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Good day, everyone. And welcome to the First Financial Bancorp Fourth Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] And please note that today’s event is being recorded.
I would now like to turn the conference over to Scott Crawley, Corporate Controller. Please go ahead.
Thank you, Will. Good morning, everyone and thank you for joining us on today’s conference call to discuss First Financial Bancorp’s fourth quarter and full year 2017 financial results. Participating on today’s call will be Claude Davis, Chief Executive Officer; John Gavigan, Chief Financial Officer and Tony Stollings, Chief Banking 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 in the accompanying presentation during today’s call.
Additionally, please refer to the forward-looking statement disclosure contained in the fourth quarter 2017 earnings release as well as our SEC filings for a full discussion of the company’s risk factors. The information we will provide today is accurate as of December 31, 2017, and we will not be updating any forward-looking statements to reflect facts or circumstances after this call.
I’ll turn the call over to Claude Davis
Thanks Scott. Thanks to those joining the call today. Yesterday afternoon we announced our financial results for the fourth quarter and for the full year 2017. Before I turn the call over to John to discuss our results in greater detail. I’d like to recap progress we made this year largely driven by the outstanding effort of our talented associates. 2017 was an exciting and transformational year for First Financial. We made great strives for achieving our goal consistently and responsibly producing top quartile results. We announced the pending merger with MainSource Financial Group, which will better position both banks and serve our client, communities and shareholders.
Additionally, we announced a 5-year $1.7 billion community investment plan to solidify our commitments to serve client's organizations in our footprint focusing on the areas of lending, economic development and philanthropy. Our full year 2017 results reflect solid loan growth despite weaker than expected credit demand across the industry. City deposit growth as well as continued improvement in credit quality. Overall 2017 was an outstanding year enabled us to achieve full year operating earnings of $1.59 per diluted share of 15% [ph] return on average assets, a 14.36% return on average tangible common equity and a sub-59% efficiency ratio when adjusted to remove non-operating items.
On a GAAP basis, full year 2017 earnings were $1.56 per diluted share resulting in earnings growth of 9.3% over the prior year. As shown on slide 3, our fourth quarter results were exceptionally strong, in March a 109th consecutive quarter of profitability.
Previous performance improvement efforts around operating efficiencies, physical distribution and deposit pricing contributed significantly to improve the overall results and improvement in the net interest margin. The primary drivers for the improved margins included elevated loan containment fees, deposit pricing changes and favorable impacts from asset mix in recent rate movements. As John will discuss in more detail, fourth quarter results were impacted by the passage of the tax reform act in late December.
This tax legislation is a significant positive for First Financial and all of our stakeholders. A more efficient corporate tax framework that results in a 21% rate as a welcome and appropriate change. Our initial actions would reward our associates in our communities. First, we increased our entry level wages to a minimum of $15 per hour which will provide a significant increase in compensations to over 200 of our team members.
In addition, we made the contribution to our foundation to support our communities. We will also evaluate franchise investments we need to make as we complete our merger in order to invest in the future growth of our company.
Finally, as is appropriate, the majority of the tax reductions will accrue to the benefit of our shareholders through improved earnings and book value growth going forward. As we do each quarter, the Board will evaluate our dividend policy and capital allocation strategies when we meet next week.
With that, I’ll now turn the call over to John to discuss more details on our results before I come back and provide an update on our merger integration activities.
Thank you, Claude and good morning, everyone. Slide 3 provides an overview of our quarterly performance. Net income was $24.8 million or $0.40 per diluted share for the quarter with a return on average assets of 1.13% and a return on average tangible common equity of 14%.
Turning to slide 4, we’ve provided a comparison of reported earnings to adjusted earnings highlighting items we believe are significant to understanding our fourth quarter performance. We’ve recognized that our results include a number of significant moving pieces this quarter particularly around expenses and income taxes and we hope this information provides additional clarity.
On the expense front, we’ve adjusted our reported expenses to include -- to exclude the write-down of a significant historic tax credit investment, merger related cost, a write-down of our FDIC indemnification asset, the charitable contribution Claude mentioned earlier as well as branch consolidation cost during the period.
I’ll note that the tax credit write-down is accounting geography should be viewed economically as a component of the income taxes. Additionally, the impairment of the indemnification asset resulted from a preliminary agreement to early terminate our FDIC loss sharing agreements during the quarter.
The termination agreement is subject to final certification and is expected to settle early this year. Excluding these items, non-interest expense totaled $54.5 million for the fourth quarter ahead of our $50 million quarterly projection as a result of higher incentive compensation and a 401K contribution based on full year performance.
