Community Financial System Inc (CBU) 2006 Q1 法說會逐字稿

Welcome to the Community Bank System conference call. 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 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 the 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, Executive Vice President and Chief Financial Officer of Community Bank System. Gentlemen, you may begin.

Thank you all for joining us for our first quarter 2006 investor call. In addition to the very solid first-quarter performance, which Mark and Scott will discuss in a moment, we were exceptionally pleased on Friday to announce our agreement to acquire ES&L Bancorp in Elmira, New York in an all-cash deal. For all the financial, strategic and growth reasons articulated in the Friday press release, this is a terrific opportunity for us and for the management, directors employees, shareholders and customers of ES&L. Bill McKenzie and his management team have done an outstanding job at building the capabilities and success of this franchise, and we are especially delighted that Bill will provide continuing leadership to our business in that region of the southern tier of New York. Mark and Scott did a great job at putting this acquisition together, and I'll now ask them to discuss our first-quarter results. Scott?

Thank you, Sandy, and good morning. I'll first make some comments relating to the financial results of the first quarter, then turn it over to Mark for some additional operating commentary, as well as some specifics related to the ES&L Bancorp transaction.

Our first-quarter earnings of $9.5 million, or $0.31 per share, were $0.12, or 29% below the first quarter of 2004, and included stock option expense of $626,000, or 1.5 cents per share, as a result of the Company's adoption of FASB 123R, Share Based Payments, as of January 1, 2006. In addition, the first quarter of 2005's results included $1.7 million, or $0.04 per share of gains on securities sales.

Year-over-year loan and deposit growth of 3% and a 12% increase in non-interest income, excluding securities gains, were offset by an increased cost of funds and an 18% decrease in investment income, resulting from the Company's successful balance sheet repositioning in 2005. Cash earnings per share, which (technical difficulty) of the amortization of intangible assets and acquisition-related market value adjustments, were $0.35 in the first quarter, a full $0.04 per share above GAAP EPS results.

I'll first discuss the balance sheet. Average earning assets were down slightly from the fourth quarter of 2005 and stood at $3.7 billion at quarter end. Average earning assets declined $169 million from March 31 of last year, comprised of a $58 million increase in loans, offset by a $227 million decrease in investments.

In 2005, the Company successfully completed the objective of shortening the average life of its investment portfolio, generating a $0.29 per share after-tax gain through the sale of securities that had optimized their total return and interest rate sensitivity characteristics. The proceeds of these securities sales were used to reduce overnight and short-term borrowings throughout 2005.

Total loans at the end of the first quarter were essentially flat with the end of the fourth quarter of 2005, a significant improvement from the 23 to $24 million portfolio decline we experienced in the first quarters of 2004 and 2005. Year-over-year, loans grew $74 million, or 3.2%, and included increases in all product types. Deposits increased nearly $80 million on a linked-quarter basis, and included seasonal increases in municipal funds typically experienced early in the year. Since last March, deposits grew almost $88 million, or 2.9%.

Borrowings were down $66 million on a linked-quarter basis, and have been reduced $334 million, or 36% from the beginning of the first quarter of 2005. Although our decision in 2005 to not reinvest securities cash flows in the then and still flat yield curve environment had a negative impact on current and future quarterly earnings comparisons, it substantially improved our overall interest rate sensitivity profile. Our investment portfolio stood at $1.3 billion at quarter end and still contains nearly $6 million of net unrealized gains, a benefit not shared by many of our peers.

Our capital levels remain strong, with our tier one leverage ratio improving to 7.68% at quarter end. Our tangible equity ratio stood at 5.9%. Also, the Company acquired an additional 158,000 of its own shares during the quarter at a cost of $3.5 million, under the 1.5 million share repurchase program authorized by the Board of Directors in April of last year. At March 31, there were 748,000 shares available for repurchase under this program.

Shifting to the income statement, the net interest margin for the first quarter declined 6 basis points to 4.06% from 4.12% in the fourth quarter of 2005, and was 28 basis points lower than the 4.34% recorded in last year's first quarter. Year-over-year, the earning asset yield increased 18 basis points, with loan yields up 33 basis points and investment yields down 9. The cost of funds rose 49 basis points to 2.34%.

