Community Financial System Inc (CBU) 2014 Q1 法說會逐字稿

Good day, everyone, and welcome to the Community Bank System first-quarter 2014 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, Dana. Good morning and thanks, all, for joining our first-quarter conference call. We have started out 2014 on a positive note. Earnings were very good at $0.54 per share, which is a first-quarter record for us. The margin was actually up in the quarter, which Scott will discuss further. Growth in noninterest revenues continues to be very additive to operating performance in both our wealth management and benefits administration businesses are running at record levels of revenue, margin, and earnings.

Loans were down slightly for the quarter, which is a seasonally expected and historically typical outcome for us. Asset quality remained very strong, particularly charge-off levels, which contributed to the earnings performance.

Heading into the second quarter our pipeline look very good. Mortgage volumes are down 30% over last year but rates are higher and the mix of purchased versus refi has improved substantially.

Auto originations in Q1 were up 52% over last year and the business lending pipeline is up more than 20% over last year, so we think we are in good sheet heading into our peak Q2 and Q3 lending quarters.

In addition, deposit balances grew sequentially, $140 million, or 2.5%, which will provide low-cost funding support for expected loan growth.

The eight branches in northeastern Pennsylvania we acquired from Bank of America this past December have been fully integrated and are performing very well. Deposit retention has been nearly 100%. Fee income is running at a level above that of our branches as a whole and we have begun to generate loans out of those branches, so we are off to a productive start with this acquisition.

With respect to the remainder of the year, we do expect core margin contraction and will work hard to offset that impact by growing our business and effectively managing our expenses and our capital for the benefit of shareholders. Scott.

Thank you, Mark, and good morning, everyone. As Mark mentioned, first quarter of 2014 was a very solid start to the year for us. Also as a reminder, for comparative purposes, our acquisition of eight former Bank of America branches in Northeast Pennsylvania was completed in mid-December, 2013.

I will first take a shot at some of the balance sheet items. Average earning assets of $6.58 billion for the first quarter were essentially even with the fourth quarter and first quarters of 2013, the net result of the productive balance sheet changes we initiated in 2013.

In addition, the mix change of the earning asset base compared to the first quarter of last year was very positive in that loans grew organically $239 million, or 6.2%, with an almost offsetting reduction in investments and cash equivalents.

Average deposits were up 4.6% from the first quarter of last year principally from the branch acquisition completed in December which allowed for a 40% reduction in Federal Home Loan Bank advances.

The multi-year trend away from time deposits and into core checking, savings, and money market accounts continued in the first quarter resulting in a further decline in overall funding costs.

Outstandings in our business lending portfolio were down modestly from year end, impacted by a seasonal fluctuations in line utilization and were 2% higher than the end of the first quarter of last year and very consistent with our market demand characteristics. Asset quality results in this portfolio continue to be stable and favorable to peers with an annual net charge-off of under 25 basis points over the last four, eight, and 12 quarters.

Our total consumer real estate portfolios of $1.92 billion, comprised of $1.58 billion of consumer mortgages and $341 million of home equity instruments, were down $8 million from December but were $87 million higher than the end of last year's first quarter, or a 4.7% increase. We continue to retain a portfolio of most of our short- and mid-duration mortgage production while selling secondary eligible 30-year instruments.

Asset quality results continue to be very favorable in these portfolios with a total annual net charge-offs over the last four, eight, and 12 quarters of under 8 basis points.

Our consumer indirect portfolio of $756 million was up $16 million, or 2.1% from the end of 2013, consistent solid regional demand characteristics. Used car valuations were the largest majority of our lending and concentrated continued to be stable and favorable.

Annual net charge-offs for the last four, eight, and 12 quarters were also under 25 basis points, which we consider exceptional. With our continued bias toward A and B paper grades and a very competitive market conditions in this asset class, yields have continued to trend lower over the last several quarters.

