Financial Institutions Inc (FISI) 2006 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Financial Institutions, Inc. third quarter 2006 earnings conference call. At this time, all participants are in a listen-only mode.

Following the presentation, we will conduct a question and answer session. Instructions will be provided at that time for you to queue up for questions.

I would like to remind everyone that this conference is being recorded and would now like to turn the conference over to Deborah Pawlowski, Investor Relations for Financial Institutions, Inc. Please go ahead.

Thank you very much, Lori. Good morning, everyone, and thank you for your interest in Financial Institutions and for your time this morning. Joining me on our conference call is President and CEO of Financial Institutions, Peter Humphrey; Ron Miller, its Chief Financial Officer; and Matt Murtha, Senior Vice President of Marketing and Communications.

Pete and Ron will discuss the third quarter nine month 2006 results and provide some outlook as to what the remainder of the year may look like, as well as the Company's long-term strategy. Following their discussion, we'll open it up for questions.

Before we get started, you should have the press release, which went out yesterday after the market closed. If you don't, you can find it on the Company's website at fiiwarsaw.com.

As you are aware, we may make some forward-looking statements during the formal presentation and the Q&A portion of this teleconference. These statements apply to future events, which are subject to risks and uncertainties, as well as other factors that could cause the actual results to differ materially from where we are today.

These factors are outlined in the press release, as well as in the documents filed by the Company with the Securities & Exchange Commission. With that, let me turn it over to Peter to start the discussion.

Thank you, Debbie, and thank you, everyone, for listening in today.

We continue to post solid financial results, which are reflective of the major improvements we have made in reducing the risk profile in our Loan portfolio, as well as achieving a reduced cost structure.

Third quarter 2006 net income was $5.3 million or $0.43 per diluted share, which is down $3.7 million from the same quarter of last year. Last year's third quarter was favorably affected by a $9.2 million gain from the disposition of lower quality Commercial-related loans, while this year's third quarter was favorably affected by a $1.4 million gain from the sale of our Trust Operations.

Our improved credit quality has led to the provision for loan losses being $2 million lower than last year, and the decline of $1.8 million in non-interest expense has offset similar drops in our net income from a year ago.

Our large challenge at this time is revenue growth. We continue to be disappointed with our approach to Commercial Lending in a very challenging market. We have been very active with sales and marketing to attract new, high-quality credits to the bank. What isn't readily obvious with the Loan portfolio today is that we have new credit that we've targeted, which are offsetting the workout of lower quality credits.

Throughout our territory we are establishing new Branch Lending programs, and our focus is retail and small business. For our Commercial portfolio, we are focused on the micro business segment that qualifies for SBA loans and need less than $100,000 in borrowings and also medium sized businesses with borrowing needs of up to $10 million.

That hits a very large segment in our 10,000 square foot mile footprint. We believe we can capture these customers through personalized and fast, friendly service. In order to earn this type of business, we have to provide a degree of service and attention that they are not currently getting. This, of course, is the basic philosophy behind being a community bank. Our objective is to be better than the rest.

As we mentioned in the press release, we've instituted same-day approval on Small Business and Consumer Lending. Our proactive outreach efforts and calling on prospects on a regular basis does make a difference.

However, we can't rely on economic growth from their growth. Our targeted prospects are already banking with someone else. In effect we need to steal our competition's customers.

Consequently, if we are available to them when their an event creates a decision point, and we have been helping them understand the benefits of our service, then the likelihood of their selecting Five Star is much higher. It comes down to basic relationship sales, quality service, and unique product offerings. Clearly, our people are the number one critical asset for our success.

To help them succeed, we've instituted new higher service standards for both our internal customers as well as our external customers and have created a stronger sense of accountability throughout our organization. It's a very different atmosphere than what was here just over a year ago.

We've also streamlined our operations to increase responsiveness. We separated the loan approval process from the daily administration process, so the new business gets immediate attention. Underwriting standards for approvals and maintenance have not changed and continue to remain very high.

Also, I should note that as we've discussed with you before, we believe a loan portfolio balance between commercial and consumer segments presents the best risk profile for us. We further reduced our allowance for loan losses in the third quarter. Our nonperforming loans were down $2.6 million from the second quarter, and criticized and classified loans at the end of the quarter were down $5.7 million from the end of the prior quarter. We have greatly reduced the risk profile of our Loan portfolio at this time, and our focus is in rebuilding a high-quality Loan portfolio, however, in a very challenging environment.

As to our source of funds, we had expected deposits to decline as a residual effect of our loan sale and bank consolidations, which happened last year.

