First Commonwealth Financial Corporation
Q3 2013 Earnings Call Transcript

Published: 23 Oct 2013

[Operator:]

Good day, ladies and gentlemen, and thank you for standing by, and welcome to the First Commonwealth Financial Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we’ll conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, today’s conference is being recorded. It’s now my pleasure to turn the floor over to Rich Stimel. Sir, the floor is yours.

[Rich 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. We’ve also included a slide presentation on our Investor Relations page with supplemental financial information that will be referenced 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, our 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.

[Thomas Michael Price:]

Hey, Thanks, Rich, and good afternoon, everyone, and thank you for joining us on today’s call. The third quarter was a solid quarter in terms of our performance with earnings per share of $0.16. Our results were driven by lower provision expense, $1 million recovery from OREO property that sold this quarter, early repayment of TruP securities and ongoing traction with expenses. Encouragingly and despite some one-time events, the third quarter illuminates the path to better overall financial performance as ROA for the quarter percolated to over 1% and efficiency for the quarter dropped to 61.5%. There is still a lot of work to be done, but our efforts are moving us in the right direction, and let me just pull from three of our five key strategic themes that I’ve shared with you in the past. Number one, clearly putting credit behind us and ensuring it becomes a source of strategic advantage; number two, becoming markedly more efficient as part of our operating excellence initiative; and three, delivering authentic community bank experience for our clients and leveraging our brands to create top line revenue growth. I’ll address each of these themes briefly. Our first best-in-class performance begins with lower long-term credit costs. In the past, we’ve asked Bob Emmerich, our Chief Credit Officer to lead a discussion around what we’re seeing on the credit front, but as our numbers and metrics have normalized, I believe this time we’ll better spend focusing on strategic growth opportunities and addressing your questions. As a result, Bob won’t be providing a detailed credit update, but he is here to speak to any credit related questions you may have. That said, I would like to take a moment to address our credit trends, given their relevance to improve performance going forward. Key credit metric such as delinquencies, non-performing loans, OREO properties, commitments of $15 million or greater, our watch loans, criticized loans, and classified loans are either at or near five-year lows. NPLs as a percentage of total loans have fallen from 1.73% in the second quarter of this year to 1.68% in the third quarter. And that’s down from a high of 3.2% in December of 2009. The story is much the same for criticized and classified assets as well. Our criticized assets have fallen from $224 million at the end of the second quarter of this year to $181 million at the end of the third quarter, again, that’s down from a high of $585 million in December of 2009. We believe that these trends pretend well for future quarters, and we’re pleased with positive impact our credit performance had on our earnings results in the most recent quarter. Quite simply, there is no substitute or disciplined credit infrastructure, because really there is no combination of operating initiatives that has the power to overcome lack luster credit performance. The second theme is just at the time of our last call we were in the vendor selection stage of the comprehensive IT conversion. That conversion process is now underway with the selection of Jack Henry & Associates as the technology partner who will be working with us to convert our core processing platform and outsource various data processing services. We expect the conversion to be completed by the end of the third quarter of 2014. At the heart of this transformative project is the migration of our company to a culture of operating excellence both in terms of how we deliver solutions to our clients and in terms of maximizing organizational efficiency. After upfront charges of roughly $12 million, this conversion will be a catalyst to ring out some $6 million to $8 million in annualized savings. We’re also doing a lot on the day-to-day front in our operating environment and with our expense base under an initiative started in early 2012, called 50s by 2015. We’ve solicited several hundred comments from employees and have been benchmarking our expense base by department to identify opportunity and to put action plans in place, it is making a difference. And the third and last theme I’ll speak to is just – the convergence of, we feel is a strong brand, positive customer satisfaction and good household growth. It needs to produce stronger revenue growth. And one of the challenges we faced has been margin compression, which totaled 27 basis points since June of 2012. This compression has sapped some $11 million in top line net interest income year-over-year and its outrun loan growth. Although loans have now grown seven of the last eight quarters, the growth has been tampered 2% over the last year. Besides soft demand creating further a year-to-date headwind for us has been several decisions to let larger marketable credits bill because of concerns about credit structure. These are credits that were on our books and we’re not on our watch or criticized list, we just felt the structure was getting beyond the balance of a thoughtful good risk return exchange. More robust commercial real estate lending has helped to offset some of these challenges, but certainly not all. We anticipate our corporate lending initiatives in Cleveland along with our Marcellus related opportunities, we’ll have a positive impact in 2014. In September, we announced the hiring of a mortgage banking executive. This followed on the heels of our June announcement that Jane Grebenc was joining the company as President of First Commonwealth Bank and also as Chief Revenue Officer. Jane’s experience with mortgage runs deep, and she will help us launch this crucial line of business for us. We anticipate the introduction of a mortgage offering in the second half of 2014, which will augment the traction we’re already seeing in non-interest income arising from interchange revenue and pretty good household growth over the last few years. Overall, we feel good about our third quarter performance and how it positions us for the future, but still a lot of work to be done. With that, I’d like to turn it over to Bob Rout for a financial review.

