Community Financial System Inc (CBU) 2005 Q2 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 given 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 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'd like to introduce today's call leaders.

Mr. Sanford A. Belden, President and Chief Executive Officer, Mr. Mark Tryniski, Executive Vice President and Chief Operating Officer, and Mr. Scott Kingsley, Executive Vice President and Chief Financial Officer of Community Bank System.

Gentlemen you may begin.

Thank you very much and welcome to the CBU quarterly investor call to discuss excellent results in the second quarter.

Results which reflect our consistent and reliable focus on building sustained and dependable shareholder value.

Second quarter earnings represent all time records in nominal and per share earnings for our Company.

Our team worked very hard and successfully to generate an all-time record in loan growth and reversed the flat pattern experienced in the last couple of quarters.

Mark will have more to say in a moment about how these results were achieved.

I'll now conclude my introductory comments by noting our very solid and consistent management of asset quality as reflected in strong performance across all relevant asset quality metrics.

Mark?

Thank you, Sandy.

And good morning, everyone joining with us on the call today.

I would start by echoing Sandy's overall sentiments about the successes of the quarter.

And would like to comment further on three particular matters of note before Scott leads a more detailed discussion on second quarter financial performance.

First, coming off a disappointing and seasonally impacted first quarter, we're extremely pleased with the record loan production delivered in the second quarter.

With the portfolio growing by $54 million or 7.6% annualized.

This increase was achieved across all business lines including consumer, commercial and indirect.

And was the result of more aggressive and directed business development efforts, improved sales and marketing initiatives, and more competitive pricing strategies.

It's also important to say these results were not achieved at the expense of asset quality.

Our underwriting standards are unchanged and remain as sturdy and robust as they ever have.

Our loan yield was up in the second quarter.

In fact, this is the third consecutive quarter of increase; due as expected to the commercial portfolio and despite the continued low interest rate environment in consumer lending lines.

The third quarter is off to a good start.

Our pipelines remain active and we're guardedly optimistic about loan growth over the remainder of the year.

The second matter of note I would like to comment on is the net interest margin.

It did fall in the second quarter, as we expected it to.

But more than a third of that reduction from the the first quarter is attributable to two or three unusual factors that Scott will explain further but are important to understanding the core margin trendline.

The bulk of the margin reduction is due to increased funding costs and lower securities yields.

During the second quarter, we took steps that have already begun to reduce our funding costs by converting $200 million of overnight borrowings to fixed rate term borrowings.

Lastly, we made substantial progress toward enhancing our interest rate risk profile through the continued planned reduction in the duration of our investment portfolio, which has declined from seven years at June 30, 2004 to five years at June 30, 2005.

This was effective principally through the sale of securities during very favorable first and second quarter market opportunities, as well as through scheduled maturities.

These planned sale also contributed to the decline in securities yield and our net interest margin.

As a result of the average book value of the portfolio is down about $70 million from year end 2004.

With that reduction used to reduce average borrowings, which are down 120 million overall.

This reduction in earning assets although planned and beneficial to our interest rate risk profile will serve to reduce 2005 full year earnings by approximately $0.05 per share.

And that concludes my comments.

Scott.

Thank you, Mark, and good morning.

Our second quarter earnings results of $0.46 per share were $0.06 per share or 15% above the second quarter of 2004.

Cash earnings per share, which excludes the after tax affect of the amortization of intangible assets were $0.97 for the first six months of 2005, compared to $0.84 per share in the first half of 2004.

An increase of 15.5%.

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 an increased cost of funds, higher recurring operating expenses and a slightly higher tax rate.

Second quarter earnings were also $0.03 per share or $0.07 above this year's first quarter results.

I'll first discuss the balance sheet.

Average earning assets were up 3.7% over the second quarter of 2004, but declined $56.8 million or 1.5% from the end of the first quarter.

Average loans were up $10.1 million from March 31,'05.

While investment securities decreased $66.9 million.

Although our decision not to reinvestment securities cash flows in the currently flattening yield curve environment negatively impacted quarterly earnings by nearly $0.01 per share, it continued to improve our overall interest rate sensitivity position.

We also continued to take advantage of market positions and sell certain securities in order to shorten the average life of the portfolio and maximize their total return attributes, which resulted in a $0.10 per share after-tax gain in the second quarter.

Even with a $0.10 per share of realized gains this quarter, the investment portfolio still contained net unrealized gains of $45.7 million as of June 30.

Deposits were up slightly from the end of the first quarter with gains in IPC balances more than offsetting some seasonal declines from municipal depositors and have an increased $48.5 million or 1.7% since December 31, '04.

