Hello, everyone, and welcome to today's First Financial Bancorp third quarter 2022 earnings conference call and webcast. My name is Victoria, and I will be your operator for today. If you would like to ask a question, please press star one on your telephone keypad. If you would like to withdraw your question, please press star two. When preparing to ask your question, please ensure that your line is unmuted locally. I'll now pass over to your host, Scott Crawley, Corporate Controller, to begin. Please go ahead.
Thanks, Victoria. Good morning, everyone, and thank you for joining us on today's conference call to discuss First Financial Bancorp's third quarter and year-to-date 2022 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 third quarter 2022 earnings release, as well as our SEC filings for a full discussion of the company's risk factors.
The information we provide today is accurate as of September 30th, 2022 , and we will not be updating any forward-looking statements to reflect facts or circumstances after this call. I'll now turn it over to Archie Brown.
Thanks, Scott. Good morning, everyone, and thank you for joining us for today's call. Yesterday afternoon, we announced our financial results for the third quarter. I'm very pleased with our performance, which was highlighted by strong loan growth, stable asset quality, and exceptional earnings. Adjusted earnings per share increased approximately 9% from the second quarter due to record revenue, which was driven by an 18% increase in net interest income. For the quarter, we achieved adjusted earnings per share of $0.61, a 1.4% return on average assets, and a 23.12% return on average tangible common equity. Recent rate increases continued to positively impact our asset-sensitive balance sheet. Our net interest margin expanded in the third quarter by 53 basis points as yields on assets increased much more rapidly than deposit costs.
Credit trends remained stable across the portfolio with slight reductions in non-performing loan and net charge-off ratios. Even with these improvements, our loan loss reserve grew modestly to account for loan growth and the intermediate economic outlook. We're very pleased with loan growth in the third quarter. Loan balances increased by $377 million or 15.9% on an annualized basis. Growth in the quarter was again broad-based and was driven by increases in C&I, consumer, and residential mortgage. Given our expectations for the economy in the near term and moderating loan pipelines, we expect loan growth to ease in the coming months. Non-interest income was once again negatively impacted by rising rates and changes made to our overdraft program in the second quarter of this year.
We also experienced an expected decline in foreign exchange income from a record second quarter and mortgage activity weakened further. Fee income continues to reflect the strength of our diversified businesses, and we expect a modest increase in the coming quarter as our leasing business grows. With that, I'll now turn the call over to Jamie to discuss the third quarter results in more detail. After Jamie's discussion, I will wrap up with some additional forward-looking commentary. Jamie?
Thank you, Archie. Good morning, everyone. Slides 4, 5, and 6 provide a summary of our third quarter financial results. The third quarter was highlighted by an expanding net interest margin, strong loan growth, and stable asset quality. Our balance sheet reacted positively to additional Fed rate hikes with our net interest margin increasing 53 basis points. We anticipate this trend will continue as the Fed is expected to increase rates over the remainder of the year. However, the margin expansion will not be of the same magnitude due to expected deposit pricing pressures. We were very pleased with another quarter of strong loan growth. Total loans grew 16% on an annualized basis with the growth widespread across the portfolio. Fee income declined from elevated levels in the second quarter. In particular, Bannockburn income met our expectations but was lower than record levels in the second quarter.
As expected, mortgage banking income declined compared to the second quarter as well as the mortgage business has been negatively impacted from higher interest rates. Additionally, service charge income declined from the linked quarter as we continue to feel the impact from changes to our overdraft program. Finally, other non-interest income declined due to higher than expected revenues from limited partnership investments during the second quarter. Non-interest expenses were slightly higher than our expectations due primarily to incentive compensation tied to the company's performance. We were pleased on the credit front as net charge-offs declined to 7 basis points and non-performing assets declined to 29 basis points of total assets. While asset quality remained strong, we recorded $8.3 million of provision expense during the period, which was driven by loan growth during the period and slower prepayment rates.
From a capital standpoint, our regulatory ratios remained in excess of both internal and regulatory targets. Similar to the second quarter, accumulated other comprehensive income declined, negatively impacting both tangible book value and our tangible common equity ratio. 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 $57.8 million or $0.61 per share for the quarter. These adjusted earnings account for $900 ,000 of losses on investment securities and $1.7 million of acquisition and other costs not expected to recur. As depicted on slide eight, these adjusted earnings equate to a return on average assets of 1.4%, a return on average tangible common equity of 23.1%, and an efficiency ratio of 58.5%.