[Robert E. Rout:]

Thank you, Mike, and thank you all as well for joining us today. As Mike mentioned, we had a good quarter with $0.15 earnings per share as compared to $0.09 in the third quarter of last year. Contributing to this quarter’s performance, there is a couple of unusual, but positive issues. The first thing, $1 million recovery on our Western Pennsylvania commercial real estate owned property that we’ve had on the books now for several years. The other issues was $1 million recovery on a trust preferred pools have paid down substantially during the quarter. These two issues in combination with lower credit related costs and our stock buyback program were the primary drivers that have improved earnings per share performance this quarter. Our net interest margin benefited from the TruP impairment recovery by accelerating $1 million of above normal impairment recreation that added approximately 8 basis points to our net interest margin for the quarter, stripping out that effect, our net interest margin was stable compared to the linked quarter. Loan growth was modest this quarter, which is slightly over $10 million as compared to the linked quarter. Certainly, our credit cleanup activities will have an effect on that number, but we’re also being very disciplined on new line structure as competitive pressures continue to build within an asset start of the industry. Provision expense was $2.7 million for the quarter. We like the trends we are seeing with the non-performing net charge-offs, criticized, and classified asset metrics. The deep cause of these measures that are presented in the conference call that was provided through this call. In addition as Mike mentioned, we do have Bob Emmerich, our Chief Credit Officer available with us today to address any specific questions. Non-interest income was $17.1 million for the quarter. In that number, there is $1 million recovery for the OREO property that was sold. That property was the third processing plant in Northern Pennsylvania, there has been a problem for a long time, and we’re happy to see it finally get resolved. Also affecting non-interest income this quarter is a $229,000 gain representing the sale of one of our last holdings in bank equities. They were no significant unusual issues in the $40 million of non-interest expense this quarter along as to get a look at more normalized run rate levels. Reducing our full-time equivalent levels by another 35 acquisitions on a year-over-year comparison, and through adjusting some of our incentive plans, has been helpful to overall staff expense. As Mike mentioned in his opening remarks, we have signed a contract to transition our outdated and cumbersome in-house IT system in the second or third quarter of next year. We expect to take approximately $12 million of charges to that conversion from the fourth quarter of 2013, up until the conversion date. These costs primarily represent severance for displaced employees, retention incentives for key personnel needed for the conversion, early termination of IT and maintenance contracts, and the accelerated deprecation of IT hardware and software values that are still remaining on the books. We will begin recognizing the accelerated depreciation for data processing hardware and software in the fourth quarter of 2013 through the anticipated conversion date. The early termination charges on existing contracts as well as staffing and employment charges will be recognized in the quarter in which they occur. We expect to start benefiting from the $6 million to $8 million projected annual non-interest expense improvement truly after the conversion date. Last item that I want to share with you is the – we usually get a question on our effective tax rate and that was currently 26% at the end of the third quarter. So with that overview, we would be happy to address any questions.

