Earnings Call Transcript - FFBC Q1 2022

Operator, Operator

Hello, and welcome to the First Financial Bancorp First Quarter 2022 Earnings Conference Call and Webcast. My name is Emily, and I'll be coordinating the call today. I now have the pleasure of handing the call over to our host, Scott Crawley from First Financial Bancorp. Please go ahead, Scott.

Scott Crawley, Host

Thank you. Good morning, and thank you, Emily. Good morning, everyone, and thank you for joining us on today's conference call to discuss First Financial Bancorp first quarter 2022 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 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 first quarter 2022 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 March 31, 2022, and we will not be updating any forward-looking statements to reflect facts or circumstances after this call. I'll now turn it over to Archie Brown.

Archie Brown, CEO

Thanks, Scott. Good morning, everyone, and thank you for joining us on today's call. Yesterday afternoon, we announced our financial results for the first quarter. Before I turn the call over to Jamie to discuss those results in greater detail, I'm going to provide a few comments on our performance. Like others in the industry, our recent quarter was impacted by revenue pressures from rising mortgage rates and the wind-down of PPP. Despite these challenges, the first quarter was in line with our expectations and a good start to what we expect will be a very strong year. For the quarter, we achieved adjusted earnings per share of $0.46, a 1.09% return on average assets and a 15.75% return on average tangible common equity. These results were driven by a provision recapture of $5.8 million, resulting from strong credit quality trends, stable economic conditions, and then prudent expense management. Improvement in the core margin highlighted in the quarter with the margin increasing 12 basis points when excluding PPP and other more volatile loan fees. The margin benefited from the upward shift in rates driving asset yields higher. Given interest rate forecasts in our assets in our balance sheet, we should see additional improvement in our margin during the year. In addition, credit quality trends remain excellent, evidenced by stable classified asset levels, lower net charge-offs, and provision recaptures. We were also pleased with our ability to diligently manage expenses, which were in line with our expectations despite some elevated healthcare costs. First quarter fee income was lower than we anticipated as rising rates negatively impacted mortgage banking revenue. While foreign exchange declined from the fourth quarter levels, Bannockburn's income can vary from quarter-to-quarter, and we expect it to rebound in coming quarters. Consumer deposit balances grew modestly as our customers continue to maintain substantial liquidity levels. Overall loan growth was muted in the first quarter as originations were slowed by the peak of Omicron in January, and higher payoffs continued in our commercial lines of business as many borrowers sold their businesses or underlying assets. We're pleased to see growth in all of our business lines with the exception of ICRE and franchise where payoffs were elevated. Loan pipelines are strengthening, and we are optimistic about improved loan growth for the remainder of 2022. The integration of Summit continues to go as expected. Its first quarter financial performance was in line with our expectations, and the cultural fit has proven to be as we had hoped. Given the impact of acquisition accounting, our projection is that Summit's contributions will be neutral to overall 2022 financial results, and we remain bullish on the future success of this addition to our company. With that, I'll now turn the call over to Jamie to discuss the first quarter results in more detail. After Jamie's discussion, I'll wrap up with some additional forward-looking commentary.

