Financial Institutions Inc (FISI) 2006 Q4 法說會逐字稿

Good morning. My name is [Lucia] and I will be your conference operator at this time. I would like to welcome everyone to the Financial Institution fourth quarter fiscal earning 2000 year's conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. (OPERATOR INSTRUCTIONS) It is now my pleasure to turn the floor over to your host, Mr. James Culligan, IR Financial Institution. Sir, you may begin your conference.

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

Peter and Ron will discuss the fourth quarter and full-year 2006 results and provide some outlook on 2007 as well as on the Company's long-term strategies. Following their discussion, we will 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 www.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 actual results to differ materially from where they are today. These factors are outlined in the press release as well as in the documents filed by the company with the Securities and Exchange Commission.

With that, let me turn it over to Peter to start the discussion.

Thank you, Jim, and thank you everyone for listening in today. Our fourth quarter and fiscal 2006 results were encouraging by most measures. We reported solid financial results, largely due to measurably-improved asset quality and to reduced operating expenses. We continue to be challenged, however, by an inverted yield curve and a difficult lending environment, resulting in a lack of revenue growth.

For the quarter, we had earnings per share of $0.23. As previously stated, difficult market conditions have resulted in a continued shrinkage of our net interest income. We have been able to offset this revenue shortfall somewhat by aggressively reducing costs and continuing to improve the quality of our loan portfolio.

There were about $250,000 in expenses that were specifically targeted to a major brand and marketing program executed during the quarter. There may be further modest cost-saving opportunities, however. We believe that for the most part we have the proper structure and capacity in place to position us well for the coming year and need to focus the bulk of our energies on revenue growth.

Our net income for the year was $17.4 million, a significant improvement from the $4.6 million in income from continuing operations reported in 2005. The increase was primarily due to a net $30 million reduction in our loan loss provision and reflects the improved risk profile of FI's loan portfolio.

We also saw a reduction in non-interest expense of $5.9 million, a direct result of the elimination of professional fees associated with the 2005 asset quality and prior regulatory matters, as well as the efficiencies gained as a result of our consolidation of the Company's subsidiary banks in December of 2005. FI's asset quality has improved, with a ratio of nonperforming loans to total loans falling to 1.71% at December 31 versus 1.82% at the end of 2005. Total nonperforming loans at the end of the year stood at 15.8 million down 2.2 million from the end of 2005.

We did see an increase in nonperforming loans from the third quarter of last year. This was related to a single credit in the dairy sector as a result of the relatively-low milk price to producers this past year. We believe that this move will assist us in the timely resolution of this credit. We believe that we have in place the appropriate underwriting and workout guidelines that will ensure quality loan portfolio in the future.

While we acknowledge the continued decline in the size of our loan portfolio, we are encouraged by the significant improvement in business activity that is being reported by our loan officers. We believe that our disciplined approach to underwriting coupled with superior service and intense calling activity will result in modest growth this coming year. In addition to growing a balanced commercial and direct consumer loan portfolio, we have also been focusing our efforts on building a quality indirect auto finance portfolio, leveraging the talents of an experienced team assembled this past year.

During this past year, I have talked quite a bit about the significant cultural change that has taken place throughout our company from a risk management culture, credit culture, sales culture, as well as our culture of accountability. As we start 2007, I believe that we have positioned the company well to take advantage of opportunities in our 10,000 square-mile franchise area.

We have a strong capital base, ample liquidity, and capacity to lend; but most importantly, we have the proper structure, controls, and talented people in place to fully take advantage of these opportunities this coming year. We have a solid business plan and have already begun to focus on the daily execution of that plan. Key elements of the plan include an intensive calling program.

As mentioned in the release, we have over 100 pairs of feet on the street, including me and my executive management team, calling on existing customers and developing new relationships. We believe that our opportunity for success is increased by leveraging our extensive branch networks, our product line, and our responsive service profile. We can improve our earnings power by carefully growing our lending business and redeploying our assets into higher-yielding returns.

In addition, we will grow our core customer base, provide continued opportunities to cross-sell our products and services. Overall, in 2007 we will build on the many accomplishments achieved in 2006. We will intensify our efforts to carefully build and grow our loan portfolio while controlling expenses and properly managing the risks embedded in this business. Ron will now discuss our financials in more detail.

Thanks, Peter, and good morning everyone. For the next few minutes, I will recap full-year 2006 financial results as well as provide some additional detail on our fourth quarter results.

