First Hawaiian Inc (FHB) 2002 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Community First Bankshares, Inc., Fourth 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 * key followed by the 1, on your telephone. As a reminder, this conference is being recorded, Thursday, January 16, 2003. I would now like to turn the conference over to Mark Anderson, Chief Executive Officer. Please go ahead, Mr. Anderson.

Well, thank you. Welcome and thank you to all of you, for joining us on the conference call for fourth quarter and full year 2002. I am Mark Anderson, President of Community First Bankshares, and participating in the call with me today will be Ron Strand, our Chief Operating Officer and Craig Weiss, our Chief Financial Officer.

2002. What a year, from so many perspectives. As a result of the events and performances in 2002, the landscape for public company marketplace continues to evolve. The tangential effects of a pre-911 softening economy and the difficulties of many sectors of the economy over the past sixteen months have contributed to a very tepid marketplace. To that we add the difficulties a number of companies have had in delivering financial statement integrity, and we face an unusual temperament in many areas.

You need look no further than the performance, or lack of performance, of numerous market indexes during 2002, and over the recently ended three-year period. Total shareholder return for the Dow for 2002 was down 15 percent, and for the last three years, the annualized total shareholder return was minus 8.5 percent. For the S&P 500, the figures were minus 22.1 percent and minus 14.5 percent.

As we all know, the NASDAQ composite has reflected a difficult period, a minus 31.25 percent in total shareholder return in 2002 and a three-year annualized return of minus 30.8 percent. Two bank indexes fared slightly better. The BKX had a minus 10.67 percent, one year TSR, and a 1.59 percent annual annualized TSR over the past three years. Finally, the NASDAQ bank index had a 6.89 percent TSR in 2002, and 12.32 percent annualized TSR for the 2000 and 2002 period.

CFBX recorded a 6.12 percent total shareholder return for 2002, which compares favorably to the NASDAQ bank index and extremely well to the other indexes. Our three-year annualized total shareholder return stands out at 22.77 percent. We're ending 2002 the same way we began it, with a challenge to every member of the Community First team to actively support our long-term investments and strategic initiatives, and to strive to realize consistent and stable improvements in performance.

Despite the difficulties of an interest rate environment that has surprised most observers and participants, we recognized a strong financial performance level in 2002. Net income of $19.7m again resulted in a return on equity approaching 21 percent. Our seventh consecutive quarter with an ROE above 20 percent. Earnings per share of 50 cents represented our second strongest quarter ever. These are only a few of the measures of success that we've been able to accomplish during 2002 -- the third year of a sustained bear market, a year which presented an unprecedented and extremely challenging interest rate environment, a year which witnessed economic softness in many areas of the economy and across many geographies, a year in which we continued to hold true to our vision and made additional significant investments in our future.

We're pleased with the results of the quarter and of the year, and I'd like to ask Craig Weiss and Ron Strand to share some additional comments. First, Craig?

Thank you Mark, and thanks to all of you for joining us on the call today.

Although we would like to report a sequential increase in earnings per share in the fourth quarter, we are extremely pleased with the fourth quarter and full year earnings per share in light of significant challenges posed by a sluggish economy.

For the year, net interest margin was a strong 5.33 percent, up 10 basis points from 5.23 percent in 2001. The fourth quarter represented the second consecutive quarter of net interest margin contraction. Net interest margin during the quarter was 5.12 percent, down 26 basis points from third quarter of 2002.

Record low interest rates, including the most recent 50 basis point cut in the fed funds rate, pre-payment and mortgage-back securities, and fewer reinvestment opportunities, have all contributed to a lower net interest margin. Until we see an increase in economic expansion, many of the same themes present in the last half of 2002 could continue into 2003.

The securities portfolio compromised approximately 29 percent of average earning assets in fourth quarter of 2002, up from 27 percent in fourth quarter of 2001. During fourth quarter, cash flows from maturities and prepayments were reinvested at a minimum of 150 basis points lower than the current portfolio yield.

Like most of the industry, this scenario suggests the likelihood of additional net interest margin compression, until we see a rebound in the economy. The company will continue its disciplined approach to asset and liability management, and intends to maintain a strong net interest margin at the top of its peer group.

Non-interest income increased 5.1 percent, or $1m in fourth quarter 2002 from fourth quarter 2001. The increase was attributed to a 13 percent, or $389,000 increase, in insurance commissions, and 80 percent, or $273,000 increase, in SBA loan sale premiums; a gain of approximately $440,000 in the sale of bank property, and continued success in originating 1 to 4 family residential mortgages through Community First Mortgage, which is accounted for under the equity method. These increases were partially offset by a reduction in deposit service charges due to lower volumes in deposit-related charges such as overdrafts.

