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Good morning, and welcome to First Financial Bancorp Second Quarter 2021 Earnings Call. [Operator Instructions] Please note that this event is being recorded.
I'd like to turn the conference over to Mr. Scott Crawley, Corporate Controller. Please go ahead.
Yes. Thanks, Nick. Good morning, everyone, and thank you for joining us on today's conference call to discuss First Financial Bancorp's second 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 second 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 June 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.
Thanks, Scott. Good morning, everyone, and thank you for joining us on today's call.
Yesterday afternoon, we announced our second quarter financial results, which were highlighted by strong earnings, lower credit costs, higher fee income and improving credit trends. Our core financial metrics reflected the strong quarter with earnings per share of $0.58, a return on assets of 1.39% and an efficiency ratio of 58.4% and after being adjusted for nonrecurring items.
The quarterly performance was bolstered by higher fee income and interchange and record revenue in Wealth Management in Bannockburn. Additionally, provision recaptured during the period positively impacted our results, driven by improved credit quality trends, which included declines in net charge-offs and classified asset balances. We're optimistic about the economic environment and expect further reductions in the credit costs in the coming periods.
We are pleased with the 23% increase in loan originations for the quarter, driven primarily by our core commercial markets, in addition to consumer and mortgage banking. Loan payoffs accelerated during the quarter in almost all commercial banking areas, with larger payoff amounts in commercial finance and ICRE driving an overall reduction in core loan balances for the quarter. Given the state of our loan pipeline, we expect originations to remain strong in the second half of the year. However, we also anticipate higher payoffs to continue due to the amount of liquidity in the market.
The second quarter was, again, very active for PPP loan forgiveness with $301 million in Round 1 and $41 million in Round 2 payoffs. Through quarter end, 86% of Round 1 and 13% of Round 2 loans have been forgiven. We expect the majority of Round 1 forgiveness payoffs to complete in the third quarter, while Round 2 payoffs are expected to continue to flow in over the remainder of the year.
Average transactional deposits increased 18% on an annualized basis as clients continue to build liquidity from recent government stimulus actions. However, we believe these balances may have peaked as we began to experience some outflows late in the quarter.
Our capital ratios remain strong in excess of both internal and external targets. We also remained active in our share buyback program, repurchasing over 1 million shares during the quarter. When combined with the common dividend, the share repurchases approximate a quarterly return to shareholders of 98% of adjusted earnings. We anticipate further share buyback activity in the third quarter, absent higher priority capital deployment alternatives.
With that, I'll now turn the call over to Jamie to discuss the details of our second quarter results. And after Jamie's discussion, I will wrap up with some additional forward-looking commentary. Jamie?
Thank you, Archie, and good morning, everyone.
Slides 4 and 5 provide a summary of our second quarter 2021 financial results. Second quarter results were solid with strong earnings, stable net interest margin, provision recapture, elevated fee income and a sub-60% efficiency ratio. As expected, core net interest margin declined slightly during the period as a result of the low interest rate environment, our decision to grow the securities portfolio and increase day count in the second quarter. However, we were able to offset some of the downward pressure with additional reductions in funding costs.
While there will be some volatility in total margin due to loan fees, we continue to expect core margin to decline slightly in the coming periods given the prolonged low interest rate environment and excess balance sheet liquidity.
On fee income, both Bannockburn and Wealth Management had record income during the quarter. While mortgage income remains strong, despite lower premiums driving an expected decline from historic levels in 2020. We were also pleased to see interchange income increase 19% from the linked quarter in what we believe is a sign that our clients are starting to return to pre-pandemic spending habits. Our net charge-offs and classified assets both declined during the period. These 2 factors, combined with a positive economic outlook, resulted in $4.2 million of provision recapture during the period.
In addition, we took advantage of market conditions and repurchased approximately 1.3 million shares during the period.
Our capital ratios are strong and remain in excess of both internal and regulatory targets. We continue to believe that our balance sheet is well positioned for both the near and long term, and our stress testing results indicate our ability to maintain these capital levels for the foreseeable future.
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 $56.3 million or $0.58 per share for the quarter, which excludes $3.8 million of legal settlement costs, $2.8 million of branch consolidation costs and $1.2 million of tax credit and investment write-downs.
As depicted on Slide 7, these adjusted earnings equate to a return on average assets of 1.39% and a return on average tangible common equity of 18%. In addition, our 58% adjusted efficiency ratio remains very strong, reflecting our ability to diligently manage expenses.
