Community Financial System Inc (CBU) 2003 Q2 法說會逐字稿

Good morning and thank you for holding. Before we begin today's call, I'd like to remind you that this is a presentation that contains forward-looking statements within the provisions of the Private Securities Litigation Reform Act of 1995 that are based on current expectations, estimates and projections about the industry markets and economic environment in which the company operates. Such statements involve risks and uncertainties that could cause actual results to differ materially from the results discussed in these statements. These risks are detailed in the company's annual report and Form 10K filed with the Securities and Exchange Commission.

And now I would like to introduce today's call leaders, Mr. Sanford A. Belden, President and CEO of the Community Bank System; Mr. Mark. E. Tryniski, Executive Vice President and Chief Financial Officer of Community Bank System. Gentlemen, you may begin.

Thank you very much and welcome to our investor call to discuss the second quarter results. Mark and I are delighted with our operating performance in all aspects and pleased with the consistency of that performance. While Mark will talk in more depth in a moment about our net interest margin and our non-interest income, I want to compliment our investment management and banking leadership on a job very well done. I believe our financials this quarter bear out the value of our increasingly diversified business mix, as very strong margins and banking fee income along with stellar performance at BPA allowed us to produce quality earnings in the face of soft performance in our equity market related businesses and continued moderate growth in commercial lending, reflective of a still slow economy.

I'm especially delighted with the evident and stabilized improvement in our asset quality metrics. Adding dedicated credit administration leadership and utilizing a deeply experienced outside asset quality consultant coupled with an intensely focused effort in credit underwriting and administration by our line lenders have all led to the improvement. Net charge offs for the quarter and year to date are similar to our experience in 2002, and we are especially pleased with the reduction in non-performing loans and the consequent improvement in the coverage ratio. As noted in the release, delinquencies continue to improve thanks to persistent and anticipatory collection work.

With all that said, we remain diligent and focused on credit administration and asset quality, and appreciative of the 185 basis point improvement in our tangible equity ratio to 6.181 percent.

Finally, I'm pleased to report that we are making excellent progress on all three pending acquisitions. We still anticipate closing on the PWC acquisition by the end of this month and the Ogdensburg acquisition in early September. Even though our Grange closing is not until late November, we are already working very closely with Tom McCullough at Grange to not only assure a seamless closing and conversion but also to leveraging our respective strengths in the northeast Pennsylvania markets for enhanced performance after the closing.

I'm delighted to note, in closing my comments, that Grange has just reported an 18 percent increase in earnings per share for the first six months, demonstrating again the excellence of our new Pennsylvania partner. Mark?

Thank you, Sandy. I will comment on some of the financial highlights of the quarter, of which we think there are many. Overall, we're very pleased to have delivered such strong growth in both net income and earnings per share compared to 2002 for both the quarterly and the year-to-date periods.

First, let me address the net interest margin which we view as the principal force behind the strength of this quarter's earnings. The margin was actually up 21 basis points from the comparative 2002 quarter and down only 5 basis points from the first quarter of 2003. There are two reasons our margins held up so well. First, we were relatively aggressive in managing down our costs of funds, particularly with respect to maturing time deposits. Second, the yield on our investment portfolio held up very nicely due to a substantial level of longer term, call protected securities we added to the portfolio in 2001 and early 2002 to protect us from falling rates. We expect the margin to continue to be strong for the remainder of 2003 with a decline of no more than five to 10 basis points from that reported in the second quarter.

The loan loss provision was down in the second quarter from both the 2002 quarter and the prior sequential quarter. We were particularly pleased with the improvement in asset quality, as Sandy mentioned, with charge offs and non-performing loans coming down slightly from the first quarter and total delinquencies declining in each of the past two quarters.

Another bright spot for the quarter was non-interest income which was up 22 percent from last year's quarter, principally on the strength of the new overdraft product introduced in the fourth quarter of 2002. Overall, revenue from our financial services businesses declined, however were substantially mitigated by the very strong performance of our BPA subsidiary whose revenues are up almost 30 percent year to date over 2002.

Excluding acquisition costs, operating expenses were up 6 percent for the quarter. Nearly half of this increase related to non-recurring personnel and related costs associated with the retirement of our predecessor CFO and the retention of our new CFO . The remainder of the increase relates to increased utility costs, insurance, branch technology enhancements and overdraft charge offs. Year-to-date recurring operating expenses are up a more modest 4 percent.

Looking forward, we expect full year, 2003, earnings will be consistent with the guidance we've previously reported and within the current estimates of the analysts that cover CBU which range from $2.95 to $3.00 per share. And that concludes our prepared remarks and we would now ask the operators to open the line for questions.

We're joined, as always, by Joel Ebcheck [ph], Chief Investment Officer. So, operator, we're ready.

