Community Financial System Inc (CBU) 2007 Q2 法說會逐字稿

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 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. Good morning and thank you all for joining our second-quarter conference call. I will start by stating my clear satisfaction with our second-quarter operating and financial performance.

Earnings per share were up slightly over 2006 despite the $0.09 per share impact of lower net interest margins. Similar to the first quarter, we overcame the margin headwind using organic and acquired balance sheet growth, continued expansion of our noninterest revenue lines and exceptional asset quality.

Organic deposit growth moderated in the second quarter was up just slightly following our first-quarter growth of 3.5%. Migration to time deposits from lower yielding account types continued in the quarter and contributed to higher funding costs. Stronger loan demand in the second quarter helped to absorb some of the deposit-based liquidity generated in the first quarter. We generated organic loan growth of over $30 million in the quarter and $85 million, including acquisitions. There were like-sized increases across all portfolios.

Noninterest revenues for the quarter were particularly strong, up 22% over 2006 with solid growth in banking fees and services, wealth management and benefits administration and consulting. Our benefits administration and consulting revenue alone was up over 50%, reflecting 26% organic growth and 24% acquired growth.

Asset quality continues to be at historically exceptional levels, resulting in reduced credit costs. We believe this is partially due to a favorable economic and interest rate cycle, but also due to the substantial improvements we made to our credit function over the past several years, which had resulted in a structural strengthening of credit quality that we believe will continue to be evident even when the credit cycle turns downward.

I would also add that we have no exposure to subprime, Alt-A, option arms or any other iteration of higher risk mortgage products. And that holds true for both our loan portfolio and our investment book.

On June 1 we closed on the previously announced acquisition of Tupper Lake National Bank, a $100 million asset bank located in the Adirondack region of Northern New York State. In addition to five branches in Tupper Lake, Saranac Lake and Plattsburg, 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 gain entry to markets that are experiencing growing real estate and development activity and outside capital inflows.

In May we completed our acquisition of Hand Benefits & Trust, a Houston, Texas based provider of employee benefit administration and trust services. Hand will become part of our existing benefits administration business, which now has a revenue run-rate of over $20 million annually. Hand is a very high-quality and well-respected provider in the industry, and we're pleased to partner with them in further expanding the geographic footprint, service capacity, product offerings and revenue base of BPA Harbridge. We expect Hand to be $0.02 accretive on a full-year basis, excluding onetime acquisition and integration costs. These two acquisitions mark the third and fourth transactions that we have completed within the last 11 months, and we continue to explore and evaluate similar opportunities for expansion as this remains an important focus of our growth strategy.

So the second quarter was a very good one in many respects, but the signature event of the quarter for us was that Community Bank was named by J.D. Power & Associates as the second best bank in the nation in customer service quality. To be number two on this list that includes 75 of the most exceptional and respected banking organizations in the country, many of which are far larger than we are, is quite gratifying. I am very proud of and thankful to all of our employees for this exceptional accomplishment, which further validates the effectiveness of our decentralized community-oriented service model.

With that Scott will give us a more detailed review of our second-quarter financial performance.

Thank you, Mark, and good morning, everyone. Our second-quarter earnings of $10.4 million or $0.34 per share were $0.02 per share above the $0.32 reported in the first quarter of 2007 and $0.01 above the second quarter of 2006.

Cash earnings per share, which exclude the after-tax effect of intangible asset amortization and acquisition-related market value adjustments, were $0.39 per share in the second quarter or $0.05 per share above GAAP reported results. Second-quarter results also included the impact of the two acquisitions as Mark mentioned -- Hand Benefits & Trust acquired in May and Tupper Lake National Bank acquired on June 1.

As Mark also noted, acquired and organic balance sheet growth, improved noninterest income generation and exceptional asset quality more than offset the net interest margin contraction resulting in improved earnings over last year's second quarter.

I will first discuss the balance sheet. Average earning assets of $4.08 billion were up $336 million from the second quarter of 2006 or 9% and were (technical difficulty) higher than the first quarter of 2007, including the Tupper Lake acquisition. Average loans were up $286 million from last year, including $144 million in business lending, $108 million in consumer mortgages and $34 million in consumer installment products. Average investments for the 2007 second quarter was $49 million above the prior year, but included an additional $150 million of short-term invested discount notes and cash equivalents, reflective of our current level of liquidity and a lack of attractive longer-term reinvestment options. Average deposits of $3.28 billion for the quarter were up 8.2% from the prior year and $100 million above the first quarter. Our primary deposit gathering strategies continue to focus on core checking products.

Total borrowings at quarter-end decreased $50 million from the end of the first quarter. In addition, we're continuing to analyze the economic value of early redeeming all or a portion of our $50 million of variable-rate trust preferred securities issued in 2001 with interest rates at least 200 basis points above current market conditions given our flexible capital and liquidity positions. On a year-over-year basis, loans grew $323 or 13.2% including the Elmira, Ontario and Tupper Lake acquisitions. Organic mortgage loan growth was nearly 3% despite the sale of $17 million of certain originations into the secondary market.

