Columbia Banking System Inc (COLB) 2002 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Columbia Banking System's First Quarter 2002 Earnings call.

At this time, our phone participants are in a listen-only mode. Later, there will be a question session with instructions given at that time.

If you should require assistance during the conference, just press zero, then star. And as a reminder, this call is being recorded. I'd like to turn this conference over to Columbia's Chief Executive Officer, Mr. Jim Gallagher.

Please go ahead, sir.

Thank you.

Good afternoon everyone. Welcome to our conference call to discuss our First Quarter 2002 Earnings release. Again, I'm Jim Gallagher. I'm Vice Chairman and CEO of Columbia Banking System.

Joining me in the call today are Melanie Dressel who is President and Chief Operating Officer of the holding company. Melanie is also Chief Executive Officer of Columbia Bank.

Gary Schminkey is here as well. Gary is Executive Vice President and Chief Financial Officer.

And Hal Russell, our Executive Vice President and Chief Credit Officer, is also joining us.

Before we begin I'd like to mention the obligatories -- issues that we'll be making some forward-looking statements and they're subject to economic and other factors. For a full discussion of some of the uncertainties attendant upon forward-looking statements, I call your attention to the disclosure and our Form 10K filed with SEC for the year 2001.

With that out of the way, today we're going to be reviewing with you the information on our first quarter's performance as discussed in the press release that we issued this morning.

We'll also talk a bit about the economy of our area, about our expectations for credit conditions in western Washington and more particularly in our own portfolio. And we'll end with a discussion of our expectations for Columbia's performance for the remainder of 2002 and beyond.

After that discussion, we'll give you the opportunity to ask questions and we'll reply as well as we can.

To start this out, as I mentioned in the press release, we're extremely disappointed to announce a net loss of $428,000 or 3 cents per diluted share for the first quarter ended March 31. That compares with the prior year first quarter of $3.1 million in earnings which was 23 cents a share.

The loss that we have for this quarter is a result of an unusually large $7.1 million provision for loan losses that we took in this first quarter. That provision was necessitated principally by a $4.9 million charge-off in connection with the troubled credit relationship that we first reported in early 2001 and that was reflected in our year 2000 financial statements. So just a little over a year ago we were talking about another aspect of this same troubled credit relationship.

The total relationship involved in the $8 million commercial loan that was previously written down to $1.4 million on our books as well as a related but separate $8.5 million real estate loan that is secured by a commercial office building located in the Seattle metropolitan area.

The discussion last year centered on the $8 million commercial loan since that was the loan that was having problems due to a diminution in collateral value of securities that was backing it up.

We did not discuss the real estate loan since that loan was then performing as agreed and we -- it was well secured in accordance with the appraisals that we then had in hand that were current. So we considered it adequately collateralized.

We took these recent large charge-offs because of information we just received of a significant reduction in the current value of the commercial office building due to the probable loss of the single tenant now leasing that building.

The building itself is generally -- is in a generally good market. It's in quite good condition. But the market in which it exists is currently experiencing substantial vacancies. And as a result of that and in view of the fact that we have to look at it now as if it will be vacant, the value of the property is currently much lower than it was just a year ago.

Because of this dramatic reduction in collateral value, we charged off the $1.4 million remaining balance of the original $8 million loan, which was partially secured by excess collateral on this real estate. And in order to attempt to get ahead of the curve on this, we charged off $3.5 million of the related real estate loan. That gets us down to having on our books a remaining $5 million balance, which is secured by this 35,000 -- roughly 35,000 -- square foot commercial property located in what we believe to be a -- quite a good market but a depressed one right now.

But because of this condition, we've also treated that remaining $5 million as being a non-accrual loan. So we're not accruing anything on that remaining balance, so we certainly hope to collect that balance. And we'll see if we can get anymore.

The rest of Columbia's management team and I expect that the steps we've taken will fully discount the risk of further deterioration in the collectibility of this troubled credit relationship. We cannot, unfortunately, be certain of that conclusion until the loan is paid in full, but we have a high degree of confidence in our current assessment.

This decline in the value of the office building is, unfortunately, only the latest in a series of problems that we've encountered relating to this credit relationship. As a consequence, our conclusions concerning resolution of the problem are more tentative as you noted above than an otherwise objective view of the facts might suggest. But given the history with this credit we would much prefer to err on the side of not having -- not being overly optimistic.

