Financial Institutions Inc (FISI) 2018 Q1 法說會逐字稿

Good morning, and welcome to the Financial Institution, Inc. First Quarter 2018 Earnings Call. (Operator Instructions) Please note, that this event is being recorded.

I would now like to turn the call over to Shelly Doran, Director of Investor Relations. Please go ahead.

Good morning, and thank you for joining us for today's discussion. Providing prepared comments on the call will be President and Chief Executive Officer, Marty Birmingham; and Chief Financial Officer, Kevin Klotzbach. For the question-and-answer session, they will be joined by Chief Corporate Development Officer, Bill Kreienberg; and Chief Accounting Officer, Mike Grover.

Today's prepared comments and Q&A will include forward-looking statements. Actual results may differ materially from forward-looking statements due to a variety of risks, uncertainties and other factors. We refer you to yesterday's earnings release and our historical SEC filings, all available on our website for our safe harbor description and a detailed discussion of the risk factors relating to forward-looking statements. We will also discuss certain non-GAAP financial measures intended to supplement, and not substitute for comparable GAAP measures. Reconciliations of these non-GAAP financial measures to GAAP financial measures were provided in yesterday's earnings release, which was filed with the SEC yesterday as an exhibit to a Form 8-K and is available on our website. Please note that this call includes information that is accurate only as of today's date, April 27, 2018.

I will now turn the call over to President and CEO, Marty Birmingham.

Thank you, Shelley. And once again, good morning, and welcome to Financial Institutions' first quarter earnings conference call. It was a good quarter for us as we continue to make progress on our long-term strategic goals. We had good loan and deposit growth with low charge-offs and a decrease in nonperforming assets. We were also pleased with the level of noninterest income during the period. And lastly, we kicked off an exciting new branding campaign, that is increasing awareness of our brand and linking our terrific community banking platform with our highly capable wealth management and insurance businesses. The campaign is designed to bring us new opportunities, and ultimately, incremental revenues.

During the quarter, we were pleased to share some of the benefits of tax reform, with both employees and shareholders. As previously communicated, our first action was a one-time award of $500 to our employees, not covered by certain incentive programs. And second, was an increase in the common stock dividend payable to our shareholders from $0.22 per share per quarter to $0.24. We continue to monitor the impact of the Tax Cuts and Jobs Act in our markets and are optimistic about the positive impact of tax reform. Low unemployment and high consumer confidence should bode well for commercial and residential loan growth. But we believe it will take time for the benefits to be fully realized.

Our total loans at quarter-end were up 2% over the previous quarter and up 16% as compared to the prior year. Total commercial industrial, commercial real estate and small business loans increased 2% from December 31, 2017, and 22% from March 31, 2017. The first quarter is often our highest in terms of -- lightest, excuse me, lightest in terms of commercial lending activity, and we were not surprised that portfolio growth was lower as compared to the past few quarters. In addition, we experienced a high amount of commercial loan closings in the fourth quarter of 2017, reducing our pipeline of loans approved for closing as well as higher-than-expected first quarter loan pay downs. We continue to be pleased with commercial loan growth and its sustainability, and we expect an acceleration of growth throughout the remainder of 2018, especially in the second half of the year. We continue to make progress in the development of our mortgage banking operations. Mortgage loan production in the first quarter was slightly ahead of our expectations, and our pipeline remains steady. The product mix is diverse, including adjustable and fixed rate products as well as home-equity, jumbo and CRA offerings. We look to expand our salable activities with an eye toward higher fee income. We remain open to adding mortgage loan officers throughout our footprint particularly, where we have the greatest opportunities.

Consumer Indirect loans were up 2.5% during the quarter, where we continue to see upward movement -- upward rate movement in this business. This trend is expected to continue, which will positively impact portfolio yields. Performance of the portfolio remains strong with delinquency levels well below industry averages and net charge-offs consistent with our historical experience. Total deposits were $170 million higher than at December 31, 2017, primarily due to public deposit seasonality and $210 million higher than at March 31, 2017.