Business lending grew organically even with a $7 million managed reduction in automotive dealer floor plans, a segment we have actively chosen to continue to underweight in current market conditions but remain committed to over the long-term. We also grew our consumer lending portfolios organically from last year's second quarter, despite a small decline in outstandings in our consumer indirect portfolio, reflective of generally soft automotive market conditions.

Our capital levels remain strong. Tier 1 leverage ratio stood at 7.90% at quarter-end and our tangible equity ratio at 4.66%. In addition, we did repurchase 233,000 shares during the quarter and have nearly 1.25 million shares available under our existing authorizations through December of 2008.

Shifting to the income statement, the net interest margin for the second quarter of 3.64% was down 10 basis points from the first quarter and declined 36 basis points from the 4% even in last year's second quarter. Results included the impact of the three bank acquisitions we've completed since August which had lower net interest margin attributes than our historic leverages. Earning asset yields improved 13 basis points from the second quarter of 2006, but the cost of funds rose 49 basis points to 2.99% reflecting continued movement into interest-bearing instruments, including time deposits, as well as a somewhat higher yielding acquired deposit.

In addition, the second quarter's results included $60 million of FHLB borrowings which we expected to be called early in the quarter and were not. These non-called bonds were reinvested during the quarter at a net margin of just under 100 basis points and provided positive net interest income of nearly $150,000 but lowered our quarterly net interest margin by 4 basis points from 3.68% to the 3.64% recorded.

Our loan loss provision for the quarter was $0.4 million compared to $0.2 million in the first quarter of 2007 and $1.7 million in last year's second quarter. Charge-offs for the second quarter were $362,000, a favorable comparison to the $622,000 reported in the fourth quarter -- excuse me, in the first quarter -- and the $1.5 million in last year's second quarter. Our loan loss allowance to total loans outstanding stood at 1.33% at quarter-end versus 1.35% a year ago.

As a reminder, this small decline in coverage ratio is related to the inclusion of lower coverage ratios on our acquired portfolios. Our coverage ratio of nonperforming loans increased to 368% at quarter-end, reflective of meaningful reductions in nonperforming assets.

Quarter-end nonperforming loans to total loans outstanding were .36%, an improvement from the 0.47% level reported at the three previous quarter-ends.

Second-quarter noninterest income, excluding security gains and debt extinguishment charges, was up 22% over the prior year. Our employee benefits administration and consulting business increased revenues by 51% over last year's second quarter, split almost evenly between acquired and organic growth. Deposit service fees and other banking revenues increased 17% over last year, driven by additional account relationships and growing debit card related revenues.

Operating expenses, excluding special charges and acquisition expenses of $165,000 in the quarter, increased 8.8% above the second quarter of 2006, due principally to the four acquisitions completed since last August. In addition to the acquisitions, increases in other operating expenses reflect our continued investments in certain technology and business development initiatives, as well as costs associated with our new branch recently opened in Springville, New York.

Our effective tax for the quarter was 25.0%, up from 24.1% in both the first quarter of 2007 and the second quarter of 2006. The proportion of tax-exempt income to total income continues to be the primary planning vehicle affecting our tax rate.

I will now ask Betty to open the lines for any questions.

(OPERATOR INSTRUCTIONS). Rick Weiss.

I was wondering if you could talk a little bit more just on margin? Do you expect it to continue to compress going forward?

I will take a shot at that. I think that it probably contracted a little bit more in the quarter than we expected, and as I've pointed out, a small piece of that was related to the fact that we ended up with some excess liquidity even above and beyond what we expected for the quarter.

I think that there is still a little bit of risk that there is some more movement into time deposits into the third quarter. I don't think that it is a pronounced expectation on our behalf. We certainly are not running a myriad of time deposit related depository specials. So I think we're, quite frankly, very happy with where we are going in terms of raising funding. So I think that there probably is some risk going into the third quarter that the number ticks down a little bit. I think it is probably in our case it is a function of us redeploying that liquidity.

I think also just as a follow-up comment to that, we stepped back a bit in terms of some -- there's a lot of liquidity on the balance sheet right now. So the funding we have had significant deposit growth in the first quarter and some deposit growth in the second quarter, but not like the first quarter organically. And we have begun to step back a bit on some of the CD pricing because we just don't need the funding.

One of the things we have seen over the last several quarters is the rate of increase in the funding costs was decreasing. We saw the opposite of that this quarter for the first time in several quarters, principally related to CD pricing. So we have started to step back a bit on the CD pricing because we just don't need that kind of funding right now.

