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Good morning and welcome to the First Financial Bancorp's Second Quarter 2019 Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today's presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Mr. Scott Crawley, Corporate Controller. Mr. Crawley, please proceed.
Thank you. Good morning, everyone, and thank you for joining us on today's conference call to discuss First Financial Bancorp's second quarter and year-to-date 2019 financial results. Participating on today's call will be Claude Davis, Executive Chairman; Archie Brown, President and Chief Executive Officer; Jamie Anderson, Chief Financial Officer; and Tony Stollings, EVP, Commercial Banking.
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 in the accompanying presentation during today's call.
Additionally, please refer to the forward-looking statement disclosure contained in the second quarter 2019 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 June 30th, 2019, and we will not be updating any forward-looking statements to reflect facts or circumstances after this call.
I'll now turn the call over to Archie Brown.
Thank you, Scott. Good morning and thank you for joining us on today's call. Yesterday afternoon, we announced our financial results for the second quarter.
Before I turn the call over to Jamie to discuss those results in greater detail, I'd like to make a few comments regarding our quarterly performance and recently announced acquisition of Bannockburn Global Forex. Our second quarter results were very strong reflecting continued top quartile performance and marking our 115th consecutive quarter of profitability. The quarter was highlighted by strong loan growth, exceptional fee income and disciplined expense management.
For the quarter our adjusted performance metrics included earnings per share of $0.58 a 1.3% return on average assets, 18.9% return on average tangible common equity, and a sub 51% efficiency ratio. All banking trends were positive with loan origination activities strengthening across many of our lending units and payoff pressures easing. These complementary trends enabled us to grow loan balances by approximately 8% on an annualized basis. Deposit growth was modest as seasonal public fund increases and retail CD growth more than offset declines in money markets and brokered CDs.
Our core net interest margin remained strong and in line with the range previously provided despite continued headwinds from lagging interest bearing deposit pricing pressures. Aside from additional provision related to the workout of the franchise credit disclosed last quarter, credit costs were better than expectations and overall credit remained stable.
Our fee income performance was exceptional this quarter with growth of over 29% year-over-year driven by record client derivative fees and solid mortgage and bankcard income. Our sub 51% efficiency ratio continues to be a bright spot, although we saw modest expense increase during the quarter even after adjusting for severance and merger related items, largely driven by annual credit [ph] increases and performance based incentives.
We're excited for the opportunity to partner with the very successful Bannockburn team which will allow us to broaden the product offering to our clients while also enabling us to provide banking service to their extensive customer base. Bannockburn has become an elite performer in the foreign exchange transaction and advisory market. The company primarily focuses on middle market clients who have a need for tailored foreign exchange solutions. We see significant synergies across our businesses and look forward to closing the transaction within the next quarter which will significant another step towards our goal of constructing a best in class commercial bank.
Additionally we were pleased to announce that First Financial's Board of Directors has approved an increase in the quarterly shareholder dividend to $0.23 per share which in addition to the Bannockburn acquisition reflects our commitment to deploying capital in a way that sustains financial and operating success while also directly rewarding shareholders. Although the announced acquisition impacted potential share repurchase activity during the quarter our strong capital levels provide the flexibility for further capital deployment opportunities moving forward.
With that, I'll now turn the call over to Jamie to discuss further details of our second quarter results and then after Jamie's discussion I'll wrap up with some forward-looking commentary and closing remarks. Jamie?
Thank you, Archie and good morning everyone. Slides 3 and 4 provide a summary of our second quarter 2019 performance. As Archie mentioned we were pleased with our performance as loan growth, net interest margin, fee income and efficiency all met or surpassed our expectations. Our profitability metrics remained strong in relation to our peer group and with the tangible book value of $12.79 we are on pace to earn back the dilution from the MainSource merger well ahead of our modeling.
Slide 5 reconciles our GAAP to adjusted earnings highlighting items that we believe are important to understanding our second quarter performance. For the quarter, adjusted net income was $57.4 million or $0.58 per share which excludes severance and merger related costs. As shown on slide 6, these adjusted earnings equates to a return on average assets of 1.63% and a return on average tangible common equity of 18.9%. Further, our 50.3% adjusted efficiency ratio reflects our ability to appropriately manage expenses.
Turning to Slide 7, net interest margin on a fully tax equivalent basis declined 6 basis points in the second quarter to 4.04%. The decline was primarily driven by higher funding cost and a greater number of days in the quarter. Basic net interest margin declined 7 basis points compared to the linked quarter as funding costs were impacted by a lag from rising interest rates and competitive pressures.
