First Financial Bancorp. — 2016 Q2 Form 10-Q
Business context and period: Unaudited results for the three and six months ended June 30, 2016. First Financial is an $8.3 billion bank holding company operating primarily in Ohio, Indiana and Kentucky. It acquired Oak Street in August 2015; year-over-year growth therefore reflects both organic growth and the acquisition.
Financial performance
- Profit: Second-quarter net income was $22.6 million, up from $18.9 million a year earlier; diluted EPS was $0.36 versus $0.31. First-half net income was $42.4 million versus $36.6 million, and diluted EPS was $0.68 versus $0.59.
- Revenue and margin: Q2 net interest income rose 14.4% to $67.1 million; fully tax-equivalent net interest margin was 3.67%, up from 3.62%. Noninterest income declined 5.7% to $20.2 million. First-half net interest income increased 14.0% to $133.7 million, while noninterest income fell 8.5% to $35.7 million.
- Expenses and credit costs: Q2 noninterest expense increased 1.3% to $49.4 million. Provision for loan and lease losses was $4.0 million in Q2 and $5.7 million for the first half, compared with $3.1 million and $5.1 million, respectively, in 2015. Q2 net charge-offs were $1.1 million, or 0.08% of average loans on an annualized basis, versus $3.3 million, or 0.27%, a year earlier.
- Balance sheet: Total assets were $8.31 billion, up from $8.15 billion at year-end 2015. Loans and leases were $5.70 billion, up 5.8%; deposits were $6.12 billion, down 1.0%. Shareholders’ equity was $846.7 million, versus $809.4 million.
- Cash flow: First-half operating cash flow was $41.5 million, investing cash outflow was $148.1 million, and financing cash inflow was $97.9 million. Cash and due from banks declined $8.7 million to $106.2 million.
- Funding and liquidity: Total borrowed funds were $1.23 billion, including $1.12 billion in short-term borrowings and $119.6 million in long-term debt. FHLB short-term borrowings rose to $1.035 billion from $849.1 million at year-end. Management reported $125.1 million of on-hand liquidity plus $1.7 billion of unused available overnight wholesale funding; remaining FHLB borrowing capacity was $186.0 million.
- Capital and returns: Consolidated common equity tier 1, tier 1 and total risk-based capital ratios were 10.07%, 10.07% and 12.70%; leverage was 8.38%. Management said the company remained well-capitalized. The declared dividend was $0.16 per share; management cited a long-term target to return 60%–80% of earnings through dividends and repurchases.
Material changes and management commentary
- Loan growth, higher loan yields and the Oak Street acquisition drove higher interest income and net interest income. Average loans increased 16.2% year over year in Q2. Increased deposit and borrowing costs partly offset the benefit; average funding costs rose.
- Noninterest income was affected by lower accelerated discount income on covered loans ($1.2 million in Q2 2016 versus $4.1 million in Q2 2015) and lower securities-sale results. Q2 other income included $2.4 million of previously unrealized income from redemption of a limited partnership investment.
- Nonperforming assets declined to $59.6 million from $70.1 million at year-end, while classified assets increased to $143.3 million from $132.4 million. Management attributed the latter to modest credit migration, not concentrated in a particular industry or geography, and said affected borrowers had plans to stabilize performance.
- Investment securities declined $134.9 million in the first half as cash flows were redeployed to support loan growth. The portfolio’s duration decreased to 2.5 years from 3.4 years at year-end.
Outlook, risks and contingencies
- Management expected the 2016 effective tax rate to be approximately 33.0%; the filing gives no specific earnings or revenue guidance.
- Interest-rate sensitivity modeling estimated that an immediate +100 basis-point parallel rate change would increase year-one net interest income 0.62%, while a -100 basis-point change would reduce it 4.76%. Management said results were within internal limits and more asset-sensitive in Q2; outcomes depend on assumptions, including deposit repricing behavior.
- Key risks include credit quality and allowance estimates, interest-rate and funding costs, economic conditions, regulatory and capital requirements, technology and operational security, litigation, and integration of acquisitions. The FDIC loss protection on remaining covered loans is scheduled to expire October 1, 2019.
- Loan commitments totaled $2.1 billion and letters of credit $16.8 million; these are off-balance-sheet commitments and do not necessarily represent future cash requirements. The company reported $0.8 million in litigation reserves and said pending matters were not considered probable or reasonably estimable as to damages.
- Disclosure controls were judged effective, but Oak Street’s internal control over financial reporting was excluded from the evaluation because of acquisition timing; integration-related control work remained ongoing.
Important facts for investors to verify
- How much future earnings growth is attributable to organic lending versus Oak Street, and how the acquisition is affecting funding costs and expenses.
- Whether the increase in classified assets and loan-loss provision signals further credit deterioration, particularly as loan balances grow.
- The sustainability of noninterest income, including the limited-partnership redemption gain and declining covered-loan discount income.
- Whether deposit trends, increased FHLB borrowing and available liquidity remain adequate as loan growth continues.
- Capital-ratio trends, interest-rate sensitivity assumptions, and the timing and impact of FDIC loss-sharing expiration and Oak Street control integration.