Community Financial System Inc (CBU) 2005 Q1 法說會逐字稿

Good morning, and thank you all for holding.

Welcome to the Community Bank System's Call. (Caller Instructions.) Before we begin today's call, I'd like to remind you that this presentation contains forward-looking statements within the provisions of the Privacy Security 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 10-K filed with the Securities and Exchange Commission.

I would now like to introduce today's call leaders, Mr. Mark Tryniski, Executive Vice President and Chief Operating Officer, Mr. Scott Kingsley, Executive Vice President and Chief Financial Officer, and Mr. Joseph Lemchak, Senior Vice President and Chief Investment Officer of Community Bank System.

I would now like to turn the call over to Mr. Tryniski.

Please go ahead, sir.

Thank you, Judy.

Good morning to everyone, and thank you as well for joining with us on our first quarter conference call.

Mr. Belden will not be with us today as he is at this same moment representing our interests with the Federal Home Loan Bank in New York in his capacity there as a member of its board of directors.

So in his stead, I will make some overview comments on the quarter, ask Scott to give a more detailed summary of our financial performance, and then, open it up for questions.

Coming off a record year of earnings and accomplishment in 2004, we are off to a very strong start for 2005 as well with a first quarter that was right on with our expectations.

Our net interest margin held in a bit better than we forecasted, and the revenues of our employee benefits businesses continue to grow at a double digit pace.

Asset quality remains very solid, as it did throughout 2004, with charge offs and delinquencies showing even further improvement over the fourth quarter.

Consistent with the annual seasonality of lending demand in our markets, total loans outstanding were down 1 percent for the quarter, the greatest part of that reduction being in business lending Encouragingly, however, nearly a third of that decline has already been made up in the first few weeks of April as spring loan demand has begun to emerge.

The investment portfolio was down slightly for the quarter as we effected some of the portfolio repositioning we discussed during our January call, which Scott will discuss in further detail in his comments.

And lastly, deposit growth for the quarter was strong at nearly 2 percent with much of that increase attributable to our municipal relationships.

Scott?

Thank you, Mark, and good morning.

As Mark has commented, our improved first quarter earnings results were in line with previously communicated expectations.

First quarter diluted earnings per share of 43 cents were up 13.2 percent from the first quarter of 2004.

Cash earnings per share, which excludes the after tax effect of the amortization of intangible assets, were 47 cents per share versus 41 in 2004's first quarter, a 14.6 percent improvement.

These increases resulted from higher earning asset levels, improved asset quality, higher non-interest income, including securities gains, and lower acquisition expenses, partially offset by the increase cost of funds, higher recurring operating expenses, and a slightly higher tax rate.

I'll discuss the balance sheet first.

Average earning assets were up 14.5 percent over the first quarter of 2004, but declined $22.6 million, or .06 percent from the end of 2004.

Quarter end loans were down $24.1 million from December 31, 2004, consistent with the previous year's first quarter demand trend.

Business lending balances were down $14.6 million for the quarter, more than half of which can be attributed to an $8 million payout from a single Pennsylvania relationship.

Investment securities ended the quarter down $39.5 million, the result of several calls and our decision to take advantage of market conditions and sell certain securities in order to maximize their total return attributes and shorten the average life of the portfolio.

These sales generated a 3-cent per share after tax gain in the quarter.

Deposits were up $236 million, or 8.6 percent over the first quarter of 2004, and increased $48 million from December '04.

Although a portion of the deposit growth is attributable to seasonal increases from municipal customers, our refocused efforts on growing core funding sources are yielding positive results.

We were also able to reduce external borrowings by $65.6 million in the quarter, further reducing our interest rate sensitivity.

We have reduced external borrowings by over 12 percent in just the last two quarters.

Our capital levels remained strong with tier one leverage ratio of 6.83 percent at the end of the quarter.

Our tangible equity ratio declined to 5.57 percent at March 31, 2005, reflective of the 500,000 shares of common stock repurchased in the quarter.

Tangible book value per share of $7.58 was just under the $7.64 average reported for the trailing four quarters.

Shifting out to the income statement, despite the continued flattening of the yield curve in the first quarter, the net interest margin, excluding accretion on called securities, was 4.32 percent and was consistent with the fourth quarter of 2004, but 27 basis points lower than the first quarter of '04 as expected.