As Archie will discuss further when he addresses our outlook, we expect further margin pressure in the back half of the year, mainly from a decrease in asset yields given the expected Fed rate cuts and the impact on our loan portfolio which is 58% variable rate.
As shown on Slide 8, the yield on securities declined 15 basis points and a 4 basis point increase in gross loan yields was offset by a 4 basis point increase in our cost of deposits. The lower investment yields were driven by accelerated prepayments, lower reinvestment rates, and the day count differential between the first and second quarters.
Slide 9 depicts our current loan mix and balance shifts compared to the linked quarter. End of period loan balances increased $172 million as ICRE and mortgage loan growth outpaced slight declines in C&I and small business banking. While we remain optimistic regarding future growth potential, we expect that pace to moderate a bit from second quarter results.
Slide 10 shows the mix of our deposit base as well as the progression of average deposits from a linked quarter. Average deposit balances increased by $29 million as public fund and retail CD growth outpaced declines in brokered CDs and money market accounts. While deposit costs are still increasing they have begun to moderate and we expect overall cost to stabilize given the expected direction of interest rates.
Slide 11 depicts our asset quality trends for the last five quarters. Provision expense declined during the period although it was a bit higher than expected as we recorded $4 million of additional reserves related to the franchise loan discussed in the first quarter. Absent a single franchise loan provision expense was sufficient to cover net charge-offs and account for loan growth during the period. Classified and nonperforming assets as a percentage of total assets were relatively flat, while net charge-offs declined to 8 basis points.
Finally, as shown on Slides 12 and 13, capital ratios remained strong and are in excess of our stated targets. Tangible book value per share increased 5% during the second quarter to $12.79. While we were not actively repurchasing shares during the quarter, primarily due to the pending announcement of the Bannockburn acquisition, we continue to evaluate capital strategies and deployment opportunities such as additional M&A activity and dividend levels that support the company's planned growth while delivering appropriate shareholder returns.
I'll now turn it back over to Archie for some thoughts on our third quarter outlook and closing comments. Archie?
Thank you, Jamie. Before we end our prepared remarks, I want to comment on our forward outlook as shown on Slide 14. We remain optimistic in our ability to maintain loan growth this year given continued strength in our loan pipelines. We expect loan balances to increase by mid-single digits on an annualized basis for the third quarter of 2019. Long term we target mid-to-high single digit growth given the investments we've made in talent, our core operating markets and our comprehensive product offerings.
Regarding the net interest margin, projections will be largely dependent on our path to fair takes [ph] moving forward. Our outlook of 3.7% to 3.75% excluding purchase accounting assumes the Fed cuts rates by 25 basis points later this month. As always the net interest margin can fluctuate depending on a variety of factors and we actually work to mitigate downward rate pressures on the assets side through disciplined deposit pricing management.
As stated earlier, credit quality is stable with the normalized provision covering charge-offs and accounting for loan growth. However, individual loans can have transitory impact from time to time. We expect fee income to decline from our record levels in the second quarter and be in the range of $27 million to $29 million over the next quarter as derivative fees moderate and interchange income declines after Durbin begins.
With respect to expenses, we continuously focus on efficiency even while making strategic investments to support the long-term success of our business. We expect expenses in the range of $77 million to $79 million and anticipate an efficiency ratio in the 51% to 53% range for the next quarter. Our strong capital levels and earnings consistently provide flexibility for capital deployment strategies. [Indiscernible] on closing we will evaluate our capital return strategies including share buybacks.
Overall the company remains well positioned to grow organically and to take advantage of our strong capital position by deploying through other growth opportunities that meet our objectives.
This concludes the prepared comments for the call. Ian we'll now open up the call for questions.
We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Scott Siefers of Sandler O'Neill. Scott, please proceed.
Good morning guys, thanks for taking the question.
Hi Scott.
Jamie, maybe first question for you just on the margin, it looks like at the midpoint in the third quarter maybe 8 basis points or so of core margin compression, and I guess, main puts and takes as you see them for the third quarter? And then as we look maybe beyond the third quarter, is that 8 basis points representative of what would happen with each Fed rate cut if the Fed were to do more or would the impact be less assuming deposit betas or deposit costs started to come back down, just would be curious to hear your thoughts?
Yes, so for the third quarter, yes I would say the impact in the third quarter would be slightly greater than what we would expect going forward, but so that the main kind of items there if you look at what's going to happen here in the third quarter assuming we have a Fed 25 basis point Fed rate cut here at the end of the month would be, you know you got it. So we have basically about, if you look at about 60% of our loan book that slows and would move down to the 25 basis points.
