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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day and welcome to the Fourth Quarter and Full Year 2020 Earnings Call and Webcast. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Scott Crawley, Corporate Controller. Please go ahead.
Thank you, Sara. 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 2020 financial results. Participating on today's call will be Archie Brown, President and Chief Executive Officer; Jamie Anderson, Chief Financial Officer; and Bill Harrod, Chief Credit Officer.
Both the press release we issued yesterday and the accompanying slide presentation are available on our website at www.bankatfirst.com under the Investor Relations section. We will make reference to the slides contained in the accompanying presentation during today's call.
Additionally, please refer to the forward-looking statement disclosure contained in the fourth quarter 2020 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 31st, 2020 and we will not be updating any forward-looking statements to reflect facts or circumstances after this call.
I'll now turn the call over to Archie Brown.
Thanks Scott. Good morning everyone and thank you for joining us on today's call. Yesterday afternoon we announced our financial results for the fourth quarter and full year 2020.
Before I turn the call over to Jamie to discuss those results in greater detail, I want to reflect on this past year and then provide some highlights in the most recent quarter. When considering a year in which we encountered a global pandemic, experienced widespread government-mandated business shutdowns, and stay-at-home orders, and a reduction in the Fed funds rate of 150 basis points, I'm very pleased with our response to these challenges and our overall management of the company.
Despite the challenging backdrop in 2020, we grew loans and deposit balances, achieved record C&I and mortgage loan production, assets under management, fee income, and total revenues. On an adjusted basis, we earned $1.66 per diluted share, achieved a 1.05% return on average assets, strengthen Tier 1 common equity and total capital, significantly bolstered our allowance for credit losses from 0.63% of loans to 1.7%, and experienced low levels of charge-offs.
Business conditions remain difficult in the fourth quarter. However, our quarterly financial metrics were strong with adjusted earnings per share of $0.51, adjusted return on assets of 1.23%, and an adjusted efficiency ratio of 56.8%. An increase in interest income which includes PPP loan forgiveness fees, strong mortgage banking, and record foreign exchange income drove our solid quarterly results.
Loan origination activity rebounded to near record levels with record production in C&I and continued strong production in mortgage. Transactional deposit growth was again very strong with increases from the prior quarter of $544 million on average or 22% annualized with all our client segments seeing growth.
Our sub-60% efficiency ratio reflected our diligent expense management despite adapting to remote working environment continued investment in processes and technologies that position the company for long-term success.
Credit trends remain relatively stable. However, with COVID-19 cases in the Midwest remaining at peak levels, a slower-than-anticipated vaccine rollout, and general economic uncertainty, we recorded $11.5 million of provision expense, resulting in an increase in our allowance for credit losses to 1.89% of total loans excluding PPP.
We believe the increase in our allowance has positioned us to absorb future losses anticipated by the pandemic or otherwise. I am most pleased with the response of our associates and their commitment to our clients and communities. They demonstrated amazing flexibility and resilience in pivoting from normal business activities and processes to work remotely or with significant changes to their in-office routines.
From the beginning of the pandemic, we prioritized keeping our associates safe and engaged, which enabled them to support our clients in one of the most stressful and uncertain periods in our history.
Our associates were constant stewards, embodying our organizational belief that banking is an essential function in the lives of consumers, businesses and our communities and we're focused on ensuring that we remain faithful to our mission.
Notably our corporate-wide effort in graining approximately 7,000 PPP loans, totaling over $900 million in a matter of months was something to remember. I'm very proud of the effort and commitment of our First Financial team.
I'll now turn the call over to Jamie to discuss the details of our fourth quarter results. And then after Jamie's discussion I'll wrap up with an update on Cares Act modifications, our hotel and franchise portfolios and then provide some forward-looking commentary. Jamie?