Turning to Slides 8 and 9. Net interest margin decreased 9 basis points from the linked quarter to 3.31%. This decline was primarily driven by lower asset yields. Our decision to -- this decline was primarily driven by lower asset yields, our decision to deploy excess liquidity into the securities portfolio, fewer loan fees and additional days in the quarter. Despite these headwinds, core net interest margin only declined 7 basis points as we were able to successfully lower funding costs. The low interest rate environment continues to negatively impact asset yields.
As I previously mentioned, and similar to the first quarter, our higher mix of investment securities contributed to the decline in total asset yields as we deployed excess liquidity on the balance sheet. In response to these declining yields, we continued to aggressively lower our cost of deposits, which declined 2 basis points during the period to 12 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 remain the same. While some additional decline is expected in the coming periods, we anticipate a gradual decline 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 were related to the payoffs of PPP loans, However, we did experience slight declines in each loan type other than consumer loans during the period.
Slide 12 shows our deposit mix as well as the progression of average deposits from the first quarter. In total, average deposit balances grew $339 million during the quarter, driven primarily by increases in low-cost transactional deposits and public funds.
We remain very pleased with the trajectory of deposit balances as average transactional deposit balances increased 18% on an annualized basis during the period. We continue to be mindful of deposit pricing and will make any necessary adjustments based on market conditions as well as our funding needs.
Slide 13 highlights our noninterest income for the quarter. As I mentioned previously, second quarter fee income remained strong and was driven by record production from Bannockburn and Wealth Management.
Mortgage income remained strong despite expected declines, and we are encouraged by the 19% increase in interchange income compared to the linked quarter.
Seasonal headwinds and government stimulus continue to suppress the trajectory of deposit service charge income, though we remain optimistic that this will rebound some in the back half of the year.
Noninterest expense for the quarter is outlined on Slide 14. Overall, core expenses were in line with our expectations and increased slightly when compared to the linked quarter driven by higher employee costs, marketing expenses and professional services. As operations continue to normalize, we expect expenses to increase slightly, with some volatility expected depending on the level of fee income generation.
Turning now to Slide 15. Our ACL model resulted in a total allowance, which includes both funded and unfunded reserves, of $173 million and $4.2 million in total provision recapture during the period. The decline in provision expense from the linked quarter was driven by improved economic forecast, lower net charge-offs and declining classified asset balances.
Net charge-offs as a percentage of loans declined to 23 basis points on an annualized basis, while classified asset balances declined $14 million or 7% during the period.
Our view on the ACL and provision expense remains unchanged. We believe we've captured the risk from future COVID-related credit stress in the ACL model and have been conservative in releasing reserves to this point 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.
Finally, as shown on Slides 17 and 18, capital ratios are in excess of regulatory minimums and internal targets. All capital ratios remained strong, and both the tangible common equity ratio and our tangible book value increased during the period. In addition, we repurchased approximately 1.3 million shares during the quarter, further enhancing our shareholder return.
Once again, we do not anticipate any near-term changes to the common dividend. However, we will continue to evaluate various capital actions as the year progresses.
I'll now turn it back over to Archie for some comments on our outlook. Archie?
Thank you, Jamie. Before we end our prepared remarks, I want to comment on our forward-looking guidance, which can be found on Slide 23.
Loan balances, excluding PPP, are expected to grow in the low single digits over the remainder of the year. Securities balances are projected to remain consistent with June ending balances as deposits are expected to remain stable over the near term. The net interest margin is expected to be positively impacted by further PPP forgiveness payoffs and the associated accelerated fee recognition through the remainder of the year. 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 provision recapture for the remainder of the year with further declines in the allowance for credit losses.
We expect fee income to be between $39 million and $41 million in the third quarter, with some declines in mortgage banking income due to lower premiums and foreign exchange income to be around $10 million to $11 million.
Specific to expenses, we expect to be between $91 million and $93 million, but this could fluctuate some with fee income.
And lastly, we will continue to evaluate capital deployment opportunities with share repurchases expected to resume later this month.
Throughout the summer, the number of associates working in our office has increased steadily in anticipation of a broader return, and we're very much looking forward to welcoming all of our associates back in the beginning of August. We've learned a great deal from the remote environment during the last 16 months and are excited to incorporate the best practices derived from that experience into our culture moving forward, including greater associate flexibility.
Overall, we continue to believe that we are well positioned to deliver industry-leading services to our clients and returns to our shareholders. As we work towards improving the performance level of the company over the second half of the year, our focus remains centered on serving the financial needs of our core business, consumer and wealth management customers, while remaining disciplined in our approach.
With that, we'll now open up the call for questions.
