Community Financial System Inc (CBU) 2011 Q2 法說會逐字稿

Welcome to the Community Bank System's second quarter 2011 earnings conference call. Please note that this presentation contains forward-looking statements within the provisions of the Private Security 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 the Form 10-K filed with the Securities and Exchange Commission.

Today's presenters are Mark Tryniski, President and Chief Executive Officer, and Scott Kingsley, Executive Vice President and Chief Financial Officer. Gentlemen, you may begin.

Thank you, Erin. Good morning and thank you, all, for joining our second quarter conference call. I believe the strength of this quarter's performance speaks well for itself, so I will comment generally on what we see as the highlights.

Earnings per share, excluding one-time acquisition costs, were up 14% over last year's second quarter and 14% over this year's previous quarter. Driving that improvement were balance sheet growth, both organic and acquired, margin improvement, (inaudible) banking revenue growth, strong asset quality and control over operating expenses. Organic loan growth for the quarter was over $30 million, and core deposits grew organically by 7% from last year's second quarter.

Beyond the organic performance, we closed on the merger of the Wilber Corporation in the first week of the quarter, bringing us 22 new branches, $444 million of net loans, over $700 million of deposits and $300 million of trust assets.

As I commented last quarter, the integration was one of the smoothest we've ever done. Our initial focus, as it always is, was playing defense and defending runoff. Our results for the first three months have exceeded our expectations, with deposits and loans both within 1% of acquisition balances. Our efforts are now turning to playing offense and building on the strong market presence and reputation we enjoy in those markets. The impact of the Wilber acquisition was immediately accretive to second quarter results and we expect will continue to be accretive into the future.

As announced in the press release, we are pleased to have raised the dividend this quarter by 8%, which represents approximately a 50% payout ratio. This increase is consistent with the strength of our earnings performance and also consistent with our primary objective, which is delivering exceptional returns to our shareholders. Also of note is that this is the 19th consecutive year we've increased the dividend, including through the period of the credit crisis and the economic recession.

With respect to the future, we are in a very strong position. Our earnings momentum is at record levels and we have a balance sheet with tremendous liquidity, capital and asset quality. This position does very well for future opportunity and to continue delivering exceptional returns to our shareholders.

Scott?

Thank you, Mark, and Good morning, everyone. First, as mentioned in the release, second quarter earnings are $0.49 a share, including $0.07 worth of acquisition expenses related to the Wilber transaction. Operating results of $0.56 per share were 14% better than the $0.49 per share of operating earnings reported in both the second quarter of 2010 and the first quarter of this year, as Mark mentioned.

I'll first discuss some balance sheet items. Average earning assets of $5.66 billion for the quarter were up $740 million from the first quarter, reflective of the Wilber acquisition, as well as over $30 million of organic loan growth in the quarter. Although some unscheduled payoffs offset new business lending generation in the quarter, we did achieve reasonable growth in Consumer Products, principally indirect auto lending.

Investment securities, including cash equivalents, were $292 million higher than the first quarter averages, principally from Wilber.

Growth in our business lending portfolio in the second quarter was related entirely to the Wilber acquisition and did include certain unscheduled payoffs, as well as a lack of recovery and general line utilization. Asset quality results continued to be stable and favorable in our legacy portfolio, with net charge-offs of 27 basis points over the last four and eight quarters.

Our total consumer real estate portfolio of $1.48 [billion] comprised of $1.1 [billion] of consumer mortgages and $330 million of home equity instruments was up $124 million from March, principally the result of the Wilber acquisition and reflected our continuing decision not to portfolio certain lower rate, longer term assets, and instead, sell those originations to Fannie Mae.

As a reminder, over the past 10 quarters, we've sold nearly $325 million of in-market, low-rate consumer mortgage originations. Although we would have liked the [optics] of earning asset growth over this period, we have been able to achieve solid gains, while limiting the future interest rate risk associated with putting these longer term assets in portfolio. Asset quality results continue to be very favorable in these portfolios, with total net charge-offs over the last four quarters of $650,000, or less than 5 basis points of loss.

Our consumer indirect auto portfolio of nearly $550 million was up 9.9% from the end of the first quarter, with over half of that increase attributable to Wilber and the remainder due to solid organic growth opportunities in the quarter. A byproduct of the improving, but still comparatively low new vehicle sales rates, has been an improvement in used car valuations, where the largest majority of our lending is concentrated.