For the year, non-interest income was up a modest 2.2 percent or $1.7m, but did include a 10 percent and 43 percent increase in insurance commissions and security sales commissions respectively over 2001.

SBA loan sale premiums increased $1.2m from 2001, but was partially offset by gains in the sale of oil property recognized in 2001. Service charges on deposit accounts were down 4 percent or $1.7m from 2001. This decrease was due in part to [an 11] [phonetic] percent drop in overdraft volume in 2002.

We continue to be very pleased with out ability to control expenses during the quarter and throughout 2002. Non-interest expense decreased 2.6 percent in fourth quarter of 2002, when compared to fourth quarter 2001, after adjusting for the amortization of goodwill in 2001.

The decrease in non-interest expenses is primarily the result of a reduction in personnel-related expenses of 4.4 percent or $1.3m. This was due in part to a nearly 6 percent reduction in full-time equivalents on a year-over-year basis. For the year, non-interest expense decreased 1.6 percent, excluding the $7.7m restructuring charge and $6.6m of amortization of goodwill during 2001.

The decrease in non-interest expense was primarily the result of a $1.7m decrease in personnel-related expenses, and decreases in other expenses such as advertising, printing, courier and postage charges. These expense reductions were partially offset by a $3.9m or $1.2m increase in net occupancy, primarily related to the early release buyout of our mainframe computer.

The ability to control expenses is a result of the efficiencies gained through implementation of our strategic initiatives and ongoing disciplined expense management. As noted in the press release, even as we control expenses, we continue to make prudent investments in people, training and systems to accommodate our growth objectives.

The leverage ratio ended the year at 6.52 percent. This is down 35 basis points on a linked-quarter basis. The decrease is attributed to continued execution of our share repurchase program, and approximately $160m of short-term leverage in the balance sheet at year-end. Taking advantage of a dip in stock price and share availability in mid-December, the company repurchased 667,000 shares in fourth quarter, and 1.9m shares during the year. The company anticipates more modest repurchase activity in the next couple quarters, and reaffirms its commitment to maintaining strong capital levels while prudently managing our shareholders' equity.

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

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

I'd like to start with some comments on credit volume and quality. While residential real estate lending has remained robust, driven primarily by refinancing, other sectors remain slow. Consumer loan demand is soft, however, we have been successful in growing our indirect portfolio modestly to our expanded dealer network. We have been challenged by zero percent financing and other incentives offered by the captive finance companies.

With respect to residential real estate, we have stayed in close contact with our higher growth markets in an attempt to determine the level of construction and real estate activity and the general mood of home buyers and investors. While all markets reported a slowing in activity, homes in the $400,000-and-under price range continue to sell at a fairly brisk pace. Homes in the $400,000-to-$1m category continue to sell, however, days on market has increased considerably. Homes with values in excess of $1m are moving slowly. We have very few homes financed that fall into this category. In addition, we remain very cautious with speculative construction and land development loans.

Commercial real estate activity is strong in select markets. I do want to stress that our commercial real estate portfolio is very diversified, with the vast majority of our loans to small or midsize companies which tend to be less sensitive to economic swings. We continue to be very selective on requests for loans to the lodging industry, as this remains a weak segment. The agricultural sector remains under stress, especially in areas impacted by the drought. However, our exposure to production agriculture is only 6.2 percent of our portfolio, and from a quality perspective is very strong.

With respect to credit quality, we have experienced an increase in non-performing assets from .46 percent at end of Q3 2002, to .50 percent as of December 31, 2002, and .41 percent at the end of 2001. While we are disappointed with the increase in non-performers, it is reflective of the weak economy.

Our special assets group continues to move [problem] [phonetic] credits through the workout process. During the fourth quarter, other real estate held increased by approximately $5m from the end of Q3 2002, which puts us in a position to dispose of these non-performers as we move through 2003. We anticipate very little, if any, loss on these assets.

Our allowance for loan losses was 1.57 percent of total loans and 245 percent of non-performing loans at the end of the fourth quarter, compared to 1.47 percent and 261 percent, respectively, at the end of December, 2001. Net charge-offs were at $3.2m or .35 percent of average loans for the fourth quarter of 2002 compared to $3.1m or .33 percent for the fourth quarter of 2001.

