First Commonwealth Financial Corporation
Q1 2013 Earnings Call Transcript

Published: 25 Apr 2013

[Operator:]

Good afternoon. And welcome to the First Commonwealth Financial Corporation First Quarter 2013 Earnings Conference Call and Webcast. All participants will be in listen-only mode. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Mr. Richard Stimel, VP, Corporate Communications. Please go ahead, sir.

[Richard Stimel:]

Thank you. As a reminder, a copy of today’s earnings release can be accessed by logging on to fcbanking.com and selecting the Investor Relations link at the top of the page and then selecting News on the left side of the page under News and Market Data. We’ve also included slide presentation on our Investor Relations page with supplemental financial information that we’ll reference throughout today’s call. With me in the room today are Mike Price, President and CEO of First Commonwealth Financial Corporation; Bob Rout, Executive Vice President and Chief Financial Officer; and Bob Emmerich, Executive Vice President and Chief Credit Officer. After brief comments from management, we’ll open the call to your questions. Before we begin, I would like to caution listeners that this conference call will contain forward-looking statements about First Commonwealth, its business, strategies and prospects. Please refer to our forward-looking statements disclaimer on page two of the slide presentation for a description of risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. And now I’d like to turn the call over to Mike Price.

[Mike Price:]

Hey. Thanks, Rich, and good afternoon, everyone. And thanks for joining us on the call today. As rich mentioned with me are Bob Rout, our CFO; and Bob Emmerich, our Chief Credit Officer. Following our earnings release yesterday we hosted annual shareholders meeting where had the opportunity to dissect our performance last year. I think the first quarter of this year was a continuation of that progress. We had $10.6 million of net income for the quarter, which translates to $0.11 per share. This includes $4.8 million in provision expense $3.1 million of that came from non-performing loan relationship that we sold. Our non-performing loans fell significantly during the quarter from $108 to $78 million. Total loans grew roughly $14 million. However, that growth occurred in the face of $30 million in NPL reductions. We also remained disciplined in our underwriting and let some credits go that had too much leverage or risk. So while our loan activity and new volumes are good, loan growth is not out running net interest margin compression. Our NIM has fallen some 30 basis points in the last year and stands at 3.45% for the first quarter, Bob will give you some color around NIM but after accounting for the interest we collected on the troubled loan payoff in the first quarter of 2012 were basically down 21 basis points year-over-year. Core deposit growth the new checking account activity continues to be a positive story, our calling efforts corporate cash management and WorkSmart program that’s the program where I’m pleased of the businesses -- of our business clients received discounted services, they're all helping us drive this growth. We’ve generated some traction in non-interest expense as well with the cadre of expense initiatives and heightened scrutiny across the organization are beginning to bear fruit. We are grinding it out there but these are incremental changes the potential for transformative change comes from the evolution of our IT infrastructure, this is a critical path to improved efficiency and operational processes. Our company is getting better every quarter. We deliver the goods in terms of an aesthetic community bank experience and we continue to improve our sales and service culture with customer satisfaction now at an all time high. We were just inform last Thursday that we jumped 29 points in four places in the J.D. Power Mid-Atlantic bank rankings and across so metrics just crossed a key threshold and a goal that were set several years ago. We have good momentum but obviously the macro environment present some challenges. Overcoming these challenges comes down to, first, lowering our long-term credit cost, two, winning in the marketplace through organic growth, three, better efficiency driven by improved technology, processes and distribution, and four, adding more legs to the revenue store. I’m confident we’re on the right path and these efforts will drive our financial performance. With that, I’ll turn it over to Bob Rout with more color on the financial particulars. Bob?

