Good morning or good afternoon all, and welcome to the First Financial Bancorp third quarter earnings call and webcast. My name is Adam and I'll be your operator today. If you'd like to ask a question during the Q&A portion of today's call, you may do so by pressing star one on your telephone keypad. I will now hand you over to Scott Crawley to begin. Scott, please go ahead when you are ready.
Thank you, Adam. Good morning, everyone, and thank you for joining us on today's conference call to discuss First Financial Bancorp's third quarter 2021 financial results. Participating on today's call will be Archie Brown, President and Chief Executive Officer, James 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 will make reference to the slides contained in the accompanying presentation during today's call. Additionally, please refer to the forward-looking statements disclosure contained in the third quarter 2021 earnings release, as well as our SEC filings for a full discussion of the company's risk factors.
The information we will provide today is accurate as of September 30th, 2021. 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 on today's call. Yesterday afternoon, we announced our third quarter financial results, which were highlighted by strong earnings, loan growth, solid fee income, lower credit costs, and improving credit trends. Third quarter results were exceptional across the board, with earnings per share of $0.63, a return on average assets of 1.49%, and an adjusted efficiency ratio of 60.1%. Third quarter earnings were the highest they've been since the MainSource merger in 2018 and were highlighted by significant provision recapture of $10.1 million. Provision recapture during the period was a result of improving credit quality trends, specifically lower net charge-offs and declines in classified asset balances. We expect further reductions in credit costs in the fourth quarter of 2021 and the first part of 2022, given our optimism for further economic recovery.
In addition, earnings were positively impacted by elevated mortgage and wealth management revenues, and we were encouraged by strong loan originations during the period. Total loan balances declined $150.6 million, driven by $225.4 million in PPP forgiveness during the quarter. Core loan balances increased to $74.8 million for the period as a result of strong origination activity, which was approximately 12% higher than the second quarter. We are very pleased with the growth in our C&I portfolio of 16% on an annualized basis. Our origination levels more than offset the loan payoffs, which remain high, particularly in our specialty finance and our ICRE units. Additionally, we are encouraged by the loan pipeline activity has increased over the course of the last quarter. Deposit balances remained elevated as we saw some modest increases towards the end of the quarter as clients continue to maintain substantial liquidity levels.
The third quarter continued to be very active for PPP loan forgiveness. Through the quarter we had over 98% of round one and over 50% of round two loans have been forgiven. We expect the majority of remaining round two payoffs to flow in over the remainder of the year. During the quarter, we repurchased approximately 2.5 million shares at an average price of $23.04, bringing our total shares repurchased in 2021 to approximately 4.6 million. When combined with the common dividend, the share repurchase is approximated a return to shareholders of 131.7% of quarterly earnings. There are approximately 367,000 shares remaining in our buyback authorization. We were also very excited to bring our associates back to physical office locations during the quarter, albeit with greater flexibility than pre-COVID.
We firmly believe we are stronger when we're together, and we've already witnessed how combining best practices learned from the pandemic with our culture of collaboration positively impacts our clients and financial performance. With that, I'll now turn the call over to James to discuss the details of our third quarter results. After James's discussion, I'll wrap up with some additional forward-looking commentary. James?
Thank you, Archie, and good morning, everyone. Slides four and five provide a summary of our third quarter 2021 financial results. We are very happy with our performance, which included strong earnings, loan growth, stable net interest margin, provision recapture, and elevated fee income. The highlights of our quarter included 3% annualized loan growth, excluding PPP forgiveness, which was driven by commercial and small business banking. In addition, the core net interest margin remained relatively stable as a positive shift in funding costs was offset by the impact from the repricing of earning assets and more days in the quarter. While there will be some volatility in total margin due to loan fees, we continue to expect core margin to face modest pressure in the coming periods given the prolonged low interest rate environment and excess balance sheet liquidity.
Fee income surpassed our expectations as both mortgage banking and wealth management remained strong. We also realized elevated income from limited partnership investments and insurance proceeds. Third quarter foreign exchange income declined slightly from record levels in the first half of the year. However, we anticipate Bannockburn will return to their typical run rate of $10 million-$12 million in the fourth quarter. Non-interest expenses were in line with our expectations, despite elevated incentive compensation, which was tied to our overall company performance, and slight increases in marketing and professional services expenses.
