Community Financial System Inc (CBU) 2004 Q3 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 that feature will be explained later in the program.

Before we begin today's call, I would like to remind you that this presentation 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 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;

Mr. Mark Tryniski, Executive Vice President and Chief Operating Officer; and Mr. Scott Kingsley, Chief Financial Officer; and Mr. Joseph Lemchak, Senior Vice President and Chief Investment Officer of Community Bank System.

Gentlemen, your line's open.

Thank you, Linda.

And welcome, all, to our third-quarter call.

I am delighted to be joined in this presentation this morning by Mark and Scott and Joe, who will report on our operating and financial performance, which is, once again, strong and consistent with our positive trendline.

I want to focus my comments this morning on three significant events in the third quarter, all of which have been previously announced.

The first is our 12.5 percent increase in the dividend to a quarterly rate of 18 cents, an increase of 2 cents per quarter.

This increase represents our fifth increase in six years, and reflects our commitment to reward shareholders with both appreciation and yield.

The second consequential event was our selection for inclusion in the S&P Small Cap 600 Index on August 31, 2004.

We are deeply honored to be included in this widely-respected index, and believe our selection was predicated in good measure on our consistent performance over the long term.

The third notable event was the completion of our senior management team, promoting Brian Donahue to Chief Banking Officer, Tim Baker to Director of Special Projects, Mike Wilson to Chief Technology Officer, and Dave Clark to Chief Credit Officer.

To quote from our September 27th release, their deep understanding of CBU's strategy and demonstrated ability to execute it successfully augur well for sustaining our strategy and performance.

Mark?

Thank you, Sandy, and good morning to everyone joining with us on the call today.

It was an active and successful third quarter for Community Bank System.

We delivered strong and high-quality earnings, led by consumer loan demand, record levels of non-interest income from banking activities and the continued strength of our wealth management and employee benefit businesses.

We remain very pleased with asset quality -- in particular, the modest level of charge-offs and the lowest delinquency rate achieved in several years.

In August, we announced an agreement to acquire a branch from HSBC, located in Danville, New York, where we already have a significant and rapidly growing presence.

This transaction will provide us a dominant share in the Danville market, and is expected to close in December.

Of significant note to shareholders, as Sandy mentioned, in August we announced a 12.5 percent increase in the common stock dividend, reflective of the strong performance of the Company and CBU shares over the past year.

And, as Sandy already noted, our addition to the S&P Small Cap 600 Index should serve to further strengthen the liquidity and visibility of CBU shares in the market.

Lastly and just as importantly, I would like to also comment on the management appointments we announced this past month.

Sandy and I are both very pleased we have further strengthened our management team, including the appointment of a Chief Banking Officer, a Chief Technology Officer and a Director of Special Projects.

All of these posts were assumed by internal candidates with extensive experience, and reflect our commitment to grow our human capital as we continue to grow our Company.

I would now ask Scott Kingsley, who joined us as Chief Financial Officer just this past June, and whom we introduced during the second-quarter earnings call, to comment further on the Company's third-quarter financial performance.

Thank you, Mark, and good morning.

As Sandy and Mark have commented, we are pleased by our third-quarter earnings results, with operating basis earnings per share up 2.3 percent from the third quarter of 2003, and year-to-date results up 5 percent over the first nine months of 2003.

These results were driven by growth in earning asset levels, favorable asset quality results and strong revenue growth in our financial services business.

First, I will address the balance sheet.

Total assets grew $67 million in the third quarter, including $27 million of loan growth driven by strong demand in consumer installment and mortgage lending.

Business loans were basically flat.

Borrowings were up $38 million in the quarter, while deposits declined $16 million.

Nearly half of that deposit decline was in public funds, consistent with seasonal expectations.

Our capital levels remain strong, with a Tier 1 leverage ratio of 6.76 percent.

Our tangible equity ratio increased to 5.68 percent at September 30th.

Tangible book value per share of $7.80 improved 13 percent over the second quarter, and was also up slightly from September 30, 2003, which was prior to both the Grange and First Heritage acquisitions.

In addition, during the third quarter, we completed the previously announced share repurchase program by buying 280,713 shares for treasury at an aggregate cost of $6.3 million.

Shifting to the P&L, the low net interest rate environment and flattened yield curve in the third quarter resulted in a lower net interest margin, declining to 4.35 percent from 4.49 percent in the second quarter, and 4.63 percent in the third quarter of 2003.

The yield on interest-earning assets declined 10 basis points from the second quarter, while the cost of funds increased 4 basis points, due primarily to higher short-term borrowing costs.

Despite this expected (technical difficulty) in this ever more challenging interest rate environment.

The loan loss provision for the third quarter of $2.3 million was equal to the amount recorded in the second quarter of 2004, and was up only $271,000 from the third quarter of 2003, despite a $483 million increase in average loans outstanding over the last year.

The ratios of net charge-offs, delinquencies and nonperforming loans to total loans outstanding were all improved, compared to last year's third quarter.

