Fifth Third Bancorp (FITBP) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2006 MB Financial earnings conference call. My name is Nicole and I will be your coordinator for today. (OPERATOR INSTRUCTIONS). I would now like to turn the presentation over to your host for today's call, Mitch Feiger, CEO of MB Financial, and Jill York, Chief Financial Officer of MB Financial. Please proceed.

This is Mitch Feiger. Before we begin I need to remind you that during the course of this call we may make forward-looking statements about future events and our future financial performance, so we caution you not to place undue reliance on any forward-looking statements which speaks only as of the date made, of course. These statements are subject to numerous factors that could cause actual results to differ materially from those anticipated or projected. And for a list of some of these factors please see the forward-looking statements disclosure in our 2006 third quarter earnings release from this morning.

Again, I am Mitch Feiger, CEO of MB Financial. And Jill York, our Chief Financial Officer, is here with us today. And thank you for joining us.

This is our first quarterly earnings conference call. In the past we felt that our Company and our results were transparent enough that our earnings press releases and 10-Qs and 10-Ks spoke for themselves. And frankly we feel that you are very busy, especially during earnings announcements -- during earning announcement periods -- and we didn't want to waste your time listening to another earnings call that didn't provide useful information.

But this quarter things are different for us, and we felt that we could help you better understand our performance and results by taking some of your time today. We will continue to host quarterly earnings calls if you feel it is helpful, so let us know.

The most significant event for us this quarter was that in the middle of the quarter, specifically on August 25, we completed our acquisition of First Oak Brook Bancshares. Consequently, our third quarter results are very difficult to interpret. To the degree possible, we're going to try and remove that noise for you in this call.

Also today in our press release contains a great deal of information that we thought would help you separate our operating performance from the impact of that acquisition. I suspect I will be referring to that press release several times this morning.

I'm going to make a few high-level comments about our Oak Brook acquisition and then our operating performance. And then I will turn over to Jill so she can provide more details and insight.

First, the Oak Brook acquisition is working out at least as well, and in many respects better, than we had expected. To refresh your memory, we announced the acquisition on May 2 of this year. And we thought that the required regulatory reviews would cause a fourth quarter 2006 closing. In fact, we closed in August, about three months earlier than we expected. And since we closed in August we were able to accelerate our systems conversion. At the time of announcement in May we had planned to convert Oak Brook Bank to MB systems in the first quarter of 2007. Now we're going to convert this coming Thursday, in three days. That will allow us to realize around 85% of $12.6 million of anticipated annual cost savings beginning around the first quarter of 2007. Hopefully toward beginning of that first quarter.

Back to our financial results for the first quarter. We owned Oak Brook Bank for 36 days in the quarter. The quarter includes the purchase accounting and securities offerings related to the acquisition. Just to refresh your memory, we issued around 8.4 million shares of common stock to Oak Brook shareholders, $30 million of trust preferred securities, $10 million of subdebt. And also don't forget, we used about $50 million of cash on hand to fund the acquisition.

We materially restructured Oak Brooks' balance sheet in the quarter by selling around $345 million of indirect auto loans, and several hundred million dollars of investment securities. The proceeds of each were used to delever our balance sheet by paying down brokered CDs at wholesale funding.

And with regard to auto loans, those of you who have followed Oak Brook -- First Oak Brook know that indirect auto lending was an important part of their program. We have significantly scaled back our indirect auto lending activities. We are continuing to make Harley Davidson loans. We think we can get paid for making those loans. But the amount of auto loans we will originate in the future will likely be quite small and not worth discussing.

Back to our financial results. In the quarter we incurred merger expenses of around $17.3 million. $16.5 million of that is part of purchase accounting and didn't run through our income statement, and $800,000 of that is not part of purchase accounting and did run through our income statement in the third quarter. Finally, earnings for Oak Brook for the 36 days that we owned them were essentially what we thought they would be.

