First Financial Bancorp. (NASDAQ:FFBC) Q2 2023 Earnings Call Transcript July 21, 2023
Operator: Good morning. My name is Rob and I will be your conference Operator today. At this time, I would like to welcome everyone to the First Financial Bancorp second quarter 2023 earnings conference call and webcast. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again press star, one. Thank you. Scott Crawley, Corporate Controller, you may begin your conference.
Scott Crawley: Thank you Rob. Good morning everyone and thank you for joining us on today’s conference call to discuss First Financial Bancorp’s second quarter and year-to-date 2023 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 2023 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 June 30, 2023 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.
Archie Brown: Thank you Scott. Good morning everyone and thank you for joining us on our call. Yesterday afternoon, we announced our financial results for the second quarter. I’ll provide some high level thoughts on our recent performance and then turn the call over to Jamie to provide further details. I continue to be pleased with our performance this year. Earnings in the second quarter were once again very strong as an expected increase in deposit costs was mostly offset by higher asset yields. Adjusted earnings per share was $0.72, which was a 29% increase compared to the same quarter in 2022, while the adjusted return on assets and tangible common equity were 1.62% and 26.46% respectively. Net interest margin exceeded expectations during the period as our asset-sensitive balance sheet has enabled the company to successfully navigate the higher interest rate environment.
We were encouraged by the stabilization of deposit balances in the last half of the quarter. Personal, business and public fund deposits were stable to increasing from May to June while the mix continued to shift to interest-bearing products. Our fee income largely exceeded our expectations this quarter with strong performance from mortgage banking, client swaps, and wealth management. Summit funding group had another nice quarter in originations, although the mix has shifted to a higher level of financed leases and loans. This shift has bolstered our net interest income but resulted in less fee income during the period. Loan growth was in line with expectations for the quarter. While loan activity slowed early in the quarter and we experienced higher commercial line paydowns, loan pipelines have strengthened in recent weeks and we expect moderate loan growth in the second half of the year.
We were pleased that asset quality remained strong during the quarter. Net charge-offs were 22 basis points on an annualized basis after having zeroed last quarter and a net recovery in the fourth quarter of 2022, while classified assets declined 13% from the linked quarter. With that, I’ll now turn the call over to Jamie to discuss these results in greater detail, and after Jamie’s discussion, I’ll wrap up with some additional forward-looking commentary. Jamie?
Jamie Anderson: Thank you Archie. Good morning everyone. Slides 4, 5 and 6 provide a summary of our second quarter financial results. Our performance was excellent, driven by solid earnings, strong net interest margin, high fee income, and stable asset quality. Our asset-sensitive balance sheet continued to react positively to the current interest rate environment with our net interest margin declining only 7 basis points during the period. We continue to anticipate modest net interest margin contraction in the near term due to fewer rate hikes and additional pressure on deposit pricing. Total loans grew 4.5% on an annualized basis, which was in line with our expectations. Loan growth was concentrated in the leasing and residential mortgage books with relatively stable balances in the other portfolios.
Fee income remained strong in the second quarter with wealth management posting another record quarter. Additionally, Bannockburn had a solid quarter and mortgage rebounded compared to previous quarters. Summit had another strong origination quarter, although as Archie mentioned, the production mix shifted to a higher level of finance leases and loans. This shift was additive to our net interest income but resulted in less fee income during the period. Non-interest expenses increased slightly from the linked quarter due to higher employee and marketing costs. Second quarter expenses were slightly better than we anticipated due to lower leasing business expenses and fraud costs. Asset quality was stable during the quarter. Classified assets declined $20 million or 13% during the period.