Thank you, Archie and good morning, everyone. Slides 4 and 5 provide a summary of our fourth quarter and full year 2020 results. As Archie mentioned, we were very happy with our fourth quarter financial performance. Earnings continued their upward trajectory as loan fees led to an increase in the net interest margin and fee income remained particularly strong.
In addition, our expense base remained relatively flat and provision expense declined from the quarter levels as asset quality remained relatively benign. While our level of non-performing loans has remained stable, we recorded $11.5 million of provision expense during the quarter. We believe our current reserve levels have reached their peak and positioned us to absorb expected credit deterioration as the economic impact of the pandemic further materializes in 2021.
Once again our capital ratios improved during the quarter and remain in excess of both internal and regulatory targets. We believe that our balance sheet is well positioned and our stress testing results continue to indicate that our core fundamentals provide us with the ability to maintain these levels for the foreseeable future.
With this in mind, we will continue to evaluate any near-term capital deployment and share buyback opportunities to capitalize on the strength of our balance sheet. Net interest margin increased 13 basis points compared to the prior quarter, driven by higher loan fees and disciplined deposit cost reductions. Given the low interest rate environment, we will continue to face pressure on asset yields. However, we believe that the fundamental pieces of the core net interest margin will remain relatively stable as we head into 2021.
Similar to recent trends, fee income was the highlight of the quarter and was the principal driver of our operating results. Mortgage banking exceeded expectations despite declining from record levels in the third quarter. In addition, Bannockburn had another record quarter of foreign exchange income and deposit service charges maintain their gradual ascent to pre-pandemic levels. While not part of our operating results, it's also noteworthy that we recorded a non-operating gain related to our Class B Visa shares.
During the quarter, we sold a portion of our shares to a third-party and the remaining shares were recorded on the balance sheet at their current market value. We utilized the total gain of $13.4 million to fund the First Financial Foundation and pay off higher cost FHLB borrowings. Fourth quarter results indicate that we remain well positioned from a regulatory capital standpoint, as capital ratios improve across the board on a linked-quarter basis.
Total capital increased 18 basis points and our tangible common equity ratio increased 22 basis points in the fourth quarter to 8.47% or 8.83% excluding the impact of PPP. Additionally, our tangible book value per share grew by $0.37 to $12.93 at the end of the year.
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 $49.7 million or $0.51 per share for the quarter, which excludes the aforementioned vis-à-vis gain, $7.3 million of debt extinguishment costs, a $5.1 million write-down of a tax credit investment, a $5 million contribution to the First Financial Foundation and $2.9 million of COVID-related and other non-recurring items such as branch consolidation costs.
As depicted on Slide 7, these adjusted earnings equate to a return on average assets of 1.23% and a return on average tangible common equity of 15.9%. Our 56.8% adjusted efficiency ratio remains very strong despite elevated incentive compensation tied to our fee income.
Turning to Slide 8. Net interest margin increased 13 basis points from the linked quarter to 3.49%. This increase was primarily related to higher loan fees which were driven by PPP forgiveness. Basic net interest margin declined slightly due to the negative impact from changes in our asset mix. In the first quarter we expect some benefit to the margin as we prepaid $120 million of longer-term FHLB debt late in the fourth quarter the full impact of which will be realized in 2021.
Slide 9 shows our yields and costs and average balance changes. Loan yields increased 18 basis points and the investment yield dropped 15 basis points. A higher mix of investment securities is putting pressure on total asset yields as we increase the balance in our investment portfolio due to the liquidity on the balance sheet.
On the funding side we continue to aggressively lower our cost of deposits which declined 7 basis points during the period to 20 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.
Slide 10 illustrates our current loan mix and balance changes compared to the linked quarter. Excluding the decline in PPP loans end-of-period loan balances were flat as increases in ICRE and C&I loans were offset by modest declines in all other loan types.
Slide 11 shows the mix of our deposit base, as well as a progression of average deposits from the third quarter. In total average deposit balances grew $362 million during the fourth quarter, driven by increases in noninterest bearing accounts, public funds and transactional deposits.