Specific to taxes, we’ve adjusted income tax expense to exclude the tax effect of the items I just discussed as well the revaluation of our deferred tax liabilities and low-income housing tax partnerships as a result of the tax reform legislation signed in late December.
Additionally, we’ve excluded the after-tax impact of the $11 million historic tax credit write-down that we excluded from non-interest expense, essentially netting the historic tax credit down to the $1.1 million after-tax benefit we mentioned last quarter.
As detailed on the graph on slide 4 and reflecting the adjustments I just described, net income totaled $27.7 million or $0.45 per diluted share with a 1.26% return on average assets, a 15.5% return on tangible common equity and a 58% efficiency ratio for the fourth quarter.
Turning to slide 5 and 6, net interest income for the fourth quarter was $75.6 million, increasing $5.1 million or 7%, while the net interest margin increased 25 basis points compared to the linked quarter to 3.82% on a fully tax equivalent basis.
Slide 6 details the drivers of the margin increase including a significant increase in loan fees, interest recaptured for non-accrual loans and a more favorable asset and liability mix during the period.
Additionally, as we have previously discussed, we implemented targeted strategies late in the third quarter intended to lower deposit cost and we recognized the full benefit of those efforts here in the fourth quarter.
Turning to slide 8, credit performance was strong during the quarter with a modest decrease in the allowance driven by a 16% decline in non-performing loans, a 7.5% decline in classified assets and annualized net charge-offs totaling 2 basis points of average loans.
Our credit metrics remain at historically lower levels. And as such, we recorded $200,000 of provision recapture or negative provision expense during the period.
Overall, we are extremely pleased with our fourth quarter and full year 2017 performance, and in particular, our ability to grow earnings and tangible book value through the combination of solid organic loan and deposit growth, strong credit performance, a continued focus on efficiency and disciplined tax planning efforts.
While results fell short of our expectations earlier in the year, we adjusted course along the way and our strong fourth quarter and full year performances are a direct result of those efforts.
Turning your attention to slide 10 and our outlook for 2018, we believe that we are positioned for continued success in the New Year. In regards to the loan portfolio, we are targeting mid-single-digit annualized growth on a percentage basis consistent with 2017.
We expect the first quarter net interest margin to be between 3.7% and 3.75% on a fully tax equivalent basis reflecting more normalized loan fee and interest recapture activity, two fewer days in the quarter and a smaller tax equivalent adjustment due to the lower corporate tax rate in 2018.
With respect to expenses, we are targeting a $51 million quarterly expense base excluding one-time costs. We remained focused on efficiency while also continuing to make strategic investments to support the continued long-term success of our business.
On credit, our outlook is stable, though we do expect that loan losses will ultimately migrate upward toward historical levels overtime.
And finally, on taxes, we expect an effective tax rate of approximately 21% for 2018 reflecting the lower statutory corporate rate, the elimination of certain deductions and reduced impact from state taxes, tax credits and tax-exempt income. We will continue to evaluate and update you on the impact of tax reform as implementation guidance becomes more available.
This concludes my remarks and I will now turn the call back over to Claude.
Thanks, John. In addition to our exceptional fourth quarter performance, we continue to be excited about our pending merger with MainSource Financial Group. Together, we continue to make progress in working through the regulatory approval process and integration planning as detailed on slide 11. The two companies do perceive shareholder approval on December 4 and we continue to be pleased with integration planning to this point and we remain on track for our first quarter close and a technology conversion in mid to late second quarter. As we move into 2018 and form the New First Financial Bank, we are excited about the scale and reach we will have to successfully execute our strategy, deliver exceptional service to clients and provide solid returns to shareholders.
Finally, I want to take the opportunity to thank our associates for their efforts in 2017. As the embodiment of our organizational value, the work that you every day drives our ability to exceed client expectations, serve our communities and deliver First Financials' current and future success.
That concludes our prepared comments for the call. And we’ll now open it up for questions, Will.
Thank you. [Operator Instructions] And our first question of today will be Nathan Race with Piper Jaffray. Please go ahead.
Question on the deposit product changes in the quarter obviously you have some changes in product based on the changes in pricing that you guys implemented last quarter. So just curious how much of the change in product type was driven by that versus perhaps some promotional activity that you guys enacted during the quarter?
