First Hawaiian Inc (FHB) 2002 Q3 法說會逐字稿

Welcome to the Community First Bankshares, Inc., Third Quarter Earnings Conference. During the presentation, all participants will be in a 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 the star key followed by the 1, on your telephone. As a reminder, this conference is being recorded, Thursday, October 17, 2002. I would now like to turn the conference over to Mark Anderson, Chief Executive Officer. Please go ahead, sir.

Thank you, Amy, and thanks to all you for joining us today, and welcome to the Third Quarter Earnings Conference Call for Community First Bankshares. Joining me again this quarter for our conference call with be Ron Strand, our Chief Operating Officer, and Craig Weiss, our Chief Financial Officer. Again, we thank you for investing your time in Community First and are very pleased to report record performance for the third quarter. It was a quarter during which we were able to reach new levels of performance in a number of areas.

Record net income of $20.4 million dollars. Record basic earnings per share of 52 cents and diluted earnings per share of 51 cents. We recorded a record level of insurance income of $3.8 million dollars. The same is true for non-interest income, which hit a record of $19.7 million dollars and also our SBA initiative generated record SBA fees during the quarter. Also during the quarter, as you may recall, we increased our cash dividend to 21 cents per share, which again, is the highest level we've ever paid as a company. And, our net book value was able to increase for our shareholders, to a new level of $9.72 per share, which is the highest level we've enjoyed.

Additionally, we again increased our leverage ratio while continuing to execute under our common stock repurchase authorization that we've been operating under for two years plus. It was a great quarter for us, with our sixth consecutive quarter with a return on equity in excess of 20 percent. We began laying the foundation for this progress during early 2000, and it carried over into 2001. Our initiatives of the last two years and change have clearly been impacting our progress and performance. It's been an interesting period, from an internal and an external perspective. Externally, we're facing increasing uncertainty in the economy. Not long ago, the frequency of discussions centering on an increase in short-term interest rates was widespread. Today, with lingering economic malaise, the consensus opinion has migrated towards an impending reduction in short-term rates. We're at an unparalleled time in our economic history with a flat yield curve and record low rates at many interest rate points. Coupled with this has been continued erosion in many sectors of the economy, which has created stress in the portfolios of many lenders. Our diligence in managing our operating fundamentals and our risk profile have been instrumental in our progress. I'd ask Craig Weiss to expand on a few more topics. Craig?

Thanks, Mark, and thanks to all of you for joining us on the call today. As Mark noted, we are very pleased to announce record performance for third quarter. I would like to comment on a few aspects of that performance.

Net interest margin was 5.38 percent for the quarter, up 3 basis points from last year, and down 10 basis points on a linked quarter basis. Although we saw margin contraction during the quarter, we are pleased with the performance in light of current economic conditions. Record low interest rates, a flattening of the yield curve, accelerated pre-payments, and fewer lending opportunities, have all had short-term negative impact on net interest margin. Continued economic weakness and a flat yield curve could further pressure net interest margin. Considering the liability-sensitive nature of our balance sheet, the most immediate relief to this pressure would be a fed rate cut. A rate cut would lower the cost of our index deposit and sweep accounts, and would likely create more slope in the yield curve, making our reinvestment opportunities more attractive. The company will continue its approach to maintaining a strong and net interest margin at the top of its peer group.

Non-interest income increased modestly from third quarter of 2001. We did see a nearly 8 percent increase in insurance commissions, and 25 percent increase in investment sales commissions from the same quarter last year. This is further evidence that our strategy of providing financial solutions to our clients is working. Increases in insurance revenues and commissions, [in] investment commissions, were partially offset by reduction in service charge income. This reduction is due primarily to lower volumes in deposit-related charges such as overdrafts. On a linked-quarter basis, service charge income remained constant. Again this quarter, we are very pleased with our solid expense controls that have resulted due to efficiencies of centralized processes and the ongoing disciplined and focused approach on expense management. On a year over year basis, non-interest expenses decreased 4.6 percent. Excluding the impact of intangible amortization expense, non-interest expenses decreased a million dollars, or nearly 2 percent. On a linked-quarter basis, non-interest expenses decreased $1.4 million dollars, or 2.6 percent.

We did see an increase in occupancy expense from last year of nearly $500,000 due to the acceleration of lease expense and a lease buyout related to the replacement of computer equipment taking place in the fourth quarter of this year. We continue to proactively look for additional area to reduce expenses. Although only one measure of expense control, the efficiency ratio dropped to under 60 percent for the first time since 1999.