We remain very pleased with the trajectory of deposit balances as average noninterest-bearing deposits grew $173 million during the quarter with additional growth expected as the most recent round of stimulus checks are dispersed to our clients. Deposit pricing remains a near-term focus and we will continue to make any necessary adjustments based on market conditions and our funding needs.
Slide 12 highlights our noninterest income for the quarter. As I mentioned previously, fourth quarter fee income remained strong and was driven by record foreign exchange and elevated mortgage banking income. We were also pleased as service charges continued to rebound and wealth management fees were in line with expectations.
Noninterest expense for the quarter as outlined on Slide 13. Overall expenses increased compared to the linked quarter. However they were relatively flat on an operating basis. The increase was driven by $7.3 million of debt extinguishment costs a $5.1 million write-down of the tax credit and a $5 million contribution to the first financial foundation. Additionally we incurred $2.9 million of COVID-19-related and another cost not expected to recur such as branch consolidation costs.
Turning your attention to Slide 14. Our fourth quarter ACL model resulted in a total allowance which includes both funded and unfunded reserves of $188 million and $11.5 million in total provision for credit losses. The model utilized the Moody's baseline economic forecast released at the end of December which was slightly improved from the forecast utilized in the third quarter.
Similar to the first three quarters of 2020, the majority of the fourth quarter's provision expense related to the expected economic impact from COVID. At this point in time, we believe we've captured the risk from future COVID-related credit stress and do not anticipate further reserve build in the near term.
As shown on Slide 15 asset quality remained stable as we have $6.6 million of net charge-offs for the period and only slight increases in nonperforming and classified asset levels. Net charge-offs were 26 basis points as a percentage of loans which remains lower than historical levels, despite the slight increase compared to the linked quarter. While our credit metrics don't reflect much stress at the current time and our portfolio performed better than we might have anticipated at the beginning of 2020, we expect some deterioration in 2021, as the economic impact from COVID continues to materialize.
Finally, as shown on slides 16 and 17, capital ratios remain strong and are in excess of regulatory minimums. Each of our capital ratios increased during the quarter and all ratios continue to exceed internal targets.
Our tangible common equity ratio grew by 22 basis points during the period and our tangible book value increased to $12.93. 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 economic impact of the COVID pandemic further materializes.
I'll now turn it back over to Archie for commentary related to specific areas of focus in the loan portfolio, our deferral program and our outlook going forward. Archie?
Thanks, Jamie. Due to the continued economic circumstances related to the COVID-19 pandemic, we've updated slides 20 through 22, which cover Cares Act modifications in our hotel and franchise portfolios. As can be seen on slide 20, I'm very pleased with the substantial reduction on our Cares Act modifications at year-end.
Only $29 million in loan balances are on full payment deferrals, with another $291 million in loan balances making interest-only payments, bringing our total loan modifications to $320 million at year-end. Additionally, the loans that have exited deferral, we've not seen any material credit issues.
Slide 21 provides detail on our hotel portfolio, which will require additional time to stabilize, mix of $186 million or 58% of our total Cares Act modifications as of December 31. The overall health of the hotel portfolio was strong pre-COVID and we've seen limited deterioration in average LTVs and updated appraisals.
Given time and additional stimulus measures, we believe this portfolio will eventually stabilize. But in the meantime, we'll continue to monitor the status of our borrowers and work with them to ensure the best possible outcome.
Our franchise portfolio, as seen on slide 22, has also improved substantially with $44 million in Cares Act modifications remaining at year-end. Drive-through and delivery concepts have demonstrated strong performance, while the face style concepts within our sit-down book continue to be impacted by pandemic-related headwinds. As the vaccine becomes more widely distributed, we expect the performance of this concept to improve.
