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Edited Transcript of FCF earnings conference call or presentation 25-Jul-18 6:00pm GMT

Q2 2018 First Commonwealth Financial Corp Earnings Call

INDIANA Jul 27, 2018 (Thomson StreetEvents) -- Edited Transcript of First Commonwealth Financial Corp earnings conference call or presentation Wednesday, July 25, 2018 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* James R. Reske

First Commonwealth Financial Corporation - Executive VP, CFO & Treasurer

* Ryan M. Thomas

First Commonwealth Financial Corporation - VP of Finance & IR

* Thomas Michael Price

First Commonwealth Financial Corporation - President, CEO & Director

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Conference Call Participants

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* Collyn Bement Gilbert

Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst

* Daniel Edward Cardenas

Raymond James & Associates, Inc., Research Division - Research Analyst

* Stephen M. Moss

B. Riley FBR, Inc., Research Division - Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the second quarter earnings conference call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Ryan Thomas, Vice President of Finance and Investor Relations. Please go ahead.

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Ryan M. Thomas, First Commonwealth Financial Corporation - VP of Finance & IR [2]

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Thank you, Michelle. 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've 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 Price, President and CEO of First Commonwealth Financial Corporation; and Jim Reske, Executive Vice President and Chief Financial Officer. After brief comments from management, we will open the phone call up to your questions. For that portion of the call, we will be joined by Jane Grebenc, our Chief Revenue Officer and President of First Commonwealth Bank; Brian Karrip, our Chief Credit Officer; and Mark Lopushansky, Chief Treasury officer.

Before we begin, I'd like to caution listeners that this conference call will contain forward-looking statements. Please refer to our forward-looking statement disclaimer on Page 2 of the slide presentation for a description of risks and uncertainties that could cause the actual results to differ materially from those reflected in the forward-looking statements.

Today's call will also include non-GAAP financial measures. Non-GAAP financial measures should be viewed in addition to and not as an alternative for our reported results prepared in accordance with generally accepted accounting principles. A reconciliation of GAAP to non-GAAP operating measures can be found on Page 13 of today's slide presentation.

And now I'd like to turn the call over to Mike Price.

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Thomas Michael Price, First Commonwealth Financial Corporation - President, CEO & Director [3]

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Okay. Thank you, Ryan, and welcome to those of you on the call today. We genuinely appreciate your interest in our company.

A record second quarter net income of $32.1 million produced core earnings per share of $0.33, a core return on assets of 1.76% and a core efficiency ratio of 55.23%. Even without the $5.3 million of gains stemming from the disposition of our remaining trust preferred security holdings, the core performance metrics were still very robust.

Before I get to the financials, there were 2 major accomplishments in the second quarter worth highlighting. First, we successfully closed and converted the acquisition of Foundation Bank in Cincinnati and are pleased to welcome the former Foundation customers and employees to the First Commonwealth family. Second, the team secured $100 million in Tier 2 qualifying subordinated debt in the second quarter, split equally between a 10-year tranche and a 15-year tranche. Driven by the bank's achievement of investment-grade ratings from both Standard & Poor's and Kroll Bond Rating Agency, the bank was able to issue a historically low spread to treasuries for similar type offerings. This provides an inexpensive layer of growth capital that both bolsters risk-based capital ratios and enables future strategic optionality. The new capital, together with strong earnings, helped bring our total risk-based capital ratio to 14.8%, up from 12.9% last quarter.

Our financial results this quarter were very good. Jim will provide more detail on the margin and the rest of the financials, but I'd like to point out a few items first. Loan and deposit growth both got a shot in the arm from the Foundation acquisition, but organic loan growth, which excludes the acquired Foundation loans, was 5.3% over last quarter and consistent with our mid-single-digits guidance. Organic deposit growth, again excluding the acquired Foundation deposits, at 4.8% was consistent with our long-term goal of funding our loan growth with deposits and keeping our loan-to-deposit ratio under 100%.

Our high retention rate of deposits at Foundation Bank in Cincinnati has been a bright spot and consistent with our 3 prior acquisitions in Ohio. Foundation's deposits at the end of the third quarter of 2017 when we were negotiating the transaction and opportunity totaled $145 million. We closed the second quarter with total Cincinnati deposits of $151 million. We're also seeing meaningful commercial loan activity and closings in Cincinnati that contributed to the second quarter loan growth figure.