The problems with this credit as well as the generally weaker economic conditions that have existed this past year in our market have also caused us to become more aggressive in placing loans on non-accrual. As a result, we've also added to our non-accrual loans an additional $4.1 million of another -- balance of another problem credit.

We've done this even though after an exhaustive review or an extensive one at least, we're quite confident that that loan, referring to the loan of which the $4.1 million is a part, presents little chance of material loss.

Now, that's -- and we'll get back and of course answer your questions as it relates to that particular relationship. But if you stop for a minute and look beyond the current credit issues that we've just been discussing and you look at how Columbia is postured right now, you could easily draw the conclusion, as we have, that the picture for Columbia is much brighter than the earnings report would indicate.

Our first quarter 2002 performance before the $5.5 million provision for loan losses which related to the $4.9 million charge-off. In other words, just to be clear on that, I said that we took a provision of $7.1 before we discovered this particular issue that was going to be lower by $5.5 million. Or it was going to be roughly $1.6 million for the quarter. So just hopefully that clarifies it.

But before that 5.5 additional provision, which covered the 4.9 charge-off, we were reporting or were ready to report $3.2 million in net income for the quarter which would be 24 cents per diluted share. That would compare with the $3.1 million or 23 cents in the first quarter of last year.

Also encouraging to us is that we are experiencing a resumption of good revenue growth, something that had been flat last year. We're showing gains in net interest income and non-interest income compared with the first quarter of last year.

Also we had increases in non-interest expense which reflect our new branch expansion activity of this last year. And many of the personnel and occupancy costs that we're now incurring in the first quarter of '01 -- or '02, excuse me -- were not within our cost structure in the first quarter of '01. So it shows a fairly large increase but it's due in great measure to those offices we brought on screen late last year and at the beginning of this year.

So we expect that non-interest expense will moderate substantially in 2002 while we also expect that revenues will show good growth. And Melanie Dressel will discuss this in more detail soon. In fact, at this point I'd like to turn this over to Melanie to discuss some of our performance for this quarter.

Thanks, Jim.

I'd like to say that despite this development, we are confident in our ability to detect and respond to credit problems at an increasingly early state, especially in light of the steps we've taken to strengthen our loan-monitoring systems and controls.

We believe that the large loss and the troubled credit relationship is an isolated situation and that the overall quality of our loan portfolio remains good.

And now I'd like to review Columbia's other results for the First Quarter of 2002. At the end of March 2002, Columbia's assets were $1.6 billion, which is an increase of 6 percent from year-end 2001. The increase is primarily in securities owned. Loans remained unchanged from the end of last year at $1.2 billion. As C and I loan demand remained soft in commercial line of credit, usage decreased.

Core deposits, which we define as non-interest, in interest-bearing checking, savings and money market accounts, increased to $858 million, which is an increase of just over 1 percent from $847 million at the end of 200, but 22 percent over the $706 million core deposit at March 31 of last year. Our total deposits were unchanged from year-end in March 31, 2001.

As Jim mentioned, total revenue increased by $2 million or 11-1/2 percent for the first quarter of 2001 -- from the first quarter of 2001, I apologize.

I should mention that we define total revenue as net-interest income plus non-interest income. During the quarter, net-interest income was $15.6 million, up $1.3 million or 9 percent. And non-interest income was up $742,000 or 22 percent, both from the first quarter of 2001.

The increase in net-interest income is largely due to the declining deposit rates while loans and other earning assets remained at a low but stable level compared with the rapidly declining rate environment we experienced last year.

The increase in non-interest income reflects the growth of our franchise but it also includes earnings from the bank-owned life insurance we acquired last year.

Non-interest expense increased $1.8 million or 15 percent compared with the first quarter of last year. This increase was primarily due to personnel and occupancy costs associated with our expansion in the King County area as well as in our more traditional Pierce County market, which Jim had previously mentioned.

During the first quarter of this year, we opened our long-awaited Redmond branch and our new second Columbia office in downtown Seattle, bringing our total network to 35 branches in 5 counties. We believe this leaves us well positioned for growth and improved profitability. And our intention now is to focus on the strong base we've built in our current market areas.