Thank you. If anyone would like to ask a question or has a comment, please press one on your touchtone phone and we will take your questions in the order that they are received. Thank you. The first question comes from Jared Shaw with KBW. Your line is open.

Good morning, great quarter.

Hi, Jared. Thank you.

Could you just comment - if you commented earlier, Sandy, I'm sorry. I missed the beginning parts of your statement. On your loan growth - I guess where you're seeing it in terms of what type of a - is it commercial or consumer? And also, geographically where is it coming from or is it pretty much spread around the franchise?

Our growth as been overwhelmingly in the residential mortgage portfolio. We have seen more moderate growth in our commercial portfolio as well as in the indirect portfolio and actually experienced some runoff in the consumer installment direct loans. The growth in the commercial business has been in New York State in contrast to Pennsylvania where we still continue to suffer a gradual erosion of our commercial book down there. We're in the process of addressing that, looking forward to support and encouragement and help from Tom McCullough as he comes on board to help us in that regard as well. But it's been largely mortgage driven. Mark has the specific details for you.

Yeah, the consumer mortgage portfolio stands at about $545m at June 30, which is up about 7 percent from the end of the year and about 17 percent, actually, from June, '02. So, as Sandy suggested, we have seen a substantial increase there. The business in commercial lending has really seen very low single-digit growth, a little over 1 percent, from both the end of '02 and for the past 12-month period.

The consumer indirect business has been quite good. It's up almost 14 percent from the - 2002 - from June, 2002, up about 6 percent year to date. So that portfolio has held up fairly well, and, as Sandy suggested, the direct consumer business has fallen off a little bit, about 3 percent from the beginning of the year.

Great. And I guess on the asset quality side, could you break down non-performing loans and separate out the 90-day past due from that? And are there any concentrations in the non-performing category or are they pretty much generally granular?

They're very much granular loans or the NP - sorry, the non-accrual loans are essentially the same ones that we've been talking about. There are three large commercial loans, aggregating about $5m in exposure that have been on non-accrual for some time and we're chipping away and making some progress.

In terms of the breakdown, Jared, at the end of June the totals are - in the 90-day category it's about $2.4m, and the non accruals are about $12.7m which together add to the $15.135m, and we are still under a million dollars in ORE, which we've been for the last couple years at $943,000 so our ORE exposure or our ORE problem is very modest.

Great. Thank you very much.

You're welcome.

Thank you. The next question comes from Mr. Bill McCrystal. Your line is now open.

Hi, Bill.

Good morning. Along the same lines, can you talk a little bit about the watch list and what - the trends you're seeing in terms of going forward as far as, you know, the borrowers' profiles?

Well, we - let me speak to the latter part of the question first and then come back to the former part or the first part. We are experiencing some uptick in dairy prices and milk prices, which is encouraging. And we're hopeful, as I know others are, that the new plan that has been proposed, called the Cooperatives Working Together Plan, or CWT, will be beneficial in reducing cow numbers and having a positive affect on the price of milk. So that's a positive development. Along the southern tier, I think that we're experiencing some of the modest recovery and improvement that Corning, Inc. is experiencing, and so that appears to be mildly beneficial.

Beyond that, I think the economy is pretty much in the state that we've talked about before - not growing very much at all. We see in selected cases some of our commercial customers being interested in expansion in their business, but that is highly selective and highly anecdotal.

On the watch list matter, we have now worked our way through a good share of the portfolio with the outside consultant looking at the risk ratings, as I noted in my prepared remarks, and in the initial work that he did in one of our portfolios in the north country there were some downgrades, but those have been reflected in the risk ratings and we're - he's now pretty much through another major portfolio with really no significant changes. We are under examination by the OCC and that seems to be proceeding as anticipated.

So while we have experienced an increase in [inaudible] assets, as I've commented in earlier presentations as a result both of imposing our risk rating standards on the portfolios that we've acquired and the slowdown, deterioration, if you like, in the economy, we think we are at a point where we have thoroughly evaluated and assessed and identified all of those risks as a result of our own internal law review process and the special work that has been done by the outside consultant who, as I mentioned earlier, had retired from [inaudible] and has now been working with us for about 2-1/2 months.

Will he be going through Grange at any point or is that not in the plan?

I think eventually he will look at Pennsylvania, and that will probably happen after the Grange acquisition has been completed. We did pretty thorough due diligence with our own lending team on the Grange portfolio, which is about 60 percent consumer and 40 percent commercial, but without any significant concentrations either by industry or by individual borrowers on the commercial side. So we were very satisfied with the results of our initial due diligence and we expect as we make the conversion that the outside consultant will take a look at some of those loans as a part of his Pennsylvania review.

OK, Sandy. Thanks very much.

OK. Thanks, Bill.