Okay. Great. Also with regard to asset quality, it seems like more and more banks that are reporting are -- just growing unease I guess about where we're going in the credit cycle. Would you expect to continue to try to build reserves? I saw this quarter your provision exceeded the charge-offs. Is that something you would think going forward?

I guess I will start, and Scott can follow up here. The comments I made broadly were that our asset quality continues to be at historically exceptional levels which is the case. And, as I said, I think it is somewhat due to the favorable economic and interest rate cycle, but it is also due to the improvements we have made in our credit processes and the structural strengthening that we have made over the past few years. So I think even when the cycle turns down, you are going to continue to see our loss experiences be less than what they were historically.

Now that may -- maybe I'm wrong, but that is my sense of where we are at here. We get some pretty decent visibility into asset quality. We've got a very active management of all of our portfolios and credits. Out over the next quarter or two, it looks like it is going to continue to be strong. So I don't see anything, and I see the other announcements out -- and not just in our markets but in markets across the country and elsewhere even in the Northeast and mid-Atlantic region, where there's emerging cracks in the credit cycle here and higher provisions, but we have not seen that. It does not look like we are -- we have any visibility into that over the course of the next couple of quarter or so. So I think we're in pretty good shape.

As it relates to the coverage, we're at a very high-level of nonperformings. We continue to take provisions that exceed our net charge-offs. It is just that the nonperformings are down. We have only got one credit that is nonperforming over $1 million. And despite the fact that it is nonperforming, we will never lose a nickel on it.

So the credit quality is as good as it is going to get. I think we have provided well and fully for it. So I think it is going to continue to be a strength I think over the course of the next couple of quarters anyway that I can see.

And I will just add to that to say I think directionally I think it is our aspiration to be providing for something a little bit above charge-offs when we have a growing portfolio. We think that is probably the prudent thing to be doing in terms of the total loan portfolio.

I will say that we did -- we actually and the number is not significantly large -- but we actually did add to unallocated loan loss reserves this quarter. And really that is a function of again improving underlying qualitative metrics, including improvements in risk ratings and improvements in some of the historical loss factors that we used to build our template with.

So from a practical standpoint, if you offered us up today two quarters back-to-back with $400,000 of charge-offs, would we take them today? For sure. But I do think to Mark's point, we have pretty good visibility, and I would suspect that we will continue to be better than our historical run-rate.

Just one last point on that. I think in the second-quarter provision was also a recovery of -- what was it, Scott, about 250, $300,000 relatively onetime event, not holding material but just for more detail on that. We did have a recovery of that magnitude in the second quarter.

Okay. Good. Hey, nice quarter, guys. Thank you very much.

(OPERATOR INSTRUCTIONS). David Darst.

You indicated you were selling some of your mortgage production during the quarter. Do you anticipate that to continue?

David, that $17 million I referred to was our total selling activity over the course of the last year. Currently we are gauging those on a case-by-case basis or instrument by instrument basis. Given our current liquidity, if we like the portfolio rate, we are putting them into a portfolio. But there are certain instruments that are out there that may be through Sunny Mae in New York State or Ginnie Mae or some of the other structural options that we continue to sell. I don't think that is going to be a major component of our originations for the next two quarters that is for sure.

Okay. So it sounds like you are holding about $60 million in cash in anticipation of these borrowings being called and they were not?

That is true. That is exactly true.

You said that had a 2 basis point impact on your margin?

Actually it had a 4 basis impact on the margin, but it did produce about $150,000 of positive net interest income. So it is probably not the world's most efficient capital utilization, but in the near-term we think it was pretty prudent as opposed to us redeploying that $60 million in a longer-term investment strategy.

Okay. You have not provided the cash amount you paid for Hand, have you?

Sorry, David, I missed that one.

Have you provided the cash dollar amount you paid for Hand?

No, we have not disclosed that, David.

Okay. Can you give us an idea of how much securities outflows might be in the third quarter?

I think for the balance of the year our anticipated securities outflow is between 65 and $75 million for the balance of the year. And I don't think there's any real concentration to that, David, in the third or fourth quarter. I think that is an average.

Is there anything in your markets that is driving economic growth that would lead you to think or even from a competitive standpoint that leads you to think that you could accelerate your consumer or commercial loan portfolios of growth?

Well, as you know, those portfolios tend to be somewhat cyclical as are most of our portfolios. Our markets are stable. They are actually doing quite well in terms of looking at the balance sheets and the income statements of our customers. The cash flows are pretty good. So we are seeing growing demand for credit in investment in actually all our markets, which is a good thing. I don't see any thunderclouds on the horizon right now. So I think we're going to continue to have opportunities to grow all of our portfolios into the future.

I don't see a double-digit growth rate. We are not in those markets as you know. But I think there are going to continue to be opportunities in all three of our markets. I think right now those being the Northern region of New York, the Southern region of New York and Northeast Pennsylvania. Though right now I think the opportunities are relatively favorable looking forward.

