Community Financial System Inc (CBU) 2004 Q4 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. (Operator Instructions).

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.

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;

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

Gentlemen, your line is open.

Thank you very much, Linda, and welcome to our fourth-quarter and year-end review.

I will make a few overview comments and then turn the presentation to Mark and Scott for a perspective on our operating and financial performance.

2004 was a very substantial year for Community Bank.

We're certainly pleased with our record earnings and operating performance.

We are especially gratified by our distinguishing and consistent record with respect to asset quality, as all of the key metrics improved over the course of the year.

Such consistent performance on asset quality is a manifestation of the most significant and enduring accomplishments of the year, namely the enhancement of our organization structure to more effectively deliver to customers across all products and markets and the strengthening and deepening of our senior management team to sustain the success of our strategy and performance.

The year featured several other very noteworthy achievements for shareholders, including a stock split early in the year, completion of our stock repurchase program, another dividend increase in August, 2 important and successful acquisitions and the wonderful recognition of our durable performance by inclusion in the S&P Small-Cap 600 Index in August.

Mark?

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

It was a strong fourth quarter and an active and successful full year of operating results for Community Bank System.

We delivered record earnings in 2004 -- over 50 million, for the first time in fact, led by strong margins, consumer loan demand, strength in the asset quality, improved non-interest income from banking activities, and the continued growth of our wealth management and employee benefits businesses.

As Sandy commented, we remain very pleased with asset quality in particular, including a 30-percent reduction in charge-off ratios and the lowest nonperforming and delinquency rates we've achieved in several years.

Balance sheet growth in 2004 came in large measure through acquisition, including the 275 million assets First Heritage Bank in Wilkes-Barre, Pennsylvania that closed in May, and a branch transaction in December in Danville, New York.

Consumer loan demand, including mortgage and installment lending, led organic loan growth, with commercial lending being down slightly year over year.

Other noteworthy operating objectives achieved over the course of 2004 were the expansion and strengthening of our management team, as I discussed during the third-quarter call, and the initiation of a number of significant technology projects designed to enhance our lending and branch capabilities.

I would now ask Scott Kingsley, our Chief Financial Officer, to comment further on the company’s fourth-quarter and full-year financial performance, as well as our expectations for 2005.

Scott?

Thank you, Mark, and good morning.

As Sandy and Mark have commented, we are pleased with our fourth-quarter and full-year earnings results.

Fourth-quarter diluted earnings per share of 40 cents were up 8.1 percent from the fourth quarter of 2003, excluding an after-tax debt restructuring charge of 1.6 million in the fourth quarter of 2003.

Full-year diluted earnings per share of $1.64 were 10 percent better than 2004's results and marked a new high.

Cash earnings per share, which excludes the after-tax effect of the amortization of intangible assets, were $1.78 versus $1.61 in 2003, a 10.6-percent improvement.

These increases resulted from acquired and organic growth in earning asset levels, strong growth in non-interest income, and improved asset quality, despite a lower net interest margin.

First, I will address the balance sheet.

Total assets declined $30.7 million in the fourth quarter, split almost evenly between investments and loans.

All of the decrease in loans was in business lending, which included some expected seasonal reductions, as well as some unscheduled commercial line payoffs.

Deposits were up $9.9 million in the quarter but included $32.6 million from a branch acquisition.

Borrowings were down 51.1 million from the end of the third quarter.

For the year, total loans grew 10.8 percent, including acquisitions.

Organic growth was 1 percent, with 3-percent growth in consumer products being offset by a 4-percent reduction in business lending.

Including acquisitions, deposits were up 7 percent year-over-year but declined 1.7 percent organically.

Our capital levels remain strong, with a tier-1 leverage ratio of 6.94 percent.

Our tangible equity ratio improved to 5.82 percent at December 31st, despite a 10-percent decline in the investments market value adjustment in the quarter.

Tangible book value per share of $7.90 was 7 percent higher than the end of the prior year.

Shifting to the income statement, the continued flattening of the yield curve in the fourth quarter resulted in a lower net interest margin, declining to 4.32 percent from 4.35 percent in the third quarter and 4.59 percent in the fourth quarter of 2003.

The yield on earning assets increased 5 basis points from the third quarter to 6.05 percent, but the cost of funds increased 10 basis points to 1.75 percent, due primarily to higher short-term borrowing costs.

The loan loss provision was $2.1 million in the fourth quarter and was 0.2 million and 1.0 million lower than the third quarter of 2004 and the fourth quarter of 2003 respectively.

Net charge-offs, delinquency, and nonperforming loan ratios all showed improvement over 2003's fourth quarter.

On a year-to-date basis, the provision for loan losses of $8.8 million was 21.8 percent below the 11.2 million recorded in 2003.

Full-year net charge-offs of 8.4 million were $1.8 million below 2003's results.

This improved asset quality profile is the result of the Company's enhanced credit risk management programs and continued emphasis on disciplined underwriting standards.

