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Good morning. Welcome to the First Financial First Quarter 2020 Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there’ll be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded.
I would now like to turn the conference over to Scott Crowley, Controller. Go ahead.
Thank you, Kate. Good morning, everyone and thank you for joining us on today’s conference call to discuss First Financial Bancorp’s first quarter 2020 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 will make reference to the slides contained to the accompany presentation during today’s call.
Additionally, please refer to the forward-looking statement disclosure contained in the first quarter 2020 earnings release, as well as our SEC filings for a full discussion of the company’s risk factors. The information we provide today is accurate as of March 31st, 2020 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 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 first quarter. To say the events of the last few months are unprecedented seems like an understatement. While the first half of the quarter was marked by strong financial performance, March was characterized by economic and logistical upheaval and uncertainty.
There are very few areas of our client base, our associate base or our operations not impacted by the COVID-19 crisis in some way. In a rapidly changing operational and economic landscape, we successfully mobilized our teams with thoughtful changes to maintain the performance and service of our customers and shareholders that they’ve come to expect and we were pleased that pre-provisioned financial results exceeded our expectations despite 150 basis point drop in interest rates.
We began monitoring the COVID-19 pandemic early on, preparing in the event it affected our markets. As can be seen on Slide 19 and 20, we immediately activated our pandemic response plan and our Executive Committee shifted to crisis management, working to develop plans and products to assist our clients, communities and associates in a meaningful way.
Our guiding principles in managing that – this crisis have been prioritizing associate and clients safety, preserving the continuity of our business, assisting our communities and ensuring the safety and soundness of our company. Across our client-facing teams, including our banking centers, we’ve updated protocols to protect both our associates and clients, enabling us to provide virtually all banking services to our communities. Over 96% of our banking centers have remained open by utilizing Drive Thru capabilities.
Our sales associates’ support teams and management have transitioned to working remotely with approximately 60% now working from home. I’ve been exceptionally pleased with our ability to rapidly adapt and function at a high level despite the challenges. Additionally, we’ve also rolled out various associate relief programs for those associates experiencing financial hardship.
For our customers, our planning efforts developed into our COVID-19 relief program which provides comprehensive assistance to clients across all segments through payment deferrals, fee waivers for our loan and deposit clients and suspension of vehicle repossessions and residential property foreclosures, to name a few.
It’s been a busy quarter and we’ve accomplished a great deal to support the evolving needs of our retail, business and governmental clients. We continue to actively monitor the actions of federal and state governments and are proactively assisting our clients to ensure that they are aware of every program of financial assistance available to them. Lastly, we’ve also been working to enhance our remote, mobile and online processes to seamlessly support a bank anytime, anywhere environment.
Since the passage of the CARES Act, the entire Bank has mobilized to launch this historical client relief programs that are part of this legislation. We conducted a significant level of cross training and redeployment of associates to rapidly meet the influx of the client requests. Our implementation of the US government’s paycheck protection program has gone well overall.
To-date, we’ve received over 5,700 loan requests representing more than $1 billion and secured SBA funding for approximately 3,600 loans, representing an excess of $750 million. Feedback from our clients has been overwhelmingly positive and are proud with the way our associates have responded as the embodiment of our corporate strategic intent to support the communities in which we work and live.
Additionally, we contributed $1 million to help fund COVID-19 relief efforts in the communities throughout our footprint, which will put funds directly into the hands of agency supporting relief efforts. The results for the first quarter were substantially influenced by the COVID-19 pandemic across net income – net interest income, fee income and most significantly credit costs. Overall we recorded adjusted earnings of $0.31 per share, 0.85% return on average assets, a 10.41% return on average tangible common equity and a 58% efficiency ratio when adjusted to remove non-recurring items.
I’ll now turn the call over to Jamie to discuss the details of our first quarter results, and after Jamie’s discussion, I will wrap up with some comments on specific areas of focus within our credit exposures and forward-looking commentary.
Thank you, Archie and good morning, everyone. Slides 4 and 5 provide a summary of our first quarter 2020 performance. Although the first quarter was an eventful one, the company’s fundamentals and core operating performance remained solid, as loan growth, fee income and efficiency all met or surpassed our expectations.
