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Good morning, and welcome to the First Financial Third Quarter 2018 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'd now like to turn the conference over to Scott Crawley. Please go ahead, sir.
Thank you, Keith. Good morning, everyone. Thank you for joining us on today's conference call to discuss First Financial Bancorp's third quarter and year-to-date 2018 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, Chief Banking Officer.
So, 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 references to the slides contained in the accompanying presentation during today's call.
Additionally, please refer to the forward-looking statements disclosure contained in the third quarter 2018 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, 2018, and we will not be updating any forward-looking statements to reflect facts or circumstances after this call.
I will 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 third quarter. This morning, I will provide some highlights of our results and then we'll turn the call over to Jamie for further details. Finally, I'll wrap up with some forward-looking commentary and closing remarks.
We continue to demonstrate the earnings power of our high-performing company. Third quarter results, which mark our 112th consecutive quarter of profitability, reflect top quartile performance, enabling us to achieve adjusted earnings of $0.58 per share, 1.64% return on average assets and 20.8% return on average tangible common equity and a 51% efficiency ratio when adjusted to remove merger-related items.
Third quarter was highlighted by a strong margin, growing fee income, disciplined expense management and stable credit quality. While we remain focused on fully realizing targeted cost phase, we continue to invest in strategic areas. During the quarter, we added debt to our commercial banking, business banking, wealth advisory and mortgage teams and are approaching full staffing levels in our targeted growth markets.
We are optimistic that these staffing investments will enable us to build momentum through the end of 2018 and position us to achieve our 2019 growth targets. This quarter's strong earnings led to further strengthening of our capital ratios, with tangible common equity increasing to 8.53% and tangible book value per share increasing to $11.25. As such, in July, our Board of Directors approved an increase to the common dividend from $0.19 to $0.20 per share, which was a second dividend increase in 2018.
With that, I'll now turn the call over to Jamie to discuss further details of our third quarter results.
Thank you, Archie, and good morning, everyone. Slides 3 and 4 provide an overview of our third quarter performance. As Archie mentioned, we are pleased with our quarterly results, highlighted by strong earnings, excellent credit quality, increased efficiency and a stable net interest margin.
On Slide 5, we provided a reconciliation of our GAAP earnings to adjusted earnings, highlighting items that we believe are important to understanding our quarterly performance. While not as significant as the second quarter, the third quarter was impacted by items related primarily to the merger with MainSource Financial Group.
Excluding these items, net income was $57 million or $0.58 per share for the quarter, which equates to a return on average assets of 1.64% and a return on average tangible common equity of 20.8% as shown on Slide 6. Further, the adjusted efficiency ratio of 51.1% in the third quarter reflects our ability to maintain the cost synergies realized from the merger and our continued diligence in managing expenses.
Turning to Slide 7. Net interest margin for the quarter declined 3 basis points from the linked quarter to 4.12% on a fully tax equivalent basis. The decline in our net interest margin was primarily driven by a decrease in loan fees and the impact of the third quarter day count.
Given our modest asset sensitivity, we did receive a slight benefit from the Fed rate hike in June, but it was somewhat muted compared to previous periods due to changes in funding mix. Given our sub-90% loan-to-deposit ratio, this trend is likely to continue in future periods as we selectively evaluate our funding strategies to ensure we maintain and secure the low-cost funding needed to support anticipated loan growth.
As shown on Slide 8, our loan yields improved by 4 basis points, while our cost of deposits increased by only 2 basis points. Loan yields did not increase as much as expected, as one-month LIBOR increased less during the third quarter than in prior Fed rate hikes. Slide 9 depicts our current loan mix and end of period loan progression from the second quarter.
Overall loan growth missed our expectations. However, we were pleased with higher origination volumes, which increased 15% compared to the second quarter with all business lines reflecting improvement. In addition, fundings increased 9%, compared to the second quarter. However, this increase was more than offset by elevated payoffs and lower line utilization.
As shown in the progression on the right-hand side of the slide, most of the decline in loan balances was in the small business banking portfolio. This decline was a result of lower-than-expected production and the planned exit of previously acquired loan relationships.
Slide 10 shows the current mix of our deposit base, as well as the progression of average deposits from the second quarter. Excluding the impact of required branch divestitures related to the merger, the decline in brokerage CDs and the outflow of public funds, which was partially seasonal, average deposit balances decreased by $90 million. Much of this decline was anticipated with the consolidation of 41 branch offices in the first six months of 2018. We remain confident in our ability to attract and maintain lower-cost deposits over time.