Nonpublic deposits were 8.5% higher than March 31, 2017, and 1.5% lower than December 31, 2017. We typically experienced a decrease in nonpublic deposits in the first quarter, however, this year's decline was a bit larger than in the past, primarily due to a decrease in commercial demand balances. We remain confident in our 2018 plan. The focus on leveraging our attractive deposit franchise and adapting our tactics to maximize core deposit growth continues to be a key priority for our team.

In February, we launched our new brand campaign. The goal of this campaign is twofold: First, to increase awareness of the depth of services we offer in community banking, wealth management and insurance. And second, to increase awareness of Five Star Bank in key urban growth markets, where our share of deposits is very low at less than 4%. Our campaign line of "Today is tomorrow and progress" conveys our customer promise and reinforces our goal to provide solutions today that lead to financial well-being in the future. And in so doing, we put our customers' financial well-being at the heart of everything we do. In connection with the rebrand process, we redesigned the Five Star Bank website. The site was transformed to reflect the new brand's look and feel and to improve functionality and navigation, making it easier for customers to use. We also updated the website content with more relevant and helpful information. Enhancements reach across all digital devices so that users have a wonderful experience whether on a computer, tablet or mobile phone. Initial feedback from the campaign has been very positive, and I encourage you to check out our new website and see why we are so excited about the new brand and the new website.

Before I turn the call over to Kevin, I'd like to talk for a moment about expenses. While we are very focused on expense control, expenses were $944,000 higher than the fourth quarter of 2017 and our efficiency ratio was 61.85%. As noted in yesterday's press release, salaries and employee benefits included approximately $1 million of nonrecurring expense, comprised of 3 components: The employee awards, I mentioned at the beginning of the call, accrued contingent incentive compensation related to the strong EBITDA performance by Courier Capital, and retirement-related expenses of the former owners of Scott Danahy Naylon. Kevin will provide additional information regarding these expenses in his comments. Excluding the $1 million of nonrecurring expense, our efficiency ratio for the quarter would have been well below 60%.

I'll now turn the call over to our Chief Financial Officer, Kevin Klotzbach, who'll provide an overview of financial results and our outlook on key areas for the remainder of 2018. Kevin?

Thank you, Marty. Good morning, everyone. I’ll start with a review of our financial results. Net income was $9.3 million in the first quarter, $1.3 million or 17% higher than the first quarter of 2017. Net income in the quarter was $1.8 million lower than the fourth quarter of 2017. In every call that our fourth quarter results included $2.9 million reduction in income tax expense, primarily driven by a revaluation adjustment of the net deferred tax liability and impact from the Tax Cuts and Jobs Act.

Net interest margin for the quarter was 3.19%, down 6 basis points from the fourth quarter of 2017. Our tax equivalent yield on investment securities decreased by 21 basis points as compared to the last quarter from 2.53% to 2.32% because of the lower federal tax rate in 2018. Partially offsetting this was an increase in our average loan yield of 7 basis points, resulting in an average yield on interest-earning assets of 3.80%, up 2 basis points from the fourth quarter.

Our cost of funds was 61 basis points in the quarter, up 8 basis points from the fourth quarter of 2017. Savings and money market accounts were 2 basis points higher and time deposits were up 12 basis points. Our average short-term borrowing rate was 28 basis points higher this quarter. Also impacting comparability of net interest margin was our funding mix, average public deposit balances, which carry a relatively low cost of funding were lower in the first quarter and more expensive average short-term borrowings were $95 million higher in this quarter as compared to the fourth quarter of 2017. One final item impacting net interest margin comparability between the fourth quarter of '17 and the first quarter of '18, was approximately $300,000 of yield maintenance fees, relating to the prepayment of mortgage-backed securities and payment deferral fees in the fourth quarter of 2017. No such fees were recognized in the first quarter of 2018.

