Earnings Call Transcript - FFBC Q3 2021

Operator, Operator

Good morning or good afternoon, everyone, and welcome to First Financial Bancorp's Third Quarter Earnings Call and Webcast. My name is Adam, and I’ll be your operator today. I’d now like to hand it over to Scott Crawley to begin. So, Scott, please go ahead when you are ready.

Scott Crawley, CFO

Thank you, Adam. Good morning, everyone, and thank you for joining us on today's conference call to discuss First Financial Bancorp's third quarter 2021 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 third quarter 2021 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 September 30, 2021, 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.

Archie Brown, CEO

Thanks, Scott. Good morning, everyone, and thank you for joining us on today's call. Yesterday afternoon we announced our third quarter financial results which were highlighted by strong earnings, loan growth, solid fee income, lower credit costs and improving credit trends. Third quarter results were exceptional across the board with earnings per share of $0.63, return on assets of 1.49%, and an adjusted efficiency ratio of 60.1%. Third quarter earnings were the highest since the MainSource merger in 2018 and were highlighted by significant provision recapture of $10.1 million. Provision recapture during the period was a result of improving credit quality trends, specifically lower net charge-offs and declines in classified asset balances. We expect further reductions in credit costs in the fourth quarter of 2021 and the first part of 2022, given our optimism for further economic recovery. In addition, earnings were positively impacted by elevated mortgage and wealth management revenues, and we were encouraged by strong loan originations during the period. Total loan balances declined $150.6 million, driven by $225.4 million in PPP forgiveness during the quarter. Quarter loan balances increased $74.8 million for the period as a result of strong origination activity, which was approximately 12% higher than the second quarter. We’re very pleased with the growth in our C&I portfolio of 16% on an annualized basis. Our origination levels more than offset loan payoffs which remain high, particularly in our specialty finance and ICRE units. Additionally, we were encouraged that loan pipeline activity has increased over the course of the last quarter. Deposit balances remained elevated as we saw some modest increases towards the end of the quarter, as clients continue to maintain substantial liquidity levels. The third quarter continued to be very active for PPP loan forgiveness. Through quarter-end over 98% of round one and over 50% of round two loans have been forgiven. We expect the majority of remaining Round 2 payoffs to flow in over the remainder of the year. During the quarter, we repurchased approximately 2.5 million shares at an average price of $23.04, bringing our total shares repurchased in 2021 to approximately 4.6 million. When combined with the common dividends, the share repurchases approximate return to shareholders of 131.7% of quarterly earnings. There are approximately 367,000 shares remaining in our buyback authorization. We're also very excited to bring our associates back to physical office locations during the quarter, albeit with greater flexibility than pre-COVID. We firmly believe we're stronger when we're together, and we've already witnessed how combining best practices learned from the pandemic with our culture of collaboration positively impacts our clients and financial performance. With that, I'll now turn the call over to Jamie to discuss the details of our third quarter results. Jamie?

