Financial Institutions Inc (FISI) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Financial Institutions Incorporated second quarter 2006 earnings conference call. [Operator Instructions] I would now like to turn the conference over to Mr. Ryan Daniels. Please go ahead, sir.

Thank you very much, Michael. Good morning, everyone. Thank you for joining us today. On our conference call this morning, I have with me Peter Humphrey, President and CEO of Financial Institutions, Ron Miller, Chief Financial Officer. I also have Matt Murtha, Senior Vice President responsible for marketing and corporate and investor communications, is also here.

Peter and Ron will discuss the second quarter and six month 2006 results, and provide some outlook as to what the second half of the year may look like, as well as their long-term strategy. Following discussion, we'll open up for questions.

As you may be aware, we may make some forward-looking statements during the formal presentation, as well as during the Q&A. These statements apply to future events which are subject to risks and uncertainties, as well as other factors that could cause actual results to differ materially from where we are today. These factors are outlined in the press release, as well as documents filed by the company with the Securities and Exchange Commission.

You should have the press release available to you. If not, you can find it on the website at www.fiiwarsaw.com.

With that, let me turn it over to Pete to start the discussions.

Thank you, Ryan. Good morning, and thank you, everyone, for joining us today. For the second quarter of 2006, we are pleased to report net income of $5.4 million, or $0.44 diluted earnings per share over the same period last year. Our solid earnings reflect our effective consolidation strategy, resulting in better operating efficiencies and improved credit quality of our loan portfolio.

Continued reduction in non-interest expense also added to our bottom line earnings. We were successful in reducing our operating risk and the overall risk profile of the company.

Financial Institutions is a stronger company today versus a year ago. Although challenges remain, we are beginning to show continued improvement in many of our key metrics from the first quarter of this year. Ron will discuss the financials in more detail later on during the call.

Based on the improved credit quality of our loan portfolio, we further reduced our provisions for loan losses. This improvement was driven by the sale of our problem loans in 2005, effective loan work-out efforts, as well as disciplined credit administration.

We also continued to reduce our non-performing loans, as well as our classified and criticized loans that remain in our portfolio from the first quarter of this year.

Although our deposits and loans decreased during the quarter, we believe their levels have stabilized, and we hope to realize modest growth over the coming quarters. Competitive pressures, a soft regional economy, and the flattened yield curve also contribute to our current challenging market environment.

Our forward strategy is to rebuild a balanced, quality loan portfolio, and we will do it with discipline and patience. Loan originations have slowed due to a more stringent underwriting requirement since mid-last year, along with a highly competitive market for quality commercial loan credits. The declines in loans are almost entirely from commercial loans, with consumer loans relatively stable.

Keep in mind, we completed the long process of restructuring our organization into a single bank structure, Five Star Bank, at the end of 2005, and our franchise has since settled down. We are pleased with our progress over the past two to three years, but there is plenty of work ahead. Every day, we continue to standardize and fine tune our policies and procedures as we work to grow revenue.

We are back to the basics of gathering loans and deposits with a focus to grow our community banking franchise. Throughout the process, we are tightly managing our staff and filling positions vacated through attrition only when necessary. We are taking a cautious approach, which takes time.

It is important to hire those who want to be part of our customer-centric and goal-oriented culture. We are staffed to scale up loans and deposits and we'll add support as required while we maintain operating efficiencies. However, to remain responsive to our customers' needs and drive deposits, we remain fully staffed on the front lines of our branches.

With our added depth of experienced veterans to our team, we have instilled a goal-oriented culture throughout the organization. All personnel are accountable for achieving results. Our compensation program is linked to customer service, retention, business development, as well as effective risk management.

Currently, we are conducting mid-year performance reviews among all levels, including managers, business development officers, and staff. By continuously tracking our progress and evaluating our performance, we are better positioned to capitalize on market opportunities as they arise.

We continue to re-brand our new name, Five Star Bank, within our 10,000 square mile footprint through print, radio, and TV advertising, which will continue through the end of the year. Throughout our organization, we are also very active within the communities we serve. We also are conducting promotional (inaudible) at our branches to build strong relationships with current and prospective customers, and they have had excellent results to date. We are educating them that the only change has been our name, and we are committed to providing the high level of service they have come to expect.

