First Hawaiian Inc (FHB) 2003 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Community First Bankshares Incorporated third quarter earnings conference call. (Operator Instructions) I would now like to turn the conference over to Mark Anderson, Chief Executive Officer. Please go ahead Mr. Anderson.

Thank you Chastity and thank you for joining us on our third quarter earnings conference call. I'm Mark Anderson president of the Community First and joining me will be Ron Strand our Chief Operating Officer and Craig Weiss our Chief Financial Officer. As we look at the quarter on a stand-alone basis we are pretty pleased with many of the results of the quarter. Return on equity remained very strong, net interest margin was also very strong. For the quarter we recorded a strong level of non-interest income. All of these were accomplished during a time we continued to exercise our enterprise wide initiatives that we believe are going to build a better Community First over the long run. All of us are pretty aware of the national economic indicators that register activity, with handful of exceptions, general economic softness and a low level of short-term interest rates continues to create a significant challenge on a daily basis throughout the trade territory we service. Loan volumes are well below our targets due to prepayments aggressive competition and fairly soft new loan opportunities throughout the marketplace. In light of very low deposit rates deposit growth has also been challenging as not occurred for us. Added to these volume challenges the low level of interest rates has created a significant margin compression challenge throughout the entire industry. Community First has historically been a margin driven company. While we've taken great strides and steps to improve this over the course of the last five years, since third quarter of 2002 our net interest margins declined 54 basis points. Of this I want to note that 20 basis points was due to the accounting change which Craig will highlight later that was implemented this quarter which reclassified costs associated with trust preferred securities from non-interest expense to interest expense. While this did not affect net income it did serve to reduce net interest margin by 20 basis points. Excluding this factor the decline in margin over the past year has been 34 basis points. We're pleased that we’ve been able to continue to generate strong financial performance in light of all the challenges we face and the difficult circumstances. We believe that we're better positioned to benefit as the economy begins to exhibit more strength in the months and quarters ahead. We also remain committed to our strategic plan and the initiatives which we've been executing. We believe that we and you will realize many benefits in the quarters ahead. On October 1st, 2003, we also completed an insurance agency acquisition bringing our total to 17 since the beginning of 2000 and widening our insurance presence to 52 markets. We will continue to execute on this light of our strategic plan in the quarters ahead. Additionally given the success of our regional financial center and community financial center model we elected to migrate an additional 16 offices from our regional financial center structure to the community financial structure. This will bring the total of community financial centers to 4424, representing nearly 2024% of our business. As this process is completed and exhibits additional success we anticipate additional offices transitioning to the CFC model. We believe this is an ideal structure that allows us to tailor our delivery model to the market opportunities. As part of today's release we also announced the execution of three lease agreements which will enable us to open new offices in the rapidly growing suburbad Minneapolis Markets, of Lionel Lakes, Blayne and Lakeville. These market extension offices will be open during early 2004 and we expect the announcement of additional offices in the future. Our market extension approach is fairly unique. Building on a more variable cost structure than typical, which give us a shorter time to break-even. We believe these offices are a tremendous opportunity to enter new vibrant markets and contribute to our long term growth of business earnings and enhance our footprint. Now I'd like to turn the conference call over to Ron Strand who will share some credit comments. Ron.

Thank you Mark and welcome to all conference call participants. We appreciate the opportunity to discuss our performance. My comments today will focus on credit volume and quality. While loan volume is down on both the linked quarter and year-over-year basis, we continue to enjoy a starring activity in select markets and loan segments. Specifically, we continue to experience growth in our indirect consumer and commercial real estate portfolios. Some markets notably California, New Mexico, select Colorado locations and Cheyenne, Wyoming continue to witness very strong commercial and single-family home activities. The resort markets have been impacted by the slowing economy especially as it relates to the upper end home bracket. A recent visit to Colorado confirms that while single family home sales remain strong, days on market for homes over 400,000 has increased considerably. We remain very cautious with spec construction and as a result have witnessed a year-over-year reduction in excess of 120 million loans outstanding, and a construction land development segment of our loan portfolio. While we continue to be active in this market we are maintaining our discipline and only finance developers with strong liquidity and equity. Consumer loan growth is due to an expanded network of automobile dealers served by our indirect loan center. We do expect a seasonal moderation of indirect volume during fourth quarter however we anticipate this segment to provide continued growths going forward.

The quality of our indirect portfolio continues to improve due to centralized credit decision making and the excellent performance of the collections and recovery department. The Small Business Administration Initiative continues to provide strong fee income to Community First, However the weak economy has impacted application volume. We continue to believe this is an excellent solution for our commercial clients in all markets served by Community First.

