Community Financial System Inc (CBU) 2013 Q4 法說會逐字稿

Welcome to the Community Bank System fourth-quarter and year-end 2013 earnings conference call. Please note 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. Today's call 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, Whitney. Good morning, everyone, and thank you all for joining our fourth-quarter conference call. The quarter was a busy and productive one for us, beginning with strong operating results. Earnings per share in the quarter were $0.02 higher than 2012, excluding acquisition expenses and the securities and debt transaction this year and the litigation charge last year.

The highlight of the quarter was loan growth, which was seasonally atypical for us, with total loans increasing $84 million, or 8% on an annualized basis. Business lending led the way with $45 million of that growth, and our mortgage and auto businesses delivered solid results as well. The second significant element of fourth-quarter performance was our benefits administration and wealth management businesses, which delivered combined revenue growth of 9% over the prior year.

As previously announced, in December we sold our trust preferred CDOs and other securities, and also redeemed our remaining Federal Home Loan Bank term borrowings. This series of transactions was done for both qualitative and economic reasons that improve our balance sheet and provide forward earnings capacity for our shareholders.

In addition, in December, we closed on our previously announced acquisition of eight branches from Bank of America in Northeastern Pennsylvania, with approximately $300 million of deposits. This transaction provides very attractive core deposits that effectively replace borrowings and improve the density of our presence and our operating leverage in that market. The integration went very well, and we are now focusing our efforts on growth initiatives, particularly around lending opportunities.

The whole of 2013 was a very productive year for the Company. Earnings remained strong and consistent with last year on an operating basis, although we were hoping improved performance in other areas would do better than just offset declining gross interest income.

Significant progress was made across the Company, starting with the balance sheet, including organic loan growth of over 6%; organic checking and savings account growth of over 6%; deleveraging of our investment book in wholesale borrowings; growth of our Tier 1 leverage ratio from 8.40 to 9.29; and improvement in asset quality metrics.

From a P&L perspective, the full-year margin improved by 3 basis points; banking fee income was up 9%; revenue growth in our benefits administration and wealth management businesses was 11%, with pre-tax earnings growing 44%; and our efficiency ratio remained below 60%.

Beyond financial performance, we closed on two acquisitions -- the BofA branches I previously mentioned; as well as a small benefits businesses in Rochester, New York, that will give us a good entry point into the Western New York marketplace. We consolidated four branches over the course of 2013, improving our average branch size and reducing operating costs.

We implemented a back-room technology application that allowed us to reduce compensation costs by $500,000. We've rebranded our Northeastern Pennsylvania market from First Liberty Bank & Trust to Community Bank, which eliminated customer confusion and consolidates our marketing structure. And we increased our cash dividend for the 21st consecutive year.

Looking ahead to 2014, we have very good operating momentum, much of which is a result of the progress in initiatives in the past two years. We also have, right now, the best balance sheet we've ever had in terms of asset mix, funding, credit quality, and capital. We are very well positioned as we enter 2014, and we will be disciplined and work hard to continue to grow earnings and dividends for the benefit of our shareholders.

Scott?

Thank you, Mark, and good morning, everyone. As Mark mentioned, 2013 was a very productive year for the Company in several areas. As a quick reminder, we completed the acquisition and conversion of 16 former HSBC branches and three First Niagara branches in the third quarter of 2012. So for comparative purposes, the fourth quarter of 2012 was the first quarter where the various operating attributes of those transactions were fully reflected. In addition, as Mark commented, our acquisition of eight former Bank of America branches in Northeast Pennsylvania was completed in mid-December 2013.

I will try to provide some additional specifics on the Company's fourth-quarter performance. I will first discuss a couple of balance sheet items. Average earning assets of $6.58 billion for the fourth quarter were up $108 million, or 1.7% from the third quarter, and down 1.3% from the fourth quarter of 2012 averages, reflective of the balance sheet restructuring activities completed in the first half of the year, which we have previously described. Compared to the third quarter of 2013, average loans were up $83 million, while average investments, including cash equivalents, were higher by $25 million. Average deposits were up modestly from the third quarter, principally from the branch acquisition completed in mid-December.