Net charge-offs for the last four quarters were $1.3 million or just 27 basis points which we consider very exceptional and an improvement over the 2008-2009 levels. Despite our continued bias toward A and B paper grades, yields have remained very consistent over the last several quarters.

In addition to the continuation of the very favorable net charge-off trend, we also reported generally stable delinquency rates in the first half of 2011, particularly in our consumer-related portfolios. Although our core banking systems conversion in late 2010, and certain changes in customer payment functionality, may have played a role in the higher levels experienced through the end of last year, we are pleased to be trending back toward the 1.44% average portfolio delinquency rate experienced over the six quarters ended June 30, 2010.

Our reserves for loan losses represent 1.40% of our legacy loans, including the second quarter's organic growth, consistent with levels reported at the end of each of the last two quarters. As of June 30, fair value-based loan marks related to the $468 million of remaining balances acquired from Wilber approximated $24 million or 5.1% of the total acquired balances. Additional non-performing assets from the end of the first quarter relate entirely to relationships acquired from Wilber.

As of June 30, our investment portfolio of just over $2 billion was comprised of $790 million of US agency and agency-backed mortgage obligations, or 39% of the total, $600 million of municipal bonds or 29%, and $570 million of US treasury securities or 28% of the total. The remaining 4% was in corporate and other debt instruments, including our holdings of pooled trust preferred instruments, which continue to fully perform. The weighted average life to maturity in the portfolio is approximately 5.9 years, with an effective duration of 4.3 years, consistent with the previous nine quarters.

The average deposits in the second quarter of $4.68 billion were $704 million above the first quarter of 2011 and 18% above the second quarter of last year. Including the Wilber acquisition, core deposits, or everything other than CDs for us, now represents 75% of total deposits, a very stable and favorable funding mix.

Our capital levels in the second quarter remained strong. We did issue an additional 3.4 million shares of common stock, or $82 million of equity in conjunction with the Wilber acquisition in April. The tier-one leverage ratio stood at 8.06% at quarter end and tangible equity to net tangible assets was 6.44%, a 52-basis point improvement from last June and 8 basis points higher than the end of the first quarter, even after the Wilber purchase. Our significant improvement in equity over the past several quarters have been generated from strong operating earnings as opposed to the diluted capital raising activity deployed at many other institutions.

As I've mentioned before -- and I'll keep trying -- consistent with regulatory instructions, our calculation of the Company's tangible equity ratio includes adding back to both the numerator and the denominator $22.6 million of deferred tax liabilities associated with tax deductible goodwill created from several of our asset acquisitions, primarily branch transactions. Exclusion of this differential would render our comparison to our peers incomplete.

Shifting to the income statement, our reported net interest margin from the second quarter was 4.13%, up 5 basis points from the first quarter of 2011, and 3 basis points better than last year's second quarter. The majority of the linked-quarter improvement in net interest margin related to accretion of certain loan marks required for fair value accounting presentation. Proactive management of deposit funding costs and productive deployment of net cash flows continued to have a positive effect on margin results.

Second quarter non-interest income was up 2% from last year's second quarter. The Company's employee benefits administration and consulting businesses grew revenues 8% over last year and its Wealth Management Group, including activities from the Wilber acquisition, generated a 4% revenue improvement.

Mortgage banking revenues were up $400,000 from last year's second quarter, related entirely to the recovery of previously recognized impairments of mortgage servicing rights.

Compared to last year's second quarter, the Company generated lower deposit service fees, reflective of the third full quarter of activity post- Regulation E, which has resulted in lowered product utilization. We [would] expect similar unfavorable year-over-year variances in this revenue stream for at least one more quarter.

Second quarter operating expenses of $47.5 million, excluding acquisition expenses, were $3.5 million or 7.9% above the second quarter of 2010 and reflected the additional operating costs associated with the Wilber acquisition completed in the second week of April, offset slightly by a decline in FDIC insurance costs and lower amortization of intangibles.

Our effective tax rate in the second quarter of 2011 was 27.4% compared to 26.7% in the second quarter of last year, reflective of a higher level of income from fully taxable sources.

On a trailing 12-month basis, our earnings are $2.05 a share, excluding $0.10 of acquisition expenses.

Our reported return on equity was 10.6% over the last 12 months, with a calculated return on tangible equity above 22%.

Our ability to generate incremental capital and reward shareholders with a meaningful and growing cash dividend annually stems directly from the commitment to a disciplined and balanced approach to our business regardless of market conditions.

