by 12% to 38 basis points and classified asset balances were relatively unchanged from the third quarter. 2023 was a record year for First Financial. Adjusted earnings per share increased 17% from the prior year to $2.77, while return on assets was 1.55%, return on tangible common equity was 25.4% and our efficiency ratio was 56%. Total revenue of $840.2 million was the highest in the company's history, increasing 18.5% over the prior year. Our balance sheet responded favorably to the interest rate environment, resulting in a 21% increase in net interest income. Additionally, record years from wealth management and Summit drove a 12% increase in non-interest income. We're extremely pleased with the performance of our balance sheet during 2023, especially given the turmoil in the banking industry in the first half of the year. Loan production was solid, exceeding 6% in balance growth, while average deposit balances increased 2.4% compared to the prior year. We're also very happy with the 122 basis point expansion in the tangible common equity ratio and a 24% increase in the tangible book value per share for the year. Asset quality trends were a bit elevated during the year. Net charge-off increased to 33 basis points for 2023 after we achieved a record low of 6 basis points in 2022. This increase was driven by two large relationships as well as the loss on the sale of a small portfolio of ICRE loans. Non-performing assets to total assets ended the year at 38 basis points; we believe we're well positioned to manage the coming year and we're cautiously optimistic regarding asset quality in 2024. With that, I'll now turn the call over to Jamie to discuss these results in greater detail. After Jamie's discussion, I'll wrap up with some additional forward-looking commentary and closing remarks.