Jamie Anderson, CFO

Thank you, Archie. Good morning, everyone. Slides 4, 5 and 6 provide a summary of our first quarter financial results. Our first quarter was solid and was highlighted by strong asset quality, a net interest margin that exceeded expectations and prudent expense management. As Archie mentioned, we believe this quarter lays a strong foundation for what we think will be a very profitable 2022. Basic net interest margin benefited from the first Fed rate hike increasing 12 basis points during the quarter. Given our asset-sensitive balance sheet, we believe this trend will continue as the Fed increases rates further in 2022. We were particularly pleased on the credit front as classified assets were relatively stable during the period and net charge-offs declined to 10 basis points. These two factors drove $5.8 million of provision recapture during the period. Fee income was lower than we expected during the period with declines from fourth quarter levels. In particular, mortgage banking revenue declined due to rising rates, which is in line with the broader industry trends. Given the inherent volatility in our foreign exchange business, we remain confident that Bannockburn will rebound in the coming quarters as we have seen in the past. Noninterest expenses were in line with our expectations as lower incentive compensation offset a significant increase in healthcare claims and seasonally high payroll taxes during the period. From a capital standpoint, our regulatory ratios remain in excess of both internal and regulatory targets. Due to rising rates, accumulated other comprehensive income declined by $142 million, negatively impacting both tangible book value and our tangible common equity ratio. Given the Summit acquisition, we paused our share repurchase program and expect to remain on the sidelines in the near term. Slide 7 reconciles our GAAP earnings to adjusted earnings, highlighting the items that we believe are important to understanding our quarterly performance. Adjusted net income was $43.6 million or $0.46 per share for the quarter. These adjusted earnings account for $300,000 of Summit-related acquisition costs and $2.5 million of other costs not expected to recur, such as severance and branch consolidation expenses. As depicted on Slide 8, these adjusted earnings equate to a return on average assets of 1.09%, a return on average tangible common equity of 15.8% and an efficiency ratio of 67.7%. Turning to Slides 9 and 10. Net interest margin declined 6 basis points from the linked quarter to 3.17%. This decline was primarily driven by a decline in loan prepayment and PPP forgiveness fees. The impact on the net interest margin from these changes was partially offset by an increase in asset yields during the period, which was driven by rising interest rates. Asset yields increased during the period following the initial Fed rate hike. Investment yields increased due to higher reinvestment rates and slower prepayments on mortgage-backed securities. Excluding fees, loan yields also increased slightly during the period, and we expect to realize the full impact from the initial Fed rate hike in the second quarter. Our cost of deposits declined 2 basis points when compared to the fourth quarter. And at this point, we believe we have reached our pricing floor. Slide 11 details the asset sensitivity of our balance sheet. As you can see, we believe we are well positioned for the expected rate increases as approximately 60% of our loan portfolio will re-price in the short term. Slide 12 details the betas utilized in our net interest income modeling. And while we don't expect much initial pressure from rising rates, as additional rate increases occur, we expect our deposit beta to be approximately 30%. Slide 13 illustrates our current loan mix and balance changes compared to the linked quarter. Loan balances decreased slightly during the period primarily due to expected runoff in PPP loans. Excluding the $34 million of PPP forgiveness, loan balances decreased by $12 million as declines in ICRE and franchise loans were partially offset by increases in other portfolios. Slide 15 shows our deposit mix as well as the progression of average deposits from the end of 2021. In total, average deposit balances decreased by $101 million during the quarter, driven primarily by a $167 million decline in brokered CDs. We were pleased with the growth in lower cost transaction deposits during the quarter, which included increases of $74 million in interest checking and $48 million in savings accounts. Slide 16 highlights our noninterest income for the quarter. As I mentioned previously, first quarter fee income fell short of our expectations, primarily in mortgage banking, foreign exchange, and derivative fees. Increasing rates and record production in 2020 and 2021 have softened mortgage demand significantly, and we expect industry-wide pressure on this business for the remainder of 2022. Foreign exchange was also lower than expected during the quarter. However, we fully expect that business line to return to its anticipated run rate in the coming quarters. On a bright note, wealth management continues to produce strong results. Noninterest expense for the quarter is outlined on Slide 17. Noninterest expenses declined by $6.8 million during the period. On an operating basis and excluding Summit, expenses declined compared to the first quarter despite a significant increase in healthcare costs and seasonally high payroll taxes during the period. Turning now to Slide 18. Our ACL model resulted in a total allowance which includes both funded and unfunded reserves of $137 million and $5.8 million in total provision recapture during the period. This resulted in an ACL that is 1.34% of total loans. The provision recapture was driven by relatively flat classified asset balances, an 11% decline in non-performing assets and a 69% decline in net charge-offs during the period. Net charge-offs as a percentage of loans decreased to 10 basis points on an annualized basis. Our view on the ACL and provision expense remains unchanged. We believe we acted aggressively when building reserves in response to the pandemic and have been steadily releasing those reserves. We expect further provision recapture and reserve release in the near term with a neutral to slightly positive provision expense in the back half of 2022. Finally, as shown on Slides 20 and 21, regulatory capital ratios remain in excess of regulatory minimums and internal targets. During the quarter, both tangible book value and the TCE ratio declined. These declines were caused by unrealized losses on the investment portfolio due to rising interest rates. Absent the change in the portfolio, the TCE ratio would have increased by 32 basis points during the quarter. As I previously mentioned, we did not repurchase any shares during the quarter and do not expect any additional share repurchases in the near term. Additionally, we do not anticipate any near-term changes to the common dividend. However, we will continue to evaluate various capital actions as the year progresses.