We have continued to report very favorable net charge-off results with first quarter 2014 results at just 0.11% of total loans being a stellar performance. Nonperforming loans, comprised of both legacy and acquired loans, ended the first quarter at $23.6 million, or 0.58% 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 March 31, our investment portfolio stood at $2.51 billion and was comprised of $306 million of US agency and agency-backed mortgage obligations, or 13% of the total; $665 million of municipal bonds, or 27%; and $1.44 billion of US Treasury securities, or 58% of the total. The remaining 2% was in corporate debt securities.

Our capital levels in the first quarter of 2014 continued to grow. The tier 1 leverage ratio rose to 9.48% at quarter end, a meaningful 70-basis-point increase over the end of last year's first quarter. And tangible equity to net tangible assets ended 2014's first quarter at 7.97%.

Shifting to the income statement, our reported net interest margin for the first quarter was 3.94%, up 6 basis points from the fourth quarter of last year and 8 basis points above the first quarter of 2013. Our net interest margin has been positively impacted by the 2013 balance sheet restructuring activity, as previously described.

Proactive management of deposit funding costs continued to have a positive effect on margin results but have not been able to fully offset declining asset yields.

First-quarter noninterest income was up 8.6% from last year's first quarter. The Company's employee benefits administration and consulting businesses posted a 6.8% increase in revenues from new customer additions, favorable equity market conditions, and additional service offerings.

Our wealth management group generated a 21% revenue improvement from last year and included solid organic growth in trust in asset advisory services while also benefiting from favorable market conditions.

Quarterly operating expenses of $55.9 million increased $1.4 million or 2.5% over the first quarter of 2013 and included a full quarter of operating costs associated with the eight additional branches acquired in December. We did experience higher weather-related maintenance and utility costs in the first quarter of this year versus last year.

Merit-based personnel cost increases were partially offset by lower retirement plan costs related to the combination of strong plan access performance and slightly higher pension discount rates.

Our effective tax rate in the first quarter of 2014 was 29.7% versus 29.2% in last year's first quarter.

As Mark pointed out, we continue to expect net interest margin headwinds going forward as most of 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 do not expect significant improvement. Our growth and all sources of noninterest revenues have been very positive and we believe we are favorably positioned for the balance of 2014 to continue to expand in all areas.

While operating expenses will continue to be managed in a very disciplined fashion, we do expect to continue to consistently invest in all of our businesses. 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 markets 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 shareholders.

I will now turn it back over to Dana to open the line for any questions.

(Operator Instructions)

David Darst, Guggenheim Securities.

Scott, did you comment on the $300 million or so of securities growth in the yield that you brought those on at?

Yes, David we'd did -- consistent with the activities we had at the end of December, we purchased about, just about $300 million of investment securities relatively early in January, so early in the first quarter, really comprised of about $240 million of Treasury securities with the yield just about 2%. Maybe a little bit higher than that and duration between five and seven years. And then we purchased some additional municipal securities in the first quarter. Again, fairly early in the quarter, to match up with our expected cash flows out of that portfolio over the next three to six months. So that would be add.

And David, really if you think about it, got the earning asset base of the enterprise basically back even to where it was prior to those Volcker-related sales and some other activities that we had right at the bitter end of the year last year.

Okay. And now your tangible common equity is this right around 8% and you are still able to do this mid- or high-teen ROTE on that level. How are you thinking about deploying capital going forward? Organic growth is still going to be accreting a lot of access capital. It looks like you have changed the language maybe around how you are disclosing the buyback. Is that something we should expect?

No, I think we said, David, the buyback has been in place a long time. I think we have that in place just as a productive and effective capital management tool in the event that it is productive to utilize it.

You are right, our returns -- our earnings are generating returns on capital that are higher than we need to fund organic growth in our markets which runs, let's call it, 3% or so.

We have a very strong dividend policy, as you know, and distribute in the 50% to 60% range of earnings back to shareholders. That still leaves us with excess capital that has accreted, particularly over the last several years despite a number of acquisitions. And I think we will continue to look for opportunities that are productive to deploy that capital through disciplined M&A opportunities. We will need some of that capital to fund organic growth.

We expect, as you know, we have increase our dividend every year for the last I believe it was 21 years and don't see any reason not to continue that trend into the future.