Non-interest income was up 5.2 percent over the fourth quarter of 2003, excluding the debt restructuring charge incurred in the prior year.

The 11-percent decline from the third quarter was due primarily to the receipt of the annual NIDA (ph) dividend in the prior quarter.

On a year-to-date basis, non-interest income increased by $6.6 million or 17.3 percent over 2003 to 44.4 million, again excluding the debt restructuring charge in 2003.

Our banking and financial services businesses both experienced solid growth, including very strong performances from our retirement plan administration and broker-dealer businesses.

Operating expenses, excluding acquisition expenses, were up 1 percent over the third quarter and included some additional statutory compliance costs, including those related to Sarbanes-Oxley requirements.

On a year-to-date basis, operating expenses, excluding acquisition expenses, were up 15.6 percent over 2003, supporting the full-year increases in net interest income and non-interest income of 14.6 percent and 17.3 percent, respectively, and reflect the additional day-to-day operating expenses from the 2 whole-bank acquisitions completed in the last 14 months.

Now, I would like to make a few comments on 2005.

The expected flattening of the yield curve in 2005 will continue to compress our net interest margin, projected at 5 to 7 basis points per quarter through the fourth quarter and reflective of the near-term net liability sensitivity of our balance sheet.

We are expecting low- to mid-single-digit growth in loans and deposits and have interviewed several new and enhanced product offerings to support those objectives.

We expect asset quality trends to continue at or near 2004's results.

We believe we can achieve growth rates in non-interest income sources of 9 to 12 percent in 2005 from a combination of banking and financial services initiatives.

Operating expenses, excluding acquisition costs, are expected to increase 5 percent over 2004, including an estimated 2-cents-per-share impact of the expensing of stock options, beginning in the third quarter of 2005.

Our effective tax rate should be similar to 2004's, assuming a relatively consistent mix of exempt versus fully taxable income sources and no significant legislative changes.

We also expect to reposition certain components of our investment portfolio in order to maximize their total return opportunities, as well as shorten the net expected duration.

In the current interest rate environment, we expect these repositioning activities to result in securities gains of between 6 and 10 cents per share in 2005.

In summation, despite the contraction of the average net interest yield to approximately 4.15 percent for 2005, we are currently projecting full-year earnings per share of $1.65 to $1.70.

Now, we will ask the operator to open the line for questions.

(Operator Instructions).

Kelly Hinkel, McConnell, Budd, Romano.

2 questions for you.

What were the deposits acquired in the branch acquisition?

I missed that.

I know you said it.

About 32 million.

32 million -- okay.

And I understand you will be doing an investment portfolio repositioning.

But where do you stand now in terms of the vulnerability of your mark to (ph) rising rates?

Kelly, we continue to still have a strong market value position within the portfolio as of year-end.

And as you know, the yield curve has flattened even more since year-end.

So there really hasn't been much change in the market value from what we were actually reporting there.

We suspect that in an up-100 basis point environment direct shift, we'll probably be breakeven in the market value of the portfolio.

So we would probably be breakeven with the 10-year, close to 5 percent in the market.

Andy Stapp, Community Bank.

You mentioned that the linked quarter decline in loans was primarily due to a decline in commercial.

And was that in Pennsylvania or New York?

It was in both marketplaces, Andy.

Okay.

And there was a pretty sizable linked-quarter increase in compensation expense in the quarter -- linked quarter.

Could you tell me what was going on there?

Andy, I'm looking at -- on a linked quarter basis?

Yes.

I'm actually looking at a small reduction.

If I go across the line for salaries, employee benefits, and fees, I'm actually seeing about an $80,000 reduction on a linked-quarter basis.

Let me see -- I was -- I thought it (multiple speakers).

Andy, maybe if your question was back to going from the fourth quarter of '03, where we are showing an increase of about $700,000, probably about half of those expenses would have been related to the Grange and the First Heritage acquisitions, with the remainder related to some additional professional fees and some costs of employee benefit increases in '04.

Okay.

Maybe I was looking at the -- got my dates screwed up.

Okay, that's all I had.

Claire Percarpio, Janney Montgomery Scott.

Thank you very much for giving us specific guidance on the margin and the earnings per share.

That's really very helpful.

I wanted to ask -- on the net interest margin outlook, is this reduced margin outlook almost entirely due to the yield curve environment, or are there some other things going on there that you can help us understand?

And then second, if you can give us any more sort of color to your expectations behind what you suggested for loan and deposit growth being low to single-digit.

Okay.

Certainly, Claire, on trying to answer your first question relative to the flattening yield curve, certainly that is the biggest driver of the continued erosion on the net interest income side.

Certainly we expect a portion of our loans to reprice as rates pick up -- where we have variable interest or the opportunities for repricing.

But we have, certainly from an expense standpoint, the cost on the borrowing side is where the difference or the lion's share of the additional costs are coming from, and we will have more of a deposit focus in 2005 than we have had over the last couple of years, just given the impact of where wholesale funding has been versus retail funding.