For the 2002 year, net charge-outs were .33 percent of average loans compared to .39 percent in 2001. While the .33 percent remains higher than our internal goal, we are pleased that we have been able to reduce charge-offs as a percent of average loans from the 2001 level in the face of a challenging economic environment.

The rollout of our loan center initiative is on schedule, with an anticipated completion date in the fourth quarter of 2003. We remain very pleased with the acceptance and performance of our loan centralization initiative.

In summary, we remain very committed to improving our loan quality through rigorous underwriting, strong credit administration processes, and the loan centralization initiative. Our approach to credit remains one of quality versus quantity. Simply stated, we will not compromise our credit discipline to increase loan volumes.

Now, I'd like to turn the conference call back to Mark Anderson.

Thanks, Ron. Thanks, Craig. We recognized record performance in many areas during 2002. However, we're not satisfied to stay at those performance levels. We continue to challenge members of the Community First team to embrace our strategic initiatives and to focus on the solutions culture that we're building. It was a very exciting year for us, and 2003 already has the ingredients to be even more eventful.

As you've heard from Ron and Craig, we face a challenging aggregation of economic and marketplace factors which will dampen some of the progress we originally intended for 2003. However, with Community First we're confident in our data and the integrity of operations throughout the organization, as we strive for continued quality performance.

Some time ago we adopted the phrase coined by football coaching legend Woody Hayes to describe our approach: "Three yards and a cloud of dust." As you can see from our performance over the past three years and the progress we've made, this does reflect our approach, and we've also been able to make and take advantage of a few big plays, and realize those opportunities.

Our performance in securities sales, insurance, and SBA lending stand out in the industry. The gains we've made with our new online initiatives for our personal banking and business banking are surpassing expectations. While we're disappointed that we're not able to add any additional markets to our organization through bank acquisitions or market extension during 2002, we'll continue to seek properly priced bank acquisition opportunities, we'll continue to bring additional insurance agencies into our organization, and we will move forward with the market extension strategy that we've developed.

All in the industry face a unique set of challenges as they enter 2003. We at Community First are firm in our resolve to adhere to our vision and values, while fulfilling our purpose: improving lives through financial solutions, and in implementing a set of strategic initiatives that we believe will differentiate us in the future. Again, we'd like to thank you for your time, your interest, and your investment.

With that, I'd like to open the conference call up to questions. Thank you.

At this time, I would like to remind everyone, in order to ask a question please press *, 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 [Alteran] [phonetic], with RBC Capital Markets.

Good afternoon, guys.

Hello, there, John.

You talked about '03 as being successful. I think you should be congratulated on the last three years. You guys have done exceptionally well over the last three years. The one thing I wanted to talk about a little bit was the margin. And I know, Craig, you described it a little bit -- you talked about the potential for a down margin. What makes your margin stabilize, and what would make it go up?

Thanks for the comments, John, and a very good question; something that we address here every day as well. You know, generally speaking, we've historically talked about the benefit of having a CPO curve, which we do have now. The thing that we're really looking at internally is we really need to see some better reinvestment opportunities. We need to put some dollars back into the loan portfolio. We cannot take loan maturities, prepayments, out of the investment portfolio, etc., coming off at rates significantly higher than we'll be able to reinvest in the current market, which is approximately the 3 to 4 percent range.

So generally speaking, John, it's going to take a little bit of economic vitality, some additional reinvestment opportunities, to help us increase the margin ongoing. Again, we'll continue to look at other avenues. We continue to take a look at deposit rates ongoing to see if there's anything we can do there to help stabilize margin in the meantime. But looking for some additional economic activity, John.

I think if the nature of the question is, is there a different interest rate environment that is better or maybe more conductive to a stronger margin, I think as we look back at the last couple of years we can clearly suggest that, yes, there is a different interest rate environment. As we look at the current environment of a 1.25 fed funds rate and prime at 4.25, that represents a very, very challenging situation when you look at the liability side of our balance sheet. Again, as a community banking organization with the core funding levels that we have, and the mix of deposits we have, we've seen a number of categories where we have had very, very modest ability to reduce interest rates over the course of the past two to four fed funds cuts. So I think that's one very important factor.

So as we look at it, there definitely are interest rate environments that are more conducive to long-term profitability, and we expect to see that occur in the future. The magic question is when. And if you want to give us some guidance on when, John, I guess we'll all be better off.

Right. The other question is, when you look at the amount of your revenues that are generated from net interest income, if you will - and I know you know the question coming, Mark - but when you listen to what you and Ron and Craig are saying on some more tepid earning asset growth, and a tougher margin, my sense tells me that 215, 214, somewhere in there, is probably too high.