Now on to MB's performance. Our performance in the quarter, excluding Oak Brook, and we're going to try and talk to that a lot in this call -- excluding Oak Brook, was worse than we expected, and certainly less than we would like. Including Oak Brook, we earned $14.7 million in the quarter, equating to $0.46 a share. This was less than last quarter and less than the same quarter a year ago.

Some of the our less than satisfactory performance may continue and others won't. So now I want to turn the call over to Jill so she can discuss those and other things with you.

Thank you and good morning everyone. As Mitch mentioned in his opening remarks, this was a noisy quarter due to the First Oak Brook merger, so I will try to provide as much color as I can on the quarter.

For the quarter, as Mitch said, we earned $14.7 million, or $0.46 per share compared to $16.6 million or $0.50 per share in the third quarter in 2005, and $17.1 million or $0.60 per share in the second quarter of 2006.

The [IVIS] estimate throughout this quarter was $0.61 per share. Based on our $32.1 million average diluted shares outstanding this quarter, the IVIS estimate of $0.61 per share translates into about $19.6 million of estimated net income for the quarter. Obviously, we were well short of that result. While we don't have the detailed models that our outside analysts used to calculate their estimates, the following are major items that we believe caused the shortfall compared to IVIS estimate.

First, as Mitch mentioned, there were merger-related expenses due to our transaction with First Oak Brook that were required to be expensed versus included in the purchase accounting. These expenses totaled $800,000 and were related to severance, termination fees and asset write-offs incurred on the MB side related to the First Oak Brook transaction. As these expenses were incurred on the MB side the correct accounting was to run these through expense versus purchase accounting. On an EPS basis this accounted for about $0.02 of the variance between our actual results and the IVIS estimate.

Next our provision for loan losses was $4 million for the quarter. On a pretax basis, we estimate that this contributed about $2.5 million of the shortfall to what the analysts had estimated for us. On an EPS basis this would account for about $0.05 of the gap.

We had one large charge-off totaling $3.7 million impacting our [needed] permission. While charge-offs were higher than we would like this quarter, we believe that our credit quality is still very stable. Our ratio of charge-offs to average loans has been 22 basis points for each of the past two years. Annualized charge-offs this year are also running at 22 basis points. So this ratio has been very consistent. In addition, our ratio of nonperforming loans to total loans at 40 basis points is lower than the previous 15 quarters.

For additional analysis purposes we added a table to our earnings release showing trends and credit quality, including potential problem loans over the past 15 quarters. The provision this quarter of $4 million is about twice what we would expect going forward, given the size of our current loan portfolio.

The third item that we believe caused a shortfall compared to the analysts' expectations was net interest income. We estimate that on a pretax basis this may have contributed about $2.5 million of the shortfall to what the analysts estimated. On an EPS basis this would be about $0.05. While our net interest margin was stable for the last quarters, we suffered from some margin compression this year. Excluding the impact from First Oak Brook, our margin declined 9 basis points compared to our second quarter of 2006.

In addition, loan growth was soft this quarter compared with our growth in the first half of the year. Much of the growth had come from lower yielding lease loans. Deposit growth has continued to be very challenging in our market. I will provide further color on balance sheet trends in a few minutes.

This quarter we included an additional net interest margin table for the month of September which was our first full month post merger.

Our net interest margin in September was 3.34% on a fully tax equivalent basis. We sold $345 million of First Oak Brook's indirect auto portfolio near the end of September. This will have a positive impact on our margin going forward. This will be offset by a bit more margin compression due to some remaining liability repricing on the MB side. We believe that our margin in the fourth quarter is likely to be between 4.35% and 3.41% on a tax equivalent basis, varying within this range and perhaps beyond this range, depending on balance sheet leverage.

From a fee income standpoint, revenues in the quarter were soft. Leasings is having a tough year. This is the first year that they have missed their plan. In addition, we had a large residual write-off in the third quarter totaling $545,000. We expect Leasings to do better next year.