Across all geographies, there were some other promising developments in loan growth this quarter worth highlighting. Consumer loans grew at an annualized rate of 6.4%, exclusive of the acquired Foundation loans. Consumer loan originations in the first half of 2018 of $196 million are up by 30% over the same period a year ago.

We had a record quarter in mortgage, with $97 million of loan origination volume, which was up from $67 million last quarter, and this produced $1.2 million in gain on sale income in the second quarter. Just as a reminder, the gain on sale income stems from the roughly 46% of mortgage loans that were sold at origination during the second quarter. That was down a bit from 57% last quarter.

Similarly, record SBA originations in the second quarter added approximately $800,000 in gain on sale income as well. We have been an SBA lender for a long time but recently refocused our efforts on this sector. Switching gears, our small business lending through our branches has more than doubled in originations over the course of the last year.

Finally, and importantly, commercial loans grew by 5.1% on an annualized basis, exclusive of acquired Foundation loans despite a third consecutive quarter of heightened loan payoffs. Thankfully, our commercial loan payoffs slowed somewhat from peak levels in the first quarter but will remain a headwind to commercial loan growth.

Turning to credit costs. Our credit expense in the second quarter was essentially 0. Provision expense of $1.2 million was offset by $1.2 million gain on the sale of a commercial loan that has previously been impaired. The gain ran through noninterest income and offset provision expense almost dollar for dollar. Our low credit expense is reflective of continuing improvement in overall credit quality. Nonperforming assets to total loans plus OREO fell from 1.12% last quarter to 88 basis points in the second quarter. In total, delinquencies fell as well.

Before I turn it over to Jim, I'd like to close with a word or 2 about the investments we're making in our digital delivery platforms because I believe -- we believe these will be essential to our ability to compete in the future.

First, our online account opening capabilities are progressing nicely. In fact, we opened more deposit and loan accounts online through the first 2 quarters than ever before. And we're looking forward to further upgrades to our platform, which should be coming online in the third quarter. Our active mobile banking and bill pay utilization rates continue to grow at a rapid pace and compare very favorably to peer averages. We're looking at implementing a second generation of P2P payment solutions for our customers later this year. It's important to note that our current P2P solution is integrated with our online and mobile bill pay solution.

Over the last quarter, we've introduced the second generation of our online personal financial management tool. It's called Money Manager. It provides improved graphics and cash flow features and perhaps, most importantly, mobile functionality. To date, there are already almost 10,000 users for Money Manager.

Our mobile wallet solutions continue to see steady adoption, with over 14,000 users at the end of the year. Apple Pay here leads the way, followed by Google Pay and Samsung Pay. We expect to see these payment methods increase as merchants are regularly updating their card terminals for contactless payment models.

And with that, I'll turn it over to Jim, our CFO.

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James R. Reske, First Commonwealth Financial Corporation - Executive VP, CFO & Treasurer [4]

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Thanks, Mike. As Mike mentioned, our second quarter earnings broke a number of records for our company. Core earnings per share, core ROA and core return on tangible common equity have never been higher. These core ratios exclude merger expense and only merger expense, as has been our consistent practice for several years now.

Obviously, as Mike pointed out, our second quarter earnings benefited from $5.3 million in net security gains from the sale of our remaining pooled trust preferred securities, and as Mike put it, credit costs in this quarter that were effectively 0 as of the result of the sale of a loan that had previously been impaired.

These 2 events also had a direct impact on the net interest margin in that they allowed for the recognition of previously unrecognized interest income related to these assets. Essentially, while these assets were in impaired status, any and all interest payments that we did receive were used to pay down principal. When the assets were disposed of, all of that unrecognized interest income came back into the margin all at once. This recognition provided a 9 basis point lift to the margin in the second quarter and explains the 9 basis point improvement in the margin from last quarter.

In explaining all this, we aren't trying to complicate the matter. We just feel that it would have been entirely disingenuous on our part not to disclose this and allow the market to believe that we have 9 basis points of margin expansion in the quarter.

The margin also benefited in the second quarter from 3 additional basis points of purchase accounting accretion from the successful completion of the acquisition of Foundation Bank in the second quarter. Without the Foundation acquisition, purchase accounting accretion's contribution to the margin would have drifted down from 4 basis points to 3 basis points. With the additional 3 basis points of purchase accounting accretion, total purchase accounting accretion in the quarter was 6 basis points. But the 3 basis points of additional accretion from the acquisition was entirely offset by 3 additional basis points of drag from the issuance of the sub debt. As a result, after all that, the margin was essentially flat from last quarter.