Our decision to allow a portion of the securities portfolio to run off and not completely reinvest resulted in the better than expected investment yield.

Loan yields were 5 basis points lower than 2004's first quarter, but were up 9 basis points from December.

Cost of funds of 1.85 percent was up 19 basis points from last year's first quarter, and was 10 basis points higher than the fourth quarter of 2004 with almost all the increase coming from higher short-term borrowing costs.

The loan loss provision was $1.9 million in the first quarter and was $.2 million lower than both the first and the fourth quarters in 2004.

Net charge offs for the quarter were $1.8 million compared to $2.9 million in the fourth quarter of 2004 and $2.3 million in last year's first quarter.

The loan loss allowance to total loans outstanding stands at 1.37 percent at quarter end compared to 1.35 percent at the end of December.

Non-performing loans to total loans outstanding are at .63 percent, consistent with the positive trends reported over the last four quarters.

The delinquency ratio improved to 1.35 percent at March 31, 2005, compared to 1.45 percent at December 31, 2004, and 1.65 percent at the end of last March.

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

Non-interest income, excluding security gains, was up 6.8 percent over the first quarter of 2004 and 3 percent above the fourth quarter of 2004, driven by a very strong performance from our employee benefits consulting and plan administration business.

A modest decline over the previous quarter in deposit service fees and other banking services was based largely on seasonal demands.

Operating expense, excluding acquisition expenses, were up 7.8 percent over the first quarter of 2004, and included the day-to-day expenses of the First Heritage and Dansville acquisitions completed in May and December 2004, respectively.

Amortization of core deposit intangibles of $2.0 million for the quarter were $345,000 higher than the first quarter of 2004, again related to these acquisitions.

First quarter operating expenses were 2.7 percent above the fourth quarter of 2004 with higher salary and benefit costs and increased occupancy expenses, including rents, utilities, and maintenance costs, being the primary drivers.

Our effective tax rate for the quarter was 24.9 percent compared to 24 for the first quarter of 2004.

The proportion of tax-exempt income to total income continues to be the significant determinant in our effective rate.

Earlier in April, the Board of Directors authorized a stock repurchase program to acquire up to 1.5 million more common shares, or approximately 5 percent of total outstanding shares, over the course of the next 20 months, or through December 31, 2006, for general corporate purposes.

Although our net interest margin for the first quarter was slightly above our previously communicated expectations, we continue to forecast small declines for the balance of 2005, based principally on higher expected funding costs.

We also plan to continue to be opportunistic relative to executing securities transactions, which can achieve maximum total returns, further reduce the portfolio's duration, and improve our overall interest rate sensitivity profile.

At this time, I'll ask Judy to open the line for questions.

Thank you. (Caller Instructions.) Okay.

Our first question comes from Richard Friary from Kelsey Management.

Richard, your line is open.

Good morning.

I know you talked a little bit about the loan growth or the loan decline and there's some seasonality and some other things going on there.

But going forward, what do you think you can grow loans and what are you going to do to really get that moving again?

I think that's an excellent question, Richard.

Good morning.

I think if you look--first to address the seasonality comment in the first part of your question.

I think if you look over the last several years, we tend to have a difficult time in the first quarter generating loan increases.

I think last year we were down around 1 percentage point as well.

And it really comes from the challenges in the first quarter of all the generating assets in our markets, because of the seasonality in all three of those portfolios.

It was particularly the business, the principal part of that decline, I think two-thirds or so was in business lending, as Scott I think alluded to.

We did have one large $8 million credit that paid out in the first quarter that we were aware of.

I think going forward, we're going to--we've been enhancing our business development efforts.

We've added to resources in all of our markets in terms of commercial lending and real estate lending and I think as you know, we are--we do not operate in markets that are going to achieve double-digit earnings growth in loans.

At the same time, if you look at our organic loan growth over the past trailing 12 months of about 1 percent, that's not sufficient as well.

I do think that the competitive environment has ratcheted up a bit.

We've always tried to focus on holding margins in there.

We've put a lot of emphasis on asset quality and credit administration the last year to two years, which I think shows in the decreasing provisions in losses that we've experienced.

I do think going forward we will have a more focused effort on loan development.

I think we are looking at the kind of dynamics in the tradeoff between margins and volume generation.

I think on the asset quality side that's an area where we are not prepared to make any sacrifices or discounts from our current posture.