We were particularly pleased on the credit front as both net charge-offs and classified assets declined during the period. These two factors, combined with a positive economic outlook, resulted in $10.1 million of provision recapture during the period. From a capital standpoint, we continue to take advantage of market conditions and repurchase approximately 2.5 million shares during the quarter. Our capital ratios are strong and remain in excess of both internal and regulatory targets. To date, we have repurchased 4.6 million of the 5 million shares that we are eligible to repurchase under the plan approved in late 2020. We expect that we will repurchase our remaining allotment in the fourth quarter, but do not anticipate any further repurchase activity beyond that in 2021. Slide six reconciles our GAAP earnings to adjusted earnings, highlighting items that we believe are important to understanding our quarterly performance.
Adjusted net income was $59.9 million, or $0.63 per share for the quarter. As depicted on slide seven, these adjusted earnings equate to a return on average assets of 1.49% and a return on average tangible common equity of 19%. Turning to slides eight and nine, net interest margin increased one basis point from the linked quarter to 3.32%. This slight increase was primarily driven by higher PPP forgiveness fees. The impact on the net interest margin from changes in asset yields and funding costs largely offset one another, and there was a small negative impact to the margin resulting from the additional day count in the third quarter. Asset yields increased modestly during the period due to higher loan fees, which include PPP forgiveness.
In the first half of the year, we increased the size of the investment portfolio, which has negatively impacted the margin over the course of 2021. However, we expect the portfolio to remain at its current size in the near term. In response to the current interest rate environment, we have continued to aggressively lower our cost of deposits, which declined another two basis points during the period to 10 basis points. These lower deposit costs reflect strategic rate adjustments, as well as a shift in funding mix from higher priced retail and brokered CDs to lower cost core deposits. Our outlook on funding costs remains the same. We anticipate a gradual decline in the near term as we approach our pricing floor. Slide 10 illustrates our current loan mix and balance changes compared to the linked quarter.
The majority of the decline in balances was related to the payoff of PPP loans. Excluding these payoffs, we were encouraged by $75 million of growth in the rest of the portfolio, which was driven by our commercial and small business banking group. Slide 12 shows our deposit mix, as well as the progression of average deposits from the second quarter. In total, average deposits declined $44 million during the quarter, driven primarily by declines in higher cost brokered and retail CDs. These declines were largely offset by increases in lower cost transactional deposits. We continue to be mindful with deposit pricing and will make any necessary adjustments based on market conditions and our funding needs. Slide 13 highlights our non-interest income for the quarter. As I mentioned previously, third quarter fee income remained strong and was driven by elevated production from mortgage and wealth management.
We were also encouraged by the 13% increase in deposit service charge income compared to the linked quarter, and 27% increase in client derivative income. In addition, other non-interest income increased 34% during the period due to increases in income on limited partnership investments and insurance proceeds. With regard to Bannockburn, foreign exchange income declined from record levels in the second quarter. However, we expect them to return to their historical run rate in the fourth quarter. Non-interest expense for the quarter is outlined on slide 14. Overall, core expenses were slightly higher than we expected and increased modestly when compared to the linked quarter, driven by higher employee costs, marketing expenses, and professional services. Turning now to slide 15, our ACL model resulted in a total allowance, which includes both funded and unfunded reserves of $161 million and $10.1 million in total provision recapture during the period.
The decline in provision expense from the linked quarter was driven by improved economic forecasts, lower net charge-offs, and declining classified asset balances. Net charge-offs as a percentage of loans declined to 10 basis points on an annualized basis, while classified asset balances declined $17 million, or 9%, during the period. Our view on the ACL and provision expense remains unchanged. We believe we acted aggressively when building reserves in response to the pandemic and have been relatively conservative to this point in releasing reserves, given the unknown impact from the Delta variant. Barring something unforeseen, we expect further provision recapture and declines in the reserve for the remainder of 2021 and the beginning of 2022. Finally, as shown on slides 17 and 18, capital ratios remain in excess of regulatory minimums and internal targets.
All capital ratios remain strong despite slight declines in our ratios during the period. As I previously mentioned, we repurchased approximately 2.5 million shares during the quarter, bringing our 2021 total shares repurchase to 4.6 million. Once again, we do not anticipate any near-term changes to the common dividend. 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. 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 20. Loan balances, excluding PPP, are expected to grow in the low to mid-single digits over the remainder of the year. Loan demand remains strong, though several portfolios are expected to continue to face payoff pressures. Security balances are projected to remain consistent with September ending balances, as deposits are expected to see some modest seasonal increases in the near term. The net interest margin will continue to be positively impacted by the remaining, excuse me, PPP forgiveness loans or payoffs, and the associated accelerated fee recognition. We expect the majority of remaining payoffs to occur in the fourth quarter, with a minimal amount carrying over to the first quarter of 2022.
