Earnings Call Transcript - FFBC Q2 2024

Operator, Operator

Thank you for standing by. My name is Ian and I will be your conference operator today. At this time, I would like to welcome everyone to the First Financial Bancorp Second Quarter 2024 Earnings Conference Call and Webcast. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. Thank you. I will now hand the call over to Scott Crawley, Controller.

Scott Crawley, Controller

Yes. Thank you, Ian. Good morning, everyone, and thank you for joining us on today's conference call to discuss First Financial Bancorp second quarter and year-to-date 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 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 statements disclosure contained in the second quarter 2024 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 June 30, 2024. 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.

Archie Brown, President & CEO

Thank you, Scott. Good morning, everyone, and thank you for joining us for today's call. Yesterday afternoon, we announced our financial results for the second quarter. I'll provide some highlights on our recent performance and then turn the call over to Jamie to provide further information. We had an outstanding quarter, adjusted earnings per share was $0.65 in the second quarter, which resulted in a return on assets of 1.4% and a return on tangible common equity of 20.9%. Loan growth was exceptionally strong again this quarter with balances increasing by 11% on an annualized basis and this was a significant driver in the increase in net interest income. Growth was broad-based and was led by commercial banking. Similarly, average deposits grew approximately 11% for the period, with interest-bearing deposits and a seasonal increase in public fund balances driving the increase. Our 4.1% net interest margin was unchanged in the first quarter and remains at or near the top of the peer group. Total adjusted revenue increased $14.4 million, or 7%, compared to the linked quarter. Additionally, we posted record-adjusted non-interest income of $61.6 million. Growth in fee income was broad-based for the period with foreign exchange revenue growing more than 60% from the linked quarter. Leasing business income, mortgage banking, and bank card income all increased by double-digit percentages, and wealth management income posted another record quarter. Adjusted expenses increased by 1.2% compared to the first quarter. The increase included a full quarter of Agile expenses, the impact of annual salary adjustments that occurred late in the first quarter, and variable compensation tied to our record fee income. Through our workforce efficiency initiative, we have eliminated 90 full-time positions to date and this work will continue through the remainder of the year. I am pleased with the 23 basis point decline in net charge-offs to 15 basis points, which marks the third consecutive quarter that charge-offs have declined. We did experience some downward credit migration during the period; however, this was not concentrated in any particular loan type and non-performing loans as a percentage of total assets was relatively flat compared to the prior quarter. Our ACL increased to 1.36% of total loans and based on our outlook for loan growth and credit quality, we would expect provision to decline to levels approximately to the first quarter incoming periods. With that, I'll now turn the call over to Jamie to discuss these results in greater detail. Jamie?

