Community Financial System Inc (CBU) 2007 Q4 法說會逐字稿

Good day, everyone. Thank you for holding and welcome to the Community Bank System's fourth-quarter conference call. 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. They are based on current expectations, estimates and projections about the industry, market 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. And 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 now begin.

Thank you, Elaine. Good morning, everyone and thank you all for joining our fourth-quarter conference call. I think we will change up the batting order a bit here for this call and I would ask Scott to make his presentation first and then I will follow up with some comments as well. Scott?

Thank you, Mark and good morning, everyone. Our fourth-quarter earnings of $11.8 million or $0.39 per share were $0.12 above the $0.27 reported in the fourth quarter of 2007. Solid loan growth, continued expansion of non-interest income sources and improved net interest margin and strong asset quality resulted in the improved quarterly core operating results.

The fourth-quarter results also included two significant nonoperating items. The first, a $6.9 million or $0.23 per share benefit related to the settlement of certainly certain previously unrecognized tax positions. The second, a $9.9 million debt refunding charge comprised of the refinance of $150 million of Federal Home Loan Bank advances into similar duration, lower-cost obligations and the early termination of $25 million of higher cost trust-referred securities. Excluding these two items and utilizing an effective tax rate in line with the first nine months of 2007, operating results for the quarter were between $0.35 and $0.36 per share.

I will first discuss the balance sheet. We improved our average earning assets to $4.23 billion, slightly higher than the third quarter and up $254 million from the fourth quarter of 2006. We grew average loans by $133 million from last year, including $28 million in business lending, $76 million in consumer mortgages and $29 million in consumer installment products.

Our average investments were $121 million above the prior year, demonstrating our current level of liquidity and an incremental investment leverage strategy initiated midyear 2007, which we discussed last quarter.

We increased average deposits to $3.24 billion for the fourth quarter 2007, up 3.4% or $108 million above the prior year. Consistent with our focus on expanding core account relationships, $84 million or 78% of that full-year growth was in checking, savings and money market instruments, as well as demand products.

Fourth-quarter average borrowings of $919 million increased $75 million from the third quarter, reflecting a full-quarter impact of the investment leverage strategy initiated in the middle of the third quarter.

On a linked-quarter basis, we grew loans $29 million or 4% annualized, including increases across all lending lines. Organic business lending growth was 1.3% from the end of the third quarter or 5.2% annualized.

Our capital levels remained improved in the fourth quarter and remain strong. The tier 1 leverage ratio stood at 7.77% at quarter-end and our tangible equity ratio grew to 5.0% despite adding nearly $200 million in assets this year, including $10 million of intangibles.

We also repurchased 85,000 shares during the quarter and 612,000 for the year and still have 940,000 shares available under our existing authorizations through December of 2008.

Shifting now to the income statement, our reported net interest margin for the fourth quarter was 3.63%, up seven basis points from the third quarter, our first linked-quarter improvement in eight quarters, driven by a decline in funding costs of five basis points. Full-year net interest margin of 3.64% was 27 basis points below 2006's 3.91%, made up of a nine point improvement in earning asset yields offset by a 35 basis point increase in funding costs.

Our loan loss provision for the quarter was $0.9 million compared to $0.5 million in the third quarter of 2007 and $1.4 million in last year's fourth quarter. Charge-offs for the fourth quarter were also $0.9 million, up slightly from the $0.8 million reported in the third quarter and a favorable comparison to the $1.4 million reported in the fourth quarter of last year. Our loan loss allowance to total loans outstanding stood at 1.29% at quarter-end versus 1.34% a year ago. This small decline in coverage ratio is due to the improved underlying credit profile of our portfolios and also includes the lower coverage ratios on our acquired portfolios.

In addition, our coverage ratio of nonperforming loans increased to 410% at quarter-end compared to 288% at the end of last year because of meaningful reductions in nonperforming assets. Quarter-end nonperforming loans to total loans outstanding were 0.32%, an improvement from the 0.47% level reported at the end of last year's fourth quarter. 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 non-interest income, excluding securities losses and debt refunding charges, was up 31% over the prior year. Our employee benefits, administration and consulting business increased revenues by 60% over last year's fourth quarter, including acquired and organic growth. Deposit service fees and other banking revenues increased 20% over last year, driven by additional account relationships and growing debit card-related revenues. Our wealth management businesses, including our property and casualty insurance agency, grew revenues by 25% over the fourth quarter of 2006. Full-year non-interest income, excluding again securities losses and debt refunding charges of $63.3 million, was up 22% from the prior year's level with balanced growth from both organic and acquired sources.