Excluding our more volatile variables such as PPP fees, purchase accounting, and loan fees, we expect the margin to be under modest pressure from the low interest rate environment as well as the excess liquidity on the balance sheet and increased balances in our securities portfolio. Regarding credit, we expect further improvement in quality trends and continue to expect additional provision recapture in the near term, with further declines in the allowance for credit losses. We expect fee income to be between $40 million and $42 million in the fourth quarter, with foreign exchange income rebounding to the $10 million-$12 million range and some seasonal declines in mortgage banking revenue. Specific to expenses, we expect to be between $91 million and $93 million, but this could fluctuate some with fee income.
Lastly, we will continue evaluating capital deployment opportunities with all remaining shares under the 2021 repurchase plan expected to be repurchased during the fourth quarter. Finally, I'm very pleased with our exceptional performance this quarter with record earnings and much improved credit trends. As we look to close out 2021, our focus remains centered on serving the financial needs of our core business, consumer, and wealth management clients. Overall, the company remains well positioned to manage in the current environment, and we're optimistic about our ability to sustain these successes through continued execution of our core strategies. We'll now open up the call for questions.
As a reminder, if you'd like to ask a question today, please press star followed by one on your telephone keypad now. Please keep your headset plugged in and unmuted locally. Our first question today comes from Scott Siefers from Piper Sandler. Scott, please go ahead. Your line is open.
Morning, guys. Thanks for taking the question.
Yeah, Scott.
Wanted to ask first, Archie, about the loan growth outlook puts and takes. In your view, what are some of the portfolios that you see doing well? Maybe a little more color on the ones that you suggested would stay pressured for the time being.
Yeah, Scott, thank you. As we highlighted, C&I is strong. Pipelines are strong and increasing. I think we would continue to see some decent growth coming in there. There are some payoff pressures there, but not as much as we're seeing at a few other portfolios. In the ICRE portfolio, we've got strong originations, but we're just having record-level payoffs. It seems mostly tied to the multifamily, where the properties are being sold or going into the permanent market. It is across a few other product types as well. Strong originations there, but very strong or high levels of payoffs. On the origination side, in some cases we'll put the loans out, but many of them are construction in nature, so there's a draw period. Even though originations are really strong, it takes time for those to draw fully up.
The other place we're seeing some payoff pressure is in our specialty finance unit. You'll see one of our slides in the quarter we showed franchise went back about $29 million or $30 million for the quarter. In some cases, refinancing for, we thought were overly aggressive terms. In other cases, we exited a couple, in some cases, a few sales. Then we're seeing also in the finance company, we've got loans in some cases to RIAs or insurance agents, and many of those businesses are selling in the current environment. There's so much liquidity in the market. The payoff pressure is probably felt mostly in the ICRE and specialty finance units. We're seeing, again, strong originations in commercial and in ICRE. The consumer side is running somewhat flattish.
Decent originations, I wouldn't say record level by any stretch, but just running in a flat mode right now.
Okay, perfect. Thank you for that. I was hoping to get a little more color on the Forex revenues. This quarter's $9 million was maybe a bit below the guide from 90 days or so, but the outlook is bound back toward the more typical range. In fact, I think you bumped up that top end of the range. Maybe just some of the nuance of what generates the rebound and how you're thinking about it longer term as well.
Yeah. Scott, this is Archie again. The revenue, it can be a little bit chunky. There's a core base of revenue consistent. Actually, when we look at third quarter, the core base of revenue was probably a little bit stronger than it had been in prior quarters. We just didn't have as many kind of chunky transactions that we would typically see. As we look into the coming quarter, we had some near-term visibility into knowing that a few chunky deals were going to be happening on top of kind of the normal core stuff. That gives us some confidence that it's going to rebound back into that $10 million-$12 million range.
Okay, perfect. Thank you very much.
Yep.
Our next question comes from Terry McEvoy from Stephens Inc. Terry, your line is open.
Hi. Good morning, guys.
Good morning.
Maybe Jamie, starting a question for you. The pressure from low rates on the net interest margin. Could you maybe just expand on how much of that is on the loan side and just new loan yields versus the security side? Then, all things being equal, at what point are the low rates kind of fully priced in where your outlook would shift to more stable?
