Community Financial System Inc (CBU) 2006 Q4 法說會逐字稿

Before we begin today's conference 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 risks and uncertainties that could cause actual results to differ materially from the results discussed in these statements. These risks are detailed in the Company's annual report and Form 10-K filed with the Securities and Exchange Commission.

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

Thank you, Betty, and good morning to everyone. And welcome to our conference call to review fourth quarter and full year operating results. I will start off by saying that we are generally pleased with both fourth quarter and full year performance, and repeat what I said in the narrative of the earnings release, which is that we delivered organic and acquired balance sheet growth, double-digit growth in nonbanking revenues, continued improvements in asset quality, and reductions in operating expenses.

The net benefit of this performance offset principally all of the decline in margin resulting from the current interest rate environment.

Fourth quarter earnings met our expectations and were ever so slightly ahead of last year's fourth quarter, as adjusted for the non-competitive items described in the first paragraph of the release.

We did record a $0.01 per share charge for acquisition and early retirement expenses, and another $0.06 per share for the impact of a trust preferred refinancing that was the clearly obvious decision in terms of the net present value analysis, and which Scott will discuss in further detail.

Organic loan and deposit generation trends slipped in the fourth quarter, with the exception of Pennsylvania, which continued its recent strong lending performance. Full year earnings met our expectations as well, and resulted in large measure on strong growth in loan revenues, growth in nonbanking revenues, reductions in operating expenses, and the lowest level of loan charge-offs we have recorded in many years.

Offsetting these earnings improvements was a 26 basis point decline in the net interest margin, and the impact of a $170 million planned reduction in our average investment portfolio.

Total loans grew nearly $300 million during the quarter, approximately $250 million of which came from acquisitions. The absence of organic loan growth in the fourth quarter after strong second and third quarter results did not meet our expectations. In fact, we had a slight net reduction for the quarter, except for Pennsylvania, where our First Liberty Bank & Trust division delivered nearly 9% annualized growth in the quarter, and continues to benefit from strength in business development efforts there during 2006.

I commented on the last two calls about a significant core deposit generation effort, the objectives of which are to achieve a double-digit increase in this important customer base and the associated balances. We began the program in early April, and for the past three quarters have increased personal checking accounts from 121,000 accounts to 136,000 accounts, reflecting a growth rate of 17% and adding over $50 million of new low-cost core deposits.

Those results have met our expectations, and we will continue to aggressively pursue core deposit relationships and related cross-selling opportunities in all of our markets.

By way of acquisition activity the second half of 2006 was busy for us as we closed down the Elmira Savings & Loan merger in August and the Ontario National Bank transaction in December. We have been very pleased with both of these acquisitions and their subsequent performance, and expect them both to be accretive for us in 2007.

We announced earlier this month our agreement to acquire Tupper Lake National Bank, a $100 million bank located in the Adirondack region of Northern New York State. In addition to five branches and Tupper Lake, Saranac Lake and Plattsburgh, they own an insurance agency subsidiary as well. This represents a very good opportunity for us to extend our dominant northern region market position geographically to the Northeast border of New York State, and to gain entry to markets that are experiencing growing real estate and development activity and capital inflows. We expect the acquisition to close in early June.

Scott, why don't you make your financial review comments, and then I will make a couple of closing comments, if I like.

Thank you, Mark, and good morning everyone. Our earnings of $8.2 million, or $0.27 per share, were consistent with the fourth quarter of 2005. However, the 2006 quarter included a $0.01 per share reduction due to stock option expenses of $392,000, which became required in the first quarter of 2006.

In addition, fourth quarter included a onetime $2.4 million charge due to the early redemption of our $30 million fixed-rate trust preferred obligations, as well as $500,000 of acquisition expenses and special charges.

The fourth quarter of 2005 included special charges of $2.9 million related to certain retirement actions last year. Excluding these noncomparative items, as Mark said, fourth quarter 2006 results were slightly higher than 2005.

Full year 2006 earnings of $38.4 million, or $1.26 per share, were 24% below 2005's record earnings of $50.8 million, or $1.65 per share,, which included $12.2 million, or $0.29 per share, of securities gains.

Cash earnings per share were $1.47 in 2006, or $0.21 per share above GAAP reported results. These exclude the after-tax effect of intangible asset amortization and acquisition-related market value adjustments, as well as the non-cash portion of the trust preferred securities early extinguishment charge.