[Operator:]

Thank you, sir. (Operator Instructions) And it looks like our first question will come from the line of Bob Ramsey with FBR. Please go ahead. Your line is now open.

[Thomas Michael Price:]

Hey Bob.

[Robert H. Ramsey:]

Good afternoon. I guess I wanted first to ask a question about the systems conversion. I mean obviously it sounds like a lot of opportunity there. How quickly do those annualized cost savings get implemented after the conversion? And is it possible if you guys are running out an expense rate today, a little bit north of $40 million did by 4Q, 2014 or 1Q, 2015 that number could be more or like $38.5 million or is there other sort of organic expense growth between here and there to keep in mind.

[Thomas Michael Price:]

Bob that’s what we are shooting for, really to ring it out at the conclusion of the project and in the ensuing quarters immediately thereafter the conversion.

[Robert H. Ramsey:]

Okay, great.

[Thomas Michael Price:]

The full impact will be in – obviously in 2015.

[Robert H. Ramsey:]

Great. And then, I also wanted to talk a little bit about your net interest margin. I get the securities benefit that you guys had in the quarter, but you striped that out in your margin still was very stable this quarter, which is a positive development. I’m curious if you think you can sort of stay in the same sort of range on a go forward basis and maybe what it was and sort of help support the margin here this quarter.

[Thomas Michael Price:]

I think just a couple of things and then I’ll turn it over to Bob, it’s just I think we have done a good job with our cost with interest bearing liabilities and we continue to kind of ring out there. That created a little bit of a cushion. Our real challenge has been our GAAP on our loans and our duration there that – Bob other thought.

[Robert E. Rout:]

Hi Bob, it’s Bob Rout. Now, we are pleased with the stabilized quarter-to-quarter margin adjusted for that non-recurring issue with the trust preferred portfolio. As Mike said, we continue to squeeze down costs in our fundings. The growth in DDA balances has been very helpful as well. With the rise in intermediate term interest rates over the last quarter or so, we’re starting to see the re-investment rates on our investment portfolios stabilized, and the real challenge is only on with loan prices. Most of our portfolio is a variable rate portfolio, commercial loans, and we feel that short-term rates start going up. And until we see some rise and yields on new loans, I think we are going to have some continued pressure in 2014 on that net interest margin.

[Robert H. Ramsey:]

Okay. Looking at loan yields, they were only down a basis point this quarter, which is a much slower pace of sort of decline that we’ve seen in recent quarters. Is that just sort of the way the quarters look out or are you guys seeing less pressure in maybe some of the higher yielding stuff has sort of already moved off the books, I’m just kind of curious how that stayed as strong as it did.

[Robert E. Rout:]

I think there is still pressure there. I think our volume was a little light in terms of new loans booked in the third quarter. And we also see that as something we were as part of the composition of the net interest margin that we can improve and we’re lagging some of our peers. We’ll tell you about the loans.

[Robert H. Ramsey:]

Great, thank you guys. I’ll hop back out of the queue.

[Operator:]

Thank you, sir. Our next questionnaire in queue will come from the line of Collyn Gilbert with KBW. Please go ahead. Your line is open.

[Collyn B. Gilbert:]

Thanks. Good afternoon, guys.

[Thomas Michael Price:]

Hey Collyn.

[Collyn B. Gilbert:]

Just a follow-up on some of the big yield discussion. So I think to Bob’s point or even to your own point Mike that, your loan yield is lower than some of your peers, but maybe it seems if that’s a function or the fact that more of your portfolio is priced off of LIBOR and prime, or maybe the direct question is how much of your loan book is priced off of that been of the very, very short end of the curve?

[Thomas Michael Price:]

I think I shared that before, it’s over $1 billion.

[Collyn B. Gilbert:]

Okay, okay. And the loan origination yield is of the kind of what you saw in this quarter. Do you have a number for that?

[Thomas Michael Price:]

I do and I think I’ve shared that number with you in the past and with a great report. And I can start right in front of you, but somebody is going to hand it to me more momentarily.