Operating expenses, excluding special charges and acquisition expenses, increased 14% above the fourth quarter of 2006 and were 12% higher on a full-year basis, principally a result of the four acquisitions completed since August 2006. Other increases in operating expenses reflect our continued investments in strategic technology and business development initiatives.

Our effective tax rate in the fourth quarter was significantly impacted by the debt refunding charges and the benefit of previously unrecognized tax benefits. The proportion of tax-exempt income to total income continues to be the primary planning vehicle affecting our tax rate. Given the fourth-quarter tax settlement and our current holdings of tax-exempt investment securities, we would expect our effective tax rate over the next few quarters to be at or slightly below levels achieved in the first three quarters of 2007. I'll now turn it back over to Mark for his comments.

Thank you, Scott. I would like to make a couple of comments on the fourth quarter and then comment on the year as a whole. We are pleased with the fourth-quarter performance in earnings, which were up nicely over 2006 despite margin contraction. Loan growth for the quarter was unseasonably strong with all of our portfolios showing growth.

Non-interest income grew at a double-digit pace and credit costs declined significantly as a result of improved asset quality. We also experienced net interest margin expansion for the first time since 2005, which it goes without saying is welcome news to us, so Q4 was a very good one for us in virtually every way.

The tax gain was a welcome result and provided us the opportunity to think strategically about how to most productively deploy that added capital. We evaluated numerous alternatives, including securities leverage, a stock buyback, saving it for future opportunities and numerous others and concluded quite convincingly that a debt refunding was the most productive deployment of that capital. Beyond the economic net present value benefit, the refunding will improve future years' earnings, net interest margin and return on equity, all of which we expect will be accretive to shareholder interests.

With respect to 2007 as a whole, I would make similar observations. First, core operating earnings, which exclude the debt refundings and the tax gain, were up 6% over 2006. We are pleased with that performance, particularly in the face of the not so gentle headwinds of the current operating environment. The reduction in net interest margin alone impacted us by more than $0.20 per share this year. Despite that hurdle, improved results were achieved through contribution across the Company, including organic and acquired balance sheet growth, the accretive impact of our 2006 acquisitions, continued double-digit expansion of non-interest revenue lines, strong growth in low-cost demand deposits, and exceptional asset quality that drove down credit costs. So all said, in the challenging and uncertain environment of the past year for banks, we think that is a pretty good outcome.

Beyond the numbers and from my view, our signature achievement of 2007 was recognition by JD Power and Associates as the second-best bank in the entire country in retail customer satisfaction. I know I made mention of this award during our second-quarter call, but the pride and gratification I share for our employees for this accomplishment bears repeating in the context of a summation of our full-year results. I think it is also directly relevant to the effectiveness of our business model as we continue to expand our banking franchise.

Our branch has also performed very well in 2007 beyond the recognition of customer satisfaction, delivering over 6% organic growth in both retail loan originations and core demand deposit balances. In addition, banking fee income was up 14% over 2006, so overall, it was a very good year for our branches.

Non-banking revenue lines continue to grow robustly and become an ever more significant component of our overall earnings mix. Total revenues of our wealth management and benefits administration businesses grew 36% in 2007. But just as importantly, the pretax earnings of these businesses also grew by 36%, so the revenue growth we are generating is hitting the bottom line with no margin dilution.

Asset quality continues to be at historically exceptional levels. I remember commenting last January that we didn't think it could get better, but it did. I know these are difficult times that may get even more difficult. I can only say that we are highly pleased that our disciplined credit standards have withstood the test of a turbulent environment and we are hopeful that will continue to be the case.

As I have said now for the past two quarters and we'll say again, we have no exposure to subprime or other high-risk mortgage products either in our loan portfolio or our investment book. Looking forward to 2008, we have a strong balance sheet and operating momentum across the Company. We expect to deliver improved margins, double-digit growth in non-interest revenues, improved return on equity and higher earnings per share. And that completes our prepared remarks and Elaine, I would ask you to open up the line for questions.

(OPERATOR INSTRUCTIONS). Steve Moss, Janney Montgomery.

Yes, good morning, guys.

Good morning, Steve.

Good morning, Steve.

Just a little question here with -- what are your expectations for the net interest margin inclusive of trust-preferred refinancing as the Fed is likely to cut rates by 50 or 75 bps here going forward?