Residential real estate activity remained robust during the third quarter, however with refinancing slowing we expect applications and closings to moderate during fourth quarter. With respect to credit quality, nonperforming assets represent a .59% of total assets at September 30th, 2003, compared to .46% in the same quarter of last year, and .58% in the second quarter of 2003. The allowance for loan losses was 1.16% of total loans and 207% of nonperforming loans at the end of third quarter compared to 1.54% and 227%, respectively at September 30, 2002 and 1.58% and 210% at the second quarter of 2003. Net chargeoffs were 3.6 million or .42% of average loans in the third quarter of 2003, compared to 2.8 million or .3% for the third quarter of 2002, and 4.2 million or .49% in the second quarter of 2003. While we are disappointed with the increase in nonperformers and chargeoffs during 2003, both increases are the result of two credits in the portfolio. Our special office division continues to closely monitor these assets to reduce loss exposure and position these credits for disposition throughout the remainder of this year and early 2004. With respect to loan centralization we remain very pleased with this initiative.

We continue to roll out our direct consumer loan underwriting and processing as well as commercial loan documentation preparation. The rollout is scheduled to be completed during the second quarter of 2004. In summary, we remain very committed to not only maintaining but also working to improve our loan quality through vigorous underwriting, strong credit administrative processes and loan center initiatives. Now I will turn the conference call over to Craig Weiss. Craig.

Thanks Ron. And thanks to all of you for joining us on the call today. Although we would have liked to have reported stronger earnings for the quarter, as Mark noted we are pleased with our third quarter results as we continue to implement our strategic plan in this challenging economic environment. Return on equity was 20.2% and return on assets was 1.32%. These returns are down slightly from second quarter, but still in line with our long term expectations. Net interest margin was 4.84% down 27 basis points from second quarter. As noted earlier 20 basis points of the drop was due to the adoption of FAS 150 which dealt with accounting for certain financial instruments with characteristics of both liability and equity. Wherein our trust preferred securities must be accounted for as long term borrowings and the related expense reflected as interest expense thus impacting the net interest margin calculation. Although net interest margin, a primary driver of net income was down, we are very encouraged by a strong level of non-interest income which includes insurance commissions, security sales commissions, service charges, and premiums on the sale of SBA loans. Net interest margin dropped seven basis points from second quarter when excluding the impact of FAS 150 as described earlier. This was in line with our expectations as we continued to experience the effect of prepayments in premium amortization due to a fall back of interest rates during the latter part of second quarter. As we continued to experience a steepening of the yield curve we expect net interest margin to stabilize as prepayments and premium amortization slows and cash flow is reinvested at higher rates. A shift in earning asset mix including increased loan demand will be necessary for Community First to show any significant increase in net interest margin. With the current weak economy we expect minimal change in loan volumes in the near term. We are encouraged by the strong level of Non-interest income. This is further evidence that commitment to our strategic initiatives will lead to a more diverse revenue stream. Non-interest income was up 6.6% on a links quarter basis and 13% from third quarter of 2002. Insurance commissions and security sales commissions were up 8.6% and 12.1% from third quarter 2002, respectively. This is a result of our continued focus on insurance agency acquisitions and the commitment to providing insurance in each of our markets.

The increase in security sales commissions is primarily the result of market performance during the year, and their focus on security sales as part of a total financial solution for our customers. During second quarter the company switched to a new provider for ATM services check card processing and other card services. The result was an increase in deposit service charges in third quarter, as final settlement from our previous provider. Also, during third quarter the company recognized a $1.2 million demutualization distribution related to its membership interest in participating insurance policies. Community First remains committed to strong control of non-interest expenses. Non-interest expenses were down 1.8 million or 3.4% on a linked quarter basis and down 1.8 million or 3.3% from third quarter of 2002. During third quarter the company prepaid longer term federal home loan bank advances and recognized approximately $835,000 in prepayment penalties. This will position the company to reduce its ongoing borrowing cost in light of a more favorable interest rate environment with a relatively short pay back period. Excluding the effect of the federal home loan bank prepayment penalty, and the change in recognition of trust preferred security expense due to the adoption of FAS 150 non-interest expenses were down .1% on a linked quarter basis as well as .1% from third quarter of 2002. We will continue to control non-interest expenses even as we further enhance our centralization infrastructure. The company continues to focus on prudently investing capital to provide long term returns to our shareholders. The leverage rate initial was 6.96% at quarter-end down from 6.98% last quarter. The company repurchased 612,300 shares of its common stock during third quarter. We will continue to execute our share repurchase program at a prudent use of capital in light of a current lack of balance sheet opportunities. I will now turn the call back to Mark Anderson.

