Community Financial System Inc (CBU) 2006 Q2 法說會逐字稿

Good morning, everyone. Thank you for holding and welcome to the second-quarter conference call. Today's conference will begin with a presentation, followed by a question-and-answer session. Instructions on that feature will follow later in the program.

Before we begin today's call, I would like to remind you that this presentation contains forward-looking statements within the provisions of the Private Securities Litigation Reform Act of 1995 that are based on current expectations, estimates, and projections about the industry, markets, and economic environment in which the Company operates.

Such statements involve risk 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 10-K filed with the Securities and Exchange Commission.

Now I would like to introduce today's call leaders, Mr. Sanford A. Belden, President and Chief Executive Officer; Mr. Mark E. Tryniski, Executive Vice President and Chief Operating Officer, and Mr. Scott A. Kingsley, Chief Financial Officer of Community Bank System. Gentlemen, you may begin.

Thank you, Betty, and welcome to our call this morning. As you know, this is my last investor call as a participant, and next Monday, I will begin the next chapter in my life as a part-time consultant to the bank, a part-time farmer, and a full-time grandfather. I'm looking forward to it.

I want to thank all of you for your interest in our Company over the years. I want to thank you for the thoughtful nature of the questions that you've posed to us over the years, which have helped sharpen our thinking about the Company.

I am very proud of the mid-teens returns on an annual basis that we have provided to shareholders over these 14 years. I am equally proud and delighted about the succession plan that has been in place now for some time under the wise leadership of the Board of Directors. We have been working on it for some time and it is, I think, an absolutely ideal succession plan.

So I am very pleased and proud at this point in time to turn the microphone over to my friend, Mark Tryniski, and six days hence, to turn my CEO cap over to him as well. So Mark, it's all yours, sir. Proceed.

Thank you, Sandy. Thank you for 14 years of very distinguished service to our customers and our shareholders, as well as your confidence in me and in our management team to continue the tradition of growth and success that was the hallmark of your tenure. So thank you.

The second quarter was a very good one for us. We're pleased with the earnings lift compared to the first quarter and the margin that remained in the [fourth]. Our revenues were strong as a result of loan growth in all categories and higher asset yields. Further improvements in asset quality metrics drove a reduced loan loss provision, and core operating expenses are down over 2005.

Loan generation was strong, with over half of the quarter's growth coming from our Pennsylvania markets, where we have been challenged in the past, and this year committed to more substantive business development efforts.

I talked on the April call about the significant core deposit generation effort, the objectives of which are to achieve a double-digit increase in this important customer base and our associated balances. We began the program in early April, and for the second quarter, increased personal checking accounts from 121,000 accounts to 126,000 accounts, reflecting a growth rate of about 17%. We will continue to aggressively pursue core deposit relationships in all of our markets.

We were very pleased to announce our new marketing partnership with regional basketball hero Gerry McNamara during the second quarter. Being a four-year star with the Syracuse Orangemen and a native of Scranton, we could not achieved a better fit for a spokesperson within our markets. As he continues his career in the NBA, his star should only continue to rise. Our promotional program with Jerry is underway, including a significant role in the core deposit generation effort I just discussed.

Lastly, I would like to comment on the status of our previously announced acquisition of ES&L Bancorp, headquartered in Elmira, New York. Integration efforts proceed apace, and we expect the transaction to close in the third quarter. We are very pleased with this opportunity and ES&L's long-standing record of earnings growth and exceptional management. As I noted during April's call, 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.

In summary, I would say we had a solid quarter and that we continue to like the trajectory of our business as we head into the third quarter. Scott?

Thank you, Mark, and good morning. Our second-quarter earnings of $9.9 million, or $0.33 per share, were $0.13, or 28%, below the second quarter of 2005, and included stock option expense of $421,000, or $0.01 per share, as a result of the Company's adoption of FAS 123(R) of share-based payments in the first quarter of 2006.

In addition, the second quarter of 2005's results included $5.2 million, or over $0.12 per share, of gains on securities sales. Excluding these two items, our second quarter's earnings per share results of $0.33 were equal to last year's second quarter. The second-quarter results were also $0.02 per share, or 6.5%, above the first quarter of 2006.

Year-over-year loan and deposit growth of 3% and 2% respectively and a 9% increase in non-interest income, excluding securities gains, were offset by an increased cost of funds and an 11% decrease in investment income, a result of the Company's successful balance sheet repositioning in 2005.