As Mark noted earlier, the leverage ratio increased 8 basis points to 6.87 percent on a linked-quarter basis. This is the result of record earnings, modest increase in asset base, and continued execution of our share repurchase program. This is the seventh consecutive quarterly increase in the leverage ratio, reflecting the company's commitment to maintaining strong capital levels while prudently investing their shareholders' equity.

I will now turn the call over to Ron Strand, our 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.

As Mark and Craig have mentioned, we continue to perform consistent with the expectations we established approximately two years ago. While loan volumes are less than desired, the volumes are down only 2.6 percent from the third quarter of 2001, when factoring out the [loan run op] associated with our decision to exit the discounted leads receivable business. On a linked-quarter basis, loan volumes are stable. We continue to experience growth in our consumer and commercial real estate portfolios. Consumer growth is largely due to an expanding network of automobile dealers served by our centralized indirect loan center. Feedback from the dealers indicates a very positive experience with turnaround time on contract approvals exceeding expectations. We do anticipate consumer growth to moderate during the fourth quarter due to zero percent offerings by the captive finance companies. Commercial real estate volumes continue to grow, which I want to stress is a very diversified portfolio and continues to perform to our expectations.

We have taken a cautious approach to construction and land development activity to reflect the slowdown in resort market sales, especially homes in the higher price range. Homes in the $300,000 and under price range continue to sell well, due in part to the lowest mortgage rates in the last 35 years. In addition, our Small Business Administration lending program continues to grow with a record performance during third quarter. Geographically, our strongest loan growth continues in the Southwest, however, we are seeing a slowing in most markets.

Prospectively, we anticipate loan volumes to remain flat due to uncertainties in the economy and our position will remain cautious with the expansion of new [product] industries where we have experienced an increase in charge ops or segments that have been impacted by a general weakening due to economic conditions.

With respect to credit quality, we remain committed to strong loan underwriting and pricing commensurate with credit risk. We continue to enjoy good credit quality with non-performing assets representing .46 percent of total assets in the third quarter of 2002, compared to [.44] percent of same quarter last year. On a linked-quarter basis, non-performing assets as a percent of total assets increased modestly, from .43 percent in the second quarter of 2002.

Net charge-offs were $2.8 million or .30 percent, while the average loans for the third quarter of 2002, compared to $3.4 million during the third quarter of 2001. On a linked-quarter basis, net charge-offs were down modestly.

With respect to loan [centralization], we remain very pleased with this initiative. We continue to roll out our direct loan underwriting and processing as well as commercial documentation preparation. This rollout is unscheduled with an anticipated completion date during the fourth quarter of 2003.

In summary, we remain very committed to not only maintaining, but working to improve our loan quality through rigorous underwriting, strong credit administration processes, and our loan center initiatives. Now, I would like to turn the conference call back to Mark Anderson.

Thank you, Craig; thank you, Ron. Appreciate your comments.

In addition to our operating performance and the continued implementation of our strategic initiatives, we continue to explore ways to expand and enhance our franchise. We're realizing tremendous acceptance of our Direct Connect Online Personal Banking Solution, with 21 percent penetration in less than two years from its launch time. Earlier this year, we also launched an online Business Banking Solution and have, in less than six months, reached more than 3,000 business clients, and by the end of the year may well reach 20 percent of our targeted penetration base.

During the quarter, we completed the acquisition of a quality Wyoming-based insurance agency, and we continue to look at numerous opportunities for insurance agency acquisitions. The number of bank acquisition opportunities remains very light, and pricing expectations continue excessive from our vantage point.

Our community financial center model continues to evolve and exhibit progress. This progress will fit into our plans for market extension-based expansion in 2003 and beyond. We're encouraged but cautious about the quarters ahead. We'll continue to manage this organization for long-term growth and success. Our performance for 2002 thus far has met or exceeded our expectations in most areas. However, even more important has been the progress we've made with the implementation of our strategic initiatives.

We'd like to thank you for your time, your interest, and your investment or potential interest in Community First. With that, we'd like to open it up to any questions.

At this time, I would like to remind everyone, in order to ask a question, please press star, then the number 1 on your telephone key pad. We'll pause for just a moment to compile the Q&A roster.

Your first question comes from John [Herk], with ABC Capital Markets.

Thanks, guys, looks like another good quarter.

Thank you, John, we appreciate it. Consistent forward progress.

Absolutely. Just a couple quick questions for you. I was hoping to get a little additional color on your stance toward new lending in this environment and specifically, where you're seeing some of the growth come from, in terms of markets.

I think that's a great topic, as we're seeing the current state of the economy and Ron is just anxious to share some of his comments, so, Ron?