The other area where we had struggled to get growth is in deposit service fees. Due to higher short-term rates this year, earnings credit rates are up, suppressing monthly deposit fees. Overall we estimate that the shortfall in fee income was approximately $900,000, or $0.02 on a fully diluted basis, compared to what the analysts may have estimated for us for the quarter.

I hope these comments have been helpful. In addition we have tried to make the earnings release as detailed as possible. Now I would like to give some color on balance sheet. From an overall loan standpoint, we grew by about 4.5% on an annualized basis from the end of the second quarter to the end of the third quarter. Since First Oak Brook was not in the beginning of quarter data, I include their balances from their second quarter 10-Q, and excluded indirect auto loans from the calculation.

In terms of the specific categories, commercial real estate was down slightly compared to the end of the second quarter, and really hasn't grown much compared to a year ago. C&I was up 9% compared to a year ago, and was also down slightly compared to the end of the second quarter.

[Weak] loan growth continues to be robust. This category has grown 37% compared to a year ago, and the third quarter continued that trend. Construction loans have also grown at a rapid pace both on a year-over-year comparison and for the quarter. On an annualized basis construction loans grew by 27% during the quarter. Excluding indirect auto, consumer loans were flat for the quarter. Also keep in mind that we may sell or securitize some of First Oak Brook's fixed-rate residential real estate loans in the fourth quarter.

From a deposit standpoint overall deposits were flat compared to a year ago. Overall deposits declined compared to the second quarter. Most of this decline was planned and was due to the runoff of some brokered CDs and high rate public funds. This accounted for $257 million of the $330 million decline in deposits.

In addition, we have yet to see our typical run-up in commercial DDA balances that normally occurs in the second half of the year. Overall DDA balances declined by $44 million compared to the end of the second quarter. While we are growing our number of transaction accounts at about 4 times the pace of prior years, we have seen a mix shift in balances from DDA accounts and other lower yielding transaction accounts to higher yielding certificates of deposit. This mix shift has put additional pressure on our margin.

From a security standpoint balances have declined from Q2, if you include First Oak Brook securities at June 30. We sold around $335 million in First Oak Brook securities, many of these were callable, and collectively securities declined approximately $318 million from the end of the second quarter. I would expect our securities balances to continue to gradually decline, as most of the cash flows for maturities and paydowns are used to repay borrowings versus reinvest in the portfolio.

Now I will turn of the callback to Mitch for some additional comments on the operating environment and our first Oak Brook integration activities.

I've got about one more minute of comments and then we will open it up for questions. As you know, we are operating, at least in what I believe is the most competitive banking market in the United States. Our loan rates are lower and deposit rates are generally higher in Chicago -- in the Chicago area than just about anywhere else. And there's no doubt, at least in my mind, that there are a lot of loans being made in our market, hopefully not by us, where rates and fees can't possibly provide an adequate risk-adjusted return.

As a result, we have had to work very hard to generate loans. I believe we have the very best commercial banking staff in the market, bar none, and we're generating a lot of loans, but we're also being very careful to make sure we're building a loan portfolio that we will be proud of in any economic environment. So time will tell.

Bottom line, loan demand is good, but not great. Loan growth was less than what we would have liked in the third quarter. But remember that loan generation can be quite lumpy. I looked -- if you look at the last ten quarters that not affected by an acquisition for us -- you've got to go back about three and half years. Linked quarter annualized loan growth has ranged from 4.5% to 26.3%. This quarter's clearly at the lower end of that range. But keep in mind that some of our strongest lenders were very busy in the second quarter doing due diligence. And second quarter work turns into third quarter loans.

Right now our pipeline for the fourth quarter, and though things could certainly change, -- I'm sorry, our pipeline for the fourth quarter looks good. And though things could certainly change, we expect loan growth in the fourth quarter to return to normal.