Our Board of Directors is actively evaluating the best uses of our capital, which include acquisitions and organic growth. Our acquisition strategy considers banks that are complementary to our existing operations and strategy. This applies to those both inside and outside of our current footprint. This includes banks in geographic territories that have stronger economic potential than our current territory, while we also look to grow our presence within our geographic footprint in order to strengthen our franchise.

With that, I'll turn it over to Ron to get into some of the financial results. Ron?

Thanks, Peter, and good morning, everyone. As Peter mentioned, we had solid results for the second quarter, with net income of $5.4 million, or $0.44 per share. And for the first six months of the year, net income of $9.1 million, or $0.74 per share.

Our earnings press release compares those results with the same periods last year, in which we recorded a second quarter loss of $12 million and a year to date loss of $9.7 million. Last year's results were largely influenced by our decision to sell a substantial portion of our private loan portfolio. That decision and our subsequent action to consolidate our subsidiary banks laid the groundwork for the improved asset quality and better operational efficiencies we are now experiencing and that are reflected in the solid operating results for the second quarter.

The most significant item in our second quarter results is a credit or negative provision for loan losses of $1.6 million. The methodology that we used to determine the amount of our allowance for loan losses has a high degree of correlation between current and historical charge-off experience, the level of loans that carry adverse risk ratings, the severity of those risk ratings, and also the total size of our loan portfolio.

Our net loan charge-offs for the second quarter were only $100,000, and are only $290,000 for the first six months of the year. That equates to an annualized net loan charge-offs to average loans ratio of only 6 basis points for the first half of 2006.

Our criticized and classified loans declined by nearly $13 million from the end of the first quarter to the end of the second quarter. Our non-performing loans were $15.4 million at June 30th, a decline of $3.2 million from March 31st.

The collective impact of applying our allowance methodology to these positive changes in the risk profile of our loan portfolio resulted in a lowering of our allowance for loan losses to $18.6 million at June 30th, 2006, and the negative provision of $1.6 million reflected in our income statement for the second quarter. This reduced allowance for loan loss level at June 30th, 2006, represents 1.95% of total loans and provides an improved coverage ratio of 121% on our quarter end non-performing loans.

In terms of revenue, we experienced some decline in the second quarter, with net interest income of $15 million, down $500,000 from the first quarter of 2006, and down $1.9 million from the same quarter last year.

The drop in net interest income is principally volume driven, as our net interest margin, at 3.57% for the second quarter of this year, was virtually the same as the 3.56% in the second quarter of last year, and down 7 basis points from the first quarter of 2006. The margin drop from the first quarter is principally from continued upward pressure on funding costs.

From a volume perspective, we are operating with a significantly lower level of earning assets from the second quarter of last year, but have experienced a smaller drop from the first quarter of this year. We have actively managed out of the company some of our higher cost funding sources.

Deposits have also declined from effects associated with our 2005 problem loan sale, and higher rate offerings from competitors' products.

From an asset perspective, our loan portfolio of $953 million at June 30th, 2006, is down $78 million from last year, and $12 million from March 31st, 2006. The decline is almost entirely in the commercial section of our portfolio, as consumer loans have shown modest increases. Rebuilding a quality commercial loan portfolio will take time, as we stay focused on our higher underwriting requirements and firm pricing disciplines.

Switching to the expense component of our earnings statement, we had $14.6 million in non-interest expense for the second quarter of 2006, which represents a $2 million decline over the second quarter of last year. For the first six months of 2006, non-interest expense was $29.9 million, or $3.1 million lower than the same period last year.

These positive results are reflective of the operational efficiencies we gained through the consolidation of our four subsidiary banks in the fourth quarter of last year, as well as expense reductions realized from our improved asset quality and regulatory profile. In addition, we have been actively managing staffing levels throughout the first half of 2006 by filling positions vacated through attrition only when necessary.

The results of the consolidation project and 2006 staffing initiatives has been a reduction of 78 full-time equivalent employees from June of 2005 to June of 2006. And in terms of dollars, our salary and benefit costs for the second quarter of 2006 were $8.1 million, a reduction of $1.2 million from the second quarter of last year.