Still, our outlook on the margin remains positive for the following reasons. First, low yields are going up faster than deposit costs. Loan yields improved by 16 basis points last quarter, net of the recognition of previously unrecognized interest income that I mentioned earlier, which compares favorably to the 10 basis point increase in our cost of interest-bearing deposits and our 9 basis point increase in our overall cost of deposits. Said differently, deposit betas while increasing remain below loan betas.

Second, the balance sheet remains asset sensitive, even with the elevated deposit betas that we've been experiencing. In particular, replacement yields on new loans exceeded yields on loans running off once again this quarter, and we expect that to continue.

And third, because we have focused primarily on smaller acquisitions, the margin only contains a total of approximately 6 basis points of purchase accounting accretion, as I mentioned earlier, which will fade out at a rate of a little less than 1 basis point per quarter, a rate which can even be absorbed by an asset-sensitive balance sheet.

Our outlook for the margin, therefore, is for slow, steady improvement within the 3.65% to 3.75% range. Next quarter, we'll have the full benefit of the Fed's June rate hike, but we'll also have a full quarter's worth of drag from the sub debt. We feel that our overall cost to deposits of 29 basis points in our total cost of funds of 54 basis points, driven in part by noninterest-bearing deposits that remain at approximately 25.2% of total deposits, is a strategic source of strength in a time when the yield on new loan production is in the range of 4% to 4.5%.

Beyond the margin, our noninterest income benefited not only from SBA and mortgage banking activity, as Mike described, but also from improvement in debit card interchange income, which increased to a quarterly record of $5.1 million.

Finally, expenses are well controlled, even after folding in the Cincinnati operations from the Foundation acquisition. The dollar amount of noninterest expense is up, as we expected with the acquisition, but remains under control, as evidenced by our core efficiency ratio of 55.23%. Please note that we have backed out security gains from the revenue portion of the core efficiency calculation as always. Finally, our effective tax rate was 19.15%.

And with that, we'll take any questions you may have.

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Thomas Michael Price, First Commonwealth Financial Corporation - President, CEO & Director [5]

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Operator, questions?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Steve Moss with B. Riley FBR.

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Stephen M. Moss, B. Riley FBR, Inc., Research Division - Analyst [2]

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Loan growth here was good, even excluding Foundation, and you had good commercial real estate growth. Wondering where you're seeing the opportunities. And what are you seeing for competition on that front?

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Thomas Michael Price, First Commonwealth Financial Corporation - President, CEO & Director [3]

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The opportunity, we had a nice quarter on the consumer loans side, both with small business and with mortgage and consumer loan originations. And I think that's more of a function of just continuing to improve quarter-to-quarter with our sales management, our service model. I think that was a big part of it. Also, on the commercial side, we're seeing some nice activity in a group we call commercial solutions, which is the small end of the corporate banking range, probably really around $1 million or so. Also, we were surprised and pleased that in Cincinnati we probably had -- in the quarter that we were closing and doing the integration, we had at least 3 sizable commercial opportunities that closed. So across all fronts and a more a function of quarter-to-quarter just getting a little better. Now again, we've given single-digit guidance, and we feel like we can use operating leverage to turn that into good earnings per share growth for our shareholders.

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Stephen M. Moss, B. Riley FBR, Inc., Research Division - Analyst [4]

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Okay. In terms of lending spreads here, has that tightened? Or have they been fairly consistent over the past quarter?

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Thomas Michael Price, First Commonwealth Financial Corporation - President, CEO & Director [5]

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Well, I'll have a better idea in an hour when we have a pricing meeting.

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James R. Reske, First Commonwealth Financial Corporation - Executive VP, CFO & Treasurer [6]

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The commercial loan spreads from last quarter, fairly consistent.

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Thomas Michael Price, First Commonwealth Financial Corporation - President, CEO & Director [7]

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Yes, I think so.

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Stephen M. Moss, B. Riley FBR, Inc., Research Division - Analyst [8]

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Okay, that's helpful. And then in terms of -- on the M&A front here, just wondering if you have any updated thoughts on M&A activity and your interest levels here.

