Jul 30, 2008
Executives
Claude Davis – President and CEO Frank Hall – EVP & CFO
Analysts
Scott Siefers – Sandler O'Neill & Partners Joe Steven [ph] – Steven Capital
Operator
Hello, and welcome to the second quarter 2008 earnings conference call. (Operator instructions) Now, I would like to turn the conference over to Claude E.
Davis, President and CEO. Mr.
Davis, the floor is yours sir.
Claude Davis
Thank you, Mike. Before we provide some additional commentary on the second quarter of 2008, Frank Hall, our CFO, will read the forward-looking statement.
Frank?
Frank Hall
Thank you, Claude. As we begin, I would like to remind everyone that our discussion today may involve certain forward-looking statements, which are not statements of historical fact.
The second quarter earnings press release should be read in conjunction with the consolidated financial statements, notes, and tables attached and in the First Financial Bancorp Annual Report on Form 10-K for the year ended December 31, 2007. Management's analysis contains forward-looking statements that are provided to assist in the understanding of anticipated future financial performance.
However, such performance involves risks and uncertainties that may cause actual results to differ materially. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to, management's ability to effectively execute its business plan; the risk that the strength of the U.S.
economy in general and the strength of the local economies in which First Financial conducts operations may be different than expected; the effects of and changes in policies and laws of regulatory agencies, inflation, and interest rates. For further discussion of certain factors that may cause such forward-looking statements to differ materially from actual results, refer to the 2007 Form 10-K and other public documents filed with the SEC.
These documents are available on the Investor Relations section of our Web site, bankatfirst.com, and on the SEC's Web site at sec.gov. Additional information will also be provided in our quarterly report on Form 10-Q for the quarter ended June 30, 2008, which will be filed with the SEC by August 10.
Claude?
Claude Davis
Thanks, Frank. Once again, we discuss the company’s in the context of a quarter where the banking sector experienced continued pressure from the declining housing market and economic conditions in general.
We believe our second quarter performance reflects our efforts in remaining focused on credit quality, balance sheet management, liquidity, and capital. These are areas in which we have had success in building quality and strength in the past and we are determined to remain diligent and continuing our efforts in the future.
The Federal Reserve has now reduced to fed funds rate 325 basis points since September 2007, and we continue to manage through those actions. While every day seems to present a new challenge or a level of market volatility, we are committed to strategies and processes that we believe effectively manage our risk and position the company well for an economic recovery.
Our second quarter 2008 return on average equity of 11.26%, while below our long-term expectations, does compare favorably to our peers in the industry and include a number of positive aspects which we will discuss today. We continue to generate solid commercial loan growth on both the year-over-year and linked-quarter basis, and our credit quality metrics remained strong and within our forecasted level.
We remain significantly well capitalized from regulatory standpoint and believe we are opportunistically positioned. Our liquidity position is strong and our core deposit levels place us in the 95th percentile of peer banks.
We have not experienced any unusual deposit activity as a result of recent headlines surrounding insured depository institutions. Greater efficiency and expense control remain key goals for all of us at First Financial, and they are contributing to the company’s performance.
Nonperforming assets remained stable, delinquency trends consistent with expectations, and asset quality coverage ratio is strong. While we remained cautious regarding current and future economic conditions for both commercial and consumer borrowers, continue to benefit from the decision to shift from consumer to commercial-based lending, reducing our exposure to the residential mortgage and indirect auto loan sectors.
Total net charge-offs for the quarter were at the top end of our expected range, primarily the result of higher home equity losses because of two loans totalling $500,000. The allowance for loan and lease losses at June 30, 2008 was 2.8 times the second quarter annualized net charge-offs consistent with the 2.9 times the level of net charge-offs in the first quarter of 2008.
Net charge-offs on home equity loans were lower than the first quarter of 2008, but still higher than our historical experience. Over the past eight quarters, home equity net charge-offs have been less than 50 basis points of home equity loans excluding the first and second quarter 2008 volatility.
While similar volatility could occur, based on our current knowledge, we believe that the last of the larger problem home equity loans have been dealt with and the portfolio quality will return to more historical levels. We have maintained stable levels of both nonperforming and classified assets for the past six quarters.
Total classified assets also include loans that are still performing, but may have characteristics that warrant a heightened level of attention. There are no particular concentrations in our total classified assets.
The ratio of nonperforming loans to total loans was 57 basis points at the end of the second quarter, down slightly from 58 basis points at the end of the first quarter 2008. Strong credit processes and procedures as well as being aggressive in the workout of problem credits remain key tools in our staying ahead of credit quality issues.
First Financial does not have a significant concentration of commercial loans to home developers with an existing portfolio of approximately $50 million. We limit our exposure from both the development and the spec home activities in any particular project by having strong internal policies requiring an extensive underwriting process including providing multiple sources of repayment.
