First Financial Bankshares - Q2 2023

Transcript

Operator (participant)

Good morning. My name is Rob, and I'll be your conference operator today. At this time, I would like to welcome everyone to the First Financial Bancorp Q2 2023 earnings conference call and webcast. All lines have been placed on mute to prevent any background noise. After the speaker's 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 the star one. Thank you. Scott Crawley, Corporate Controller, you may begin your conference.

Scott Crawley (Executive VP and CFO)

Thank you, Rob. Good morning, everyone, and thank you for joining us today on today's conference call to discuss First Financial Bancorp's Q2 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 Q2 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 13th june 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 (President and Chief Banking Officer)

Thank you, Scott. Good morning, everyone, and thank you for joining us on our call. Yesterday afternoon, we announced our financial results for the Q2. 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 Q2 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 finance 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.

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 H1 of the year. We are pleased that asset quality remained strong during the quarter. Net charge-offs were 22 basis points on an annualized basis after having 0 last quarter and a net recovery in the Q4 of 2022, while classified assets declined 13% from the linked quarter. 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?

Thank you, Archie. Good morning, everyone. Slides four, five, and six provide a summary of our Q2 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 expectation. 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 Q2, 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. Q2 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 Q2 were 22 basis points as a % of total loans on an annualized basis compared to 0 in the Q1, resulting in year-to-date net charge-offs of 11 basis points.

We recorded $10.7 million of provision expense during the period, which were driven by slower prepayment rates, net charge-offs, and loan growth. As a result, our ACL coverage ratio increased by five basis points to 1.41%. From a capital standpoint, our 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 nine 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 Q2 as loan yields grew by 40 basis points. Investment yields increased 7 basis points due to the repricing of floating rate investments and slower prepayments on mortgage-backed securities. Our cost of deposits increased 40 basis points compared to the Q1. We expect these costs to increase further in reaction to sustained competitive pressures in the coming quarters. Slide 11 details the betas utilized in our net interest income increase with greater velocity in the Q2, 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 balance 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 detail on 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 detail on 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.

While our portfolio is not immune to general economic stress on office space, we continue to believe that lending to 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 to our 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 2 large business customers who initiated large transactions that resulted in lower deposit balances. Deposit balances were stable in the last 2 months of the quarter. Slide 19 highlights our net 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 Q1, the contribution from Summit to the net interest margin exceeded Q1 amounts. Non-interest expense for the quarter is outlined on slide 20.

Core expenses were lower than we initially expected. They were a slight increase compared to the Q1. 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 Q1. 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 0 in the Q1 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, nonaccrual 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 Q2, 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 Q2 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 6.56% 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?

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 pipeline 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, but 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's still some uncertainty around Fed rate management, loan demand, and deposit pricing competition. Our asset-sensitive balance sheet has helped us offset much of the deposit pressures thus far in the cycle.

We continue to expect modest contraction in the Q3, with our net interest margin in a range between 4.25%-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 Q3, 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 Q3 and in a range between $53 million-$55 million, including the leasing business. Specific to expenses, we expect to be between $117 million-$119 million, which includes the depreciation expense from the lease portfolio.

Excluding the leasing expense, we expect expenses to be stable in the Q3. Lastly, our capital ratios remain strong, and we expect to maintain our dividend at the current level. We're extremely pleased with our Q2 results. The position of our balance sheet, our strong net interest margin, consistent loan growth, robust fee income, and stable asset quality are 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?

Operator (participant)

At this time, I would like to remind everyone in order to ask a question, press star, then 1 on your telephone keypad. Your first question comes from the line of Daniel Tamayo from Raymond James. Your line is open.

Daniel Tamayo (Director, Banking)

Good morning, guys. Thanks for taking my question.

Good day, Danny.

Maybe, maybe just starting first on the margin guidance, if you could just let me know what the assumptions baked in there for non-interest bearing, you know, degradation or declines going forward are? Then just, well, let's start with that.

Dan, it's Jamie. What we're looking at here is we obviously saw the mix shift in the from the Q1 to the Q2, like many are saying. We expect generally that same type of mix shift to continue on in the Q3. Essentially the same level of deposit cost increase and maybe slightly more than what we saw in the Q2. You know, we had a 40 basis point increase from 1 to 140 linked quarter here in the Q2, we expect that to continue around that same level and with that same general level of mix shift that we saw in the Q2 to continue on in the Q3.

Maybe again, on the, on the cost side, just with the pressure that we're seeing, you know, maybe even a little bit more of an increase on the deposit costs than we saw in the Q2. We're just seeing those ramp up pretty significantly. Again, that's baked into our forecast of the margin range that we gave in the outlook there.