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Thomas Michael Price, First Commonwealth Financial Corporation - President, CEO & Director [9]

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Yes. I mean, our pattern has been for smaller, low-risk opportunities where we've taken nice depositories and really put a higher-end commercial chassis on top of that and, again, accretive immediately, although modestly, and really treated tangible book value fairly. And that's probably a predictor of the kinds of things we'll look forward to in the future. We've looked at some larger deals. Frankly, we've been the bridesmaid. We've just been -- remained fairly disciplined. But we're excited about opportunities to grow through both M&A, organically, and we're really looking for good depositories. That being said, we're not seeing, at least in our part of the vineyard, a lot of action. So that's a bit disappointing.

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James R. Reske, First Commonwealth Financial Corporation - Executive VP, CFO & Treasurer [10]

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If I could just add one thought on that. These small acquisitions have been very good for us getting into new geographies as market penetration deals. But as Mike said, we want to remain disciplined and make sure the deals are both financially and strategically. Well, having said all that, that doesn't mean we wouldn't look at a large acquisition if the right one came along and it made sense for us.

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Stephen M. Moss, B. Riley FBR, Inc., Research Division - Analyst [11]

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Up to what size would you guys consider in terms of acquisition?

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James R. Reske, First Commonwealth Financial Corporation - Executive VP, CFO & Treasurer [12]

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It's really hard to say. The old adage, banks are sold and not bought. The typical rule of thumb was that you look at banks that are 20% to 30% of your asset size, but there could be ones outside those ranges that still makes sense for us. We would just look at the opportunity. And we look at it with a disciplined lens to make sure that it made sense for us and we weren't stretching anyway on pricing or structure.

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Operator [13]

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The next question comes from Collyn Gilbert from KBW.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [14]

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Jim, just a question for you on the balance sheet. So you had sort of cash and securities billed this quarter. I'm assuming that had to do maybe with just kind of leveraging some of the proceeds of the sub debt or -- but could you just talk about how you're thinking about sort of the securities and liquidity position maneuvering to the rest of the year and to next year?

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James R. Reske, First Commonwealth Financial Corporation - Executive VP, CFO & Treasurer [15]

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Yes, sure. So on the securities side, generally, our thought has been to maintain the securities portfolio at a fairly steady level and let the balance sheet build around that. I think, a couple of years ago our securities portfolio was maybe a little bit -- a larger proportion of total assets. And so we've actually kind of worked with that strategy to reduce that kind of balance sheet leverage by letting -- holding the securities to fully flat and letting the assets build around it. That strategy will be informed by the market. So we don't want to a make a stupid market decision in any given quarter. There are times in which we find things that are good opportunity to buy securities or good yield and times when we don't. And so that strategy will fluctuate based on market condition a little bit. With the sub debt, part of what happened in the quarters is we got the sub debt issued and immediately redeployed about $50 million of that into securities that were really appropriate deals and took the other $50 million and paid down short-term borrowings. So that was a little bit of a dynamic you saw with some of the liquidity position in the second quarter.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [16]

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Okay, okay. All right, that's helpful. And then just on the fee side, I presume that the pickup in BOLI will not repeat going forward. And then also just could you just give a little bit of color as to your outlook on fee growth and then specifically what you're anticipating on the SBA side?

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James R. Reske, First Commonwealth Financial Corporation - Executive VP, CFO & Treasurer [17]

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Well, I'll take the BOLI question. And Mike, if you want to talk about the SBA and fee income generally. I mean the -- so the BOLI income has income from several different source. And of course, we have policies from our own bank and all the banks we acquired over the years that are all part of the portfolio. There's a steady income from the BOLI portfolio. And then when there's a death experience, there's a shot in the arm as they [were] this quarter. So both are part of BOLI gains. You -- we have had that -- in the last several years, we've had similar gains from a death experience. But you also have the slow, steady benefit in noninterest income from the regular BOLI business as well. So it's hard to predict how that's been unfolding in the quarters to come.