Turning to slides 9 and 10, net interest margin increased 53 basis points from the linked quarter to 3.98%. Once again, this increase was primarily driven by an increase in asset yields during the period resulting from rising interest rates. The increase in asset yields was partially offset by a slight increase in funding costs. As a result of rising rates, asset yields surged during the period, with loan yields increasing 89 basis points. In addition, investment yields increased due to higher reinvestment rates and slower prepayments on mortgage-backed securities. Our cost of deposits increased 11 basis points compared to the second quarter, and we expect these costs to increase further in reaction to competitive pressures from an increasing rate environment. Slide 11 details the asset sensitivity of our balance sheet.
We remain well positioned for the expected rate increases as approximately 2/3s of our loan portfolio reprices fairly quickly. Slide 12 details the betas utilized in our net interest income modeling. While we haven't realized aggressive increases in costs to this point, as additional rate increases occur, we expect our deposit beta to be approximately 30% over the full cycle. Slide 13 outlines our various sources of liquidity and borrowing capacity. We believe our liquidity and borrowing capacity sufficiently provide the flexibility required to manage the balance sheet through the expected economic environment. Slide 14 illustrates our current loan mix and balance changes compared to the linked quarter. As I mentioned before, loan balances increased 16% on an annualized basis, with every portfolio growing compared to the linked quarter. The largest areas of growth were in the C&I, retail mortgage, and consumer portfolios.
However, we were also pleased with the trajectory of the ICRE and Summit books. Slide 15 shows our deposit mix as well as the progression of average deposits from the linked quarter. In total, average deposit balances declined $167 million during the quarter, driven primarily by a $77 million decline in public funds, a $58 million decline in retail CDs, a $49 million decline in money market accounts, and a $47 million decline in non-interest-bearing accounts. Slide 16 highlights our non-interest income for the quarter. Overall fee income declined from the second quarter, driven by declines in foreign exchange, service charges, mortgage, and other non-interest income. Bannockburn met our expectations for the quarter. However, their total income was lower in the third quarter following record output in the second quarter.
Also consistent with our expectations, deposit service charge income declined in the third quarter as we realized the impact from overdraft program changes. Consistent with the second quarter, mortgage demand was light due to higher rates and record production in prior years, and we continue to expect further pressure on this business for the remainder of the year. Finally, other non-interest income normalized during the period, which was higher in the second quarter due to elevated income from limited partnership investments. Non-interest expense for the quarter is outlined on slide 17. Like the second quarter, the third quarter was relatively quiet on the non-interest expense front. On an operating basis and excluding Summit, expenses increased $2.6 million compared to the linked quarter due primarily to an additional incentive compensation tied to the company's performance. Turning now to slide 18.
Our ACL model resulted in a total allowance, which includes both funded and unfunded reserves of $141 million and $8.3 million in total provision expense during the period. This resulted in an ACL that was 1.27% of total loans at September 30th. As I mentioned previously, the provision expense was driven by our strong loan growth and slower prepayment speeds, which increased the duration of the portfolio. Despite the increase in provision expense, credit quality remained stable. Net charge-offs as a percentage of loans decreased slightly to 7 basis points on an annualized basis, while non-performing assets declined to 29 basis points of total assets. In addition, classified assets declined $4.6 million during the quarter. Our view on the ACL and provision expense remains unchanged.
We expect our ACL coverage to remain stable or increase slightly in the fourth quarter as our model responds to changes in the macroeconomic environment. Finally, as shown on slides 20 and 21, regulatory capital ratios remain in excess of regulatory minimums and internal targets. During the third quarter, tangible book value and the TCE ratio continued to decline due to a drop in accumulated other comprehensive income. Absent the impact from AOCI, the TCE ratio would have been 8.1% at September 30th compared to 5.8% as reported. Our total shareholder return remains robust with approximately 40% 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.
Thank you, Jamie. Before we end our prepared remarks, I want to comment on our forward-looking guidance, which can be found on slide 22. Loan demand remains solid. Pipelines are beginning to ease, and we expect growth to moderate to high single digits over the fourth quarter. We expect total deposit balances to remain flat or decline slightly over the near term. Our asset-sensitive balance sheet continues to benefit from rising rates, and although there are many variables that impact magnitude and timing, we expect the margin to continue to expand to a range of 4.3%-4.45% in the fourth quarter based upon anticipated interest rate increases. The competition for deposits is increasing, and we expect the margin expansion to moderate as we get further into 2023.
