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#Thank you, Chad.
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 have also included a slide presentation on our Investor Relations page, with supplemental financial information that may be referenced throughout today's call.
With me in the room today are Mike <UNK>, President and CEO of First Commonwealth Financial Corporation; and Jim <UNK>, Executive Vice President and Chief Financial Officer.
After brief comments from management, we will open the phone call to your questions.
For that portion of the call, we will be joined by Brian Karrip, our Chief Credit Officer; and <UNK> <UNK>, our Chief Treasury Officer.
Before we begin, I would like to caution listeners that this conference call will contain forward-looking statements about First Commonwealth, its businesses, strategies and prospects.
Please refer to our forward-looking statements disclaimer on Page 2 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 <UNK>.
Hey, thanks, <UNK>.
And welcome, everyone, and thanks for joining us.
On today's call, I'll take a few minutes to reflect on where we've been in 2017 and where we're going in the year ahead.
Fourth quarter results were affected by the recent passage of tax reform legislation.
First, as previously disclosed, the new tax law required us to take a $16.7 million write-down of our deferred tax asset.
Adjusting for the DTA and for merger-related expense, core fourth quarter net income of $20.6 million produced core earnings per share of $0.21, a core ROA of 1.11% and a core efficiency ratio of 62.2%.
Second, in response to the tax law change, we decided to provide a onetime bonus payment of $1,500 to all of our employees.
This comes on the heels of keeping our employees' health care premium costs and benefit flat to down for yet another year while adding roughly $500 in each respective HSA account.
We have not disclosed the $1,500 bonus publicly until now that have resulted in a $2.5 million onetime expense for the company, which is financially material to our fourth quarter results.
This bonus is not adjusted for in any of our published core numbers.
Jim will provide more detail in a moment, but other key fourth quarter performance elements included the following: a $4.3 million gain from the redemption of our trust preferred securities holdings, which had been marked down ever since the financial crisis; modest provision expense of $2.3 million, reflective of strong underlying credit metrics; and loan growth of 2.2% and commercial loan growth of 3.3%, as traction and mortgage in commercial real estate was partially offset by muted growth in branch-based consumer lending.
Looking back on the full year of 2017 and again adjusting for merger expense and the onetime DTA charge, favorable variances in spread income and fee income, combined with lower credit expense and a boost from securities gains, more than offset the increase in noninterest expense that came in part from running 2 new regions of the bank.
Full year 2017 core net income of $78.5 million enabled $0.82 of core earnings per share, a core ROA of 1.09%, both of which were significantly improved over the prior year.
Core earnings per share of $0.82 was up 19% year-over-year.
Similarly, our ROA of 1.09% beat the pure bank median, and by pure, I mean the 52 regional banks with total assets between $2 billion and $10 billion, and showed progression over the prior year.
Major tailwinds in 2017 included the following.
First, the biggest part of top line revenue, net interest income, of $233 million was up 15% year-over-year as commercial banking continued a nice growth trajectory, predominantly in commercial real estate, and our 2 Ohio acquisitions were successfully integrated.
Two interest rate hikes and good pricing discipline in deposits also helped propel the net interest margin to 3.61% by the fourth quarter.
Second, fee income of $75.3 million grew 18% year-over-year as our Ohio acquisitions began to contribute and mortgage, wealth and insurance had strong years.
Our debit card business continued to show nice progression and contributed meaningfully as well.
Finally, provision expense of $5.1 million was well below prior year figures as leading credit indicators continued to improve.
Two large recoveries of previously charged-off loans totaling $3.1 million also aided our 2017 provision expense.
Despite the low provision, our allowance for loan loss figure ended the year at $48.3 million, and our coverage ratio of 96 basis points of originated loans remains in line with our peers.
In short, 2017 was a very good year for First Commonwealth and demonstrates a trajectory and a matching desire to become one of the top-performing community banks in the country.
A big part of the 2017 story was the integration of the branches we acquired from FirstMerit and the acquisition of Delaware County Bank and the further buildout of the Ohio franchise through the recently announced acquisition of Foundation Bank in Cincinnati, Ohio.
We are extremely pleased to welcome Foundation to the First Commonwealth family.
They are a well-run and a well-led profitable community bank.
This acquisition will provide a platform for growth in Cincinnati and will leave us with a presence in each of Ohio's 3 major metropolitan areas, nicely complementing our core Pennsylvania footprint.
Following the acquisition, we will have approximately $1.4 billion in deposits and a similar amount in loans in Ohio, with over $600 million of those loans coming organically above and beyond what was acquired through acquisitions.
With regard to the Northern Ohio branch acquisition in particular, I would point out that branch acquisitions are typically difficult to execute.