For this year's second quarter, our legal and professional fee costs are down $373,000, and FDIC premiums are down $580,000 compared with last year.

In summary, our quarter was solid, with improving credit quality and meaningful reductions in overhead. We believe there are still cost reduction opportunities to be realized in our company, and that our credit quality has room for further improvement. Our net interest margin will continue under pressure from increases to our funding costs. And our most significant revenue opportunity remains the redeployment of lower yielding investment assets into higher yielding quality loan assets.

I'd like to turn the program back to Peter.

Thank you, Ron. Before I turn it over for questions, I'd like to summarize. In 2005, we implemented decisive strategic actions to improve our asset quality through the sale of problem credits, and also eliminated non-core community banking functions. We were successful in reducing both our overall operating risk and operating cost structure. We are now seeing the results of our effectiveness in this first half of 2006. We improved our asset quality, resolved our regulatory issues, and streamlined our overall organizational structure.

Looking ahead, with a strong foundation in place, and the time to fine tune our operations further, we look in the near term to organically grow our market share. There is plenty of opportunity to gain from the larger players. We also continue to control our cost structure from our consolidation.

Operator, we'll now open the call to questions, please.

Thank you. [Operator Instructions] Our first question will come from David Darst, FTN Midwest.

Good morning.

Good morning.

Peter, could you give a little more granularity on the credits that are remaining? Maybe the top three by size? On the non-performing loans? And maybe an expected resolution timeline?

Well, I can tell you, David, that the good news is, the remaining non-performing loans have no large credits in them. Basically, all those credits are $0.5 million and less. So we have a very active loan work-out team and process in place. We continue to make good efforts to put specific time frames. So when we'll reduce those levels to what we would view as more acceptable is difficult, as you know, whether it's the foreclosure process, the bankruptcy process, and other actions required. It's tough to put specific time frames. But I can assure you, we know that we need to reduce those non-performers quite a bit more.

But again, the good news is, there are no larger credits in that group. To a degree, the bad news is when you work out a large credit, it reduces the number significantly. So we will have further reductions, but it'll come through kind of onesies and twosies, if you will.

Okay. And at this point, you really don't know how that'll impact your reserve until you actually resolve them?

True. As you I think know, the methodology in a reserve is to go in and look at, on a loan by loan basis, from an impairment standpoint, what the value of collateral is, and ultimately, what we think the exposure to loss is. A very active process. Very fluid process. But we feel very confident today that we have identified our exposure loss, and that the methodology really hasn't changed any. And we think it's a very strong methodology.

Okay. And then how about on your expense base? So it's a pretty good run rate going forward? Or do you expect to have some more cost savings?

Well, we're not really trying to quantify it. I think we just, as I suggested in my remarks, I think we still have opportunity for some additional reductions. I don't think there's any single home runs. As we alluded to, we've been very disciplined in looking at vacated positions when they're left. There isn't exactly a target, but it's really a very hard look to, as people leave -- and obviously, we replace those that are necessary. But [where not], to take a serious look at our staffing a little. So I think there'll be some of that that will continue to dribble in over the next few quarters.

I think in the non-compensation pieces of the company, we continue to look at and see opportunities in the areas of contracts from our four subsidiary banks, with actually four different vendors on occasions and four different contracts. As those things are coming up, we're seeing some opportunities there. We have some excess space in our facilities at this point in time, and are looking at that. So I think there's just a lot of little things that'll continue to benefit us as we go forward. But nothing really dramatic.

Okay. What about things like share repurchases or other ways to -- it sounds like you'll have excess capital over the near term. Anything you're looking at to improve that?

Well, just as the -- perhaps a standard general statement, David, is that obviously the Board continually evaluates our capital position, and is familiar with all the various opportunities to redeploy the capital. Certainly, our primary focus is on having capital to grow our company with.

Okay. Thanks.

You're welcome.

[Operator Instructions] We'll move on to Damon DelMonte at Keefe, Bruyette & Woods.

Hi. Good morning. I was just wondering if you could elaborate a little bit more on your acquisition strategy. Is this something that's more theoretical in nature, or is this something you're going to be aggressively pursuing?