Okay, great. Thanks, Jamie. Maybe help me think about post rate hikes. Obviously, you guys have really seen asset yields come through nicely as rates have risen. You know, once we get into that post rate hike time frame, you know, potentially in the Q4, you know, how do you think the overall margin reacts at that point? I mean, you expecting more or budgeting for more deposit increases, and do the asset side stay relatively flat at that point?

Yeah, I mean, as we get towards the end of the year, I think we'll still see some deposit increases in deposit costs coming through. I mean, if you look out maybe even a little bit farther and assume then that the Fed, let's say the Fed pauses for a little while, you know, we think our margin stabilizes, somewhere around 3.90%-4% in the middle of next year. That assumes, again, that assumes that the Fed, you know, increases here in July, you know, but pauses, you know, at a minimum there in the first part of 2024.

Mid-next year, looking at a margin kind of, stabilizing before any rate cuts, if those do come, somewhere in that 3.90%-4% range.

Okay. Terrific. Yeah, I'll go ahead and step back. I appreciate all that color, Jamie.

Right. Thanks, Danny.

Operator (participant)

Your next question comes from a line of Brendan Nosal from Piper Sandler. Your line is open.

Brendan Nosal (Director, Equity Research)

Hey, good morning, guys. Hope you're doing well.

Yep. Thanks, Brendan.

Maybe, on the leasing piece, can you walk through the mix dynamics within leases this quarter between operating and financing and any kind of how that progresses from here, and how that kind of factors into the C and expense guide?

Yeah. This is Jamie again, Brendan, welcome to the call, by the way. In the Q2, we did see a pretty significant change. First of all, it can bounce around a little bit from quarter to quarter. It's not necessarily always the same consistent mix quarter to quarter. In the Q2, we did see a pretty dramatic shift of production, and it was virtually all finance leases and all of the leases, virtually all of the leases, 90%-95% of the leases were held in the portfolio, as opposed to, we'll have some quarters well, where we'll sell some leases out into the secondary market and produce some fee income.

The combination of those two things, a high finance lease production quarter, a high quarter where we're holding most of the leases, you're gonna see that the leasing income contract a little bit. Going forward, we typically see finance leases in that, you know, 60%-70% range. We are holding the vast majority of the leases going forward. You may not see that the leasing income line growing as much as we were seeing in the when we first had the had the division.

When we look at it, you know, we had about $10.3 million in leasing business income down in the fee income section, and we see that growing by about a million and a half each quarter here for the next couple of quarters, and that's probably as much of a lens that we have into it at the moment. Typically what we see is the ratio on the fee income side, so the expense side is about 1.5 to 1. We see the expense side growing by about $1 million. We had right about around $7 million in leasing business expense. We see that part growing by about $1 million each quarter for the next couple quarters.

Terry McEvoy (Managing Director, Research Analyst)

All right. Fantastic. That's super helpful commentary, Jamie. Thank you. Maybe one more from me. Can you guys offer a little more color on what your OB increase in NPA this quarter, as well as the charge-offs you experienced? I guess, kind of were they both driven by the same two credits you noted in the release? If so, how do you feel your reserve for this point?

Archie Brown (President and Chief Banking Officer)

This is Bill Harrod. Good morning. The increase in the non-performing assets was, as we talked about earlier, was really driven by 2 borrowers, one on the C&I space, one on the CRE space, which, you know, when looking at them, you know, we don't consider them systematic across our portfolio, very unique circumstances. We're obviously working through resolutions on both. The C&I credit was really related to management issues, and the CRE credit is a small office that's been having challenges with their lease rollover. We have, you know, the charge-offs were driven mainly by the write-down of our CRE loan in the nonaccrual to bring it down to appraised values. We are, you know, properly reserved on the other.

Terry McEvoy (Managing Director, Research Analyst)

All right. Excellent. Thank you for taking my questions.

Operator (participant)

Again, if you would like to ask a question, press star, then the 1 on your telephone keypad. Your next question comes from the line of Christopher McGratty from KBW. Your line is open.

Nicholas Mutafekis (Analyst)

Hi, this is Nick Mutafekis on for Christopher McGratty. Good morning, guys.

Archie Brown (President and Chief Banking Officer)

Hey, Nick.

Nicholas Mutafekis (Analyst)

Maybe just on deposits, if you bifurcate, you know, commercial and retail at least on the non-interest side, you know, in the mix as a whole, maybe you can make a comment on how those two segments have bifurcated and kind of the dynamics between commercial and retail. Are you seeing, you know, commercial you've already seen the outflows in commercial, and then maybe there's a catch-up in retail? Maybe you can make a comment on that.