Jamie Anderson, CFO

Thank you, Archie, and good morning, everyone. Slides 4 and 5 provided summary of our third quarter 2021 financial results. We are very happy with our performance which included strong earnings, loan growth, stable net interest margin, provision recapture and elevated fee income. The highlights of our quarter included 3% annualized loan growth, excluding PPP forgiveness which was driven by commercial and small business banking. In addition, the core net interest margin remained relatively stable, as a positive shift in funding costs was offset by the impact from the repricing of earning assets and more days in the quarter. While there will be some volatility in total margin due to loan fees, we continue to expect core margin to face modest pressure in the coming periods, given the prolonged low interest rate environment and excess balance sheet liquidity. Fee income surpassed our expectations as both mortgage banking and wealth management remain strong. We also realized elevated income from limited partnership investments and insurance proceeds. Third quarter foreign exchange income declined slightly from record levels in the first half of the year. However, we anticipate Bannockburn will return to their typical run rate of $10 million to $12 million in the fourth quarter. Non-interest expenses were in line with our expectations, despite elevated incentive compensation which was tied to our overall company performance and slight increases in marketing and professional services expenses. We were particularly pleased on the credit front, as both net charge-offs and classified assets declined during the period. These two factors combined with a positive economic outlook resulted in $10.1 million of provision recapture during the period. From a capital standpoint, we continue to take advantage of market conditions and repurchased approximately 2.5 million shares during the third quarter. Our capital ratios are strong and remain in excess of both internal and regulatory targets. To date, we have repurchased 4.6 million of the 5 million shares eligible to repurchase under the plan approved in late 2020. We expect that we will repurchase our remaining allotment in the fourth quarter, but do not anticipate any further repurchase activity beyond that in 2021. Slide 6, reconciles our GAAP earnings to adjusted earnings, highlighting items that we believe are important to understanding our quarterly performance. Adjusted net income was $59.9 million or $0.63 per share for the quarter. As depicted on Slide 7, these adjusted earnings equate to a return on average assets of 1.49% and a return on average tangible common equity of 19%. Turning to Slides 8 and 9, net interest margin increased 1 basis point from the linked quarter to 3.32%. This slight increase was primarily driven by higher PPP forgiveness fees. The impact on the net interest margin from changes in asset yields and funding costs largely offset one another, and there was a small negative impact to the margin resulting from the additional day count in the third quarter. Asset yields increased modestly during the period due to higher loan fees, which include PPP forgiveness. In the first half of the year, we increased the size of the investment portfolio, which has negatively impacted the margin over the course of 2021. However, we expect the portfolio to remain at its current size in the near term. In response to the current interest rate environment, we have continued to aggressively lower our cost of deposits, which declined another 2 basis points during the period to 10 basis points. These lower deposit costs reflect strategic rate adjustments, as well as a shift in funding mix from higher-priced retail and brokered CDs to lower-cost core deposits. Our outlook on funding costs remains the same. We anticipate a gradual decline in the near term as we approach our pricing floor. Slide 10 illustrates our current loan mix and balance changes compared to the linked quarter. The majority of the decline in balances was related to the payoff of PPP loans. Excluding these payoffs, we were encouraged by $75 million of growth in the rest of the portfolio, which was driven by our commercial and small business banking group. Slide 12 shows our deposit mix as well as a progression of average deposits during the second quarter. In total, average deposits declined $44 million during the quarter, driven primarily by declines in higher-cost brokered and retail CDs. These declines were largely offset by increases in lower-cost transactional deposits. We continue to be mindful with deposit pricing, and we'll make any necessary adjustments based on market conditions and our funding needs. Slide 13 highlights our non-interest income for the quarter. As I mentioned previously, third quarter fee income remained strong and was driven by elevated production for mortgage and wealth management. We were also encouraged by the 13% increase in deposit service charge income compared to the linked quarter, and a 27% increase in client derivative income. In addition, other non-interest income increased 34% during the period due to increases in income on limited partnership investments and insurance proceeds. With regard to Bannockburn, foreign exchange income declined from record levels in the second quarter. However, we expect them to return to their historical run rate in the fourth quarter. Non-interest expense for the quarter is outlined on Slide 14. Overall core expenses were slightly higher than we expected and increased modestly when compared to the linked quarter, driven by higher employee costs, marketing expenses, and professional services. Turning now to Slide 15, our ACL model resulted in a total allowance, which includes both funded and unfunded reserves of $161 million and $10.1 million in total provision recapture during the period. The decline in provision expense from the linked quarter was driven by improved economic forecasts, lower net charge-offs, and declining classified asset balances. Net charge-offs as a percentage of loans declined to 10 basis points on an annualized basis, while classified asset balances declined $17 million or 9% during the period. 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 relatively conservative to this point in releasing reserves given the unknown impact from the Delta variant. Barring something unforeseen, we expect further provision recapture and declines in the reserve for the remainder of 2021 and the beginning of 2022. Finally, as shown on Slide 17 and 18, capital ratios remain in excess of regulatory minimums and internal targets. All capital ratios remain strong despite slight declines in our ratios during the period. As I previously mentioned, we repurchased approximately 2.5 million shares during the quarter, bringing our 2021 total shares repurchased to 4.6 million. Once again, we do not anticipate any near-term changes to the common dividends. 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 20. Loan balances excluding PPP are expected to grow in the low to mid-single digits over the remainder of the year. Loan demand remains strong, though several portfolios are expected to continue to face payoff pressures. Security balances are projected to remain consistent with September ending balances, as deposits were expected to see some modest seasonal increases in the near term. The net interest margin will continue to be positively impacted by the remaining PPP forgiveness loans or payoffs, and the associated accelerated fee recognition. We expect the majority of remaining payoffs to occur in the fourth quarter with a minimal amount carrying over to the first quarter of 2022. Excluding our more volatile variables such as PPP fees, purchase accounting, and loan fees, we expect the margin to be under modest pressure from the low interest rate environment, as well as the excess liquidity on the balance sheet, and increased balances in our securities portfolio. Regarding credit, we expect further improvement in quality trends and continue to expect additional provision recapture in the near term with further declines in the allowance for credit losses. We expect fee income to be between $40 million and $42 million in the fourth quarter, with foreign exchange income rebounding to the $10 million to $12 million range and some seasonal declines in mortgage banking revenue. Specific to expenses, we expect to be between $91 million and $93 million, but this could fluctuate some with fee income. Lastly, we will continue to evaluate capital deployment opportunities with all remaining shares under the 2021 repurchase plan expected to be repurchased during the fourth quarter. Finally, I'm very pleased with our exceptional performance this quarter with record earnings and much improved credit trends. As we look to close out 2021, our focus remains centered on serving the financial needs of our core business, consumer, and wealth management clients. Overall, the company remains well-positioned to manage in the current environment, and we're optimistic about our ability to sustain these successes through continued execution of our core strategies. We will now open up the call for questions.