Thanks for the question, John. While I indicated that we are seeing slowing in most markets, that's certainly not the case in all markets. We have several communities and states where the economy is still very strong. A good example would be Las Cruces. Tremendous activity in that market. Southern California, we see tremendous opportunity. We are still seeing very good opportunities to lend money in these communities and markets. A good example: we just looked at a high quality project this morning which [we've approved]; a development project. So, while we're being cautious with some of these segments, there's still a pretty vibrant economy in many of our markets. Another one -- Colorado, certainly, is still pretty sold. While there's some weaknesses in resort markets, the housing sector is still very strong in the housing range in the $200,000 to $500,000 range in Colorado. Cheyenne, Wyoming is just on fire from the economic development standpoint. So there is still good opportunity.

I think, John, if I can add to Ron's comments, and a number of our initiatives and steps over the last couple years really played in well to some of the opportunities. We did form a joint venture, Community First Mortgage organization, that's had an opportunity to begin participating in the refinance boom activity that's out there. We think that as that portion of our organization continues to gain footing, it is going to be a very significant contributor to our client satisfaction and growth, and our performance. So I think that's one area where, clearly, there's a lot of activity out there.

Another, as I mentioned in my comments, we saw record level SBA fees. Just tremendous growth in that solution line. We remain very, very encouraged. Our organization has clearly identified a wide range of opportunities in which we can help our clients with the SBA solution, and we expect continued progress along those lines.

Ron also touched a little bit on the consumer side, and it's one that we have clearly put in place a very, very high quality portion of our organization, with centralized indirect underwriting and collection process. They are seeing some excellent progress in terms of the originations that they've been able to generate, the relationships they've been able to form with existing and new dealers. And we think over time, again, we don't anticipate the captives being able to support zero-rate financing forever. Sooner or later they're going to have to do something. But even with that, we're able to compete on a turnaround time very, very significantly. We've got about 350 approved dealers throughout our organization, which is just tremendous. It's up dramatically from what we were on a decentralized basis. So while there is increased challenge and competition from other sources, we think that the service, the turnaround, and really the long-term sustainability of that portion of the franchise is going to give us the ability to see some consumer growth in the quarters ahead. So thanks, John.

Great. Another quick question for you, Mark. In terms of investment sales, it's been strong this year. Just wondering what your outlook is, if you have any significant sales campaigns on the horizon?

Well, again, John, you've hit a great question. If you look at the quarter, we're obviously a little disappointed with the performance of Securities Sales Commission. We had an absolutely gangbuster second quarter, concurrent with a very significant campaign that exceeded our expectation during the course of that quarter. Third quarter, we did not have a campaign; we actually launched one and we're finishing the third week of that campaign right now. And it's going well.

However, as we look at the marketplace, clearly, there is a wide range of concern. Those equity-based instruments have been tepid at best, whether it be individual securities or mutual fund products. On the annuity side, clearly the fixed-rate annuity has been the most desirable product. Unfortunately, the rate levels that are out there today are not as attractive as we saw even six months ago. That being said, we will believe that we will have a better fourth quarter in the area of investment product sales. But again, given the tenor of the marketplace, we're probably a little ways away from moving back towards some of the record levels that we saw during second quarter.

Fair enough. And then one last question on buy-back. Just gauging your appetite for future buy-back in the coming quarters?

John, good question. As part of our capital management strategy, we will continue to look for opportunities to repurchase our shares. Again, we did purchase about 356,000 shares during third quarter, which is approximately what we had originally laid out in our 2002 plans. We'll look for some strategic opportunities to repurchase additional shares in the marketplace.

Okay, great. Thanks, guys. Good quarter.

Thank you.

Your next question comes from Andy Collins with U.S. Bancorp.

Good afternoon. Just a couple quick questions. First, on the efficiency ratio. It still managed to improve this quarter, despite a little pressure on revenues. I'm wondering if you guys are setting new targets on that. And number two, I was wondering about the non-performing asset growth, if it was in any one kind of discernable category.

Andy, this is Craig and thanks for the question. Good questions. Let me comment on the efficiency ratio question and then I'll turn it over to Ron for some comments on credit.

We have not internally set any specific target as it relates to efficiency ratio. Obviously, a little under 60 is very positive from our standpoint. There are a number of interrelated pieces to the efficiency ratio that make it not the sole driver that we look at from an expense management standpoint. We are very encouraged with some of the efficiencies that we've gained with the centralization initiatives that have taken place. We do have a very disciplined and focused approach on expense management. Again, the efficiency rates were not necessarily the driver of that, when you take a look at some of the linked quarter and year over year reductions that we've seen on expenses. We do look very favorable on that and continue to collectively look for additional areas in which to reduce expenses.