Moving to our outlook. Slide 23 provides some forward-looking guidance, which will still be impacted by the ongoing pandemic and related government stimulus programs in 2021. Loan growth excluding PPP is expected to remain flat over the near term, as we've seen pressure in certain portfolios, but we expect improvement and continue to target mid-single-digit growth for the year.
Regarding deposit balances, we expect further increases, given our current round three PPP pipeline and potential for additional stimulus activity. Our net interest margin is expected to be positively impacted by further PPP forgiveness payoffs and the associated accelerated fee recognition over the next several quarters. Excluding our more volatile variables such as PPP fees, purchase accounting, loan fees, we expect the margin to be relatively stable.
Regarding credit, the full impact of the pandemic is yet to play out. However, we expect moderate declines in our provision expense going forward. We've added $130 million to our allowance for credit losses during 2020 to address future losses that may materialize. This brings our total ACL to greater than three times the balance at 12/31/19. We do not anticipate any further increases to the reserve as a percentage of loans moving forward.
Specific to fee income, we expect continued strong mortgage originations in the first quarter. However, we expect some seasonal decline in volume and lower premiums. Foreign exchange income remained strong, but below the peak level of our fourth quarter performance.
Deposit service charges are expected to continue to move toward the pre-pandemic trend after seasonal lows in the first quarter. With respect to expenses, we expect to be in the range of $88 million to $92 million per quarter, but this could fluctuate some with fee income.
In light of accelerated changes in customer behavior observed during the pandemic, we continue to evaluate our distribution channel for opportunities to become more efficient. In this quarter, we'll consolidate three banking centers.
Lastly, given our strong earnings and capital position we expect to resume share repurchases in the first quarter using our newly authorized share repurchase program and we look to be active in the market in the first quarter.
2020 was a challenging year for many and I'm extremely proud, how our associates came together to support the well-being of our customers in our -- in communities. I'm also very pleased with our strong financial performance this year. The overall safety and status of our company and our ability to remain focused on growing long-term shareholder value despite the challenging business conditions.
As we move forward into 2021 we remain confident in our ability to navigate this difficult operating environment and believe we've positioned the company for even stronger financial performance when health crisis subsides.
We'll now open up the call for questions.
Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question from Scott Siefers with Piper Sandler. Please go ahead.
Good morning guys. Thanks for taking the question. I was just curious you've given a lot of good color on credit expectations and you certainly have a pretty substantial reserve right now. Just as you look through the course of the year to the extent you're comfortable I was hoping you might give us a sense for where you would expect actual loss content to peak out and when that manifests itself? Is that a first half event or second half of the year? How are you thinking about those dynamics?
Yeah, Scott, so it's still going to be dependent upon what happens with the pandemic and vaccine distributions. But I would say we were talking mid part of the year into the third quarter probably is where I think we would see it peaking now. And again that's going to be somewhat dependent upon what happens with some of those bigger issues in the economy.
Bill any other comments on that?
No that's accurate Archie.
Okay. And any sense for order of magnitude of deterioration their losses are so low now. And you've got a very substantial reserve, which under CECL is presumably there to pull expected lifetime losses, or have a bucket for lifetime losses. And any sense for order of magnitude of deterioration?
Scott, I don't know that we have a sense for it yet. We saw just a little bit more in Q4. For the year losses were 14 basis points. For the quarter 26 and it was primarily related to one-buffet style concept, in which some stores -- we've learned some stores in that -- with that one bar are not going to reopen. They been closed permanently. And so we made a partial charge for that. We had limited deterioration outside of that. So it's difficult to say; right now I'd say they're still going to be on the lower side. As we get further in the year we may have a little more clarity, but it doesn't feel like a significant increase in charge-offs at this moment.
All right. Perfect. Thank you. And then just in terms of overall loan growth, which presumably will snap back in the second half. And just curious when you're talking about mid-single digit growth number is that for the full year on a next PPP basis, or are you suggesting that we -- just snap back to a mid-single-digit annualized rate in the second half of the year? In other words, I guess I'm getting to order of magnitude of that snapback presumably.