Operator, Operator

Our first question today comes from Scott Siefers from Piper Sandler. Scott, please go ahead. Your line is open.

Scott Siefers, Analyst

Good morning, guys. Thanks for taking the question. I wanted to ask first Archie about the loan growth outlook, sort of puts and takes. In your view, what are sort of the portfolios that you see doing well? And then maybe a little more color on the ones that you suggested would stay pressured for the time being?

Archie Brown, CEO

Thank you, Scott. We noted that the commercial and industrial sector is performing well with strong and increasing pipelines, which suggests we can expect decent growth there. Although there are some headwinds, they are not as significant as those in other portfolios. In the ICRE portfolio, we have strong originations, but we are also experiencing record-level payoffs, primarily associated with multifamily properties being sold or entering the permit market. This trend is also observed in some other product types. While originations are robust, many of our construction loans work on a draw period basis, meaning it will take time for them to be fully utilized. Additionally, we are observing payoff pressures in our specialty finance unit, where, as noted in one of our slides, franchise loans saw reductions of around $29 million or $30 million this quarter. Some of this is due to aggressive refinancing terms, and in some cases, we exited a few loans or made some sales. We are also seeing similar trends in loans to registered investment advisors and insurance agents, as many businesses are being sold in the current environment with abundant market liquidity. The payoff pressure is primarily affecting the ICRE and specialty finance units, although we continue to see strong originations in both commercial and ICRE. On the consumer side, growth is relatively flat with decent originations, but not at record levels, so it’s currently stable.

Scott Siefers, Analyst

Okay. Perfect, thank you for that. And then, I was hoping to get a little more color on the ForEx revenues. So, this quarter is $9 million, it was maybe a bit below the guide for many days or so. But the outlook is down back toward the more typical range. And in fact, I think you sort of bumped up that top end of the range. So maybe just some of the nuance of what generates the rebound and sort of how you are thinking about that sort of longer-term as well?

Archie Brown, CEO

Yeah, Scott, this is Archie, again. The revenue could be a little bit chunky. There's a core base of revenue that's pretty consistent. And actually, when we look at the third quarter, the core base revenue was probably a little bit stronger than it had been in prior quarters. We just didn't have as many chunky transactions that we would typically see. So, as we look into the coming quarter, we had some near-term visibility into knowing that a few chunky deals were going to be happening on top of kind of the normal core stuff. So, that gives us some confidence it’s going to rebound back into that $10 million to $12 million range.

Scott Siefers, Analyst

Okay, perfect. Thank you very much.

Operator, Operator

Our next question comes from Terry McEvoy from Stephens Inc. Terry, your line is open.

Terry McEvoy, Analyst

Good morning, guys. Maybe Jamie, starting a question for you, the pressure from low rates on the net interest margin, could you maybe just expand on? How much of that is on the loan side and just new loan yields versus the security side? And then, all things being equal at what point are the low rates kind of fully priced in where your outlook would shift to more stable?