So you're talking, you know we have about, call it a 10 basis point drop on the assets side and 2 to 3 basis points that we would pick up on the funding side in the third quarter and net that call it 7 or 8 basis point drop there in the third quarter. And then going forward, I mean we are projecting given every 25 basis point cut in rates so to where our balance sheet is a 6 to 8 basis point drop in our net interest margin.
And just depending on how much we can, the deposit competition, how much we can get in and trim, manage rates, deposits and get those rates down, it would be on the lower end of that and potentially even lower than the 6 basis points pressure that we would see. So - but conservatively 6 to 8 basis points for every 25 basis point drop.
Okay, perfect, that's terrific and I appreciate it. And then just as we look at the impact of purchase accounting adjustments, I guess vis-à-vis my own model may be state a little more elevated than I would have thought, but one, I could always be wrong but then two, just to hear your thoughts going forward as well?
Yes, so going forward for the third quarter we're projecting that to be based on our models and expected prepays 19 basis points for the third quarter and then that drops about a basis point or 1.5 basis point every quarter there going forward.
Okay, all right, thank you very much and then final question, maybe Archie just a little more color on loan growth. I know paydowns have been a factor in the past few quarters, just curious as you see it was the 2Q as you sort of normalize back toward a more typical range was that better originations, lower paydowns, how did those dynamics work out?
Yes Scott, thanks. Our origination side was just a little bit stronger than Q1 was our strongest quarter post merger, so we did see a slight tick up in originations for the second quarter, but the real, the big impact was on the payoff side, payoffs dropped by probably 25% from Q1 and that was even down from Q4. So significant drop in payoffs and as we think about our outlook, I think we guided her to kind of mid-single digits. We still see strong origination activity in Q3 but with a little bit more of a tick up in payoff balances in Q3.
Okay, perfect, that's terrific. Thank you guys, very much.
Thanks Scott.
Our next question comes from Chris McGratty of KBW. Chris, please proceed.
Yep, good morning. Jamie can I just – I just want to followup on Scott's question on the margin. I think you've said 58% or 60% of the book floats. Could you remind us at 630 the breakdown between prime and LIBOR and others, because it would seem, I recall you guys have a lot of LIBOR exposure, so this quarter plus next quarter would suggest that you might be at the higher end of the compression if the Fed moves and then overtime you may not feel there is much pressure because you have kind of LIBOR leading and then you've got the deposit reprising catch up. So could you just review those numbers for us?
Yes, so overall, I'm going to give you dollar amounts here as opposed to percentages, but roughly $3.5 billion on the loan side, between $3.5 billion and $4 billion is LIBOR based and about $1.5 is prime based.
Okay and then the 2 to 3 basis point…
And let me add, just so you know, just so you know Chris we also have about a $0.5 billion in the investment portfolio as well that floats as well and it is mostly indexed at three months LIBOR.
Okay and also that was part of the decline in the securities score?
Correct, yes.
Okay, the 2 to 3 basis point you kind of easing of the funding cost that you're talking about if the Fed moves, how do you feel if we get more than one cut the ability to increase the negative beta if you will on the deposits? Like what's – can you go to like some banks have talked about like a 40% to 50% move, but we're also at a lower rate, interest rate to start with, any thoughts there?
Yes, so the majority of that, of the two to three basis points that we're projecting in the third quarter would be related to borrowing that just move, on the funding side that would move automatically. But right now when you look at our CD books we are close to where our - where the runoff rate and new CDs is washing out, but not quite there yet. I would say we are about 10 basis points upside down and we’re, I would say, probably a couple months away from that washing out.
And then so, I think what you see is in subsequent with - given subsequent rate cuts that we'll start to see some - the overall cost of our CD book is going to come down. And then we can also take a look at the other, like money market accounts and just other interest-bearing deposit accounts and trim those rates as well, especially if rates come down further. And then obviously at some point you hit a floor where you just can’t bring those down anymore. So there’s a period in there where you can do that and then you hit the floor.
Got it, okay, that’s helpful, thank you. Maybe last one, for you all on capital. You talked in your prepared remarks about not being able to buy stock because given the deal, I have two questions, number one, are you able to buy stock now that the deal has been announced, and is the expectation to look at the buyback? And secondarily, I think last quarter you talked about depository deals in Michigan or Ohio, maybe an update there of whether that might be a better use of capital given where evaluations are? Thanks.