Archie Brown, CEO

Thank you, Jamie. Before we end our prepared remarks, I want to comment on our forward-looking guidance, which can be found on Slide 22. Our near-term forecast for loan growth is strengthening, and we expect balances to grow low to mid-single digits over the near term, excluding PPP and Summit. Securities balances are projected to be consistent with the first quarter ending balances, while deposit balances are expected to remain relatively stable over the near term. Our asset-sensitive balance sheet positions us very well to benefit from the expected rise in interest rates. A significant portion of our loan portfolio is indexed to short-term rates. And although there are many variables that impact magnitude and timing, we expect our margin to improve from rising rates, especially early in the cycle when deposit rate pressures are muted. Regarding credit, we expect continued improvement in asset quality trends and additional provision recapture in the near term to be less than in recent quarters. The allowance for credit losses is expected to continue to decrease on a percentage basis, but much uncertainty remains regarding the impact of supply chain bottlenecks, pandemic evolution, and inflationary pressures on our client base. We expect fee income to be between $47 million and $49 million in the second quarter with continued growth in Summit leasing revenue, some rebound in capital markets fees, and modest seasonal increases in mortgage banking and interchange income. The rate headwinds will continue to put pressure on overall mortgage banking income trends, and we expect some decreases in overdraft income due to updates to our program. Specific to expenses, we expect to be between $100 million and $102 million, but this could fluctuate with fee income performance. Regarding Summit, our outlook is unchanged, and we expect the acquisition to have a minimal impact on overall 2022 earnings with a slightly negative impact near term from the intangible amortization. We expect the acquisition to provide $400 million in annual originations, which will provide a strong lift to loan growth as the year progresses. Lastly, our capital ratios remain strong, and we expect to maintain our dividend at current levels. Overall, our first-quarter performance has laid a strong foundation for the year, and we believe our asset-centered balance sheet is well positioned for rising rates that are expected over the course of 2022. We made strategic efforts to diversify our product offerings in recent years, and we believe those efforts position us to deliver industry-leading services to our clients and returns our shareholders have come to expect. With that, we'll now open up the call for questions.

Operator, Operator

Our first question today comes from Scott Siefers from Piper Sandler. Scott, you can go ahead.

Scott Siefers, Analyst

Let's see, I wanted to start first on fees. Archie, I appreciate the comments towards the end in your guidance commentary. Just hoping for maybe a little more color in helping to bridge the gap between the sort of $41.5 million run rate in the first quarter and then the $47 million to $49 million. Again, I feel like directionally, you kind of pointed us where to go with Bannockburn and then some capital markets as well as some other things. But just given the magnitude of the gap, how much should we be anticipating that some of these things do come back here in the near term?

Jamie Anderson, CFO

Yes, Scott, it's Jamie. So, a couple of things there. We expect Bannockburn to have had a lower quarter than we anticipated. They can experience some volatility in their income. Looking back at the last year, their third quarter was weaker, followed by a record fourth quarter, and then a slight decline in the first quarter. We expect their income to increase by roughly a couple of million dollars. Seasonally, even with rising mortgage rates, we should see some seasonal lift in mortgage activity overall. Additionally, we typically see a seasonal increase in debit card income. The first quarter was low for swap fee income, but we anticipate that will recover as demand increases and loan activity picks up. For Summit, the fee income in the first quarter was about $6 million, and we expect that to increase by between $0.5 million to $1 million. Overall, we see improvements across the board, with the main contributors being those I just mentioned.

Scott Siefers, Analyst

All right. That's perfect color. And switching gears just a bit. You talked about low to mid-single-digit loan growth in coming periods. Maybe a little more color and can sort of see the numbers on Slide 13. But in your view, sort of why a slower start to the year than we might have anticipated? And then maybe a thought on what reported loan growth might look like. We've got a couple of moving parts between Summit coming on. PPP is still going off, et cetera.

Archie Brown, CEO

Yes, Scott, this is Archie. I think the big thing that we saw during the quarter was just a little more elevated payoff activity, especially in our ICRE group, where, in many cases, assets were being sold, a little bit in our commercial banking group. We saw companies being sold. And then in franchise, we moved out one large credit that concerned us kind of a hangover from the pandemic. And we saw some a few loans that I think, paid off. We just weren't willing to agree on the terms, in some cases, releasing guarantees or rates that we thought were just too low for the risk in that business. So, we saw some pay downs in that business. So that probably brought down some of the growth we were expecting in the quarter. And we still see some potential elevated payoff activity in, I would say, ICRE and maybe a little bit of franchise in the near term, which is why we maybe downshifted to say low to mid-single-digit growth, excluding Summit. When you take Summit, including Summit in the loan growth picture, I think you're talking more high single digits, maybe more than that, say, 7% to 8% kind of range, including Summit.

