First Hawaiian Inc (FHB) 2002 Q2 法說會逐字稿

Welcome to the Community First Bankshare Incorporated second quarter earnings conference call. During the presentation all participants will be in listen-only mode. Afterwards, you will be invited to participate in a question and answer session. At that time, if you have a question, you will need to press star followed by the number one on your telephone. As a reminder, this conference is being recorded Thursday, July 18th, 2002. I would like to turn the call over to Mark Anderson, Chief Executive Officer. Please go ahead, sir.

Thank you. Thanks to all of you for joining us, and welcome to the conference call. We are pleased you have elected to invest some time with us today, and to discuss the results of a record quarter for Community First. Joining me today on this conference call again will be Ron Strand, our Chief Operating Officer, and Craig Weiss, our Chief Financial Officer.

The results of the quarter continue to provide strong evidence that the series of initiatives that we began to implement over two years ago have positioned us for consistent and high quality earnings growth. Second quarter 2002 witnessed numerous record performance levels for Community First in a number of important areas.

Diluted earnings per share, as you saw, were 49 cents, an increase of 2 cents over first quarter, and a 6 cent increase over the second quarter of 2001. Basic earnings per share were 50 cents. Both EPS measures were better than all estimates for the quarter for us. That enabled us to increase net book value to an all-time high of $9.35 a share. The strength in earnings helped drive and contribute to the highest return on equity as well. We are pleased with the shareholder return level that we have recorded, 22.3% during the quarter.

During late first and early second quarter, we conducted an internal sales campaign focusing on investment securities. This product line has represented the most rapidly growing aspect of our business over the past five years, and even in the face of the market challenges that we have seen, we were able to offer our clients alternatives that we believe enabled us to realize $3.5 million of security sales commission income, again a record quarter of performance.

Another growing element of our business that represented a record quarter performance is the area of small business administration guaranteed lending. Another area in which we have been able to develop ways to work with our clients and enhance solutions for those specific borrowers. This emphasis increased our income from that category again to a record level for us during the second quarter. These accomplishments speak well of the results of the efforts of our team as we continue to emphasize the prudent utilization of capital and consistent and predictable performance.

Underscoring the diversity of our progress, we also recorded a 5.48% net interest margin. The strongest one in five years, and one of the best on the record. We also generated $3.3 million of insurance commissions, our second best level of quarterly performance for insurance commissions.

These are results. The results of the commitment of every employee of this organization as we continue to evolve in a very significantly changing business. While it's gratifying to see the performance levels and they are even better than forecasted, we are currently in the implementation phase of our two largest initiatives ever. Initiatives that we believe will help us and enable us to become one of the most client relationship focused and sales oriented organizations in this industry.

All of this comes at a time when the integrity of financial statements, public companies, their executives, and in some cases their accountants are suspect. We as a management team and as a company are appalled by the apparently [INAUDIBLE] breeches of sound accounting applications and fiscal prudence. We've prided ourselves on the quality of our performance and the voracity of our financial statements. The lack of integrity by some companies, and we hope they represent a distinct minority, has dampened investor confidence and tightened legislative and regulatory scrutiny. While this should not be necessary, it appears as though significant changes are on the horizon. Amid the changes, Community First will continue with integrity, emphasizing consistent performance and confidence.

To talk more in detail about our financial position and our performance, I would ask Craig Weiss, our Chief Financial Officer to share some comments. Craig?

Thanks, Mark. And thanks to all of you for joining us on the call today. As Mark noted, the company reported strong financial results for second quarter. In addition to the record levels of diluted earnings per share and return on equity, and the strongest net interest margin in five years, net income was 19.9 million, up 12% from second quarter of 2001. Return on assets was 1.42%, the highest quarterly return on assets since 1997.

Although we have had success in increasing revenues from fee income based products such as insurance and investment sales commissions, financial performance is primarily driven by net interest margin. The company continues to implement an approach to asset and liability management that has led to the strongest net interest margin in five years. The approach includes ongoing repositioning of the balance sheet and a disciplined approach to pricing of assets and liabilities.