Fourth quarter results also included the first full quarter impact of ES&L Bancorp acquired in mid-August, and a month's worth of activity for Ontario National Bank acquired on December 1. I will first discuss the balance sheet.

Average earning assets of $3.97 billion were up $127.6 million from the third quarter of 2006, and 7.1% higher than the fourth quarter of 2005, including the ES&L and ONB acquisitions. Average loans were up $262 million from last year, including $135 million in business lending, $81 million in consumer mortgages, and $46 million in consumer installment products.

Average investments for the 2006 fourth quarter were consistent with the prior year, but include an additional $61 million of short-term cash equivalents in expectation of certain debt reduction transactions in early 2007. As a reminder, in 2005 we successfully repositioned our balance sheet, 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. We then used the proceeds to reduce overnight and short-term borrowings throughout 2005.

Average deposits of $3.13 billion for the quarter were up 5.2% from the fourth quarter of 2005, principally from acquisitions. Our primary deposit gathering strategies continue to focus on core checking products.

Total borrowings at year-end, net of invested cash equivalents, increased $53 million from the end of 2005, due to the two all-cash acquisitions in 2006, as well as the additional trust preferred securities issue.

In December we issued $75 million of trust preferred securities at a rate of three months LIBOR plus 165, and immediately entered into an interest rate swap agreement to convert the variable rate of the trust preferred securities into a fixed-rate obligation at 6.43%, taking advantage of the then inverted swap curve. The proceeds will be used for general corporate purposes, including acquisitions, and to early redeem $30 million of fixed-rate trust preferred debt next week, including a call premium of 4.54%. The cash flow payback of this early redemption is only 16 months.

On a year-over-year basis loans grew $290 million, or 12%, including the ES&L and ONB acquisitions. Organically we achieved a 4.3% increase in consumer installment loans in 2006, with success in both home equity and select indirect auto products. Although we did sell certain new mortgage originations into the secondary market again in 2006, residential mortgages increased $17 million organically over the last 12 months.

Excluding acquisitions, business lending outstandings declined slightly, but included a $14 million managed decline in automotive dealer floor plans, a segment we have actively chosen to underweight in current market conditions, but remain committed to over the long term.

Our capital levels remain strong, including the recently issued trust preferred securities, which offset a portion of the cash funded ES&L and ONB transactions, as well as the adoption of FASB 158, Employers Accounting for Defined Benefit Pension and Other Post-retirement Plans, as of December 31, 2006. The Tier 1 leverage ratio stood at 8.79% at year end, and our tangible equity ratio was 5.07%.

Also in December the Board of Directors extended the current share repurchase program and added a 900,000 share authorization as well through December 2008.

Shifting to the income statement, the net interest margin for the fourth quarter declined 13 basis points to 3.74% from 3.87% in the third quarter, and was 38 basis points lower than the 412 reported in last year's fourth quarter. Results included the impact of the ES&L and ONB acquisitions, which had lower net interest margin attributes than our historical averages. Year-over-year the net interest margin declined 26 basis points from 4.17% in 2005 to 3.91% for full year 2006.

Earning asset yields improved 30 basis points from 2005, but the cost of funds rose 58 basis points to 2.60%, reflecting continued movement into higher interest-bearing instruments, including time deposits, as well as the somewhat higher yielding required deposits.

Our loan loss provision for the quarter was $1.4 million compared to $1.3 million in the third quarter of 2006, and $2.2 million in last year's fourth quarter. Our year-to-date provision of $6.6 million was 23% below the $8.5 million recorded in 2005, but was still $500,000 above year-to-date net charge-offs of $6.1 million. Our loan loss allowance to total loans outstanding stood at 1.34% at year end, and reflected the acquired ES&L and ONB loans and reserves with coverage ratio slightly below our average.

Year-end nonperforming loans to total loans outstanding were at 0.47% compared to 0.55% at the end of the fourth quarter of 2005. This favorable and stable asset quality profile is primarily the result of our credit risk management programs and continued emphasis on and adherence to disciplined underwriting standards.

Fourth quarter noninterest income, excluding securities gains and net extinguishment charges, was up 3.3% over the prior year. Our employee benefits administration and consulting business increased revenues by 16% over last year's fourth quarter, thanks to new clients as well as enhanced product offerings, resulting in a full year improvement of $2 million, or 18%.

