Community Financial System Inc (CBU) 2014 Q4 法說會逐字稿

Welcome to the Community Bank System fourth-quarter and year-end 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, Jennifer. Good morning. Thank you all for joining our fourth-quarter and year-end conference call. The quarter was a good one, and about as we expected, with EPS up 6% over 2013; a margin that's holding in; positive but modest loan growth, with particular strength in business lending; and 6% growth in core noninterest income. Overall, it was a good and steady and clean quarter.

With respect to full-year 2014, it was the most productive year in the Company's history, including record earnings per share, which were up 9% over 2013; loan growth across all portfolios of $140 million, except for home equity, which was down slightly; core deposit growth of over $190 million; 7% growth in banking fee income; revenue growth of 12% from our benefits administration and wealth management businesses, with pre-tax earnings up 36%; lower credit costs; improvement in our operating expense efficiency from 59.3% to 57.9%; growth in the Tier 1 capital ratio from 9.29% to 9.96%; and we increased the dividend for the 22nd consecutive year.

Looking ahead to 2015, we have very good operating momentum, much of which is the result of the progress in growth initiatives of the past two years. We also have running now the best balance sheet we've ever had in terms of asset mix, funding, credit quality, and capital. Our capital accumulation over the past several years has been considerable, which creates a particularly favorable opportunity.

We are tremendously well positioned as we enter 2015. And we'll be disciplined, and work hard to deploy capital to continue to grow earnings and grow dividends for the benefit of our shareholders.

Scott?

Thank you, Mark, and good morning, everyone. As Mark mentioned, the fourth quarter of 2014 was a very strong operating quarter for us, with year-over-year operating improvement trends consistent with those generated in the first three quarters of the year. 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 discuss some balance sheet items. Average earning assets of $6.69 billion for the fourth quarter were up less than 0.5% from the third quarter of 2014, and were up 1.6% from the fourth quarter of 2013. However, all of the growth in earning assets was in loans, a very positive mix development, meaning that average loans grew organically $154 million or 3.8%. Average deposits were up 5.0% from the fourth quarter of last year, principally from the branch acquisition completed last December.

The multi-year trend away from time deposits and into core checking, savings, and money market accounts continued in 2014, resulting in a further decline in overall funding costs. Outstandings in our business lending portfolio were almost 1% higher than the end of the third quarter, a positive trend in a year of modest net growth, but consistent with our market demand characteristics. Asset quality results in this portfolio continued to be stable and favorable to peers, with 2014 net charge-offs of under 10 basis points of average loans.

Our total consumer real estate portfolios of $1.96 billion, comprised of $1.61 billion of consumer mortgages and $342 million of home equity instruments, were also up almost 1% on a linked quarter basis. We continue to retain and portfolio most of our short- and mid-duration mortgage production while selling the secondary eligible 30-year instruments. Asset quality results continue to be very favorable in these portfolios, with total net charge-offs in 2014 of just 8 basis points of average loans.

Our consumer indirect portfolio of $834 million was down $8 million from the end of the third quarter, in line with seasonal demand characteristics. Despite improving new car sales, used car valuations -- where the largest majority of our lending is concentrated -- continued to be stable and favorable. 2014 net charge-offs in this portfolio were 38 basis points of average loans, a level we consider very productive. With our continued bias toward A and B paper grades, and the 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-offs results, with 2014 results at just 0.15% of total loans being a stellar performance. Nonperforming loans -- comprised of both legacy and acquired loans -- ended the fourth quarter at $23.8 million, or 0.56% of total loans. Our reserves for loan losses represent 1.14% of our legacy loans and 1.07% of total outstandings; and, based on the trailing four quarters results, represent over seven years of annualized net charge-offs.

As of December 31, our investment portfolio stood at $2.51 billion and was comprised of $277 million of US agency and agency-backed mortgage obligations, or 11% of the total; $672 million of municipal bonds, or 27%; and $1.5 billion of US Treasury securities, or 60% of the total. The remaining 2% was in corporate debt securities. The portfolio contains net unrealized gains of $75 million as of year-end.