Well, I would tell you it's coming from both the loan side and the reinvestment side on the securities portfolio. Speaking directly to the investment portfolio, if we get about, call it between $100 million and $150 million a month in cash flow off of the securities portfolio, and those reinvestment rates are just a little bit lower still than our overall yield on the portfolio. From a loan perspective, when you look at the yields, the runoff yields and the origination yields, a new loan coming on the books in the third quarter was coming on at about 335. A loan coming off, rolling off, paying off, maturing, was about 30 basis points higher than that. We still have that about a 25, 30 basis point differential on the loan side as well.
When we see that stabilizing obviously on the deposit side, our deposit costs are at 10 basis points at this point. Getting more relief from the deposit side is really just not going to happen much. We may get another basis point or two, but at this point, we're basically at the floor. When you look out into when that kind of stabilizes, we're looking out into the middle of next year when the margin stabilizes somewhere around a core margin of 3%.
Great. That was very helpful. As a follow-up question, it sounds like the remaining authorization on the share repurchase, 366,000, that's what we should assume for the fourth quarter. If that's the case, at the end of this year, there'll still be a fair amount of excess capital. Could you maybe just remind me what your targeted capital ratio is? As you think about next year, would we expect another share repurchase plan, or would you like to see capital grow to evaluate capital deployment opportunities, to use your terminology here on your slide?
Terry, this is Jamie. Yes. If you're building out your model, our plan is to complete the 350,000 or so, 360,000 shares in the fourth quarter. Obviously that $5 million repurchase plan, that authorization will be up, and I suspect it's dependent on how the board looks at it when we go back to them here at the end of the year. Our plan would be to renew that plan. I would suspect another $5 million shares just to have the flexibility. It'll be dependent on what I would consider to be normal capital management process of whether we would see other opportunities potentially on the M&A side. Obviously dependent on where our price is at that point as we look out into the future. We will want that flexibility to have another plan out there.
Great. Appreciate that, and have a nice weekend. Thank you.
Yep. Thanks, Terry.
Our next question is from Chris McGratty from KBW. Chris, please go ahead. Your line is open.
Hey, good morning, guys.
Hey, Chris.
Archie, I just want to follow up on that narrative on capital. I guess what are you seeing in terms of opportunities for traditional M&A? We've seen a lot across the country. I'm trying to decipher if you're trying to send a message that you're more optimistic about organic growth or potentially complementing it with deals, just the hesitancy on the buyback. Thanks.
Yeah, Chris. This is Archie. I don't think we have any near-term line of sight on whole bank deals. There's been a few things that I would say I always have some discussions with banks in the region, but I'd say nothing that I have some confidence in. As James said, the authorization just gives us the flexibility that based on what our outlook is at any point in time, we can decide, do we want to repurchase shares? Certainly if the price is appropriate or hold back and do something else. We prefer it to be organic growth, if that increases, if the balance sheet starts to really move up with the earning assets in 2022, that's the preferred path. I can't say we've got anything on our sight there.
We do look from time to time at fee-based businesses and other specialty type companies, and again, have had some conversations, but nothing with any clarity at this point.
Okay. Can you just remind me, you obviously did a larger transaction years back, and it's proven to be pretty successful. What's the kind of range of opportunities if you were to do something? What's kind of a wheelhouse deal for you?
Chris, ideally, it's a banking company in the Midwest that's kind of more of a metropolitan footprint with more of a commercial bank orientation. Probably a quarter to half our size. Now, having said that's the ideal, and we probably can't find too many that fit that exact model. That probably says we see ourselves being fairly selective when it comes to whole bank M&A.
Okay. That's helpful. If I could just, one more. We've heard a lot from your peers about the inflationary pressures that are in the market with wage pressure and employee costs. You guys have been really good about keeping costs down over the years. How are you thinking about intermediate-term wage pressure and expense pressure broadly?
Chris, it's Archie again. It's real. We're seeing, well, for any of the, you can imagine, technology talent, lending talents, security talent, fraud, risk talent, and then even on the entry-level side, we're seeing those pressures. I was looking prior to the call, our FTE count's down about 50 from year-end, down about another 15 or so from prior quarter. I think our view is keep working on headcount reductions, but the trade-off's going to be higher wages for the folks that are here. I think it's a combination of that. We have some branch closures. I think we have a couple this quarter, and we anticipate more in 2022. That will also provide some offsets.
Great. That's helpful. Thanks a lot, Archie.
Yep.
As a reminder, if you'd like to ask a question, please press star followed by one on your telephone keypad now. Our next question is from Jon Arfstrom of RBC. Jon, please go ahead.
Thanks. Good morning, everyone.