Operating expenses, excluding stock option and acquisition expenses as well as special charges, increased less than 1% over the year ago quarter from $31.5 million to $31.8 million. This includes the incremental ES&L and ONB-related operating cost. Excluding those, quarterly and full year operating expenses actually declined in 2006.

Our effective tax rate for the quarter was 20.6% down from 24.4% in the third quarter and 24.1% in the fourth quarter of 2005, due principally to fluctuations in our proportion of tax-exempt income, as well as the impact of the debt extinguishment charge incurred during the quarter.

I will now turn it back over to Mark for a couple of closing comments.

Thank you, Scott. Overall we were very pleased with the progress made throughout the Company in 2006. Our organic business development and cross-selling capabilities have improved. And we will be committing even more resources to this effort in 2007, particularly in our commercial banking business.

The performance of our Pennsylvania division has greatly improved, both in the consumer banking and the commercial banking businesses. We need to get even better in Pennsylvania, but I think we have laid the foundation for continued progress.

We reduced operating expenses. We grew noninterest income, and we improved asset quality, all of which will provide support for future earnings.

Lastly, and with respect to 2007, we expect a continuation of the current yield curve environment with a 10 to 15 basis point reduction in net interest margin below that in 2006. We expect continued loan and deposit growth at levels commensurate with our markets. We expect asset quality to remain strong and stable. We expect our noninterest income lines to perform well. And we will continue to closely manage operating expenses. We have strong liquidity and capital levels that are well-positioned to continue the operating and performance momentum built in 2006.

And those are my comments. Betty, if you would open up the line to any questions.

(OPERATOR INSTRUCTIONS). Kevin Timmons.

A couple of questions on the margin guidance. If you would split 10, 15 below the full year of fiscal '06 that would imply between 376 and 381, which is about where you were in Q4. Is that the intention of the guidance? And do you expect that to be pretty much Q1 on or fluctuations during year?

I think that your math is correct. And I think we think that probably the first couple of quarters will be slightly lower than the second couple of quarters.

I note that deposit costs continued to go up at about the same pace. The expectation in the second half looks a little bit better than the first. Does that include the assumption that the deposit costs increase begins to moderate there?

It does. It certainly does.

And we think we're going to continue to get some lift on the earning assets yields, the loan yields, as we have the last several, I think, three or four or five quarters consecutively.

Tax rate, are we looking at more 25% for '07 than the 20.4% for fourth quarter?

Yes, I think the fourth quarter at 20.6 is unusually low. I think for modeling purposes we are between 24 and 25.

In terms of provision versus net charge-offs, again expecting given some loan portfolio growth you're probably grow the reserves somewhat but not a whole lot?

I think that is pretty accurate also. I think we have consistently provided a provision above charge-offs on a quarterly basis. And certainly with a growing loan portfolio that would be our intent going forward.

Your thought right now is that charge-offs probably remain roughly where they are, given what the picture looks like now?

I think we're pretty comfortable with that. I think we did have very good charge-off quarters in the third and the fourth quarter. So I think we would be holding ourselves to a very high standard if we expected that for the next four. But I think somewhere between where we were early in the year versus where we ended the year is probably relevant.

And we also had some visibility into the first kind of couple of quarters of the year as well, given all the ongoing analysis of the portfolio, so we think that the first couple of quarters are going to continue to be strong in terms of asset quality.

I assume you guys are having the same kind of winter we're having here in Albany, so your snow removal and heating costs will probably be a little bit lower than planned?

I think you are -- that is a fair analysis until the the last couple of weeks. The skis were not out. You're right.

It sounds good. Thanks.

Rick Weiss.

I was thinking -- I was looking at your loans to deposit ratio, and unlike most of the industry you are still very low. Have you ever given thought to any sort of loan participations or something to grow loans faster? I am just wondering what your thinking is on that?

Yes, we have. As you know, some of the history surrounding our lower than peer level of loan to deposit is really -- it dates back starting back in 2001 when we did those sizable fleet branch transactions and got -- I don't remember the exact number, but it was in the hundreds of millions, $300 million or $400 million in deposits, with almost no loans attached to them, other than some small consumer loans. So that was kind of the genesis of needing to put to work all of those deposits. And that it certainly one of our strategic objectives. I think you'll see that ratio grow over time.