Yeah. Nathan this is Tony. What you see here is directly related to those strategies that we implemented late in the third quarter, early in the fourth quarter. The key has been the retention of those deposits, the retention rates have been well inside anything that we modelled in terms of net outflows. So, it’s been a very, very a big positive and there are two reasons for that. One is, it's still a very competitive price product in the market and also our sales teams have done a tremendous job in all of their client concentrations [ph] and explain the changes in. You can see their efforts reflected there. The primary takeaway is that we now have a significant amount of our deposits and they are pricing back in our control and that’s where it ought to be.
Yeah. And just changing gears and about thinking about loan growth, I appreciate the guidance for 2018, just curious in terms of -- utilization trends in the quarter and obviously you have some good CNG growth in the quarter as well. So just kind of curious on some of the drivers there by geography and asset class as well?
Yeah. Overall, it’s been fairly flat, I think...
The line utilization.
Yeah. The line of utilization. Our overall growth is in fourth quarter was pretty representative of the full year, it’s in our metros, it’s in Oak Street franchise and it’s in some of our specialty lending lines. So fairly consistent there. The portfolio stays fairly balance on a year-over-year basis, a little bit of uptake in the service side, office a little bit, a little bit in hotel, but that’s coming off a very small base. So, it’s been spread around pretty well.
And on the C&D side, a lot of that, I think was just farmed off previously committee construction loans. We’ll see that and then it will begin to plateau.
And the next question today will be Jon Arfstrom with RBC Capital Markets. Please go ahead.
Just on loan growth. Claude, you made a comment that industry-wide loan demand has been a little bit weaker. You've seen anymore, any signs of optimism from your borrowers?
In the fourth quarter, late fourth quarter, we actually did. I would say, we’ve gone into ’18 with a better pipeline, across really all asset classes and we did in 2017. So, I think that’s a reflection of better activity, one.
Two, I think we are beginning to spend some more optimism across different industries, different clients. You can see that a lot of the business confidence indexes and I think we see as well in our client base. So, we’re hopeful that reflects a solid 2018.
As we’ve talk about that Jon in the past quarters, we’ve actually had these in origination activity. We just seen elevated prepayment, which on one hand, you can tell in the fourth quarter was a positive, when you look at prepayment fees, really Jon. So, parts of our business where we have prepayments and all these included the reason for that is in the event of elevated pay-off. So, it’s a little bit of mixed bag there, yes, the answer to your direct question, we see more optimism, more activity at this point this year than we did last.
Just on that prepayment fee topic. It seems like you did a little better than expected on the margin and maybe Tony that goes to your comments on doing a little better on your deposit strategy. But is there anything else you to tribute the margin strength to, if you set aside the loan fees, just better execution on the deposit plan?
Jon, I think on the margin kind of the reverse of maybe what we saw earlier in the year, particularly in the second quarter, where, you always have some volatility in different factors that can impact the margin. And generally, in any given period some go in your favor and some going against you and they net to something smaller, earlier in the year, we had a number of factors that all moved again us at the same time. And I think you’re seeing here in the fourth quarter, where most of those same things moved in our favor here in this period, it’s fees payment, obviously very strong for the quarter, interest recapture during the period. I think we hit on the high-end of our range in terms of execution on the deposit pricing strategies, some favorable mix on both sides of the balance sheet. And a little bit of lift from the December rate hike, is LIBOR, one-month LIBOR had really started to move in anticipation of that.
Yes. So, it's a little better than we thought, it was going to be and obviously the guidance is a little better as well. So that’s the reason for the question. And then I guess John as long as you have the mic, the quote losses revert to historical levels in terms of credit, I think what you’re seeing is longer term you’re not seeing any kind of big snap back in the provision in the near term?
That’s correct.
And our next question will be from Chris McGratty with KBW. Please go ahead.
Claude maybe a question for you. Given the comments on the near-term expense guide of around 51 million. When we think out post integration, and you get the cost saves in, how you’re thinking about running the company from an efficiency perspective. Is this something where the combined scale post 10 billion can run 50% or better or can you maybe opine about that and also kind of the investments you might need to make with the cost of 10 and then kind of anything offsetting the tax when following it.
Yeah, first of all, I think what we’ve tried to assume in a lot of the cost save estimates that we’ve provided is kind of reflective of some of the investments that we think we’ll need to make. So, we’ve tried to look at that net cost save number of 48 million to be inclusive of those items. Traditionally we’ve guided to a 55 to 60% efficiency ratio at First Financial standalone which we’ve achieved. We think that will improve pretty significantly in the combined company. I wouldn’t say sub-50 but I think in the low to mid-50s is I think where we’ve looked at it John is that correct?