Regarding credit, much uncertainty remains regarding inflation and the impact of rate hikes to the economy and our customers. Over the fourth quarter, we expect continued stability in our credit quality trends and ACL coverage to remain stable to slightly higher. We expect fee income to be between $44 million and $46 million in the fourth quarter, with continued strength in our diversified fee-producing businesses. Specific to expenses, we expect to be between $105 million and $107 million, but expenses could fluctuate with fee income performance. As our operating lease portfolio grows, we will see corresponding depreciation expense growth of approximately $1 million per quarter, which is included in our range.
Regarding Summit, our outlook is unchanged, and we expect the acquisition to have minimal impact on overall 2022 earnings and provide approximately $400 million in annual originations. Lastly, our capital ratios remain strong, and we expect to maintain our dividend at current levels. Overall, we had a really nice quarter, and we're optimistic that we can sustain the momentum over the remainder of 2022 and into the new year. Our strong balance sheet is well positioned to continue to benefit from rising rates. With a loan deposit ratio under 80%, strong liquidity, and positive credit trends, we believe we are well situated to manage a potential economic downturn. We'll now open up the call for questions. Victoria?
Thank you. If you would like to ask a question, please press star one on your telephone keypad. If you would like to withdraw your question, please press star two. When preparing to ask your question, please ensure that your line is unmuted locally. Our first question comes from Scott Siefers at Piper Sandler. Please go ahead. Your line is open.
Thank you. Morning, guys. How's everybody doing?
Good, Scott.
Hey, Scott.
Hey. I guess, Jamie, maybe first question is for you. It kind of feels like at almost every turn in the tightening cycle you guys have been maybe a little more asset sensitive than you had modeled. It sounds like we'll get another big lift in the fourth quarter. Archie, you had noted, you know, moderating margins into 2023 as deposit costs sort of keep up. You know, after we get to a point where the Fed stops raising rates, maybe just some thoughts on, you know, how much further could you expand the margin and can you sustain positive NII momentum after the Fed stops raising rates?
Yeah. Scott, this is Jamie. We do expect to see another pretty sizable increase here in the fourth quarter in the margin. It's just, I mean, from the pace of the interest rate hikes, you know, and just how they're coming on, you know, we expect to see that lift here in the fourth quarter as well. Even into the first quarter, if you look at, you know, based on the Fed funds futures and what we're expecting in terms of rate hikes going in to the beginning of next year. You know, we expect the margin to peak.
If you would've asked me maybe six, you know, a few months ago where our margin was going to peak, I would have said maybe in that 4.20% range. But just given the way things have changed, I think the peak is a little bit higher. The peak is probably somewhere in the first quarter of next year, and where the peak is going to be a little bit higher, and you know, somewhere in that 4.40%-4.50% range into next year. Then you know as the Fed stops and on the backside of that, the deposit side starts to catch up. I mean, we just had no time for the deposit side to really ramp up to where it should be.
You know, that's going to happen more on the backside when the Fed stops. You'll then start to see the margin start to come back, you know, come back down and, you know, moderate in the middle to the back half of next year.
Yeah. Perfect. All right. Thank you for that color. I guess, you know, just given that we're getting closer to the end of the tightening cycle and hopefully have you guys given any thought to sort of moderating your asset sensitivity to protect against the falling rates. You know, a lot of guys are putting on swaps now to do so. You know, what if so, what would be the best way in your mind?
Yeah. We're looking at several things. You know, kind of I would say evaluating. We haven't done anything yet, I would say material. Maybe the only thing we've done at this point is some slight rebalancing in the investment portfolio to maybe extend some duration there on the investment portfolio. I would say that's on the fringes. I mean, I would tell you we're evaluating various options to kind of protect the NIM on the downside and reduce that asset sensitivity. I mean, we're looking at costless collars and looking at, you know, building in some floors and whatnot. Haven't done anything yet, but expect to do so here in the next, you know, within the next quarter.
Perfect. All right. Good. Thank you guys very much for taking the questions.
Thanks, Scott.
Thank you very much, Scott, for your question. Our next question comes from Daniel Tamayo at Raymond James. Please go ahead. Your line is open.
Thank you. Good morning, guys.
Morning.
