Community Financial System Inc (CBU) 2004 Q1 法說會逐字稿

Good morning everyone. Thank you for holding, and welcome to the Community Bank System call. Today's call will begin with a presentation followed by a question-and-answer session. Instructions on the feature will be explained later in the program.

Before we begin today's call, I'd like to remind you that this presentation contains forward-looking statements within the provision of the Private Security Litigation Reform Act of 1995, that are based on current expectations, estimates, and projections about the industry, markets and economical 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 10 K filed with the Securities and Exchange Commission.

And now I would like to introduce today's call leaders. Mr. Sanford Belden, President and Chief Executive Officer; and Mr. Mark Tryniski, Chief Operating Officer and Chief Financial Officer of Community Bank System. Gentlemen, your lines are open.

Thank you very much, Operator, and Mark and I are joined this morning, as we customarily are on these calls, by Joe Lempsheck [ph] our Chief Investment Officer.

I'd like to welcome you all to our first quarter 2004 Investor call. I'm delighted to report on another quarter of consistent, solid performance featuring a strong net interest margin, significant increases in non-interest income, and persistent improvement in asset quality indicators, including delinquency, charge-off and non-performing loan metrics. These results were achieved despite continued softness in our direct installment loan business, and especially in our commercial lending business, where we continue to hold the line on our underwriting standards, despite intensifying competitive pressure on those standards in several of our markets.

The key non-operating achievement in the first quarter was approval by our shareholders of a 2-for-1 stock split on March 26th. And the subsequent effectuation of the split on April 12th, to shareholders of record as of March 17, 2004. The very important driver of our first quarter success was the full and effective assimilation of the Grange branches in to our First LIberty business in Pennsylvania. While we have not achieved our initial goals at First Liberty with respect to loan growth in Pennsylvania, positive signs and emerging momentum are already developing under the energetic and enthusiastic leadership of Tom McCollough.

That leadership will be nicely a augmented on May 15th, when our merger and conversion with First Heritage will be completed. Bob Matley and his team of experienced and successful lenders have a long track record, including 2004, of building a very solid loan portfolio of high-quality business at First Heritage, and we are confident that Bob's leadership will produce similar patient results at First Liberty.

Our experience with the entire First Liberty -- First Heritage team has been an outstanding during the build-up to what we expect will be a very successful merger on May 15th.

Mark?

Thank you, Sandy. Good morning.

As Sandy said, we are very pleased with our first quarter earnings results with operating basis EPS up 5% from the first quarter 2003, and up 8% over the last quarter 2003. These results were driven by the continued strength of our net interest margin, increases in non-interest income, and improved asset quality. I'll first address the net interest margin, which held up well in the quarter despite the challenges of the interest-rate and competitive environment.

The reported margin for the quarter, 4.67 was down 12 basis points from first quarter 2003, and up eight basis points from 4.59 in the last quarter of 2003. Excluding the accretion benefit on called securities, the margin was 4.59, equal to that of the last quarter of 2003. Although the earning asset yield fell slightly in the quarter, we have been able to reduce funding costs equivalently, principally through the benefit of declining rates on rolling time deposits.

Improved asset quality metrics, including the lowest level of charge-offs since the third quarter of 2002, lead to a reduced loan-loss provision in the first quarter as compared to the average provision over the trailing four quarters. Net charge-offs, delinquency, and nonperforming loan ratios all showed improvement in the first quarter of 2003.

Non-interest income was up 19% over the comparative 2003 quarter, primarily the result of the acquisition of Harbridge Consulting Group and Grange National Bank in 2003. We have been very encouraged by the continuing improvements in the revenue expansion of all of our financial services businesses, which excluding the impact of the Harbridge acquisition, increased organically by over 13% this quarter, as compared to 2003. Our asset-based businesses delivered single-digit revenue growth in the quarter, however benefit plan, administration, and consulting revenues were up 32% organically, and 165% including the impact of the Harbridge transaction.

Excluding acquisition costs, operating expenses were up 18% for the quarter due principally to the three acquisitions made in 2003 after the first quarter, and to a lesser degree to increase compensation and benefits cost. Our operating efficiency ratio of 54.5% was likewise up from the 52.3% in the first 2003 quarter, and was equal to that of the last quarter of 2003.