The adoption of CECL and the impact of the pandemic resulted in $25.5 million of provision expense and reduced overall earnings. However, our earnings power and balance sheet strength has put us in a position to absorb elevated credit costs, while maintaining capital in excess of internal and regulatory targets.
We were pleased with net interest margin, which declined only 12 basis points on an FTE basis compared to the prior quarter. Foreign exchange, trust and client derivative income were all strong during the quarter and offset and otherwise flat expense base to result in a sub 60% efficiency ratio.
We believe we are well positioned from a regulatory capital standpoint, as these ratios remained relatively flat on a linked quarter basis. Our tangible common equity ratio declined 82 basis points in the first quarter, due to the adoption of CECL and share repurchases.
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 $30.7 million or $0.31 per share for the quarter, which excludes a $1 million contribution to fund COVID relief in our footprint and $1.5 million of other non-recurring items, such as branch consolidation cost and certain other COVID related expenses.
As shown on Slide 7, these adjusted earnings equates our return on average assets of 85 basis points and a return on average tangible common equity of 10.4%. Despite the slight increase during the quarter, our 58.2% adjusted efficiency ratio remained strong and reflects our diligent approach to expense management.
Turning to Slides 8 and 9, net interest margin on a fully tax equivalent basis was 3.77% for the first quarter. The 12 basis point decline since year end was better than we anticipated, given the 150 basis point reduction in interest rates during the quarter.
The decline in our net interest margin was primarily related to fewer loan fees and lower purchase accounting accretion during the period. While asset yields dropped by 16 basis points during the quarter due to the Fed rate cuts. We were able to offset this by proactively managing our funding costs which declined by 13 basis points during the period.
The impact of the recent Fed actions are further shown on Slide 9, as declining interest rates, lower loan fees and purchase accounting cause the yield on loans to decline by 29 basis points and the investment yield dropped by 12 basis points due to lower reinvestment rates. In response to these declining yields, we aggressively lowered our cost of deposits 10 basis points during the period.
Slide 10 depicts our current loan mix and balance changes compared to the linked quarter. End of period loan balance has increased $106 million, which was primarily driven by ICRE originations. The remainder of the portfolio was relatively unchanged from year end. Archie will provide additional detail on various aspects of the loan portfolio later in the presentation.
Slide 11 shows the mix of our deposit base as well as the progression of average deposits from the linked quarter. In total, average deposit balances were relatively flat during the first quarter as interest-bearing DDA and non-interest bearing deposit growth, combined with brokered CD balances to outpace a decline in retail CDs, money market accounts and public fund balances.
As I previously mentioned, we were able to successfully manage deposit cost, resulting in a 10 basis point reduction to 64 basis points. Over the near-term, we will continue to monitor deposit pricing and make any necessary adjustments based on market conditions and funding needs.
Slide 12 highlights our non-interest income for the quarter. First quarter fee income was positively impacted by a 65% increase in foreign exchange income, record wealth management fees and continued momentum in client derivatives and mortgage banking income.
Non-interest expense for the quarter is shown on Slide 13. Higher salaries and benefits were driven by seasonal increases in payroll taxes, elevated healthcare costs and incentive compensation related to the aforementioned strong foreign exchange and client derivative income. In addition, non-interest expenses included a $1 million contribution to fund COVID relief efforts in our footprint and approximately $1.5 million of other costs not expected to recur such as merger related and branch consolidation cost.
Next, I’ll turn your attention to Slide 14, which discusses our allowance for credit losses and related provision expense for the quarter. As you can see, we made the decision to adopt CECL as of January 1, and our day one impact was in line with what was disclosed in our 10-K.
Our first quarter model resulted in a total ACL, which includes both funded and unfunded reserves of $158 million and $25 million in total provision for credit losses. The model utilized the Moody’s baseline economic forecasts released at the end of March, and included considerations for both COVID and the government stimulus. It’s worth noting that substantially all of our first quarter provision expense was related to the expected economic impact from COVID.
As shown on Slide 15, credit quality was fairly benign in the first quarter, as we had $900,000 of net recoveries for the period and a slight increase in non-performing assets. The increase in NPAs was driven by a single specialty finance credit that was modified during the period and classified as a TDR. Classified loans increased by $35 million during the period as three large relationships, including the previously mentioned TDR received risk rating downgrades during the period.