The repositioning is accomplished within the conservative interest rate parameters approved by our Board of Directors. Although the company's balance sheet is considered liability sensitive, that alone does not measure the potential change in net interest income as interest rates do not impact all assets and liabilities equally, or simultaneously. An important driver in the company's ability to maintain a strong net interest margin, will be a continued stabilization of interest rates.

Total deposits for the quarter were down 4.1% from second quarter of 2001. Much of the reduction is due to the company's deposit pricing strategy. The most significant reduction in deposits was in certificates of deposit, which were down 12.3% from second quarter of 2001.

Certificates of deposits are our highest cost deposits due to the availability of lower cost wholesale borrowings, the desire of some customers to move into investment products which result in additional fee income to the company, and a lack of lending opportunities. The company's strategy is not to overpay for certificates of deposits. Overpaying for these deposits would have a negative impact on returns to shareholders.

Exclusive of these higher costs of certificates of deposits, deposits actually increased 3.4% from second quarter of 2001. We do recognize the long-term importance of growing our core deposit base and the impact it can have on product sales, customer retention and earnings, and continue to look for ways to grow deposits in a profitable manner.

Non-interest income increased $736,000 or 3.9% from second quarter of 2001. As Mark noted earlier, the primary driver of this increase was a record level of investment sales commissions and a nearly 14% increase in insurance revenues. Partially offsetting the increased revenue from insurance and investment sale commissions is the reduction in service charge income on deposit accounts. The reduction is a combination of reduced deposit related fees due to the impact of banks sold over the past year, and a reduction in overdraft volumes.

We continue to be very pleased with our control over non-interest expenses at a time when the company has a number of major initiatives in process, including the continuation of long center centralization and continued implementation of an automated platform for new account processing.

Excluding the impact of the adoption of FAS-142, which eliminated the amortization of goodwill as an expense for financial reporting purposes, non-interest expenses were down approximately $760,000 or 2.1% from second quarter of 2001. We remain focused on controlling expenses in all categories across the entire company, which is reflected in our quarterly performance. We do anticipate a modest short-term increase in expenses due to cost redundancies with the continued roll-out of the initiatives I mentioned earlier.

In second quarter the company completed the redemption of all outstanding 8 and 7/8ths percent [INAUDIBLE] capitol one securities. Proceeds from the issuance of the 8 and 1/8th percent [INAUDIBLE] capitol 3 securities completed in March of this year, were used to redeem the capital one securities. The offering and redemption will save the company $450,000 a year in dividends. During second quarter, approximately $400,000 of additional dividends were recognized due to the one-month lag in the timing of the issuance of the cap three securities and the redemption of the cap one securities.

Due to a strong level of earnings, a modest contraction of the balance sheet, and a moderating level of share repurchase activity during the quarter, the leverage ratio is 6.79% at the end of second quarter. This is the 6th consecutive quarter of an increasing leverage ratio, and reflects the company's commitment to maintaining strong capital ratios in a time of corporate and economic uncertain.

I would now like to turn the call over to Ron Strand, Chief Operating Officer, to discuss loan activity and credit quality.

Thank you, Craig, and welcome to all of our conference call participants. We appreciate the opportunity to discuss our performance.

I would like to start my remarks from a credit quality perspective to be followed by comments on loan volume. As noted in the earnings release, nonperforming assets represented .43% of total assets in the second quarter of 2002, compared to .41% in the same quarter of 2001. The allowance for loan losses was 1.52% of total loans and 252% of nonperforming loans at the end of the quarter, compared to 1.39% and 247% respectively in the second quarter of last year. Net charge offs were $3.1 million or .34% of average loans for the second quarter of 2002, compared to 2.9 or 31% for the second quarter of 2001. On a link quarter basis, net charge-offs were up slightly from $2.9 million or .32% of average loans recorded during the first quarter of 2002.

By category, net commercial charge offs represented the largest dollar amount, followed by consumer. However, it should be noted net consumer charge offs were 50% less during the second quarter of 2002 versus the same quarter during 2001. We believe this speaks volumes in regard to the effectiveness of our recently implemented collection and recovery department. Commercial real estate and agriculture net charge offs were negligible during the quarter, while losses on residential mortgage loans increased from the first quarter of 2001. However, they remain at a very manageable level.