The full-year trend, away from time deposits and into core checking, savings and money market accounts, continued in the fourth quarter. Quarterly average borrowings increased slightly as we used short-term credit facilities to finance the purchase of additional investment securities in anticipation of the closing of the previously announced branch purchases from Bank of America. This productive pre-investment of acquired liquidity was similar to the strategy we deployed prior to the closing of last year's HSBC/First Niagara branch transactions.

Borrowings declined to $142 million at year-end from the receipt of liquidity from the branch transaction and the extinguishment of our remaining Federal Home Loan Bank term advances right before year-end. In late December, the Company sold its entire portfolio of bank and insurance trust preferred collateralized debt obligation securities, or CDOs, in response to the uncertainties created by the announcement of the final regulations implementing the Volcker Rule. In conjunction with the liquidation of the trust preferred CDOs, the Company extinguished $226 million of FHLB advances and sold $418 million of Treasury securities previously classified as held-to-maturity.

The net impact of these transactions was a $6.9 million pre-tax loss, or $0.12 a share recorded in the fourth quarter. The Company reinvested the net liquidity created from these transactions of approximately $246 million into Treasury securities which had similar blended duration characteristics as the Treasury and CDO securities sold in order to mitigate the net interest income impact of the securities sales and debt extinguishments.

Despite recent regulatory clarifications on certain securities which have been determined to be exempt from disposition, including the CDOs we sold, we still believe it was in the best long-term interest of the Company and our shareholders to proceed as we did. We clearly recognized the potential for additional regulatory commentary at the time we made the decision to dispose of the CDOs, but concluded the qualitative improvement to our balance sheet and the elimination of the uncertainty surrounding these types of securities wasn't prudent.

It is worth noting that we could, and may choose to, recover the net loss incurred on these transactions in under two years, through reinvestment of the additional $225 million of investments sold into similar duration securities.

Outstandings in our business lending portfolio were up nicely from the third quarter, as productive new loan generation and improved line utilization was able to more than offset contractual and other unscheduled principal reductions. Asset quality results in this portfolio continue to be stable and favorable to peers, with annual net charge-offs of under 25 basis points over the last 4, 8, and 12 quarters.

Our total consumer real estate portfolios of $1.93 billion, comprised of $1.58 billion of consumer mortgages and $347 million of home equity instruments, were up $10 million from September despite the significant slowdown in refinancing activities. We continue to retain in portfolio most of our short- and mid-duration mortgage production in 2013, selling secondary eligible 30-year instruments, and were able to productively add to our outstandings at blended yields above 4%. Asset quality results continued to be very favorable in these portfolios, with total annual net charge-offs over the last 4, 8, and 12 quarters, of under 8 basis points.

Our consumer indirect portfolio of $740 million was up $27 million, or 3.7% from the end of the third quarter, consistent with seasonal expectations and strong regional demand characteristics. Used car valuations, where the largest majority of our lending is concentrated, continued to be favorable. Annual net charge-offs for the last 4, 8, and 12 quarters were under 25 basis points, which we consider exceptional. With our continued bias toward A and B paper grades, and the very competitive market conditions in this asset class, yields have trended lower over the last several quarters.

We have continued to report very favorable net charge-offs results, with 2013's results at just 0.17% of total loans being a stellar performance. Nonperforming loans, comprised of both legacy and acquired loans, ended the fourth quarter at $22 million or 0.54% of total loans. Our reserves for loan losses represent 1.15% of our legacy loans, and 1.08% of total outstandings; and, based on the trailing four quarters' results, represent over six years of annualized net charge-offs.

As of December 31, our investment portfolio stood at $2.18 billion and was comprised of $307 million of US agency and agency-backed mortgage obligations, or 14% of the total; $668 million of municipal bonds, or 31%; and $1.18 billion of US Treasury securities, or 54% of the total. The remaining 1% was in corporate debt securities.