Daniel Tamayo, Analyst

Maybe we just start on the NII and NIM expectations. Obviously, you guys are very asset sensitive and expecting that to improve nicely in the year. But you talked about deposit beta assumptions, but I just kind of want to make sure that we're still on the same page in terms of impacts from rate hikes, maybe how many you guys are expecting or budgeting for during the year and that sort of thing?

Jamie Anderson, CFO

Yes, it's Jamie. In our internal forecast, we expect Fed funds to be around 2.25% for the year. Looking at our loan portfolio, about 60% is set to reprice, and most of this repricing will occur shortly after a rate hike, within three months. This should result in a noticeable increase in net interest income as the rate hikes take effect. On the deposit side, following the first rate hike, there was minimal pressure on deposits, mostly on a case-by-case basis for some public funds. If we see a 50 basis point move in May, we likely won’t reach the full beta outlined in our projections of 25% to 30% right away. Instead, it will gradually increase as additional rate hikes occur. So, I would expect that with the next hike, let's say a 50 basis point increase in early May, we won’t experience the full impact on deposits immediately.

Daniel Tamayo, Analyst

So that still kind of an 8 basis point impact on the net interest margin early and then maybe coming down to 5 to 6 basis points overtime.

Jamie Anderson, CFO

Correct. Yes.

Daniel Tamayo, Analyst

Okay. Great. And then how are you thinking about that you've got significant excess liquidity still? How are you thinking about the deployment of that excess liquidity and how that impacts, is impacted by any kind of assumptions you're making for deposit flows?

Jamie Anderson, CFO

On the liquidity front, we have increased the overall balance in our investment portfolio. The investment portfolio and deposits will work in conjunction with each other. If we begin to see deposit outflows, we will adjust the investment portfolio accordingly. Currently, our plan is to maintain the investment portfolio at a relatively stable level while closely monitoring deposit balances and any changes in deposit composition. We will modify the portfolio as needed. We have strong cash flow from the investment portfolio, projected at around $1 billion over the next 12 months. Furthermore, we have capacity for short-term borrowings on the balance sheet. If deposit runoff exceeds our expectations, we are prepared to respond appropriately.

Terry McEvoy, Analyst

Could you walk me through the impact of Summit in the first quarter? You've provided the fees and the expenses, but I'm curious about the net interest income contribution. What size does the loan portfolio need to be for us to break even and effectively model that? Additionally, since this is the first quarter we're seeing leasing business income, do you anticipate much volatility on a quarterly basis regarding fees?

Jamie Anderson, CFO

Yes, that's a good question. In the first quarter, we shared our figures related to noninterest income and expenses. The impact from spread income was modest when we transitioned it over to their balance sheet, particularly because their operating leases were relatively minor. The contribution to net interest income in the first quarter was limited, around $800,000 to $900,000. As we expand the balance sheet, we expect this to rise. By the end of March, we had about $80 million in finance leases, along with approximately $70 million in other assets. We anticipate total originations for the year to reach about $400 million, with $300 million coming from finance leases and $100 million from operating leases. Additionally, they plan to sell 30% to 35% of their production, depending on credit and other factors, which means approximately $140 million in sales. The remainder will remain on the balance sheet as either finance or operating leases. Regarding leasing business income, it mainly depends on the sales of production and the residual income generated afterward. We expect some fluctuations, but the overall base should grow as the year progresses.

Terry McEvoy, Analyst

Again, maybe just as a follow-up, the loan growth guidance, is that annualized? And then if it isn't, I guess, a follow-up question, I was having a tough time kind of funding that loan growth given the actions with the securities and just the balance sheet mix. Is it going to be funded with cash flow from the securities portfolio assuming deposits are stable or maybe drift lower?

Jamie Anderson, CFO

Correct. Yes. Yes, we would fund that either from just the short-term borrowings, overnight borrowings and whatnot, and then and/or...