Jamie Anderson, Chief Financial Officer

Thank you, Archie, and good morning, everyone. Slides four, five, and six provide a summary of our most recent financial results. The second quarter was really strong, highlighted by exceptional earnings, a flat net interest margin, record fee income, and solid balance sheet growth. Our net interest margin remains very strong at 4.10%; this was unchanged from the linked quarter due to increases in both loan and investment yields, offsetting the pressure on deposit costs. We were pleased that the increase in deposit cost moderated in comparison to prior quarters, and we expect this trend to hold. However, we expect slight margin contraction in the near-term. Total loans grew 11% on an annualized basis, which exceeded our expectations. Loan growth was broad-based with larger increases in C&I, Summit, and Agile. Average deposit balances increased $350 million, or 10.6% on an annualized basis and included a seasonal increase in public funds. Overall, the deposit mix continues to shift to higher-cost deposits; however, we maintain 22% of our total balances in non-interest-bearing accounts and are strategically focused on maintaining deposit balances. Turning to the income statement, second quarter fee income was the highest in the Company's history. Foreign exchange and leasing had solid quarters, and wealth management had their best revenue quarter ever. Non-interest expenses increased slightly from the linked quarter due to higher variable compensation. However, we are starting to recognize the impact from our efficiency efforts and expect to see further benefits in the coming periods. Our ACL coverage increased 7 basis points during the quarter to 1.36% of total loans. This resulted in $16.4 million of provision expense during the period, which was driven by loan growth and slight credit migration. Overall, asset quality trends were mixed with significantly lower net charge-offs and an increase in classified assets. Annualized net charge-offs declined 23 basis points during the period and NPAs as a percentage of assets were relatively flat at 35 basis points. From a capital standpoint, our regulatory ratios are in excess of both internal and regulatory targets. Tangible book value increased $0.44 or 3.5%, while our tangible common equity ratio was flat during the period. Additionally, our Board of Directors elected to increase our common dividend during the period. We have always been focused on delivering value to our shareholders and this step is further proof of that commitment. Slide seven reconciles our GAAP earnings to adjusted earnings, highlighting items that we believe are important to understanding our quarterly performance. Adjusted net income was $61.7 million or $0.65 per share for the quarter. Adjusted earnings exclude the impact of our efficiency initiative as well as acquisition, severance, and branch consolidation costs. As depicted on slide eight, these adjusted earnings equate to a return on average assets of 1.4%, a return on average tangible common equity of 21%, and pre-tax pre-provision ROA of 210 basis points. Turning to slides nine and ten, the net interest margin was unchanged from the linked quarter at 4.1%. Loan yields increased by 10 basis points during the period and the yield on the investment portfolio increased by 22 basis points. The increase in investment yields was driven by higher reinvestment rates, as well as the full quarter benefit from the portfolio repositioning we executed in the first quarter. Funding costs increased 13 basis points during the period, which was significantly lower than in prior periods. Our cost of deposits increased 14 basis points compared to the linked quarter. However, as you can see on the bottom right chart, that pace of growth declined significantly by the end of the quarter. Slide 11 details the betas utilized in our net interest income modeling. The increase in deposit costs has moved our current beta of 2 percentage points to 45%, which matches our internal modeling. Going forward, we expect deposit cost increases to be a function of mix. 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 14 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 growth in almost every portfolio. As you can see on the right, the largest areas of growth for the quarter were in C&I, Summit, and Agile. We expect Agile's growth to moderate in the coming periods as historically the second quarter is the strongest quarter for originations. Slide 15 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 16 provides detail on our office portfolio. Similar to last quarter, about 4% of our total loan book is concentrated in office space, and the overall portfolio performance metrics remain strong. No office relationships were downgraded to classified during the quarter, and our total non-accrual balance for this portfolio remains approximately $17 million. Slide 17 shows our deposit mix as well as the progression of average deposits from the linked quarter. In total, average deposit balances increased $350 million during the quarter, driven primarily by a seasonal increase in public funds, as well as increases in retail CDs, money market accounts, and broker deposits. These increases offset modest declines in non-interest-bearing deposits and savings accounts. Similar to recent quarters, this was expected as the current interest rate environment has driven customers to higher-cost deposit products. Slide 18 illustrates trends in our average personal, business, and public fund deposits as well as a comparison of our borrowing capacity to our uninsured deposits. On the bottom right of the slide, you can see our adjusted uninsured deposits were $3.2 billion. This equates to 23% of our total deposits. We remain 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 19 highlights our non-interest income for the quarter. Total fee income increased to $62 million during the quarter, which was the highest quarter in the history of the Company. Bannockburn and Summit both had solid quarters and wealth management posted its best revenue quarter ever. Additionally, mortgage, bank card, and deposit service charge income increased from first quarter levels. Non-interest expense for the quarter is outlined on slide 20. Core expenses increased a modest $1.4 million during the period. This was driven by an increase in variable compensation tied to fee income, the full quarter impact from Agile, and annual salary adjustments. We have also started to recognize some of the expected benefit from our ongoing efficiency initiative. Turning now to slides 21 and 22, our ACL model resulted in a total allowance, which includes both funded and unfunded reserves of $173 million and $16.4 million of total provision expense during the period. This resulted in an ACL that was 1.36% of total loans, which was a 7 basis point increase from the first quarter. Provision expense was driven by loan growth and credit migration. Net charge-offs declined 23 basis points to 15 basis points, and our NPAs to total assets held steady at 35 basis points. In other credit trends, classified asset balances increased to 1.07% of total assets, primarily due to the downgrade of four relationships. These downgrades were not concentrated in any loan or collateral type. Our ACL coverage increased, and we continue to believe we have modeled conservatively to build a reserve that reflects the losses we expect from our portfolio. We anticipate our ACL coverage will remain relatively flat or increase slightly in future periods as our model responds to changes in the macroeconomic environment. Finally, as shown on slides 23, 24, and 25, regulatory capital ratios remain in excess of regulatory minimums and internal targets. During the second quarter, tangible book value per share increased 3.5% and the TCE ratio was flat due to balance sheet growth. Absent the impact from AOCI, the TCE ratio would have been 9.13% compared to 7.23% as reported. Slide 24 demonstrates that our capital ratios would remain in excess of regulatory targets, including the unrealized losses in the securities portfolio. Our total shareholder return remains strong, with 36% of our earnings returned to our shareholders during the period through the common dividend. As I mentioned earlier, we were very pleased that the Board elected to increase the common dividend, demonstrating our commitment to provide an attractive return to our shareholders. We will continue to evaluate various capital actions as the year progresses. I'll now turn it back over to Archie for some comments on our outlook.