Our loan loss provision for the quarter was $2.2 million, compared to 2.3 million in the fourth quarter of 2005 and 1.9 million in last year's first quarter, and was $139,000 higher than our quarterly charge-offs. Our loan loss ratio -- excuse me. Our loan loss allowance to total loans outstanding stood at 1.36% at quarter end, consistent with the average level reported for the last eight quarters. Nonperforming loans to total loans outstanding are at 0.62%, compared to 0.55% at the end of the fourth quarter and 0.63% a year ago. The delinquency ratio was 1.2% -- excuse me -- 1.26% of total loans at March 31, 2006, an improvement from 1.35% reported a year ago. This favorable and stable asset quality profile is primarily the result of our enhanced credit risk management programs and our continued emphasis on and adherence to disciplined underwriting standards.

Non-interest income, excluding securities gains, was up 12% over the first quarter of 2005. Deposit service fees increased 10% over the prior year's first quarter, driven by several revenue enhancement initiatives put into place during 2005.

Our employee benefits administration and consulting business posted a 19% increase in revenues over last year's first quarter, thanks to new product offerings and the addition of new clients. Trust, investment and asset management fees were also up 15% year-over-year. There were no investment securities sales in the first quarter of 2006.

Operating expenses, excluding the effect of the change in accounting for stock options, decreased just under 1% year-over-year. A $0.5 million reduction in the amortization of intangible assets was partially offset by increases in employee medical costs and occupancy expenses, principally utilities and real estate taxes. The Company continued to aggressively manage all aspects of its operating expense structure in the first quarter.

Our effective tax rate for the quarter was 25.0%, consistent with the 24.9% reported in the first quarter of 2005. The proportion of tax-exempt income to total income continues to be the most significant determinate in our effective rates.

I will now turn it over to Mark for some additional comments on the first quarter.

Thank you, Scott. I'd like to amplify several of the more critical points made in your commentary relative to the quarter and then discuss the ES&L acquisition.

First-quarter earnings were in line with full-year expectations of $1.30, as we communicated during our January call. We're satisfied with margins of over 4% given the current interest rate environment. And excluding securities gains, we reported a 12% increase in non-interest income on the strength of both banking fees and revenues from our wealth management and benefits businesses.

We talked last quarter about cost reduction initiatives which have been implemented, resulting in a reduction of total operating expenses from the first quarter of 2005, adjusting to the new stock option accounting expense. We continue to take steps to remove costs in a number of areas, but do expect sales and marketing expenses related to our core deposit gathering initiative to increase over the remainder of the year.

Perhaps the brightest spot of the quarter was lending performance, particularly commercial lending. As Scott said, our experience for the past two years has been a 20 to $25 million seasonal runoff in the first quarter, with most of that typically being in our commercial line. This quarter we had a total seasonal runoff of only $3 million, with commercial balances actually increasing over the quarter. Our pipeline remains strong; in fact, the commercial pipeline is running about 20% ahead of 2005, so we are hopeful for our growth prospects as we begin the second quarter.

I made reference earlier and during our January call to a significant core deposit generation effort. Our objectives are to achieve in 2006 the double-digit increase in this important customer base and their associated balances. This program was kicked off about two weeks ago and the early results are very encouraging. So, I look forward to reporting our progress on this initiative as part of our July call.

Lastly, I would like to comment on our recently announced acquisition of ES&L Bancorp, headquartered in Elmira, New York. We are very, very pleased with this transaction. ES&L has a long-standing record of earnings growth and is exceptionally well managed. Their CEO, Bill McKenzie, is a seasoned and highly respected banker, and will be staying on with us in a senior business development role, focusing on commercial lending opportunities in both the Elmira and robust Ithaca markets.

Our market share in [Shimon] County, when combined with our existing single location there, will be about 11%, providing us with a formidable presence, but more importantly, with significant opportunity for growth through our expanded retail, commercial and financial services product offerings.

From a financial perspective, the acquisition will be immediately accretive, excluding onetime transaction costs of under $1 million. The all-cash purchase price of 39 million represents a multiple of 1.79 times book value and 13 times trailing earnings. We expect the transaction to close in August and very much look forward to partnering with ES&L to grow our business in the Greater Elmira and Ithaca regions.