Okay. So if you have $30 million or so portfolio growth in each quarter, that is about a little less than the securities outflows for the second half of the year. So we will probably see a flat balance sheet for the remainder of the year?

David, I think if you presume that the federal home loan bank actually does some of the calling of some of the borrowing arrangements or the term arrangements that we have in place, I think that is probably reasonable to say.

That being said, there were certainly some -- during the quarter or near quarter-end, there were certainly some upticks in the yield curve that we are not so sure it won't reappear. And I think that that does put us into an opportunistic element relevant to specifically municipal securities. Because, as you know, the curve in the municipal side is actually a little bit steeper or actually steep compared to flat or inverted on the nonmunicipal side from a bond standpoint. So I think if we saw a little bit of improvement there and it opened up a little bit more, I think we would be opportunistic again, not with a ton of money but maybe with some of this excess liquidity.

Okay. And maybe you could comment on your tangible equity level and share repurchases going forward?

I could walk you through the mechanics. As you know, the tangible equity level as an indicator for us is not something that we spend a lot of time focusing on. But I will say this, it changed from the first quarter based on the 13 or $14 million of intangible assets we added as a result of the Tupper Lake and the Hand acquisitions.

Simultaneous with that, we had about a $7 million tickdown in the market value adjustment associated with our investment portfolio. That runs through equity. So, therefore, it lowers the numerator. And then, in addition, we did purchase, as I said, 230,000 shares. We were not actively purchasing the shares because of anything specific other than we were trying to remove some of the dilution that had happened from restricted share grants and exercise of options since last year's third quarter. So actually we were zeroed in on trying to get back to a September 30, '06 outstanding number.

Okay. But -- so you are -- you continue to buy back stock and take your tangible equity level lower, and then you could lever the balance sheet if the yield curve steepens and that -- (multiple speakers)

David, I do think that clearly in our evaluation, if you use last night's closing price where we were at 1903, that represented 14 times consensus earnings, 12 times cash earnings per share with a dividend rate of 420, we will obviously have that as a consideration of our capital planning.

Okay. Thank you.

(OPERATOR INSTRUCTIONS). Damon DelMonte.

Most of my questions have been answered. I just have a couple of housekeeping ones. Could you break out what the stock option expense was for this quarter?

Sure. Give me two seconds here. Let's go on with your second one while I'm looking for that one.

Okay. The second one is with regard to the annual dividend that you are received in the third quarter. Are you still on track to get around $800,000?

Yes.

It is our expectation right now. $0.02 a share approximately.

Okay. I just wanted to have that in there for modeling purposes. Those are the only to housekeeping questions I had.

David, for the quarter stock option expense was $550,000.

(OPERATOR INSTRUCTIONS). Rick Weiss.

I was wondering if I could come back and just ask what your thoughts are on the M&A market in New York State? I don't know if you saw this morning, Partners Trust got sold. So it looks like things might be picking up. How do you feel about pricing and that kind of stuff?

Well, we don't disagree that things might be picking up. The market, the environment, the operating environment is difficult. As you know, the interest rate cycle tends to be cyclical, although we have had a very long good cycle, and now it has turned the other direction for a bit here, and it has created some challenges, which in turn create institutions looking at their strategic alternatives to continue to enhance shareholder value, whether that is through continued independents in operations and their own growth strategy or partnering with someone else whose model and operating talents they respect.

So I think the answer to one part of your question is that the market will continue to be strong.

I think in terms of the pricing, as you know, one of our growth strategies because of the markets we are in centers around partnering and acquiring smaller community oriented, well-managed institutions that are in markets that are not too dissimilar from our footprint. And I think we have tended not to -- I think we have been disciplined in terms of our pricing.

I think if you looked at all of our last several -- those types of smaller institution transactions -- we have been pretty disciplined in the pricing.

I think everybody looks at a transaction from a different point of view, every acquirer, and I think it is difficult to make a judgment on the value that someone else sees in a particular transaction. I would say it appears to me that the Partners Trust shareholders were very well served. You know their core earnings run-rate is about 30 -- what? They were at $0.32 a share without a loan loss provision, and the takeout price was 1250. So on a core operating earnings basis, it looks like a 40 multiple, which we would not be prepared to pay. I mean we cannot just -- that is not an observation of that transaction specifically as much as just how it relates to our ability to evaluate and make those kinds of transactions sensible and accretive to shareholder value.

So we're going to continue to look for opportunities. I think the market will continue to be good, and we will continue to be disciplined.

Okay. Thanks. It just sounds like you guys are kind of walking away from potential deals just because of the pricing.

Well, if the multiples are in the '30s and '40s, yes, we would walk away.

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

Very good. Thank you, Betty. Thanks for everyone for joining the call. We will talk to you again next quarter. Thank you.

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