Thank you, Archie, and good morning, everyone. Slides 4, 5, and 6 provide a summary of our fourth quarter financial results. The fourth quarter was another good quarter highlighted by strong earnings, net interest margin that exceeded expectations, stable asset quality metrics, and solid loan and deposit growth. Our balance sheet continues to respond favorably to the current interest rate environment. While our net interest margin declined slightly, the pace was less than we expected and remains very strong at 4.26%. We anticipate further net interest margin contraction in the coming periods due to additional pressure on deposit pricing and changes in funding mix. Total loans grew 11% on an annualized basis, which exceeded our expectations. Loan growth was concentrated in the leasing, specialty finance, investor CRE, and residential mortgage books with relatively stable balances in the other portfolios. Non-interest income declined in the fourth quarter. The largest decline was foreign exchange, which was negatively impacted by a $4.6 million loss on a trade. However, this loss was mostly offset by lower non-interest expenses. Additionally, leasing business income declined during the quarter. However, this was primarily a function of product mix; Summit originated a larger volume of finance leases during the period. Non-interest expenses declined from the linked quarter due to lower employee costs and marketing expenses. Overall, asset quality trends were stable with lower net charge-offs, flat classified assets, and declining non-performing asset balances. Annualized net charge-offs were 46 basis points during the period and were driven by a single $9 million relationship that we previously reserved for. We recorded $10.2 million of provision expense during the period, which was driven by net charge-offs and loan growth. Our ACL coverage remains conservative at 1.29% of total loans. From a capital standpoint, our regulatory ratios remain in excess of both internal and regulatory targets. Accumulated other comprehensive income improved $100 million during the period. As a result, tangible book value increased 13.5%, while our tangible common equity ratio increased by 67 basis points during the period. Slide 7 reconciles our GAAP earnings to adjusted earnings, highlighting items that we believe are important to understanding our quarterly performance. Adjusted net income was $59 million or $0.62 per share for the quarter. Adjusted earnings exclude the impact of the FDIC special assessment as well as costs not expected to recur, such as acquisition, severance, and branch consolidation costs. As depicted on Slide 8, these adjusted earnings equate to a return on average assets of 1.37%, a return on average tangible common equity of 22%, and an efficiency ratio of 58%. Turning to Slide 9, net interest margin declined 7 basis points from the linked quarter to 4.26%. As we expected, higher funding costs outpaced the increase in asset yields, primarily due to a 31 basis point increase in the cost of deposits. These costs were partially offset by a favorable shift in funding mix and a 14 basis point increase in asset yields due to higher rates and a more profitable mix of earning asset balances during the period. On Slide 10, you can see the increase in asset yields included an 11 basis point increase in loan yields. Additionally, the yield on the investment portfolio increased 13 basis points. As I previously mentioned, our cost of deposits increased 31 basis points compared to the linked quarter, and we expect these costs to continue to increase in the first quarter but at a slower pace than we saw in the fourth quarter. Slide 11 details the betas utilized in our net interest income modeling. Deposit costs increased with greater velocity in the fourth quarter, moving our current beta up 5 percentage points to 38%. Our modeling indicates that our through-the-cycle beta is approximately 40%. Slide 12 outlines our various sources of liquidity and borrowing capacity. We continue to believe we have the flexibility required to manage the balance sheet through the expected economic environment. Slide 13 illustrates our current loan mix and balance changes compared to the linked quarter. As I mentioned before, loan balances increased 11% on an annualized basis, with broad-based growth. Summit, specialty finance, ICRE and mortgage all had strong quarters while the other loan portfolios were relatively flat. Slide 14 provides detail on our loan concentration by industry. We believe our loan portfolio remains sufficiently diversified to provide protection from deterioration in any particular industry. Slide 15 provides detail on our office portfolio. About 4% of our total loan book is concentrated in office space, and the overall LTV of the portfolio is strong. No office relationships were downgraded during the quarter, and our total non-accrual balance for this portfolio declined to $23 million. Slide 12 shows our deposit mix as well as the progression of average deposits from the linked quarter. In total, average deposit balances increased $416 million during the quarter, driven primarily by a $284 million increase in money market accounts, a $123 million increase in public funds, and a $158 million increase in combined retail and brokered CDs. These increases offset a decline in noninterest-bearing deposits and savings accounts. This was expected as the current interest rate environment has driven customers to higher-cost deposit products. Slide 17 illustrates trends in our average personal, business, and public fund deposits as well as the comparison of our borrowing capacity to our uninsured deposits. We saw increases in all three deposit types, with personal deposits increasing $97 million, business deposits increasing $124 million, and public fund balances increasing $123 million. On the bottom right of the slide, you can see our adjusted uninsured deposits were $3.2 billion at the end of the year. This equates to 24% of our total deposits. We are comfortable with this concentration and believe our borrowing capacity provides sufficient flexibility to respond to any event that would stress our larger deposit balances. Slide 18 highlights our non-interest income for the quarter. Fee income declined to $47 million during the fourth quarter. The biggest driver of the decline was lower foreign exchange income, which was negatively impacted by a $4.6 million loss on a trade. This loss was offset by a reduction in the related employee costs and non-interest expenses. Leasing business income declined during the period due to a heavier mix of finance lease originations during the period. Additionally, wealth management had another solid quarter, and other non-interest income increased during the period, driven by higher syndication fees. Non-interest expense for the quarter is outlined on Slide 19. Core expenses declined $4.7 million during the period. This decrease was driven by lower employee costs, which are tied to fee income as well as lower marketing expenses. Turning now to Slides 20 and 21, our ACL model resulted in a total allowance, which includes both funded and unfunded reserves of $160 million and $10.2 million of total provision expense during the period. This resulted in an ACL that was 1.29% of loans, which was a 7 basis point decrease from the third quarter. Provision expense was driven by net charge-offs and loan growth. Net charge-offs were $12.6 million or 46 basis points on an annualized basis and were primarily driven by a $9 million relationship that had been previously reserved for. In other credit trends, non-accrual loans decreased during the period due to the charge-off I previously mentioned, while classified asset balances were relatively flat quarter-over-quarter. Our ACL coverage was 1.29% at year-end. As I mentioned last quarter, we have modeled conservatively in prior quarters to build a reserve that reflected the losses we expect from our portfolio. We expect our ACL coverage to remain relatively flat in the coming periods. Finally, as shown on Slides 22, 23, and 24, regulatory capital ratios remain in excess of regulatory minimums and internal targets. During the fourth quarter, tangible book value increased 13.5%, and the TCE ratio increased 67 basis points or 10.3% due to a $100 million improvement in accumulated other comprehensive income. Absent the income from AOCI, the TCE ratio would have been 9.05% at the end of the year, compared to 7.17% as reported. Slide 23 demonstrates that our capital ratios will remain in excess of regulatory targets, including the unrealized losses in the securities portfolio. Our total shareholder return remains robust, with 39% of our earnings returned to our shareholders during the period through the common dividend. We believe our dividend provides an attractive return to our shareholders and do not anticipate any near-term changes. However, we will continue to evaluate various capital actions as the year progresses.