I would say in summary that we had a successful quarter, that we like the trajectory of our business right now, and that we are optimistic as we head into the second quarter. Those are my prepared comments, and I would now ask Elaine to open the line for questions.

(OPERATOR INSTRUCTIONS). Damon DelMonte, KBW.

First of all, congratulations on the ES&L acquisition. It looks like it's going to be a nice pickup for you guys. A couple of questions. One, regarding the service fees, was there some seasonality in the first quarter's results?

There really is. We have experienced that for about the last three first quarters, that the first quarter utilization of a lot of our banking service deposit service products is actually much lower in the first quarter than we experienced in any of the other three of the year.

With respect to margin, any comments on what your views are for the rest of the year?

I think we're (technical difficulty) still believing that since the first quarter is a couple of days shorter than the other quarters that numbers anywhere on the 4% range are clearly possible. To the extent that we're not adding to our investment portfolio, I would say that 3.95 to 4.05 range is pretty good for the remaining part of the year.

Kevin Timmons, CL King.

A couple of questions on run rates. The employee benefit line, the fiduciary income line, expense line -- are those numbers decent run rates to work with? Some of them have some pretty big changes on them.

I think on the wealth management side, on the asset fees, trust fees, broker-dealer side, that's probably -- the 15% year-over-year is probably something we don't expect for the balance of the year. Maybe we are expecting a number that's about half of that. We had some trust estate-related fees in the first quarter that made that a little better comparison.

So, that means second quarter is flat or down a little bit, likelihood?

On a linked-quarter basis? I would say you're probably pretty close. I think, we think, probably flat.

But the EBA line and the expense lines are fair representations of the core number?

They are.

Tax rate remaining around 25%?

I would say if you stayed in the 24 to 25% rate, you would be safe.

You sound pretty optimistic on the loan growth and so forth. So, that will help you keep the margin up to around where you're talking about?

That's what we're hoping. As I said, our pipeline remains pretty strong. Even the real estate pipeline has held up reasonably well. So, as I said, our commercial pipeline is about 20% ahead of where we are at the same time last year. So, we're hopeful heading into the second quarter that we'll continue to see some strong results.

On the deposit side, you guys don't break out the deposits by type. Can you tell us a little bit about change in mix on the deposit side?

We have continued to experience by and large the trend of the last several quarters with the rising interest rates, which is a slight migration out of some of the core checking and savings lines into the somewhat higher-yielding money market and time deposit lines. And we experienced a bit of that same trend in the first quarter as we had over the course of the past several quarters.

Do you know if, without looking it up, off the top of your head, if the trend accelerated, decelerated or was roughly flat?

I think it decelerated or was flat. I know it wasn't greater than what we've seen over the course of the last couple of quarters. I think it was either -- it either decelerated or it was flat. We can give you a bit more information on that as a follow-up, if you'd like.

(indiscernible) your competitive position versus other -- and I know it's a broad question, because you compete with different companies in different markets -- but in general, are you keeping your rate levels around where they have been relative to the top players in the market?

I would say from a pricing philosophy, we've never been at the top of the market. That's not our -- that's not our spot. We've never been at the bottom of the market either. We try to maintain a middle-of-the-road pricing profile. Based on a lot of analysis around what other banks are doing, what the market itself is doing, I think a lot of our focus has been on generating core deposits, which not only carry a lower cost which are much more valuable and a (indiscernible) rising rate, but also have other -- have the cross-selling opportunities associated with them. We typically in all of our markets try to be in the middle of the road.

With that said, the overall deposit costs in our northernmost counties that we do business in in New York are lower on the deposit side, a bit higher on the loan side. And our margins are a bit better in those markets than they are, for example, in Pennsylvania, where there's a bit more competition and we experience slightly lower margins. But for each of the markets that we price in, which are three separate and distinct markets -- the northern region of New York, what we call the southern region of New York, which is kind of the [finger lakes] (indiscernible), and then in Northeast Pennsylvania -- for all of those markets, our pricing philosophy is essentially to be in the middle of the pack.

Rick Weiss, Janney.