Yeah, I agree with that.
Okay. And maybe if I could John on the follow-up, the 51 million of expenses post I guess the near term, is it fair to assume kind of you get the cost -- I guess when you assume the full cost saves will be in?
Chris what we’ve modeled and what we’ve communicated is that we would expect 75% of the cost saves to be realized in the first 12 months post close and then you know 100% of cost saves would be in the run rate one year after close. So, assuming as Claude said that we expect to close here in the first quarter we would expect a 100% of those cost saves to be in the run rate beginning in Q2 of 2019.
I’m sorry, you’ve mentioned something about the tax issue, I want to make sure we didn’t kind of blow through that question, do you have one?
No, I was just assuming -- trying to estimate, we’re all trying to estimate how much of the gross savings from lower taxes will actually flow to the bottom line versus setting this side of portion to invest in the company.
Sure, sure.
Maybe a follow up for John, on the securities portfolio, any meaningful alterations in kind of how you’re thinking about given the moving yield and post taxes, I think combined if you just put the two companies together it would suggest around a $3 billion portfolio. Is that about or maybe as a percentage of bringing the assets below 20s, is that how you’re thinking about it or should we think maybe a little bit of a delever in the close.
In terms of the size of the combined portfolio, I think you’re right on Chris and I really don’t think our strategy post-merger changes much and that ultimately the size of the portfolio will depend on the opportunities we see on the loan growth side and if loan growth is stronger and we have opportunities to deploy capital that’s certainly our preference and you would see the portfolio come down overtime, and a bit of a delver as you mention there. If loan growth stays in this low to mid-single-digit type range, then you’d probably see that the portfolio either be flatter or even potentially grow some. Then there was plain delever at close Chris.
Okay, okay. Got it. Thanks, guys.
And the next questioner today will be Kevin Reevey with D.A. Davidson. Please go ahead.
Good morning, gentlemen. So, Claude, where are you guys as far as your deposit strategy initiatives, are you pretty much done or you’re probably in the six or seventh inning and should we expect more benefits from that to accrue as we move into the first and second quarters of 2018?
No, I mean we’ve implemented the strategy that we intended and I think the ongoing strategy that we always talk about is growth in DDA and core transaction accounts, and we saw some good progress on that in the fourth quarter which aided our margins. But in terms of the major change that we talked about third quarter that’s been implemented and you saw the 6-basis point improvement related to that.
The other part that we’re in the process of doing as we’re working through our integration, planning activities with MainSource, the whole point of that in the beginning was to look at best-of-both model. And so, we’re going through product mapping and product planning with both organizations trying to take the best of both. And to the extent that we see opportunities as a result of that then we’ll announce that after close and the opportunities are the impact of that. But that’s really the next nature, that’s a deposit initiative that we’ll undertake.
The only thing I would add to that is the strategies are implemented, the position that we’re in now is that we’re in control and the consensuses of the three increases across 2018 we believe that we are positioned right now as a competitively priced product but also have the control now across those rate increases to manage, our cost much more effectively.
And then once you close the MainSource deal Claude, how are you thinking about acquisitions going forward? Are you solely focused on the integration or you’re kind of looking -- doing -- looking to focusing on the integration at the same time as you’re having discussions and then what kind of institutions would you would looking at post close?
Yes, now this is Claude. And I think throughout '18 we’re going to be focused on integrating the two companies and really to the earlier question on efficiency and your question on deposit, we see a lot of great opportunities just bringing these two companies together to make sure we execute it appropriately, get the cost saves. But we see some real revenue opportunities that we have to look at and really try to realize here. So that will be our first and focus primarily in 2018. As we’ve always done and I know as MainSource has done, we’ll look at acquisitions when they make good strategic sense. And as we bring the two Boards together in the new First Financial Bank Board that will be one of the first things we look at is what's the corporate strategy both around organic growth but also acquisitive growth. So yes, we will continue to look, continue to talk, but 2018 will predominantly focus on the integration.
Our next question will be Erik Zwick with Stephens Inc. Please go ahead.
First, with regard to non-interest or fee income. What are your expectations for fees in 1Q 2018, is the $18 million in change result from the fourth quarter a good starting point for that quarterly run-rate?