Thank you Ron, thank you Craig. We continue to focus on the long term. Building on our vision of Community First as a diversified financial services company that focuses on creating value for our clients employees and shareholders. While the environment has been very difficult we remain committed to the execution of the strategies we set in place. We believe our attention to continued steady and incremental progress will position us well for future performance. Focusing on the long term we believe the next several years will provide many opportunities as we strive to deliver unique and effective financial solutions to our clients. Again we want to thank all of you for participating in this call and at this point we'd like to ask the operator to open up for any questions. Thank you.

Thank you. (Operator Instructions) . Your first question comes from Jon Arfstrom with RBC Capital Markets.

Good afternoon everyone.

Hello Jon.

Couple of questions here. You talked a little bit about mortgage slowing and I am wondering if you could just remind me how the mortgage joint venture accounting works and I guess this time around you're not going to be forced to go and right-size the mortgage company, just remind me how the creations are split and the accounting flows.

Jon, this is Craig. As a reminder, the income as well as all operations of Community First Mortgage rolls through the financials under the equity method of accounting. Our net contribution from community First Mortgage rolls through as other non-interest income as you're looking at our income statement.

We own 50% of the joint venture so effectively if for a given period Community First Mortgage generated an income of $1 million over a period of time, 50% of that would be Wells Fargo Home Mortgage, 50% of that would be Community First. Under the equity method as Craig Points out $500,000 of that over a period of time would roll through our non-interest income. If there is a reduction, 50% of the reduction then obviously rolls through our income statement as non-interest income.

Okay. You really don't have any discretion over how that's managed, I mean you do within reason, but it is someone else's responsibility to get that in shape?

There's an operating committee that is represented of two members of Community First senior management team and two members from Wells Fargo and really it's a constituent building process to make sure they can drive consensus and they've been able to do that to this point. To the degree that there are needs to change the operation of Community First Mortgage that group would do it. We've also utilized Wells Fargo as the processing entity. So again in terms you mentioned earlier in terms of the need to potentially downsize, that's not the need of Community First Mortgage which is really the employer of primarily producers. The processors are housed by Wells Fargo Home Mortgage and any staffing changes would need to be accommodated in that fashion.

Jon to add to that from the oversight perspective, Community First Mortgage is 50% owned by Community First Home Mortgage, wich is 100% owned by our national bank. Ron Strand and I are on the board of directors of Community First Home Mortgage from an oversight perspective.

Ok, that's helpful. The other question I guess I had was maybe a little more macro, but it seems to me that you're trying to become a bit more urban over time here. And can you give us an idea of how some of your maybe urban Minneapolis branches have performed? I know you entered Ramsey a few years ago and the markets like Lionel Lakes and Lakeville, some these suburbs give us an idea of how you performed in those markets so far.

Let me address that and if Ron and Craig would like to add to it they certainly can. We've had some tremendous performance in some of our urban markets and some of those marketplaces that are represented by offices opened not so long ago. I’ll start with Ramsey, which is i suburban Minneapolis, this is a bank that has averaged a nice level of loan and deposit increase. It’s a 50 to 60 million dollar bank now, it is a startup a few years ago. It's got a good mix of commercial and retail activity. It is nicely profitable for us. As a matter of fact, it's got a return on equity that's in excess of 25% in return assets in excess of 2%. This has performed extremely well for us.

Another example what we have going in California all of these office at one point were De Novos. We acquired them late in 1999 and they've had time to mature. Pretty clearly California has been the most rapidly growing balance sheet and income statement part of the community First banking structure over the course of the last 12 months. So that's performed extremely well. So again, that's one that adds to it as well. You are correct as we look at expanding our area of opportunity, it really comes down to where we see the ability to attract a wider range of clients in some marketplaces that have a better growth level of expectation, and we've initially focused on the outer suburban Minneapolis marketplace, Minneapolis, St. Paul. Clearly as we look at the demographic projections for Lionel Lakes, Blaine and Lakeville, they’re exceedingly strong in terms of the level of residential and commercial projected activity and, so again these are opportunities for us that match up very well with the work that we’ve built and the infrastructure that we've built for our business in a number of areas. It touches on the mortgage solution which again we've been a great mortgage originator through the Community First Mortgage solution and that’s going to make good sense in expanding market places. Our SBA solution is one that has definitely been a significant factor for us and these marketplaces should be very, very prime for that type of business opportunity as well. So again, we're feeling pretty positive about our opportunities. As we've approached the market extension model, ours is much more of a variable costed approach. We've looked at lower cost of fixed assets through lease execution on some reasonable terms rather than building a large building. Again we're focusing very heavily on a commission incentive based structure for our people where the best thing that could happen was for us to have a lot of salary expense, compensation expense because that means they would generate a lot of business.