With respect to the balance sheet, earning assets at the end of the quarter were up nearly 400 million over the comparable 2003 quarter, as a result of the Grange acquisition, which added approximately 260 million of assets. Organic loan growth of nearly 100 million, or 5.4% increase, and net securities purchases of 47 million.

Organic loan growth over the past four quarters reversed course in the first quarter of 2004 with the total portfolio falling 1% from the end of 2003, with reductions in both business and installment lending. Both of these lending categories were impacted by the severity of weather conditions in our upstate New York markets in January and February. Additionally, business lending has been effected by what we believe to be irrational and imprudent competitive behavior in certain of our markets. Our posture in these markets has been to remained steadfast to our high quality underwriting standards and to be prudent in pricing credit risk. However we are very encouraged by marks loan booking activity, which was up 26% over the first two months of the quarter. And we're hopeful this trend continues into what is typically a strong spring lending season.

Our capital levels remain very sound with a tangible equity ratio of 6.3% at the end of this quarter. Included in that capital is a market value adjustment on our ever well-managed securities portfolio of 47 million, which gives us a great deal of financial flexibility in managing our balance sheet. Which is an appropriate introduction to my final comment, which is that we are presently evaluating elective actions to prepay a portion or all of our outstanding Federal Home Loan Bank term borrowings, similar to what we did in the fourth quarter, which effectuated would result in a one-time after-tax prepayment cost of up to $20 million. We believe that such a debt prepayment is likely to result in the strengthening of our interest rate sensitivity profile, optimization of future earnings performance, and improvements to longer-term return on equity.

That concludes our prepared remarks, and we would now ask the operator to open the line for questions.

Thank you, sir. If anyone has a question or comment, please press 1 on your touch-tone phone.

Thank you. Our first question comes from Bill McCrystal from McConnell Budd. Bill, your line's open.

Good morning. Last things first here. On the Federal Home Loan Bank, can you give us some sense of what the impact would be margin-wise and going forward, and also best guess at the likelihood of going ahead and doing it.

To answer your first question first, there would be an upward revision to our net interest margins, of course, because we would be ultimately refinancing those term borrowings, which right now are about six years out, with a coupon of about 5.8% or so, and we would expect to refinance those for a shorter term maturity. We're looking at a number of different variables, but potentially converting those to term borrowings again, but with a shorter maturity, so we would pick up a differential there in our margins, which would improve our margin going forward, obviously. We're still evaluating the potentials, however.

The other point I want to make on that is that we're doing this to -- as much as optimize our future earnings performance and enhanced return on equity, really to help us better manage our balance sheet on a longer-term basis. That's really the genesis of this, Bill, is to help us better reduce interest-rate sensitivity that we have in certain time frames in our balance sheet right now based on our current analysis.

Would you also -- would you think that there'd be restructuring on the investment portfolio side also, if you were to undertake this?

No. That's not one of the things that we're -- that we are looking at right now. We've looked at some leverage strategies. Obviously there's been opportunities in the marketplace and we've capitalized on those to some degree as of late. But not in a significantly material fashion, but that's something that we also look at.

But I don't think what -- one of the things we're not looking at is any kind of sale of our investment portfolio. As you know, we've been very pleased with the performance of that portfolio and one of the downsides, if there is one of that success, in managing the portfolio over the last several years, has been the significant increase in the market value adjustment which has had the effect of impeding and our return on equity.

And, I don't know whether you intentionally or -- the likelihood of going ahead and doing this?

I'm sorry. We're still evaluating the alternatives but at this point I would say it's more likely than not, or at least equally likely as not.

That's fair enough.

Maybe you could comment a little bit about you mentioned that March bookings were up. A comment about the mind set of the customer given the current economic conditions, and what your thoughts are for loan growth going forward.

We have seen some renewed interest on the part of our commercial customers now that the long winter is behind us. So we're seeing some increase in commercial activity. We also are seeing some early payoff from the energy and momentum that we're building in the Pennsylvania markets.