Finally, as shown on Slide 16 and 17, capital ratios remained strong and are in excess of regulatory minimums. During the first quarter, we repurchased 880,000 shares before suspending the program on March 13th. Our regulatory capital ratios remained relatively flat and exceeded internal targets.
Our tangible common equity ratio declined by 82 basis points during the period, due primarily to the adoption of CECL. We expect our dividend will remain unchanged in the near-term. However, we will continue to evaluate various capital actions as the economic impact of the COVID pandemic develops.
I’ll now turn it back over to Archie for some commentary regarding our loan portfolio and our outlook. Archie?
Thank you, Jamie. Given the current economic circumstances related to the COVID-19 pandemic, we’ve added Slides 21 through 25 to highlight specific areas of focus within our loan portfolio.
In the very early stages of forming our strategic response to the pandemic, we thoroughly conducted a review of all asset classes that we would expect to be most directly impacted, including restaurants, hotels and retail commercial real estate. That review included conversations with every bar of a certain size to assess the immediate impact of COVID-19 on their business operations.
As of the end of the first quarter, our franchise portfolio was $455 million or 5% of total loans. Our review the portfolios subsequent to the broader implementation of stay at home orders indicated that approximately $138 million of loans to clients with either strong delivery expertise where that utilize a carry out model will be minimally impacted or potentially see improvement in revenues.
Fast casual concepts with Drive Thrus, which totaled approximately $162 million have seen material revenue declines. Lastly, the Sit Down casual dining segment which totaled $155 million at March 31 have seen severe impacts to revenue streams. 93% of the franchise portfolio was pass rated pre-pandemic, a significant portion of franchise customers are taking advantage of relief programs, including payment deferral, the PPP program, rent relief and franchisor relief as mitigates to revenue disruptions.
Our hotel book had outstanding balances of $401 million or 4% of total loans as of the end of the first quarter. The entire hotel industry has been substantially impacted by declining occupancies, so most of our portfolio is concentrated in the Midwest Metropolitan markets reliant on business travel, which has fared better than other locations.
Our portfolio is quite diverse with limited service hotels representing approximately 80% of our exposure. Pre-pandemic 100% of this portfolio is pass rated and has an average loan to value of 61%. And almost all these customers have taken advantage of relief options over the PPP program.
The retail CRE portfolio had outstanding balances of $846 million or 9% of total loans as of March 31st. Loan to values range from 60% to 70% across most of the portfolio. The bank has focused on strong locations with adequately capitalized sponsors.
This is essential in rightsizing deals that do not rebound or pre-crisis levels or in cases where market demand will decrease over the next 24 months. Pre-pandemic 100% of this portfolio was pass rated, majority of this customer segment has also taken advantage of relief or PP options with us.
Given the challenging environment and uncertainty over the rest of the year, we were adjusting our guidance this quarter. Slide 26 shows the key factors that we expect to impact our performance moving forward. Loan growth is expected to be in the low single-digits excluding the transitory impact of the PPP program. Core deposit growth is expected to be in the mid single-digits.
With the dramatic Fed rate cuts in March and a gradually declining LIBOR rate, we expect to see further net interest margin compression. The net interest margin is expected to decline 6 to 8 basis points for each 25 basis point cut to rates. We’ve been very proactive in our deposit cost management and expect cost to rapidly come down in the next quarter and then to continue to gradually fall as higher cost time deposits mature. From an economic forecast indicate a high likelihood of credit stress over the back half of 2020. Therefore, we expect elevated provision expense in the near-term.
Fee income is expected to increase in the next few months due to higher mortgage revenue driven by refinanced activity. We anticipate headwinds across deposit overdraft, service charge and interchange revenues, which will largely be dependent upon the length of stay at home orders and the timeframe required for spinning to return to more normal levels. Wealth, foreign exchange and derivative fees are uncertain due to business disruptions and market volatility.
With respect to expenses, we believe the run rate to be consistent with the last two quarters. We follow a disciplined approach to expense management and it paused on most planned hiring, discretionary expenditures and significant investments except were critical to support current operations.
Regarding the PPP program, we will see transitory loan growth and incremental revenue from the $750 million in approved loans with average fees of approximately 3%. We anticipate some incremental expenses related to the program.
For 2020, without taking into consideration the impact of PPP loans, we expect our pretax, pre-provision income to be in the range of $220 million to 240 million, assuming that consumer and business activity ramps back up over the second half of the year.