We're ready for questions now, Nick.
[Operator Instructions] First question comes from Scott Siefers of Piper Sandler.
I guess first question I wanted to ask was on the deposit levels. Archie, you suggested in the release and in some of your prep comments that some of those flows could be reversing. I guess just based on what you're seeing and what you guys are expecting, sort of what makes you say that rather than just thinking they'll kind of stick around for a while? And what's your best guess regarding how much of those deposit inflows that we've gotten over the last year or so ends up sticking around?
Yes, Scott, let me start. Maybe Jamie can follow on, because this also relates to some of our decision on the securities portfolio.
We saw balances peaking in the second quarter, deposit balances. And depending on -- you can look at it several ways. One of the ways I look at it is the average balance per account for, say, business and consumer, and we could see an inflection point occur kind of mid part of the quarter. So we think it's gradual. We don't think it's a rapid descent down. But we do see just sort of a gradual outflow that's beginning to occur and we think will continue for the foreseeable future.
Jamie, do you have any follow-up on that?
Scott, this is Jamie. So as Archie mentioned, we did see deposit balances peak around that April time frame. End of May, we get some public funds in kind of seasonally. But when we look at kind of core consumer and business deposits, we did see those -- I mean I don't know if we necessarily hit like an inflection point where it's going to start flowing out rapidly. But we did see balances in June go down for the first time in a while. So -- and when I say they were down, I mean, they were down like only about $20 million, $30 million. So -- but it did go the other way for the first time in a while.
So it's something that we are obviously monitoring given the fact that we increased the securities portfolio, and we are ready to unwind that if they start flowing out faster than what we anticipated. So we think, just as the economy opens back up, people start getting out, spending again, that we'll start to see those balances. Like you said, at a minimum, they're not going to keep going up, stable to down over the next year.
And I guess I'd follow on one more point. The interchange income, we already saw it jumped nicely in the quarter, and we think that's a demonstration that the consumer is out spending again, and probably even more so maybe in the back-to-school time frame that we're all approaching.
And then finally, with PPP forgiveness fees, coming through a lot of those businesses that were sitting on the dollars waiting for their forgiveness once, they get it, then they start to do something with it. Part of our paydowns during the quarter, one aspect of the loan paydowns was excess liquidity paying down loan balances. So that was a part of the story.
Yes. Okay. Good. That's all great color. I appreciate that. Just 2 sort of real ticky tack ones. Jamie, do you have the remaining PPP fees for Rounds 1 and 2 by any chance?
Yes, it's $16 million. You're talking about the unearned fees, right?
Yes, exactly.
Yes, yes. So we had -- at 6/30, we had, in balances, about $400 million in total PPP balances with about -- I think it was like just north of $16 million in fees, like $16.4 million in fees sitting out there.
Okay.
And like -- and Scott, like we mentioned, I mean, we think the Round 1 fees, we've obviously amortized quite a bit of those at this point. So it's skewed more towards that Round 2 tranche. But the timing of that is a little bit of a wildcard, but we think that, that comes in here in the back half of the year in the -- obviously, in the third and fourth quarter.
Okay. Perfect. And then I guess final one is just the legal fees. Anything -- just curious what that charge was for, to the extent that you can discuss it.
Yes, Scott, this is Archie. Like many banks, we’ve been subject to some lawsuits relative to overdraft fees that have been going on for a while now, specifically for us in Indiana and Ohio. We believe that our practices are fully disclosed, and we work hard to make sure that our customers are informed and that they have the tools to be able to avoid overdraft charges.
But we’re seeing this type of – this type of litigation is very time consuming and expensive in large part because the amount of data that we’ve got to sort and disclose is, in some cases, goes back 10 to 15 years. So we just determined it’s in our best interest to settle the Indiana lawsuit and then we’ve signed a settlement agreement that’s being presented to the court for approval.
We do have overdraft litigation in Ohio remaining. We continue to believe that our defenses are adequate and available to us to get that suit resolved.
The next question comes from Jon Arfstrom, RBC Capital Markets.
It's an interesting discussion on deposits, and you touched on it partially with PPP. But any idea where the commercial customer deposits are going? Is this step back type spending a prelude to stronger growth? Just any ideas on that?
Jon, I was having a little hard time hearing you. I think your question was what are we seeing with regard to commercial customers? And in terms of CapEx growth and investment?
Yes. Just on the deposit flow question.
Yes.
You touched on it with PPP, and I'm just curious if you have ideas where that money is going? And is it into CapEx, which leads to growth later?