Our capital levels in the fourth quarter of 2014 continued to grow. The Tier 1 leverage ratio rose to 9.96% at fourth quarter end, and tangible equity to net tangible assets ended December at 8.92%. As mentioned previously, these higher capital levels and our strong operating income generation allowed us to again raise our quarterly dividend to shareholders in 2014 to $0.30 per quarter, or a 7.1% increase. Tangible book value per share increased to $15.63 per share at year end, and includes $35.8 million of deferred tax liabilities generated from tax-deductible goodwill, or $0.88 per share.

Shifting now to the income statement, our reported net interest margin for the fourth quarter was 3.89%, which was even with the third quarter of this year, and up 1 basis point from the fourth quarter of 2014 (sic - see press release, "2013"). Consistent with historical results, the second and fourth quarters of each year include our semiannual dividend from the Federal Reserve Bank of approximately $0.5 million, which adds 3 basis points of net interest margin to fourth-quarter results compared to the linked third quarter. Total active and disciplined management of deposit funding costs continue to have a positive effect on margin results, but have generally not been able to fully offset declining asset yields.

Fourth-quarter noninterest income was up 6% from last year's fourth quarter, excluding the $6.9 million of net losses incurred on sales of investment securities and debt extinguishments in the last year's fourth quarter. The Company's employee benefits administration and consulting businesses posted a 9% increase in revenues from new customer additions, favorable equity market conditions, and additional service offerings.

Our wealth management group also generated a 9% of revenue improvement from last year's fourth quarter, and included solid organic growth in trust and asset advisory services, while also benefiting from favorable market conditions.

Seasonally, our fourth-quarter revenues from banking noninterest income sources were down slightly from the levels reported in the third quarter, but were 2.9% higher than the fourth quarter of 2014 (sic - see press release, "2013"). Consistent with prior years, the third quarter included the annual distribution from our participation in certain pooled retail insurance programs, which approximated $900,000 or $0.015 per share this year. Quarterly operating expenses of $56.7 million increased $1.5 million or 2.7% over the fourth quarter of 2013, excluding acquisition costs, and included the operating costs associated with the additional branches acquired in December 2013.

Merit-based personnel costs increases in 2014 were partially offset by lower retirement plan costs related to the combination of strong plan asset performance and slightly higher pension discount rates. Fourth-quarter salaries and benefits costs were consistent with the third quarter of this year, reflective of equivalent number of payroll days in each quarter.

Seasonally, as expected, our facilities-related costs in the fourth quarter began to tick up from the warmer months of the third quarter, but we're still almost $0.015 per share lower than the winter-dominated first quarter of this year. In addition, we did record approximately $300,000 of expenses in the fourth quarter related to certain branch efficiency initiatives.

Our effective tax rate in the fourth quarter of 2014 was 28.8% versus 28.2% in last year's fourth quarter. On a full-year basis, our effective tax rate was 29.6% in 2014, up from 29.0% in 2013.

We continue to expect net interest margin challenges going forward into 2015, as most of our existing assets are still being replaced by 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 in all sources of noninterest revenues has been very positive, and we believe we are favorably positioned to continue to expand in all areas.

While operating expenses will continue to be managed in a disciplined fashion, we do expect to continue to consistently invest in all of our businesses. We expect first-quarter 2015 compensation increases averaging 3% across our organization, and are projecting almost $0.02 a share of additional retirement plan costs in 2015, a direct effect of lower discount rates at the end of 2014 compared to those at the end of 2013. 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, and a task that has become seemingly more difficult each quarter. We also expect to be net negatively impacted from certain statutory tax code changes enacted in the past year in New York and Pennsylvania, and are currently forecasting an increase in our combined effective tax rate to approximately 31% in 2015.

Despite certain of these apparent headwinds, we have faced similar market conditions and characteristics and dynamics in the last few years in this 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 Jennifer to open the line for some questions.

(Operator Instructions). Alex Twerdahl, Sandler O'Neill.

I'm just wondering, do you have much ability as we head into 2015 here, to continue this mix shift that you've had in the balance sheet, replacing securities with loans? I was under the impression that a lot of your securities were more bullets, and they didn't really -- wouldn't roll until maybe 2016 or 2017, and that maybe those opportunities might be harder to come by. Is that fair, or do they still exist?

Alex, I think they still do exist. We have about $120 million of expected cash flows off our existing portfolio in 2015. The lion's share of those are municipal-based. And, unfortunately, in the market today, replacing high-quality municipal securities has been a challenge, as there's been some compression of the net yield characteristics. But that's still our plan. We'd like to replace expiring municipal cash flows.