I guess my first question is -- see that the loan yields went up 7 basis points on a linked-quarter basis. I'm wondering if you can discuss maybe some of the loan pricing competition in your three markets, as well as what percentage of your loans are adjustable.

Let me take the second half of that, and then I'll let Mark run at the first one. On the business lending side of our portfolio, roughly 62% of that is adjustable or moves with either a prime or some other type of an index orientation. As you've heard us here before, the lion's share, or the vast majority of our consumer mortgage portfolio is actually fixed rate. And as we mentioned in the press release, we are still selling all of our above-15-year conforming mortgages into the secondary market, just because those instruments don't represent good use from an (indiscernible) standpoint for us in the current environment.

On the consumer direct and indirect side, we've got about $250 million of home equity lines of credit that are truly variable in nature. And as you can remember, the remaining piece of our portfolio, or about $400 million of our consumer installment loans are generated from the indirect side of our business, or the auto lending side. And as we mentioned before, the average life of that portfolio, though it's fixed rate, is about 26 to 27 months. So, the opportunity for repricing in a rising rate environment, or any interest rate environment is pretty profound. In other words, the cash flows out of that portfolio almost make that a pseudo-variable product.

In terms of the pricing on the loan side, it's not tremendously dissimilar from what I just described on the deposit side. There's certainly differences in the competitive environments in the three of those markets on both sides of the balance sheet, and we react accordingly based on those markets. But we -- as Scott said, the business lending, we've experienced several now -- looking at the numbers -- one two three four five six seven -- almost eight consecutive quarters of growth in yields on the business lending side. We expect that might continue into the remainder of the year. There's actually been a little bit less lift on the consumer side. But we do expect rises in those yields for the remainder of the year.

From a competitive point of view, as I said, it's not too dissimilar from the deposits. We try to be not at the top and not at the bottom. We're very -- we priced according to risk and according to opportunity in terms of the individual customer relationship. We're seeing more competition, as we have said on previous calls, in Pennsylvania, which continues to be a more intense competitive environment. But we have not at all yielded. In terms of asset quality, as Scott said, our metrics remain strong. We are hopeful they continue to remain strong, based on our underwriting disciplines and credit administration standards.

Would you attribute any of the -- when you're saying the commercial loan pipeline is up 20% from a year ago. Have you changed your pricing in the last year?

Solely in response to the changes in the underlying indexes. But not our spreads.

The reason for the increase, I guess, is what I'm driving at; it's not because of undercutting [pricing of your] competitors.

No. That would drive the yields down instead of up. We're not doing that. And frankly, we could get more loan growth than we're getting if we wanted to make concessions in certain markets and certain opportunities as it relates to pricing and structure. But we have determined we're not going to do that.

No doubt it's tough out there. Let me ask you one other question, if I could. Basically, how are you going to be funding the Elmira acquisition? Can you just do it with the cash flow that you'll have?

Currently, it should be a combination of current cash flow generated by the Bank pushed up to the holding company. We may find ourselves in a short-term (indiscernible) position at the holding company for a handful of months also. But we haven't -- we [haven't done an] alternative long-term strategy yet.

I guess that's it. Just one other comment. I hope you guys enjoyed the game last night, Scott. But it's only 2-0 in the series and the Flyers can come back.

David Darst, FTN.

Could you give us an idea of what your new auto yields are?

Sure. Let me (indiscernible) a second here. Actually, Mark, I don't think -- I don't think in terms of our new generation, other than, say, the last two quarters, David, in terms of new generation, I don't have that sitting in front of me. I would be happy to call you on that.

The entirety of the portfolio. The yield was in the [580s] first quarter. I think that's not too far afield from the (indiscernible) we can get back to you. (multiple speakers) it's pretty close to that.

And our (indiscernible) are probably just a touch up from that.

What about credit quality this quarter? It looked like it ticked up a little bit.

Actually, we had a very good credit quality quarter. We had -- as you can see, our charge-offs were right in line with where they have been. And it's actually not unusual for us in the first quarter to have a little bit of a tick up in terms of nonperforming ratios. That's sort of been our modus [operandus] over the last couple of years. [In other words] by saying that, our fourth quarter tends to be where our nonperforming ratios are the best of the year. And I think that that's probably a result of some of the cleanup activity that we push forward on a little harder in the fourth quarter.