We've made a commitment to slow the growth of expenses and grow our revenue more rapidly. We intend to bring spending in line with revenue growth. Since we're well positioned for growth in the markets we serve, we expect these efforts to improve profitability later this year and beyond. We expect the number of new branches to open to slow this year as we devote our efforts to maximizing the potential of our existing branch network.

We're pleased that Columbia's net-interest margin improved at 4.54 percent for the first quarter this year from 4.42 percent in the fourth quarter of 2001 and 4.24 percent from the first quarter of last year.

Our average interest-earning assets increased 3 percent to $1.42 billion compared with $1.37 billion in the same period of last year.

Reflecting on our recent actions regarding troubled loans, non-performing loans were $24.3 million or 2.07 percent of total loans at March 31, 2002, compared with $18.4 million or 1.57 percent of total loans at 12/31/01.

At March 31, 2002, Columbia's allowance for loan losses was $15.2 million or 1.3 percent of loans and 62.73 percent of non-performing loans. This compares with an allowance of $14.7 million or 1.27 percent of total loans and 80.3 percent of non-performing loans at the end of December 2001.

Over 65 percent of non-performing loans are represented by just two banking relationships, which we considered to present little chance in material loss.

I'll now turn it back over to Jim to discuss the performance goals for the balance of 2002.

Thanks, Melanie.

As we discussed in our recent 10K filed with the Securities and Exchange Commission, economic growth slowed in the Puget Sound region, which is our primary market area in 2001. And recovery has been estimated by local economists to take place in mid-to-late 2002 or beyond.

Many businesses clearly have weaker balance sheets than they had a year ago due to recent economic events. Further, the commercial office market is substantially weaker than last year. And though there is not as much evidence at this point, we expect that other commercial real estate will be somewhat weaker as well.

There are moderate signs of improvement showing at this time but we'd have to say that the picture is far from clear right now. We are seeing some increase in request for business credit, a good sign for some, for a bank like us. And the quality -- even more importantly -- the quality of what we're seeing is beginning to improve.

This trend, if it continues and actually becomes a trend, coupled with an expected moderate increase in short-term interest rates throughout this year, should help our recent resumption of revenue growth.

But with the additional provisions of the loan loss this last quarter and the reduced income that we anticipate because of our increased non-accrual loans, we expect that our earnings will be reduced for the year 2002 by up to 26 cents per share. That means that we expect that earnings for the year will be in a range of 77 cents to 87 cents adjusted for our recent 5 percent stock dividend rather than the again-adjusted $1.05 to $1.14 per share that we had previously announced.

Our ability to meet or to exceed those revised earnings will depend on stable or improved credit quality and it'll depend on a stable or rising short-term interest rate environment.

I would like to emphasize here something that I mentioned in our press release this morning. Particularly, Columbia -- that is that Columbia continues to be strongly capitalized and has adequate reserves to protect against possible future asset, quality issues.

With over $133 million in equity capital and reserves, and with over $150 million in regulatory capital, we are well capitalized as that term is used by the regulators. And we have the financial strength to serve our present and our future customers.

We will continue to expand our banking franchise by growing our market share in the markets where we are now represented and by continuing to emphasize superior products coupled with great service.

And particularly -- in particular we look forward to the rest of this year when we expect to gain real traction in the Seattle King County metropolitan market, to gain better control of our expenses and to assure strong credit quality.

We would now like to take questions from any of those of you who have them. I'll remind you that in addition to Melanie Dressel, I have Gary Schminkey, our Chief Financial Officer, and Hal Russell, our Chief Credit Officer, present. So please let us know if you have any questions.

Ladies and gentlemen, if you wish to ask a question, please depress the one on your touch-tone phone. You'll hear a tone indicating that you have been placed in queue. You may remove yourself from queue by depressing a pound key.

Once again, if you have a question, please press one. Our first question is from the line of from RBC Capital.

Please go ahead.

Hi. Good afternoon, everyone.

Hi Joe.

I -- just a question on the kind of loan growth going forward. You had last quarter talked about targeting say a 4 to 6 percent growth on average. What are your kind of current expectations there? And what's the pace of activity may be? Is it little more back-end loaded or weighted or whatever? And then similarly on the margin, kind of what expectations might you have there for the outlook for the year? Thanks.