However, a protracted economic recession could cost some of our clients to experience difficulties. As I stated last quarter, these are challenging and uncertain times but we believe that by continuing our strong emphasis on credit costs, maintaining a strong capital base, and continuing to grow earning assets in a profitable manner, we will continue to produce solid financial results and return to our targeted performance levels.
Frank will now review the highlights of the other areas of the second quarter.
Frank Hall
Thank you, Claude. There are a number of specifics I would like to highlight in our second quarter results of $0.21 per share.
But first though, I want to highlight an item that we consider to be nonrecurring in nature specifically the approximate $0.02 per share effect of a reversal of retiree medical liability. Excluding this item, our second quarter earnings per share is approximately $0.19.
The net interest margin for the second quarter of 3.72% on a nontax-equivalent basis decreased from the first quarter 2008 by 6 basis points. Approximately 3 basis points of the decline is due to the increase in our earning assets through securities purchases and the remainder is due to the lingering effects of the Fed rate cut effect on our asset sensitive balance sheet.
We continue to estimate our full year net interest margin to be between 3.67% and 3.75% on a nontax-equivalent basis. There will be a more pronounced third quarter decrease in our net interest margin as our liabilities continue to re-price slower than our assets.
The third quarter is expected to be our low point for net interest margin for the year. For the fourth quarter and subsequent periods, the effects of liability repricing will be more pronounced resulting in a positive effect on our net interest margin.
Despite the near-term margin pressure, we expect to have stable and increasing net interest income throughout the remainder of the year. Our investment portfolio grew in the second quarter through the purchase of approximately $120 million of securities, primarily agency mortgage backed security pass-throughs and hybrid ARMs with a weighted average yield of 5.06%.
Loan growth continues in the commercial and commercial real estate sectors. This is a consistent point of emphasis as we shift our asset mix from a consumer heavyweight into one of commercial.
We have experienced over 14.6% growth in average commercial, commercial real estate, and construction loans over the same quarter in 2007. We have also disclosed this quarter some additional information on our small and granular portfolio of shared national credits.
This is a relatively immaterial portfolio in total but an industry hot button, and we are increasing our transparency on this portfolio to address any potential concerns. We view these loans no differently than any other loan participation or commercial credit in that they are subjected to our conservative underwriting guidelines with some additional restrictions on both individual loan size and aggregate portfolio size.
There are approximately 40 individual issues averaging approximately $925,000 each for a total portfolio of $37 million. These have been acquired over the past 18 months with no individual issue greater than $2 million and no expectation for the portfolio to grow past $50 million.
First Financial's allowance for loan and lease loss was $29.6 million at the end of the second quarter, compared to $29.7 million for the first quarter. While the percentage allowance to loan decreased by 3 basis points on a linked-quarter basis.
Our overall coverage ratio remained strong at two times our nonaccrual loans. The allowance for loan and lease losses to period end loans ratio was based on our estimate of potential losses inherent in the loan portfolio in today's economic environment.
Total deposits on both the linked-quarter and year-over-year basis have declined primarily due to runoff in time deposits driven by our pricing decisions and a decline in public fund deposits. We continue to see market pricing for deposits that is outside our range of target profitability.
Rates paid by our competition in certain markets have had an effect on our retention rates, but we have held our expected margin on the deposit portfolio with disciplined pricing. Our strong liquidity position and our available wholesale funding capacity has provided us the luxury of making prudent deposit pricing decisions.
We continue to see positive results from our sales efforts, and on a linked-quarter basis, noninterest-bearing deposit balances both period end and average experienced strong growth in the quarter. Noninterest income on a linked-quarter excluding the effect of the first quarter $1.6 million gain on the redemption of Visa common shares increased primarily due to higher service charges on deposit accounts and higher bank card income, offset slightly by a charge associated with the market value change in our Freddie Mac perpetual preferred stock and lower mortgage loan sale gains.
Our fees in the wealth management area held flat with the first quarter. Our overall outlook for noninterest income remains unchanged with modest growth on a full-year basis.
Noninterest expense for the linked-quarter excluding the effects of the retiree medical benefits liability reduction were up slightly. Our overall staffing and salary levels remained disciplined with some opportunity for improvement.
Expense control remains one of our areas of emphasis and we maintain our outlook of flat expenses for the year. Our capital remained strong relative to minimum regulatory requirements.
We have chosen, however, to manage our capital using more conservative internal targets. These targets are tangible equity to tangible assets of 6.75% to 7.25%, leverage ratio of between 8% and 8.5%, and a total risk-based capital of between 11.5% and 12%.
We are within all but one of these ranges and are evaluating various balance sheet strategies to improve regulatory capital ratios to stay within all of these targets. The management will evaluate multiple solutions, some of which may involve select asset sales or securitizations to improve the risk weighting of the underlying asset.
We will announce specific plans as they become more certain. We appreciate your interest in First Financial and this concludes the prepared comments section of the call.