Yeah. We think it's still mid-year -- mid- single-digit growth for the full year Scott. What we've seen is commercial, C&I originations and production is strong, it was really strong in the fourth quarter record levels. And that momentum we believe is going to continue and grow stronger through the year where we saw pressure was with all the mortgage production, we saw some pressure on the mortgage portfolio, the loans we keep on balance sheet and getting refinanced down, home equity pressure got refinanced down. And then franchise, which we are probably more intentionally running down we had some additional payoffs there. So that's where we saw pressure. But C&I production is strong, and we still feel like as we come out of the pandemic there's going to be some good momentum.
Perfect. All right. Thank you very much.
Our next question comes from Jon Arfstrom with RBC Capital Markets. Please go ahead.
Thanks. Good morning, guys.
Hey, Jon.
Hey, Jon.
Archie, it's good to hear on some C&I. That's a good sign. I guess, maybe Bill, maybe Archie more a theoretical question. But in a normal stable economy, what kind of reserve levels do you think you would need to hold what would be more normal for your company? I know, it's a tough question but just what are your thoughts on that?
Yeah. Jon we – I would say, somewhere probably in that 130-ish kind of range. I think is where you think – if we weren't in the middle of a pandemic and we were kind of in just normal business conditions probably at that level.
Yeah. So Jon, this is Jamie. So if you look at where our day one CECL number came out it was about $119 million, which was $129 million of loans. So, I mean, in theory you would say we get down somewhere into that level whether it's that $125 million to $135 million range, but somewhere back to that level as things start to stabilize.
Okay. That's super helpful. And then Jamie your – one of your last comments was you expect some deterioration in credit in 2021. I think, what you're saying is charge-offs. Is that right, or…
Charge-offs, yeah. Absolutely. Yeah. We're talking about just on the backside of the pandemic expecting some lift in charge offs, which again, we've already baked that into the reserve, right? So yeah expecting that to flow through and really it's kind of back to Scott's question that he had before is just with the order of magnitude of what those charge offs are, but at this point a little more optimistic than what we would have been in the in the spring of 2020. But yeah, that's what we're talking about. We're talking about a lift in the level of charge-offs.
So, really the underlying message is not to put words in your mouth, but very little at least in the near-term until growth picks up in terms of provisioning required. Is that fair? And that the charge-offs have just come out of existing reserves?
Correct. Yeah, unless something would change from a macro level at this point we would in any given quarter, it could be lumpy as well, right? Charge-offs work. So – but in any given quarter unless things would deteriorate from this point at most we would be providing for the charge-offs and probably releasing some reserves going forward.
Yes. Okay. Okay. And then last topic is just margin. I think it's nice, I know you're fighting the good fight on this, but it's nice to see the words relative stability. Can you help us understand some of the puts and takes and maybe the magnitude of the debt prepayment benefit to NIM?
Yeah. Yeah. So, I mean, obviously we're going to see I mean with rates stabilizing, I mean we're still going to but at a lower level, we're going to see reinvestment rates on the securities portfolio putting pressure on yields. And then just overall some lagging re-pricing on the loan side putting pressure, we still have a little bit of room on the deposit side fourth quarter deposit costs were 20 basis points. We see those coming down into the low-teens in the middle of 2021. And then again, we – like we did pay off those FHLB advances, which were $120 million at a cost of about $250 million. So, that's going to save us in the ballpark of about $3 million – a little bit less than $3 million, but close to $3 million a year.
Good. Last editorial comment, but business conditions remain difficult as something you said a couple of times, Archie and it's notable to me that you put up a 16% return on tangible equity in this environment. So just say nice job guys.
Thank you.
Thanks, Jon.
Our next question comes from Chris McGratty with KBW. Please go ahead.
Hi, good morning.
Hey, Chris.