Yes. I don't know that I know fully what we're experiencing so far and it was not the major story. It was probably 1 of 3 major themes in the payoffs that we saw was customers aren't taking -- commercial customers aren't taking excess liquidity and paying down debt. So that's a piece of the story. We saw that -- with that 15% or so of kind of the maybe additional payoffs that we saw in the quarter, I'd say was related to that.
This quarter, I've spent a lot of time with our business clients, and I can tell you, Jon, they're all saying something similar, things like having our best year ever. It's that kind of a theme happening over and over.
The two main problems, the primary one at this point that's a surface is around supply chain disruption and the second, of course, being labor. But I think the supply chain disruption kind of gets into the second part of the CapEx discussion is, can they get what they need to go ahead and invest in plant and equipment and other things? Or is that going to take time to play out until some of the supply disruptions work themselves out?
I know I talked to one client two days ago that bought a major piece of machinery over in Europe. And they certainly don't expect to deliver until later in the year. But right now, they think it's on time, but they are prepared that, that could go into next year. So I think that disruption could delay how some of that cash gets deployed, but they're all having really kind of great years or best year ever type of experiences.
So I think it's coming. It just may be more over the back half later in the year or even into '22, where we see a lot of that spending.
Okay. And I guess that's probably reflected in pipelines. Is that fair? You've seen higher pipelines, and it's just a matter of everything pulling through?
I think that's right. Pipelines have really started to strengthen up pretty quickly in the spring, and they've been -- I don't think they've spiked. I would say we're not quite at levels we were pre-COVID, but we're pretty close and they're steady at that level.
Jamie, I understand your guidance on the margin, and thanks for fee comment, the fee numbers on PPP. But how do you feel about net interest income? You feel like you can continue to bump long here and hold that relatively stable? Or is there a potential for some NII growth in the second half of the year?
Yes. I mean a lot of that is going to depend, Jon, on the amount of loan growth that comes in. Our -- and if we can, we're going to get -- like we mentioned, we're going to see -- when you kind of cut through the margin and look at -- strip out the day count, strip out loan fees, that sort of thing, the choppiness we're going to see in PPP fees. We're going to see a couple of basis points of margin pressure every quarter here for a little while until it stabilizes, maybe 3 or 4, 5 quarters from now, in the middle of next year.
So what -- the variable there, obviously, is if we can get some loan growth here in the back half of the year and grow the earning asset base. Our plan at the moment is to -- we'll look at the funding side for this is to keep the securities book flat and then grow the earning asset base off of the loan growth that we get in the back half of the year.
And Jon, this is Archie, I’ll pick up on the loan growth a little bit.
We’re saying low single-digit kind of growth in the back half. And I think the other variable we saw in payoffs this past quarter was kind of the category of sale of business or refinance to permanent market. That was a little bit elevated compared to what we’ve seen in recent quarters.
And while we may still see some of our ICRE product going to the permit market, I don’t think we’re going to see the same level of sales that we – of businesses that we’ve seen in the second quarter.
So one, we think while they may be elevated, payoffs may not be quite as high. And we are seeing, at least quarter-to-date, some nice growth to start the quarter, which supports where we are in the pipeline. So we think, based on what we’re seeing, we’re going to get into that low single-digit level for the rest of the year.
The next question comes from Daniel Tamayo, Raymond James.
I just wanted to see if I could get your current thoughts on what the M&A environment looks like for you, including kind of what would be an ideal acquisition given the environment overall and your strong capital position?
Yes, Daniel, we think there's a case for M&A when you think about what's coming in '22 and '23. The industry won't have PPP, and mortgage banking is returning a little bit more to normal. While we'll still potentially have some provision recapture going into next year, even just the environment for the industry is going to get a little more difficult, I think. And so I think that sets up well for M&A. So we would have an interest to be involved in M&A, certainly if we can find the right opportunities.
Ideally, for us, it would be banking companies. It would be, say, 15% to 25% of our size in Midwestern metropolitan markets in which they have a meaningful share. Now that's ideal. And we'll see what -- over time, what may come up. But that's probably what we would be thinking about if we could have it our way.
And in terms of internal kind of profitability metrics that you think through when you're considering that -- those decisions, what do those look like?
When you say profitability metrics, you mean just sort of like – yes. So I mean from – like from an earn back and certainly well under 3 years, I think the environment is setting up to be maybe even lower than that. Certainly, IRR is north of 15%. Some meaningful accretion once you get through just the first year of all the integration work.
Next question comes from Chris McGratty of KBW.