Right.

It's great that the asset quality has improved and all, but if you ultimately over time aren't growing the loans sufficiently it's kind of hard to grow the business.

We don't disagree.

And I mean are these competitive pressures anything new?

I mean, is it something insurmountable?

Has somebody new come into the area and cut rates or anything like that?

No, certainly not.

I think, as I said, we've always been very attentive to margin and I think need to look more closely at the dynamics between the tradeoff of margin and rate.

I think clearly if we wanted to give up some margin we could certainly grow our loan portfolio much more dramatically.

And I think you make an excellent point, which is that growth is important to the future.

We certainly understand that, but again, have tried to balance that growth off with holding our margins in.

But because of the competitive pressures in some of the markets that we're in, we're going to need to take a closer look at that prospectively and are doing that currently in order to ensure that we continue to provide sufficient loan growth for our business going forward.

What would you say that primary demand for loan growth in your markets in overall?

I would say it's no more than a mid-single-digit number.

All right.

And that's going to vary by market.

I mean, some of our markets are less than that and some might be a little bit more than that.

But I would say that on average is a composite.

Is it reasonable to think that maybe you can get your loan growth to that level in the next 12 months, 18 months?

We think that's certainly a possibility.

That's what our expectations are.

If you look at what our--our internal expectations are consistent with that, Richard.

Okay.

Also, my next question, which I think is a little bit hinged to this, your return on equity.

I guess it's sort of an annualized number, 11.47 percent in the release.

And it has sort of been 10, 11, 12 percent for the last few quarters.

I'm wondering if there's anything else you can do in running this business to get that up north of 15 percent?

Well, I think what we do is we continue to grow our earnings over time.

I think if you look at--as you know, when you look at the pricing characteristics of an acquisition at 2 to 2.5 times book value, they are not immediately accretive to return on equity.

And we had a couple of significant investments that were made in the end of '03 in the first and second quarter of '04 in Pennsylvania.

And we are still in the process of trying to grow the earnings down there to hit an appropriate run rate on our return on equity.

Yes.

Do you think you can get your efficiency back to the low 50s?

I mean, that's where our--.

--Where expenses continue to be a challenge.

Yes.

I mean, our expectations are in between 50 and 55.

All right.

Well, thank you for answering my questions.

Thank you.

Your next question comes from Claire Percarpio from Janney Montgomery.

Claire, your line is open.

Thank you.

Good morning.

Good morning, Claire.

A couple of questions.

Is there something that's changed in the last couple of quarters in a meaningful way as far as the competitive climate in trying to get the loan growth?

Or do you think as these pay downs get behind you it will start to normalize a little bit?

I think there's a couple of things that I referred to previously, Claire, that related to margins.

And in certain markets, I think we need to be more attentive to that tradeoff.

Well, Mark, I mean those margins that you've mentioned, is that more because of the way you're funding or the inability to fund it with core deposits, or what's changed on those margins?

Or is it all pricing side and structure?

Are you alluding to structural things you don't like in the competition that are making the--that's making the quality of the deals being put on less appealing?

I think that's certainly part of it.

Particularly, I would suggest, in our Pennsylvania markets where there are term and structure issues related to competitive credits that we're not prepared to concede on some of those structure and term provisions of those credits.

So I think that we are seeing some of that in Pennsylvania, a little bit less of it in New York.

I think the other point I would make is that we've--this focus we've had on asset quality as credits come up for renewal, including some very large credits, we've made decisions that are not advantageous to outstanding balance, but we think are advantageous to overall credit risk to the Company.

So a large part of it, if you look at the absence of what we would also characterize as sufficient growth in business lending, a great part of that has been the efforts to improve asset quality.

And some of that has happened in Pennsylvania on the heels of the acquisitions we did there.

Okay.

And Mark, can you hold your expense growth below your revenue growth if revenue growth disappoints in '05, or can you hold, because if you don't get the balance sheet growth, can you manage down the expenses enough to still get positive operating leverage?

I think we've got--we certainly have some variable component of our efficiency ratio, Claire, that we can manage.

But at the same time I would tell you I think if you looked at our franchise, and particularly, the average size of our branches, which is generally smaller than our peers by a reasonable margin, we're operating relatively efficiently.

But there's certainly room on a variable expense kind of basis to maintain that efficiency ratio.