Our third quarter average deposits were down 10% from the same quarter last year. We have managed [inaudible] majority of price sensitive and high cost CDs since the beginning the year, and other deposit categories have experienced deposit outflows associated with the effect of the 2005 loan sale and from competitors offering higher rate products.

Overall, our retention rate has continued to improve throughout the year. Sequentially, our deposit base is up due to increases in public deposits, which have a seasonal nature.

Our efficiency ratio has been steadily improving throughout the year. There are still some areas where we can reduce cost, but growing revenue will have a greater impact to this ratio and is our number one priority at this time.

As we reported in the release, the Board approved up to $5 million for a stock repurchase plan and the early repayment of a $25 million long-term borrowing. Also during the quarter, we raised our common dividends 12.5% to $0.09 per share. Given our solid capital base and the recent indications by our regulators of solid performance, we felt that this was the right time to take these value-enhancing moves.

Ron Miller will now discuss our financials in more detail.

Thanks, Peter, and good morning, everyone. Peter discussed our third quarter bottom-line results, so let me first give a brief overview of year-to-date earnings.

For the nine months of 2006, net income was $13.4 million or $1.17 per diluted share. This compared to the loss of $705,000 or $0.16 per diluted share last year.

Loss for the first nine months of last year was largely related to actions taken to sell a substantial portion of the Company's problem credits, as well as actions to strategically realign the Company. Part of that strategic realignment was to focus on our core community banking franchise. Our last year's nine-month results included a $2.5 million loss related to the discontinued operations of our former benefits administration and compensation-consulting subsidiary.

We continued with the strategic realignment with a consolidation of our four banking subsidiaries into one bank in December 2005. And now, in the third quarter of 2006, have completed the sale of [inaudible] from our trust business. These actions have resulted in an improved low risk profile and lower levels of non-interest expense but are now reflected in our 2006 earnings.

Peter has talked about our improved asset quality and lower loan-loss provisions. Since the end of last year, we have reduced our nonperforming loans by $5.2 million and have reduced our total criticized and classified loans by $30 million. We had net loan charge offs for the first nine months of 2006 of $708,000, which represents an annualized net charge-off ratio of ten basis points.

The math that we used to determine the level of our allowance for loan losses has a high degree of correlation with our charge-off experience and the severity of the risk rating of our loans. With the loan level of net charge-offs, significant improvement in the risk profile of our loan portfolio, coupled with a smaller overall loan portfolio, we have reduced our allowance for loan losses from $20.2 million at December 31, 2005 to $17.7 million at September 30, 2006.

This is reflected in our income statement by a credit for loan losses or negative provisions of $491,000 for the third quarter of 2006 and $1.8 million for the first nine months of 2006. Peter discussed revenue as our largest challenge. Our net interest margin for the third quarter was 3.56% and 3.59% year-to-date, only a three basis point decrease from the same quarter last year, essentially flat from the second quarter of this year, or down nine basis points compared to the first nine months of last year.

Net interest income for the third quarter this year was down $1.6 million from the same quarter last year and $6.3 million when comparing the first nine months of this year with 2005. The decline in this revenue source is largely the result of a $155 million average decline in the level of our total earning assets when comparing the third quarters of each year and an average decline of $176 million when comparing year-to-date 2006 versus 2005.

We have had some [inaudible] reductions in our deposits and have had other deposit clients associated with the residual effect from our loan sale and bank consolidation. Also adversely impacting net interest income is a shift in the mix of earning assets from higher yielding loans into lower-yield investments, as well as the impact from a flattening of the overall yield curve.

Our net-interest -- our non-interest income for the third quarter was $7 million, down $7.8 million from a year ago, and for the nine months ended September 30 was $17.1 million, down 30% from the previous year. The two largest items affecting that comparison are the $9.2 million third-quarter gains last year related to our 2005 loan sale and the sale in the third quarter this year of our Trust Operations.

We had announced last March and in April the agreement to sell our Trust Operations, and subsequently, we received the necessary regulatory and court approvals allowing us to complete the sale on September 29. The transaction resulted in a $1.36 million gain on sale for the third quarter.

The sale of the Trust Operations will not have a significant impact on our earnings going forward with the revenue from those operations at just slightly less than the expenses. Trust was not a core business for us, and it lacked the scale or the potential to achieve a scale necessary to make sound financial sense to retain.

Of the remaining portion of our non-interest income, the largest component is service charges on deposits, and income from that source was relatively unchanged when comparing third quarter this year to last year, but is up $200,000 from the second quarter of this year, largely from some fee increases that were implemented.

The third quarter of this year included an annual experience dividend relating to our group creditors life and health insurance plans of $350,000, which was a similar in amount to the third quarter of 2005. Non-interest expense for the quarter was down $1.7 million when compared to the same quarter last year and down $4.9 million or 10% for the first nine months of 2006 compared to last year.