Archie Brown, President & 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 26. Loan pipelines continue to be healthy, though we expect a modest increase in payoff trends and seasonally low production in our Agile business unit to contribute to overall loan growth in the low single-digits on an annualized basis over the near term. For securities, we expect the portfolio to remain stable. Deposit growth has been steady, and we expect to grow more modestly over the next quarter as seasonal public funds move out. Our net interest margin continues to remain strong and resilient, and we expect it to be between 4% and 4.05% for the next quarter; this assumes a 25 basis point rate cut by the Fed in September. We expect our credit cost to decline slightly in the back half of the year, while ACL coverage as a percentage of loans is expected to be stable to slightly increasing. For the full year, we expect net charge-offs to be approximately 25 basis points to 30 basis points. Fee income is expected to be between $58 million and $60 million, which includes $13 million to $15 million for foreign exchange and $16 million to $18 million for the leasing business. Non-interest expense is expected to be between $122 million and $124 million and remains stable, excluding the leasing business. Finally, we're pleased to announce that our board of directors approved a $0.01 increase to this common dividend to $0.24. The 4.3% dividend increase results in a dividend payout ratio within our target range of 35% to 40% of net income and increases our already attractive yield. I'm encouraged with our operating performance through the first half of 2024 and look forward to continued success for the full year. We'll now open up the call for questions.

Operator, Operator

Our first question comes from Chris McGrady with KBW. Your line is open.

Chris McGrady, Analyst

Good morning. Jamie, maybe start with a margin question, obviously, outperform expectations this quarter. Your slides show a cumulative beta of 45% on the deposit, 70% on the loans. How are you thinking about NIM if the forward curve plays out? I know you have a September cut, but I know the market's...

Jamie Anderson, Chief Financial Officer

Yes.

Chris McGrady, Analyst

Expecting more next year. How do we think about margin into next year?

Jamie Anderson, Chief Financial Officer

Yes, so, obviously, we were asset-sensitive and benefited from the increase in rates over the past six to eight quarters. When we look at it and we consider rate cuts, what kind of a methodical 25 basis point rate cuts by the Fed. The first couple, we think that we're going to have some difficulty reducing deposit costs significantly. We will get some relief on some of the more rate-sensitive categories. So we think that the first cut or two impacts the margin a little bit more significantly than the ones going forward. So the first couple of rate cuts, we think we get about an 8 to 9 basis point decline in the margin, and then going forward from there, we expect about a 5 to 6 basis point decline in the margin in the subsequent cuts. The first couple of cuts will be difficult to get the full impact on the deposit side. Also, I would tell you our strategy at this point, given the fact that we've seen some outsized loan growth, especially with the acquisition of Agile over the past two or three quarters, we've been leaning more towards being a little more aggressive on the deposit side and bringing in deposit balances, trying to match off that loan growth with deposit growth, even if it's in some of the higher cost buckets.

Chris McGrady, Analyst

That's great. Thanks for that. And Archie, maybe a question on capital. You've generated really good capital, and your CET-1 ratio is pretty solid. How are you thinking about potentially using your excess capital and your multiple into '25?

Archie Brown, President & CEO

Yes, Chris, primarily I'd say funding the Company's growth internally would be first and foremost. Certainly, we just did the dividend increase, but it's those kinds of things. I don't think we see a buyback in the near term and part of this is we're focused on growing our tangible value that continually increases.

Chris McGrady, Analyst

Are you seeing more opportunities for traditional bank mergers and acquisitions compared to fee income deals?

Archie Brown, President & CEO

Yes, Chris, let's discuss bank M&A first. Some early-stage conversations are taking place, but I don't anticipate any developments in the near term. There seems to be more interest in discussions due to our current position in the cycle, particularly with expectations that rates may begin to decrease and that we might be nearing a soft landing. On the non-bank side, we are not looking to pursue any other acquisitions at this time.

Chris McGrady, Analyst

Okay. And then finally, could you just remind us your parameters when you look at it? You haven't done one since the MainSource deal five or six years ago.