It is also one of our strategic objectives to grow the ratio of loans to total earning assets as well, which implies a lower level of investment securities going forward. So both of those are part of our objectives. We understand we can't solve that overnight. I think it is a great question.

We don't do a lot of loan participations. We do some. We're pretty careful about it. And we have considered some other origination sources on some levels, and there are some things even going on as we speak in terms of outside originations in certain market and lending categories for which we have a fair bit of expertise. But I would expect that that ratio is going to grow over a period of time.

I think we would like to certainly continue to see that move up. We probably should acknowledge that from the end of 2004 to the end of 2006 that ratio went from 80% to 85%, while our investment securities as a portion of earning assets went from 41% down to 31%. So as Mark pointed out, that is a strategic objective. We continue to work on that, and I think we would like to continue to see that moving up.

Right. I guess what I'm trying to take from your answer would be mostly organic that you would think, rather than purchasing loans, or that is an open issue? Fair enough.

One of the things that we have done with the last couple of acquisition transactions is we have kept loans and sold the investments. So that has provided some support to those ratios as well.

Also, let me switch over to another ratio, your tangible equity to tangible assets. It is getting close to 5. Do you have a figure you guys want to shoot for, or like it goes where it goes?

We really don't. We really don't. I think it has been as low as in the 4's in the past. We have had some conversations in the past with you and others about the utility of that metric, but we don't have a target. We understand that are a lot of folks who look at it -- who look at that. I think that the charge -- the way we look at it is we need to make sure to the extent we drive that number lower because of intangible assets that we put on the books, we have to be sure we're getting the earnings strength out of those intangible assets. And that is to us the bottom line. If we can continue to do that that metric is going to have less utility, but it is certainly critical that we get the earnings out of those intangible assets that we put on the balance sheet.

You probably have picked up on this already, but in the fourth quarter that adoption of FAS 158, the pension accounting, was actually a $10 million charge to other comprehensive income. So where there used to be pension assets in a prepaid scenario residing on the asset side of the balance sheet, the requirement of that FASB was to actually move them to a charge to other comprehensive income. So probably 20 basis points of our reduction this quarter came from just that accounting announcement, which I'm sure everybody on the call knows, is not a reduction of regulatory capital.

Okay. I think you gave me too much credit on that, because I did miss it. But thank you for pointing that out.

Kevin Timmons.

Rick covered part of my question on cash flow equity. But I guess just to add my two cents in there, from my view I do look at cash flow equity ratio as a key number on the capital structure, understanding that the regulatory ratios are what you have to manage to for that purpose.

But ultimately from the market's perspective, many other capital instruments counted in some of those regulatory ratios are viewed as effectively a long-term debt for capital as opposed to true equity. So that is my two cents on that.

The other question I did have though was the newly issued trust preferreds and the redemption, when will the redeemed stuff actually come off the books?

The redeemed stuff comes off the books January 31. So the $30 million fixed-rate at 975, January is the last month we're incurring interest on that instrument. And the charge was $1.4 million of an early redemption charge. That is the early call premium. And then we had almost $1 million of capitalized fees associated with that original trust preferred issuance, back when issuing those things was a much more expensive transaction. So that is what made up the $2.4 million charge.

But to answer your question, January is the last month for the $30 million. As a matter of fact I think we're early redeeming next Tuesday.

Part of the equation on the margin is that you are caring for a month, or whatever it was -- it works out to be, extra capital that is costing you on the margin?

No question that happened in the month of December. And we made that point to say that we were carrying some excess liquidity arguably in that month of December, some from the trust preferreds issuance, some from the Ontario National Bank acquisition, and some from just continued investment portfolio cash flows. But you're right, we certainly did not have a positive spread against those net items in the month of December.

But you're obviously very beneficial on the $30 million replacement number. On the remaining amount, beyond the 30 million, how negative the spread -- will the spread be on that portion, about 100 basis points or so, until you get at the poise of the loans?

I'm not exactly sure as to how to answer the question, because I think we would certainly from our perspective take that -- let me back this up for a second. From our perspective the excess trust preferred funding, or the $45 million, we should probably look at that as a source of permanent financing for the two cash deals we did in 2006. So I don't think we're trying to earmark that excess proceeds per se to redeploying it onto the balance sheet. I think we think that we have used that to actually already accomplish the cash flow needs that were out there for the third and fourth quarters.