I'll now turn it back over to Erin to open the line for any questions.

Thank you. (Operator Instructions). Sir, I have Jason O'Donnell. Jason O'Donnell, your line is now open.

Good morning.

Good morning.

Good morning, Jason.

Nice quarter. At what rate did you grow your total deposits organically this quarter on a linked-quarter basis?

I think this quarter, they might have been flat. Let me pull that out real quick here. Quarter-over-quarter, the core deposits were exactly flat.

So core deposits were flat and total deposit growth was also flat?

I think deposits were actually down --

Right.

-- from the first quarter to the second quarter, so time deposits were down about a point and a half. So net-net, actually, core deposits were up -- I'm sorry -- core deposits were up .8 of a point; time deposits were down 1.5 points. Net-net, total deposits organic grew .3 of a point in the quarter.

Okay.

(Inaudible), Jason, given the fact that in the second quarter, there's always runoff of municipal funding that comes in the first quarter.

Yes, that's helpful, thank you. And then on the operating expenses, it looked like they came in a little bit better than expected. How much of the 19% in cost saves on the Wilber deal would you say you've achieved at this point?

I think we're probably closing in on 90% of what we targeted. I would suspect that prior to the -- before the end of the year, we should be at a run rate of what we thought we were gong to get in total and I think there's the injection of some more marketing expenses and similar advertising kind of expenses, Jason, which may trail off a bit here as time goes on, but we expect to get all of the cost reductions we expected.

Okay. Okay. And then finally, if I recall correctly, the bulk of your non-performers are in the CRE and resi mortgage categories. Have you witnessed any shifts in the composition ion the first half of this year?

Not really. I think what you'll notice -- and it's a pretty good observation of yours -- we do have in our non-performers from a commercial standpoint tend to be in the commercial real estate side, not a big number, obviously. And on the consumer real estate side, the process of working through a foreclosure and the disposition of the assets on the residential mortgage side is only elongating the timeframe necessary, and I think that's an industry issue. I don't think that's something that's just within our domain. So I would suspect that you'll continue to see more assets in a non-performing status coming out of residential mortgage just because it's taking longer to dispose of the asset.

Makes sense. Thanks, guys.

Thanks, Jason.

Thanks, Jason.

The next question is from Damon Delmonte. Damon Delmonte, your line is now open.

Hi, good morning, guys, nice quarter.

Thank you, Damon.

I'm wondering if you guys could talk a little bit about your business lending loan category? You had pretty good growth this quarter. Could you talk a little bit about where you're seeing the growth and could we also talk a little bit about pricing trends you're seeing as far as competitive pressures?

Sure. I think what we've seen over the course of the past quarter is a rebound. From our perspective, the pipeline was very strong in the first quarter, slightly down in the second quarter, but a lot of that was actually funded over the course of the past two quarters, but I think we've seen very favorable movement, more activity, more opportunities, in both New York and the Pennsylvania markets, so I mean, for us, which is good. As you know, we did have organic loan growth, which was pretty solid for us this quarter, and that's something we haven't done in the last several quarters. I don't know how many it goes back, but three or four or something like that anyway.

So we saw a slight turn both in terms of consumer lending and business lending in this quarter. We hope that continues. We know we have a lot of productive opportunities in the pipeline.

In terms of the pricing and structure, I will tell you we are seeing particularly some of the bigger banks being much more aggressive in our marketplace with respect to structure and pricing, and some of the big payoffs that Scott referred to were situations where [it would be] significant credit relationships for us, but other banks, and particularly some of the larger banks in our markets, are doing things from a pricing and a structure point of view that we are not prepared to do. So some of those have run off. I would say overall, activity is improving and pricing and structure is getting more aggressive.

That's helpful, thank you. And Scott, I guess this might be for you. Can you just talk about what the impacts of the margin was from the accretable yield from the Wilber acquisition?

Sure. I think that generally, the improvement from the first quarter to the second quarter is also related to loan mark accretion and that from our perspective is based on what we establish the marks at and then what the determined duration and value of that accretion going forward would be. So I think, Damon, I would look at it as 5 basis points in the margin and suspect that that kind of activity will continue for the foreseeable future until you get to a point where you have to reassess the total size of your mark.

Right. So kind of in the next few quarters, when we think about the margins, we should kind of start at this -- well, we'd start at like a 4.08 base, but then assume you get 5 basis points from accretable -- the accretable yield, and then how do we look at the rest of the margin?