Our mortgage business has held up quite nicely through mid-April 2004. So we've been pleasantly surprised that the pipeline has remained vital and reasonably strong. Not quite as strong as last year, but still very solid.

We've just -- are just launching direct installment loan promotion program which we hope will generate additional direct installment business, and as both Mark and I noted, we've had continuing gradual success with our indirect installment lending business, and the performance on the indirect installment portfolio continues to be very strong. The charge-offs remain below 1% as they traditionally have, and the delinquencies are very well-behaved.

How is the current financing -- by the cap is, basically zero percent? And is that more of an impact than the weather, or is it a combination of both?

Our business is largely used in executive autos , so we really only get an indirect effect from the manufacturer programs in the sense that to the degree those programs are more attractive, they may persuade some buyers who might otherwise be used car buyers to buy new cars, and we'd lose those transactions. But we're not really directly affected as much in the new car business because that is not the primary focus of our portfolio.

Okay. Thanks very much.

Thanks, Bill.

Thank you. Your next question comes from Claire, and I apologize, Percarpio from Janney. Claire, your line's open.

Hi. The operator interrupted me during part of the discussion on the net interest margin pick up, but I'm going back to this Federal Home Loan Bank idea. Did you say what your payback period would be, and what your interest-rate sensitive posture is now, and what it would be after this?

What we do, Clare, is we analyze our balance sheet and the performance of our net interest income over a variety of different scenarios out into the future using changes in rates, as well as changes in the shape of the curve.

Right now, our interest-rate sensitivity over the near-term is to rising interest rates. At some point beyond that, not too far beyond that, in between a year and two years, we become more rates down sensitive. So the primary motivation for this analysis of the debt prepayment really is to on a longer-term basis out beyond a year-and-a-half, let's say, to two years is to reduce our overall interest rate sensitivity in those time frames.

And that's why, Claire, this is Joe Lempsheck, the reason we're looking at possibly replacing these borrowings and not simply converting them to short-term borrowings, is as Mark said, we have some sensitivity in the very near-term.

And so what we'd like to do is lock-in a lot of that curve differential between the 585 rate that we're currently paying on those six-year borrowings, and trying to establish a much lower rate on those cost of funds for at least the first two years. It's really in those outer years that we have some of that interest sensitivity to flat or falling rates, as the rest of the time deposit base brings prices to its lowest level. And because we have this strong core deposit base, if rates begin to rise down the road, that core deposit base we feel will be very effective at hedging our interest-rate -- or risk to rising interest-rates some point down in the future.

Claire, also to answer your question on the payback period, we don't look at it in the sense of a payback period, because that implies that it's a -- an investment that's going to provide some kind of a return. Now, there is a -- in a sense if rates stayed the same, there would be a payback period that would be roughly equivalent to the six-year term of the borrowings that we'd be prepaying.

Okay.

In addition, Claire, we look at this on a net present value basis as well. Obviously, there's a penalty to pay on paying these borrowing off, but when we look at the net present value of where we would be putting those funds today, as well as the net present value of what that cash flow stream currently is, we feel that the net present value numbers work in our favor, particularly dependent upon what our interest rate risk is in the future.

Okay. So just to summarize, what kind of a net present value do you come up with, and what interest rate scenario are using if you were to, you know -- if you were to say we're going to do this, what would that scenario be?

It depends on which scenario you're looking at. We have to look at it in all scenarios both the rising and falling rate environments. We're not claiming to have it all encompassed in just particular one scenario.

Maybe I should get into this more off line, but are you assuming the Fed's going to go up 100 to 200?

We looked at it across all potential interest-rate environments, including on a shock basis changes in the shape of the yield curve. That's how we applied a net value present value calculation to it in that fashion.

One of the things particularly compelling about this, Claire, is it does, as both Mark and Joe have said, give us an opportunity to enhance, improve our interest-rate risk profile. At the same time that we can enhance our return on equity.

So it's really in our judgment and low risk, well-managed risk way to effectively leverage of the equity base in this company and enhance returns to shareholders. We've not done this, at least at this level at this order of magnitude in the past, but the circumstances are such and the way we manage to the balance sheet through time puts us in a position where we think this is a pretty attractive opportunity to enhance value for shareholders in a pretty low risk, well-managed way.