As Peter reported, net income for 2006 was $17.4 million, or $1.40 per share. And for the fourth quarter, it was $3 million, or $0.23 per share. One of the more significant items in those results is the provision for loan losses, which was a credit of -$1.8 million for 2006 and zero for the fourth quarter.

Even with the resulting decline in the amount of our allowance, the ratio of allowance for loan losses to total loans was 1.84% at year-end, compared with 2.04% the prior year. The year-end allowance to nonperforming loans ratio, or coverage ratio, was 108%, which compares with 112% previous year. This ratio was impacted by the addition in the fourth quarter of a $3.6 million loan in the dairy industry that was placed on non-accrual. Even with that addition, nonperforming loans are down $2.2 million from last year. Our loss exposure on that new non-accrual loan was provided for in the fourth quarter.

From a balance sheet perspective, 2006 was marked by reductions in the size of our loan and deposit base. Total loans declined $66 million, principally in commercial related loans which decreased $50 million. Consistent with our improvement in asset quality, a portion of the decline in commercial related loans is attributed to actively managing off the balance sheet some of our weaker credits.

Our overall criticized and classified loans were $48 million at year-end, a reduction of $38 million from the previous year. Total deposits in 2006 decreased $100 million, of which $15 million was brokered CDs. The company enjoys high levels of liquidity, with our investment portfolio and Fed funds sold representing 47% of earnings assets and a loan to deposit ratio of just 57%. With those high liquidity levels, we have managed our deposit costs in a matter that has resulted in not retaining some of our higher cost deposits.

From a revenue standpoint, with the decrease in our loans and the overall reduced level of our earning assets, we have had some declines in net interest income. In addition to those volume and mix changes, net interest income has been affected by a decline in net interest margin. For the fourth quarter, our net interest margin was 3.44%, a drop of 12 basis points from the third quarter. And our full year 2006 net interest margin was 3.55%, was 11 basis points less than 2005.

The inverted yield curve faced by our industry together with a highly competitive environment for new loan pricing and deposit origination has put downward pressure on our net interest margin in 2006. Margin management in 2007 will remain a challenge from these same factors.

Our non-interest expense for full-year 2006 was $59.6 million, which represents a $5.9 million, or 9%, decline from 2005. The reduction in overhead results from the efficiencies we have gained from the consolidation of our four subsidiary banks in December 2005 and lower costs associated with asset quality issues and regulatory matters. We have reduced staff levels in 2006, gained efficiencies from consolidated vendor management, lowered legal and other professional fees, and had a significant reduction in our FDIC insurance cost.

Our fourth quarter 2006 non-interest expense was $15.2 million, which was $600,000 higher than the third quarter of 2006. Unique to the fourth quarter are approximately $700,000 in overhead costs. The largest item included in that number are $250,000 associated with advertising cost for a fourth quarter branding campaign and $168,000 in write-downs on other real estate properties.

Continued control of expenses is a focus for 2007 in both compensation costs and other operating expenses, with an expectation of an overall lower cost structure than 2006. Revenues generated for redeployment of liquidity assets into loan assets together with our overhead initiatives is expected to lead to an improved efficiency ratio in 2007. And now I would like to turn the program back to Peter.

Thank you, Ron. As stated before, we believe that 2006 was a solid year with improvements in most areas. We are focused to build on that success by carefully growing our loan portfolio in a disciplined manner. We are also focused, as Ron has mentioned, on enhancing existing and gathering new customer relationships with an eye on effective cost management. I appreciate your interest in our company today. Thank you.

(OPERATOR INSTRUCTIONS). Jared Shaw, KBW.

Actually, the first 10 minutes of your call nothing came through. So if some of these questions were addressed then, I apologize. On the margin, you know, the margin was a lot weaker than we were expecting. Is there anything in there that you would classify as more one-time in nature or is it just the yield curve impacting the quarter?

The fourth quarter margin of 3.44%, which is down 12 basis points in the third quarter. I would not consider there anything to be abnormal in those numbers.

So assuming that nothing really changes in the yield curve, that's the number that we should be using as a base going into 2007?

I think it's a representative base for the fourth quarter and, again, 2007, with the current competitive environment and interest-rate curve, will remain challenging in margin management.

And right when the call started coming on you were talking a little bit about the indirect portfolio and potentially growing that. Is that something that could benefit margin or is that more of a margin-neutral event?