Then maybe one question for Ron, I know it is a small PC business but how is the ag portfolio doing?

Actually most of the producers this year are doing, had a pretty good year compared to last year. Last year of course we had several areas of drought, this year we had record yields especially in the valley area here and even out in western North Dakota. The other thing that is very encouraging is the safe stock market is extremely strong, probably as strong as it's been in recent memory. So most of our ag producers are having a very good year and as you're well aware that trickles down to the main street of many communities that we serve so we're feeling very good about our agricultural portfolio. It has been one of the strongest from a credit quality perspective, quite frankly one of the strongest portfolios we've had.

Thank you.

Next question comes from Ben Crabtree with Piper Jaffray.

Thank you. I guess I'd like to talk a little bit about the conversion, if you will, the reorienting of the regional financial centers into the community financial centers. I guess one of the questions is what kind of functions would you move out of those branches as you convert them and what would typically happen? Maybe I'm asking too much to generalize but what would typically happen to the employment and cost levels of those operations when you convert them into a community financial center?

Well, John, this is Ron. Let me take a run at that and see if I can answer it for you. Actually, the community financial center concept, we perform all of the products and services that we offer in a regional financial center are certainly available in our community financial center models to those communities served by those banks. The difference is really in the leadership in that generally speaking in our regional financial centers we have complex credit such as construction loans, complex commercial credit. So leadership of that bank tends to have more of a commercial credit orientation. As we look at the market opportunities or lack of market opportunities in some markets that we serve, obviously, we're not presented with opportunities for complex commercial credit. However, all of the communities we serve have a very strong deposit base, and these people have the same financial solution needs as those folks in larger communities. So in some respects, our markets, community financial center models are served on the base of the leadership as someone fromMerrill Lynch, Prudential, Edward D. Jones, someone like that. And we support them centrally on the credit side, So that's the primary difference.

So are you saying there really isn't a significant reduction in expense that occurs or improvement in efficiency that occurs when you make that conversion?

Yes, there is over time, John. What happens is Over time, there is a significant difference in that most of our -- and as Mark suggested we hope there is a difference. But there is variable pay. Most of the -- there's much more variable pay involved in the community financial center model.

Ok. I guess this is for Craig, kind of went by me a little quickly, I didn't get it all written down when he was talking about special items in non-interest income. The change from your kind of processing provider, there was a one-time benefit in the quarter?

Yeah, we changed providers for ATM and other card services during the latter part of second quarter. As part of catching up and coming whole, if you will, with outstanding items, catching up on some of the income that typically trails in on this kind of activity, there was a one-time -- say one-time from the standpoint of a catch-up or a final settlement if you will from our previous provider that did roll through earnings in third quarter.

And roughly how big was that?

That was about $550,000.

Okay. And then you said there was a $1.3 million participating insurance, I suppose that ends up being kind of a dividend or something?

It was actually we referenced $1.2 million. And we have a number of insurance policies for different purposes, one of them being with a mutual company that was acquired. And as part of the mutual company the purchase price was allocated to each of the members of which our share of that was $1.2 million.

And then on the prepaying the flub advance, that did go through non-interest expense?

That went through non-interest expense to the tune of approximately $835,000.

Right, okay, thank you.

Thank you. (Operator Instructions) Your next question comes from David ConradKonrad with KBW.

Good afternoon.

Hello David.

One quick question, follow-up on the bond premium amortization. I wonder if you could give us a little more color on what that was this quarter maybe relative to, you know, year-ago quarter in terms of getting a feel for what kind of acceleration impacted the margins.

David, I -- you must have been away from the phone a little bit. I had trouble picking up the question. But as it relates to premium amortization, I mean we're not going to get specific on actual dollar amount. But I will tell you that we are seeing a fairly notable decrease in premium or are anticipating that during the fourth quarter. We did see a relatively high level of prepayments in the early part of third quarter due to a fall-back in interest rates in the latter part of second quarter, typically you see about a two-month lag. So we do anticipate from a margin perspective, as it relates to prepayments and some reinvestment opportunities, that we should start to see that stabilize. Partially due to a reduction in amortization and prepayments in the portfolio.

Okay, great, thank you.

Thank you. Your next question comes from Ron Peterson with Moors and Cabot.