Yeah, Erik this is John. I think fee income in 2018, I’d say similar to trends in 2017 and 2016. We continue to kind of chip away if you will and incremental growth across a couple of different fee lines there. In recent years, you’ve seen kind of a tail off of covered loan income that ran through those fee income line, so maybe in the bottom line total fee income maybe you didn’t see significant growth there. But I think 2018 are largely be a continuation of that, we’ve seen good progress certainly on our client derivative fees here in 2017, wealth management fees had a good year, cards and a deposit service charges, offset a little bit by some fee income and the mortgage area there. So, I think 2018 will largely play out similar to 2017.
That’s helpful. And then could you talk about how you reached your decision to terminate the FDIC loss sharing agreement and why now is the appropriate time?
Sure. Erik, I think on that its certainly something that if you follow the headlines you’ve seen a number of banks exit loss share over the last 12 months to 24 months or so and its certainly something that we’ve look at as with any kind of transaction like that. You got to have both sides on the same page and a deal that works for both and at this point loss share for us is so immaterial to our overall balance sheet. The economics here of the early termination, we had an indemned asset of about $7 million here and we have paid $5 million impairment charge here at year-end and expect to sell the remaining approximately $2 million balance here early in 2018.
All right. And then my last question kind of turning to credit. You mentioned your expectations for I’d called it kind of near-term stability and then for losses to revert to historical levels overtime. First, thinking about the combine franchise, The First Financial and MainSource. What would you expect the kind of average loss rate to be over a full credit cycle? And second, do you think that the positive effects of the tax reform extend this current cycle even longer?
Yeah. Erik this is Claude. It’s hard to say what kind of what normal credit losses, I mean we’ve obviously seen a very low period here through the last, really few years but obviously very low in 2017, not only ours but the industry. I think with most senior credit portfolios you typically see that 30 to 50 basis points is norm higher end and being in more challenge periods, lower end being in more normal periods. So, we all then will be below that. So, the hope is that we continue, but I think as John pointed out in the outlooks slide, what we are suggesting is that reversions to means typically happen and that’s the way we think about our planning cycle is that overtime experience reversed to the mean and we should expect that in plan forward in our own profit planning, not suggesting we see that happening tomorrow as we had in the earlier question, but it’s a part of our planning cycle. And then sorry, the second question was, say it again.
Just whether the positive effects of the tax reform extend this current cycle even longer?
Yes. I think so, if you think about most of our clients and their profitability and most would be kind of corporate or some kind of the passthrough, so this should really benefit them. And the positive for me, as I think about credit macro, is that the tax benefit will help offset, I think what we’ll see in rate increases with most of our loan portfolio will be in variable rate. They’re going to see an increase in some of the credit costs. And that should be more than offset by their reduced tax costs. So, hope is that we’ll continue to maintain the profitability that we’ve seen with most of our client basis has been very strong.
[Operator Instructions]. And the next question today will be Andy Stapp with Hilliard Lyons. Please go ahead.
Most of my questions have been answered. But I do have a question on the non-core expense items. Do I assume correctly that the expenses related to the charitable contribution, the implication asset in the historic tax credit were all included in the non-interest expense and how are the M&A and branch consolidation charges allocated?
Andy, its Claude. They were all included as non-core in terms of those specific.
I mean which slide is it.
Andy, you’re correct in that they were all in our GAAP or as reported non-interest expense, the last part of your question there, the merger related cost, it’s a little bit of mix there primarily in the professional services line item. And I would say largely those expenses were largely tied to technology and contact negotiations and terminations.
And our next question today will be Daniel Cardenas with Raymond James. Please go ahead.
Just a quick question on branch rationalization efforts. Maybe a quick update as to where you are in the process, are you pretty much where you think, you should be or a little bit ahead, a little bit behind?
Well, Dan, this is Tony. The real heavy lifting is yet to come. But we were able -- both companies were able to accelerate some activity here in the fourth quarter, we closed combined about 15 locations. So, we’ve got a good start, but most of that heavy lifting will come post close and in that probably first three to six months after closing.
And no backlash from the committees where some of these branches are being consolidated?
Well, I mean there is always. There is always on happiness and in some cases a bit of angst about it with once you are the sole bank provider in an area. But nothing that we would say is unusual.
And Dan, if you remember, as a part of our model we assumed up to 5 million of potential loss revenue kind of related to those closures, obviously on the 15 that we’ve done combined it's still very early in that process bid. We think that’s a very reasonable and conservative estimate.
And this will conclude the question-and-answer session. I would now like to turn the conference back over to Claude Davis for any closing remarks.
Thanks, Will and as always thanks everyone for your interest in First Financial and we’ll look forward to our first quarter earnings call. Thank you.
And the conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.