With respect to loan volumes, we have taken a cautious approach with the extension of new credit industries where we have experienced an increase in nonperforming loans, or segments that have been impacted by a weakening due to economic conditions. Examples of these include certain industries in our commercial portfolio, and some construction and land development projects. While volumes have decreased in our consumer portfolio from the second quarter of 2001 to the second quarter of 2002, I am pleased to report that during the months of April, May, and June our new and district loan volume exceeded indirect runoffs by a significant margin.

My remarks on loan volume would not be complete without commenting on the discounted lease portfolio, which has decreased $72 million from the second quarter of 2001 to the second quarter of 2002. As you may recall, during late 2000 we made a decision to exit this line of business due to thin pricing and increased credit risk. The balance of discounted lease assets carried by community first was $58 million as of June 30th, 2002, and continues to run off at approximately 5 to $6 million per month.

On a positive note, we have enjoyed good growth in our commercial real estate portfolio. This is a very diversified portfolio, and as you may recall from my remarks earlier in this discussion, net charge-offs in this category have been negligible.

Geographically our strongest loan growth continues in the Southwest. However, we are seeing a slowing in all markets. Demands for new home purchases continues to be strong, but refinance activity has slowed. The real estate joint venture with Wells Fargo continues to produce good results. However, we will not see an appreciatable benefit from this venture until 2003.

To sum up my comments on volume and quality, we have not and will not compromise quality for quantity.

In regard to loan centralization, we are very pleased with this initiative. Beginning October 1st, 2001, all consumer collection and recovery activity was centralized. This is paying huge dividends, as we have seen net consumer charge-offs reduced 29% during the first six months of 2002, compared to the same period during 2001. And as stated earlier, a 50% reduction for the second quarter of 2002, versus the second quarter of 2001.

During the fourth quarter of 2001, we also centralized the underwriting and documentation preparation for all indirect consumer paper. During the transition, we did experience a reduction in the volume of new dealer paper. During the second quarter of 2002, new loan volumes exceeded run-off, and reports from our dealer network indicate a high level of satisfaction.

During the second quarter of 2002, we began the rollout of our direct consumer loan underwriting and processing, as well as commercial loan documentation preparation. While we're in the beginning stages, this process is going smoothly and is on schedule. Given the market sensitivity, this process will take longer than the indirect initiative, and will not be completed until late 2003.

In summary, we remain very committed to not only maintaining, but working to improve, our loan quality through rigorous underwritings, strong credit administration processes, and the loan center initiatives.

Now, I would like to turn the conference call back to Mark anderson.

Thanks, Ron. Thanks, Craig, great comments.

Our team is pleased with our performance and progress. However, we believe that we have significant opportunities ahead to further differentiate ourselves in the industry. So we are not standing still.

During the quarter we completed our initial insurance agency acquisition in the state of Utah. We have high expectations for additional insurance agency acquisitions during the balance of the year. For us it was a slow quarter, in terms of looking at bank acquisition opportunities. We saw very few deals, and none of those offered the return that we believe is appropriate for our shareholders. We are, however, continuing to review other opportunities for market place expansion.

During the quarter we were also named a dividend achiever by Merchant. Formerly it was known as Moodies Dividend Achievers. What is remarkable to this, as we learn about it, as out of more than 10,000 publically traded companies only 282 recorded 10 consecutive years of dividend increases. Out of that group, Community First ranked number three in terms of the third highest annual compound growth rate for dividends when compared to a group of 282 out of an universe of more than 10,000 companies. A tremendous accomplishment.

Add to that some other significant accomplishments in a very difficult market place. Our quarter end stock price increased for 10 consecutive quarters. Our earnings per share have increased every quarter since first quarter of 2001, when we recognized our one-time restructuring charge.

Also, we've increased our leverage ratio for six consecutive quarters while continuing to execute a very successful common stock repurchase program. That repurchase program has seen us repurchase nearly 12 million shares of stock since second quarter of 2000. That represents almost 25% of the shares that were then outstanding.

Community First is a client focused, employee oriented organization that understands the importance of our shareholders and prudent capital management. We congratulate you on your selection and support of Community First. Thank you for that interest. With a 10-year shareholder return of 19.8%, we compare very favorably in the market place. And over the last tumultuous 12 months, we were able to generate a 17% total shareholder return.