In conclusion, First Financial has weathered many tough times during the bank’s 156-year history. This is another of those moments and it’s certain to be added to the history books. Every challenging event is filled with great moments to work together as a company, community and a nation.
I said earlier how proud I am of the First Financial family and it bears repeating. These events will likely be transformational for the industry and society, but the challenges will also provide unique opportunities to build and strengthen customer relationships, improve the digital client experience and evaluate our standing in the communities we serve or elevate our standing in the communities we serve.
As we move forward, we will continue to be diligent stewards of the company, while providing exceptional service and support to our customers and maintaining the wellbeing of our associates.
This concludes the prepared comments for the call. We’ll now open up the call for questions.
We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Chris McGratty from KBW. Go ahead.
Hey, good morning everybody.
Hey, Chris.
Hey, good morning. Jamie, can I start with the – just the margin, I just want to make sure I understand the Slide. So if you look at the first quarter, it was, you know, partial reflective of the six cuts by the Fed so. Is the message that you’re trying to tell on the core margin that we still have, you know, multiple you know, 6 to 8 basis point impacts coming as margins reset in the next couple of quarters?
Correct. Yeah, so, I mean eventually our margins should settle out. So if you think about it. We had, you know, as we’ve guided in the past, our margin gets affected by 25 basis point rate cuts, it goes down 6 to 8 basis points. So if you use the midpoint at 7, I mean when you think about it, essentially towards the end of the first quarter, we had 6 of those 25 basis point rate cuts. So our margin will eventually settle down from the first quarter, roughly 40 basis points.
And that – and so Chris for one thing to keep in mind, I think we’ve kind of tipped it in the outlook slide is that, the – you know, that assumes then that one month LIBOR comes in line, I guess with the Fed funds rate, right now you know, you’re seeing a 45 to 50 basis point differential to where between Fed funds and one month LIBOR. So that assumes that that comes back in line.
Okay, got it. And then –
Yeah.
Maybe a follow-up, Jamie on the margin. So if I’m doing the math on the PPP loans, right you’re going to get on the loan fees 3% of $750 million, so call it $22 million, assuming these loans, I know you have to amortize it, but assuming they –
Yeah, yeah, yeah –
Come back, you know, next quarter or two. That $22 million should be flowing through margin over the next 6 months that’s the math, right?
Yeah, that’s the – so I mean, obviously when we set these up, we will set up that 3% fee upfront, it will amortize over the life of the loan. So you know, we’ll take in you know, [124th] [ph] of that fee every month until it pays off. We’re expecting the – you know, a large percentage of those to pay off within 6 months, but there could be some that extend out beyond that as well.
Okay, got it. And then maybe –
So we’ll see a pop – Chris, so you’ll see – what you’ll see then is, when they pay off obviously you get – you pull all that into income and you get it popped during that timeframe.
Exactly. Yep, I got it.
Yeah, yeah.
Thank you. And then, Archie maybe just a question on the comments, I think you said it in your prepared remarks, you know, the dividend is steady for now, but you’ll evaluate I think capital action. Can you just elaborate on that? Is that suggesting potential coming to market for capital or shrinking the balance sheet – I mean, can you just talk through what you’re messaging there? Thanks.
Yeah, I think maybe I’ll just make a high level comment and may we have Jamie just walk you through kind of how we’re concluding this. But yeah, our view is that we feel good about being able to continue to pay the dividend you know, based on what we know at this time and we’ll get you know later in the year our outlook it’s always dependent upon where our outlook is going forward. But at this point, we feel – I think we feel pretty good about it and maybe Jamie will talk about how –
Yeah, so Chris when – so when we did our stress testing, you know, we looked at several different scenarios of stress test on the loan portfolio, but I mean, when you look at kind of a common, you know, look at the DFAST, severe case, you know, which we think is one of the more severe cases, you know, apply those losses to our portfolio, we come up with approximately $500 million in losses over a two-year period using that methodology.
So, you know, when you – under that scenario, looking at our excess capital that we have our pretax, pre-provision income, even a conservative number over that two-year period and keeping the dividend flat, we still remain above regulatory capital ratios, above those regulatory minimum. So that’s kind of how we triangulate it.