Well, as we look at it, we think that 2003 presents a number of challenges to performance. You've hit a number of them right there. We believe we're positioned to improve EPS further. It's not, in our minds, going to be at the double-digit rate we would have targeted in a different economic environment. But our expectations for the year, as we focused on full-year performance rather than quarter-to-quarter performance -- recognizing there is some seasonality and cyclicality of our performance - it really does suggest that we have the ability to improve earnings per share that approaches the levels that are commensurate with the lower end of the band of expectations and estimates that are out there today.

And I guess the other question is - the other thing, Mark, I know you're big on capital allocation and how you use your capital, and Craig made a comment on the buy-back. What do you view as the primary use of capital right now? Is it the buy-back? Is it a dividend increase, although you've done that recently? Is it to build capital internally? Can you just talk on that a little bit?

Well, John, that's an absolutely excellent question, and you're correct. We have focused significantly on the allocation of our capital. It really comes down to the opportunities at hand. We would look at it and suggest that primary opportunity, or primary allocation of capital, may shift from quarter to quarter based on the opportunities. We'd like it to be a situation where bank acquisition opportunities represent a good allocation of capital, but frankly, given everything we've seen for the opportunities for us, and really what's happened across most of the markets we place our interest in, we really don't see that as being a near-term opportunity to allocate capital.

So it really then comes down to a mix issue. We've tried and strive to be fair and representative in our dividend policy. We had two increases last year. We've got a relatively attractive dividend yield paid out last quarter, somewhere close to 40 percent of EPS and dividends. We'd like to maintain a stable dividend policy which suggests that we would like to see our dividend level increase as we go and proceed through 2003.

We also look at other opportunities to augment capital, but they're much more modest. Those more modest opportunities are really in the area of insurance agency acquisitions -- we completed four last year; they integrate very, very nicely. We're going to continue to look for those opportunities this year and we have some comfort that we're going to see a number of those come together, but again, they're not large capital consumers, but they have tremendous long-term returns on capital.

The other area that we have developed that is more of a short-term impact on earnings capital rather than balance sheet capital, is that of looking for market extension opportunities. Depending upon the growth rates that we might be able to realize as we move down that path over the course of the next 12 months, they would be very modest capital utilizers. That really leaves us with what we think is the most viable alterative over the course of the next 12 to 24 months, and that is to utilize those excess funds to repurchase shares. Again, we continue to think that we represent a very, very good return opportunity in the marketplace, and are not averse to continuing to execute under our repurchase program.

So as I look at it, that's really the priority, and again, I'm not sure that one takes precedence over the other, because there's a real balancing act. But I think if you look at it on a weighted basis, a pretty significant amount of capital over the next 12 to 18 months is really going to be balanced between fair and ongoing dividend policy and timely effective repurchase activity.

From a capital standpoint, Craig did identify a modest reduction in capital. We had increased our capital for most of the past two years on a quarter-to-quarter basis; we continue to be within the band that we believe is fair and appropriate. We'd like to see our capital ratio increase modestly, but again, there's a lot of factors there relative to opportunities to repurchase our stock or put that capital to work elsewhere.

That's very helpful, and I think your comments on quality over quantity are absolutely right on in this environment. So congratulations on the year, guys.

Thank you, John.

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

I'm going to be a little bit more blunt here in trying to get to '03. What are your expense growth and your revenue growth assumptions like? Could you kind of range them for us in '03? You know, high side, low side, and how they play out under various scenarios?

Well, I guess, Andy, I'll be a little more blunt, too. We really have not given formal guidance in any of those areas, so I think it would be very awkward for us to try and provide meaningful guidance to you at this point in time. Those growth expectations and change expectations are a function of so many diverse variables, especially as you look at the different categories, whether it be earning asset, driven interest income categories, or whether it be non-interest income categories. Clearly, we expect the most significant growth rates to occur in a handful of our fee income growth areas.

On the non-interest expense side, I think as you can see looking back at the past few years, and from Craig's comments, we've done a very, very good job of recognizing the importance of a solid expense management discipline, especially in a soft economic environment.

So I guess, as we look at it and look across our geography, you see more banks than we do, and I think that we are not going to be an anomaly and be able to recognize an abnormal growth rate in those income categories relative to our peers. And I think that, as Ron suggested, we're not going to focus on quantity over quality; it's going to be a long-term quality perspective for us. So that's about the best I can give you, at that point.