I think it is part of our overall plan to redeploy liquidity assets, our lower-yielding investment assets, into loans and I think that we would expect to receive returns higher on those assets and see margin improvement with that redeployment.

And when is the -- what is sort of the timeline on that? Is that something you are starting now and what your goals --

This is Peter. We have been building this indirect program throughout all of 2006. We have hired a team of very experienced lenders out of the Rochester market and have put the necessary systems in place and have developed a good core dealer network, if you will, and half grown that portfolio this year modestly, but with some good opportunities for 2006.

But having said that, we have put limits in place from an asset liability standpoint to maintain a good diversified portfolio and don't look at an indirect exceeding 15%, per se, in that portfolio. We have established a range for that one load segment, approximately between 10 and 15% of our portfolio.

And where was it at the end of the quarter?

It was roughly about 11.5%.

And then, on the asset quality you said that there is a $3.6 million dairy loan that was added to NPAs. Was that -- is that more just a cash-flow issue with the farm or is there something more beyond that?

It is basically a cash flow issue. And that is why we commented it is the result of the fairly weak milk price that the producers have experienced this past year. There has been some recent improvement in milk price, but it is still at a relatively low level. So it is clearly a cash-flow issue and obviously in our loan loss reserve methodology, our calculations to what exposure there is to loss has already been factored into that reserve.

And with the expenses -- Ron, you were saying that there is a $250,000 advertising campaign this quarter and $168,000 in write-downs. Are both of those unique to fourth quarter or do you expect the advertising budget to stay higher going into '07?

Both of those are unique to fourth quarter and you may not have picked up comment, there's about -- collectively, I think there is about $700,000 in overhead cost, the other items being smaller than the ones we just described. But collectively about $700,000 in costs that are unique to the fourth quarter.

Okay. So nothing else changing, we should see first-quarter's numbers -- expense numbers down $700,000?

Yes.

And then on the fee income side, any hope for some recovery there or is that -- should we -- is that a good base to use going into '07?

We do have a few fee initiatives, but nothing that will significantly increase those numbers. But we would expect to see some positive increases in the recurring portion of our non-interest income. As I think as outlined in the financials attached to the press release, is there is certainly a number of nonrecurring items in '07 that are broken out -- I mean in '06 that are broken out separately.

Thank you.

David Darst, FTN Midwest Securities.

Can you give us how much growth there was in the indirect portfolio during the quarter?

There is modest growth in the quarter. There is a $25 million increase year end. From 12/31/05 to 12/31/06, indirect grew by $25 million. I think it was relatively small in the fourth quarter. I'm sorry I don't have that number off the top of my head. I think it is $3 million to $4 million.

Yes, the fourth quarter was a somewhat-weak quarter. I think everyone is aware auto sales generally were down or weak in the fourth quarter. And that flowed through to a smaller growth number for us as well in that quarter.

And how about your commercial pipeline? How does that feel for you?

Well as we mentioned, we have an intensive calling effort out there on both commercial and retail, but especially commercial. And we see some good activity and that is resulting in some positive movement in the pipeline.

Can you give us an idea of what that number is?

It is really nothing that we would like to quantify. Directionally it is getting better. And as we all know, the pipeline numbers don't necessarily always translate into loan outstandings growth. So we are always a little careful on getting too specific with the pipeline figures.

And then do you have a number -- a dollar amount of loans that you would like to continue to work off?

Well, I mean, you see the non-accrual numbers out there. Obviously, we have a very focused workout program and team in place. Every problem loan is different. There is a customized approach. Some are work with and hopefully they will improve. Some are to work out of the portfolio -- some voluntarily and some involuntarily through liquidation. Clearly, we know that the ratio is still about where we would like it to be and we look for further improvement in that metric in 2007. We do believe, though, that the quality of the portfolio continues to improve.

You indicated criticized loans were 48 million. How does that compare to September 30?

Again, I don't have the exact number, David, but I would -- an approximate number is probably a $10 million reduction from September 30. And again, it was $38 million year-end to year-end.

Just to make a point -- I mean, that has been one of our challenges is to continue to improve the portfolio, as I said and as Ron has said, we see a nice reduction in the criticized classifieds. Some of that is due to those loans, in fact, improving in their performance. But also, it is a result of moving some of those loans out of and off the balance sheet. So that has impacted our outstandings as well. So I mean our originations are improving, but that is in the face of a steady stream of loans leaving the bank from the problem loan area. And obviously, we hope that continues, but at a smaller level, helping us to improve the net loan outstandings performance.