Borrowings were down 56.5 million or 6.6% from the end of the first quarter and have been reduce 122.1 million or 13.3% on a year to date basis.

Our capital levels remain strong with our tier 1 leverage ratio improving to 7.1%.

Our tangible equity ration increased to 6.0% at June 30, '05.

Tangible book value per share was $8.09 at quarter end.

An improvement from 6.7% from the first quarter and was a $1.21 per share or 17.6% above June 30, 2004.

The Company acquired 142,000 of its own shares in the quarter at a cost of $3.38 million under it's 1.5 million share repurchase program authorized by the Board of Directors in April.

Shifting to the income statement, the continued flattening of the yield curve in the second quarter resulted in the net interest margin being reduced from 4.49% in the second quarter of 2004, and 4.34% for the first quarter of 2005, to 4.16% for the second quarter of 2005.

Loan yields improved 2 basis points from the first quarter.

While investment yield declined 16 basis points including the effect of accretion on securities called in the first quarter.

Cost of funds increased 14 basis points from the first quarter, driven by rising short-term borrowing rates as well as certain rate increases on certain time-deposit products.

The second quarter cost of funds was also increased by 4 basis points from the first quarter for changes in rate impacting acquisition related items, principally mark-to-market amortization on certain acquired time-deposits.

The loan loss provision was $2.1 million in the second quarter, compared to 2.3 million in the second quarter of '04 and 1.9 million in this year's first quarter.

The quarterly loan loss provision was 0.12 million above quarterly charge-offs of 2.0 million and was deemed prudent given our solid loan growth and stable asset quality.

The loan loss allowance to total loans outstanding stands at 1.35% at quarter end, compared to 1.37% at the end of March and 1.35% again at the end of December of '04.

Non-performing loan to total loans outstanding are at 0.56%, consistent with the end of the second quarter of 2004 and an improved position from the 0.63% at the end of the first quarter.

The delinquency ratio improved to 1.32% at June 30, '05, compared to 1.35 at the end of the first quarter and 1.50% from a year ago.

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

Non-interest income, excluding securities gains, was up 6.1% over the second quarter of 2004, and 2% above the first quarter of '05.

Driven by improves in deposit service fees and continued strong performance although slightly below the first quarter results from our employee benefits consulting and plant administration business.

Operating expenses, excluding acquisition expenses, increased by 6.2% over the year ago quarter from 29.4 million to $31.2 million.

This was due primarily to additional expenses from the First Heritage acquisition, increases in salary and benefit costs at rates slightly above the consumer price index, and higher amortization of core deposits intangibles.

Second quarter operating expenses were less than 1% above the first quarter 2005's level, despite higher costs associated with disposing of several ORE properties as well as costs related to our new branch in Clarks Summit, Pennsylvania.

We continue to aggressively pursue operating expense reductions including the use of branch staffing models, active vendor improvement programs, and technology upgrades that enhance customer service and productivity.

Our effective tax rate for the quarter was 26.1%, compared to 24.9% for the first quarter.

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

We expect a continuation of the challenging operating conditions of a flattening yield curve for the balance of the year.

Including further declines in our net interest margin to a level in the 390's by year end.

We also expect to continue to pay down short-term borrowings with excess cash flows, including those from our securities portfolio in the current interest rate environment.

As such, we are projecting earnings of $0.65 to $0.70 per share in the second half of the year, excluding the impact of any additional securities transactions.

If the interest rate environment again creates opportunities for improvements in our overall interest rate sensitivity profile, while allowing for continued reduction in the average life of the securities portfolio, we may find it appropriate it to pursue further securities sales.

Conversely, if long term term rates move up and the yield curve steepens, we are well positioned to reconsider investment opportunities.

Also our improved capital metrics, allow us the flexibility to more actively fulfill our authorized share repurchase program if market and other conditions so warrant.

I'll now ask Linda to open the line for questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Kevin Timmons from CL King.

Mr. your line is open.

Hi, guys, how are you doing?

On the indirect lending, can you tell me what is driving the volume increase there?

A couple of things, Kevin one is seasonality.

The second quarter in that business is typically very active and robust.

I think secondly, we ran some more - - we were more active promotionally than we have been.

And then thirdly, and this is really one of the greatest factors is really the GM employee discount sale really pushed a lot of cars off the lots in the quarter.

So those three factors I'd say really contributed to the growth in that business in the second quarter.

So primarily external factors more so than internal?

I'd say it's a combination of both as it relates to all three of those observations I made.

Okay.