Our capital levels in 2013 continue to be strong. The Tier 1 leverage ratios rose to 9.29% at year-end, a meaningful 89 basis point increase over year-end 2012; and tangible equity to net tangible assets ended 2013 at 7.68%. Consistent with our second- and third-quarter discussions, and our tangible book value per share of $12.80 is down from the $13.72 per share level at the end of December 2012, and relates entirely to the decline in AOCI, over half of which we realized in the balance sheet restructuring activities completed this year. Excluding the effects of changes in AOCI, we have actually added noticeably to capital over the past 12 months, principally through consistently strong earnings results.

Shifting now to the income statement, our reported net interest margin for the fourth quarter was 3.88%, down 6 basis points from the third quarter of this year, and 5 basis points above the fourth quarter of 2012. Year to date, 2013 net interest margin has been positively impacted by the balance sheet restructuring activities previously described. Proactive management of deposit funding costs continue to have a positive effect on margin results, but has not been able to fully offset declining asset yields.

Excluding gains and losses on security sales and debt prepayments, fourth quarter noninterest income was up 7.7% from last year's fourth quarter. The Company's employee benefits administration consulting businesses posted a 6.8% increase in revenues from new customer additions, favorable equity market conditions, and growth from the Company's Metro New York actuarial and consulting business acquired at the end of 2011. Our wealth management group generated 16% revenue improvement over last year, and included solid organic growth in trust and asset advisory services, while also benefiting from favorable market conditions.

Quarterly operating expenses of $55.2 million increased $1.3 million or 2.4% over the fourth quarter of 2012, excluding acquisition expenses in both periods and a litigation settlement charge in the fourth quarter of 2012. Fourth-quarter operating expenses, again excluding acquisition expenses, were $200,000 above this year's third quarter, and included two weeks of additional operating costs associated with the acquired branches in Northeast Pennsylvania. Our effective tax rate in the fourth quarter of 2013 was 28.2%, and 29.0% for the full year, versus 29.2% in last year's fourth quarter and full-year 2012.

We continue to expect net interest margin headwinds in 2014 as most of our existing assets are still being replaced by new assets with modestly lower yields. Our funding mix and costs are at very favorable levels today, from which we don't expect significant improvement. Our growth in all sources of noninterest revenues has been very positive, and we believe we are favorably positioned, going into 2014, to continue to expand in all areas. While operating expenses will continue to be managed in a disciplined fashion, we do expect a full quarter of costs associated with the branch acquisition completed in December, as well as annual salary adjustments of 2.5% to 3% in January.

Our asset quality has continued to remain a differentiating feature of our business model and we don't expect that to change going forward. Tax rate management will continue to be subject to the successful reinvestment of cash flows into high-quality municipal securities, as it has been for the last several years. We have faced similar market characteristics and dynamics over the last few years in this low interest rate environment, and expect to execute on our business model in a consistent manner in order to create growing and sustainable value for our shareholders.

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

(Operator Instructions). David Darst, Guggenheim.

Hello, good morning. Mark, you outlined where your balance sheet is today as kind of optimal. You have significantly improved your loan-to-earning-asset mix and a number of other ratios. So what would make you -- or what would you look for to be willing to reinvest the $225 million this year, to try and recapture the lost earnings that could be at a lower margin?

I would say, most likely, David, the right market environment to do that; so that is something that we'll be looking at here in the first quarter and beyond, I think. We'll be opportunistic about it. If the opportunity arises, we will do it; and if the opportunity does not exist, we likely will not do it.

And would you consider maybe doing more of your own residential mortgages? Or are you specifically looking at the Treasury market and the Treasury curve to --?

Yes, I think we're talking about just reinvesting, just as it related to that particularly, the particular series of transactions, reinvesting -- just basically reloading our balance sheet to where it was before in terms of the securities book. So, that's really just -- and by way of -- I guess the point is, we have some dry powder remaining, David, in terms of just the balance sheet and the earning assets from that. It's a transaction that has -- it was a series of transactions that were structured -- effectively neutralized the ongoing earnings impact of the transaction.

But we didn't reload the balance sheet back to where it was. So the point really that Scott made was just that, if we do that, it will actually recover the $7 million loss in under three years -- actually, something like 2.5 years. So that is something that we will continue to be aware of in terms of market opportunity.

Okay. And then you've announced a buyback or a reauthorization. Is that something you want to have just for flexibility? Or is there an increasing probability that you might actually use the buyback this year?