With regard to deposits, we made some changes to our deposit rates in anticipation of closing the Oak Brook transaction. The effect of that, though very difficult to quantify, is somewhat lower deposit levels, especially the area of public deposits. In the past for MB the fourth quarter has traditionally been our best quarter for growth. We're hopeful that this year will be the same. In fact, in many years the fourth quarter has provided just about all of our deposit growth for the year.

Our goals continue to be improving our deposit mix and growth rate. We have made a huge step forward improving our deposit growth rate with our Oak Brook acquisition. We continue to work on improving our deposit mix.

With regard to the impact of our Oak Brook Bank acquisition, please keep in mind that almost none of our expected cost savings have been realized, and little will be realized in the fourth quarter. Since we're three months ahead of schedule, cost savings at an annual runrate of around $10 million or $11 million per year should be almost fully in place in the first quarter of 2007. We continue to expect savings of at least $12.6 million per year, and perhaps more starting in 2008. At $12.6 million per year, it equates to around $0.22 per share per year.

As I said, systems conversion is schedule for this Thursday. Oak Brook's earnings are on target. Oak Brook's credit quality remains pristine, as advertised. Staff retention has been excellent. And so far we haven't had any unpleasant surprises, and we haven't lost any significant customers. Lastly, we should be done by year end.

All right, at this point I would like to open it up for questions, and hopefully we can answer them. We certainly will try to the best of our ability. Nicole, let's open it up.

(OPERATOR INSTRUCTIONS). [Todd Beakman], Fidelity Investments.

It looks like he's dropped the line. Kevin Reevey, Ryan Beck.

Can you talk about what you're doing to grow your leasing income business, because that number did come in lighter than we expected?

Let me start out by answering, and then Jill can jump in if she has anything to add. Remember that the fee part of our leasing business, which is only one component, comes from leases that were bought three and four years ago. Most of the fee part comes from gains on the residuals. What we're looking at right now -- we're realizing in 2006 business that was booked in 2002 and 2003. I think that was a tough time to originate high-quality leases. I think our people did the best job they can. For that same reason, we're quite hopeful that 2007 is going to be a better year for the leasing business. Anybody (inaudible)?

I think in addition, in that 2002/2003 timeframe there were some schedules written that had some higher residual balances or at the high end of what we typically write. And those have been tossed in terms of remarketing. As a result, we have had a little bit higher losses on residual remarketing this year than we did say in 2005 or 2004.

On the trust income line item that was down about 55% linked quarter. Can you give us some guidance as to what we should expect in the fourth quarter?

That number to me does not sound correct. Actually, I have a schedule here, so bear with me for a minute, that breaks out trust for us, excluding Oak Brook. Let me find here the right line. What I show is that trust, excluding Oak Brook, is down about $110,000 on say $1.5 million or so revenue from the second to the third quarter. This can be a little lumpy from period to period. I know in the second quarter we do have some trust tax revenues that relate to year-end filings. The second quarter is typically a little higher than the third quarter. That is what I really attribute that slight decline to.

The trust business has got its core growth rate inside trust and asset management -- is right around 10% in fees. But it vary a bit quarter to quarter. It could vary based on tax preparation work, and it could vary based on estate settlement work as well.

Can you talk a little bit about what you're doing to grow your DDA balances, particularly your business DDA account?

I would be happy to. We have had and continue to have a very robust really state-of-the-art treasury management productline or product set. I think one of the things that we're doing in our Oak Brook systems conversion here is we're taking the opportunity to upgrade a couple of our systems to make them even better.

So treasury management and treasury management sales are key to growing our commercial DDA. The other things that we do are -- we expect a whole relationship with all of our commercial customers. Pretty much, if you're a commercial borrower here, you need to have your checking account here. It is just expected. That is what we do.

One of the things that we started this year, and we're going to advance more next year, is shifting -- without getting into specific details -- shifting more of our commercial banker incentives to deposits and low-cost deposits. If you go back here say four years ago, or three years ago, the lion's share, maybe 80% or 90% of the share of lenders -- of commercial bankers incentives annual incentive was based on loan quality and loan originations and loan growth. Things like that. That has become much more balanced here, and I think in 2007 it will shift even more towards the deposit side.