Relative to your second question, in terms of loans and deposits, certainly I think that we have initiatives in place across all of our product offerings.

We certainly are not pleased with a 4-percent drop in commercial lending.

We had some anticipation of some of that after the acquisitions in Pennsylvania during the year, but at the same point in time, we certainly think that the commercial side of the portfolio needs to show positive trends for us going forward.

And we think, on the consumer side, if we were capable of getting 3 percent in the '04 environment that our processes and products in place should lead to little bit of a higher rate in 2005.

And I think also, Claire, we have recognized that in some of the marketplaces we operate in, that we have kept a very high margin in place across our portfolio.

And we suspect that there may have to be some competitive pricing discussions.

(Operator Instructions).

David Chiaverini, Advest.

My question is regarding the repositioning of the balance sheet.

When did you say that was going to occur?

Dave, I think our plan is to do that throughout 2005.

Certainly, there is some reinvestment risk to do it all at an early or a concentrated time frame.

So, I think we will believe that will occur throughout the year.

And when you define reposition, are you saying that you're going to reduce borrowings or are you just going to take a different duration on those securities and keep them (multiple speakers) --

I think (multiple speakers) to keep the balances very similar to where they are today and to take a shorter duration.

Okay, okay.

Have you considered just lowering the amount of borrowings to assets and maybe doing a buy-back instead?

Well, one of the expectations, Dave, is to be more aggressive in terms of the deposit gathering.

If you look at our -- over the last couple of years, we haven't been as aggressive because the alternative cost of funds -- the wholesale cost of funds was just much more attractive than the retail cost of funds.

I think that has started to change now, given where interest rates seem to be headed.

So we are going to focus more aggressively on reducing overall borrowings through the generation of retail deposits, going forward in 2005.

Okay.

And in order to get those deposits, are you seeing deposit pricing pressures and you're going to have to start paying up?

I think that there will be deposit pricing pressures.

I think that certain deposit categories are less sensitive to changes in rates than others, and I think we have a good sense of which ones those are.

I think we do need to get a bit more competitive on some of our CD products in some of our markets, which we've already begun to do.

So I think between the introduction of more attractive deposits, deposit products, as well as some more aggressive pricing in the right places, in the right markets, in the right amounts, we think we can accomplish that.

Okay.

And then on the commercial lending side, do you think it's a slowdown in your markets overall, or do you think that you're not lowering your pricing on the loan side enough to get more share or to get some of those loans up?

What do you see going on there?

I think there may be -- some of it may be pricing.

We've focused a great deal on maintaining our asset quality and our underwriting standards over the course of the last couple of years -- and, I would even say even, overall, maybe have strengthened those a bit through better credit administration and loan review and loan workout and a lot of other focuses.

But I do think we need to be a bit more aggressive in the marketplaces we are in.

I don't mean as it relates to underwriting, because we won't do that.

There is a fair bit of sometimes irrational behavior in some of the markets that we're in, which is not something that we chase after.

So I think we just need -- it's a matter of being more externally aggressive in some of our markets.

And I think pricing is also going to be important.

But as you know, strong margins have always been important to us.

And we will continue to pursue strong margins.

But I do think, in order to balance out some of those volume-related expectations, that we're going to have to at least be very focused on pricing as well.

Okay.

And the hire -- I shouldn't say the new hire, but the promotion of Mr. Wentworth -- is he going to be focusing on trying to get some of the commercial lending or commercial loans up?

Is that going to be one of his focuses?

His focus, Dave, is going to be more on the retail side.

More on the deposit generation, making sure we have the right products in the right markets at the right prices to compete effectively and to achieve our growth goals for 2005.

So his focus will be more so on retail, but some of his responsibilities will cross over into commercial, in terms of advertising and pricing in certain other areas.

Jared Shaw, Keefe, Bruyette & Woods.

I just had -- it was 2 questions.

One on the securities gains -- looking for the 6 to 10 cents for the year.

Will that be spaced out over the course of the year, or is that going to be taken more towards the beginning of the year?

Jared, we expect that that will space out during the year.

Again, I think we're looking at that relative to the underlying reinvestment risks.

So I think we expect that to be spread throughout all 4 quarters.

And then is that 6 to 10 cents included in your guidance of 1.65 to 1.70?

It is, Jared.

Okay.

And then finally, just looking -- I think this goes back to an early question.

Looking at the salaries and benefits line out in this quarter of 16.6 million, comparing it to prior, did you restate that number and include some other things in it?

Because if you look at last quarter's press release, it looks like it grew from 15.6 for third quarter to 16.6 for third quarter.

Jared, I think we just grouped salaries and benefits and professional fees.

We may have had some of the fee side grouped differently.

I can certainly follow up with you on that after the call.

That may just be a reclassification.

You're right.

Yes, it looks like something was moved from other to the salary line.

So you think that's professional fees?

I'm sure that's what it is.

Thank you.

There are no other questions in queue at this time, gentleman.

Thank you all very much.

Bye-bye.