Our lower costs are the result of efficiencies gained from our bank consolidation at the end of 2005, which has resulted in reduced compensation costs, a reduction in legal and professional service fees related to last year's asset quality and regulatory issues, as well as lower FDIC insurance costs and the consolidation of the Company's banking charters.

Sequentially, non-interest expense for the third quarter of 2006 was almost identical to the second quarter of 2006. The Company's deficiency ratio for the third quarter of 2006 was 66.64% compared with 67.29% for this year's second quarter and down 70.24% -- from the 70.24% for the third quarter last year. The improved deficiency ratio is reflective of a proportionately greater reduction in non-interest expense than in revenue.

Finally, again as Peter mentioned, our Board has approved the early repayment of a $25 million term loan. This loan was originally take out by the parent company in December of 2003, the proceeds of which were primarily used to make capital contributions to two of our former subsidiary banks that were under formal agreements with the Office of the Controller of the Currency. Repayment of the loan will take place today, and we estimate an annualized increase in our net interest income from this action of approximately $500,000.

With that, I will turn it back to Peter.

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

Certainly. [OPERATOR INSTRUCTIONS].

We'll take our first question from David Darst with FTN Midwest.

Good morning.

Good morning, David.

How do you feel about the Loan runoff this quarter? It looks like it was about the same rate that we saw in the second quarter. Is that -- is it beginning to slow any as you got into the later part of the quarter?

The Loan loss is clearly moderated, and as we stated, really it almost -- it actually mirrors the reduction in our problem Loans. So that would suggest that when you look at what I would call the core portfolio of the quality customers who are holding their own, my sense is the portfolio has stabilized. But I think if you're familiar with Western New York, it's a very challenging environment out there. The economy's soft, and the competition is fierce. And as we said before, we're going to be very patient and very disciplined in our approach to rebuilding a high-quality portfolio both on our underwriting and on our pricing.

And with the current environment, that has been a major challenge, quite candidly, in trying to attract good, quality credits with appropriate pricing. Obviously, the somewhat inverted yield curve adds to that challenge as well, but we remain confident over time that we'll be successful in rebuilding this portfolio, but it will take time to clearly -- to me, that's our greatest opportunity. It's a challenge, but it is an opportunity. Having a relatively low loan-to-deposit ratio and still maintaining a relatively good margin, we think there's some good opportunities to improve net interest income, but we're going to do it in a patient and disciplined fashion.

Okay. Sounds good. And how about with your non-interest expense? Is this -- have you gotten most of the cost savings out that you can? And is this a good run rate going forward?

We think there's some additional opportunities to reduce our costs, but we think the bulk of those cost reductions have already really been captured. We look to the short term and the long term, and we're trying to strike the right balance to make sure we continue to invest in our future, whether that be in people, systems, facilities, and programs, but we think there are still some modest opportunities for some cost savings.

Okay. Thank you.

[OPERATOR INSTRUCTIONS] We'll go next to Damon DelMonte with Keefe, Bruyette & Woods.

Hi. Good morning. Just wondering if you could comment or kind of frame for us your thoughts on M&A activity given the announced share buyback. Are you changing your view as to maybe being more focused on doing share repurchases rather than looking to do acquisitions? Or is that just a supplement until something comes along?

I think it's the latter, frankly. When we look at both the short-term and long-term approach in building shareholder value, we feel looking at a share buyback today makes a lot of sense. We have a very strong capital base, and depending on market conditions, we'll drive our decision as to how much of the authorized buyback we implement.

On the acquisition front, we remain fully focused on that. However, again, we want to be opportunistic when and if those opportunities arise. And as we all know, that's very hard to predict. So it's a multiple approach to the market, looking at the short-term and long-term shareholder value enhancements. We think the share buyback is more in the short term and look at acquisitions more in the longer term, but again, understanding that you can't predict the acquisition timeframes.

So it's a multi-pronged strategy.

Okay. Great. Thank you very much.

Since there are no other questions in the queue at this time, I'd like to turn it back over to our presenters for any additional or closing comments.

Thank you, Lori. Again, thank you, everyone. As we discussed, we're working on continuous improvement of our operations and remain focused on developing a broader and stronger base of customer relationships and our 10,000 square-foot footprint.

Our strategy is focused on core community banking by providing friendly, quality response of service, [inaudible] [quality] to community banks, and we believe that there's a significant potential in our market, in that footprint that I mentioned, for us to tap into that that underserved or rather under-recognized by larger banks in this region.

We appreciate your time this morning and thank you for your interest in Financial Institutions. Have a great day.

This does conclude today's conference. Thank you for your participation. You may disconnect at this time.