[Bob Rout:]

Thank you, Mike, and good afternoon, everyone. As Mike mentioned we had $0.11 earnings per share for the first quarter of 2013 with a mixed bag of performance metrics. We will discuss the net interest income first. On a year-over-year basis we saw a 6% or $2.9 million decline in our net interest income and 30 basis point decline in our net interest margin. As with several areas of discussion here today. Some of our year-over-year comparisons are affected by an usual transactions that occurred last year. And one of those issues included a $1 million recovery on the delinquent loan relationship that paid off in the first quarter of 2012 that affected our NIM and also net interest income first quarter 2012 comparison. But even adjusting for the effects of collecting on a large past due interest payment, there's no doubt that our net interest income is being squeezed by this unusually low interest rate environment. We have partially mitigated that squeeze with solid year-over-year average loan growth of $107 million, some additions to the investment portfolio and also by continually to work funding mix within our asset liability management parameters. We expect that margin squeeze to continue but we are not prepared to give specifics on forecasted levels. Bob Emmerich will be providing more color on asset quality, but $29.3 million reduction in non-performing loans on a linked quarter basis through sales, payoffs, the improvement in customer financials and also through some charge-offs is meaningful. Those actions did, however, result in slightly higher provision expense to $4.5 million this quarter as compared to $3.8 million in the first quarter 2012. The unusual items in non-interest income last year include a $1.7 million gain on a held for sale loan and $1 million of rental income on an OREO property that has since been sold. Other than that there were no significant changes other than a small improvement in the credit risk reserve for our commercial loan swaps. You heard us speak in past calls about the reduction in non-interest expense and improved efficiency being a strategic focus of the organization. This quarter's $5.3 million or 11% reduction is primarily the result of improved credit quality and reducing our levels of problem loans. Troubled commercial loans as you know are very complex and by their nature take a long time and a lot of expense to resolve, so pulling our level -- troubled loans down to the levels that we haven't heard today can be very beneficial to a number of other income and expense line items as we minimize some of those collection activities. Beyond that we are seeing good control many of the other non-interest expense line items, but also clearly we understand that more opportunity is available. As that credit heals and as earnings return, we continue to actively manage our capital to appropriate levels, those management strategies included the authorization for repurchasing $75 million of our common stock, through Tuesday we have achieved $46.5 million of those authorizations. On April 1, 2013, we redeem $32.5 million or 9.5% fixed rate trust preferred securities. This redemption does have $1.6 million of early termination fees, as well as the acceleration of some amortized cost that is going to affect our second quarter 2013 results, but we expect that we will recover those costs over next two quarters through improvements in our net interest margin. And our final capital management action was a 20% increase in the quarterly dividend to $0.06 share that was announced yesterday. Currently, our effective tax rate is 26.5% for those of you that are so interested. And with that, I will turn over the discussion to Bob Emmerich our Chief Credit Officer for more in-depth discussion on credit quality changes this quarter.

[Bob Emmerich:]

Thank you, Bob. In the first quarter, First Commonwealth’s non-performing loans were down $29 million to $78.3 million or 1.86% of total loans. The bank benefited from a low level of inflow of NPLs as less than $4 million of loans were newly classified as non-accrual or TDR during the quarter. The bank also reach resolution on four larger problem accounts. Those credits were as follows. The bank sold a $15,537,000 note secured by an apartment project in Eastern Pennsylvania. The bank also sold $1,671,000 note secured by related mixed-use property in Eastern Pennsylvania, both of these notes were sold at combined loss of $1.3 million, which was provided for during the quarter. The bank sold its share of a note for land development project in Nevada that was one of the Marshall Bank participations. The Bank's book balance on the note was $2,514 million and the Bank realized a gain on sale of $126,000. The bank restored to accrual status a $3,841,000 participation in a loan to a hotel resort in Washington state, this loan was also Marshall Bank participation originated in 2007, it was placed on non-accrual at year end due to disputes between the bank group and the borrower on terms and extension for the original loan. The parties did reach agreement during the quarter, the loan was brought current and First Commonwealth received a $754,000 parcel paydown as part of the extension agreement. In addition to the resolutions covered above the bank wrote-off in the first quarter the specific reserves for two loans that were provided for in the fourth quarter. The bank took a charge of $2.8 million on a loan to Western Pennsylvania non-profit healthcare facility as the borrower shut its doors and filed for bankruptcy. The bank took a $2.5 million charge on the loan to a Pittsburgh student housing project, the guarantors were uncooperative and supporting the loan and the bank has commenced foreclosure. There were no significant OREO sales in the first quarter nor any significant write-downs. Consequently, our total non-performing assets were down a similar $29 million to $90 million or 2.13% of loans plus OREO. Provision expense for the quarter was $4,497 million compared to charge-offs of $9,422 million as the two larger charge-offs mentioned above were previously provided for. The [AAA] allowance stood at $62,262,000, or 1.48% of net loan at March 31st compared to $67,187,000 or 1.6% at year end. Reserves on impaired loans were $13.375 million or 17.1% of impaired balances. The remaining general reserves were $48.887 million or 1.18% of the remaining loan portfolio. That concludes my remarks on credit and I will now turn back to Mike Price.