OK thanks Joe. I'm going to ask two people to answer that. I didn't mention it earlier but Don Hirtzel, our Executive Vice President and head of our commercial lending and our production area, is also here. So the first part as to our loan growth, I'll ask Don to respond to. The margin issue, Gary Schminkey will answer.

Thanks.

Our loan growth as you know has been relatively flat. But the opportunities for us in King County are still tremendous. We just got our two offices opened up there about 60 days ago and our response has been very, very good. We've exceeded our expectations in both those locations.

So the activity is fairly strong. Our pipeline looks very good and we're encouraged by the response we're getting in some of our new markets.

You're continuing to expect the rate of growth going forward? We had...

Yeah, the rate of growth -- I think it's -- well we're thinking it's going to be more moderate than it was in the past. We're still looking for some real loan growth in our portfolio.

OK.

Hi, Joe. It's Gary.

Hi, Gary.

For the net interest margin, we're still seeing an , you know, as of the end of March compared with our quarterly number. And what we noticed about three months ago was that as our cost of funds has continued to decline, the average yield on our loans has stabilized or has actually increased slightly. So I think we are seeing a slight turn around in that, you know, on the loan yield side.

So I think going forward what we can expect, you know, barring any other actions by the Feds is that we would continue to increase slightly on the net interest margin. I think there is a bottom as far as the core deposits are concerned. And we may be reaching that or have reached that.

And as the markets tend to -- or begin to do better, you know, we may see somewhat of an outflow of core deposits going back into the market which we've talked about here. And, you know, of course that would cause our costs to increase to some degree.

What -- to just follow up on that, what do you see is driving the stabilization or maybe increase in loan yields? Is it just competitive-wise or better pricing for the risk? Anything you could point to?

Hi, Joe.

This is Hal.

Hi, Hal.

I think it's a couple of things. One is that we're not bending to the competition as, you know, some are I suspect. We're finding that our customers that know of our existing and new markets are receptive to the rates that we're offering. Additionally, with the enhancement of our special assets department, there is some significant rate increases related to those loan relationships. So we're finding that the majority of the respective borrowers that we deal with are receptive to what we've considered to be fair rates.

OK. Thanks very much everybody.

Despite that we're not promoting special assets on the growth...

I sure hope not.

Thank you. Our next question will be from the line of from . Please go ahead.

Hi, everybody.

Hi, Steve.

I just want to go over the non-performing loan totals. Maybe to make sure -- I keep going over this, I apologize, but to make sure I understand what evolved during the quarter. You show non-accrual loans of $23.8 million. The previous quarter was $17.6, and you had $6.5 million in charge-offs. Were those -- I know you charged off on the office building. Was that already in non-performing?

No.

OK so that's not an additive number?

That's right.

So there was roughly $6 million of additional non-performing loans, not accrual loans, that came on during the quarter.

Well that would be the net number I think. This is Hal, by the way, Steve. We had a number of loans that were within non-accrual category that paid off or were reduced. And then we added the remaining balance of this particular credit and then we added the remaining balance of another relationship that we felt was prudent to be included in non-accrual.

So the $6 million , the net addition anyway comes really from two places?

Yes.

The one we know about and the one that -- what's -- can you give us any...

Netted -- or 9.1 gross addition.

That's correct.

Right.

That's correct.

OK. And what sort of loan is the other one?

The other one we've spoken about in the past and it's the relationship that we've had with a number of years that it's more of a traditional C and I relationship. It has a variety of collateral that we're very comfortable with.

OK.

And we had the majority of that non-accrual earlier or the end of 2001 and just decided to put the balance of it on as well.

OK. All right I guess the second question is unrelated but maybe to Don or Melanie. When you are adding the new relationships you're getting in King County and some of the commercial loan growth you're getting, is that coming along with core deposits like you've seen in the past?

Absolutely. You know, we're looking to bank relationships so clearly we aren't in the business for just doing transactions. And looking also to bank the individuals that come with those primary companies, so that's an important part of our business.

Also our new Redmond and our second in Columbia offices in Seattle -- they're both exceeding our expectations on both sides of the balance sheet right now.