Okay. Let me switch gears then. Can you give more color on the competitive pressures in your market? Is it other banks? Is it credit unions?

Well, I would say with respect to asset generation, Clare, it's largely other banks. It's largely smaller community-sized institutions, and it's largely concentrated in the Pennsylvania markets. So that's where we've had, I'd say, the greatest amount of challenge in holding and adhering to our underwriting standards, getting reasonably paid for the risk that we're taking, and we have experienced, as we reported earlier, we have experienced some erosion of business down there.

Okay. Is the lower tax rate in the quarter sustainable? I mean, if you're not changing your investment portfolio?

It's similar to what was in the last quarter, and we do an analysis of that every quarter, Claire, to make sure we're right on with where we need to be, and we think right now that it's where it needs to be for the quarter. That isn't to say that an analysis next quarter won't give us a different answer one way or another, depending on results, but we're very comfortable with it for the first quarter.

One last question, what is the duration of your bond portfolio?

I want to say--let me grab the portfolio here--the duration currently is 4.73.

And does that -- when your callables roll off, does that portfolio -- is the yield and the duration change sort of dramatically at all over the next couple years? You've got an awfully nice yield on the portfolio at the moment.

Well, I think a lot of that has to do with the sensitivity of the portfolio. Let me pull out another look here. In terms of duration, if rates go up 200 basis points, we see the duration going from 4.73 to 5.25. If rates fall 100 basis points, we see the duration going from 4.73 to 4.50. So there's not a lot of fluctuation in either extension risk or shortening of that portfolio. A lot of that has been due to buying much more in the way of bullets, and longer-term uni's, and not being in the mortgage-backed product that so many people have been hurt with in terms of the performance. So, that's the type of portfolio I think you want to see where it doesn't have a lot of fluctuation in average life or duration.

Right. Yeah, that's terrific. And that's not going to change much. What's the life [inaudible] of the callable protection? Is that just a portion of the portfolio?

Yes, that's just a portion of the portfolio. I'd say it probably makes up a third of the portfolio at this point in time.

Okay. Thank you.

Thank you. Our next question comes from Andy Stapp from Cohen Brothers. Andy, your line's open.

Good morning, Andy.

Good morning. I was just wondering if you could provide some insights regarding the sequential decline in deposit service fees?

I think there is no real explanation other than just the variability in that line. From quarter to quarter you can see that it does tend to vary a bit from quarter to quarter, but there is nothing in there, Andy, that's wholly unusual in any respect.

Okay. How about the 24% sequential rise in benefit administration fees? Are any the first quarter contingent payments in there?

No. That's -- that's fee income.

Okay.

And that increase is principally driven by the strength of that business, which as I said in my comments over the past 12 months has shown, I think it was 30% or so, organic growth.

Okay. On the wealth management side, your fees have been declining over the past few quarters despite a rise in assets under management. Is that just a function of the mix in the assets under management?

Some of it's a function of -- some of it's a function of the mix and some of those businesses have started to turn around to a greater degree than other of those business lines are -- those businesses delivered about single-digit revenue growth in the quarter over the prior year, so they have been, as you observed, relatively flat.

They have -- one of the things that's affected some parts of those business is that the margins, the fee-based, the asset-based businesses. The fees on average are declining, and have been declining slightly over time because of the -- similar to all of the asset-based businesses, not just ours, but others as well, because of the competitive environment of that particular business.

Okay. All right. You're sequential deposit growth was sluggish, it is that a seasonal phenomenon?

It does tend to be seasonal. The other thing is that it bounces around depending on the timing of municipal deposits and other such things, so I would chalk it up more to seasonality and the typical fluctuations, particularly as it relates to the municipal deposits.

Right. That's what I thought. Okay. The rest of my questions have already been addressed. I thank you.

Great, thank you, Andy.

Thank you gentlemen. There are no other questions in queue.

Thank you very much. We'll talk to you next quarter. Thanks a lot. Thanks, Operator. Bye-bye.

You're welcome. Have a great afternoon.

Thanks.