[Mike Price:]

Hey. Thanks, Bob. And with that, we really would like to open the lines to questions that you may have.

[Operator:]

Thank you. (Operator Instructions) Our first question is Bob Ramsey, FBR. Please go ahead, sir.

[Bob Ramsey:]

Hey. Good afternoon, guys.

[Mike Price:]

Hey, Bob.

[Bob Ramsey:]

I was just -- I guess looking for little bit more color around the margin. I don’t think I quite caught it. I know you said that it was affected by collection of fees or interest on a large past the loan book. Could you just go over that again for me?

[Bob Rout:]

Bob, hi. It’s Bob Rout. If you are looking over year-over-year basis, in the first quarter 2012, one of our troubled loans that we had on non-accrual actually found financing elsewhere and we were made hold on that delinquent interest and it was a $1 million. And that added about 8 to 9 basis points to that net interest margin in the first quarter 2012. If you adjust for that, think on a year-over-year basis. You will see us down net about 20 or 21 basis points. Now on a linked quarter, on this quarter-to-quarter comparisons, you will see fluctuations mostly related to loan fees as old loans pay off to have deferred fees. You will accelerate those and in some of our corporate syndications, you also have some amendment type fees that don't get (inaudible). The other thing that you want to think about with our margin is that we deliberately put more into our investment portfolios over the last couple of quarters until the loan demand ramps up. And as you know, these are pretty skinny spreads that we are put on if you are getting 100 and 125 basis points. Even with taken on some interest-rate risk, you're doing pretty well. The other thing is affecting our margin is in both the fourth quarter and also in the first quarter this year. We extended out some of our wholesale funding times, not a lot. We just took it out overnight and may be stretched that as the year, year and a half just to keep our asset liability management position where we wanted it to be. But the real key in this margin is getting the loan growth going. With that said, we are seeing some softness in both the pricing and also the credit structure, as banks everywhere are just scrambling trying to put on earning assets. And that's basically other than to say that we do expect that margin to continue to be pressured just because of the interest rate environment.

[Bob Ramsey:]

Okay. No, it’s helpful. It is. You mentioned the competitive pressures on pricing and structure and we’ve heard that from a number of banks out there. I’m just curious, what your view is on what the source of pressure? Is it big banks? Is it tiny banks? Is it any sort of distinguishing characteristics of who is being tremendously aggressive on the pricing and structure front?

[Mike Price:]

Hi. This is Mike. I think it’s all of above. I think just a couple examples. In this year, this quarter we let three credits go, one downtown, a large office building. We had seven years on the loan and our primary tenet was looking to build some Class A office space and they only had five years left on the lease. We let that loan go. It was a large one, about $25 million that got absorbed in the marketplace pretty quickly. We had to deals that were larger loans that were -- I would call leverage recaps with private equity. They drove the leverage up to an area that we didn’t feel comfortable with and we let those. One loan, I think we cutter exposure pretty substantially, good company though. The other one we let it go and again, all three of those credits were absorbed by the market. And those were credits that moved off our balance sheet. So when you look at our loan growth of $14 million for the first quarter, that’s net of the headwind of the downward pressure with the NPLs, and then also literally owns $45 million to $50 million of credits that we let go. So that -- and those were more big banks. Honestly, those three credits that we are seeing it all over.

[Bob Ramsey:]

All right. That’s discouraging but I think you guys are not the only ones reporting that pressure out there. I’m curios to -- I mean, it certainly sounds like the pricing pressures industrywide have stepped up from where they were a quarter ago. I think last quarter you guys had said that it would be reasonable to expect, maybe 5 to 7 bips of margin compression a quarter. As you look at the world today, does it seem that the pressures are greater than one you last gave that guidance?