Jamie Anderson, CFO

Yeah. Well, I mean, I would tell you, it's coming from both the loan side and the reinvestment side on the securities portfolio. So, speaking directly to the investment portfolio, I mean, as we get about, call it between $100 million and $150 million a month in cash flow off of the securities portfolio. And those reinvestment rates are just a little bit lower still than our overall yield in the portfolio. So that's putting some pressure on the securities portfolio. And then from a loan perspective, when you look at the yields, the runoff yields and the origination yields, a new loan coming on the books in the third quarter was coming on at about 335. And a loan coming off, rolling off, paying off, maturing was about 30 basis points higher than that. So, we still have about a 25 to 30 basis points differential on the loan side as well. And then, when we see that stabilizing, and then obviously on the deposit side, I mean, our deposit costs are at 10 basis points at this point. So, getting more relief from the deposit side is really just not going to happen much. We may get another basis point or two, but at this point, we're basically at the floor. So, when you look out into when that kind of stabilizes, we're looking out into the middle of next year when the margin stabilizes somewhere around a core margin of three.

Terry McEvoy, Analyst

Great. That was very helpful. And then as a follow-up question, it sounds like the remaining authorization on the share repurchase 366,000, that's what we should assume for the fourth quarter. If that's the case, at the end of this year, there'll still be a fair amount of excess capital. So could you maybe just remind me what your targeted capital ratio is? And as you think about next year, would we expect another share repurchase plan? Or would you like to see capital grow to evaluate capital deployment opportunities to use your terminology here on your slide?

Jamie Anderson, CFO

Yes, Terry, this is Jamie. To clarify, if you're developing your model, our plan is to complete the repurchase of approximately 360,000 shares in the fourth quarter. The current 5 million share repurchase authorization will expire, and I anticipate that its renewal will depend on how the board evaluates it towards the end of the year. Our intention would be to renew that plan, potentially for another 5 million shares, to maintain flexibility. However, this will also rely on what I consider a normal capital management process, including any other opportunities that might arise, particularly in terms of M&A. Additionally, our decision will be influenced by the share price at that time as we plan for the future. We aim to retain the ability to implement another plan.

Terry McEvoy, Analyst

Great. Appreciate that, and have a nice weekend. Thank you.

Jamie Anderson, CFO

Yep. Thanks, Terry.

Operator, Operator

Our next question is from Chris McGratty from KBW. Chris, please go ahead. Your line is open.

Chris McGratty, Analyst

Hey, good morning, guys. Archie, I just want to follow-up on that narrative on capital. I guess, what are you seeing in terms of opportunities for traditional M&A? I mean, we've seen a lot across the country. I'm trying to decipher if you're trying to send a message that you're more optimistic about organic growth or potentially complementing it with deals, just the hesitancy on the buyback. Thanks.

Archie Brown, CEO

Chris, this is Archie. I don't think we have any immediate prospects for whole bank deals. There have been some discussions with banks in the region, but I lack confidence in any particular opportunity. Jamie mentioned that the authorization provides us with the flexibility to decide whether to repurchase shares if the price is right or to hold back and pursue other options based on our outlook at any given time. We prioritize organic growth, and if that improves and our balance sheet increases with earning assets in 2022, that would be our preferred approach. However, we occasionally consider fee-based businesses and specialty companies and have had some conversations about them, but there’s nothing clear at this moment.

Chris McGratty, Analyst

Okay. And can you just remind me, you actually did a larger transaction years back, and it's proven to be pretty successful. What's the kind of range of opportunities if you were to do something? What's kind of a wheelhouse deal for you?

Archie Brown, CEO

Chris, ideally it's a banking company in the Midwest that's because of more of a metropolitan footprint with more of a commercial bank orientation, and probably a quarter to half our size. Now, having said that, that's the ideal, and we probably can't find too many that fit that exact model, but that price says we see ourselves being fairly selective when it comes to whole bank M&A.

Chris McGratty, Analyst

Okay, that's helpful. And if I can just one more, we've heard a lot from your peers about the inflationary pressures that are in the market with wage pressure and employee costs. You guys have been really good about keeping costs down over the years. How are you thinking about intermediate term, wage pressure and the expense pressure building?

Archie Brown, CEO

Yes, Chris, it's Archie again. We are seeing significant pressures in technology, talent, lending, security, and fraud and risk areas. Additionally, we're experiencing these pressures on the entry-level side. Before the call, I noticed that our full-time employee count is down about 50 from year-end and another 15 from the previous quarter. Our plan is to continue reducing headcount, but this will result in higher wages for the employees who remain. This situation is compounded by some branch closures; we have a few this quarter and expect more in 2022, which will also help mitigate some of the costs.