How do you manage -- how do you measure your core customer base? Is that number of accounts or number of households? And can you give us the directions, say the number of households or number of core accounts that you had at year-end compared to, say, September 30 and, say, June 30?

This is Matt Murtha. It has been fairly steady in both levels. The back half of '06 is virtually the same as it was even from July 1 in both households as well as accounts outstanding.

So that is really a good reflection of our ability to stabilize the franchise. As you know, this time last year we were still experiencing some run-off as a result of our problem loan sale, some reputational issues. We feel very confident that that is well behind us now and that our customer base, our household base is stabilized nicely.

How about share repurchases? Do you have any intentions to accelerate a repurchase program?

We announced the program I think it was October 25, $5 million buyback program over a year's period of time. As we stated in a press release, very modest buyback shares in the fourth quarter. And I guess the only comment I would make on that is that the guidance our Board has given us is to do it from time to time as we think what that shareholder value would be enhanced.

Sounds good. Thanks.

Julienne Cassarino, Prospector Partners.

You know the growth is simply not materializing for whatever reason. I think there is probably a couple of reasons that you're having trouble regenerating growth and I think some of them simply may be structural. I think it is probably hard for you to get new lenders to come work with you, that's my guess. At any rate, you should be -- you are over-capitalized for your growth. And I think you should be returning capital to shareholders in the form of a buyback dividend and that you should also be considering some other alternatives if you are not going to get the growth.

That's a statement or question. I will take it as both. On the growth issue, there are some macro issues that are in play in Western New York where we are located. The macro-economic climate is not that strong. We are seeing some signs of modest strengthening, but overall it is not that strong. So the demand is not as strong as we like to see it, number one.

Number two is it is a highly-competitive market. And we feel at this stage in the credit cycle, we are going to be remain disciplined on our underwriting. And frankly as a result of that, we have been passing on a fair amount of opportunities that we have looked at. So we have been looking at a lot of lending opportunities, but are remaining disciplined to our underwriting criteria.

Your other comment on attracting good lenders -- we have hired a lot of new lenders this past year, commercial lenders, that we think complement our existing team extremely well. And we think that 2007 will result in better lending performance as a result. On the capital issue, I will flip that to Ron, but that is something we look at continuously.

Just to echo Peter's comment there, we to review it. Our Board reviews our capital position and I understand your comment. And we view -- certainly review all alternatives on a regular basis.

Any other questions?

(OPERATOR INSTRUCTIONS). Chris Buonafede, OZ Capital.

A couple of questions. One, I think in response to a prior question you mentioned you don't generally give a lot of detail about the numbers in the pipeline. But can you give us some kind of sense for what originations are -- were during the fourth quarter and what payoffs were?

We really don't break those numbers out from a public standpoint. But as I mentioned earlier, I mean there are a lot of metrics in play. You have your typical amortizations and you have your early payoffs. Some of those are voluntary, but some of them are due to work-out efforts. I can tell you that our originations are improving. And that is why we feel that 2007 should show some modest loan portfolio growth.

But there are a lot of factors in play on that. But we feel that we have positioned ourselves well with a good lending team in the marketplace that we are in. But I just caution, we are going to be very disciplined in our lending approach. We want to build a good quality loan portfolio and we think that that may take longer than any of us would like. But we think that that will continue to grow, but very modestly.

I agree in terms of the building of the quality. We definitely don't want to see -- we definitely don't want to return back to the days of a year and a half ago or so, that's for sure. Secondly, can you tell me what the dollar cost of deposits was in the fourth quarter?

I'm sorry, can you rephrase that?

Can you tell me what the cost of deposits was in dollars in the fourth quarter?

Total interest expense, or --

I have that, just for the deposit piece.

So basically, Ron is looking up some information. This is to net out other types of --

I am trying to get a sense for the all-in cost of deposits.

By all-in you mean other than interest expense?

Just the total -- the net yield on all -- the net cost, and you can give it to me in dollars or terms of yield, or cost in terms of rate, on total deposits?

Hang on just a second.

Two point -- our cost of funds for the fourth quarter was 2.41%. Is this helpful?

Okay. On the credit quality side, is the loan that went into non-accrual is that -- I assume that was something that was originated sometime ago. Is that correct?

That's correct.