On Slide 11, overall asset quality remains excellent. Classified and nonperforming asset balances were flat in both dollars and as a percentage of assets, and remains low, compared to historical norms. We had 2 basis points of net recoveries for the quarter, while provision expense increased due to the anticipated resolution of a nonperforming relationship and the migration of two large credits to special mentioned status. This resulted in some reserve bill during the quarter. While we did add to the reserve balance during the period, it is worth pointing out that none of the downward credit migration affected nonperforming balances.
Finally, as shown on Slide 12, capital ratios expanded during the period in conjunction with our strong earnings. I'll note that all ratios remain in excess of stated targets and we expect further expansion in the coming quarters. We will continue to evaluate capital deployment opportunities that are in-line with providing solid shareholder returns while continuing to support the company's growth initiatives.
I'll now turn it back over to Archie for some closing comments.
Thank you, Jamie. Before we end our prepared remarks, I want to give you some closing thoughts on the quarter and our outlook going forward. We're now more than a quarter removed from the core systems conversion related to our merger with MainSource. Much of our focus during the quarter was on achieving stabilization around new teams, technology, and processes along with resolving any client issues that resulted from the conversion. Even with much of our focus on internal priorities, I view the first two quarters as a combined company as having been truly successful.
Having seen the potential for the combined company play out through top quartile return on assets and return on average tangible common equity, we're as excited today as we were when we first announced the merger. As we're now in the later stages of the integration, we made the decision to remove the outlook slide from our earnings presentation. Our work in the third quarter to build sales teams makes us optimistic in our ability to return to more mid-single-digit loan growth over the longer-term.
Over the near term, we expect loan commitments to increase, but continue to be offset by continued elevated levels of payoffs. We expect net interest margin to be relatively stable as we remain focused on managing funding costs, though it could fluctuate depending on purchase accounting accretion and loan prepayment activity. With most of the merger and conversion activities behind us, we're now focused on strategic initiatives aimed at growing the company in an efficient, risk appropriate fashion.
We expect noninterest income to approximate adjusted third quarter results in the near term, and expenses to decrease slightly from adjusted third quarter results to the mid-to-upper end of the range we guided last quarter. With respect to credit, our outlook remains stable. We look forward to spending the remainder of the year executing on our strategic objectives with a disciplined approach and focusing on the financial needs of our business, consumer and wealth management clients.
This concludes the prepared comments for the call. Keith will now open up the line for questions.
Yes, thank you. [Operator Instructions] And the first question comes from Scott Siefers with Sandler O'Neill.
Good morning guys, how is everyone doing.
Hi Scott.
Let's see, first question on the margin. So, Archie, I appreciate the comments on the likely stability, so with that said, I guess I was braced for more margin erosion based on what you guys had guided to on the second quarter call. So, one maybe, Jamie, sort of, puts and takes or in other words, how the margin was able to come in better? And then within the context of the outlook for a stable margin in the fourth quarter. Can you maybe parse that as to how you see it coming in from the core of roughly 3.83% on the FTE basis? And then, of course, you had the reported 4.12%. So, in other words, how does that nuance move around?
Yes. I mean the main driver in the third quarter that I would say, the delta between what we were potentially expecting the margin to do and where it came in, was related to loan fees. So, when we were guiding in the third quarter we were assuming that loan fees – there's just volatility in that number. So, we were expecting loan fees to come down slightly. And then also, the modeled amount of purchase accounting accretion. We were expecting to come in at 23 basis points, it came in at 29 basis points. But on the core side, the biggest delta there was related to loan fees.
So, loan fees were pretty stable quarter-to-quarter. And then to your question going forward, what we were seeing in terms of the margin? So, if you assume – take out purchase accounting, I think that's what you were asking about, kind of take that out and assuming no volatility in loan fees, we're expecting the margin to be stable. So, what you saw in the third quarter was really low increase in cost of deposits, but a 7 to 8 basis point increase in our cost of funds due to a change in the funding mix and about a 9-basis point increase on our asset yields.
And so, given all that, our margin was – the core margin was relatively stable. We really see the similar trends happening here in the short-term with may be less of a mix change and more of an increase on the cost of deposit side. So, some of the migration that we saw out of deposits into – and more of the interest rate sensitive categories out of deposits and into on the borrowing side. We think that, that won't necessarily happen in the fourth quarter, but what you'll see then is a slighter – a higher increase in the cost of deposits.