But in terms of delinquency rates, especially consumer delinquency -- very, very strong right now; certainly, leading us to believe that as we go forward, if those types of ratios hold up, that we will probably be hard pressed to have a similar-looking provision on some of the future quarters. I think that, again, we continue to monitor on the commercial side. And you would expect that some of our customers would have a little bit more of a profound need on a cash flow standpoint, just based on how rates have gone up on the servicing side. But we have really not seen any of that weakness to date.

Based on your optimism or your outlook currently for loans, is this higher than you previously had expected? Are you expecting (indiscernible) for the year or a little better?

I guess I wouldn't be prepared at this point to make any kind of judgment on that, other than, as I said, and Scott pointed out as well, the first quarter was a very strong performance for us relative to the seasonal runoff we usually experience. So, I would hope to at least achieve the results we talked about in January.

How about any update on branch rationalization plans or any strategies you've looked at.

We have continued along that path, and we've done a number of things in terms of our cost reduction initiatives. As you can see, some of those were fruitful and impacted the first quarter. We continue to look at opportunities to consolidate branches. In fact, we just announced last week a couple of consolidations that we're going to be affecting over the course of the next three months in Pennsylvania, which the purpose of which really is to, as a result of the several acquisitions that we've done down there over the last few years, to just kind of clean up and consolidate some branches as a result of the overlap that exists in Pennsylvania. But we're going to continue to do that probably more on an ongoing basis, David. And I wouldn't look for an announcement that says we're going to consolidate or close some large number of branches. But we'll continue over time to assess and evaluate our branch infrastructure and make those judgments on an ongoing basis over time.

Bill McCrystal, McConnell, Budd & Romano.

Just wanted to follow up a little bit on David's question on asset quality. Mainly, as it regards your internal list, obviously we see the reported numbers. But what do you see as you look through the portfolio in a broader sense, in terms of what the outlook is?

We've been running pretty consistent over the course of the last many quarters in terms of the internal watchlist, to call it that. We have had some large relationships that we've managed very well and rolled off that list. There's been a handful of other ones that have rolled onto the list. But in terms of the internal watchlist, it has stayed relatively consistent over the last several quarters.

(technical difficulty) relatively stable, so I'm guessing you didn't really see much impact from the change in the bankruptcy laws.

Actually, the comment I'll make on that is that we did, as you know about, in the -- whether it was the third quarter or the fourth quarter of last year, I think it was a little of both. We probably had a little bit of a higher charge-off ratio on the consumer side in those quarters. And I would argue we're getting a little bit of the recovery side of that early in 2006. In other words, a number of those people that rushed to beat the change in the law have quite frankly now been -- the bankruptcies have been certified or signed out by the court, and in not all those cases did we end up with full charge-out exposure. So, I actually think there's certainly a few more of those to go. But I think in general, our impact, or the impact on our customers was not that profound.

And as Scott said, our charge-offs in the fourth quarter for that consumer portfolio was about 120 basis points; it typically runs 80 to 90 basis points. It was actually only 50 basis points in the first quarter. So, I think we captured for the most part those losses in the fourth quarter of 2005.

Just maybe touch a little bit on -- you didn't really mention much about revenue enhancements in the deal. But going into the stronger growth markets, relatively speaking from where you traditionally are in Ithaca, do you see any potential for revenue enhancements as you put some of the broader product space that you guys have into Elmira's books?

That's what we're hopeful of. As you know, Ithaca is a very strong market. It's one of the stronger markets, and has been for a number of years, in Upstate New York. It has become more heavily banked as a result over the course of the last few years as well. But ES&L has been there for a number of years. They've got a lot of very strong commercial relationships in the Elmira area. So, we look forward to a continuation of those relationships, as well as the opportunity and potential for leveraging our larger lending limits and capital structure into some of those opportunities. So it's not -- we're not hopeful just of revenue generation in terms of loan growth, but as you alluded to, returns associated with a broader set of products on the retail side, on the commercial side, and on the financial services side as well.

Gentlemen, currently we have no further questions in queue.

Very good. Thank you. We will talk to you all in July.

Thank you, everyone. That concludes today's conference. Thank you for your participation. You may now disconnect.