Net charge-offs in the second quarter were 22 basis points as a percent of total loans on an annualized basis compared to zero in the first quarter, resulting in year-to-date net charge-offs of 11 basis points. We recorded $10.7 million of provision expense during the period which was driven by slower prepayment rates, net charge-offs and loan growth. As a result, our ACL coverage ratio increased by 5 basis points to 1.41%. From a capital standpoint, regulatory ratios remain in excess of both internal and regulatory targets. Accumulated other comprehensive income declined $25 million during the period; as a result, tangible book value increased $0.26 or 2.4%, while our tangible common equity ratio improved by 9 basis points. Slide 7 reconciles our GAAP earnings to adjusted earnings, highlighting items that we believe are important to understanding our quarterly performance.
Adjusted net income was $68.7 million or $0.72 per share for the quarter. Adjusted earnings exclude the impact of a $1 million tax credit investment write-down, $1.7 million of costs associated with our online banking conversion, and $1 million of other costs not expected to recur. As depicted on Slide 8, these adjusted earnings equate to a return on average assets of 1.62%, a return on average tangible common equity of 26.5%, and an efficiency ratio of 54.9%. Turning to Slide 9, net interest margin declined 7 basis points from the linked quarter to 4.48. As we expected, higher funding costs outpaced increases in asset yields primarily due to a 40 basis point increase in the cost of deposits. That being said, we were pleased that asset yields increased 33 basis points due to higher rates and a more profitable mix of earning asset balances during the period.
On Slide 10, asset yields increased during the second quarter as loan yields grew by 40 basis points. Investment yields increased 7 basis points due to the re-pricing of floating rate investments and slower prepayments on mortgage-backed securities. Our cost of deposits increased 40 basis points compared to the first quarter, and we expect these costs to increase further in reaction to sustained competitive pressures in coming quarters. Slide 11 details the betas utilized in our net interest [indiscernible] increased with greater velocity in the second quarter, moving our current beta up 6 percentage points to 27%, with our through-the-cycle beta estimated at approximately 40%. Slide 12 outlines our various sources of liquidity and borrowing capacity.
We continue to believe we have the flexibility required to manage the balance sheet through the expected economic environment. Slide 13 illustrates our current loan mix and balances changes compared to the linked quarter. As I mentioned before, loan balances increased 4.5% on an annualized basis, with growth driven by Summit and mortgage loans. The other loan portfolios were relatively unchanged when compared to the prior quarter. Slide 14 provides details of our loan concentration by industry. We believe our loan portfolio remains sufficiently diversified to provide protection from deterioration in a particular industry. Slide 15 provides details of our office space loans. As you can see, less than 5% of our total loan book is concentrated in office space and the overall LTV of the portfolio is strong.
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While our portfolio is not immune to general economic stress on office space, we continue to believe that leaning into borrowers with Class A and B assets in primarily suburban markets within our footprint mitigates much of our risk. Slide 16 shows our deposit mix as well as the progression of average deposits from the linked quarter. In total, average deposit balances declined $98 million during the quarter, driven primarily by a $287 million decline in non-interest bearing accounts and a $102 million decline in savings accounts. This was expected as higher interest rates have driven customers to more expensive products, like CDs and money market accounts. Additionally, brokered CDs increased $214 million during the period, partially offsetting the decline in transaction accounts.
Slide 17 depicts trends in our average personal, business and public fund deposits, as well as a comparison of our borrowing capacity for uninsured deposits. While personal deposit and public fund balances were relatively stable in the quarter, business deposits continued to decline. As we discussed last quarter, this decline is primarily related to a post-COVID decline from record high balances. On the bottom right of the slide, you can see our adjusted uninsured deposits were $2.5 billion at June 30. This equates to 20% of our total deposits. We are comfortable with this concentration and believe our borrowing capacity provides sufficient flexibility to respond to any event that would stress our larger deposit balances. Finally with respect to deposits, Slide 18 depicts average deposits by month.
As you can see, deposit levels experienced a decline in the first part of the year but normalized thereafter. April was negatively impacted by two large business customers who initiated large transactions that resulted in lower deposit balances. Deposit balances were stable in the last two months of the quarter. Slide 19 highlights our non-interest income for the quarter. Wealth management had another record quarter while Bannockburn continued to post strong results. In addition, mortgage income rebounded during the period. Summit had another very strong quarter; however, leasing income declined during the period due to a shift in product mix to finance leases. While the fee portion of the business was lower than the first quarter, the contribution from Summit to the net interest margin exceeded first quarter amounts.