[Bob Rout:]

No. I think it’s longer that this industry period goes on, the more pressure banks are going to feel. It just doesn't seem to be any ending sight to it at this point. When you looked at our maturities of deposits coming off, there might be a little room but it’s not like they are coming off 100 or 200 basis points. I mean, they are coming off at maybe 50 basis points. So you are not getting that same benefit. And the big curtains in the investment portfolios. As we have some of our investments maturing at 144 basis points and we will put them one at 1.10.That is probably where most of the pressure is happening in the intermediate-term investment portfolios. So as we build our portfolio, waiting for some of the loan demand to have, that’s going to have a downward effect on our net interest margin. But it’s still incremental revenue to the bottom line.

[Mike Price:]

Bob, this is Mike once again. Just, we grew loans in the first quarter, that's for the last five quarters. We grew middle-market lending last quarter. Our consumer lending, open on the indirect in the home equity side, we feel good about. We’ve got to nick the last two quarters with some paydowns that I just described three of them that we control. So, I think the value proposition for community bank can be such that albeit modest, we can still grow loans. We control our own destiny. Our credit cultures has got lot better. We can lower our credit cost. We can get more efficient and we can add more legs to the revenues stores. So there is still opportunities for banks like ourselves. And interestingly, the credit that Bob Rout started with, the $1 million heeling a year ago, that was a Marcellus play. That's what made that hole and may that particular landfill viable again and absorbable in the market. So there is some -- but there's some pluses too. It’s not all headwinds.

[Bob Ramsey:]

Okay. And then last question and I'll hop back out and get back in line. But you mentioned the pressure from the securities, although it’s positive spread I guess at the end of the day. How are you thinking about what the right size of the securities book should be it and is the intent to sort of continue to grow with, at the margin and what are you buying to put in the securities portfolio today?

[Bob Rout:]

No. We don't plan to expand that investment portfolio unless we come into to a large amount of liquidity through the influx of deposits or reduction in our loan balances. We don’t see us doing any type of leveraging on that. An answer to your second question, where we are putting on agencies and mortgage-backed securities and maybe a little bit of CMOs.

[Bob Ramsey:]

And what’s the yield on what you are purchasing right now.

[Bob Rout:]

Well, probably on the high-end, a 15-year mortgage back would be 150. You probably have the agency stuff below 1%.

[Bob Ramsey:]

All right. Thank you very much for the color guys.

[Bob Rout:]

Thank you, Bob.

[Operator:]

The next question is from Mac Hodgson, SunTrust Robinson Humphrey. Please go ahead.

[Mac Hodgson:]

Hi. Good afternoon.

[Bob Rout:]

Hey, Matt.

[Mac Hodgson:]

Just a couple of questions. One on the buyback. I think you gave an update 40 -- maybe it was $46 million, maybe $46.5 million purchased today.

[Bob Rout:]

Yeah.

[Mac Hodgson:]

I think it was -- if my math was right, I had about $40 million at the end of the quarter. Just kind of double checking how much, how many shares you bought back in the first quarter. You just want to give common outlook on -- it seem like you guys slow down a decent amount in 1Q. Just trying to get an outlook on repurchases going forward.

[Mike Price:]

We had a pretty productive blackout period. We are working under our 10b5-1 plan and we were picking up just recently, $0.5 million maybe 70,000 to 80,000 shares. I will get you the exact numbers. We will continue to buy -- if we are not going to be the one pushing the price upwards. We've done very well buying on dips be in patient and that has worked out extremely well for us. But just someone just hand me here a couple of the numbers and looks like we brought back approximately 6 million shares.

[Mac Hodgson:]

6 million shares under what timeframe?

[Mike Price:]

About today.

[Mac Hodgson:]

6 million shares today. Okay. I think that just seems -- I had a maybe $325,000, $350,000 in the first quarter. Does that sound right?

[Mike Price:]

We obviously scale down through these numbers.