Noninterest income was flat in the quarter compared to the fourth quarter. There were no gains on investment securities as compared to $660,000 in the fourth quarter. However, we did recognize $568,000 of income from investments in limited partnerships. Income from these investments is difficult to predict, as it fluctuates based on the maturity and performance of underlying investments. Investment advisory income was relatively unchanged from the fourth quarter, but it was up $347,000 from the first quarter of 2017. The growth was driven by an increase in assets under management, including the acquisition of assets of Robshaw & Julian Associates, a Buffalo-based firm acquired in the third quarter of 2017.

Insurance income was up $180,000 over the fourth quarter of 2017 and down $32,000 from -- compared to a year earlier in 2017. The first and third quarters are typically higher than the second and fourth quarters because of annual contingent commission revenue received in the first quarter and the timing of commissions and commercial accounts. As SDN transitions its book of business to a higher composition of personal lines as compared to commercial lines, we are experiencing lower seasonality in this income category.

Moving on to expenses. I'd like to provide some additional information regarding the $1 million of nonrecurring salaries and employee benefits expense in the quarter, which is comprised of 3 components: First, was an increase in the accrued contingent incentive compensation related to the financial performance of Courier Capital for the 3-year period 2016 through 2018. This potential future payment of compensation, contingent upon meeting specific EBITDA performance targets was included in our agreement to acquire Courier back in 2016. The incremental expense recorded in the first quarter of 2018 increased the amount accrued to date based on the actual performance for 2016 and '17 and our forecasted performance for 2018. Second were the $500 employee awards announced and paid in the first quarter of 2018. And third and finally -- and the final component was the compensation expense incurred in connection with certain contractual obligations owed upon the retirement of 2 former owners of SDN. These were senior leaders, who have been with SDN for many years, they were integral in building SDN into a successful agency that attracted our attention back in 2014, and we appreciated their efforts in retaining clients and attracting new business as we integrated SDN.

Advertising and promotional expenses was $257,000 higher in the quarter as compared to fourth quarter of '17 because of the new Five Star Bank brand campaign. There will be seasonality in advertising expense going forward and there will be higher-than-historical experience. This higher level of expense was included in our 2018 guidance for the noninterest expense during our January conference call.

Moving on to credit. The loan loss provision was down $1 million compared to the fourth quarter, primarily as a result of the $1.6 million decrease in net charge-off. First quarter charge-off annualized were 30 basis points, 9 basis points lower than our 10-year average of 39 basis points, but by comparison, our 2017 full year net charge-offs were at 38 basis points. Our ratio of nonperforming loans and total loans was 38 basis points as of March 31 as compared to 46 basis points at December 31. Our effective tax rate for the first quarter was 19.6%, reflecting a lower corporate federal rate as a result of the Tax Cuts and Jobs Act.

I'd now like to reaffirm our outlook for the full year and some key areas. We continue to expect high single-digit to low double-digit loan growth in our loan portfolio for 2018, with growth in commercial and residential mortgage lending at a higher rate than Consumer Indirect, as Marty discussed, the first quarter is typically a lighter quarter for us in commercial lending in the rest of the year, and we expect growth for the entire loan portfolio to be higher in the third and fourth quarter than the first and second quarter. We continue to plan for mid- to single-digit growth in nonpublic deposits. We continue to expect net margin for the full year to fall between 3.20% and 3.30%, we continue to expect that our noninterest income in 2018 will be relatively flat as compared to 2017 at around $35 million. This outlook does not include any security gains, which still is $1.3 million at 2017 nor any nonrecurring items, which still at $1.2 million in 2017. We expect noninterest expenses for the second and third and fourth quarters to be within a range of $23 million to $24 million per quarter. We believe the efficiency ratio for the entire year will be within a range of 58% to 60%. Our goal is to be below 60% every year. We expect to continue to convert a portion of our securities portfolio into loans, this will occur as securities mature and we receive payments on mortgage-backed securities. We expect the effective tax rate for 2018 will be within a range of 19% to 21%.