Right. I mean, I guess your expenses were down about 7.8 percent this year, with the way we calculate it. So if we were going to get growth next year, we can probably expect more aggressive expense management. Is that fair to say?

Well, there's a lot of factors behind what the impact of expense reductions were, as you take a look at the one-time charge that was taken at first quarter, you look at the shift in accounting. And I'm not sure exactly what you've got in all of your numbers, nor do I think this is probably the time or the forum for us to delve into details of income statement and expense level. But our expectation is that the number you threw out as an expense level reduction -- that is a huge number. And I think there's some factors behind that, and that's not a level that we would anticipate seeing for 2003, again, especially recognizing that we continue to make some relatively significant investments in our loan center, and in moving forward with an online teller for our online platform system.

Certainly. What about the tax rate? It came down a little bit here this quarter. Just wondering - was that as a result of pretty aggressive tax management strategies and is it an ongoing kind of change or is it one-time in nature?

Andy, this is Craig. And no, it would not be the result of any aggressive tax management strategies. End of the year is typically when you come whole at some assumptions and annualization factors and so forth that are occurring throughout the year. I think when you look at the overall tax rate for the year, it's pretty commensurate with what we saw for the quarter. You know, we did see effective tax rates a little bit lower in second and fourth quarter but not directly attributed to anything in particular.

Okay. Great, thank you very much.

Thank you, Andy.

Again, if you would like to ask a question, please press *, then the number 1, on your telephone key paid. Your next question comes from Ron Peterson with Sandler O'Neil.

Good afternoon.

Hello there, Ron.

In looking at your loan portfolio numbers, looking at a period-end basis, that number sequentially in the quarter was down whereas, looking at the averages, that number increased. I was wondering if you could just explain what's going on in the portfolio?

I want to make sure I understand the question, Ron. You were looking at the quarter-end loans or year-end loans versus the averages. Which was it, for the year or --?

Well, comparing the period-end loan number, looking back to the period end number for third quarter, that number decreased on an annualized rate, about 7.5 percent. But looking at the averages, the number increased. I mean, what [was going on] [phonetic]]? Were the loan sales at the end of the quarter? I mean, I would imagine that if your period-end numbers are going down, your average number would decrease as well rather than increase, and I was just wondering what was going on within the portfolio.

Well, again, I think, as is always the case, there's a number of different ingredients that would drive that. Typically - and again, you are correct; as we look at the quarter, I think, the numbers that I've got suggest that third quarter, we had about $3.65b in average loans that were up on average $3.7b. On a quarter-end basis, though, you can look at the $3.65b number, the average being relatively consistent with the quarter-end number. However, at year-end, we saw a notable reduction in our loans outstanding, to $3.58b.

Again, I think that that is only modestly a result of some of the production and sale activity of the SBA loans; that is only a very, very modest portion of that. The balance of it really is going to come down to borrower behaviors and some of the things that we saw in terms of some relatively notable pay-downs in some of the balances of our customers.

I think there's another factor there that we saw that will account for the biggest portion of that, and that is that at the end of third quarter, in our short-term liquidity position, we had $130m which represents a big portion of that as commercial paper, which is carried as a loan on the balance sheet, that was gone at the 12/31 date. It would have been there through the bulk of each of those quarters. So that's the biggest factor behind it.

Okay, thank you. And you talked a little bit about the $150m - I believe that was the number - short-term leverage strategy. Could you explain the funding, what assets you put on, what kind of spreads?

Well, I don't know if it was - it wasn't necessarily a strategy at the end of the year. We had some securities that were going to be maturing in the early part of first quarter, and in essence had become fully funded, if you will, as those securities roll out. We had about $120m of securities that had settled prior to year-end. So this is kind of an anomaly with a point-in-time measurement. It's not a strategy, if you will. We were flush with some liquidity, as you look at the November time frame, with public funds, etc. So it was more of an anomaly settlement issue over year-end, as opposed to any type of leveraged strategy, Ron.

Okay, thanks.

At this time, there are no further questions.

Well, if there are no further questions, on behalf of all of the parts of Community First's management and directors, I'd like to thank all the participants in the call. We appreciate your ongoing interest and support; we feel very, very positively about the performance we turned in for 2002. We feel very good about 2002's fourth quarter. We're anxious to move through and address the challenges of 2003, and continue to report on what we believe will be ongoing execution of our strategic initiatives, and continued improvement in our performance. So thank you all, and have a great day.

Thank you for joining us today for today's conference call. You may disconnect at this time.