Andy, on the -- I'm sorry. Craig, go ahead.

I was going to say, again, Andy, we haven't set any targets internally, but we would like to see a 1 percent or so decrease per year in the efficiency ratio as we continue to drive our Community First Financial Center model through the entire corporation.

Okay. And on credit?

Andy, on the credit question, very good question. We see nothing systemic. There's no one market that these increasing non-performers can be attributed to. There's no one segment. For the most part, the increases were in our commercial portfolio on the non-performers. But again, nothing systemic that we can point to. On the charge-offs, the vast majority of infrequent charge-offs, while down from the previous quarter, the largest segment, I should say, was in the consumer area, which is really a reflection yet of cleaning-up of our portfolio prior to centralization. We have a centralized collection department and they have been very proactive. So, at this point, we don't see anything that suggests that there is any one segment of our portfolio that is going to cause us problems in the near term.

Expanding on Ron's point, if I can, Andy, on the consumer side – this is Mark. As we went into the consumer centralization process, and worked with our professionals in that area, we really anticipated what we've characterized as two waves of accelerated charge-offs. One early on, which if you look back, we did realize late last year, early this year, within a brief respite which was during second quarter. It's backed off considerably. And then the next wave coming through now.

And really the rational for that is, as you change standard on things like extensions and collections, the most chronic wave ends up moving through very quickly. For those where you're stepping up the level of focus, it takes a little bit longer and basically that's been about a one-year incubation period, and we're seeing that move through. We saw that impact during the course of third quarter. If we look at our five-year average on the consumer charge-off side, it's less than 100 basis points, but it's unfortunately higher than 80. Our target is to see that drop considerably; we think we can push it down 50 percent or more over the course of the implementation of our consumer collection process and our centralized underwriting activity.

So we believe that we're moving through that second wave now, and should be substantially through it in the coming quarter or two, and with that, see some easing on the consumer side, and that's really where we've targeting to see some overall net charge-off improvement.

Thank you on that. Also, one last question, that was margin pressure. I guess if we see a little bit of steepening both at the – you know, as we get a little rate cut and we do a little bit more steep [statements] in the long run. I was wondering kind of how that scenario might play through in terms of margins, because it did come in about 10 basis points. I know it's difficult to judge, but is there any kind of metrics we can use going forward for margin one way or the other?

Well, very good question, Andy, and I wish I had a concrete answer for you. But I think the theme here is, we're being cautiously optimistic. Obviously, we're seeing some of the same pains that others in the industry have seen with record low rates, [wanting] a yield curve, you know, accelerated pre-payments. Our balance sheet is slightly liability-sensitive at this point in time. If we were to see a drop in fed rates here, coming up in the November meeting, that would have a short-term positive impact on the company, as we would reset about $1.2 billion of deposits and repo accounts that are indexed to prime. Again, the assets I would take a little bit of time to catch up, so we'd be, again, cautiously optimistic that we'd be able to manage margins within a fairly narrow band.

Okay, so it would be much narrower going forward in terms of any pressure on the margins, whereas it might even come back a little bit if we get a rate cut.

That's correct. A couple of other items that impacted Q3. We were fairly liquid in the third quarter; had some additional fed funds on the balance sheet due to a couple of items – one would be some of the pre-payment activity that was taking place. But we also had a deposit campaign during the latter part of second quarter, into early part of third quarter, that [would] provided us with some additional liquidity. We're anticipating being fully funded in that early November time frame. We should have a modest positive impact on margin as well. We've also taken a look internally at some of our deposit pricing and have taken another crack at some standardization on some of our transaction accounts. We think that'll also further enhance some of the margin activity going forward. Again, these aren't going to be significant drivers, but will help to the tune of a few basis points.

Okay, thank you very much. Congratulations on a good quarter in a difficult environment.

Thank you, Andy.

Your next question comes from David [Bastia] with [Valley] Brown.

Good morning, gentlemen. I just had one additional question. The other non-interest revenue category on your earnings report was $3.628 million, up around 44 percent, linked quarter. I just wondered what that was comprised and if you could provide that detail.

We can provide that. Again, it is a category that includes a number of items. That is where our SBA premium income goes. There's gain and loss activity in the sale of fixed assets; your [OREO]. It's a conglomeration of debit card, wire transfer fees – just a number of fees that make up that particular category.

Any particular one stand out?