And now I'd like to turn it back to Marty.

Thank you very much, Kevin. Before we do open the call for questions, I just have a few concluding comments. First, I'd like to reiterate how pleased I am with our first quarter results. And importantly, the efforts of all my associates within the Five Star family. We remained focused on strong execution of our plans that are designed to take advantage of significant opportunities across our operating footprint in support of our long-term strategic goals. And we remain and continue to be very excited about our company's prospects and look forward to the rest of 2018.

Cole, this concludes our prepared remarks, and we are now ready to open the call for questions.

(Operator Instructions) And the first question comes from Alex Twerdahl from Sandler O'Neill.

First off, I appreciate all the guidance that you just gave Kevin, but just to clarify couple of things. One on the margin, can you just try to get us, if I sort of back out some of the moving parts for this quarter, the FTE adjustment, the yield maintenance fees. Am I right in calculating the margin sequentially was more flat to up and then actually compressing by 6 basis points?

That would be correct, Alex. It was more flat for a number of reasons. One, is the tax equivalent adjustment -- onetime adjustment that occurred with respect to the security investment portfolio, the municipal bond portfolio. And the second, of course, as you mentioned is the extraordinary item on the noninterest expenses. So closer to flat than down adjusted.

Okay. And then as we kind of look out across the rest of the year for the margin. Is the biggest wild card just deposit costs out there? And maybe you can share with us, what you're factoring in, in terms of the rate outlook and deposit betas as it relates to that?

Yes, so we've talked about this for quite a while, we thought and it actually occurred that the first 100 basis points rise by the fed would be relatively free, turned out, that was about 2 basis points or a beta of about 2. Going forward, historically, on the way down, we noted that the betas between rate decreases and our deposit costs were 25 to 33 basis points, so betas are 25 to 33. We're starting to see that type of correlation and we would expect it to continue.

Okay. And that's what's factored into the margin outlook of 3.20% to 3.30% for the remainder of the year?

Yes.

Okay. And then you said a couple of times that you expect the loan growth to really ramp up starting in the third quarter, so as we kind of do the modeling, it's fair to assume that the loan growth would be similar in the second quarter to what we saw in the first quarter kind of like up 2%-ish? Or do you think it's going to be more flat in the second quarter and then really see a nice acceleration into the end of the year?

So at the end of the day, I think, we Alex, come back to the mid-to-high single digits loan growth on average for the year. And we do believe, that it will start to accelerate in terms of from now until the end of the year with emphasis on the last 6 months.

Al, if you might recall, in the last earnings call, we had -- we did indicate December was a particularly high month for closings and we did put some pressure on our pipeline. So we've seen restoration since that time, and whether or not that restoration evidenced itself in the second quarter or later, but it is there.

Okay. And then just final question, if I missed what your outlook was for fee income for the remainder of the year. If you could just repeat what that was?

Yes, so we've stayed flat on fee income for the year, which is a little bit -- it needs a little further explanation in that when we say flat, it's not really flat because last year, we had the security gains and the contingent liability reversal. So if you look at the true run rate for the year-over-year, it's up a little bit.

Okay. And that's inclusive of the investments in LPs that are little bit harder to project?

Yes, they're almost impossible to project. Remember, last year, we didn't get hardly any limited partnership income. We had a very nice quarter, this quarter. I would not expect that to repeat itself, very often. But it's very hard number for us to predict.

And the next question comes from Damon DelMonte from KBW.

So just -- my first question is, just want to talk a little bit about credit, this is a good quarter for you guys, net charge-offs were less than we are looking for and kind of lower than historical rate, the provision was also a little bit more favorable than we're looking for. How are you viewing the run rate for credit over the coming quarters for the rest of this year? Do you think that provision could track a sub $3 million per quarter level? Or do you expect it to kind of normalize and maybe require a little bit more provisioning?

