First Financial Bancorp. — Q2 2017 Form 10-Q
Business context and reporting period. First Financial Bancorp. is an Ohio-based bank holding company serving primarily Ohio, Indiana and Kentucky, with nationwide commercial-finance lending. This unaudited filing covers the quarter and six months ended June 30, 2017; balance-sheet comparisons are with December 31, 2016. Amounts below are in U.S. dollars unless stated otherwise.
Key financial metrics
| Metric | Q2 2017 / June 30, 2017 | Comparable period / prior year-end |
|---|---|---|
| Net income | $22.7 million | $22.6 million in Q2 2016 |
| Diluted EPS | $0.37 | $0.36 in Q2 2016 |
| Six-month net income / diluted EPS | $47.2 million / $0.76 | $42.4 million / $0.68 in H1 2016 |
| Net interest income | $68.5 million in Q2; $137.5 million in H1 | $67.1 million in Q2 2016; $133.7 million in H1 2016 |
| Fully tax-equivalent net interest margin | 3.56% in Q2; 3.63% in H1 | 3.67% in Q2 and H1 2016 |
| Noninterest income / expense | $17.5 million / $51.6 million in Q2 | $20.2 million / $49.4 million in Q2 2016 |
| Total assets / shareholders’ equity | $8.71 billion / $898.1 million | $8.44 billion / $865.2 million at Dec. 31, 2016 |
| Loans and leases / deposits | $5.87 billion / $6.47 billion | $5.76 billion / $6.53 billion at Dec. 31, 2016 |
| Allowance for loan and lease losses | $54.9 million; 0.93% of period-end loans | $58.0 million; 1.01% at Dec. 31, 2016 |
| Borrowed funds / long-term debt | $1.21 billion / $119.7 million | $927.5 million / $119.6 million at Dec. 31, 2016 |
| Cash from operating activities | $42.0 million in H1 | $46.5 million in H1 2016 |
Material changes and performance drivers
- Q2 net interest income increased 2.1% year over year, supported by higher average earning assets and organic loan growth. However, fully tax-equivalent net interest margin fell 11 basis points to 3.56%, as deposit and short-term borrowing costs rose faster than earning-asset yields.
- H1 net income increased 11.2% year over year. The filing attributes the lower H1 effective tax rate, 31.5% versus 33.3%, partly to a $1.2 million tax benefit from adopting the share-based compensation accounting update.
- Q2 noninterest income declined 13.6%, largely because prior-year other income included a $2.4 million gain on redemption of a limited-partnership investment and covered-loan discount income declined. Q2 noninterest expense rose 4.3%, with higher compensation and data-processing costs.
- Loans grew 2.0% from year-end, led by commercial real estate, construction real estate and commercial-and-industrial lending. Investment securities increased $193.9 million, or 10.5%, in H1.
- Deposits declined 0.9% from year-end as time deposits and noninterest-bearing deposits fell; savings deposits rose 12.0%. Management said time-deposit balances declined partly through intentional runoff of higher-cost brokered CDs. Borrowed funds increased, principally reflecting funding needs and public-fund deposit seasonality.
- Nonperforming assets rose to $62.7 million from $54.3 million at year-end, mainly after three commercial relationships were downgraded to nonaccrual. Classified assets nevertheless declined to $98.4 million from $125.2 million. Q2 annualized net charge-offs were 0.13% of average loans and leases, versus 0.08% a year earlier.
Outlook, risks and notable items
- Management expected a 2017 full-year effective tax rate of approximately 31.5%–32.5%. The filing provides no specific earnings or revenue guidance.
- On July 25, 2017, after quarter-end, First Financial announced a definitive stock-for-stock merger agreement with MainSource Financial Group, valued at approximately $1.0 billion. MainSource shareholders would receive 1.3875 First Financial shares per share; the filing estimated ownership of the combined company at approximately 63% for existing First Financial shareholders and 37% for MainSource shareholders. Completion, integration, costs and expected benefits remain subject to risk.
- Management reported $147.3 million of on-hand liquidity and $2.5 billion of unused, available overnight wholesale funding. Remaining FHLB borrowing capacity was $414.4 million. The company reported that it met capital requirements and was categorized as well capitalized; consolidated total risk-based capital was 13.05%, Tier 1 capital 10.54%, and leverage 8.69%.
- Interest-rate exposure models showed estimated NII increases of 1.63% and 2.60% in Year 1 under immediate +100 bp and +200 bp shocks, respectively, and declines of 3.69% under a -100 bp shock. Management noted the balance sheet became less asset-sensitive during Q2; model outcomes depend on assumptions, including deposit betas.
- Key risks include credit deterioration, rising funding costs and margin pressure, interest-rate sensitivity, liquidity and wholesale-funding access, regulatory and operational risks, and merger execution. The company disclosed ordinary-course litigation but no related reserves, stating that pending damages were not considered probable or reasonably estimable at quarter-end.
- The expected-credit-loss standard (CECL) was under evaluation, with adoption required for periods beginning after December 15, 2019; management had not quantified its impact.
Most important facts for investors to verify
- Merger terms, approvals, closing conditions, expected timing, integration costs and dilution following the July 25 announcement.
- Whether loan growth can continue without further deterioration in nonaccrual loans, nonperforming assets and net charge-offs; note the increase in nonaccrual commercial relationships.
- Whether deposit pricing and wholesale borrowing costs continue to outpace asset repricing and pressure net interest margin.
- Liquidity and capital resilience as borrowed funds rise, and the availability and cost of FHLB and other wholesale funding.
- Management’s 2017 tax-rate outlook and the eventual effect of CECL and other pending accounting standards.