Steve, I think that -- I think as we have said that the debt refunding charge that we took related to both the FHLB borrowings and the trust-preferred is likely to improve our margin by 10 basis points in 2008. I think that in the environment of a falling rates environment, if the Fed is moving at basis point moves at 50 at a time, yes, we have a hard time staying up with that in terms of lowering our funding costs fast enough to keep up with that drop as it affects our variable rate or prime-based or LIBOR-based assets. But I think that is a short-term scenario for us in terms of impacting that result and that if we ever challenged in the first couple of quarters of 2008, if there were rates down, I think we would be hopeful that we could make that up in the second half of the year.

Okay. And it sounds like things are looking good on the asset quality front. Any further -- any areas of concern?

Right now, we really don't have any, Steve. Obviously, in this environment, we keep pretty close track of all of those metrics and in fact, if you look at the delinquency rates of all our portfolios, they are right around 1% and have pretty much been there for the entirety of 2007. Our criticized assets have been stable all year long as well. As you can see, the charge-offs were significantly less in 2007 and we have been -- we think we have been pretty disciplined over the course of 2007 and even prior to that. In the second half of 2006, we strengthened some of the lending standards, particularly in our auto installment, our indirect auto lending business. We were writing in 2006 about 80% A and B paper. Right now, that is up to almost 90%. So the asset quality metrics really across all our portfolios right now look very strong.

As I said, it is a difficult environment there with the subprime in the current credit markets and their impact across the financial industry, but we think we are pretty well-situated. I would like to say again that I think the asset quality measures aren't going to improve from here. And frankly, that is likely to be the case. The net charge-off levels we have this year were just exceptionally low and we would expect they would maybe normalize a bit next year, but right now, none of the delinquency or nonperforming metrics are really indicating any potential asset quality turbulence in the near term.

Okay, thank you very much. Nice quarter.

Thank you, Steve.

Thank you, Steve.

[Bret Morris], FTN Midwest.

Hey, guys, how are you doing today?

Good morning, Brad.

I was hoping you could give me a little more color on where you saw personnel expenses going and maybe what the increases were this quarter?

Sure, I will take a shot at that, Bret. In the fourth quarter, for us quite frankly, the jump-up from the third quarter was really to square off a lot of employee benefit plan accruals and adjustments associated with incentive plans, pension arrangements, healthcare-related benefit plans. I think that it is probably pretty safe to assume that if you took somewhere between where we experienced in the third quarter and the fourth quarter, that is probably our quote moving run rate with the expectation that our people were probably awarded a cost-of-living merit increase the first of the year.

But in terms of -- in terms of people count itself, we actually have not had increases to the core banking business in terms of FTEs. All of our adds have come in the financial services businesses, primarily our benefits and plan administration business where those increased revenues, both acquired and organic, have required additional service capacity. And we are fine with that and if we continue to have to scoot up based on double-digit increases in those businesses which have a higher people cost complement than the core banking business, we will continue to make those investments.

Okay, great. And then also can you tell me what you are thinking about your securities portfolio? I saw there are some pretty large decreases in the averages.

Actually, I actually think, in terms of quarter-over-quarter, we actually had a slight increase in the averages. I will say that the one undertaking that we did have in the fourth quarter, I think we mentioned in the third-quarter call, we did do about $200 million of investment leverage in early August and initially deployed those assets into short-term agency discount notes. As we enter -- as we were entering a rates down environment certainly from an [outlook] planning standpoint, it became much more productive for us to put some of those cash flows back into the investment portfolio into longer maturing items and for us, with our acumen in municipal securities, we have selected that group. Not only is it a valuable tax planning tool for us, but quite frankly there is a little bit more slope to that municipal curve than there was to the taxable curve. So some of that redeployment has actually gone there.

We are comfortable with where the securities portfolio stands in terms of its content and its size right now, but I will mention that we do have about $150 million of cash flows coming back off that portfolio early in 2008 and we will have to make a decision whether we want to redeploy those longer term or quite frankly use those on the case that if certificate of deposit or timed deposit funding again doesn't make market sense, we may allow some more timed deposits to actually run off, not to our core customers, but in places where we just have rate shoppers.

Which just as a follow-up to that is something that we did in the fourth quarter because of the liquidity. The CDs that rolled off in the fourth quarter actually had a higher cost than the returns on the liquidity that we had and I think was in the cash and cash equivalents line, so it is really an effort to very tightly manage our net interest margin, which, as you saw and I commented on, actually increased in the fourth quarter for the first time since 2005. What really drove that was a reduction in deposit costs, so we continue to manage that as tightly as we can.

All right, great. Thanks, guys. That's all I had.

Thanks very much.

Thank you, Bret.

Currently, there are no more questions in queue. (OPERATOR INSTRUCTIONS). Gentlemen, I have no more questions in queue.

Great. Thank you, Elaine and thank you all for joining us. We will talk again in April.

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