Well, clearly, as we mentioned earlier, SBA fees have gone from a very, very small level a year ago and an attractive level last quarter, to a very significant level. In fact, I think yesterday's SBA fee probably rose on a quarter to quarter basis. Something in the neighborhood of 15 to 20 percent. On a year over year basis, SBA fees are up substantially, probably approaching double. So that's one key area. The other element is debit card activity. We, as many others in the industry, are seeing an increased utilization of that channel by our client. We're seeing slowly increased penetration, even though we are probably half the industry average in terms of penetration on our debit cards, and it's one of the areas that we see [as] an opportunity. Our transactions have increased modestly and I think as a result, we're seeing debit card revenues that are growing in the mid to high teens on an annualized basis. So those are really two key drivers of what's been pushing some of that activity.

A couple other areas, David, and these aren't significant contributors. But I mean, online banking fees, for example, roll into that account. We've also had, as we go through liquidating some repossessed personal property, and some other properties, those impacts also [roll] through the other fee income area.

Okay. Thank you.

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

Good afternoon.

Hello, Ron.

You mentioned the deposit campaign that you ran late second quarter, early third quarter. Looking at your deposit growth, it hasn't been what -- [quite] the growth that many of your peers are seeing. I was just wondering if you could provide some color as to your strategies or expectations for deposit growth and deposit mix.

Well, again, I think we're seeing a lot of conflicting factors there, and there are so many different issues behind what drives deposit-based activity. Keep in mind over the course of the last year and change, we did move out of some marketplaces, which changed the complexion of our deposit mix. We have also seen some tremendous investment sale activity over the course of last year and in some cases, those are alternative products to some of the deposit-based products.

What we've really tried to do, and it's an ongoing challenge, is to balance the pricing of deposits for client retention and growth, to that of managing for profitability. We've seen a wide range of pricing expectations; we'd like to see deposits turn around and see some positive movement, and I think that's clearly the path that we reflected as we move into the deposit campaign during the course of the quarter. So in terms of a strategy, we clearly believe there's an opportunity to see some growth in it. However, as you look at the real level of interest rates, we may be seeing some of our peers that are doing it, but in general, it's not a very attractive environment for [fee]-based product and some of the money market-based products. So I think that's one of the challenges that's out there.

One of the things that we've done to try and augment this is that we have identified initiative over the course of last year for a cash management, dedicated, corporate-wide initiative. We've staffed that function and are working with all of our banks to drive the acceleration of our cash management solution to our business banking clients, and we think that's going to be an opportunity to bring in some new business that we can build on and also help our clients be much more efficient in terms of how they're able to operate and hopefully drive some deposits that way. So that's really the best that we see.

Okay, and then a follow-up regarding the [loan] growth, particularly indirect auto. What kind of growth rate do you anticipate in that portfolio and how large a piece of the total would you expect that to grow to?

Well, we've got, in 2003, Ron, we're looking at fairly modest loan growth overall for the company. But we anticipate the growth in this portfolio, depending upon what the captives do with their offerings, obviously – but we've seen tremendous growth in this segment since we've started the indirect. A few months back we were generating about $12 or $13 million dollars in new paper a month. In August-September, we're in the low $20's. We anticipate that that will ramp up even more during 2003. We've been very successful getting new dealers on line. As Mark mentioned., we've got about 350 dealers. We're seeing increased activity. We've been out, both Mark and I have been, in the field, visiting with dealers. They're very satisfied with the turnaround times. We're meeting our service level -- we're exceeding our service level agreement, and we are often the first choice for the automobile dealers, because the idea, of course, is to get that salesperson back on the floor as quickly as possible. And we can turn indirect from start to finish in about 20-plus minutes. So we feel very good about that, and we anticipate that our consumer portfolio will do significant growth, we believe [into the teens], as we move forward.

Okay, thanks.

At this time, there are no further questions. Mr. Anderson, are there any closing remarks?

Thank you, Emmy. Just to close, I'd like to, on behalf of the company, Ron and Craig, thank all of you for participating in the call, for the questions we received; again, very, very good questions. Hopefully our responses were able to provide some additional clarity on some of those items. We are quite pleased with the performance that our organization has been able to accomplish. The progress and success over the past couple of years has been very, very positive. Clearly, a number of record level performances as a result of a significant effort by a significant number of people in the Community First team. So we appreciate all of your support, your interest.

Clearly, we believe Community First is an organization that is focused on the long term, continuing to move forward and we believe that third quarter 2002 really is a typical quarter of what we want to try and do, and that's to try and hit on as many of the bases as we can to keep moving the franchise forward, drive performance on a consistent basis. So with that, thanks to all of you for your interest in the call and the interest in Community First, and have a good day.

This concludes today's Community First Bankshares, Inc., Third Quarter Earnings Conference Call. You may now disconnect.