And then, Claire, we did not take any reductions in the quarter.

Instead, actually, we improved resources on the development and the loan generation side in terms of adding resources into our markets to go after the loan growth as opposed to pulling back.

Okay.

And then--thanks, that's helpful.

And then, shoot, I forget what my last question was on that.

Do you still plan to expend stock options beginning in July?

We're probably not going to do that.

I think we believe in it as an appropriate accounting convention, but I think it's certainly a little awkward doing it in mid-year and the accounting standard setters, as you know, have changed the rules, not just the timing, but also the accounting itself, a number of times over the last couple of years.

So I think our expectation now is to wait until the FAS and the SEC agree on what the timing is for those rules as well as what the rules themselves are.

Thanks.

Thanks, Claire.

Thank you.

Your next question comes from Kerry Hinkel with McConnell, Budd.

Kerry, your line is open.

Hi, Kerry.

Good morning, Kerry.

A question about Northeast Pennsylvania.

Last year, at some point, organic loan growth was down.

Are you seeing more of the same or are you more optimistic on that front?

And secondly, I was just curious if the income for the benefits consulting is a good run rate going forward, because it popped up quite a bit in the quarter.

I guess I'll answer the first question first.

You're right.

Last year, year-over-year, we did have a decline in lending balances in Pennsylvania.

Had the same for the first quarter of this year as well.

I will tell you that right now the pipeline is stronger in Pennsylvania than it has been in a long time.

We're seeing strength of activity down there that we haven't seen in a while.

We have added resources in Pennsylvania to try to capitalize on the opportunities that we've got in Pennsylvania.

We're--I think the distractions of integration and all of those kind of things, some of which we experienced in 2004, are behind us now and we're very well positioned I think in Pennsylvania looking into the future.

Kerry, your second question is a very reasonable question.

The spike up in benefit administration, consulting, and actuarial fees, you probably will not be able to sustain that.

The actuarial fees in the first quarter were just in terms of the time of year, I mean, those typically are higher than average.

That being said, we certainly probably are holding that business unit to a 15 percent target.

So was 26 percent on a linked quarter basis better than we thought?

Sure it was.

But we certainly expect mid-teens from them.

We've experienced that in the past and expect that to go forward.

Thank you.

Thank you, Kerry.

Thank you. (Caller Instructions.) It appears we have no questions at this time.

Oh, excuse me.

We have another question from Claire Percarpio from Janney Montgomery.

Claire, your line is open.

Thanks.

What are your plans for the level you plan to take borrowing to?

Where are you--what are you thinking you'll reduce it to?

Well, I don't know if we've got an exact number in mind, Claire.

I think it's dependent on a number of factors, one of which would be the extent to which we do some repositioning of the securities portfolio to try to lower the duration a bit.

That's going to be in itself somewhat dependent on the yield curve and what the market looks like out over the next several months.

I think the other variable would be deposit growth in terms of funding there.

We've taken borrowing down I think short-term 60 or 70 million.

I think if we saw a light decrease out again over the next quarter or so, I think we would be okay with that because we think it better positions our interest rate sensitivity profile.

And Mark, are you willing to give us--or Scott, any range of guidance on both the margin for the year or give us a little more numerical guidance on the pace of margin compression?

And any guidance on EPS for the year and whether you're comfortable with the consensus?

I guess, Claire, I'll start just on the EPS guidance and Scott can comment on the margins.

I think in January we commented that we expected $1.65 to $1.70 a share.

We're at this point right on with those expectations and would continue to be supportive of that range of EPS of $1.65 to $1.70.

Claire, as far as the net interest margin, I think our expectations, again, will be consistent with what we said in January, that we would suspect a 5 to 7 or 8 basis-point drop in the second and third quarter really based on our expectation that funding costs are going to continue to come up.

And from a practical standpoint, the only way that that would be significantly different is if we did not opt to reinvest some of the cash flows out of the investment portfolio.

Clearly, the first quarter's margin benefited from letting some of that run off, but needless to say, we sacrificed a little bit on the absolute from an income standpoint.

Thanks.

Okay.

Thank you, Claire.

Thank you.

And we have no further questions at this time.

Wonderful.

Thank you, Judy, and thank you all for joining us today.

Bye-bye.

Thank you.

That concludes today's presentation.

You may now disconnect.