Archie Brown, President & CEO

Well, I mean, they can change over time. I certainly tell you that deposit franchises are a lot more important today than they would have been several years ago. But we like in-market, we like denser area markets, more metro-focused areas in our footprint, or I would say adjacent to our footprint.

Chris McGrady, Analyst

Great, thank you.

Terry McEvoy, Analyst

Hi. Thanks. Good morning, everybody. Maybe...

Archie Brown, President & CEO

Hey, Terry.

Terry McEvoy, Analyst

Jamie, I have a question for you. Regarding the margin, you mentioned sensitivity to the deposit mix in the near term. I'm curious about your views on non-interest-bearing balances for this year and if you have any early insights into the third quarter, particularly how you plan to fund loan growth with higher-cost deposits.

Jamie Anderson, Chief Financial Officer

Yes, if you look at the chart and the presentation regarding deposit costs, we have noticed a significant decrease in pressure on deposit costs in the last couple of months of the quarter, with a change of about 2 to 3 basis points during those months. Both from a cost perspective and the shift in mix, we see this pressure easing considerably. We believe we are at or close to the bottom for non-interest-bearing balances, particularly the ratio of non-interest-bearing to total deposits, which we expect to drop to the low 20s. Currently, we're at 22%, suggesting we have reached or are near the bottom. Moving forward, as outlined in our outlook, our projected deposits for the second half of the year and our loan growth forecasts have softened compared to the strong performance in the first half. We aim to fund this growth, particularly in the next two or three quarters, through deposits rather than borrowing, though we recognize that some of this may come from higher-cost options like CDs and money market accounts.

Terry McEvoy, Analyst

Perfect. Thanks for that, Jamie. And as a follow-up, just the transportation sector keeps coming up this earnings season when discussing credit, any comments on your transportation C&I portfolio or within Summit and whether you see any stress there or just taking a step back, any segments within C&I you're monitoring and keeping a close eye on?

Archie Brown, President & CEO

Yes, we are watching the transportation sector very closely, as most banks are, just with some of the challenges that they've been facing. You know, we haven't had any material issues, and overall, we feel pretty good about the book, but there is some stress, especially in some of the smaller and some of the larger trucking companies out there, but our exposure is manageable.

Terry McEvoy, Analyst

Thanks for taking my questions.

Daniel Tamayo, Analyst

Hey. Good morning, guys.

Archie Brown, President & CEO

Hey, Dan.

Daniel Tamayo, Analyst

Thanks for taking the questions. I know you talked a little bit about this, and I apologize if this question's been asked. I know it's on late, but the loan growth guidance down, I heard you mention seasonally strong, Agile in the second quarter, so I get that part. But anything else that's driving that? I mean, is it more of a normalization? Just curious, kind of, I guess, on the commercial side, how pipelines look and how we should think about loan growth over the next several quarters. I know it's not the official guidance, but if you take a step back and think about what opportunities for you might be over the next several quarters, that'd be helpful.

Archie Brown, President & CEO

Yes, Dan, this is Archie. We've had a couple of really strong quarters in loan growth, and it's been a combination of some decent production, but also much lower than normal payoff activity, especially in our commercial real estate portfolio. So that has buoyed some. As we look forward, pipelines I would say softened some in the mid-part of the second quarter. They seem to be strengthening back now, but that will create a little bit of building back into production in the back half. We mentioned Agile will have their big part of the year early to mid-part, so that'll flatten out for most of the back half of the year. And we are anticipating more payoff, commercial real estate; we start to see some late in the quarter. We'll see more Q3 our Oak Street unit; we've got a few large payoffs that we're expecting to come in the back half of the year. So that payoff activity is just a little bit stronger combined with Agile. And I would say on the CRE side still that production is a little bit lower than it has typically been and you can imagine just the market with rates where they are, the market's a little softer and we're probably a little more selective there in the current environment.

Daniel Tamayo, Analyst

Okay. Thanks, Archie. And then maybe on the expense side, you guys have done a really good job of managing expenses despite this good revenue growth and balance sheet growth. I'm just curious, where you've been able to pull out the FTEs or identify cost saving opportunities in this environment? And just as you've been going through that, just curious, how that's been going, if you've had any issues or identified any kind of areas that you need to invest as you think about continued growth over the next few years?