I think that's fair. I think in terms of -- just in terms of where we are from a funding standpoint, there continues to be opportunities to continue to push down the funding cost. You would think that the (inaudible) should be running out of those, but that being said, I think everybody is seeing that and that's not dissimilar for us. I think you're seeing people go back into core money market or checking instruments in lieu of making any call at all on duration on CDs, because CD rates are so low. I mean, I think the average CD rate in our markets for a one-year instrument is 50 basis points. So I don't think you're going to see the customer committing to that.

I do think there's some risk in our margin relative to reinvestment of investment cash flows. Finding opportunities to reinvest at our current yield characteristics certainly aren't plentiful, so I think that if there's risk to our yield on a totality basis, it's right there.

And can you remind us what your average quarterly cash flow is from your securities portfolio?

I can. I think for the balance of this year, we expect another $200 million of cash flows off the portfolio, so I think we're running now with this $2 billion size in the neighborhood of $100 million a quarter. It might be a little bit faster. We have a little bit more things maturing in the third and fourth quarter of this year than maybe we're projecting on a full-year basis in 2012, but I think it's fair to use a $75 million to $100 million quarterly cash flows off that $2 billion base every quarter.

Okay, great. Thank you very much, guys, very helpful.

Thanks, Damon.

Thanks, Damon.

Your next question comes from Rick Weiss. Rick Weiss, your line is now open.

Okay, thank you. Good morning.

Hello, (inaudible).

Hi. I just wondered if I'd follow up a question on the expenses, if you can provide some run rate for the next couple of quarters? It's clearly on the merger charges.

I think that if you take out the acquisition expenses, I think the second quarter is probably pretty indicative of where we think the run rate is. We did not own Wilber for all 13 weeks of the quarter, but -- so there's maybe a little bit of a modest pickup there. I think to Mark's point, I think we do think we've had some -- in the Wilber region, we've had some exaggeratedly large marketing costs and rebranding costs that were borne in the second quarter. And Rick, we typically pick up a little bit of operating leverage in the second and third quarter, and things get a little bit more expensive for us to run in the fourth than the first, but maybe that's a spend per share differential.

Okay.

So I don't think we're far off the run rate that you should expect.

Okay. That's helpful, thank you. And also with respect to, I guess, indirect auto lending, you picked up, what, like $50 million or so from Wilber?

A little under that.

Yes, a little under that, Rick.

Okay, a little under that. Do you intend to kind of focus more on indirect business or still keep it around 15% of the portfolio?

I think, Rick, for us, the indirect auto has always been a very productive asset class for us. Remembering that for us, indirect auto is still in-market originations. In other words, we've got relationships with 35% to 40% of our customers that are in that indirect pool. It's just originated from an indirect basis out of the dealer, as opposed to that these people are physically in our footprint. So we're not out of our area of influence.

I think we like the asset class relative to the current rate structure. We certainly like the asset class relative to the duration of cash flows in the current environment, and at a run rate of 27 basis points of loss, we know that number is a best-in-class number. So I think we are -- continue to focus on that asset class to the extent that A and B-type credit [soak] is available for us at productive rates. I don't see us dropping down deeper into the portfolio to start to buy C and D-level paper, but in fairness, I think there's some opportunities with some rebound on the automotive side to pick up very adequately performing A and B-type paper for the next several quarters.

Okay. And on --

Said another way, Rick, right now in the current interest rate environment, that indirect lending line is actually the highest risk-adjusted return of any of our lending lines right now.

And that's on used cars and new vehicles?

It's mostly new. It's about -- the origination for us is about 70% or so used and 12% or 13% new and the other 12 or 13 is boats and motorcycles and those kinds of things. And I know used lending doesn't sound as attractive, but the yields are higher, the residual risk is lower and the LTV risk is lower. So it's really -- in the environment right now, it's a very productive business.

Okay. That makes sense. And finally, I guess the last question would be, anything unusual going on with your regulators?

No. As you know, we are limited on our commentary and I would just say that we have a very productive and strong relationship with our regulator.

Rick, the only thing I would add to that observation is that the OCC, certainly in our region, is picking up more customers over the course of the next year, so I think they will also have a larger sphere of influence in our general geographic area than maybe they had a year ago.

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

Thanks, Rick.

Thanks, Rick.

Your next question is from David Darst. David Darst, your line is now open.

Hi, good morning.

Good morning, David.