However, our Northern Ohio branches retained over 92% of the deposit balances.
I would also add that we actually grew deposits through the acquisition and integration of Delaware County Bank.
Our Ohio M&A activity has been supplemented by investment in separate downtown Cleveland and downtown Columbus commercial loan production offices as well as 2 mortgage loan production offices in Hudson and Dublin, Ohio.
The story unfolding in Ohio is positive, and our commercially oriented brand resonates with customers.
One final note as we look forward to 2018.
Obviously, the recent tax legislation has substantially lowered our effective tax rate.
Like all companies, we're in the process of considering how best to deploy increased after-tax income.
The first step was to give some of the tax benefit back to our employees, particularly on the heels of a busy, productive year.
We also need to rebuild capital levels to replace capital loss due to the DTA write-down.
Beyond that, we continue to evaluate ways to balance rewarding our shareholders with the need to reinvest in our company to promote growth and our ongoing digital transformation on the other.
And with that, I'll turn it over to Jim.
Thanks, Mike.
I will try to provide some additional color on our results, all while providing some limited guidance as to where we think our financial performance is headed in the near term.
As you all know, we don't provide explicit EPS guidance, but hopefully, we can describe our earnings trajectory in a way that is helpful to you as you try to better understand where our company is going.
The net interest margin was essentially flat to last quarter.
The margin benefited from annualized growth of approximately 5% in average noninterest-bearing balances in the quarter, driven by the commercial nature of our balance sheet.
However, our cost to deposits increased in the fourth quarter, mostly due to competition for time deposits in the form of CD specials and competition for public funds, which is a trend that we think will continue to 2018.
Fortunately, asset yields also went up towards the end of the fourth quarter in response to the Fed's rate hike and the deposit of replacement yields throughout the quarter, leaving the margin unchanged from last quarter at 3.61%.
Looking forward, we expect that our NIM will continue in the range of 3.60% to 3.70% until the next rate hike.
We believe that steady progression within that range is possible even without a rate increase, as positive replacement loan yields slightly outpace the increases in our cost of funds.
In addition, we continue to reiterate our guidance of mid-single-digit loan growth.
Fourth quarter noninterest income, exclusive of securities gains, is primarily driven by a surge of swap fee income as commercial customers sought to lock in fixed rates.
Beyond swap income, we expect fee income to show a nice, steady trajectory in 2018, in part because of the steadily growing contribution from our wealth, mortgage, SBA and insurance service offerings.
Provision expense of $2.3 million in the fourth quarter was well below our long-term historical averages, but reflects our improving credit quality metrics.
This compares favorably to the average provision expense we experienced of $3.9 million per quarter over the last 3 years.
While there is always some variability in our provision expense from quarter-to-quarter, in the long run, we expect that our credit costs will probably be closer to our long-term average, driven more by continued growth in our balance sheet than by legacy credit costs.
Turning to noninterest expense.
As outlined in our press release, a number of expenses impacted noninterest expense in the fourth quarter, including $2.5 million for the onetime employee bonus and $600,000 of expense related to growth in unfunded loan commitments.
Unfunded loan commitments expense is not an unusual item for us, but the number is volatile, and we think it's helpful to disclose it separately.
In addition, we are also able to employ, in a few limited cases, approximately $700,000 in expense management strategy to take advantage of the tax law change, none of which was individually material, but in the aggregate, added notably to fourth quarter expense.
Thankfully, the $4.3 million security gains in the fourth quarter more than offset these items.
But if you look at total fourth quarter noninterest expense and adjust for the items I mentioned, you get a pretty good idea of our expense run rate going forward.
More importantly, we continue to believe that our core efficiency ratio should be back into the 50s in 2018 through growth in spread and fee income as we continue to be mindful of expenses.
Our effective tax rate was 30.47% through the first 3 quarters of last year, but the DTA write-down in the fourth quarter obviously brought the effective tax rate for the full year up to 46.82%.
The more meaningful figure is our current estimate for our effective tax rate in 2018, which is approximately 19%, although we will update that figure as the year progresses.
And with that, we'll take any questions you may have.
We actually have <UNK> <UNK>, our Chief Treasury Officer, here comment on that.
One moment, please.
And that's on a total securities portfolio, about $1.2 billion.
Yes.
A couple of themes there, but I'm happy to comment on that.
Just in a general sense, looking back over the last year or 2 years, we had consistently been projecting deposit betas that were more than what the actual deposit betas were.
In other words, we have projected the beta based on an internal model just like any other bank.
And then in reality, the deposit betas were far less than that.
We think that we're coming to a point in the market cycle with the interest rate changes where that dynamic is going to change, that following several rate hikes by the Federal Reserve and now perhaps several more next year, the consumers and people and other holders of deposits will start to be more rate-sensitive.