Archie Brown, President & CEO

Yes, Danny, we've discussed this in both quarters, so it's worth talking more about it. We consider effective expense control and management to be an ongoing necessity. In recent years, our industry, including us, has invested significantly in advanced technologies and tools, creating a substantial capacity within our system. Last year, we initiated some beta testing in a couple of areas to conduct a thorough review of our production and support areas. We began with a few groups to test our concepts and identified excess capacity that could be eliminated. Currently, we are undertaking a careful review across the entire Company, which has primarily focused on support areas so far. We aim to complete this work by the end of the year, encompassing most or all of the Company. So far, we are approximately 35% to 40% done. It’s uncertain if these figures will remain the same as we delve into areas with potentially less capacity. We will continue this work each quarter and will keep all of you and other stakeholders updated on our progress.

Jamie Anderson, Chief Financial Officer

And Danny, just to jump in as well, this is Jamie. I mean what that has also allowed us to do is we were able to essentially absorb the expenses with Agile through that. The expense base didn't go up a lot and also use those savings to invest in other areas that will help us grow in the future.

Archie Brown, President & CEO

Yes. To Jamie's point, we have opened a couple of offices, commercial banking offices, added a few other salespeople in our wealth group and still been able to keep a lid on the expenses.

Daniel Tamayo, Analyst

Yes. No, it's certainly showing through, so I appreciate all that color. Thanks.

Operator, Operator

Our next question comes from the line of Jon Arfstrom with RBC. Your line is open.

Jon Arfstrom, Analyst

Good morning, guys.

Archie Brown, President & CEO

Hey, Jon.

Jon Arfstrom, Analyst

On Chris McGrady’s question about the margin coming down, if rates come down, can you talk about how you expect the fee businesses to perform if short rates come down? Do you think that will have any kind of impact on maybe some improvement there?

Archie Brown, President & CEO

Jon, maybe slightly. We think Bannockburn has shown in multiple rate environments at this point that they can generate income with their clients. So we think they'll continue to perform effectively. Leasing volumes are strong. We'll continue to see the leasing income side grow, I think, in even a different rate environment, maybe even more. On the mortgage side, it's really going to depend on probably what happens more in the 10-year part of the curve. We would expect a little bit of an increase maybe on the mortgage side if the markets hold up. Wealth is going to continue. We've put a lot of investment in our wealth group, and we think they're going to continue to just incrementally make improvements as we go forward. So those are the big areas.

Jon Arfstrom, Analyst

Yes, okay. You touched on leasing. It's obviously been very strong. It feels like it's a little bit different than the commercial outlook. Can you just talk a little bit about the pipelines in leasing and what you're seeing there? Is it market activity or market share? Or what is it?

Archie Brown, President & CEO

They are operating on a national level, with salespeople spread across the country and various business connections. This allows us to gain broader insights. Banks are in good shape, particularly with larger companies, as they often engage heavily with them. The pipelines are looking solid, although we may be slightly limiting our ability to originate in the current environment, where our focus is more on funding. Looking back to last year, we've experienced a couple of year-ends with them, and their peak origination activity typically happens in the latter part of the year, especially in the fourth quarter. This will likely increase. We anticipate low single-digit growth in the short term, and while it’s unclear what the fourth quarter will bring, it's expected to be strong.

Jon Arfstrom, Analyst

Okay. Good. That helps. And then, Bill, can you just talk a little bit more about the downgrades, and we probably know what the themes are, but any themes? And then, should we expect the classified increases to continue for the next few quarters? Thanks.

Bill Harrod, Chief Credit Officer

Yes. So the downward credit migration in the classified bucket was driven by two multifamily and two C&I credits. The first multifamily deal is currently under an LOI. The other has experienced conversion and stabilization delays. The two C&I credits are both longtime customers, 20-plus years that are just navigating through some shifts in their respective markets. We think there's reasonable solutions for all of them. As we look out, we do expect our classified to remain stable. Looking at our special mention for the quarter, they were down a little flat. And so that's kind of what we're looking at, at this point, kind of stable.

Jon Arfstrom, Analyst

Yes. Okay. All right. Thanks, guys. Appreciate it.

Archie Brown, President & CEO

Thanks, Jon.

Jamie Anderson, Chief Financial Officer

Thanks, Jon.

Archie Brown, President & CEO

I want to thank everybody for joining today and hearing our story for the quarter. We look forward to talking with you again next quarter. Have a great Friday, a great weekend. Bye now.

Operator, Operator

This concludes today's conference call. You may now disconnect. Have a good day.