Yes, Chris this is Archie. Yes, we are in position in the market at least to be able to do buybacks going forward this coming quarter. It’s certainly one of the key strategies that we will be evaluating relative to you know, other priorities as well in the coming quarter. As we’ve said, we've got the capital flexibility and assuming this is kind of our analysis in terms of overall pricing, it will be one of the levers we'll evaluate closely.
With regard to acquisitions, I think our primary focus is still on trying to identify some additional fee-based businesses talked before about trying to do in a well [ph] space we continue to work hard there. On the banking side, preference number one is still to do something in market in Metros where we’re headquartered. We did say last quarter we would consider maybe something in some of the adjacent states, but I could tell you there’s really nothing closed there in terms of what we’re evaluating right now. I think we’re open to looking at some things, but at this point nothing, nothing that we see on the horizon.
Got it, thank you, I appreciate it.
Yes.
Our next question comes from Terry McEvoy of Stephens. Terry, please proceed.
Good morning.
Hi Terry.
Maybe just, do you have any updated comments on the credit performance of the franchise portfolio last quarter outside of the one credit that was in the press release and mentioned earlier?
Sure, Terry. You know, overall we feel good about that portfolio. The - maybe to just kind of give you a little bit of a rundown, we saw one credit during the quarter move from a watch status to an accruing TDR substandard status. That’s a large multi-concept operator that thought this really thorough and participation credit and we’ve worked with the lead bank in the bar, we don’t think there’s any loss in that credit and the problems in that credit is really related to the smaller portion of this concept, the smaller concept in this portfolio. When - we have pretty much done a deep scrub, deep dive in the portfolio. We have I think maybe four loans totaling around $11 million and special mention one other small substandard accruing TDR and that's about it. So I think we feel better about the book now than we probably had in the last few quarters.
Thanks and then just as a followup, the client derivative fees rounded up to call it $5 million last quarter. Could you just talk about the size of those fees, is it - will it be called chunky going forward where it can bounce anywhere between $2 million and $5 million just given activity in the quarter?
Yes, Terry it is kind of chunky. Our middle sea [ph] is going to range from $40,000 to $30,000 then they can range on up to you know, into the hundreds of thousands. So, from time to time we’ll get a very large one and then more often than not it is just the smaller pool, but in the quarter we had two or three sizable ones that happened. So we don't forecast that kind of level going forward, although we still think, given the interest rate environment we still think derivative fees will be something that performs pretty well for us.
Great, thanks Archie.
Yes.
[Operator Instructions] Our next question comes from Nathan Race of Piper Jaffray. Nathan, please proceed.
Hey guys, good morning.
Good morning Nathan.
Going back to Terry’s question on credit, I appreciate your commentary in terms of expecting stability going forward, so is that fair to assume, you know the provision line goes back to what we saw perhaps in the back half of the last year, you know, absentee issues that we’ve seen in the, well tied to that one of credit within the quick service portfolio?
Yes, Nate, we feel pretty good. If you just look at our charge offs over the last year aside from that franchise credit our charge offs were averaging somewhere in that 15 basis point range and I think that's kind of how we view it, you know, at least in our current outlook. So when we think about that plus loan growth that’s worth maybe a 78% of loan growth that’s kind of how we view provision kind of going forward.
Okay, great. And then if I could just ask one more related to the core NIM, it seems like the big challenge in the NIM this quarter was the uptick in the cost and so I’m just curious to know given the uptick in wholesale funding towards the end of the quarter, is it fair to assume that you guys are comfortable letting the loan to deposit ratio rise from the 88% level that we see today or are you guys looking to kind of keep that closer to 90% or I guess how should we think about overall balance sheet growth dynamics assuming you know, you get to that kind of 4% to 6% loan growth target going forward?
Yes, Nate this is Jamie. So, yes we do have some room in our loan to deposit ratio, you know, we can let that run a little bit and that can get into the, you know, somewhere in the low 90s I think where we would be comfortable with that. So, yes, that could affect the - obviously it could affect the funding mix a little bit and then have an impact on the margin and that’s just dependent on what we see here going forward with loan growth. But you know, in that mid-single-digit range that the loan to deposit ratio could tick-up a little bit.
Perfect. I appreciate you guys taking the questions. Thank you.
Thanks Nate.
Thank you.
[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back here over to Archie Brown from any closing remarks.
Thank you, Ian. I want to thank everybody for joining our call today and we look forward to talking to you again soon. Have a nice day.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.