I think I heard you've mention for the securities gains you calculated that as contributing $0.10 per share in the quarter?

That's correct, Kevin.

Okay.

What marginal tax rate with you using to do that calculation?

Just about 36% on the marginal rate.

Okay.

On the margin you made some - - gave a couple of references to things for you to consider there.

Is there any broader guidance that you can give us as to what it looks like going forward?

I know it's a tough environment to do that, but - -.

I think, Kevin probably not significant beyond my comments that we expect by the end of the year we would be into the 390's.

Certainly anything past that we're not prepared to make additional comments at this time.

Okay.

Thank you.

Kevin, though, just to score the points that Scott made in his presentation, it's our view that we have a lot of flexibility, depending on what happens with the yield curve.

We can deploy resources in different ways, a combination of security sales, stock buy-back, and reinvestment in securities if the yield curve tilts upward again.

So, we have got a lot of arrows in our quiver in what you quite accurately describe as an uncertain and challenging environment.

Everybody is waiting for something to happen so they can take their moves.

Right.

Okay.

Thank you.

Thank you our next question come from from Claire Percarpio from Janney Montgomery Scott.

Yes.

Hi, I think I just have gotten some of it answered.

So, I guess just to clarify then you seem more - - margin pressure and earnings pressure in the second half with the second half being sort of flat to down excluding securities gains.

Any willingness to talk about '06 and timing for - - what - - are you - - if you can comment on what quarter you think your margin bottoms in?

Hi, Claire, it's Mark.

It's got - - I think we've got some visibility based on current expectations out through the end of the year.

It's difficult right now to go beyond that and give any kind of reason - - a reasonable range of guide dance depending on what the Fed does and on the short end how far they go.

In the beginning of the year we - - in terms of putting together a forecast of the year we looked at futures market, which set five rate increases.

Well, that's not going to happen.

There's been discussion about the short end of the curve going to 4 to 4.5, which would be kind of Greenspan's historically comfortable range.

We don't know whether that happens or that doesn't happen.

So it's difficult.

I think the other complexity is really the high end of the rang, which as you know hasn't moved.

And as much as we have gotten excellent expansion of yields on the customer lending portfolio and our - - as I commented our overall loan yield is up in each of the last 3 quarters.

The consumer lines - - the yield on the consumer lines continues to be low because of the historically low rate environment in the mortgage area and still the indirect area, which our credit line is more pegged to kind of five and ten-year rates.

So it really - - I know that's not a very good answer.

I think we do have, again, some visibility through the end of the year based on some reasonable assumptions about what happens for the remainder of the year.

But it really is going to be to a great deal dependent upon what happens with both ends of the curve.

Thanks.

Thank you, Claire.

Thank you.

Our next question comes from Ben Collins from Adelphi Management.

Ben your line is open.

Hi, guys.

It's actually Adelphi Management.

And my question is, can you give me a little guidance on possible growing your deposit base?

And/or any ideas on some acquisitions or future growth?

Well, I think I'll take the acquisition parts of it first.

We are always actively considering acquisitions.

That's been a long-standing part of our strategy and we expect to have it continue as a long-standing part of our strategy.

Focused, as we have been on community banks, in the 250 to 500 million size range.

And if we could find appropriate opportunities to do more branch acquisitions we would love to do those as well.

Okay.

I guess, Ben, I would be happy to take the deposit question.

Year to date we're up about $50 million in deposit, which is - - in total deposits, which is pretty good growth for us.

We've - - we as Scott commented our cost of funds has gone up a bit.

Some of that is trying to be a bit more aggressive in certain selected marketplaces.

We can still gather deposits at effective cost of funds by raising the rates a bit.

But I would say we have been a bit more competitive in the marketplace, particularly in the time deposit area.

And we would expect over the remainder of the year to continue to see deposit growth.

Thank you.

Thank you.

Our next question comes from Kelly Hinkle from McConnell, Budd.

Kelly your line is open.

Hi.

Just one quick question.

I was wondering what the cost was of disposing of the REO properties?

I can get you that Kelly, here.

It was probably upwards of $200,000 of the term line that we had been on; in terms of the write-down of the value of the properties, clean up and other disposition costs.

So, we would probably peg that for quarter at 200,000 above our historic trend.

Thank you.

Thank you.

We have another question from Kevin Tim from C.L. King.

Kevin your line is open.

My question was answered thank you.

Thank you. [OPERATOR INSTRUCTIONS] We have a question from Damon DelMonte from KBW.

Damon, your line is open.

Thank you, good morning.

Just to clarify on the EPS guidance, the $0.65 to $0.70, that was including or excluding any securities gain?