We will now open up the call for questions. Mike?
Operator
Yes, sir. (Operator instructions) Our first question comes from Scott Siefers of Sandler O'Neill.
Scott Siefers – Sandler O'Neill
Good morning, guys.
Frank Hall
Hi, Scott.
Scott Siefers – Sandler O'Neill
Just had a couple of questions here. Frank, you talked towards the end of your comments about the possible balance sheet strategies such as securitizations and asset sale, and then also -- but you made those comments in the scope of helping relieve some of the risk-based capital ratios, so presumably those would be things like residential mortgages.
I guess I'm curious maybe at top level to the extent you are comfortable talking about it, what sort of asset classes could you consider selling in this environment that you could so in a manner that made economic sense?
Frank Hall
Yes, Scott. To the extent that we can offer details, unfortunately, I can't but I think you get a sense of what it is that we are trying to achieve here.
Either an improvement in the risk weighting of the assets or I would describe them as nonstrategic asset sales more so than anything on a significant or material level.
Scott Siefers – Sandler O'Neill
Okay. And then jumping to the Freddie preferreds, I think that has got a basis of $5 million, do you have a sense for where the fair value of that is today?
Frank Hall
The stock traded yesterday I think close to $12 a share, which would be another $1.2 million mark from where we were at the end of the quarter if third quarter ended yesterday, so that's where we are now.
Scott Siefers – Sandler O'Neill
Okay. And then I guess either Claude or Frank, in the case of your CRE [ph] growth, can you discuss a little about what specific segments that's coming from?
Claude Davis
Sure, Scott. It's clearly outside of the residential development, other than developments that we were already a part of that maybe funding up as those projects continue.
Any other projects are not concentrated in any one asset class. We are trying to make sure that we do the obvious things, which are to make sure that there is good equity in the project that the guarantors have strength in capacity to support the project.
And if the project is based on -- in terms of current economics things that make sense. So, it's not any one area or industry other than it's principally in our metropolitan markets where we seeing that growth.
Scott Siefers – Sandler O'Neill
Okay, perfect. And I guess there's one last question on capital, I mean, obviously you guys don’t have any capital issues but I was just curious to hear in this kind of environment how you are thinking about the dividend, because obviously you've got excess capital on most metrics, if not all, but the payout ratio is relatively higher, so I'm just curious to hear how you guys think about that dynamic?
Frank Hall
Yes, Scott. I would say that it's consistent with what we have disclosed about our capital plan in general.
We view it holistically as far as capital management. And historically, what we'd said is that we seek to maintain the dividend and raise it when we are able to maintain it.
So again, as we look at and continue to refine our capital plan, dividend is obviously part of that, but that is our historical view.
Scott Siefers – Sandler O'Neill
Okay, perfect. Thank you very much.
Claude Davis
Thanks, Scott.
Operator
And our next question comes from Joe Stieven of Stieven Capital.
Joe Stieven – Stieven Capital
Good morning guys. First of all, good quarter.
Scott sort of asked one of my questions, but I'll sort of take a step back. On a macro prospective, talk about pricing on both the lending side and deposit side just in general because we've heard for some people that you're starting to see better and better risk pricing on the loan side, and then some people have also heard that the rational deposit pricing is sort of coming down.
But then, again, everyone thought you got some players that appear to be keeping rates high, but with the fact that you got Countrywide, who is sort of gone, and IndyMac, just sort of -- just some big picture questions on both the loan and deposit pricing.
Claude Davis
Sure, Joe. On the loan side, I would tell you that I think in general, I think your observation is accurate that we are seeing – I would not say significantly better loan pricing but marginally better loan pricing and we've always tried to be disciplined in using a loan pricing model that achieves our target profitability levels.
But, I would tell you, it's easier to get those levels and above today than it may have been a year and a half or even a year ago on the loan side. So, I think there is some better risk-based pricing out there.
And just as importantly, I think there is more rational structure competitively that people are looking at and I think clients now understand that they can't shop and get weak [ph] structure as well as low price any longer. I think both of those issues are positive for the loan book.
The deposit side, I would tell you that the non-CD rate picture has improved and I think is less irrational in certain segments than it may have been three or six months ago at the height of liquidity crisis for several large banks. Where we are still seeing some pricing that is not, in our view, profitable for us, is on the CD or time deposit side where we have some competitors that are still pricing very aggressive for their needs that from our prospective and our liquidity position don't make sense.
So, better on loans, better on deposit on the non-CD side, CD side is still a bit irrational.
Joe Stieven – Stieven Capital
Okay, thanks guys.
Claude Davis
You bet Joe, thank you.
Operator
(Operator instructions) Okay, we show no further questions at this time sir.
Claude Davis
All right. Well, Mike, thank you and thank all of you for your interest in First Financial.
Operator
The conference has now concluded. Thank you for attending today’s presentation.
You may now disconnect.