Right now, we do have a bit of capital that probably is in excess of what we need certainly to capitalize our existing balance sheet and reasonable growth and need to be disciplined and active about how we deploy that capital for the benefit of shareholders going forward.

Okay. And Scott, with bringing on the branches and the weather, it still looks like you were able to take some incremental costs out of the Company.

Yes, David, a great point. I do think that it is typical for us to run $400,000 to $600,000 of maintenance and utility costs in the first quarter above what the other quarters tend to look like. And that was not inconsistent with this year's first quarter.

I think the acuity of the weather in this year's first quarter made utility costs significantly higher than what we had been planning for and given the fact that it's is 37 degrees today in Syracuse, maybe we aren't quite through that yet.

But at the same point in time, I would expect we will see some improvement along that line.

We did get some cost savings, I had this in one of my comments, out of the fact that over the last two or three years we have had very good pension plan asset returns. And you haven't really seen those in our numbers because discount rates on the liabilities attached to our defined benefit plan have actually been going down. So quote, the net pension expenses has either been rising or flat.

This year with a little bit higher discount rates at the end of the year and great asset plan performance, we find ourselves in a meaningfully over-funded position in our core defined benefit plan. And we are getting a benefit of that through the actuarially determined pension costs. So we had some good offsets of what would otherwise be an increase in personnel costs in the first quarter from that pension savings.

Is $54 million to $55 million a good run rate? For expenses?

You know, David, we are at $56 million. I am pretty comfortable with that $56 million range. The first quarter has a little bit higher costs associated with payroll taxes and certain other benefits tend to be a little bit front-end loaded. The utility maintenance costs are little bit higher.

That being said, there's one or two more operating expense days in the balance of the year, in the future quarters. The first quarter is a short quarter. But then also carries through to the earning asset side of the equation, as well. I think the net change is we are pretty comfortable with that as a run rate, David.

We've got some technology initiatives in front of us for the balance of the year that we do expect to continue forward on. We do expect those to be to a certain extent, efficiency-creating initiatives. But that being said, always get all of the efficiencies out of those projects during the implementation. So we could be a little bit more expensive on the technology side for the balance of the year.

Okay, got it. Okay, thank you.

Collyn Gilbert, KBW.

Scott, just to drill down a little bit more on the comments about NIM headwinds. And if we look at -- so you had indicated that your securities purchases this quarter was 2%. Your securities yield was like [346]. Should we expect the continued securities purchases to be in that range so that gradual bleed will continue on the security field?

No, I think, Collyn, what I would expect for the balance of the year this year instead is to actually see that natural cash flows off the portfolio which are in the $100 million to $125 million range would probably not be reinvested. Instead, we would allow that modest amount of short-term debt that we have on the books today actually get paid off with the cash flows from the investment securities portfolio. And then assume that are deposit growth characteristics can keep up with the loan demand or close to that.

So from a net standpoint, I wouldn't expect a lot of investment -- cash flow reinvestment for the balance of 2014.

Okay. Okay. What is the split of your borrowings between the short term and long term?

They are all overnight. At the end of the quarter, $217 million of all overnight. The other $100 million of borrowings you see is our trust preferred obligations that are still tier 1 capital for us that I don't see paying those off in my lifetime.

Okay. All right.

And then just also tying to the NIM, what is the differential that you're seeing now between your loan origination yield and, again, your portfolio yield?

Good question. It is a mix across the portfolios. We have almost gotten to a balance level on the mortgage side on the residential asset side where new mortgage production and the blended yields of the portfolio are close together.

On the commercial side, probably not quite at that crossover point yet that we are still seeing asset yields for new opportunities be slightly lower than our blend.

That being said, our blend is a little higher than everybody else's from a comparative standpoint. And clearly on the indirect side you are getting erosion with lower yields to get that asset class.

But that being said, we're okay with that because we really like the duration of that asset class as we start to step toward this perceived rate increase going forward. I don't think any of us believe that rates are going to go up here over the next three, six, nine, 12, 15 months. But that being said, that's an asset class that turns in cash flow so fast that we don't mind having a little war in that class because we will get the chance to reinvest those in new loans on the way out.