I would say we think it's a good policy to have in place on an ongoing basis, in the event an opportunity arises. And we haven't actually bought back shares in six or seven years, I believe. And we bought those back in the low 20s. So it's more, at this point, David, just a good housekeeping in the sense of having the policy and the authorization from the Board in place to be able to execute on that if we thought that that was an appropriate opportunity in terms of returning capital to shareholders, and that was a superior alternative to other capital deployment opportunities.

Okay. And then how about -- you announced a small acquisition in your benefits business, and you gave us some guidance on what the incremental revenues would be. Is that still a focus for future M&A, and continued through -- to expect the same (technical difficulty) rates we've seen there going forward?

It is. I think we have grown historically over a number of years in that benefits administration business very strongly, both organically and through M&A opportunities. I think we'll continue to focus our efforts on growing that business through both means, both organic and acquired, as well as our wealth management businesses. Those businesses continue to perform extremely well. They are growing rapidly. They had an extremely good year in 2013, some of it organic, some of it market tailwinds, but continue to be very productive for us.

As you know, there's not a lot of balance sheet in those businesses, so the return on equity -- the accretion to the return on equity is substantial. We like those businesses. We think we have very good leadership in those businesses. And we'll continue to look to opportunities to invest in those businesses. Obviously we have, right now, a lot of capital. And so we certainly are not capital challenged in terms of investing in any of our businesses, but we'll be mindful of ultimately the need to buy high-quality businesses that we can integrate that create incremental, sustainable, earnings growth and dividend capacity for our shareholders.

So we will look to continue to grow those business through both organic and acquired means, David.

Okay, great. Okay, thanks. I'll hop out.

Collyn Gilbert, KBW.

Thanks. Good morning, guys. Scott, just a follow-up on your comment about the buyback. What would need to happen -- or maybe frame a scenario for us that would cause you to buy back the stock at this level, or think that that was a good use of capital. I just want to better understand how you think about that.

Yes, Collyn, it's Mark. I think, as I said in response to David's question, I think it's just good to have an authorization outstanding, and it's good to have as many opportunities and alternatives in terms of productive capital deployment available to you at any time as you can. And I think -- we think, our Board thinks -- that the stock buyback is just one of those.

Frankly, the challenge with the stock buyback is it's pretty diluted to both value metrics, and we don't necessarily manage the organization in terms of growth in shareholder value along both value metrics. It's earnings growth per share and dividend growth per share.

But with that said, I think if the variety of alternatives and opportunities for us in terms of capital deployment were such that a buyback was in the best interest of our shareholders, in terms of its relative value compared to those other alternatives, we would do it. But I think it's unlikely that at our present trading valuation multiple that that is something that we would do, relative to other alternatives. The yield curve is (technical difficulty) pretty low, but the yield curve is reasonably steep. And we think there's M&A opportunities and a variety of other opportunities, dividend growth, to create returns to our shareholders. But we just think that having the buyback as one of those alternatives is productive for us.

Okay, okay. And then just a question a loan growth. Usually the fourth quarter is a seasonably lower or slower quarter, but you guys put up some good numbers this quarter. Was there anything specific that you could attribute that to? Is that reflective of increased momentum as you guys go into this year? Or just maybe talk a little bit about that.

And then just one other follow-up. On the indirect side, you said you've been seeing some good business there. I'm just curious if you have a sense of who you might be taking share from.

Well, I think in terms of the growth, we had organic growth in all of our lending businesses, I think with the exception of home equity, which was flat or down, down I think $1 million or $2 million. But very strong business loan growth; very productive, still, consumer mortgage growth. Now that slowed a lot in the fourth quarter. Direct loans to consumers through the branches actually had a pretty good outcome in the fourth quarter. And the auto lending business was, I would say, unseasonably strong, which grew almost 4% in the quarter.

So, business loans grew about 4%; mortgages grew a little bit; and the auto business grew about 4%. So, you're right -- it was unseasonably strong for us. The business lending growth -- I think I had made a comment on our third-quarter call that the business lending pipeline was very strong. And some of that was related to projects and transactions and deals they were actually related to or approved in prior quarters, and just ended up getting closed in the fourth quarter. So some of it, really, from the business lending side of things, was really just timing. But it was a lot of really good transactions and really good opportunities in the fourth quarter. So we were very pleased -- very pleased -- with the fourth-quarter performance, which for us is usually a little bit better than flat, but it's not up the way it was -- $84 million in the quarter.