On a year-to-date basis, the provision for loan losses of $6.7 million is $1.5 million below 2003.

Net charge-offs of $5.5 million year to date are $2 million below 2003's results.

Non-interest income, excluding security gains, was up 24 percent over the comparative 2003 quarter, and 15 percent over the third quarter of 2003, excluding a $795,000 prior-year secondary mortgage market impairment charge.

Revenue growth was particularly strong in our employee benefits and wealth management businesses.

In addition, consistent with the last several years, the third quarter's non-interest income reflects receipt of the annual NIVA (ph) dividend.

Excluding acquisition costs, operating expenses were up 19 percent over the 2003 quarter, due principally to the additional recurring operating expenses from the four acquisitions completed since last year.

Third-quarter operating efficiency ratio of 50.7 percent compared favorably to the prior year, and on a year-to-date basis, our efficiency ratio improved from 53.0 percent in 2003 to 52.7 percent year to date in 2004.

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

(OPERATOR INSTRUCTIONS).

Lydia Wright (ph).

It's Claire Percarpio.

Can you give comment on your outlook for the net interest margin?

And if you have answered this, I apologize -- perhaps give us some sense of interest sensitivity and margin outlook for the fourth quarter.

And I don't know if you want to do that into next year.

A little more color on the loan growth on the commercial side and in the New York and PA markets, and on that nonperforming increase?

Thanks.

Well, let me, I guess, take those in order, Claire.

I think in the margin we were off a little bit this quarter, as Scott suggested, which was consistent with what our expectations were, given the changes in the interest rate environment.

We did, however, have to kind of dissent the change in our asset yield from quarter to quarter.

We are showing an increase in commercial.

Our yields on the commercial have already started to reprice upward.

So we did have an increase in the yield on the commercial loan assets from second quarter to third quarter.

The yield on the installment portfolio and the mortgage portfolio were down a bit off second quarter, which is what we expected.

In terms of the cost of funds, I think they were down a couple of basis points from the second quarter.

They were essentially flat;

I think that they were down 2 or 3 basis points, is all.

So we are relatively pleased with where the margin is right now, and we think that into the fourth quarter, we are likely to get a bit more compression.

I think our ability to lower deposit costs has essentially hit bottom.

As I said, we only achieved a 2 or 3 basis point reduction from the second quarter to the third quarter.

We expect that our commercial yields will continue to increase into the fourth quarter, but I think it's going to take a little bit longer for the changing interest rate environment to manifest itself in higher yields, as it relates to our installment and mortgage portfolio.

So I guess, in summary, Claire, we would expect that the fourth-quarter margins would be down a bit from where they are right now.

I guess I don't want to comment in great detail, as it relates to 2005.

That is, as you understand, highly contingent upon where the yield curve goes and where interest rates go out into the future, which could be affected by a number of events, including political, geopolitical and economic and the like.

But we do expect that there will be -- again, we have hit rock bottom in terms of repricing our deposits down, so we expect a flattening of our deposit pricing and, again, further slight compression into the fourth quarter of this year.

Sandy, do you want to --?

No.

I was just going to comment on the nonperforming loans, Claire.

The increase over the end of June, I think, is largely attributable to the unwinding or the winding out of problems that have been with us for some time, rather than any particularly newly emerging problem credits.

And the number, while modestly higher than at the end of June, is still within what we would consider to be the acceptable range, and we are actively working to bring that back down into the lower end of the range.

So nothing extraordinary involved in that slight increase in nonperforming loans.

There was one credit that was $1 million or so, a hair over, that was added into the NPA bucket in the quarter.

I think the last question you had, Claire, related to loan growth.

And I guess I would characterize my response in terms of organic loan growth.

As Scott has said, loan growth in the consumer area, both the mortgage lending and the indirect installment lending, has been very strong.

Year to date through the first three-quarters of the year, organic loan growth in total is about 2 percent.

For the third quarter alone, it was a little over 1 percent.

So the organic growth in the third quarter was reasonably strong, annualized to almost 5 percent.

I think you wanted some color, as well, on the breakout of that between the New York and Pennsylvania markets.

Organically, year to date -- well, in the third quarter, the New York market was up about 1.6 percent organic, and the Pennsylvania market was about flat.

Year to date, New York is up about 4 percent and Pennsylvania is down a bit.

But what we have seen in Pennsylvania is a lot of pipeline activity in Pennsylvania.

Another thing that is very encouraging to me, which really, I think, helps us certainly justify the reasons why we entered into the First Heritage transaction was to leverage those deep commercial relationships that First Heritage has into a larger capital base, so that we can make larger loans.

Down in Pennsylvania, we're actually starting to see that.

So there's a very encouraging pipeline in Pennsylvania.

And again, our growth there was flat this quarter, but the pipeline looks very strong in Pennsylvania.

That's very helpful, and thank you.

It looked like a good quarter.

Bill McCrystal, McConnell, Budd, Romano.