Okay. So, if I interpreted that correctly, so on the funding side, I guess, it ends up being a wash with just some change in how it looks cosmetically, such that overall it sounds like you're saying core margin flattish with the 3.83% and then I'm guessing sort of similar PAA impact as well. Is that a fair conclusion?
Well, the modeled purchase accounting accretion for the fourth quarter is 22 basis points. So, we had 29 – we got 29 in the second and the third quarter, and based on the model and the prepayment fees that we have assumed, it's 22 for the fourth quarter.
Okay. So, then the core a little better in the fourth quarter than in the 3Q and then a little less PAA means reported is the same?
Right.
Right? Right, okay, perfect. And then if I could sneak in one more. So, yes, it looks like you said mid to upper end of the $75 million to $77 million expense range for the fourth quarter. Is there any opportunity to decrease costs thereafter? Because I think if I recall correctly, all the cost savings from the deal were supposed to – weren't supposed to be in completely until early 2019, so is there additional cost? And then I noticed you had the severance charge as well. Is there anything else we should be thinking about on the cost side go forward?
Scott, this is Archie. I – you were saying, as you said, kind of mid to upper range from what we guided last quarter, it would be slight if any. I mean, we are building – as we talked about here, building some additional investment into some of our revenue teams, if you will, and there may be some things going down on the other side, but with that it – we're kind of getting close.
Okay. All right, perfect. And then nothing to read into that additional severance charge in the third quarter?
No.
No. That's a continued reduction, kind of post conversion.
Yes, and as we think about 2019, Scott, it's just kind of off the Q4 base. We think about 2019 expenses being kind of just the normal increase that you would see with merit increases or health care costs, things like that.
Okay, perfect. Thank you, guys, very much.
Thank you. And the next question comes from Jon Arfstrom with RBC.
Good morning guys.
Good morning, Jon.
Just a couple of questions on lending. You guys talked about the payoffs in the small business line being down. Can you maybe break out for us how much of the decline was the planned exits versus general payoffs?
Hey, Jon, it's probably – there are probably three things happening in that portfolio. Probably a quarter of it was related to loans that we had actually sitting in kind of what we would call like a special assets bucket. There – so we really will absolute exit those. Another – the third, which probably is related to, what I call, small ICRE credits that either they're maturing or we're talking to the bar about terms going forward and we're trying to tighten those up. And if we can't get them tightened then we're okay with those exiting, so that's probably another piece. And then the other piece would be amortization and then just prepayments.
Okay. And the overall message on growth, I hear you're on the mid-single-digit growth longer term. Are you seeing some of this likely persist into Q4? And given some of the origination activity you're talking about, when we hit 2019 you feel better about the growth outlook?
Yes. They are – when we talk near-term elevated payoffs, there's probably three areas that I'm currently seeing that really make us feel that way. One is, we will see a little bit more of the same phenomenon in the small business banking portfolio, maybe to not quite the same extent. We are seeing – we do have in the ICRE buckets the scheduled maturities where several years ago construction loans, construction periods done stabilized. Some of those will get refinanced into the permanent market, but that schedule is a little higher still in this quarter.
And then the third is, in our finance company, in our Oak Street insurance business, we're seeing just a really highly competitive market right now, more so than in recent years. And we're seeing a few payoffs that are coming through there here, as we get into the latter part of the year. So, I think the core businesses will all start to – those trends will start to abate as we get into the new year, and we'll keep watching what's going on in the finance company.
Okay, good. And then just somewhat related, can you give us little bit of color on the personnel additions, maybe some early results and what's left to do? Seems like you're close to being completed there, but give us an update, please.
Sure. Last quarter we talked about this, that we had – we were upgrading and adding more bankers into most of our metropolitan markets that are in our footprint, and we made a lot of progress on that front this quarter. We still had probably one metro market where we're a couple of banker’s light [ph] that we want to get done here over the next quarter. So, but other than that, during the quarter we got most of those positions filled and so they're starting to build pipeline and activity. But we did see even with some of the earlier additions improved commitment levels, origination levels in Q3, and we think that can continue and get into Q4.
Okay. Great job you guys. Great performance and good luck on the growth, getting the growth going. Thanks.
Thanks Jon.
Thank you. And the next question comes from Nathan Race of Piper Jaffray.
Hi guys, good morning.
Good morning.