Maybe we just start on the fee guidance, the decline there. You know, if we could just talk through some of the, you know, puts and takes in terms of what drove that. Maybe if we could just talk a little bit about what your expectations are for Bannockburn in particular going forward. That'd be great. Thanks.
Yeah. Daniel, I'll start. This is Jamie. Kind of just going through the various line items. The first one, like we disclosed, I think a few months ago, we made some changes to our overdraft program. The impact was what we expected. It's not any different than what we expected, but that did drive that service charge revenue down in the third quarter. That impacted that line item. In terms of mortgage, I mean, you know, as you expect, I mean, you know, our mortgage rates are up, you know, 400 basis points or so from a year ago. In terms of that activity has fallen off dramatically. Obviously seeing an impact there.
On the wealth management side, you know, a lot of those fees are based on the market values of the portfolios and of the assets under management, getting impacted by, you know, the downturn in the market. You know, offsetting that a little bit, we are still seeing strong income on the foreign exchange side. You know, we were down a little bit this quarter, but coming off of, you know, what was a record quarter for them. You know, they have a base of income. You know, there are some quarter-to-quarter fluctuations.
When we look at that income at this point, you know, they're somewhere in that $12 million a quarter range, so about $48 million-ish on an annual basis of revenue at Bannockburn. We, you know, going forward, expect that to, you know, increase in that 5%-10% range on an annual basis for the near term.
Okay, great. That's helpful, Jamie. Thanks. Then I guess a similar question, but on the expense side. You know, in particular, it looks like the guidance for the fourth quarter is, you know, similar to what you put up in the third quarter. And then you call that specifically the million increase in leasing expenses. Just curious how we should be thinking about kind of growth rates from there if that's just a unique situation in the fourth quarter where expenses should be roughly stable-ish. And also if that million is included in the guidance that you've given. Thanks.
It is. Yeah. The million is included in that guidance. That's just obviously as we put operating leases on the books, that line item there is going to continue to grow. I mean, absent that, I would tell you it's really just the pressure that we are seeing is really on the employee cost side. Outside of that then I would just call it inflationary pressure on employee costs, you know, other expenses are relatively flat. Essentially, you have that increase on the Summit side every quarter, kind of just ramping up and then some pressure there in wage costs, healthcare costs and whatnot, that is impacting the employee cost line.
Outside of that, relatively flat.
Daniel, this is Archie. Jamie, the other item on the corresponding side is as that leasing business expense goes up, we're also seeing corresponding benefit in the fee side.
Yeah, correct.
From the operating lease.
All right. Thanks for all the color guys. That's all for me.
Thank you.
Thank you for your question, Daniel. Our next question comes from Terry McEvoy at Stephens Inc. Please go ahead. Your line is open.
Morning, this is Brandon Rud on for Terry. My first question.
Hi.
Is about deposits.
Yep.
Non-interest-bearing deposits pre-COVID end of 2019 were about 26% of total deposits. In this last quarter they were about 32.5%. Do you think they could return back to that pre-COVID level the next year and a half or so?
Yeah. Brandon, this is Archie. You know, certainly there's some money that's surged into demand deposit accounts during COVID. You know, you would expect over time some of that will work its way back out and as businesses and individuals spend some of that or start to put some of that money to work. I don't know that we're going to be able to hold it at the low- 30s. I think we believe just given our strategy and focus on growing our business sector in particular, we think that number will probably be higher than where it was pre-COVID.
Okay. Perfect. Thank you. Next one here is, do you have any sectors or regions across your footprint that you're expecting to drive your loan growth going forward?
This is Archie again. I mean, I think it's across our footprint. You know, our footprint's pretty tight if you think about where we're located, you know, four hours, 4.5 hours across the whole footprint. It's coming really from all of those markets. We also have, as you know, some national businesses with Oak Street and Summit and even in some of our more regional and commercial real estate. All those areas will help drive some of that growth as well.
Gotcha. Thank you. Last two here kind of go hand in hand talking about credit. Can you talk about how your restaurant franchise borrowers are managing the current environment? Also can you remind us your exposure to office, hotel and retail CRE? Just kind of how you stress those portfolios for the higher interest rates.
Yeah. This is Archie. I'm going to start, but I'm going to turn it to Bill to kind of get into the details. On the restaurant book and hotel book, just to let you know, we have those books are much smaller than they used to be. I think the restaurant portfolio is now under $300 million, so it's about half of what it was four years ago. The hotel book is down about 40% from where it was 2.5 Years ago. It's you know, a little bit over $300 million or so. They are much smaller.