Okay, that makes sense.

So just given some of the dynamics that you have talked about on the balance sheet and then the NIM outlook, do you think you can still grow NII or is that going to flat line in here for a little bit?

If I was looking at the last three quarters I would say the opportunity is around us making sure that the balance sheet grows. So it is incumbent upon us, as Mark pointed out, to get that second-quarter and third-quarter loan growth that we seem to get every year and we need to perform in the second and third quarter to get that.

Because I don't think naturally we're going to get rate bump that's going to impact and improve net interest income generation in 2014. And I'm even skeptical whether you will see it in the first couple of quarters of 2015.

Sure. Okay.

And then just shifting gears to fee income, you guys have great momentum there. What is your outlook? Do you think -- it seems like the fee income growth is stayed in a tight band of that 8% to 10%. Are you guys now at a point where you think the momentum can increase from here or is that just the nature of the beast in terms of what we can expect going forward?

I think with respect to those businesses, Collyn, we have invested a fair bit in those businesses over the last several years in terms of both internal and organic resource growth as well as some very productive smaller acquisitions. I think we will continue to invest in those businesses. They have -- as we have invested in them, one of the things we have focused on is maintaining margins. So it's not about -- we are not just managing the top line, we are managing the bottom line because this is about earnings results. And right now, as I said, they are running at record levels of revenue margin and earnings in terms of dollars and margin.

We are getting some benefit on both the wealth management and the benefits administration business because of the strength of the market conditions over the past several years have been helpful. But even absent that, there's been very strong growth in those businesses in terms of organic relationships.

And also operating leverage as we have done a very good job in managing the operating expenses and actually improving the margins by simply focusing on growing the revenues at a faster pace than we are growing expenses, which is pretty simple, but it has been effective.

To get back to the your question in terms of the 8-ish to 10-ish percent growth, we would love to continue to see that. We think that's a great performance. I don't know if that will continue forever but I think over time we would expect to see growth in those businesses in terms of revenue and earnings performance that is greater than that of the bank.

Okay. Okay. That's all I had for now. Great. Thanks, guys.

Matt Schultheis, Boenning.

A couple of quick questions. Do you have any estimates for the impact of the change of the New York State tax code for tax (inaudible)?

We do, Matt. And for us going into -- it won't impact 2014 but starting in 2015 it is a net negative for us. And in fairness, we have been a very efficient New York State tax payer for the last 10 or 15 years. And some of the structural changes that came through, the new budget for April 1, take away some of the latitude that we might have had relative to planning and in certain assets classes that we were focused on.

So it is a quote, net expectations and that's ours -- we will see an increase.

The other thing is we're at that unique asset size where in New York State we're not getting a lot of the benefits of quote, the community banking provisions anymore because we're over a certain threshold. So Matt, I would say that if everything being equal, we will have a hard time sustaining an effective tax rate below 30% in 2015.

(Operator Instructions)

Matthew Breese, Sterne, Agee.

Just getting back to the margin discussion, with the buildup securities this quarter and your expected loan growth outlook, in the near-term, what kind of margin compression should we be expecting?

I think it is consistent, Matt. And I will come back to your question two ways. I think it is consistent with what we said in the fourth quarter. It is 3 to 5 basis points a quarter. Again, assuming the components of the balance sheet remain relatively consistent.

That being said, I don't think we have built up securities in the first quarter. I think we ended from an average security standpoint the first quarter exactly where we were in the fourth quarter. It was that gap in the middle at the end of the year where we had lower ending balances.

And in fairness, I think we thought given our current capital we needed to deploy at an earning asset level that was consistent of where we were in the fourth quarter of last year. So that is what was our plan for a while.

I think back to your question relative to where that margin erosion is coming from, again, it is in those assets classes where you are seeing lower rates of new assets than our blended average which, again, I think our blended average is higher than most of our peers today.

So, I wouldn't think it's a big surprise that's our peers may say they have reached crossover characteristics before we get there.

Right. And then with the pipelines you reference in your commentary, to what extent do you think you can grow loans in 2014?