In our annual report we highlighted the football philosophy "Three yards and a cloud of dust". That expression is preceded by the phrase "You don't get hurt running straight ahead". This has been and continues to be our approach. To achieve steady progress we focus on fundamentals and execution, rather than on an unproven play book and dream plays. Our second quarter performance bears this out.

Community First, again, is a very high quality company that will continue running straight ahead. We greatly appreciate all the interest you have shown, the time you have invested, and your support. Thanks, again, and we look forward to additional contact. So with that, Laticia, we would ask you to open it up for conference question.

At this time I would like to remind everyone in order to ask a question press star then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster.

Your first question comes from John Arstrom with RBC Capital Markets.

Good afternoon guys.

hello there, John.

Love the comments, Mark.

Thank you. We like the material we had to work with.

Couple of things. It sounds like you guys are more than willing to give up some loan growth to maintain your clean asset quality numbers. How do you balance that, how should we think about that?

Well, John, we obviously would like to make as many good loans as we -- are out there. We are being cautious in certain industries right now. Especially as it -- in the higher end homes in the resort markets, that market has become very soft.

In the short run, I can tell you that our focus remains on credit quality. We do see opportunities, you know, we just approved a multi-million dollar loan yesterday in one of our resort communities. But we are looking for high quality borrowers with a lot of liquidity and balance sheet strength and projects that work. So it is, you are right it's a delicate balance. But given the two, we always graph tate towards quality versus quantity, and we'll continue to do so.

Actually, year-over-year, taking out the CFFI discounted lease portfolio, in what has been a rather interesting economy considering 9/11 and economic uncertainty out here, we have maintained our core loan volumes, which we think is pretty good, and we have been able to maintain a good margin. So we are really very pleased with where we are at. Obviously when the economy starts to strengthen, we will be looking for more loan volume.

Okay. And then, I guess two other related questions. On the insurance trust and investment security sales. When I look at the trust results, even though they are down sequentially, they look like they are hanging in there. And I'm curious what's going on there.

And then, in terms of some of your investment and insurance products, who is buying these things? What types of products are they? Are they fixed annuities? Are they commercial insurance policies? If you can just give us an idea what's under there, we'd appreciate that too.

Great questions. because again, you've focused on some areas that have been very significant contributors to some of our key income and bottom line performance over the past couple years. Let me address the trust fee question first, then Ron would like to respond to the discussion on insurance and investments.

In the trust area you are right, we have been hanging in there. We would love to be able to say we are seeing 10, 15% growth. But so many of those accounts are on a managed fee basis based on market place performance. And not everybody has been able to generate 20% return on their stock like Community First has over the last 10 years. Evidently, there's a few companies that have had negative performance returns over the last one, two, three years. So as a result, many of those diversified and balance funds that are tied to whatever the index is appropriate, we have seen decline in asset values, which has reduced fees on it.

We are hanging in because we are getting new business. Again, we've continued to focus on driving performance, looking for new accounts, recognizing that the market place is not going to give us the ability to increase our fee income just because the indexes are increasing. So it's really hard work getting new business, and fighting and scratching and clawing to keep even because the market place is having a negative effect on fees. Ron, some thoughts on insurance and investments?

Very good question, John. On the investment side, we are seeing a lot of product sales with respect to annuities. Primarily fixed annuities. In fact, during our recently completed campaign, approximately 65% of the sales were annuity sales. This is a nice product mix for us, especially given the current rate environment. You know, many of our customers are looking for higher return, and as Craig mentioned, what we are willing to pay on certificates of deposit or money market accounts. So fixed rate are a nice alternative and that's where we see a lot of people moving.

On the insurance side, actually three things, really are at play here. First, we are increasing our own book of business. We are having very good success there. Secondly, there's a hard market out here. And we are seeing increased commission income flowing into the company from that hard market. And third, we have been successful in the last year or so with some acquisitions. We continue to see that. Mark touched on that in his comments.

One of the things that's happening on the insurance side is that the companies are looking for, you know, they are starting to drop many of the independent agents that can't deliver enough book of business. And what we're seeing are these smaller agencies, these independent agencies seeking out companies like Community Insurance to affiliate with. And oftentimes, these are folks that still want to retain employment with Community First. So this has been a successful combination for us.