Thank you, Jamie. Before we end our prepared remarks, I want to comment on forward-looking guidance, which can be found on Slide 25. Loan pipelines remain healthy, though we expect loan growth to moderate as we approach seasonal lows in activity and be in the mid-single digits over the near term. For securities, we expect a decline in balances as we continue to utilize the portfolio of cash flows to support loan growth. Deposit growth in the recent quarter was very strong, but we expect some of the seasonal flows to reverse in the first quarter causing balances to be stable to slightly down. Our net interest margin has remained strong and resilient despite the deposit pressures impacting the industry. We expect some further compression in the first quarter with the net interest margin in a range between 4.05% to 4.15%, assuming no Fed cuts. Specific to credit, we expect our credit costs to remain consistent with the prior quarter, while ACL coverage as a percentage of loans is expected to be stable to slightly increasing. We expect non-interest income to be in a range between $53 million and $55 million as foreign exchange and end-of-term leasing income rebounds to more normal levels and the operating lease portfolio continues to grow. We expect expenses to be between $120 million and $122 million, which includes the depreciation expense from the lease portfolio. Specific to capital, our capital ratios remain strong, and we expect to maintain our dividend at the current level. Finally, I want to commend our associates for the great year and record financial results. They were client-focused and executed at a very high level despite the industry uncertainty earlier in 2023. I'm extremely proud of the work our team accomplished during the year. As we enter the new year, we have strengthened our team by adding talent in key areas, including wealth management and commercial banking. We've expanded into new markets, including Chicago, Cleveland, and Evansville, Indiana. And we've built a strong and diverse company that I believe positions us well to have some sustained success in 2024 and beyond. With that, we'll now open up the call for questions.

Our first question comes from Daniel Tamayo with Raymond James.

First, maybe just expanding on the NIM guide. I know you've got some pressure expected in the first quarter without any cuts. But as you think about the rest of the year, maybe relative to the Fed's outlook with three cuts in the back half of the year. Just curious how you think that would impact the margin or net interest income?

Yes, this is Jamie. We do expect to experience some pressure in the first quarter. Over the past year, our deposit pricing and cost of deposits have shown that we were lagging by about a quarter. This is why, in the fourth quarter, our cost of deposits has risen a bit higher than the peer group. We anticipate experiencing this for one more quarter, which is reflected in our guidance of 4.05% to 4.15%. We expect around 15 basis points of that. Looking ahead, as many banks begin to adjust, it will depend on how swiftly we can reduce deposit prices. In the first cut, we expect limited relief, primarily from those that are indexed, but not much from the deposit side. This initial cut is likely to have a dilutive impact on our margin of about 10 to 12 basis points, which will improve with further cuts to around 5 or 6 basis points. We forecast four cuts, starting with one in March, although it will occur late in the quarter, leading to substantial impacts. Overall, we project one cut each quarter, with our margin in the second half of '24 anticipated to be in the 390 range.

Okay. That's very helpful, thank you. I'm curious about the leasing business and the shift to finance leases that you mentioned. What prompted that change? Is it related to rates? I'm interested in understanding what influenced that and what your expectations are for future developments.

Yes. We are gaining a better understanding of this business as we have owned it longer; we have had it for a couple of years now. The economics of the transactions are essentially the same, whether it is a finance lease or an operating lease. It primarily depends on the customer rather than our influence. They simply had more customers fall into that category. It's essentially a geographical issue on the financial statements, affecting the margin with a finance lease compared to an operating lease, which presents the gross amounts in non-interest income and non-interest expense. Therefore, when you examine our overall volume of earning assets, we finished the year slightly higher than we had expected. Some of this increase is due to the fact that we included more finance leases in earning assets rather than categorizing them as other assets.

Okay. I understand. So there's some geography moving around, but ultimately about neutral to the bottom line.

I guess I got to ask, can you just shed some light on the $4.6 million trading loss? What changes have been put in place to prevent that from happening again? Or is this just kind of the nature of that business?

Yes. Terry, I want to have Bill here, our Chief Credit Officer, answer the question on the trading loss.

Sure. Terry. The situation involved a long-term customer of the trading team even before joining the institution. They had a material business interruption and were unable to fill their side of the trade. And when you lay this out over about the 40,000 trades you do year in and year out, it's really kind of a one-time thing. It was some spot trades. And so we don't expect it to be systematic through the platform. And we have the right oversight and continue to do the lodging and work on our normal stuff. So we've enhanced some things, but not materially because it's one of the thousands.