And to your point, there still is that opportunity to allow a mix change between certain expiring investment cash flows just being put back into investment securities -- or, I'm sorry, into loans. We certainly we do expect, Alex, to continue to chase deposit growth, new account growth. So we do think that from a funding standpoint, we'll continue to be successful gaining core accounts. So it will certainly be dependent on loan growth characteristics being able to, quote, sop up that kind of liquidity.

Okay, great. And then do you have any commentary on the price of natural gas having fallen, price of oil falling? And even though fracking is now officially banned in New York State, I know there's a lot of infrastructure, especially in the more southern part of the state where you guys have some branches, and into Pennsylvania. Is there any -- have you seen anything to -- or any discussion around the potential impact to the economy in some of those areas?

There has been -- I think there hasn't -- to date, we haven't seen any reduction in that investment. I think a lot of the big, the national companies and the big companies that are drilling in our area -- the Marcellus Shale -- have not yet been public about lots of layoffs and cessation of drilling. With that said, we have somewhere in the neighborhood of $70 million of credit exposure in that general area, related to gas. The majority of that is pipeline-related, which is still very active. All of it is within our footprint as well, so we're not lending to these investors outside our footprint.

So, it's not unreasonable to assume that there will be a reduction in drilling activity in the Marcellus, possibly, but it's something that we're monitoring closely. We're monitoring the receivables and the operating cash flows of those companies that do have exposure to the national drillers in the Marcellus area that we're in, principally Cabot. We understand it; we keep an eye on it; we're familiar with it; and we monitor it.

As far as New York, there's been oil and gas drilling in New York for a long time. It continues to be relatively active; it just isn't fracking. So that continues, and the volume and activity moves up and down over time, as to be expected with the price of oil and gas. But it's something that we've been lending into for quite some time, and are staying close to it to monitor our exposure.

Okay, thanks. And then just final question, I know that you've been pretty vocal about an acquisition being your most preferred use of excess capital. But does a special dividend sit on that stack of potential uses as well? Or is it just raising your regular dividend, as you have been doing, really the only options for a dividend?

We looked at a one-time dividend, and we've looked at other companies that have done it. We've looked at other uses of that capital, which we think, over time, would be more productive. Frankly, we've talked to a lot of our largest institutional investors and other investors, and have those conversations with them. And it's almost universal that they're opposed, or not in favor of, a large, one-time dividend. So we will monitor our opportunities to deploy that capital. We are in the banking business, so we would prefer to deploy the capital through M&A, other things that help us to grow our business over time.

We look at buybacks. We did buy back some shares in the fourth quarter. But there was kind of a run up there in the market, and we decided to step back for the time being. But I think that if you look at the rate of capital accumulation, it runs about -- after the dividend -- $45 million a year. So it's a good problem to have, Alex, and one which we spend a lot of time evaluating.

Again, in terms of priorities, M&A would certainly be first. Share buybacks, we would not exclude, given the substantial level of what we view as excess or free capital right now, and are unlikely to consider, in the near term, a one-time dividend.

Okay, great. Thanks for taking my questions.

Collyn Gilbert, KBW.

I was just curious, given your comments on indirect -- and I know that you had indicated obviously that it was getting more competitive last quarter, too -- is there a point where you will pull back from growth in that segment? Or how are you guys thinking about that longer-term? And that leads to my part B of that question, is just how you're thinking about loan growth in general for the rest of 2015.

Sure. We've been in the indirect auto lending business for quite some time. More than half of our business is used autos, and we like the risk/reward profile of the used business better. And we've made some investments to grow that business over the last couple of years, actually before -- coming out of the recession, when we knew that there was going to be a growth opportunity in that line of business. I think it's still a very strong business in terms of demand for automobiles. The risks are starting to grow a little bit. You're seeing the used car values come down somewhat, which creates a little bit more risk.

You're seeing other -- generally, what we've seen is smaller banks who haven't been in this before looking to grow loans and get into that business. So, we've seen a slight deterioration in the credit quality of the application flow. So we will -- we're going to stick to our disciplined underwriting. 70%-plus of our originations are A and B paper, as it's been for a long period of time. Loss rates continue to be very acceptable. The only thing I would suggest at this point that would slow us down would be further deterioration in the credit quality of the application flow.