We'll have Bill Harrod, our Chief Credit Officer, talk about what he's seeing in those portfolios as well as, I think you said, the retail CRE portfolio.
Yeah, sure. You know, as far as, you know, the office and retail books and hotel books, those are actually performing very, very good. You know, hotels have rebounded nicely, and, you know, up to, you know, some cases, you know, exceeding pre-pandemic levels. You know, we're very happy with that portfolio, and its progress. On the franchise, you know, book there, they have some, you know, cost headwinds as far as the labor and inputs, but we're also seeing rises in prices across a lot of the platforms to help mitigate that. They, you know, still have good volumes compared to 2019. We feel, you know, pretty bullish there as well.
On the office, you know, we continue to you know monitor that portfolio very diligently, including stress testing not only on the interest rate environment. One thing about our vertical book in the real estate side is the vast majority of that is swapped, and so it has interest rate hedges on it, so we feel pretty good about that. That said, we do run through our models including not only interest rate you know shocks as well as rent rolls, and looking out you know short-term, midterm and long-term expiries to try to rethink the risk and attack it quickly and before it becomes you know a potential issue with re-leasing. So, you know, we do that across our real estate books. Hopefully that helps.
Got it. Yep. That's very helpful. I appreciate you taking my questions. Thank you.
Thank you.
Thank you very much. As a reminder, if you would like to ask a question, please press star one on your telephone keypad. Now our next question comes from Chris McGratty at KBW. Please go ahead. Your line is open.
Oh great. Thanks. Hey guys. Jamie, a question on the just spot rates. Do you have the spot deposit interest-bearing deposit and the spot loan yield?
Like for September? Is that what you're asking?
Yeah, like for the end of the quarter. Exactly.
Our cost of deposits in September was 27 basis points.
27. Okay.
Yeah. Hang on here real quick. Let me back into it. Our loan yields for September.
Let's see here. Was around 5.40.
Okay. Thank you. The 30% beta you cited, was that total or is that interest-bearing? Just make sure I'm clear.
Total. It's total.
Okay.
Yeah.
Obviously.
Great.
I mean, Chris, real quick on that. I mean, you know, we haven't really seen a whole lot so far in the cycle, you know. We're starting to see some pressure, and then it's just, you know, we're seeing that here starting out a little bit in the fourth quarter, some competitive pressures. You know, obviously, that beta is gonna start to move up here. Then, you know, on the backside, again, like I said, that beta moves up pretty substantially on the backside of the rate hikes, so.
Great. I guess maybe on the loan yield outlook, I mean, if they continue to reprice higher, I mean, you're gonna have your borrowers are gonna be paying, you know, north of 6%, mid-sixes on a loan. At what point does the pressure on the borrower become more acute with relation to credit?
Yeah. Go ahead.
Go ahead, Billy.
Yeah.
Yeah. I mean, it's hard to look at that on a global basis. You know, when we look at credits and underwrite credits, you know, we have built-in shocks. And those built-in shocks, you know, go out in duration and size depending on the deal. You know, we test them, you know, to really ensure that they're bending and not breaking. And then on, you know, and also a lot of our book is hedged on the loan side, both in commercial and on the ICRE. Now that's waned a little bit just with the rising rate environment that we're in right now. People are, you know, holding out a little bit. Overall, the book is protected that way.
It's really through our downside, base case downside and severe cases that we've proved that they don't bend. Now, you know, of course, like any expense, it's an increase in pressures, and they'll figure out ways to, you know, deal with it.
Yeah. Chris, this is Archie. I think this is part of the case for where we're seeing a little bit of softening in the pipeline and slowing down of the growth is that we know, especially in our ICRE group, certain projects are being postponed or put on hold and just waiting for the environment to get a little bit better. That is driving some of our outlook around loan growth.
Got it. Thank you.
Yep.
Thank you very much for your question, Chris. At this time, there are no further questions, and I would like to pass back over to Archie Brown for any final remarks.
Thank you, Victoria. Thank you all for joining us on today's call and hearing more about our story in the third quarter. We're excited about the fourth quarter and 2023, and we look forward to talking to you again the next quarter. Have a great day.
Thank you everyone for joining today's conference call. You may now disconnect.