Jamie, I just want to circle back to some of your comments on the deposit flows in the quarter. It sounds like there's some seasonal aspect impacted things here. But just curious, what extent you guys expect some higher cost deposits to continue to run off here in 4Q and into 2019? And just kind of what your expectations are for deposit pricing over the next couple of quarters? Obviously, it's probably a little more competitive deposit price environment, but just curious to kind of get your thoughts on just how you guys can perhaps continue to lag deposit price in some areas?
Yes, Nathan. This is Archie. I'll start, and if Jamie wants to add to it. But we have seen the pressure in – with each Fed rate move we see a little more pressure. With the most recent one, we got a few more calls from some of our public fund clients, and we have to make a decision, do we retain those dollars or not. And then if they're core clients, typically we will work to try to retain the dollars. And I think we're just – with each Fed rate we'll see increase – we'll see more of that kind of pressure. We did see a slowing of attrition of dollars in our other interest sensitive buckets. Things like money market, interest checking, those are slowing down.
And again, we're starting to make a few tweaks to rates in those areas. And as Jamie alluded to, we'll see a little bit more maybe higher deposit costs coming into Q4, but it would be offset with lower mix change that – compared to what we experienced this time. So, those are probably the two big things. The other thing that I did observe kind of looking at quarter-over-quarter, our noninterest-bearing balances relative to our business clients and our consumer clients, relatively flat, if you look at June to September. So, we feel like in those areas that things are pretty stable right now.
Okay, got it. That's helpful, I appreciate that. And then just thinking about the relative and absolute size of the securities portfolio from here. It sounds like growth is still going to be a little challenging on the lending side of things here in the fourth quarter, so I was just curious any thoughts on kind of how you guys are thinking about reinvesting any excess liquidity in the securities book? And just – how we should think about the absolute and relative size of that portfolio in 4Q and into 2019 as well?
Yes, this is – Nathan, this is Jamie. So, the – in the short term, we're just – we're – our plan is to keep the securities portfolio flat. And then here over the next couple of quarters, as we are monitoring growth on the loan side that outlook could change, but for the time being, we're going to keep it flat.
Alright, I appreciate all the color guys. Thanks.
Thanks.
Thank you. And the next question comes from Kevin Reevey with D.A. Davidson.
Good morning gentlemen, how are you?
Good Kevin. How are you?
Good, thanks. So, getting back to loan originations, which markets are you seeing the strongest growth, is it in Cincinnati? Is it Indianapolis? Is it in your Louisville market?
Yes, Kevin. This is Archie. Our headquarters’ market, greater Cincinnati, is showing strength, and our nonmetro markets are showing pretty good stability and strength. And as I discussed earlier, we were building teams in those other metropolitan markets, so we've got stabilization in Columbus and Louisville at this point, and not a lot of growth coming yet. But we – certainly in Columbus, I think we're a little further ahead right now, so things are starting to happen there.
And then in your prepared remarks, you talked about line utilization was down. Can you tell us what that number was at the end of the third quarter versus the second quarter?
Yes. I think it went from, like, 51% to about 50%. So, about a 1 percentage point change in utilization, which has an impact of around $40 million.
Great. Thank you very much.
Thank you. And the next question comes from Terry McEvoy with Stephens.
Good morning, guys.
Hi, Terry.
Circling back to expenses again, and I just want to get comfortable really with the first quarter of 2019. The expenses behind the hires and commercial and wealth management. That's kind of built into your fourth quarter comments on expenses and there shouldn't be, call it, a step up in the first half of next year related to the new hires?
That's correct, Terry.
That's correct, yes.
Okay. Thank you. And then just thinking about revenue synergies. As I ran through the income statement, client derivative fees kind of jumped up to $3 million. And anything else you can highlight as the two companies have come together and some of the synergies that you're seeing maybe internally versus maybe what we can see just in the release?
Terry, that's the obvious one. And that was one we did anticipate, although Q3 was really strong. We would expect and we've seen a little bit on the service charge side, generally that's improving wealth. We mentioned, we hired some additional wealth advisers, and we rolled out really a more robust wealth advisory program throughout our footprint here in recent month or two. So, I think we will start to see the momentum there. Those are probably the big drivers outside of what you saw in the swap income.
And then just, Jamie, one last question. As you were going through the asset quality slide, you mentioned a few loans that moved into the classified category. Could you just run through that statement again and whether there was any kind of common themes among those credits?