Well, I think our history speaks for itself. We have over the last say ten years been successful in acquisitions, whether it be branch or whole bank acquisitions. And now that we have really turned the company around, have a very strong team in place, we're back actively evaluating what acquisition opportunities that are out there.

We know that -- our primary focus is to continue to grow the revenue side. Be disciplined from a risk management standpoint. And look for cost save opportunities. But at the same time, we'd like to leverage our capital base, as Ron said, both organically, but also through acquisitions. We believe there's some potential acquisition opportunities out there, but are not in any position today to get overly specific. But we do think that there will be some good opportunities going forward, and we frankly want to position ourselves to take advantage of those when they come along.

Okay. Great. And then just one question on the provision level going forward, for Ron. Now that all of the problem loans have pretty much been resolved and taken out of the portfolio, what would be a fair run rate going forward?

I think, Damon, I'd probably answer it this way. And I take you back to my earlier comments on our methodology. There is obviously a high degree of correlation between changes in the risk portfolio of our portfolio, as well as the level of net loan charge-offs and the level of our allowance. Like you'd expect, we have continued loan net charge-offs and improvements to the loan portfolio, there will be a resulting positive impact on the level of our allowance and associated with our provision.

Okay. Great. And do you see your earning asset base stabilizing at this level? Or would you expect to continue to see some declines?

We think it's stabilized. When you're working out problem loans, our phrase is either up or out. And so some of those loans go back out in the line, and frankly, some of those loans are liquidated. So there'll be some attrition to the loan portfolio from your basic amortization payments and through work-out efforts.

On the flip side, we have significant activity going on from our calling efforts to strengthen relationships with current customers that we hope will turn into continued loan requests, as well as reaching out and trying to build new relationships. We have now a full team in place on the front line, both from a branch staffing standpoint, but especially from the commercial lending standpoint, and are looking at some positive pipeline activity. So we feel that the portfolio clearly has stabilized. And as we said, we look forward to some modest asset and loan growth in the next few quarters.

Great. Thank you very much.

(Inaudible) Capital [Josh Roth] has our next question.

Hi. This is Chris Buonafede. How are you?

Good.

Question. I just want to ask about the -- in relation to the prior question, the discussion related to the acquisitions. How do you think about those in relation to where your stock trades? I think it's about 1.5 of book value and less than 2 times tangible book. How do those ratios come into play when you think about acquisition?

Let me take a stab at it, and then Ron can get into more of the specific modeling that we do. But I think you understand the metrics. Our stock is obviously trading on a [B] basis and a price to book basis below our peers. So that makes it challenging to use our stock in an acquisition mix, if you will. So that is a challenge. So as we look to model and we get into valuation methodologies, then that's when we would look to a bit more in cash in the mix, and any potential opportunity.

But I'll flip it to Ron, because he's what I call the keeper of the valuation model. And there's no question. Clearly, our hope is, with our continued improvement, with the financial results of the company and the risk profile improving, that our stock will reflect that. And over time, we'll fall back into our peer group and allow us to be more successful using that stock as potential acquisition currency. But Ron, maybe you can comment a bit more.

Well, you pretty well covered it. Just to reiterate basically what Pete said. I think obviously with our relation to book value, (inaudible) book value our stock trades at in relation to what generally is the expectation of someone on the other side of the transaction creates a challenge in a stock transaction.

Can you also discuss about the appetite for -- given that the stock trades at low multiples of book value relative to the peers, your appetite for buying stock back as a use of some excess capital?

Well, again, just as we mentioned earlier, the Board always considers our various options. And if we had -- something in that direction was announced, it would get announced when appropriate.

Okay. Thank you.

There are no more questions at this time. I'd like to turn the call back over to you gentlemen for any additional or closing remarks.

Well, thank you. In closing, I'll repeat what I said before. Every day, we're becoming a stronger company. Our strategic is focused on core community banking through patience and discipline. We're back to the basics of gathering all the deposits. And now we have the right team in place to accomplish our future goals. We appreciate your time this morning. And thank you for your interest in Financial Institutions, and have a great day.

Once again, thank you all for joining us. That does conclude today's presentation. Have a great afternoon, and enjoy your weekend. ??

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