Well, I think as you know, if you looked historically for us we are usually, if things go well we are flat in the first quarter. We are usually down historically in the first quarter. There's a little bit of net runoff. I think we lost $12 million I think it was, in the first quarter this year which is 0.3% or something, pretty seasonally typical.

I think if you look again historically, where we grow our loans is in the second and third quarter. And fourth quarter usually again is somewhat flattish. We usually hope to be up in the fourth quarter but again, you get more seasonality that starts to kick in in the second half of the fourth quarter.

So we really need to get it done in the second and third quarter. I think the last two years we have grown loans organically, a couple hundred and 50 million dollars. A big part of that is that the mortgage growth which we think is second to recur. So I don't expect this year's growth in loans is going to be $250 million.

I think there's a chance we can still grow the mortgage portfolio, as well, but it won't be the same kind of double-digit growth level that we had last year.

On the other hand, the auto lending businesses very strong. As I said, the originations are running about 30% ahead of last year so I think we can continue to perform well there.

The commercial loan pipeline, as I said, is up over 20% where it was over last year. We actually had a good fourth quarter last year in business lending.

So I don't think we're going to be at -- I think Scott said fourth quarter -- first quarter of last year and first quarter of this year in that trailing 12-month period, we were up about 6%. I don't we're going to see that again. I would expect we will be closer to the 3%, maybe half of that which is consistent generally with the growth in our markets over all.

Right. Okay. And then getting back to your excess capital commentary and maybe the potential to use some of that in an acquisition, could you remind us of your parameters around an acquisition? Touch on geography, size limitations, the type of bank that would be a good fit. Just color around that.

Sure. I think that first, we look at really the qualitative implications of the opportunity. It's not all about the [vitals]. It's got to be something that makes sense for us. In terms of geography, in terms of integration, synergy, culture, balance sheet profile, all of those kinds of things which were much more qualitative, we have never done -- geographically, we have never done anything that is a big jump for us in terms of -- we have always -- we have grown substantially over time but we have done it in a geographically contiguous fashion.

We would certainly look for and have looked and continue to look at opportunities that are in adjacent states, that are close to our existing footprint like Vermont and New Jersey and other parts of Pennsylvania and Eastern Ohio, which are, despite the fact that those are different states, they are generally geographically contiguous reasonably in terms of our existing footprint.

So we're not going to buy a bank in Florida. We're not going to buy a bank in Texas. We're not going to buy a bank on the West Coast.

So, in terms of opportunity for us, it will be generally contiguous geographic expansion. And that includes banks as well as non-bank opportunities. So, we continue to look at opportunities in the wealth management and business -- or benefits administration space. And the growth there has been very productive.

And just to remind everyone, the benefits administration business, we do business in I think, 48 states and are the largest 401(k) provider in the Commonwealth of Puerto Rico. So that is a national business. It is really entirely unconstrained by the Bank's footprint. And so we continue to look for opportunities in that space, as well, which has been very productive for us.

At the end of the day what we're looking for is opportunities to acquire franchises at appropriate price levels that we believe can help support our principal objective, which is to grow earnings in a sustainable fashion over time.

That's great color. What kind of size parameters would you be comfortable acquiring if it were to be just a traditional whole-bank acquisition?

Typically what we have done our [ending is done in between] $100 million and $1 billion. And even we have gotten a little bit larger. We certainly have I believe, the capacity and the internal capabilities to do something larger. That doesn't mean we are looking to do that. We don't look at size as an objective. Frankly our objective is to create growing and sustainable earnings for shareholders. I would rather shrink than do that, because it is easier to manage a smaller institution. But when you have regulated capital levels over time you can't shrink, you have to grow. But you need to do that in a disciplined fashion. So, we will continue to look for those opportunities. But again, it is about growing sustainable earnings for the benefit of our shareholders.

Understood. Thank you very much.

And there are no further questions in the queue at this time.

Excellent. Thank you all for participating. We will talk again next quarter. Thank you.

Thank you.

Again, that does conclude today's presentation. We thank you for your participation.