Okay. So if you were to – if that scenario were to play out, you’d still feel – they wouldn’t have to come and do anything inorganic with the capital. Is that the right message?
Yeah, I – I mean I think that’s right, Chris. Now having said, you know, I would say that, you know, we are in a really uncertain environment and, you know, Jamie and I bunches were here 12 years ago and, you know, when you get that kind of market dynamics in an uncertain time, it is good to have capital flexibility.
So, you know, we’ve looked at tier II off and on, we’ll continue to evaluate it in this environment with a, you know, 60 basis point 10-year, low cost taxable capital does seem prudent to consider at some point. So I’m not sure what we’re going to do or when we will do something, if we do it, but with rates this reasonable it really doesn’t seem to have any downside in an environment like this.
Understood, thanks so much.
Yep.
[Operator Instructions] Our next question is from Scott Siefers from Piper Sandler. Go ahead.
Good morning, guys. Thanks for taking the question –
Hey, Scott.
Hey, I guess first question I wanted to ask is, just on the PPP loans and maybe Jamie if you could expand upon the comments on you know, how rapidly some pay off and how some might expand I mean my understanding is, if all kind of goes as planned, they can pay off I think as little as something like a 10 weeks. I’m just curious given the fluidity in the situation I guess sort of the lack of really concrete rules on a lot of them or known rules, you know, under what circumstances you guys feel that they would be forgivable versus kind of sticking around on the balance sheet for a little while?
Yeah I mean, like I mentioned I think conservatively we are expecting you know call it between 50% and 75% of these to you know, be relatively short, but you know, just given the – those low rate and you know, just the unknown there could be some that extend beyond that so Bill maybe you want to –
Yeah, yeah absolutely. You know that as we look at the request and the processing through the system, obviously one thing that’s important is the number of employees to be maintained during the 8-week period. You know as this goes on, we’ll get a better lengths into how many companies are able to maintain that same level that they went into it as they apply for the loan and that’s really going to dictate what the carry is going to be, and then based upon the rate of that carry and that interest rate on the PPP loans, we suspect that will be you know paid off within the two-year period but on average you know, shrink that balance about 12 months or so, just because the cost to capital is low enough that a borrow by extending that out a little bit.
Yeah, okay. That makes sense, I appreciate the color there. And then as I believe, just as you guys look to the loan modifications, I guess I’m specifically referring to the business side, the roughly $950 million in modifications to-date. Can you sort of walk through what the thinking will be as we go through those forbearance periods, you know I think this is becoming kind of unchartered ground for a lot of us and just you know, how will you kind of go through the thought process of okay, it looks like you know once we get through this modification period, then we’re – this guys are going to be fine or this one might have some stress how will that sort of read due diligence process going in your guys’ minds?
Hey, Scott this is Archie. I’ll start, I’m going to have to do I’ll really walk you through, we got to how we’re thinking about it, but for the first deferral just primarily through our conversation if the borrow had impact and requested a deferral, we were going to give them that deferral and in some cases, we will – and many of those we’ll give them a second deferral of another 90 – got under – and many – there’ll be certain issues we’ll look at maybe little bit differently on borrowers maybe Bill described what that kind of things we would think about for the second deferral.
Yeah, absolutely and so you know, as we look at the second deferral it’s really about the time and the individual situation and what I mean by that is, the longer that the current shelter in place, lockout continues the more likely that we’re going – it’s going to be necessary for us to grant additional 90 days on a more systematic or more global perspective. But then we’ll also dive into the individual situations as businesses will take little bit longer, certain business will take a little bit longer to revamp or get back up to normal, and it’s about pacing.
And so you know, one of the key things we did on the front end was, have our customer outreach program so we can kind of get a lens as first 90 days, we’ll kind of – we’ll monitor and see how it flows. The second 90 days is going to be a little bit more deal specific in a so much that we’ll start to craft and tailor credit products and/or relief to their individual needs.
Okay. That’s perfect. I appreciate the description. So thank you guys very much.
Thanks, Scott.
Thanks, Scott.
[Operator Instructions] At this time, we have no questions. So this concludes the question-and-answer session. I would now like to turn the conference back over to Archie Brown for closing remarks.
Thank you, Kate. I want to thank everybody for joining us today and just ask you to be safe and healthy through this trying and unprecedented period. And we look forward to talking to you again soon. Have a nice day.
The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.