So, I guess one of the bright spots, if you will, in terms of the spread in the indirect business, which really ebbs and flows with interest rates. When interest rates are low, the ROE of that business is low; and when interest rates are higher, the ROE is higher. So right now, the ROE on that business is not very strong.

But on a brighter note, we have hit the point where the yields on originated product are almost exactly what the overall yield on the portfolio is. So we don't expect to see any further declines in spreads on the indirect business going forward.

Okay. Okay, that's helpful. And then just in general, how are you thinking about loan growth for the remainder of the year? (multiple speakers) portfolio.

Yes, the last couple years have been good. For us, in our markets, we are in stable but lower-growth markets. And if we can get 3%-plus, we can do well by our shareholders with that level of growth in the loan portfolio, which we managed to achieve the last couple of years. Most of that has been consumer-oriented; to a much lesser degree, commercial-oriented. We did have very strong quarter in the commercial banking business in the fourth quarter.

I think the mortgage business will be stable, and will likely grow modestly in 2015. I think the auto business will also grow, but at a lesser pace. Our predictions over the last couple of years have been double-digit growth. We don't think that's going to happen again in 2015. So, I think we would hope to put another 3% or greater -- achieve that in 2015, as well. And I think we can perform well with that kind of organic loan growth.

Okay. Okay, that's helpful. And then just back to the securities discussion, the yield increased in the quarter. And I know at the beginning of the call, you kind of ran through what it was you purchased. But just trying to understand, is your objective to try and maintain that yield? Or how should we think about that securities yield now, obviously, with what the dip in rates have done here, as we look into the first quarter?

It's a good question, Collyn. I think it's always our aspiration to maintain what we think is an above-peer yield, so we're still very comfortable with what we have in our portfolio. Our only purchases in the portfolio in the fourth quarter were some small amounts of municipal securities to replace expiring cash flows. They came on at lower yields than what expired, for sure; and then a handful of assets in mortgage-backed securities, which are primarily CRA-based outcomes for us.

So, I think if you looked at where the rates were today, Collyn, and we were left with only knowing where the rate structure is on January 22, we would say that we are not buying a lot of stuff at durations that are beyond five years, because the risk/reward just does not appear to be there today.

And since we are a short-term overnight borrower to the tune of about $300 million a night right now, we can have the patience and the diligence to pass on replacing those until a better point in the market actually inflects.

Okay, that's helpful. And then just my final question, just on your general outlook for fee income. You guys have done such a great job in building out the benefits business, and a lot of those areas of your business. How are you thinking about the growth rates of there as we again look forward to this year?

I think we will continue to invest in our benefits administration business. We will continue to invest in our wealth management business. We expect continued strong growth going forward in both of those businesses. On the banking side, it's going to be a challenge. You're starting to see, and have seen over the last couple of years, a moderation of the overdraft line, which has been offset by an increase in the interchange lines. So, in terms of opportunities to significantly grow the non-banking fee income line, that's going to be a much greater challenge. But we think, overall, in 2015, we will continue to grow noninterest income.

Okay. Okay, that's great. That is -- oh, I know. Just one question on the pickup in net charge-offs for the quarter. What's driving that?

It's interesting, Collyn. It was sort of, quote, across the board, across all of our portfolios. And it's not the first occurrence where our fourth-quarter net charge-offs were larger than every quarter of the year. That was the same pattern in 2013, same pattern in 2012, same pattern in 2011. And so my guess is that we've been bringing something along in a productive fashion throughout the year, and we have not reached our conclusion in the fourth quarter. We are very active relative to [its] charge-off.

Great, okay. That's super. That's all I had. Thanks, guys.

(Operator Instructions). Matthew Breese, Sterne Agee.

Scott, you had mentioned earlier that you were expecting, for 2015, some margin compression. I was hoping you could give a bit more color around that, and maybe provide to what extent you expect the margin to compress, given the current yield curve.

Yes, great question, Matt. We -- to try to frame a little bit, just using the third and the fourth quarter together, so understanding that we still expect the Federal Reserve to pass a dividend twice a year. But if you remove that from the third quarter versus the fourth quarter, where we had a very similar mix of assets, we actually had an organic drop in net interest margin of 3 basis points. We've been giving that kind of 2 to 4 basis points a quarter guidance over the course of the last, say, 12 to 15 months, or maybe even a little bit longer than that.