Brad Milsaps, Sandler O'Neill.

Just a couple of questions on the deposit side. Have you guys made a decision yet which direction you're going to go in terms of how you're going to tackle the retail branching side? First Oak Brook had very much a brick and mortar -- added a handful of branches per year, and you guys had sort of gone in the opposite direction of maybe adding one or two, but really pressing the gas total on the extended hours, etc. Have you come to any conclusion there on what you're going to do going forward?

With regard to branching, if we are confident that we can build open and grow branches as rapidly as Oak Brook did, I think we will continue to branch. Now we are not going to get crazy about it. But we've got 62 branches now in the Chicago market. And if we added two or three, four a year I think that would be perfectly acceptable.

But like before, before Oak Brook at MB we were not confident that we knew how to build them, open them and grow them in a manner that we got a good return on our investment. It seems, and now that we've worked with the Oak Brook folks for quite a while here, we're gaining a lot of confidence that we will be able to do that.

Now we have got two branches that just -- one just opened and one is about to open here. One is in Glenview, right on the Glenview Northbrook border in Chicago and the other is going to open in Oaklawn shortly. We're going to watch those very carefully to make sure that they perform the way we think they should perform. And if they do, then we will go down the path of opening 2, 3, 4 branches, something like that a year.

The first part of this question was --? What was the first part of your question?

Just kind of which -- it sounds like you answered it -- which kind of strategy you're going to pursue going forward. It sounds like a mixture of both.

That is the branching part of the strategy. Yes.

Then secondly, just to make sure I understand how the cost saves are going to come in. You said you thought you could get 85% of the $12.6 million that you projected back when you announced the acquisition in May. Do you expect that to come in pretty evenly on a quarterly basis, or do you think you'll see a lot of that upfront?

We're going to see almost all of it at the very beginning of 2007. We're going to be done with the systems conversion this week. And there is the cleanup part which requires pretty much full staffing still. And I am guessing that -- barring a catastrophe -- that will go through the end of 2006. And then our staffing levels and our operating expenses will show those costs saves. Some of it, a little bit of it may flop into January or early February, but not much.

I think it would be fair to say that for 2007 we are expecting, at least what we communicated in terms of savings, which was $10 million and probably more than that.

Can we expect anything on the MB side in terms of cost savings? I know you talked a little bit about revenue being under pressure for MB on a stand-alone basis. How much leverage do you think you still have on the MB side to cut some cost?

I think we're watching our expenses as carefully as we can. I think we continue to invest in lenders, in investment management folks. For revenue related people we continue to invest. I don't think we have lost sight of the need to invest in those areas. But in terms of our back office, we're trying to do the best we can to control costs.

Final question, and I will step back. Did you guys keep First Oak Brook syndicated loan book in the merger?

Yes.

Yes.

Are you going to manage -- how are you going to manage that? Are you going to manage that sort of lower or is that a business you're going to stick with?

That is a good question. I don't know that we have formed a final opinion on that. I will tell you what we have done. What we have done is we've worked with -- there's one syndicated lender at Oak Brook basically. We have drawn, if you will, parameters for him that if he can source loans that meet those parameters we maybe -- those are the kinds of things we would be interested in.

I don't think the book is going to grow much, if it grows. It is about $100 million now. It is a pretty small piece of the total. By the way, some of their -- I shouldn't say that. I don't know that that to be the case.

So it is a small pace. I don't think it a material component. And if we'll even out there -- we will leave it out there only for our benefit. In other words there may be opportunities for us in some of those credits to participate in treasury management activities or other kind of loans, or who knows what.

(OPERATOR INSTRUCTIONS). David Konrad, KBW.