Thank you. The next question comes from Mr. Wilson Smith of Cohen Brothers. Your line is open.

Good morning, gentlemen. Nice quarter.

Thank you, Wilson. Appreciate that.

And as we - Mark, how much more expansion in the - you know, the service charge area can you expect? You've had some just wonderful growth. You know, you said in the release it's up $1.8m over the previous year. How much more room is there to bump that up, do you think?

Well, we think that it's - at this point, this program has been in place now for a little better than two full quarters and we think it's hit its effective run rate at this point.

And we - our experience is more favorable than what we had anticipated before we began and launched the program, both in terms of the fee income generated as well as our loss experience. So we have - we've had very positive performance with this product. As Mark noted, I think we've been at it long enough that it's a steady state operation and we're not going to see much variation from the pattern that's now established.

Good. Well, I must admit, Sandy, it's a little bit more growth in there than I anticipated, too.

Well, you know, when one gets the prize on the upside, it's not the worst thing that ever happens to a [inaudible].

This is true, this is true. Also on a little different tack here, it looked like your tax rate came down this quarter. Is that going to be something that's going to continue?

No, it's not going to continue to decline. It's going to run right where we've got it for the rest of the year, Wilson. We've got a higher level of tax exempt securities in the invested portfolio now which is really what's driving that reduction in the effective tax rate. But it's going to stay about where it is for the rest of the year.

OK, good. And what - your margin, as you said, has been holding up very well, and, as you say, it's definitely come down maybe about 10 basis points for the rest of the year...

Right.

How much more room do you have to lower rates on the deposit side?

We've got a little bit of wiggle room, mainly on the CD side. We're still seeing some of the longer-term CDs maturing and rolling over at much lower rates so we still expect to get for the next couple of quarters some benefit out of reduced CD rates. That's where the majority of our opportunities are on the interest checking and savings. In money market type accounts there's not a lot of room left to go there. Those are - we've got marginal levels of room to play with there. It's really - on the cost of funds side, the benefit we have going forward in the next couple of quarters is really going to come from those maturing CDs that get rolled over at much lower rates.

And then you... I'm sorry...

No, go ahead. That's fine.

I was just going to ask now - and when you look into your crystal ball for '04, do you have any thoughts that you'd be willing to share with us about the condition of the margin in '04?

Well, frankly, we haven't done our forecasting for that yet, Wilson, and we need to do that first and factor in some of our strategic plans and [inaudible] balance sheet management plans as well as the Grange acquisition in the fourth quarter which is going to have an impact on that modeling. So I'm not trying to be evasive. We just haven't done that exercise yet and expect to do that probably here in the third quarter actually.

Yeah, it's probably worth repeating what I said in the last - or when we talked about Grange itself. That we do anticipate there's some potential deposit cost improvement in those markets as well and that will all be factored into our thinking and planning for 2004.

Good. And most of the loan growth has been coming on the residential mortgage side. And as I recall, that's really, you know, not a non-adjustable rate and not really particularly short term. It's mostly non-conforming. How much more room do you have, you know, with the existing AL strategy that you have to be able, you know, to continue to add fixed-rate mortgages?

Joel is going to answer that question, Wilson.

Actually, Wilson, in terms of the mortgages themselves, a good majority of those mortgages are in fact conforming mortgages.

Oh, OK.

But we do have a situation where if we did need to sell them into the secondary market, we could. Number two, the vast majority of the mortgages that we are booking and holding in portfolio are the 10- and 15-year type mortgages, so we are, in fact, selling off the 30-year product right now. And so we do have some opportunity there as well to not see as much exposure to a rising-rate environment with those mortgage assets. And quite frankly, just the asset liability position of a bank significantly shows us doing better in a rising-rate environment than a falling-rate environment due to the high nature of core deposits that we continue to have.

If you notice, we have much fewer short-term borrowings today than we did a year ago, and so once again, that gives us some capacity in a rising-rate environment to actually help increase earnings as rates move up.

And, Joel, one last question for you now. With the structure of the inventory portfolio now, as rates continue to come down here, are we actually going to see a little winding in the spread, given the fact that you locked in those rates and they're not callable?

I'm not sure if we'll see much of a widening here because we do have the other assets in play that will continue to wind down. So some of the higher yielding direct loans and some of the higher yielding indirect loans that continue to roll off are going to be placed back on the balance sheet at a lower rate. So given the balance between the call protected investment assets versus some of the non-call protected loan assets that will continue to, I guess, become lower in yield, we should see a continued modest reduction in interest rates - or interest margin going forward.

OK, thank you.

Thanks, Wilson.

Thank you. Gentlemen, we have no other questions in queue, but just as a reminder, if you have any questions, press one on your touchtone phone. No? Gentlemen, it looks like we have no other questions.

Thank you all very much. Appreciate your time and attention. So long.