[Collyn B. Gilbert:]

Okay.

[Thomas Michael Price:]

Yes, I’ll go ahead and I’ll take your next question.

[Collyn B. Gilbert:]

Okay. Okay, and just thinking about the credit recovery, I mean, it was meaningful certainly obviously this quarter, where do you think you stand now in terms of your outlook, in terms of maybe your reserve target. Are you thinking that now you’ve gotten the balance sheet to the point where net charge-off could continue to run at this sub 50 basis point level or just how should we sort of think about kind of credit trends from here?

[Thomas Michael Price:]

I would just pick up on your last point, I mean, we certainly feel like it could run at the sub 50-basis point level and I think that’s a good place to start. And to your question on loan yields that is, I’d love to look at the most recent quarter and month versus kind of a rolling 12-month average and see where the pressure is. And this new volume rates are well actually it’s still down a little bit versus the 12-month average, 12-month average for us blended consumer and commercials about 343, and we’ve been slightly below that over the last three months. So it’s just still a little downward pressure.

[Collyn B. Gilbert:]

Okay. Okay and then just on the reserve, do you guys have a reserve to loans target in mind?

[Thomas Michael Price:]

We do not.

[Collyn B. Gilbert:]

Okay. Okay, that was it. Thanks, guys.

[Thomas Michael Price:]

Thank you.

[Operator:]

(Operator Instructions) Our next questionnaire in queue will come from the line of Matthew Breese with Sterne Agee. Please go ahead. Your line is open.

[Matthew Breese:]

Good afternoon, guys.

[Thomas Michael Price:]

Hey Matt.

[Matthew Breese:]

Just on the fee income front specifically service charges and deposits, there is a sharp uptick this quarter and I just wanted to get some color around that and what’s going on there?

[Thomas Michael Price:]

Yeah, I think it’s really the combination of – we’ve just put on a lot of households over the course of the last few years. And I think you’re also seeing the same phenomenon in the interchange income. Now with interchange income, I do think we are seeing the average swipe with our debit card has improved a little bit as well.

[Matthew Breese:]

Okay. So there is nothing seasonal about what we saw this quarter or one-time it’s really you feel like that’s a good run rate from here.

[Thomas Michael Price:]

Yes, I don’t think so.

[Matthew Breese:]

Okay. And then as it relates to the conversion costs, how will that $12 million be spread out. Is it going to be front-loaded in fourth quarter and then kind of trickle through the next two or three quarters or is it going to be evenly spread out?

[Thomas Michael Price:]

I think Bob has done a lot of work and he can handle that.

[Robert E. Rout:]

Hi, Matt. This is Bob Rout. I think you would see over the quarterly charges that the biggest one coming in the fourth quarter that’s when we’ll start recognizing severance and maybe start recognizing some of the early combination charges on some of our maintenance contracts. Now deprecation will be equal in the subsequent quarters, but the other costs I had think to see the bulk of those happened here in the fourth quarter.

[Matthew Breese:]

Okay. And then to be clear on overall expenses, so looking out once the conversion is done, we are in the 2015 or so, the annual rate will be around 160, if that’s the bogey, I’m trying to understand you guys want to in fact beat that bogey correct?

[Robert E. Rout:]

Yes.

[Matthew Breese:]

Okay. That’s all I had. Thank you, guys.

[Robert E. Rout:]

Thank you.

[Operator:]

Thank you, sir. (Operator Instructions) Presenters, there appears to be no additional questionnaires in the phone queue. I’d like to turn the program back over to Mr. Mike Price for any additional or closing remarks.

[Thomas Michael Price:]

Just a few, thank you, operator. Just I think, I’m out and about, and with a number of you over the course of the next quarter, I really look forward to that and we just appreciate your interest in our company. Thank you very much.

[Operator:]

Thank you presenters, and thank you ladies and gentlemen. Again, this does conclude today’s call. Thank you for your participation and have a wonderful day. You may now all disconnect.