Yes, just to clarify. So – well, no common theme on those credits to start with, but just to clarify, those that move into the classified bucket they moved into the special mentioned bucket. There's two large credits, no – so no theme there, obviously, it was just two. But two large credits that just helped drive that – the provision expense there for the quarter. So, it went into special mention, they didn't go into substandard.
Great. Thanks for clearing that up. Thanks guys.
You’re welcome.
Thank you. [Operator Instructions] And the next question comes from Chris McGratty of KBW.
Hi, good morning everybody.
Good morning, Chris.
Jamie, maybe a question on the deposit breakdown. I think one of the strategic merits of the deal was the granularity of MainSource's deposit base. I'm interested in just kind of a high-level comment on differences in deposit betas, thus far, between the two. I'm not sure if you guys still segregate legacy First Financial and MainSource, but just kind of the responsiveness of either portfolio?
Alright. Yes. I had you in the pool to mention deposit betas first. So, I think – so I – we don't still segregate the two deposit betas because we've consolidated branches and whatnot. So – but – I mean when you look at – I think you really look at the overall funding base and when you look at that funding base from the second quarter to the third quarter. When you look at the overall cost of funds, it went up 8 basis points. So, I think – and our – the deposit beta was very low.
It really only – our deposit costs only went up 2 basis points. But when we really look at and we're looking at the overall cost of funds and we are – we do not see from the third to the fourth quarter and here going forward, that we're going to have that change in the funding mix like we had in the third quarter. So, the cost of funds moving up 8 basis points, we may see a higher cost of deposit movement going forward here as we – as that mix change doesn't happen. But I think you're going to see the beta move up just because we let some of the higher rate dollars move over into borrowings.
Yes, Chris, this is Archie. In the quarter, really the only rate increases we were seeing in the portfolio is probably in the public fund bucket and some CDs. We're running some CD specials to retain CD dollars, but in terms of transaction accounts, very little movement in rates quarter-over-quarter. As Jamie said, as we go forward, especially the more higher interest sensitive kind of transaction deposits, we may see a little pressure there, as well as some more public fund pressure.
That's great. And if I could just ask one on the other side of the balance sheet. Most banks struggled with LIBOR headwind this quarter. Jamie, could you just remind us how much LIBOR exposure you have in the loan portfolio? And then the breakout between one and three months or whatever you have?
Yes. So, we have – so if you look at the loan book, we have 55% of the loan book is floating and the vast majority of that would be tied to LIBOR. About 80% of that 55% is tied to LIBOR. And virtually all of that would be one-month LIBOR. On the security side, we have about 15% of the portfolio that is floating, and that would be tied to three-month LIBOR.
Great. And then lastly, if I can sneak the tax rate question. Q3 has a decent run rate going forward?
Yes.
Awesome, thanks a lot.
Thanks Chris.
Thank you. And the next question comes from Daniel Cardenas with Raymond James.
Good morning, guys.
Hi, Daniel.
Just a quick question on the margin. As you guys kind of look at the number going forward. Can you remind us how you are viewing rate increases? How many rate increases do you have budgeted here over the next year?
Yes, we – I mean we have one here in December coming up and then – I mean, two more next year. But what we would, I mean either way, we think that our margin is going to be stable because when the rate increase occurs at the – here in the short term, we are essentially – the cost of funds increase is basically offsetting that, call it 8 to 10 basis point movement up on the asset side. Just from the competitive pressures on the deposit side.
Okay, alright. And then in terms of loan growth expectations, as you look at 2019, is that still primarily market share takeaway? Or are you seeing something in your local economies that's giving you hope that we'll see borrowers, kind of come off the sidelines a little bit more aggressively?
Yes, Dan. This is Archie. I think it's just kind of the environment we've been in, which is we're getting some from existing clients, we get some from taking – getting a client from another competitor and then the economy role is strong in all of our markets. So, it kind of comes from all those. But really, I think our cautious optimism is more around that we're getting high-quality bankers on the team and getting staffed and then getting in place and starting to generate activity over the next year.
Okay, good. All my other questions have been answered. Thanks, guys.
Thank you, Dan.
Thank you. And as there are no more questions at the present time, this does conclude our question-and-answer session. I would like to turn the conference back over to Archie Brown for any closing comments.
Thank you, Keith. And thanks everybody for joining us today where we can talk about our quarter and just the optimistic view that we have of our company going forward. Have a great day.
Thank you. The conference is now concluded. Thank you for attending today's presentation, you may now disconnect your lines.