Cash earnings per share, which excludes the after-tax effect of the amortization of intangible assets and acquisition-related market value adjustments, were $0.37 per share in the second quarter and $0.72 for the six months ended June 30, a full $0.08 per share above GAAP EPS results.

I will first discuss the balance sheet. Average earning assets were up $34.2 million from the first quarter of 2006, and stood at $3.74 billion at quarter end. Average earning assets declined $78 million from June 30 of last year, comprised of the $73 million increase in loans, offset by $151 million decrease in investments.

As a reminder, 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 returns and interest rate sensitivity characteristics. The proceeds of these security sales were used to reduce overnight borrowings and overnight and short-term earnings throughout 2005.

Total loans at the end of the second quarter were up $36 million from the end of the first quarter of '06, and included increases across all types. Average deposits of $3.03 billion for the quarter were up $27 million from the first quarter and $55 million, or 2%, from the second quarter of 2005.

Borrowings at June 30, 2006 were up slightly from the end of the first quarter, but have been reduced $60 million year-to-date in 2006, and are down $205 million, or 26%, from June 30, 2005. Although our decision over the last 1.5 years to not reinvest securities cash flows in the then and still flat yield curve environment continues to have an unfavorable impact on year-over-year earning comparisons, it has improved our overall net interest rate sensitivity profile.

Our capital levels remain strong. Our tier 1 leverage ratio improved to 7.73% at quarter end. Our tangible equity ratio stood at 5.9% at June 30. Also, the Company acquired an additional 101,000 of its own shares during the quarter at a cost of $2 million under the 1.5 million share repurchase program authorized by the Board of Directors in April 2005. At June 30, there were 650,000 shares available for repurchase under this program.

Shifting to the income statement, the net interest margin for the second quarter, as Mark said, declined 6 basis points to 4.00% from 4.06% in the first quarter of 2006, and was 16 basis points lower than the 4.16 recorded in last year's second quarter. Year-over-year, earning asset yield increased 32 basis points, with loan yields up 42 basis points and investment yields up 14. The cost of funds rose 51 basis points from the second quarter of 2005 to 2.50%.

Our loan loss provision for the quarter was $1.7 million, compared to $2.2 million in the first quarter of 2006 and $2.1 million in last year's second quarter, and was $180,000 higher than quarterly charge-offs. Our loan loss allowance to total loans outstanding stood at 1.35% at quarter end, consistent with the average level reported for the last eight quarters.

Nonperforming loans to total loans outstanding are at 0.45%, improved from 0.62% at the end of the first quarter and 0.56% a year ago. The delinquency ratio was 1.15% of total loans at June 30, 2006, an improvement from 1.32% reported a year ago. This favorable and stable asset quality profile is primarily the result of our enhanced credit risk management programs and are continued emphasis on and adherence to disciplined underwriting standards.

Non-interest income, excluding securities gains, was up 9% over the second quarter of 2005. Deposit service fees increased 7% over the prior year's second quarter, driven by several revenue enhancement initiatives put into place during 2005 and increased product utilization.

Our employee benefits administration and consulting business posted a 20% increase in revenues over last year's second quarter thanks to new product offerings and the addition of new clients. There were no investment security sales in the first half of 2006.

Operating expenses, excluding the effect of the change in accounting for stock options, decreased to 1.3% year-over-year. A $0.5 million reduction in the amortization of intangible assets was partially offset by increases in occupancy expenses, principally utilities and real estate taxes. The Company continued to aggressively manage all aspects of its operating expense structure in the second quarter.

Our effective tax rate for the quarter was 24.1%, compared with 25.0% in the first quarter of 2006 and 26.1% reported in the second quarter of 2005. The proportion of tax-exempt income to total income continues to be the most significant determinant in our effective rate.

I will now turn it back over to Betty to open the line for questions.

(OPERATOR INSTRUCTIONS) Damon Delmonte.

Nice quarter. Before I ask my question, Sandy, congratulations on a great career and enjoy your retirement.

Thank you very much, Damon. I appreciate that. Thank you, sir.

With respect to the provision this quarter, it was lower than we had seen last quarter and what we were looking for this quarter. Is this a good run rate, given the current levels of asset quality?