Good afternoon. Looking back I see average earning asset levels and net revenues have declined modestly over several quarters. Obviously some of that was due to your strategy to let these leverage strategy or leverage portfolio run off. And then also the economy slowed down. I know a lot of your peers and competitors may have recently leveraged balance sheets with obviously lower-yielding assets but obviously that helps earns per share and ROEs. I am wondering if you could provide some color on why you haven't implemented a strategy like that and also absent leveraging, what kind of pickup in the economy or shape of the yield curve might we need before you can start to see some renewed growth in loans and average earning assets?

Well, Ron, this is Mark. Let me respond. It is a great question. We have, again, a very, very active internal asset liability management process, we have looked at a wide range of alternatives putting leverage on the balance sheet. Our concern is that narrow margin leverage transactions increase the level of risk on our balance sheet and ultimately our income statement in the event that interest rates do move up, we just have not been comfortable with any of the alternatives presented to us in terms of the ability to not potentially detriment our income statement long term. So again our approach is to continue to manage this on a premise that we need to not increase the level of risk that we're absorbing in that perspective.

So again I don't see that happening. We have clearly accumulated capital which gives us the ability to reacquire shares. Frankly in this environment we would rather reacquire shares rather than leverage our balance sheet a significant amount, And that may be something we would look at, as part of our repurchase program, until we see some economic activity. With respect to economic activity again, as Ron points out we've got a handful of markets that are seeing some growth and that's good but we need to see more dynamic activity across the marketplace and in the national economy. And I think until that happens I mean our consumer loans, our real estate loans, commercial real estate loans, we're definitely looking for every opportunity that we can find. The reality of it is that it's a very, very tepid marketplace and you look at the prepayment, for example, our residential real estate loans are down 25 million linked quarter and they're down 150 million from the end of last year and that's a result of rapid prepayments and us and unfortunately potentially some others having an opportunity to refinance those and they're going to stay out there. In terms of a slope of a yield curve again, I think just -- it's not necessarily -- it's partially the slope and it’s partially the level of interest rates, we've had a difficult time attracting deposits when you look at a 1% rate in fed funds and you look at treasury rates where they are, so again I think as we look back, where we were tow years ago represented a very, very attractive level of interest rates for us so it realize really comes down to a yield curve with normal historical slope anda real short term level of interest rates that is more consistent with a Fed funds rate that is definitely north of 1%, north of current levels and hopefully in that 3 to 5% range is one that's going to give us the ability to perform much stronger because it's going to indicate a more vibrant economy but again as we look at the drivers the huge one is just the lack of economic activity the impact on our volume.

Okay, thank you.

We now have a follow-up from Ben Crabtree with Piper Jaffray.

Yes, thanks. There were a couple of items mentioned in the Releasethat I though might have had impact in loan volume and I wanted to find out if that's true. It was mentioned in one point that SBA premium increased. I'm wondering if there was a significant volume of loans that were delivered to the SBA, whether that had an impact on loan volume and also whether that was a significant fee source in the quarter, what that might have been. And the other thing was the comment about the special asset group. I'm wondering if, in fact, you moved significant number of, let's say criticized loans off the books and whether that had an impact on loan volumes as well.

Ben, this is Ron. Actually, the movement of SBA loans off the balance sheet is not -- does not impact Community First. But that's ongoing. So it's -- you know, there's no spike in the number of loans that we would have on balance sheet you know from quarter to quarter, it could vary slightly but generally speaking, that would not have an impact on our blanks sheet. With respect to premium, premium was up slightly from Q2. So not a major issue as you look at the non-interest income number from Q2 to Q3.

Okay.

With respect to special assets, these assets do stay on our balance sheet. They are not moved off the balance sheet. And with respect to volume of special assets I can tell you that we have stabilized and actually have seen a slight reduction in the volume of assets in our special asset group.

Okay, thank you.

At this time there are no further questions. Do you have any closing remarks?

Thank you. Again, we'd like to thank everybody for participating on the call, for each of those who made inquiries relative to performance, to add clarification, we thank you for some very, very good questions. Hopefully our response added color to it. Again it is a very, very challenging environment as much so as we have seen in our time. We are extremely pleased that we have been able to hold our net interest margin as well as we have. It is really a result of significant effort as you look at some of the mix callenges out there. We are also very, very pleased that we have been able to see the successes throughout the income statement and in generation of return on equity that we have. So again we remain very, very encouraged about the long term outlook for Community First. We are battling through a very difficult environment and think that we’ve positioned the company well, to take advantage of an economy that will ultimately rebound. With that we'd like to thank you for your time, and look forward to visiting with you again Thank you.

Thank you for joining today's Community First Bankshares Incorporated Third Quarter earnings conference call. You may now disconnect.