Jamie, maybe a question for you. I think you referenced the high 50s efficiency in, well, obviously, the tough rate and growth environment. Is that kind of -- it feels like there'll be a little bit of upward pressure on that just because of mix and loan demand. But can you just help me sort through if this rate environment persists for, I don't know, another year? I mean, my guess is low 60s is kind of fair?
Yes, that's true. I mean what we're getting -- obviously, we're getting some benefit now from -- on the revenue side. It's really not a function of the expenses, it's really a function of the revenue side, the pressure that we're seeing there that side of the equation.
So when you look at that, we're getting some benefit now from -- especially from the PPP loans. So when that -- going into next year, when that goes away, we'll likely see our efficiency ratio move up to those -- that area where you're talking about.
Yes, Chris, this is Archie. I think the other thing that I think about on the efficiency side is that while we will -- on the expense side, we will see a little bit of normalization -- further normalization of expenses, things like T&E, as people are more fully back to work and visiting clients, et cetera. But we're also going to do some work -- further efficiency work primarily in the branch rationalization category. We've done some. We'll do some more as we head into next year and try to offset some of that expense pressure. But I think Jamie is right, the other side of that is just how much can we keep revenue up.
Understood. Got it. And then just on credit, can you remind me, I didn't -- it wasn't obvious in the deck. The -- where CECL day 1 reserves were? And kind of thoughts about the risks of the book today versus maybe a year ago? Could you go below that level?
Yes. Chris, maybe I'll start and then maybe, Bill, you can talk about the portfolio. So Chris, when -- pre-pandemic day 1 CECL, our reserve was at 1.29%. And compare apples-to-apples now, if you take out the PPP loans, our reserve is at 1.75%. So in theory, as things normalize -- and the question mark is the timing of when this occurs, whether that's over -- we think internally here, when we talk about it, we think that just given the composition of our portfolio, that hotels are going to be a little slower to recover here. We think that, that happens here over the next, give or take, over the next year or so where we get back to that day 1 range. So that's -- for us, that's another 45 basis points of reserve release, either through charge-offs or running it through the -- or obviously running it through the provision expense.
That's really helpful. And maybe if I can sneak one more in on capital. Can you just remind us targets? Because I'm trying not to read too much into the comments about buybacks and then flipping to a deal. I'm just trying to get a sense of if you were to do something on the near term? Like what the bogey is on capital?
In terms of the -- I mean, if you look at our TCE ratio now and here in a little while -- here in the next couple of quarters, PPP will be gone. We’re up close to 9% from a TCE ratio. We – our target would be, if we did a deal, would we go below 8% down to 7.5% for a short period of time? Yes. But typically, we target around 8%.
[Operator Instructions] Next question comes from Terry McEvoy of Stephens.
Jamie, you mentioned in your prepared remarks, there was some room to bring down deposit costs, but you were getting closer to a floor. Can you just talk about how much room is left? And then as you think about kind of mix shift of deposits maybe that you saw in the back half of the quarter that can continue. How could that come into play as I think about all-in deposit costs as well?
Yes. So when you look at our deposit costs for the quarter, they were at 12 basis points. I think for the -- as we kind of -- if you looked at it maybe on the last day of the quarter, on 6/30, they were around 11. So I mean, we do have, in our forecast, though, that floor could be somewhere around -- possibly go as low as 8, but it's probably somewhere around 8 or 9 basis points.
But that is -- that's really the floor. I mean, at that point, we have cut all the transaction deposit account rates that we had -- that we can. And then it's just really just the CD book repricing over that -- over the next year to get to that 8 or 9 basis points. But we think that that's the floor.
And then just as a follow-up comment, maybe a question on the hotel portfolio. In the deck, you talked about updated appraisals and feeling good about where things were at the end of the quarter. Some of the concerns about rising COVID cases that are in the headlines? Updated thoughts on that portfolio would be helpful.
Yes. Overall, we’ve been seeing our hotel occupancy continue to increase as things have opened up and we expect that to continue. Obviously, the Delta variant could impact that. But based on what we’re seeing in the trends, we’re confident that the rebound is occurring. And what we’re seeing at first in more of the limited service hotels, and we’re starting to see more and more activity in the business center hotels as the summer rolls on.
That concludes our question-and-answer session. I'll turn the call back over to Mr. Archie Brown for closing remarks. Please go ahead.
Thank you, Nick. I want to thank everybody for joining us today. Hope you're having a great summer. We look forward to talking to you at the end of next quarter. Have a great day. Bye now.
That concludes today's conference. Thank you for attending. You may now disconnect.