Damon, I think, to your point, it is probably almost $0.01 per share below where we had been on an average run rate. So certainly, the trends and the signs that we are seeing would suggest that the performance of the portfolio is capable of repeating that. But in terms of modeling purposes, we would acknowledge that this is our best quarter in quite a while.

Okay. And then as far as the tax rate goes, is the 24% level a good level or should we --?

I think if you looked at the blended rate for six months at 24.5%, that is a fair rate to use.

Great. Finally, in the expense items, under either non-interest expenses, it looks like it was a little bit higher than last quarter. Anything unusual in there? I know there were some consolidation costs from those branches.

As a matter of fact, the two items I was actually going to point out is we did consolidate two small branches in Pennsylvania, and during the quarter incurred about $160,000 worth of costs. And those two branches are actually being consolidated late next week, is the actual closure date for those.

We also had about $300,000 more in marketing and development costs in the second quarter than in the first quarter, Damon, related to this core deposit program that we are running. We expect to probably see spending along that line in the third quarter also as the program gets fully evolved.

Great, I think that's all. Thank you very much.

David Darst.

Could you comment on the linked-quarter decline in trust that's been in the BPA line of business?

Sure, David. If I was to look at the -- and you're just going to go on a linked-quarter basis -- is that your question?

Yes.

If you go to the trust and investment asset management side, what you really see is over the last three or four quarters, that has basically been flat. In the first quarter of '06, we had some estate fees in our trust departments to the tune of almost $200,000, that certainly are less than predictable in terms of timing. And although we appreciate those fees, as you can expect then, the servicing side of those trusts goes away. So it is a positive pop at that one point in time in one quarter and then, quite frankly, a detrimental effect going forward.

Relative to the benefit plan administration consulting side, that decline really relates to the fact that the actuarial consulting side of that business really does have a seasonal high in its first quarter. And if you can go back to that, David, really it relates to the fact that they do an awful lot of year-end pension valuation work, where the billing or the revenue really comes in the first quarter.

And then they see effectively a flat base perspective for the following three quarters. But we've had the bump up probably now since we've owned that group.

Okay. Then can you comment on your balance sheet going forward and what your plans might be for further reduction of securities and borrowing? And any remixing of the loan portfolio that you may anticipate.

I will take a shot at the borrowings and the investments, and I'll let Mark give you a little bit of color on the components of the loans. But as you can see, what happened in the second quarter is we did have some natural cash flows coming off the portfolios. And as rates have actually gone up, we have had a little bit more in terms of calls on certain securities than we would have otherwise estimated.

But given the reinvestment opportunities, we expect that to actually continue. So we don't currently see ourselves in the market on the investment securities side in the near-term, David. And our intent is to continue to use those to get us down -- or lower our short-term borrowings.

The one thing I will remind you and remind the other people on the call, when we do do the Elmira transaction, Elmira was a net borrower effectively at the end of their first quarter, and we expect they're in that same situation. So we will be paying attention to maybe $30 million to $40 million of some short-term borrowings as we pick them up.

Okay. Then, Mark, can you comment on loans? As you do that, could you maybe give us some color on indirect and direct, the composition you're seeing there?

Sure. I'd start by reiterating my point earlier that we had a good quarter in loan growth. It came in all three categories, I would say. The thing that was particularly satisfying to us was that a great deal of the growth, the lion's share of it, occurred in Pennsylvania, where we have been working hard to get improved traction. So we are very satisfied with the growth for the quarter overall, and in particular, as I said, in Pennsylvania.

The second quarter is typically fairly strong in terms of indirect loan growth, and this quarter was no different. You can see that the lion's share of the loan growth was actually in the indirect portfolio.

One of the things which is in fact less growth than what we have seen in prior years seasonally in that portfolio for a couple of reasons. One is that we're trying to -- we have worked a bit harder to hold the margins up in that business. We have also increased the percentage of A & B paper in total.

So if you look at the yields on our indirect portfolio, they have been relatively flat. But the net charge-offs on that portfolio the last of couple quarters since we have been pursuing more A & B paper is actually a whole lot less than what it has been historically. So the risk -- the loss-adjusted returns on that portfolio have actually improved.

We continue to focus a great deal on our commercial lending, including in Pennsylvania. I think we are seeing overall a more competitive environment in terms of structure. And we have continued, as Scott said, to adhere to very disciplined lending standards. Although I think in large part the improvement in our asset quality is also as much a function of the nature of the economy and the fact that people tend to be paying their bills more now than maybe in the past, which is not to say that is going to last forever. But I think we have been the beneficiary of that on some level, just the general economy.