And so we think that our deposit betas are going to increase and probably converge well with the models are telling us.
To be really specific in response to your question, we are assuming in our planning ---+ for our planning purposes 2 rate hikes next year, one in March and then one later in September.
It will be spread out evenly for each employee over the course of the year.
Yes.
I mean, we've made quite a few investments, 2 banks, a call center in Columbus, 2 mortgage loan offices in Ohio, 2 LPOs in Ohio.
We've built out an SBA group.
We're investing in digital.
Obviously, they'll be more to come there in the ensuing years.
We've also invested in a regional market president model and our markets in Ohio.
And now with Cincinnati as well and Foundation Bank, I think it's important that we realize the investment in those markets, we have a terrific foundation and we really use some operating leverage here in the ensuing year.
Yes, just a couple of things on pipelines.
The SBA pipeline is built nicely.
Indirect is a little soft, and that's really weather-related.
Mortgage pipeline is really consistent with the prior year, and we really have had nice year-over-year growth in that business the last few years.
And then in commercial real estate, we really have a good construction pipeline.
In C&I, quite frankly, our pipeline is stronger than it's been in several years.
So a lot of that is the new markets and the buildout there, but the pipelines look very good across the board.
It depends on which category you're looking at.
Give me one second, I could probably give you an aggregate number of overall loan yields.
One moment.
I also think, yes, on Page 6 of the supplemental deck, it shows the average loan yields going from 3.99% last year to about 4.29% in the fourth quarter of 2017.
And just recall, we have a commercially oriented book, about 60 ---+ so we have 64% of our loans are commercial, most of which are variable.
So we do nicely as rates have gone up.
Yes, I'll try to just give you some limited color.
Nothing in that number is sort of material.
And to be honest, we're hesitant to even disclose the figure.
We suspect that many companies looking at a kind of almost generational or once-a-generation shift in tax rates, are going to employing strategies to the extent they can, to take advantage of the tax rate change.
And actually, GAAP gives you very little discretion in terms of a little bit expenses or revenue from period-to-period, but there are a few minor things we can do.
For example, accelerating decisions that we're thinking about making early next year for purchasing equipments or office equipment, that kind of thing and purchasing those in the fourth quarter.
So it's a combination of those types of things.
Again, none of which was material, but all add up to the number.
The fact that we spend that money now will then, in turn, slightly reduce managed expense going forward, spread across several periods next year.
But the aggregate effect, to be honest, is not going to be that material.
Yes.
Thinking about ---+ if you think about the adjustments, taking that $700,000 into account, the $2.5 million onetime bonus into account, unfunded credit expense, the number we disclosed, which again that we always have that bouncing around a little bit.
You're probably going to adjust to a figure between $47 million and $48 million.
In the portfolio in general, the guidance we've given is mid-single digits.
I think we have more engines lined up against that than we have in the past.
And I think we have a mortgage portfolio that is not just running off, it now gives us a little tailwind.
I think we'll have a tailwind this year in C&I, which we haven't had for a few years.
And commercial real estate and construction, I suspect that will be ---+ that's been the most robust segment.
It'll probably be muted a bit, but I expect, across the other categories, it'll more than pick that up.
The other thing we saw was just leaking oil in small business and consumer over the last couple of years.
And in the fourth quarter, we really ---+ and throughout second half of last year, we just had more momentum with production as these new markets came online.
Just regional office and projects in some metropolitan areas and ---+ mostly in the metropolitan areas, everything from 1 to 4 family housing to office and multifamily.
I think I'm trying to say that the provision expense is going to be approximate ---+ going to converge with a more normalized view of our charge-off expense going forward.
And I think part of it is not as it was a couple of years ago due to legacy credit cost, but just consistent with overall balance sheet growth.
And as you know, because you've been following us for some time, that provision number has just been volatile and it bounce around from quarter-to-quarter.
We're just trying to be as subtle as we can, thinking about what a long-term run rate would be.
So in some quarters in 2017, we had large recoveries that brought the number down and obviously can't count on those quarter-to-quarter even.
The other thing I would add, <UNK>, is our charge-offs for nonperformance this past year were really strong year-end figures by historical standards.
The migration in our criticized loan categories was really positive for the year as well.
Our commercial loan portfolio became more granular in the last year.
I think we also probably like a lot of organizations are looking around the corner at the next credit cycle and trying to think about how prepared we are for that, whether that's a year away or hopefully 3 or 4 more years away.
So I think the guidance might be somewhere between where we were, maybe several years ago and where we are this past year.
Just as always, we appreciate your sincere interest in our company, and we are ---+ look forward to being with many of you in the next quarter or 2.
Thank you very much.