How much of that -- I know I remember last year in relation to the loan sales and all that, there was a kind of reduced exposure to that industry rather significantly. If I am not mistaken.

Correct.

What is kind of left in terms of exposure to the dairy industry?

Well, our total agricultural component of our portfolio is roughly 6% of the total portfolio. So we have reduced that fairly meaningfully. The dairy component of the overall ad portfolio, we don't have that specific figure. But I think the overall figure will give you a sense that it is a much smaller element of our portfolio, therefore our exposure to the ag and dairy industry is much less today.

And then you felt pretty comfortable that this one would be rectified fairly -- or at least given the comments in the prepared statements, you felt pretty comfortable that this loan would be kind of a resolved at some point during, 2007. Was that --

That is our hope. I mean it is in an aggressive workout mode and as I said, all workout loans are unique. And it is our hope that we can get that resolved this coming year.

And then the last thing, I will just reiterate the last caller mentioned about capital and the share buybacks. And I think the share repurchase program was outstanding for a year -- in the original release, the expectation was you would buy the stock back within one year, is that correct?

Correct.

So I assume that nothing has changed in terms of that front. And I think given -- from our standpoint, given the shrinkage in the loan portfolio, the Company obviously has a very healthy capital base and a very stable deposit base. It is obviously not levered much at all. Using some of that capital for share repurchase, particularly where the stock is, we think is actually a very -- would be a very good move. And we would hope that you would be a little bit more aggressive in terms of that front, given where the stock is trading.

We understand your point.

Okay. Thank you.

(OPERATOR INSTRUCTIONS). David Dusenbury, Dalton Greiner.

Just a couple of odds and ends. Just want to make sure I heard it correctly, criticized assets for the third quarter of this year was 38 -- was $48 million?

Criticized and classified, special mix and substandard assets were $48 million at December 31.

And then back up a quarter for me. How much have they declined quarter to quarter?

Approximate $10 million.

And then in terms of the number of lenders you have hired, can you remind me how many you have hired in terms of percentage increase, kind of when they came on board over the course of the year?

I can't give you the exact figures. All I can tell you is that we --

So, how about our percentage increase? Just something to work with.

We had a fair amount of turnover in lenders and this was part of the challenge in creating what we felt was the appropriate credit culture within this company and the underwriting processes that we now follow. So we had a fair amount of turnover in the tail end or the mid of 2005 and that continued somewhat into, let's say, the first six months of '06.

We were able to basically replace all of those lenders that have left us. And that number is roughly about 15 lenders, commercial lenders. We have been able and very successful to attract a good group of quality lenders that is working with our existing and our historical group of very strong lenders. And as a result, and I think you know the dynamics of the business, it takes a while for those new lenders to develop their relationships, to get their pipeline flowing, and for those sales efforts to result in loan outstandings. So we think that we are building good momentum on our calling and our sales pipeline. And that is why we are optimistic for some modest growth in 2007.

And these 15 lenders, are they from within the market, were they other senior lenders from other institutions?

Generally, they are in market. So they are familiar with the market, they are familiar with good lending opportunities. And that has been helpful.

I would imagine they could have come with a book that they could have culled through?

In some cases that is true, but it is an extremely competitive lending environment. And a lot of banks, ourselves included, put some meaningful prepayment penalties on our credits. So it is not as easy for a lender to bring over a book of business as you would think. We hope that happens over time, though.

And then in terms of your outlook for the net interest margin, what assumptions are you making, in terms of interest-rate outlook, over the course of '07?

We read, I think, the same interest-rate and economic forecasts as most people. And I think that the ones that we are using for our planning purposes basically have a drop in rates occurring somewhere in the second quarter and a bit more in the third and fourth quarter and taking the inverted curve and basically flattening it, but not turning it positive.

So a rate cut in a second, a rate cut in the third, and a rate cut in the fourth?

A drop in the second, third, and fourth. Yes.

And then I hate to pick-pile here, but in terms of the capital. Your capital ratios are, I mean as far back as I can go very quickly to 95, they are above all those levels. So I would also welcome a more-aggressive attitude in terms of stock buybacks.

Well noted.

(OPERATOR INSTRUCTIONS). There appear to be no questions at this time.

Well thank you, everybody, and that concludes our call.

Thank you. This concludes today's Financial Institutions fourth quarter fiscal earnings 2003 earnings conference call. You may now disconnect. Have a wonderful day.