So the mortgage market, it softened a little bit. Our pipeline, however, in the mortgage market is still actually running a bit ahead of where it was year-to-date last year, so that business has still been pretty strong for us. We're still selling a lot of our -- I think most of our 30-year -- there's 30-year production.

So we think that, again, the pipelines remain strong and we are very optimistic as we head into the third quarter as it relates to loan generation.

Okay, thank you. I guess can you (indiscernible) credit a little bit further? A lot of the other banks that I follow in your general region are seeing one and two credits come up this quarter. They have cited them as being company-specific issues, but they seem to be a little more widespread at various banks. So are you seeing higher fuel prices or building costs or just higher rates affect any of your businesses or any of your customers?

Not yet, David. Our commercial portfolio is really -- like the other portfolios -- is as strong as it has been a long time in terms of asset quality. We will tell you one thing that we have seen as kind of an industry issue for us, and I know for some others as well, has been the auto industry. We have probably a $40 million portfolio of floor plan relationships, and we have had some pickups in that portfolio. In fact, a fair amount of the charge-offs over the course of the last six months or so have been in the indirect floor plan portfolio.

But the consumer side of that has been strong. The direct and indirect lending to individual consumers auto paper has been very strong in terms of its asset quality characteristics. In fact, that portfolio, the charge-offs and delinquency rates are as low as they have ever been for that portfolio. Some of the relates, again, back to the fact that we have concentrated on A & B paper.

But I would say that is the only industry where we've seen any kind of a hiccup in performance, and we have addressed that. We have fully reviewed internally all of our floor plan relationships. We've reviewed all of the documentation associated with those. We've revisited all of the controls over our floor plan checks and inventories and those kind of things.

So we are satisfied where we stand right now, but that is certainly one industry or segment of our commercial portfolio that I would say has experienced a bit of softness.

Okay, thanks.

(OPERATOR INSTRUCTIONS) Rick Weiss.

I was wondering with respect to your commercial loan portfolio, what are the loan rates tied to? Is it primarily prime-based or LIBOR-based?

It's more prime the LIBOR. I would say as of late we've started to do a bit more LIBOR-based, but by and large, it is prime-based.

Are you able to pass on pretty much every time the Fed raises the 25 basis points to customers, or is there some kind of negotiation that occurs?

Well, as you can understand, there is always a negotiation that occurs. I think our objective really is to price each credit according to its risk profile and its structure. We certainly -- we use prime as the starting point for that negotiation. So we do get --if you look at our commercial loan yields, they have been increasing fairly rapidly over the last number of quarters.

And just to give those numbers, this quarter, the net interest margin or the yield on our commercial line was 7.25. Last quarter was 6.96. The quarter before that, 6.78; 6.52, 6.33 -- so it's been -- over the course of the last about seven or eight quarters, as the short-term rates have been going up, we have been able to pass that through to our customers. As well as the fact, Rick, that the existing portfolio automatically reprices every time there is a 25 basis point increase in the rates.

Okay. So I'm guessing that, depending what the Fed does of course, but do you think that the margin will be fairly stable, plus or minus, say, 10 basis points? Is that the rate you're shooting for (multiple speakers)?

I think that is a very fair comment. I think the plus or minus 10 basis points is very fair. I think in the third quarter for us, just based on length of the quarter and some other things, that's sort of always been the low point of the year for us in terms of margin, if you look at the past handful of years.

The other thing we will have in the third quarter is a slight dilution of our net interest margin because the Elmira assets -- or the net assets of Elmira will come onto the books at a slightly lower margin than our core base. Not a lot lower, but slightly lower; but probably enough dilute it just below the (technical difficulty).

Okay, got it. I was wondering if you could just talk a little bit about what you're seeing in the M&A market right now.

Well, I think it has been active. We expect it is going to continue to be active, and that we will have opportunities to grow our Community Bank based business model in the quarters ahead. There's clearly more activity, there is more interest than I think we have seen probably in quite a while, Rick.

That is basically throughout your market areas, would you think?

That is New York and Pennsylvania, yes.

Thank you very much. Nice quarter, guys.

(OPERATOR INSTRUCTIONS) It appears we have no other questions.

Thank you very much. Goodbye.

That concludes today's conference. Thank you for participating. You may now disconnect.