That's great. Thanks a lot.

Our next question is from the line of from DA Davidson.

Please go ahead.

Good afternoon. A couple of questions. Also your operating costs have gone up $4 or 500,000 a quarter for I think three or four quarters in a row now. I believe most of that's attributable to the new offices. Could you talk a bit about your expectations for operating costs? I would suspect that some of those variable costs, things like that, will level off here in the coming quarters. But I wanted to get a feel for what rate of expense growth you anticipate.

And then question two is if things work out in your favor on the loans and you end up with sizable recoveries, would you leave that in reserves? Because your overall reserve numbers are still, you know, better but not to the level of your peers. I wonder if you would recapture that or just leave it in reserves.

We'd -- we would more than likely leave it in reserves in answer to your second question. We recognize that, you know, we'd like to have our loan loss allowance a little bit higher than it is -- more to the middle of the range of our peers.

On the expense side, and Gary you can jump in here too, you know, in the majority of our additions to expenses and associated with additional branches, fill its occupancy and salary expense. And we really don't anticipate that we're going to -- well we're certainly not going to be opening up new branches this year at the same pace that we have in the past years.

But we won't overlook opportunities that may exist out there in our, you know. As you know we've always been looking for opportunities to pick up people who are very well known in the market area and then we'd build a branch around them. But at this point in time, we are really anticipating that we're going to slow down that branch growth.

And some of the other things that have occurred have been improvements in our -- in some of our operating systems which should also improve our expense control. We're still putting some numbers around various initiatives that we're undertaking at this point in time. We don't have a real solid number for you Jim, but Gary, maybe you'd like to add to that.

Yeah, the one thing I want to add Jim is that included in the expenses are some that are tied to volume. And one of the things that -- one of the items in there is our merchant services area, which has been extremely fast growing on the non-interest income side. And accompanying that is the faster growth on the expense side as well. And those two expenses are not netted together so there is a factor of that as well. And it's based on volume.

But we did improve this last year. We substantially improved the spread between the revenue and expense on that particular operation.

Correct.

Yeah.

One follow up if I can. What's -- where's the head count today versus a year ago?

Let's see. We're at about 600 today. And I'm sorry...

We don't have that number right in front of us right now Jim, but we can get it for you.

It's a little bit less than 100. We opened up five new branches last year.

OK. It looks like it was like 515 or something a year ago if that's right. Thank you.

You're welcome.

And our next question is from with Haberman Brothers. Please go ahead.

How are you all?

Hi, Russ.

Could you talk a little bit about what other similar exposures you have in the Seattle -- like is commercial real estate market -- how big is -- how big of exposure do you have to that category in total?

Hi Russ. This is Hal Russell. You know, we've had an on-going analysis for our entire commercial real estate portfolio for quite some time. As we said, as we recognized the weakness of the vacancy rates, we immediately started addressing some of these issues.

The King County market in itself -- and this is not differentiating between non-owner occupied and owner occupied -- represents about 25 percent of our total commercial loan -- or commercial real estate portfolio.

It's the second largest county as far as commercial real estate exposure, but more than half of what we have in our Pierce County market. And then if you take into consideration that which is non-owner occupied, it is significantly smaller. It's closer to about 12 percent of the total loan portfolio.

And then we break it down a little farther and look at the region or the specific area that this particular loan is in, and it represents a very, very small amount -- probably closer to 3 percent.

So we don't think we have a whole lot of exposure to anything related that would be similar to this. And it's important to note that the analysis that we have done related to our commercial real estate was ongoing long before we recognized this problem and took action.

And could you also give us an indication of what you've seen on your, maybe your 30 and 60-day delinquencies. Are those up much for last quarter?

No, actually we've seen tremendous improvement in that area. We see quite a bit of improvement. A lot of that's related to a real emphasis that our account officers are placing on managing that -- their respective portfolios.

Just one final question. Do you have much exposure on the construction side and if so, what are you seeing in that category today?

Would you define "construction side" a little more?

I expect either commercial or residential.

We think -- we consider that to be a fairly limited amount within our portfolio. We intentionally slowed the growth down to virtually nothing within that portion of our loan portfolio because of some concerns that we had with absorption rates.