Just to add one thing, John, as it relates to the insurance side. You talk about a mix of business. Year-to-date about 85% of our revenues have come from the property and casualty side, both a combination of personal and commercial. That mix is consistent, actually up modestly from what we have seen historically on the insurance run.

If you would, John, like to have you or any of your friends, some insurance or some investment products or annuities, we can help you.

I could do what I -- I can give it my best shot, I guess. [ laughter ]. I'll talk to [INAUDIBLE] some insurance. Thank you guys.

Okay, thanks, John.

Your next question comes from Andy Collins with U.S. Bank Corp, Piper Jaffray.

Good afternoon, guys. 63% link quarter improvement in investment sales, that's pretty impressive. I'm wondering what you think that number can get to over the long term? It's about 4% of revenues. I'm wondering what your goals are as a percentage of totals? I'm also wondering, you know, as the equity markets start to improve, do you think that will be an equally good opportunity for you?

Well, Andy this is Ron Strand. We started our investment sales -- sold our first product in November of 1995. And we have had very good success with this. As you are aware, we have a little bit different approach to the sale of investment products than many of our competitors, in that we have many of our platform people licensed. We believe that we need to serve all the markets, not just the high growth markets. We have over 300 people licensed with a minimum series six. We have about 75 people with series 7. Your question is a very good one.

We think that this is the future of financial services. We think we need to offer these on the bank platform. We don't know, ultimately where this can go, but I can tell you, I have great confidence that we will see year-over-year growth in this line of business. 60 some percent obviously quarter-over-quarter -- or year-over-year is not achievable, but we see consistent 10 to 15% growth in this business. And, as you indicate if we can do this in a market that is rather tepid, certainly when this -- the market comes back, we see great opportunity here. We are getting more and more adept at selling these products.

The other thing that is interesting, is that we have been able to attract some very, very good talent during the last six months because of the market being off. And these people from Merrill Lynch and other investment companies have been coming to work for us.

So, the other thing that we believe is going to help us here, is our model, our Community Financial model out here versus our regional, in that many of our Community Financial Centers are managed by people with an investment background. So that is their focus.

Andy, just to follow-up quickly. This is Craig. The comment about where we see this going, at least in the near tomorrow. Ron's right, 63% year-over-year increase in investment sales commissions is not attainable. We do, at least in the coming quarters, anticipate some strong double digit increases in this area.

Again, last year, 2001 being relatively soft in the equity market. You know, we do see ourselves probably not in that 63% level, but with some pretty strong increases year-over-year, quarter-over-quarter. Again we'll have another fall investment campaign that will take place here shortly, and that's one of the areas we are looking at where a lot of the investment sales commissions have been very heavily weighted towards a couple of campaigns that are occurring annually throughout the company.

We do want to make sure we have a little more even flow on the investment sales side. We don't want to see the ups and downs that we have tended to see historically as it relates to the timing of certain campaigns. That's one thing we will be taking a look at as well.

Your next question comes from Ron Peterson with Sandler, O'Neal & Partners.

Good afternoon.

Hi, Ron.

The interest margin of 5.48, I know you guys always maintain very strict pricing disciplines throughout the company. I was wondering if you could give a little color on where you see that heading?

Great question, Ron. This is Craig. I'll respond if anybody want to follow-up, feel free to do so. It is obviously a very strong margin. One of the highest margins that we have seen. A couple of items here that are somewhat out of our control, but the stabilized interest rate environment is a real plus.

The steepening yield curve. When you are in a spread business, typically that will work in your favor. What we have done, aside from a disciplined approach to pricing of assets and liabilities at bank levels, we have tried to do some things within the investment portfolio, and altering our mix of borrowed funds as well to try and keep ourselves relatively short, if you will. We do not make interest rate bets under virtually any rate scenario. We feel we are within a range of sensitivity that we are comfortable with as it relates to the impact on net interest margin, and that our Board is comfortable with.