[Mac Hodgson:]

And I can ask another question while you look. One question, I had, Mike, you mentioned, evolution of the IT infrastructure. Just wanted to see if you could elaborate a bit on that and maybe quantify the degree of cost savings you could achieve. So that’s completed.

[Mike Price:]

Yeah. Through -- we really started on evaluation last year and third party. We went through an RFP process with less than three technology providers. We’ll hopefully drive that to conclusion here in the second quarter. And we expect not only savings from that but quite frankly a better technology platform, a better integration and then probably the third punch to that is really enables key evolution in our operations environment at all levels throughout the company and to build a better background.

[Mac Hodgson:]

And what’s implementation timeline, how long does it take to put something new in place?

[Mike Price:]

It’s probably at least 12 months.

[Mac Hodgson:]

I have one other ones on the trust preferred reduction. I was curious, I think last quarter, while you’ve indicated maybe 1 or 2 basis points of margin benefit this year. And I think that assumes you’re going to -- may be finance the repayment. I was just kind of curious how you ended up funding the redemption at their early part of this month. And if your accretion expectations on them are different?

[Bob Rout:]

No. I think that accretion that you have when the margin is well within range. I think it’s more two to three basis points.

[Mac Hodgson:]

Okay. That’s really all I had.

[Bob Rout:]

Thank you.

[Operator:]

Our next question is Collyn Gilbert, KBW. Please go ahead.

[Collyn Gilbert:]

Great. Thanks. Good afternoon guys.

[Mike Price:]

Hey Collyn.

[Collyn Gilbert:]

Mike, you might have just covered this, I just had a pop off for a second but just surrounding the IT infrastructure that you intend to build or sort of refine. Did you guys quantify what you think the cost savings could be related to some of these initiatives or where you think the run rate on expenses could go?

[Mike Price:]

We have it. I think we’ve alluded to this year perhaps getting to a run rate of about what 40, 41. I think it’s about extending the guidance we’ve given at this point.

[Collyn Gilbert:]

Okay. Okay. That was all I had. Thanks.

[Mike Price:]

Thank you.

[Operator:]

Our next question is from Matthew Breese, Sterne Agee. Please go ahead.

[Matthew Breese:]

Good afternoon guys.

[Mike Price:]

Hey, good afternoon.

[Matthew Breese:]

Hey. On the salaries and benefits line this quarter was up quite a bit. I know it’s partially due to seasonal items. What should we be backing out of that for next quarter that was first quarter only kind of?

[Mike Price:]

Yeah. There were some seasonal items and there were some elevated benefits expenses including hospitalization. And I’ll let Bob speak specifically to those.

[Bob Rout:]

Yeah. We had probably $800,000 of payroll taxes which is a seasonal effect. We also had some unusual claims within our self-funded medical plan, what we term as sharp claims and that accounted for about $200,000. You can’t predict that they are going to normalize next quarter but we’re hopeful that that’s what’s going to happen. Displaying salaries on a quarter-to-quarter basis, they were actually down slightly $2000.

[Matthew Breese:]

Okay. So the actual core number this quarter was really $40.5 million and in line with guidance?

[Bob Rout:]

I’d have to look at the -- you're talking about the total non-interest expense.

[Matthew Breese:]

Right.

[Bob Rout:]

I’d have to look at the actual what you’re backing out.

[Matthew Breese:]

Okay.

[Bob Rout:]

But I think Mike’s number running normalized $41 million a quarter probably be a safe conservative number.

[Matthew Breese:]

Okay. Could you give us some color on what the loan pipeline looks like this quarter compared to year-end? And what are the yields you are seeing on your commercial stuff?

[Mike Price:]

This is Mike. And looking at the 12-month average year, the last three or four months have come in slightly under that average and spread to index yield is about 330. And in the pipeline, we feel like the pipeline has picked up just the last three to four months.

[Matthew Breese:]

Any geographies that are stronger than others?

[Mike Price:]

Well, unlike the past, we’re only in our local geography, which is about 200, well radius 250 miles. But we really have had a lot of success in Pittsburgh. And that market has been very good to us, on the consumer side in small business and also middle market. Our commercial real estate, the geography there has been a little larger. And again there obviously we’ve regrouped the last four or five years. And we’re doing a few deals at Ohio but there really, the anchors and the centers and the things you would know and they really kind of plumb projects.