Well, Claire took care of most of my questions.

But I do want to follow upon, Mark, what were you speaking about in Pennsylvania, as far as the flat growth in the quarter and year to date being slightly down.

Do you feel that it's market-driven, or do you think that you just haven't gotten the traction yet in some of these markets, with recognition and so forth, as far as your ability to grow in those markets?

Well, I think there's always a little bit of that, Bill, in terms of getting up to speed in the marketplace, and the challenges that you always face when you are converting an existing franchise with very strong brand value in the market into another brand.

And I think that we have gotten traction in Pennsylvania, as I just suggested.

Our pipeline in Pennsylvania is very strong, and a lot of that is an outgrowth of the Heritage transaction and the relationships that we have in northeastern Pennsylvania, which are very deep, and the ability to leverage those relationships through larger credits.

So I think we are clearly on an upward trajectory in Pennsylvania, in terms of where our expectations are going (indiscernible).

Do you think there is anything to the fact that maybe some of the local community banks are -- and I don't know this; maybe you can help me in this way.

Are they sort of looking at you guys now as the big bank coming in from out of market?

Is that a strategy you are seeing?

That's a good question.

I should have commented on that, because I think that's an important point, when we're talking about the northeastern Pennsylvania market, which is that it is a -- I would characterize it as a more competitive market overall than our New York markets are overall.

I think I commented last call about what we felt were oftentimes irrational decisions being made by some of our competitors in some of those markets of Pennsylvania -- clearly not all of those markets.

But it is some of those markets, and we have (technical difficulty) sized credit go, if you will, because we did not want to compete on terms and underwriting standards.

We still continue to see a little bit of that in the northeastern Pennsylvania markets, but it's a highly competitive marketplace.

I think we are in there, certainly, competing with the bigger banks, the Wachovias and MNPs (ph) and Citizens and PNPs (ph) of the world that run into there, as well as the smaller community banks in northeastern Pennsylvania.

As you know, it's a fairly well-fragmented banking market; there is a lot of smaller community banks, and all of those community banks don't always behave in a way that is wholly irrational (ph).

But I think we have competed well down there, and our pipeline is pretty strong in Pennsylvania.

Bill, we have taken steps to finally and fully differentiate the First Liberty brand, and those actions, coupled with the deep confidence we have in the Pennsylvania leadership team and our decentralized approach to those markets down there, as all markets, means that we believe we are very well-positioned to continue to compete as a community bank, and compete effectively against the other community banks in those markets at the same time.

As Mark indicates, we compete very effectively against the larger banks.

And on the indirect side, could you give a sense of what the FICO scores are looking like today, relative to either a year ago or year to date, earlier in the year?

I know I had that for you, Bill, last quarter.

And I apologize;

I don't have that report sitting in front of me.

I know that --

Well, if you could just give a general sense?

I mean, is it stable?

Are you seeing improvement?

Just, I guess, the trend, sort of.

The trend, I think, continues to be that the FICO scores are going up and not down, in terms of the percentage of the new paper that we are putting on.

The average FICO scores are higher, as they were last quarter.

And again, I don't have that in front of me right now.

If we can get back to you with exactly those numbers?

But I think the A and B paper that we are underwriting is over 80 percent, as I think it was last quarter.

And I guess just one final question.

It probably doesn't apply, but is there any fallout or potential fallout on the insurance side from the ongoing investigations?

Nothing that we see, Bill, that is directly relevant to us at all.

Right.

I didn't think your business model would, but I figured I should ask, given it seems to be dominating a lot of the markets right now.

Other than maybe the ability to achieve some cost savings in our insurance negotiations next time around.

Andy Stapp, Cohen Brothers.

Good morning, and congratulations on a solid quarter.

How much did you increase interest rates on non-maturity deposits during the quarter?

Scott Kingsley Very modestly.

I don't believe we have moved any of our NOW accounts at this point in time, and if anything, there has been just a very modest movement in the money market fund.

Are you starting to see any competitive pressure on such rates?

Scott Kingsley Not so far in the marketplace.

Mostly what is being offered out in the marketplace currently is specials on time deposits, as opposed to wholesale movement in the NOW accounts.

You do see a lot of free checking accounts coming out now from some of the larger institutions, but the major specials that we are looking at tend to be on the short-term time deposit side.

And on your commercial loans, do you have any floors on your loans?

You mean on the prime-based loans, Andy?

Yes, where interest rates would have to go up sufficient to hit the floor, before you would get any pop on your interest income on some loans.

Are you talking about a cap or a floor?

Floor.

Yes, we would have some deals with some of our prime, variable-rate customers where we have a floor in how low the rate index to prime can go.

Okay.

You are below the floor now, is really what I am getting at, where your interest rate can't go up until you hit the floor, is what I am trying to drive at, how much of an impact that would be.

(multiple speakers).

Yes, I would say virtually none.

There are no other questions in queue at this time.

Thank you all very much, and we will talk to you in January.

Thank you.