I have a couple of questions. The first is a little bit of a housekeeping. Maybe, Jill, you can help me with. Is the gain from selling the auto loans of about $338,000, where does that show up on the income statement? Is it netted out of the loss of other assets, the 296?

No, it is within the other category.

The $1.7 million other.

Correct.

I guess the other question I had was just on credit in general. I don't know if you would like to shed any light on the one credit, the 3.7 credit, just on an industry, or what happened here? But it sounds to me that you feel like, although 20 basis points is a good normalized level, and the issue may be more just getting credits at a decent risk-adjusted rate of return rather than credit cost going forward.

Yes, what you say is always the case. We get paid for the risk we're taking. The credit where we took the loss is in an industry that is struggling a bit in the economy right now. Although it wasn't a construction loan, so it is not that. I could tell you about the industry it in and the credit, but it doesn't matter. This was a loan that -- I think frankly this was a loan that shouldn't have been made, and it didn't matter what industry it was in. We don't -- looking back on what happened on this particular credit it isn't the kind of thing that happens around here. I don't know whether it is worth discussing much more than that. I consider it a bit of an oddity. We had one about -- when was the other one -- maybe the beginning of 2005, was it?

Yes, the first quarter of 2005.

The first quarter of 2005 we had another one that was around $3 million. I think part of it -- we have got a $5 billion dollar loan portfolio and the loan activity around here is very intense. The number of loans -- we originate more than $1 billion of loans a year. And I think that we try to be perfect and we're not -- and we're not perfect. I wish we were.

But fortunately when we looked at -- and I looked at, and we all looked at the cause of this one, we don't see that as happening elsewhere or other times in the Company. I consider it quite isolated.

Ross Haberman, Haberman Funds.

A quick question on the $12 million of savings which you talked about. Will most of that hit the bottom line, or again do you need to do additional spending on the Oak Brook Bank to really achieve that saving?

You cut out a bit when you got to the second half of your question.

Story, the question is will that $12 million hit the bottom line, or do you need additional spending and marketing or so forth to really achieve that?

That $12 million will -- that will hit the bottom line.

It will. Okay.

Yes. Basically we didn't even factor in much in the way of marketing savings. We assumed that we would spend much of what Oak Brook is spending today in marketing. We don't have to spend additional money to get the $12.6 million.

None of that is revenue. None of that is revenue enhancement. We never forecast revenue enhancement. We don't include that in our projections.

They had a great deposit franchise there and their lending business was fair to say the least. Are you having much runoff on their deposits, on their branches more than you might have built into your into expectations?

No, no. We did through pricing, we made the decision to let their high rate public fund CDs come down a bit from the end of the second quarter to the end of the third quarter, but that was planned.

But in all fairness, they have been operating in the market pretty much as they were before under the name Oak Brook Bank. Their customers have not seen the changes that are about to come on Thursday. I think when most companies have runoff, it is in that two or three month period following the name change and the system's conversion.

What kind of assumptions do you have built into the deposit side? What kind of runoff deposit assumptions?

I don't think we have ever talked about that. One thing to keep in mind is Oak Brook's cost of funds, particularly their margin of cost of funds are pretty high rate, so the alternative at wholesale funds isn't far from it. If we lose some ratebase kind of money, I don't think it is going to have much impact.

That said, the past -- the group of people here are very experienced at this. And in the past we have been very successful at retaining deposits through that period. In one instance we actually grew them through that period. I think we all feel pretty good about how this is going to work out going into the process.

That was my questions. Thanks guys.

(OPERATOR INSTRUCTIONS). There are no further questions at this time. I would now like to turn the call back over to Mr. Feiger.

Thank you very much for joining us today. And if you think this was helpful, and you had desire, let us know if we you think we should continue on our quarterly calls. We tried being open, as open as possible with you. And I think if you read our release, you'll see that is the case. Thank you and goodbye.

Thank you.

Thanks for your participation on today's conference. This concludes the presentation. You may now disconnect. Good day.