That's not including any additional securities gain, Damon.

Thank you.

Our question comes from David, and I apologize, Darst from FTN.

David your line is open.

Thank you.

Can you give us a little information on what your security cash flow are, excluding sales or calls, for the next 2 quarters?

Yes, I can David.

Our expectation of natural cash flows from the portfolio from July through the end of the year is just over $55 million.

And certainly that plays in some expectation relative to some additional calls based on where the rates are now versus the securities we're holding.

But a touch over 55 million is our expectation for the balance of the year.

And if - - maybe loan growth would be maybe 80, 75 to 100 over that time frame.

So we would probably expect average earnings assets to may be flat to up, unless you take another securities gain?

Make sure I understand the question, David in terms of additional loan growth for the balance of the year?

Yes.

I think - - typically the second quarter is one of our strongest.

We're probably not going to exceed that in the third or the fourth quarter.

So we would expect growth at a click less than the second quarter rate in the third and fourth quarters.

So, I think that David if it truly - - it we did not deploy any of that investment cash flows at all, back to the portfolio, the loan growth would probably not be terribly in excess of that expectation.

Okay.

Do you have have plans to then - - I guess you do have plans to price your deposits accordingly, and maybe hold costs down, and - -.

I would say that's true, David.

Certainly from - - in areas where we certainly can defer or keep the costs down on the deposit side, certainly that's in our plan.

As Mark has mentioned there are probably certain areas on the time deposit side where in order for us to stay to the low middle of rate charges that we bump into completively, we probably suspect that between now and the end of the year we will have to take some of those roots out.

I think it's also fair to say we continue to look aggressively at operating expense reduction opportunities, as we've achieved much closer to full functionality on the integration of Pennsylvania businesses.

And we have firmly now established our new management team.

We think that there are some opportunities for some non-interest expense reductions.

Okay.

Thank you.

Thank you we have no further questions in queue at this time.

I'm sorry, we do have another question from Ben Collins from Adelphi management.

Ben your line is open.

Hi, just to ask one more time, guys.

Can you give me some idea what is happening out there with your competition?

And what is happening on the local environments?

Are you taking initiatives to bring in - - fight off the competition and bring in some more deposits?

Well, it's a competitive environment out there, certainly, Ben.

And we react to it differently in different markets.

In the north part of our New York market, for example, there's a bit less competition than in the southern part of New York and in Pennsylvania certainly.

But with that said the competitive environment continues to grow there from other banks as well as certain non-banks.

So I would say it's highly competitive in all of our markets.

Particularly so in Pennsylvania on both the lending and the deposit gathering side.

I think our philosophy is not to be at the bottom of the pricing grid in the market in terms of deposit.

It's also not to be at the top end of the pricing grid because I think our view is it's hard to make money if if you are positioned in either one of those places over the long term.

So we'll continue to be selective about where we price deposits and what products we may up-price because we perceive in doing so given the interest rate environment of the competitive environment.

But overall our philosophy is to try to remain somewhat neutral in terms of the competitive pricing grid across all our markets.

Thank you.

In addition to that any thoughts on what is happening with your consumer mortgage portfolio?

Other places are doing a bang up business in consumer mortgages, and I was wondering if you had any comments about your perspective on that?

Well I think our originations are running at somewhere around 85%, I think or so, of last year's originations.

So, not quite the same run rate.

But I think that's consistent with the market overall.

I think if you look at our portfolio, the largest share of our portfolio is real estate mortgages.

The vast majority of those are fixed-rate mortgages. 15 to 30 years.

And I guess we haven't pushed as hard on the real estate mortgages given the profile that it takes in overall loan portfolio.

But we think our activities have been pretty good.

Our pipeline is pretty good.

We've developed some additional products that are responsive to the market.

So I think we've done a very good job with the real estate portfolio.

And it continues to run, as I said, at only about a 15% or so reduction from last year's record and historically high pace.

I think it's also important to point out that we have not entered into any of these exotic mortgage products, the interest only products or the supervalue products.

So we have stayed with some enhancements to our existing product line up as we're every mindful, as we've said several times now about asset quality.

So you don't find that the market is calling for adjustable rate mortgages, and that's where most of the demand is?

That's not what we have seen in our marketplace.

Interesting.

And we're not chasing that business.

Thank you.

Take you.

Thank you. [OPERATOR INSTRUCTIONS] Gentlemen we have no further questions.

Thank you all very much.

We'll talk to you in three months.

Thank you.

Thank you.

That concludes today's conference.

Thank you for your participation.

You may now disconnect.