[Matthew Breese:]

And my last question really related to the provision, it feels like you guys have really hit the inflection point on credit. And the provision was to elevate this quarter, it sounds like due to a single item. How should we be thinking about provision going forward? Are we in a reserve building period or notably?

[Mike Price:]

I think if you take our last-type quarters of provision, it just did a straight line average. It’s $5.1 million and I think that -- we're still cautious with credit. We’ve been kind of through a store. And there has been a lot in the second half of last year that provision expense really belied what was the credit cost related to it, which included other OREO and ripple effect. So we’re planning to close the industrial credit and we want to be fully and clearly out of the woods that we feel like we’re on a way. Our NPLs, our NPAs are criticized or watched are really at four to five year lows with what’s happened here in the last quarter. There may be another hick up or two but we feel good about the general direction. Bob Emmerich, anything else you would share on this one?

[Bob Emmerich:]

No. I think you covered well, Mike.

[Matthew Breese:]

I appreciate the color guys. Thank you.

[Operator:]

(Operator Instructions) Our next question is John Moran, Macquarie Capital. Please go ahead.

[John Moran:]

Hey, good afternoon guys.

[Mike Price:]

Good afternoon.

[John Moran:]

One, kind of ticky-tack question on OpEx, the other was kind of down a bunch, anything ran more in line with what we had seen in last year, second and third quarter. But just wanted to kind of see if there was anything going on in that line and where good run rate is there?

[Bob Rout:]

This is Bob Rout. And both are linked and also a year-over-year quarter. The other line expenses is also associated with OREO cost or OREO valuation charge downs.

[John Moran:]

Okay. So this quarter 6.5 is probably a better place to think about that in terms of kind of building out forward look?

[Bob Rout:]

Yeah. That’s a much closer number than $9 million or $10 million that you saw than in any other quarters.

[John Moran:]

Okay. Got you. Most of the rest of mine in terms of detailed question has been asked and answered but maybe a big picture strategic one for Mike. Mike, you alluded too earlier. I think I can’t remember it was in the Q&A or your prepared remarks, sort of, adding a couple of other legs to the stool here. Maybe you could elaborate on what that could mean and what you think you’re missing?

[Mike Price:]

I think the big one we missed through the cycle is mortgage. However, mortgages of business that you have to be very thoughtful in terms of how you enter it. There is certainly lots of compliance-related impact there. And you just have to be careful that as you book in your mortgage, you are not losing more money than you’re making and you just don’t know it. So I think but I think but I think done well and de novo or via an acquisition, that’s something they can add at least several cents per share. And also a brand is really well perceived here in western P.A. I mean, any objective measure we look at couple of third party, JD Power, people like doing business with, quite frankly, they ask us for mortgage and so for us doing two to three mortgages per branch that are 100 grand per, that’s a pretty nice business. And we just want to get in the right way. We’ve had a couple of opportunities to enter that business and it’s just been a little two price off the highs of the mortgage business over the last couple of years but we’ll have an opportunity there, I’m sure then we really build good core corporate banking and retail businesses and whether it’s adjuncts to that. I think there will be some nice opportunities. We have season people at the executive vice president level have run lines of business of larger companies that are pretty familiar with a broader product offering to both commercial customers and consumer. So those are the things that we’re looking at. I think we also have a good opportunity to build our wealth business. I think it’s been pretty flat. And I think we can do a better job of cross selling, the capability there with some pretty good professionals that we build. We’ve only had our wealth team in place in Pittsburgh which were not for a year. So that’s not very long. And our brand really resonates with centers of influence in Pittsburg. And I don’t think it’s a stretch to cross sell that and move our wealth revenue up as well. So I think there’s lots of opportunity.

[John Moran:]

Got you. Thanks very much for taking my question.

[Bob Rout:]

Thank you.

[Mike Price:]

Thank you.

[Operator:]

Having no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Mike Price for any closing remarks.

[Mike Price:]

We genuinely appreciate your interest in our company. And we invite your calls and look to be helpful in any way we can. Thank you very much.

[Operator:]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.