Archie Brown (President and Chief Banking Officer)

Yeah, Nick, this is Archie. I think we show on the 1 slide, I think it's 18. You can look at the at the balance trends there by month, and you'll see pretty much the stabilization that's occurred during the quarter, really for each of our segments, so personal, public funds, and business. I mean, at this point, as Jamie said, we're going to continue to see some mix shift going forward, but we feel like we're at the place now where deposits are going to grow, and we're kind of in more, I guess, more normal operating cycles with businesses. They still have some liquidity. Even the past quarter, leave some of that to pay some lines down.

We'll probably see a little bit of pressure on the business NIB balances, like we've seen. You know, generally, they're going to grow overall and maybe a little more tick up in the interest-bearing side. Jamie's got another comment.

Yeah, Nick, this is Jamie. The other thing on the personal side, as we've seen the last few months, we're seeing the average balance per account come down. We are growing the number of accounts, net new accounts, and it's helping to offset that. We are seeing pressure just on the, you know, each individual account, the average $ that are sitting in those accounts coming down, which is what we expected, just given the large increase in the, you know, throughout 20 and 2021 during COVID, and the large increase in deposits. We're offsetting a good portion of that with the fact that we are that we're adding accounts.

Nicholas Mutafekis (Analyst)

Great. Maybe, I don't know if it's in the slide deck, if I missed it, too, but just the as far as the CD growth, maybe the duration of the CD portfolio.

Yep

... between retail and brokered?

Yeah. Yeah, all of that is relatively short. I mean, we're putting on, you know, our specials would typically run either in, like, the 7 months or 11 months, but it's all less than, you know, 12 to 15 months. Brokered would typically be in that 6-to-12-month range.

Okay. Thanks, guys.

Archie Brown (President and Chief Banking Officer)

Yep. Thanks, Nick.

Operator (participant)

Your next question comes from the line of Terry McEvoy from Stephens. Your line is open.

Terry McEvoy (Managing Director, Research Analyst)

Thank you. Good morning.

Archie Brown (President and Chief Banking Officer)

Hi, Terry.

Terry McEvoy (Managing Director, Research Analyst)

Hi. Maybe let's start with a question or two on the loan portfolio. Could you just talk about what you're seeing and hearing from your customers in commercial and small business banking, maybe pipelines and what are their kind of concerns, given some of the macro headlines out there?

Archie Brown (President and Chief Banking Officer)

Yeah, Terry, this is Archie. You know, we saw, especially at the beginning of the quarter, some softness, and I think it had a lot to do with, you know, some of the turmoil that had occurred at the latter part of the Q1 in the industry. Pipelines certainly softened, activity slowed. Somewhere around mid-quarter, it just shifted, and we're seeing much stronger and better activity at this point. Now, I say that I'm talking about primarily on the commercial banking side, probably middle market side in particular. With respect to commercial real estate, it's sort of mixed. I mean, there's opportunities, but certainly the industry and we are being more selective or a little more defensive in the areas we're targeting.

We are seeing, you know, relative to quality in that space, we're seeing a lot better structures, more equity into projects and things like that when we do them. C&I side, much better demand in the back half of the quarter. CRE side, there is demand, but we're just much more selective, so it's a little, I'd say it's just a little slower activity because of that.

Appreciate that. Thank you. Getting back to the discussion on Summit and some of the moving parts, what are the economics different at all to the bank, whether it's run through fee income or net interest income? I'm just thinking about the capital that goes with the holding it in the loan portfolio.

Yeah. Terry, this is Jamie. It's relatively, you know, marginal on either side from an economic standpoint. If you think about the capital side of it from a risk-weighted asset standpoint, whether it's sitting in that... I think they're both 100% risk-weighted, whether they're sitting in other assets or whether they're sitting in the loan book. From a capital allocation standpoint, they're both at 100%. The economics, I mean, it's the timing of it moves a little bit, but the economics are virtually the same.

Great. Maybe one last one. Is the company considering selling any loans going forward in order to either, like, reduce concentration in the portfolio or de-risk a certain asset class?

Yeah. Terry, that is part of our normal operating rhythms to periodically go out and test the market, getting pricing discovery on various pools. You know, we take a look at that to get a lens in what's happened in the market. You know, we're under no obligation to execute, we will take a look, and if this case makes sense, we'll do it.

Great. Thanks for taking my questions. Have a nice weekend.

Thanks, Terry.

Thanks, Terry.

Operator (participant)

There are no further questions at this time. Mr. Archie Brown, I'll turn the call back over to you for some final closing remarks.

Archie Brown (President and Chief Banking Officer)

Yeah, Rob, thank you. Thank you. I want to thank everybody for joining the call this morning. We're glad that you were on with us to hear more about our quarter and our story. We look forward to talking to you again next quarter. Have a nice day.

Operator (participant)

This concludes today's conference call. Thank you for your participation. You may now disconnect.