Jon Arfstrom, Analyst

Thanks. Good morning, everyone. Hey, nice job on the buyback first of all, those big numbers. You touched a little bit, I think a lot of this has been covered in a lot of the key topics, but can you touch a little bit more on the reserve path? And where you think that could go longer-term?

Jamie Anderson, CFO

Yeah, John, this is Jamie. As we've indicated, we took a proactive approach during the pandemic to build our reserves, especially considering our portfolio's composition and our exposure to hotels and franchises. We believe we acted decisively at the beginning. Following the emergence of the Delta variant, we've adopted a cautious stance on releasing those reserves, wanting to assess how the situation would evolve. Fortunately, losses have not approached the levels many anticipated. However, we believe there is still potential for further release unless there is a noticeable decline in credit conditions. Given our credit trends and the improvement in classified assets, along with the decrease in charge-offs, we foresee additional releases happening in the next few quarters. Currently, our reserve, excluding PPP loans, stands at approximately 162 loans. When comparing this to our pre-COVID baseline under CECL of around 130 loans, we anticipate that over the next year, the number will trend back toward that initial level. This suggests an approximate 30 basis points of reserve release. The timing for this is uncertain, but we expect it could occur within the next year, depending on credit performance and any potential changes to that outlook. Overall, we see ourselves returning to that 130 loan range.

Jon Arfstrom, Analyst

Okay. Good, that's helpful. A question on deposits, it's interesting to see the term seasonal in your guidance and almost feels like normal again. But what are you thinking on deposit flows? Do you think this big wave of deposits and liquidity is starting to fade and we're getting back to more normal deposit flows? And I guess the other question that continually comes up, do you expect some of your commercial customers to start to tap their deposits before you see loan growth really pick up? Do you have any thoughts on them?

Jamie Anderson, CFO

Yeah, John, this is Jamie. I'll start. The seasonal part of that comment relates to our operations in Indiana. In Indiana, we have property taxes due in May and November, and we see a significant increase in deposits from our public funds around November. That's the seasonal aspect. However, I have to admit that I've been mistaken each quarter regarding when we anticipate some of these deposits, specifically the surge deposits, to start running out. They appear to be holding steady, at least over the past few quarters, despite the decline in CDs. We are still incorporating some deposit outflow into our forecasts for next year due to that surge, but it's not substantial. The key question is the pace at which it happens and where those withdrawals are coming from. It feels like predicting normal deposit trends has been challenging. I would have expected more outflow by now, but it simply hasn't happened.

Archie Brown, CEO

Hey, John, this is Archie. I have a few additional thoughts to share regarding Jamie's comments. In this quarter, we observed some increased outflows on the consumer side, while the business sector remains close to peak levels, possibly even improving slightly. Businesses have ample cash. I didn't mention earlier that some customers are using their cash to pay down lines of credit or for other purposes. However, our commercial and industrial utilization rates increased this quarter, moving from the low 30s to the mid 30s on our line utilization. This indicates strong economic activity; despite some supply chain disruptions, business clients have revenue, orders, and backlogs. Overall, the environment is very positive, even with various interruptions and uncertainties. I believe that while businesses may use some of this cash to pay down debts, they will also invest and expand. Therefore, I feel quite optimistic about the situation.

Jon Arfstrom, Analyst

Yeah. Okay. You kind of just touched on what I wanted to ask next Archie was you look at that Slide 10, which is your loan portfolio. The ICRE bounces around from quarter to quarter, and Oak Street and franchise can be somewhat variable, but that commercial and small business number really stands out. It sounds to me like you're saying that's not an aberration, that that's a trend. Is that fair?

Archie Brown, CEO

Well, I’d say that's what we're focusing on. And we're encouraged, certainly encouraged by what you see on that slide and we think that's where the growth is going to be coming from.

Operator, Operator

As we have no further questions, I'll hand back to Archie Brown for any closing remarks.

Archie Brown, CEO

Thank you, Adam. I want to thank all of you for joining our call today and for your interest in our company. Have a great Friday and a great weekend. Talk to you next quarter. Bye now.

Operator, Operator

Thank you all for your attendance. This concludes today's call. You may now disconnect your line.