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Thomas Michael Price, First Commonwealth Financial Corporation - President, CEO & Director [18]

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Yes, Collyn, this is Mike. On the mortgage side, I think we're getting our mortgage sized for a $7.5 billion bank. So that's continued to grow nicely over the last several years. So we expect -- there's some -- to be some traction in front of us there. SBA, we're just beginning. We really doubled down on that business about 12 to 15 months ago. And that's really aside from the small business through the branches as we sell most of that production. And then the other thing I was encouraged by was just interchange income, really a record for us at $5.1 million. I think that just speaks to more households through the acquisitions and then just good retention of our deposit relationships. So those are nice drivers that probably, hopefully, can pay dividends for us into the future.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [19]

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Okay, that's helpful. And then just finally on the deposit pricing competition. Do you have a sense of -- I mean, I know it's going to vary, obviously, depending on bucket, but just generally sort of the average deposit size of your retail customer? And the reason I asked that -- or asked differently, right, is that we're seeing -- and you guys are in, obviously, a little bit of different market than what we're seeing kind of the New York metro market. But it seems to be the larger commercial-oriented deposits are the ones that are seeing the most increased pricing pressure. So I'm just trying to get a sense of what -- may be the granularity of your deposit base looks like that's allowed you guys to sort of keep that deposit beta as low as it is and anticipating it to sort of stay certainly below peers. So I don't know if you have any color you can offer to that.

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Thomas Michael Price, First Commonwealth Financial Corporation - President, CEO & Director [20]

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Yes. A couple of thoughts on the deposit beta. I think about half of our deposits, particularly on the noninterest-bearing side, are commercial. So the commercial nature of our franchise lends itself to a robust deposit portfolio, I think, to start. Jim, you want to add something?

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James R. Reske, First Commonwealth Financial Corporation - Executive VP, CFO & Treasurer [21]

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Yes, just a few thoughts, kind of breaking down your question. I mean, the retail bank -- and the answer does depend on the category deposits that you're talking about. The deposit size -- average size is very granular. It's several thousand dollars per account. It'll be a little larger average size in a sector like public funds. And as we've been saying for a while now, the public funds sector is where you see some real intense pricing competition. But overall, it's only 10% of our total deposit base. But the retail franchise is really comprised of very granular small-dollar amount deposits.

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Thomas Michael Price, First Commonwealth Financial Corporation - President, CEO & Director [22]

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And I think that's reflective of the demographics in a lot of our geography in Western Pennsylvania and Ohio.

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Operator [23]

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(Operator Instructions) The next question comes from Daniel Cardenas with Raymond James.

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Daniel Edward Cardenas, Raymond James & Associates, Inc., Research Division - Research Analyst [24]

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Just a couple of quick questions here. On your NIM guidance, thank you for that. But can you maybe remind me how many rate increases, if any, you have built into the -- your outlook for the second half of this year?

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James R. Reske, First Commonwealth Financial Corporation - Executive VP, CFO & Treasurer [25]

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Yes, thanks for asking. We've actually changed that. We went into the year thinking there'd be 2 hikes this year. Obviously, with 2 hikes so far in the first half and so much have changed in the market's view of what's happening in the second half of the year, we are now baking in, in our revised reforecasting 2 more hikes this year. So when I gave that guidance for the second half of the year, that anticipates another hike in September and another hike in December. And obviously, the December hike would not be felt in our numbers until the ensuing year.

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Daniel Edward Cardenas, Raymond James & Associates, Inc., Research Division - Research Analyst [26]

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Right. Correct. Okay. Good. And then, how should I be thinking about your credit cost on a go-forward basis? Your provision number has been ebbing and flowing here over the past year. So should it just be kind of for continued balance sheets growth and charge-offs? I mean, how should I be kind of putting my arms -- wrapping my arms around that number on the provision side?

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Thomas Michael Price, First Commonwealth Financial Corporation - President, CEO & Director [27]

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Yes, just pretty simply, I think the guidance Jim and I have given in the past is to just look back 2 or 3 years on the provision and probably put it in an average and then with growth provide about 1%.

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James R. Reske, First Commonwealth Financial Corporation - Executive VP, CFO & Treasurer [28]

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Yes. We try to consistently talk -- kind of talk about that because we realize there's variability there quarter-to-quarter, but the best way to understand this is to look over a longer term and look at kind of those numbers and how those play themselves out.

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Operator [29]

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This concludes our question-and-answer session. I would like to turn the conference back over to Mike Price, President and CEO, for closing remarks.

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Thomas Michael Price, First Commonwealth Financial Corporation - President, CEO & Director [30]

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Just thank you once again. We sincerely appreciate your interest in our company and look forward to being with a number of you over the course of the next quarter or 2. Thank you very much.

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Operator [31]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.