You know, the market is still relatively robust. However, the absorption period seems to be longer than what it has been in the past. So there's not a lot of activity in that regard.

And just one final question. How many new branches are planned for this calendar year?

Well we recently opened the two that I mentioned. And there's a possibility of a third. And that's all that we have on the drawing board right now.

OK thank you.

You're welcome.

Our next question is from with News Tribune. Please go ahead.

Good afternoon.

Good afternoon. Hi.

Now one thing, the third -- you will have a third beyond second Columbia and Redmond?

Yes. That's what we have planned.

Thank you. Could you just take a moment to characterize how concerned you are with the figure of 2.07 percent with the non-performing loan. Say, give a sense of how worried you are about showing that figure.

Hi, this is Hal Russell.

Mr. Russell, nice to hear...

It certainly is a number and a percentage that is higher than we would ever want it to be. And every effort is being made to drive that down. If there is level of comfort associated with it, it is that the entire amount within that category -- that non-performing asset category -- is represented almost to the point of 65+ percent by two particular relationships. And it's the two that we've been speaking of.

So we're pretty confident that we've addressed the majority of the weaknesses related to those two relationships and taken the appropriate action to put them in the best possible light in the event of collection that we'd suffer what we think to be not a material loss.

So the number is bigger than what we are comfortable with. We're optimistic that that will decrease. And all efforts are being made to get to that point.

Thank you very much.

You're welcome.

I might add on that just following up on that question, the 2+ percent is certainly high by our historical standards. And it's a bit high in the industry. But since we do feel so much more comfortable with those two relationships now, if you were to exclude them, our non-performers would be actually well within acceptable tolerances in the industry.

And except for the one that we spoke of earlier that was for commercial real estate, the -- our problems with that one credit, we had a variety of collateral securing the other loans in that category.

And we have a question from the line of with Columbia Bank.

Please go ahead.

And he disconnected, sir.

OK.

If anyone else has a question, you can press the 1 at this time.

We have a follow up from .

Please go ahead.

A question for Jim. Jim, bigger picture thoughts. You've clearly been growing your footprint, your market share for quite a while. Any thoughts on sort of slowing the growth down, squeezing better efficiency, better growth, more profitable growth out of your existing system you have now? Sort of let the earnings catch up to your market-share growth and -- before, you know, before opening up another slew of new branches say next year as well as the year after?

Russ, that's -- I'll pick up on a point that Melanie was making a little earlier. We have definitely turned our attention to the fact that we have proven that we can grow this franchise very quickly. And so we've had some bumps in the road as we've just described with generally quite good quality in our assets.

What we have not yet proven is that we can make it as profitable as a franchise like this should be. And we're well aware of that fact. So that's the reason that we are really increasing our attention on the idea of improving our productivity in a number of areas, really getting a lot more performance out of the assets and also the people that we have because they're all capable. The people are certainly capable of it.

So we clearly are focused on the idea that we want our revenue growth to exceed our expense growth and hopefully by a reasonable margin. And we really have it as a target to hit 15 percent return on equity as soon as possible. And it should be achievable in the not-very-distant future.

Now that implies that we're not going to run an awful lot of growth through the income statement in the form of a slew of new branches in the foreseeable future. And that's our intent.

On the other hand, we are in a very dynamic market and we are committed to being -- continuing on our growth orientation. So we've got to get smarter about the way we're doing it and we're about that process in spades I'd say. And we realize that the shareholders need to participate in this -- in what we're doing to a greater extent than they have up to now.

Well just a quick response to that. I think it would be a lot easier to get to your 15 percent return on equity if most of your emphasis and concentration were focused on your existing set of branches because as you well know it takes a lot of time and effort to keep on looking for and finding these new locations and building it up from scratch.

I guess I for one -- my personal view would be for you to concentrate on your existing set and sort of maximize what you have for a while to show your investors that you can hit that 15 percent with what you have, you might say.

Well and I...

That would be my personal view.

Yeah. I hear you. We hear you. And we are definitely focused on doing that.

Thank you.

At this time there are no further questions.

OK. I'd like to thank everyone for participating in the conference call.

And that does conclude our conference for today. Thanks again for your participation and for using AT&T's Executive TeleConference Service.

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Thanks very much.

Thank you.

Thank you, sir.

END