Jamie, maybe start with you on the margin. I think -- I just want to make sure I got the jumping-off point. The stability that you're talking about is relative to that basic 291 plus the factors that you identified?
Yes. Yes. So we'll get some volatility in like we do in loan fees. Obviously, with PPP that's going to bounce around. We have a little bit of volatility quarter-to-quarter in purchase accounting. But yes, we're talking about that kind of core 291 excluding all those factors.
And what are the remaining revenues coming from PPP and the accretion that you have -- that we should model in?
Yes. So at year-end, our total PPP balances are right at -- we're right at $600 million and the remaining fees related to those is just under $14 million, $13.7 million.
And on the accretion, how…
On the accretion help me out what you're asking?
No, just the -- what's left of the purchase accounting coming through?
On the purchase accounting from the last deal, is that what you're asking?
Yes exactly. Sorry about that.
Yes. Hang on, let me get that. Yes. So I mean, we still -- we had 12 basis points of purchase accounting accretion in the fourth quarter. And I mean, we should see roughly that and it's trailing off here over the next year or so.
Okay. So is the message -- if we just take a step back and understand the challenges of predictive margin in this environment, is the message that mid- single-digit loan growth and a little bit of a lower NIM should allow for general stability in core NII? Is that a right interpretation?
Yes. Excluding the PPP fees, correct. Yes.
Yes. Okay. And then just finally on the pace of capital return, how do I think about the $5 million, which I know is a two-year authorization against some cautious optimism on the economy how aggressive are you going to be with the buyback?
Yes. I mean, I think, we're going to be methodical about it and not -- we're not going to do $5 million in the first quarter by any stretch. But I think we will be in the market but kind of at a consistent level and then kind of see how the pandemic materializes here and what credit looks like and really constantly kind of taking a look at credit and seeing what it looks like. But if we said we would do in that ballpark of million shares a quarter that would be plus or minus where we would be.
Okay. Thanks for that. And then just lastly on the tax rate obviously a lot of moving parts this quarter. What's the right number we should be using going forward?
18%.
And that's a GAAP number, right?
Yes.
Perfect. Thanks all of that.
[Indiscernible]
[Operator Instructions] Your next question comes from David Long with Raymond James. Please go ahead.
Good morning, everyone.
Hi, David.
It's encouraging to hear about the C&I, growth pipeline and the numbers that you're talking about there, just curious where the growth is coming from. Is it -- have you been taking market share? Have you hired, or is this just the overall health of your client base at this point?
Yeah, David, I think it's a little of each. We are taking some share of clients from competing. That started probably more pronounced after the early round of PPP last year, where we had some nice wins that came because of some -- probably some competition maybe not meeting some of expectations of their borrowers. And we started to get some windfall there.
And so that's a little bit of it. We have added bankers. And kind of a larger middle market space, throughout the latter part of 2020. And they're now starting to produce some nice new relationships for us across our footprint. So I'd say it's those two primary drivers. And overall, I mean, our client base is pretty strong that we're seeing that obviously with liquidity that our clients have. And that's sitting in our bank as well as just general – again, low delinquencies, just general better credit performance than we were thinking a few months ago.
Got it. And then just if you could, comment on the spreads that you're seeing in the C&I business it still seems to be pretty competitive. In the past cycles coming out you've seen some widening of the spreads, but I haven't been hearing that this cycle. Just curious, what you're seeing on commercial spreads at this point?
Yeah. I don't think they've improved, at this point. So I'd say they're kind of similar if anything, maybe slightly tighter than they were even a couple of months ago. So it's pretty competitive out there.
Got it. Great. Thanks for taking my questions.
Okay.
This concludes our question-and-answer session. I would like to turn the conference back over to Archie Brown, for any closing remarks.
Thank you very much, Sara. And thank's all of you for joining today. And looking more about our quarter, we look forward to talking to you a little later in the year. Have a great day. Bye now.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.