So if you look at our press release and look at the last 5 quarters. We have had provision expenses anywhere from $2.9 million to $3.9 million, and the difference, quite frankly, is a commercial credit of that. Historically, since I've been CFO, we've had 1 per year, last year, we actually had 2, in 2 different quarters. So I think if you look at the provision at the core rate, you're probably looking at that $2.9 million number, but it will certainly be anticipated because we've had one -- at least one of them every year I've been here as CFO and that changes the dynamics. So we don't give guidance on provision because it is such a high estimate or a highly volatile estimate to make. But I think if you look at the performance, I think you could probably draw some kind of conclusion.

Got you. Okay. That's helpful. And I guess with respect to the outlook for loan growth, which appeared to be very favorable. Any particular, I know, obviously, Buffalo, Rochester are the main areas that you guys are focusing in. But anything outside of those 2 matured markets where you're seeing good growth opportunities? Have you guys ventured further east a little bit in the state or maybe further south something like that?

So we basically are focused on our footprint and we do follow our customers, where they may expand their businesses or have operations, but now generally speaking, we are landing in our footprint, Damon.

Okay. Great. And then I guess lastly, do you guys have an update on the disclosure in the 10-K on the CRA downgrade?

We do not. I think we were very thoughtful in terms of making sure that disclosure was appropriate, and have nothing further to add.

Okay. And has there been any type of restrictions in the way that you're operating or running the bank as a result of that?

None.

And the next question comes from Joe Fenech from Hovde Group.

Just to clarify on what you consider to be nonrecurring costs, Kevin, if you were to exclude, I guess what you feel was truly nonrecurring on the expense side, it sounds like that impacted the bottom line by about $0.03, $0.04 a share after taxes, is that how you're thinking about it?

Yes.

Okay. And on the expense outlook, you launched a new marketing campaign, as you talked about it in February, can you give any specifics on what the full quarter impact of that looks like on the expense side? And then thinking about the run rate, it sounds like you take out the nonrecurring expense you talked about and then added maybe some added amount for the marketing. I know you said it'll be a bit seasonal, but $23.5 million-or-so, it sounds like the right way to be thinking about this go forward expense run rate?

So we gave expense guidance between $23 million and $24 million per quarter. The first quarter was unusual for the items that we -- that incurred, and I there is, I think those were unusual, and I think we're very comfortable with the $23 million to $24 million outlook for the next 3 quarters.

The increased marketing spend wasn't included in the guidance in last quarter and the one that you just reaffirmed.

Absolutely, thank you, Marty. I forgot the first half of the question. But certainly, the marketing expenses that we saw in the first quarter will continue. We've made a dedicated effort in our market space to make the market more aware of our company, and we are -- we did increase spending in the first quarter and that will continue throughout the year.

Okay. And then on capital guide, just trying to get a sense for where that lower bound threshold is that you're comfortable with on TCE, you're just over 7%. I know you just upped the dividend. So it seem as though you're comfortable operating here, and I know in the past you've talked about a lower risk balance sheet, assuming you still feel that way and that's the reason for being comfortable here right around the 7% range on TCE.

That is where we are.

Okay. And then any update, Marty, thoughts on M&A, you think changed from your comments last quarter or prior to that?

No, there really hasn't been any change in that outlook, and we're focused, as I suggested on driving the things that we can control of, Joe, which is the array of organic opportunities right in front of us. We are opened to strategic opportunities, but right now, what's in our control are the organic.

I know it's been said many times before, but we have less than 4% deposit market share in Buffalo, Rochester and that is a real opportunity that our company has, that not all companies have, and we're really looking forward to taking advantage of that.

(Operator Instructions) And the next question comes from Matthew Breese from Piper Jaffray.