So we were very pleased with the performance of all the product businesses in the fourth quarter.

Okay. Okay, that's helpful. And just one housekeeping item for modeling purposes. Given the movement of some of the balance sheet moves this quarter, what was the -- can you give us what the asset yield and the cost of interest-bearing liabilities were at December 31?

I could give that to you, Collyn. I've got that in front of me, so it's going to take me a couple of minutes to get back through that. But I would say that it was not, from the asset side, not radically different than the fourth-quarter average. From the liabilities side, two days from the end of the year, you have the extinguishment of $225 million of liabilities in the mid-3s -- 3.50%, 3.60%, type rate on those term advances, so those are gone. And the $140 million of short-term borrowings that we have on the books is probably at 40 basis points.

So, otherwise, on the deposit side, endings and averages are probably pretty close to the same thing, which is what we really think from a balance sheet perspective in terms of this very efficient-looking balance sheet at the end of the year. If you think about $7.1 billion, and rightsizing the balance sheet funding, 70% of that is core deposits; or $5 billion of money market, checking, and savings accounts at 7 basis points. It's a pretty good head start when you have an expectation that rates might go up over the course of the next two or three years.

Yes, good point. All right, thanks, guys.

(Operator Instructions). John Moran, Macquarie Capital.

Hello, guys. How's it going? I just wanted to follow up on that last one. With a couple of moving pieces that I know you've got -- a full quarter of Bank of America costs coming in, some wholesale funding gone, some liabilities gone. If I'm doing the math properly -- and I think I might be -- I get basically kind of a push; and then, Scott, it sounds like from your commentary, some additional core margin compression expected here in 2014, with funding costs about as low as they're going to ,go and some continued declines in the asset yield. Am I thinking about that right? And is 4Q's core margin likely to carry into first quarter here?

A couple of different answers to that, John, but I think you're on the right track. I think in terms of a push on net interest income generation, it's certainly what we've been saying. In other words -- we, quote, reinvested enough of the net liquidity from those transactions at the end of the year to, quote, create the push going into the first quarter.

Now, as you can appreciate, there are some seasonal issues associated with net interest income generation when you compare a fourth quarter to a first quarter, the largest of which being there's two less days in the quarter, which is not insignificant.

We tend to get Federal Reserve Bank dividends only in the second quarter and fourth quarter, so that's $0.0075 per share that, quote, you won't see in the first quarter. But I think, generally, you've said it right. I think we have looked at this 3 to 4 basis points of core margin compression per quarter going forward, which is not dissimilar to what the core outcome of 2013 looked like. So, growing the balance sheet enough to be able to offset that in terms of natural core margin erosion -- again, it's the task for 2013, but one could argue that was the task for 2011 and 2012 as well.

Got it. Okay, that's helpful. And then I think you alluded to it in the prepared remarks, you exit the year in a pretty good position in terms of the balance sheet. Outside of possibly reinvesting or redeploying the $225 million, there'd be no other big structural things considered at this point, right?

No, John. Really, I think we ultimately, to say it in short order, accomplished where we like the balance sheet to get to, with the expectation that you're modeling an ALCO environment that's expecting long-term interest rate changes on the way up over the course of the next several years.

To Mark's point, do we think short-term interest rates are going to move in the near term? We probably don't, but I think that's the consensus amongst most people. So does that create some yield curve opportunities in the near term? When you're carrying 200 basis points of Tier 1 capital leverage above what we're used to carrying.

Got it. All right. Thanks very much for taking the questions.

At this time we have no further questions in the queue.

Great. Thank you, Whitney. Thank you all for joining. Please stay warm. I want you to know we have branches in the North country of our franchise -- it was almost 40 below this morning, and they opened on time. So everybody stay warm. Thanks, and we'll talk to you again in the second quarter. Thank you.

This now concludes the conference. Thank you for your participation.