Hey, Jon.
Hey, Jon.
Hey. Nice job on the buyback, first of all. Those big numbers.
Thanks.
I think a lot of this has been covered in a lot of the key topics, but can you touch a little bit more on the reserve path and where you think that could go longer term?
Jon, this is Jamie. Like we mentioned, I think we were aggressive during the pandemic of building the reserve and especially given the makeup of our portfolio, our exposure to hotels, our exposure on the franchise side. We think we were aggressive on the front end, especially given the Delta variant, we have been purposefully conservative on the back end of releasing that. Just kind of wanted to see where things were going to shake out. Obviously, losses have been nowhere near what people have expected. I think we still have some room to go unless we see things turn the other way in terms of credit, just given our credit trend, given the improvement in classified assets, the charge-offs that we're seeing now starting to come down.
We see some additional release occurring here over the next few quarters. If you look at our reserve now, you take out the PPP loans, we're at around 162 of loans. You look at kind of as a proxy where we started pre-COVID with CECL, we were at around 130 of loans. If you use that as a proxy, obviously the denominator will change some with some loan growth. We expect that over the next year, that that will come back down into that range where we started on day one of CECL. It's another 30 basis point-ish of reserve release. Like I said, the timing is probably the question here over the next few. Probably is when that happens. Also, any deterioration in credit from here, anything that could change that in terms of that variable.
Outside of that, we see us coming back down to that 130-ish range.
Okay. Good. That's helpful. Question on deposits. It's interesting to see the term seasonal in your guidance. It almost feels like normal again. What are you thinking on deposit flows? Do you think this big wave of deposits and liquidity is starting to fade and we're getting back to more normal deposit flows? I guess the other question that continually comes up, do you expect some of your commercial customers to start to tap their deposits before you see loan growth really pick up? Do you have any thoughts on that?
Jon, this is James. I'll start. The seasonal part of that comment is related to the Indiana operations. Over in Indiana, we have property taxes are due May and November, and we get a big pop of deposits coming in from our public funds in that November timeframe. That's the seasonal aspect of it. I would say from outside of that, it feels like I've been wrong on this every quarter in terms of when we expect some of these deposits, the surge deposits, to start running out, and they really seem to be going the other way. Obviously not at the pace that they were, but at a minimum, they've been flattish here over the last couple of quarters. That's with CDs going down.
We are still building into our forecast some deposit outflow into next year just with that surge that we had. It's not meaningful and the question is going to be the pace that that occurs and where it's coming from. Yeah. Normal now on deposits seems like it's just been hard to predict. Like I said, I would've thought at this point that we would've seen some more outflow, but we just haven't.
Yeah. Okay.
Yeah, Jon, this is Archie. A couple other thoughts to add on to Jamie. If you look at our quarter, we saw some more outflows probably on the consumer side. On the business side, it's still pretty close to peak. Matter of fact, may have even edged up a little bit more. They're flush with cash. I failed to mention when we were talking here about some of the pressures. We have already seen, in some cases, customers take cash and pay down lines or do other things. Even with that, though, I would tell you that our C&I utilization rates moved up during the quarter. I think we moved from the low 30s to kind of the mid-30s on our line utilization. I think what it says is there's this really good economic activity out there.
It's disrupted some with the supply chain stuff, but business clients have revenue, they have orders, they have backlogs. It's a really positive overall environment from that perspective, just with a lot of these interruptions and questions in the middle. I tend to think, yeah, they'll use some of this cash, maybe pay down some things, but they also will be expanding and doing other things with it. I'm probably more optimistic about it all.
Yeah. Okay. You just touched on what I wanted to ask next, Archie, was you look at that slide 10, which is your loan portfolio, and the ICRE bounces around from quarter- quarter and Oak Street and Franchise can be somewhat variable, but that commercial and small business number really stands out. It sounds to me like you're saying that's not an aberration, that that's a trend, and you expect that trend to continue. Is that fair?
Well, I'd say that's what we're focusing on. We're certainly encouraged by what you see on that slide, and we think that's where the growth is going to be coming from.
Yeah. Okay. All right. Thank you.
Thanks, Jon.
Thanks, Jon.
As a final reminder, it's star one to ask a question today. As we have no further questions, I'll hand back to Archie Brown for any closing remarks.
Thank you, Adam. I want to thank all of you for joining our call today and for your interest in our company. Have a great Friday and a great weekend. Talk to you next quarter. Bye now.
Thank you all for your attendance. This concludes today's call. You may now disconnect your line.