Non-interest expense for the quarter is outlined on Slide 10. Core expenses were lower than we initially expected; however, they were a slight increase compared to the first quarter. This increase was driven by elevated employee costs and higher marketing costs. These increases were partially offset by lower fraud and leasing business expenses. Turning now to Slide 21, our ACL model resulted in a total allowance which includes both funded and unfunded reserves of $161 million and $10.7 million of total provision expense during the period. This resulted in an ACL that was 1.41% of total loans, which was a 5 basis point increase from the first quarter. Provision expense was driven by slower prepayment speeds, net charge-offs and loan growth. Overall, asset quality remained relatively stable.
Net charge-offs increased from zero in the first quarter to $5.7 million or 22 basis points of total loans on an annualized basis. While this amount is higher than the previous two quarters, we believe 11 basis points of net charge-offs year-to-date is a reasonable amount. Classified assets decreased 13% to $139 million; however, non-accrual loans increased during the period due to the downgrade of two relationships. We continue to expect our ACL coverage to increase slightly in the coming periods as our model responds to changes in the macroeconomic environment. Finally as shown on Slides 23, 24 and 25, regulatory capital ratios remain in excess of regulatory minimums and internal targets. During the second quarter, tangible book value increased $0.26 or 2.4% and the TCE ratio increased 9 basis points due to our strong earnings.
Accumulated other comprehensive income declined $25 million during the second quarter and continues to impact our TCE ratio. Absent the impact from AOCI, the TCE ratio would have been 8.76% at June 30 compared to 6%, as reported. Slide 25 demonstrates that our capital ratios will remain in excess of regulatory targets, including the unrealized losses in the securities portfolio. Our total shareholder return remains robust with 33% of our earnings returned to our shareholders during the period through the common dividend. We believe our dividend provides an attractive return to our shareholders and do not anticipate any near term changes; 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 going forward.
Archie?
Archie Brown: Thanks Jamie. Before we end our prepared remarks, I want to comment on our forward-looking guidance, which can be found on Slide 26. As I mentioned earlier, loan pipelines strengthened in recent weeks and we expect Summit to remain a significant contributor to growth the rest of the year. We continue to be more selective in certain segments where we expect overall growth to stay in the mid single digits in the near term. Regarding securities, we will continue to utilize the portfolio cash flows to support loan growth. We expect deposit balances to grow modestly in the near term as our pricing strategies continue to gain traction. There is still some uncertainty around fed rate management, loan demand and deposit pricing competition.
Our asset-sensitive balance sheet has helped us offset much of deposit pressures thus far in the cycle. We continue to expect modest contraction in the third quarter with our net interest margin in a range between 4.25% to 4.35%, based on an additional anticipated July interest rate increase. Specific to credit, we’re still in a period of uncertainty regarding inflation and the impact of higher rates to the economy and our customers. Over the third quarter, we expect continued stability in our credit quality trends and ACL coverage to be slightly higher. We expect fee income to be stable in total in the third quarter and in a range between $53 million and $55 million, including the leasing business. Specific to expenses, we expect to be between $117 million and $119 million, which includes depreciation expense from the lease portfolio.
Excluding leasing expense, we expect expenses to be stable in the third quarter. Lastly, our capital ratios remain strong and we expect to maintain our dividend at the current level. We are certainly pleased with our second quarter results with the position of our balance sheet, our strong net interest margin, consistent loan growth, robust fee income and stable asset quality expected to sustain our performance in the back half of the year. Additionally, our earnings power, strong and increasing capital levels, and high reserve levels provide additional support in the event of a downturn in the economy. With that, we’ll now open up the call for questions. Rob?
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