Scott, I guess based on your outlook for your loan demand, and what you acquired in the securities portfolio from Wilber and then their loan portfolio, do you think there will be some remixing going forward and your assets will be stable, or should we see a little more growth from the loan demand?

David, I think we'd love to believe that forward engagement in the Wilber areas of influence would result in a little bit higher demand characteristics and our ability to capitalize on that going forward, particularly on the consumer installment and mortgage home equity side. Wilber was in a position where a lot of their lending sort of took a back seat to some of the other activity they were doing relative to workout and stabilization of their existing portfolio. So they were certainly not as aggressive and as responsive to the market as I think we'll be able to be.

Whether that actually starts to take off for us, David, here in the third and fourth quarter, or there's a little bit longer process to get that under way, we would see. I think we're intrigued with the opportunities that are coming back around, as Mark mentioned, early in the integration process. So I think we would certainly be pushing even for a higher than diluted average growth rate in that marketplace going forward.

Okay. And then did they have a trust business? Is that the reason you had some trust growth this quarter?

Absolutely, Dave, they did. They have a very robust trust business. I think Mark mentioned about $300 million of assets under management, very capable people, that they generated about $300,000 or $400,000 of revenues in the quarter, very additive to our trust business, very additive to our entirety of our Wealth Management offerings. Looking forward to be able to leverage those skills and to grow the totality of that business moving forward.

Okay. And then usually in the third quarter, you've got a seasonal item that comes in into other income. Should we expect that again this year?

We should.

Okay.

I think it's probably -- since we got bigger, it's probably $0.01 per share.

Okay, great. Thank you.

Thanks, David.

Thanks, David.

Your next question comes from John Moran. John Moran, your line is now open.

HI, thanks, guys.

Hi, John.

Just real quick, Scott, I wanted to go back to the kind of core margin. Could you remind us what the original loan mark was on the Wilber transaction?

It's not wildly different, John, than what's left, so if the remaining mark is in around $24 million, it was maybe $24.5 million, $24.6 million, as the original net loan mark.

Got you. So there's roughly 600 that's coming in a quarter then from that loan mark?

Right. Certainly, that's what the answer was in the first quarter and the second quarter here, yes.

Got you, got you, terrific. Thanks very much.

Thanks, John.

The next question comes from John Stewart. John Stewart, your line is now open.

Hey, Good morning, guys.

Good morning, John.

Good morning, John.

Sorry, I just wanted to back on the expenses for the quarter. Can you give us a contribution from Wilber in the quarter?

In terms of to the expenses?

Correct.

I can probably work through that with you, John. I can't do it right here on the call, but I'd be happy to follow up with you on that one, yes.

Okay, good. That would be helpful. And then, Scott, can you go back and just talk again about what the $400,000, I think you said, recovery in the mortgage banking line was this quarter? Can you just talk about that again?

Absolutely. It's really not that complicated, but it's a subject matter that no one pays much attention to. As we were selling mortgages over the last three or four quarters, you create a mortgage servicing right simultaneous with the sale of the instrument.

Right.

And just going forward from that point, you have to then revalue, or you re-evaluate the mortgage servicing right you've created based on current prepayment patterns and interest rates and all those kinds of good things. Well, during those past three quarters, we've actually been taking some small impairments of mortgage servicing rights on our existing portfolio, mortgage servicing rights.

Yes.

Given where the numbers came to this quarter, we basically recovered those prior three quarters. They were never big enough in the prior three quarters, John, to mention, but when they all come back as a recovery one time -- especially in a quarter where we really didn't have a robust quarter of actual new loans being sold into the secondary market. It was a modest quarter compared to the last three or four.

And did you say that was $400,000?

It was; it was.

Okay.

And John, as you know, those mortgage servicing rights, the impairment and the subsequent write-off, if that's the way it goes, it's solely a function of the interest rate environment.

Yes, understood.

(Inaudible) up and down with value based on where the interest rate environment is.

Yes, okay. I just wanted to make sure I heard that correctly, okay. And then you guys both alluded to kind of higher than expected prepayments, I think, particularly in your business lending book. Were there any sort of heavy fees in the quarter, prepayment penalty-type fees in the quarter, that might have affected the margin this quarter?

No.

Okay. All right. That was all I had, thanks.

Thanks, John.

Thanks, John.

At this time, I have no questions in queue.

Excellent. Thank you, all, for joining us today. We look forward to our call next quarter. Thank you.

Thank you, Erin.

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