And I think we believe that that 6.43 rate on a long-term basis, we should not be unhappy with that in the trust preferred offer.

I have had no problem with that. I would do this deal in a second if I were you.

I think to do it today would cost you -- what -- 40 basis point or so more than we've got it on the books for.

David Darst.

Going back to the capital conversation, could you comment on repurchases, and have your slowed down repurchase activity during the fourth quarter and --?

We had virtually none.

How about in the first quarter?

We were in the box out period, we have not done any.

Do you intend to until Tupper Lake is completed?

I think we will continue our standard -- our stance on that would be that if that is the best use of the capital, given the opportunities of the market, we look at that as a very capital efficient way to spend some of it. If we think that the opportunities are out there in terms of portfolio growth or acquisition, I think we would rather go that way.

We've certainly got -- given the liquidity and the capital ratios right now -- we have got a lot of flexibility heading into 2007.

Other than the trust preferreds that you will take off the balance sheet this quarter, do you have any other essentially borrowings that will be -- that as they mature you will pay off?

We do. We have about $75 million of those coming due mid-February, and we actually expect to again liquidate those with excess liquidity.

Then on the fee income side, I indicate you guys at about 22,000 new accounts. Are those all primarily checking?

Yes, those are all core personal checking accounts.

Have you seen any increase in service charges?

A little bit. I think what has happened, and what we saw in the first quarter of 2005 before we implemented this program, was an evolving sensitivity on the part of the consumer to some of the overdraft charges. And we think what we did during 2006 to grow those relationships has served to offset that sensitivity and even provide a little bit of uptick. We are seeing a little bit, but it is not 17%. It is not commensurate with the growth in the rates either.

The other thing we have seen over the course of last year with those accounts, the cross-sell rate on the debit cards is in the '90s -- the 90% range. And we have made a concerted effort to grow our debit card penetration over the last couple of years, which admittedly was about half of the industry average. We were in the 30's and the industry is in the 70's somewhere. That is now pushing 50%, and we expect to go higher with it in 2007. And the revenue that that generates, as well the interchange fee revenue, is about double. The runrate right now is about double what it was in 2005. So we expect that to continue to rise as well.

Then as far as BPA is concerned, and that line of business, is fourth quarter seasonally strong?

Actually, it is actually not. If you think about the benefits administration side of that business, it is relatively consistent. Though what does happen in these daily evaluation plans today is you're not married to the beginning of the year in terms of kicking off a new plan. Because the portability of some of that stuff it can come at anytime. I would not say the fourth quarter is seasonally strong. I would say the fourth quarter gets a little bit of a boost in 2006 because assets were up in terms of the performance of the assets, which some of our compensation is based on asset values. Relative to the actuarial side of that business usually that first quarter is usually its strongest quarter.

Could you give us an indication of how you would gauge that growth? Do you have a strong pipeline for new business, or is it other activity within the current accounts?

I think it is a little bit of both. But I certainly think our expectations for 2007 in that business unit are double-digit again in terms of revenue improvement. We have certainly said before that we're pretty bullish on that group. They have organically very, very well, and have developed a number of different sources in terms of ending up with plan assets as part of their administration. And we feel very good about that unit and its chances of keeping -- moving up forward on a going forward basis.

In terms of the year to year comparison, as Scott mentioned, some element of the revenue stream there is directly correlated to assets under administration. And as you know, the markets did quite well, particularly the second half of the year, which is going to add some additional lift to their revenue expectations going into 2007.

It sounds good. Thanks.

Damon Delmonte.

Most of my questions have been answered already, but just two quick ones. With regards to the Tupper Lake acquisition, you said that was going to close in June?

Yes, that is what we expect, early June.

About how much in loans did you expect to get from that?

It is about $50 something million -- in between $50 million and $60 million in loans, and I think around $80 million to $90 million -- $85 million to $90 million in deposits.

Then with respect to your securities portfolio, right now it is about 27% of total assets. Do you have an estimated reduction range for the rest of this year?

We don't really. We do expect right now, given the environment, that that will continue to run off -- the cash flows will continue to run off somewhere in the neighborhood of $100 million over the course of 2007. Which isn't to say that if the markets change course in a way that provides a significant advantage to us in terms of capital market activities that we won't response accordingly, but right now that would be the expectation.

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

Very good. Thank you, Betty. Thanks to everyone who joined us this morning. Bye-bye.

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