Obviously if we were to see rates drop for whatever reason, we are at a point on the liability side where we would have a tough time repricing downward some of our liabilities with the levels of rates that we are seeing today. But generally speaking, you know, we have done pretty well. Much like Ron has mentioned on the credit side, where we like to look at quality over quantity, we are taking the same approach on the cd side. We do not want a detriment to return to our shareholders by increasing the cost of higher priced certificates of deposits.

Hopefully we can maintain a stabilized rate environment. The yield curve will continue to help. We feel pretty comfortable with where our margin will be, at least over the short-term.

Okay. As a follow-up to that, obviously stable rates with a steep yield curve definitely helps not only you, but all the banks. Assuming, you know, short-term rates would raise, you know gradually say 100 basis points over a six-month period without any corresponding increase in long-term rates, in other words get a flattening of the yield curve, about what kind of impact would that have on your net interest income?

Um -- at this point, if you take a look at some of our simulation modeling. As long as we have a modest increase in rates -- and I would consider 100 basis points over a period of time relitively modest, it would not have a dramatic impact on our net interest margin. Again, part of the component of net interest margin is loan fee. As we see some additional activity in that area, that will impact margin as well.

I think, if you are looking at a relatively modest increase in interest rates, Ron, over a relatively modest period of time, we feel pretty comfortable that the impact will not be dramatic on net interest margin.

Okay, thanks.

Your next question is a follow-up question from Andy Collins with U.S. Banc Corp, Piper Jaffray.

Sorry about that, I guess I lost you guys. In terms of the loan growth, also I wanted to ask a follow-up on that. What do you think in terms of the economy? When might we see a reacceleration in loan growth, assuming that we get -- you know, the economy starting to pick up again here in the beginning of the year, but maybe 2002?

Well, Andy, as per my previous comments, we've deliberately held back in various sectors. Obviously we serve some -- especially in Colorado, some very nice markets with respect to development loans. And we have been very, very cautious with those. We have seen a real slow down, especially on the high end homes. And we certainly don't want to get into any multi-year, multi-phase projects until we think the economy, indeed, has turned around.

Clearly the stock market nervousness has caused many people to hold back on high end purchases. So, in that regard, you know, we are in a wait and see mode. Certainly as the economy starts to recover, we are going to be back in -- back looking for more business in that sector.

But we see other sectors that, frankly, when you look at our footprint, we remain very concerned about the agriculture sector, even with the new farm program. That's one we are being very careful with, always have been. Some other industries that have been struggling are the trucking industry, and -- very sensitive to fuel prices and what's going on in the economy.

So I don't think what we see looking forward, I would expect third and fourth quarter, very strangely -- frankly are going to look very much like they look today. Until we see some real strength in the economy, I do not see loan growth factoring into our equation.

I think the other element is some of the things we are trying to do with increased SBA lending and generation of sales there. The development of the joint venture and sale of individual one to four family real estate loans. As we look at our portfolio and the discipline we have in place. As the economy does come around, and we hope it is around and performing better by early 2003. There's a lot of variables and questions to that.

As we see it come out, I think that looking through the mix of our loan portfolio, the 2003 or 2004 opportunity where we believe in a normal economy for growth, it may be in that six to 9% range. But I think there's a lot of caveats and assumptions built into that.

As Ron points out, we'll take six over nine if it's quality. We'll take zero over six if that's quality. Our focus is driving to the bottom line. And that loan loss provision we see some of our peers taking takes a big chunk out of their earnings.

Okay. Also, I guess, you know, the earnings seem to accelerate on a link quarter basis a little bit here. I was just wondering if we can see an acceleration occurring through year-end?

Well, again, I think in effect looking at it, let me put it by saying we feel comfortable with the estimates that are out there, which show a continuing increase in earnings per share during the course of the year. We are not going to go out and say that we are going to, by any notable measure, exceed those. But again, we believe those are reasonable expectations and they show steady progress, which is what we are looking for.

Okay. Great. Thank you very much.

Thank you, Andy.

Operator: At this time there are no further questions.

Well, if there are no further questions, we would like to thank you, Laticia, for your kind assistance, and thank all the conference call participants for their time today. For those that asked questions, excellent questions. Hopefully our responses were appropriate. Again, good luck to call of you. Thanks. Count on Community First to continue to move forward.

Thank you for participating in today's teleconference. You may now disconnect.