And I will acknowledge that in some cases we've done better than that. We've been able to actually leak a little bit out of our funding costs or productively add some cash flows to the investment portfolio that have offset some of that.

That being said, on the surface from just a sheer modeling standpoint, I would look at that sort of 2 to 3 basis points a quarter going forward in the net interest margin. And really it's a function of us being productive at redeploying cash flows in the investment portfolio, to take off what we don't use in the mix change to loans.

And again, back to Collyn's question, if you just use January 22 as your date to look at that, there's really not a lot of attractive securities out there for us today. So I would argue, at least for the first part of the year here, we are probably going to pass and use expiring cash flows to just pay off short-term debt; which, again, will have the risk of pushing down net interest income and the margin a little bit, but it's probably the productive outcome just based on the choices in the market.

Right. So, given that kind of margin outlook, and the loan growth outlook along with that, we should expect lower net interest income in 2015 versus 2014. Is that correct?

Yes, I think from a modeling standpoint, Matt, that that's not out of the realm of possibility. I have to admit, I think this is our fourth consecutive January call of saying that. It hasn't happened yet. But certainly from a modeling standpoint, you could see that in 2015.

Well, I think the other point, Scott, is if you look at the funding costs, that they're -- the decline in the funding cost has gotten to the point where it's almost zero. So we've been able, the last couple of years, to continue to bring down funding costs as asset yields have come down. And we have essentially -- we're just about at the bottom there.

Good point.

Maybe thinking ahead about the eventual increase in interest rates and your interest rate sensitivity, what kind of deposit beta are you assuming for your interest-bearing accounts?

Matt, ask that one more time. I couldn't hear the end of your question.

Looking ahead towards when the eventual increase in interest rates actually occurs, what kind of deposit beta are you assuming for your interest-rate-bearing accounts?

What we've actually done from a modeling standpoint, and what we disclose on a quarterly basis, Matt, is we're using -- what happened is actual changes in account structure and the variability from a rate standpoint in that period of 2004 to late 2006. Now, I'm not saying that that's the perfect representative period of time to think about into the 2015, 2016 timeframe, or even 2017 timeframe. But it's the only one we've got that actually had an interest rate increase. And we can actually look back and say, how did our deposits, our products react to that?

That difference that you have today is in 2004 you still had a meaningful part of your population in timed deposit instruments. That piece has gone away. So, we are always a little bit conservative, we think, or a little bit hesitant to look at what's going to happen to deposits and accounts like money market accounts. We just have never had this kind of proportional outcome in our existing deposit portfolio to know exactly what the frustrated CD customer is going to do. At what rate change will they actually make some kind of a duration commitment?

So we've modeled it out, that 2004 to 2006, where our variation was something like 11% to 30% of the Fed Fund's rate change during that period of time. I would say that this cycle probably takes longer, Matt, if you asked me to prognosticate that today. And I think we like our position in being the last guys to the table because of our loan-to-deposit ratio right now.

Very helpful. My last question, around M&A. A bit more deal activity this year versus last. You guys did not participate in that. And I just wanted to maybe get some thoughts around that, and is that an indication of how you feel about bank valuations and take out valuations?

No, I think you're right. The deal activity was up in 2014. And I think it's assumed that it's going to be even higher than that in 2015. And we seem to have gotten off to a good start, based on recent activity. I think we continue to look for those high-value M&A opportunities that are accretive to our franchise.

And we continue to be active. We continue to be engaged. We continue to have looks at opportunities across our footprint and beyond. And it's a function of, in our minds, of being disciplined; and in terms of pricing, in terms of the quality of the franchises, and the opportunity for our shareholders.

And so we did look at a number of things, had a number of opportunities in 2014 that didn't play out. And I would hope and expect that we'll get the same opportunities or more in 2015. But we'll continue to be active and engaged, and we'll also continue to be disciplined in how we view those opportunities, and the threshold for creating transactions that will be additive to long-term and sustainable shareholder value.

Appreciate it. Thank you.

No further questions at this time.

Very good. Thank you all. We will talk again at the end of the next quarter.

Thank you.

Thank you. That does conclude today's call. We do thank you all for your participation.