Archie Brown, CEO

This annualized growth when we talk about low mid-single digits or my answer to Scott, 7% to 8%, that's annualized growth.

Chris McGratty, Analyst

Jamie, I have a question regarding credit. There are definitely a lot of economic concerns at the moment. I'm sure you've reviewed the portfolio closely. If there is going to be a pressure point this year or next, where do you anticipate it in your book?

Bill Harrod, CFO

Yes, this is Bill Harrod. A couple of areas we're focused on right now. In the C&I book, obviously, we're thinking about the supply chain inflation, doing some deep dives into our impacted C&I space. And then also we're getting ahead of the office portfolio. As leases come up for expiry, we're getting ahead of that. We're doing a deep dive. We do expect some changes in the office space world in post-COVID. So, those are two main areas that we're focused on right now.

Chris McGratty, Analyst

Okay. Great. And then I may have missed this. Can you remind us the percent of loans that we price within three months? I know, Jamie, you said a lot of the variable rate does, but just the specifics?

Jamie Anderson, CFO

Yes. We have 60% that reprice within a year, and most of those are within three months.

Jon Arfstrom, Analyst

Just on Slide 10 on the securities portfolio, I hate to keep asking about it, Jamie, but you guys are talking about another 200 basis points up in short rates through the end of the year. Just curious, how you're approaching reinvesting the cash on the securities portfolio, kind of what are you buying, how you're trying to protect yourself? Obviously, we saw the AOCI mark, but just philosophically talk about what you're doing and what you're buying.

Jamie Anderson, CFO

Yes. I would say the composition of the portfolio remains similar to what it is now, with a mix of agency mortgage-backs, municipals, and some other asset classes. Our approach to the securities portfolio will depend on the balance and the level of loan growth we are experiencing, as well as any reductions on the deposit side. We will likely maintain a relatively flat stance on the securities portfolio and may trend down if loan growth improves throughout the year. We will also continue to be relatively defensive regarding reinvestments.

Jon Arfstrom, Analyst

Okay, I got it. Archie, I may have missed this, but can you remind us of the updates to your overdraft program and just kind of walk us through the impact of that.

Archie Brown, CEO

Yes, Jon, we've been making ongoing adjustments over time. Going back to before the pandemic, we were generating around $22 million in revenue annually. This year, our budget was around $15 million. However, due to changes from larger competitors entering our markets, we've been implementing further modifications. These changes are likely to have some impact by midyear, affecting the second quarter and more significantly in the latter half of the year. We are taking steps such as reducing fees and adjusting our cushion before we charge EBIT, along with increasing peripheral fees. Overall, these adjustments will likely show a more pronounced effect in the latter part of the year, contributing to our results next year. If we consider the $22 million figure from pre-pandemic times, we might end up around 35% to 40% of that for next year. In the second quarter, we may see a slight decline from our current position.

Jon Arfstrom, Analyst

Okay. Okay. Good. And then just bigger picture on the environment. You've had a couple of questions on loan growth seeming a little bit slower than peers, but I understand what you're carving out. And I guess the question is, are you more optimistic on growth than last quarter? I mean, obviously, we get the math on the margin, so that's pretty positive. And we understand what you're saying on the fees, and that's better. But are you more optimistic on the overall lending environment for the next several quarters?

Archie Brown, CEO

I believe I am, Jon. The main difference this time is the elevated payoffs we've mentioned. I'm feeling somewhat more optimistic than I was earlier in the year. There are still many unpredictable factors contributing to uncertainty. However, we have teams dedicated to increasing loan growth, and we're observing a positive rebound on the consumer side, which we didn't emphasize much this morning. If we compare this to the first quarter, we believe similar trends are emerging in the second quarter. Consumer lending had been a challenge in recent years, and while it won't drastically change the game, if it helps stabilize our position rather than worsen it, that provides us with added support. Alongside that support, we anticipate better commercial growth and improvements from our finance company and Summit. All these factors together make me optimistic about a stronger year ahead that will continue to strengthen throughout the year.

Operator, Operator

At this time, we have no further questions. I'll hand back to Archie Brown to conclude today's conference call.

Archie Brown, CEO

Thank you, Emily. Thanks, everybody, for joining us today and hearing more about our first quarter results. We look forward to talking to you again next quarter. Have a great Friday and a great weekend. Bye now.

Operator, Operator

Thank you, everyone, for joining us today. This concludes our call. You may now disconnect your lines.