Just a couple of quick ones, most of them have been answered. I just wanted to get a sense of given the flatter yield curve, I wanted to get a sense for your ability to defend and maintain that margin. So my question is really, how much of the loan portfolio either reprices immediately or within a short timeframe of like 12 months?

Look, the entire loan portfolio has variability at about the 15% to 20% level. And most of that repricing is fairly, fairly quickly, meaning, within a month or 3 months.

And the duration of the indirect portfolio, is that 2, 2.5 years?

It is 2.2 years. And that's been constant for quite a long period of time.

Okay. And how are yields holding up for auto loans?

Very nicely. We're seeing opportunities in the marketplace to increase our rates, and we've done that.

Kevin, as you and I've talked recently, the production that we're putting on now is actually replacing run-off that is higher, higher-yielding.

Yes, so in this last quarter what we've seen is that, the -- as Marty mentioned, the new rate that we're putting out is actually higher than the rate that was put on for the loans that are maturing. So we think about our margin, in fact that we recognize that we came in at 3.19%, that was very close to our number, our number -- our guidance number 3.20% to 3.30% encompass the full year. There are some positive factors going on within the portfolio, and one of those positive factors is that late in the first quarter, the new loan rate on indirect was actually higher than the runoff rate.

Does that hold true for the rest of the portfolio? And to what extent?

It would be dependent on the segment, Matt, and I have to get back to you on that, on a segment analysis.

Okay, no problem. My last question is really regarding the income from the investments in limited partnerships. Just remind us of what those are? How many you're involved in? And what are the drivers behind a weaker quarter of income versus this quarter where we saw much stronger results?

So Matt, this is Bill Kreienberg, we have an array of limited partnership investments. I don't have the number in front of me, but it's 8 to 10, they're mostly SBICs. The income that was driven in this quarter came primarily from some mature limited partnership investments that we've held for 5 to 7 years. So these funds typically, in their -- at their outset, they're going through a capital raise, they deploy the capital that they raised in the market, and then as the investments mature, they distribute back to the limited partnership owners. So these happened to be of our portfolio. We have 4 that we've recently deployed investments in, in the past 2 years, but these were more mature investments that, this is just part of their life cycle.

And do you expect, I mean we have the guidance, but we've seen a number of these kinds of funds start to return capital? Do you expect more of that and -- into '18 to '19?

It's really hard to predict. What we do expect is this investment type has provided us, we've been in here for a decade now, over the time period, we receive a low double-digit return on the investment and we expect that to continue. But the actual predicting of when the income shows up is totally out of our control. It really isn't within the life cycle of the underlying investments, and those companies in those various SBICs, and when they decide to do certain things that trigger events for their companies like refinance the debt or sell and that's just totally out of our control.

And the next question comes from Kevin Parks from Parks Capital.

So just a question on the preferred, I understand it might be a delicate subject given that it's generally owned by the Humphrey family, but to what extent is refinancing or taking out the preferred part of the conversation you have either at support level or is it just kind of more as part of the management team?

Yes, so there is no condition upon which we can cause the preferred to be automatically redeemed. And there has been and could be discussions about potentially offering a price but nothing has been decided.

Got it. And would you, I guess hypothetically speaking, in -- an instance in which you would tender board or offer a premium for it, would that kind of necessitate, would it be a refinancing or taking out the cash on hand equity, small equity raise, how do you guys think about that?

The way that I choose to think about it is if we're producing a 10% approximate return on equity to our common shareholder, and we have preferred that we have no control over, that we pay a lower yield on that is to the financial advantage of the common holder. And so when you start talking about paying a premium, when that premium then causes you to have a negative outcome with respect to a preferred borrowing rate, if you want to look at it like that as I do, then that would not be attractive to me.

Seeing that there are no further questions in the queue. This concludes our question-and-answer session. I would like to turn the call back to Martin Birmingham for any closing remarks.

Thank you, Cole, I want to thank everybody for their participation this morning. We'll look forward to connecting after our second quarter earnings release. Thank you.

Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.