Perfect. And then as a follow-up question, you had impressive growth in loans in the fourth quarter. What portfolios do you think should provide some loan growth over the near term? The mid-single digits is the outlook? And then the flip side is, do you expect to see contraction in any portfolios due to just the business itself or some areas that you might be deemphasizing given the economy and interest rates, et cetera?

Yes, Terry, this is Archie. I believe we will see broad-based commercial growth. As you may have noticed in the slide, our commercial numbers were somewhat weaker this quarter due to ongoing line paydowns from last year, where customers had liquidity and chose to use it to reduce their lines as rates increased. We don’t anticipate much more of that. In fact, we might begin to see some line draws as we enter 2024. Therefore, I expect commercial banking to strengthen. Our Oak Street unit performed well in Q4 and should continue to show strength early in the year. Jamie mentioned Summit, but it’s worth noting that Q4 is typically their largest quarter, so we expect a slight decrease in Q1, followed by steady growth throughout the year. The mortgage sector has been consistently growing, although originations may soften a bit, accompanied by a decline in payoffs. We expect growth to continue due to low payoffs. ICRE saw some growth in Q4 primarily from line draws on construction loans, but I don’t think it will maintain that pace moving forward. Overall, while we expect decent broad-based growth, it won’t be at elevated levels. In terms of areas we’re scaling back, the franchise fixer portfolio is the most notable one, which has decreased by about $0.25 billion over the years. We anticipate it will continue to amortize down as we’ve significantly reduced our focus on originating new loans in that area. On the ICRE side, we are concentrating on specific product areas, but we've been scaling back on office, hotels, and are very selective with multifamily, healthcare, and industrial for the past three to four years. Consequently, I expect ICRE to grow slowly as we progress through the year.

Our next question comes from the line of Chris McGratty with KBW.

Jamie, maybe on net interest income, if I put the pieces together of the remixing of the earning assets and your margin comments, it would feel that kind of the trough would be mid-year, Q2, Q3, kind of mid-140s. Is that about right?

That's right. Yes.

Okay. And at that level, like kind of 146, 147 is kind of a fair step down?

That's right. Yes.

Okay. Great. And then in terms of capital, you guys have been consistent like dividends stable and strong buybacks aren't a priority. Is there a capital return narrative for the bank in 2024? You guys have a multiple. Obviously, marks are less onerous. But is M&A something that might be on the horizon?

Yes, Chris, thank you for your question. First, in terms of supporting growth, we believe we have a diverse business that is quite resilient and capable of growth. Therefore, we will prioritize internal organic growth. The conditions for mergers and acquisitions need to improve further. We experienced some changes with declining rates in December that could influence how purchase accounting affects capital. We believe these conditions should continue to evolve to make M&A a more realistic option in 2024. We'll keep this in mind, although it has been about six years since our last bank acquisition. We are not actively pursuing many opportunities right now. However, there are certain markets and types of companies that interest us, and if the accounting aligns and we have a positive outlook on the economy, we may consider utilizing capital for such purposes this year. Nonetheless, our primary focus remains on organic growth.

Okay. Great. And then in terms of credit, your charge-offs and provisions have been a little bit higher than peers. I think it's partly business mix. But can you help us about forecasting what you think is normal in this kind of environment? Should provision levels stay kind of elevated in this range? Or do you expect movement either way?

I was reviewing some data, and if you look back over the last five or six years, our return on assets is among the top quartile of the KRX during that period. Our net charge-offs were approximately 10 basis points higher than the median for KRX. We believe the trade-off of significantly higher and consistently stronger earnings is worthwhile. As for where we expect to be by the end of the year, we anticipate charge-offs to be around 25 basis points, give or take. We think about this for the year ahead, and with current provision levels remaining stable or slightly increasing, we are confident that we can achieve a really strong year in terms of earnings.

I would now like to turn the call over to Archie Brown for closing remarks.

Mondy, thank you. I want to thank everybody for joining today's call and hearing about our results in the fourth quarter and the full year; we really are proud of the results, and we're excited about 2024. We look forward to talking to you again next quarter. Have a great day and weekend. Thank you.

This concludes today's call. You may now disconnect.