Huntington Bancshares Inc (HBAN) 2003 Q3 法說會逐字稿

Good afternoon.

My name is Latange, and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Unizan Financial Corporation third-quarter earnings 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) I would not like to turn the conference over to Mr. Jim Pennetti.

Sir, you may begin your conference.

Good afternoon.

Welcome to our financial results conference call for the third quarter.

Hopefully, you have had an opportunity to review the press release we distributed at the opening of the market today.

Joining me this afternoon are Unizan Financial Corporation's President and CEO, Roger Mann, and Jim Nicholson, our Executive Vice President and Chief Operating Officer.

This conference calls being broadcast live over the Internet on our website at www.unizan.com.

And, additionally, the call is being recorded and will be available later today via webcast replay on the Internet or via the telephone 1-800-642-1687 for U.S. participants or 706-645-9291 outside United States.

The conference ID number is 2933482.

Unizan's third-quarter 10-Q is scheduled to be filed on or about November 12th.

Before we get started, I would like to remind you that during the course of this conference call, we may make projections or other forward-looking statements regarding future events for the financial-performance outlook of Unizan.

We caution you that such statements are only projections and that actual events and results may differ materially.

Reference is made to Unizan Financial Corp's filings with the Securities and Exchange Commission, including its annual report on form 10-K for the year ended 12/31/02 and other periodic filings.

Additionally, the Corporation will file an A-K of the transcript from this conference call.

Now at this time, I would like to turn the call over to Roger for some opening comments.

Thank you, Jim, and good afternoon everybody.

Thank you for participating in our call and your continued interest in our company.

Before I turn the call back to Jim, I would like to recap several third-quarter highlights.

Number one, SBA activity continued to be very strong for our company.

Number two, our new strategy of concentrating on smaller aircraft is producing positive results as asset quality was strong, quality of new business is excellent and our pipeline is starting to build.

Three, in our retail banks, our sales training and service projects are beginning to produce favorable results, as our sales per FTE per day have increased over 50 percent since the beginning of the year.

Number four, in our wealth management company, we have reengineered our retail brokerage program and staffed our distribution network in all of our markets.

This will be the first time that we have been fully staffed in this area.

We have also hired a new Director of Investments from a large, regional financial services company with significant experience in this area, and have implemented a philosophy of open architecture and offering the use of outside money management to complement our internal expertise.

Through teamwork and cross referrals, we have to-date exceeded our 2002 insurance production -- of which approximately half of the new business to-date has resulted from internal referrals which were non-existent in 2002.

We continue to execute on our strategic direction and position our company for long-term growth.

Now, for the financial details, I will turn the call back to Jim Pennetti.

Jim?

Thank you, Roger.

I'm going to provide some more detail and insights on the third-quarter's results and discuss some of the items which impacted the quarter's numbers.

Net income for the third quarter was $6.8 million or 31 cents per diluted share.

Last where, we earned 30 cents per diluted share.

Now let's look at some items which affected his quarter's EPS.

First, Unizan recognized net security gains during the quarter by selling about $39 million of bonds and taking $1.8 million in net gains.

This was $1.2 million after-tax or 5 cents per diluted share.

There were three distinct strategies related to these sales.

The first one involved a deleveraging strategy where management paid off $44 million of Federal Home Loan Bank advances with the proceeds of lower-yielding mortgage-backed securities.

These bonds also had higher extension risks, and given their market values, management decided to recognize the gains and pay down the Federal Home Loan Bank advances, which at an average rate of about 6 percent.

The prepayment of the Federal Home Loan Bank advances did impact the margin, which I'll address in a few minutes.

The impact of the FHLB expense to earnings per share was 3 cents.

The second sale was a $5.5 million of smaller mortgage-backed security pools (ph) which provided a gain of $343,000 after-tax.

These proceeds were reinvested in CMOS and mortgage-backs with more stable average lives and cash-flow structures and liquidity.

Management's goal was to reduce its exposure to extension risks on the securities it sold.

The last sale was a $5 million of trust-preferred securities, which lowered Unizan's credit exposure to one particular holding company.

Because of this holding company's acquisitions, we found ourselves with more credit exposure to hit (ph) than we desired.

There are no performance problems with this particular company.

We just had more concentration there than is prudent.

The other item in the securities-gains-losses line was the impairment charge for the North Country Trust-Preferred security.

Unizan took a charge of $250,000 or 1 cent per diluted share in the third quarter.

Management will continue to monitor that situation.

And it is possible that there could be further impairment in the future.

During the quarter, we recovered over $500,000 on the mortgage-servicing right asset.

This equated to 2 cents per diluted share.

So we have recovered about half of our 2003 write-down on the MSR.

Now, I would like to take a closer look at the margin and some of the factors which impacted the margin as we compare third quarter and second quarter of '03.

I have already discussed the prepayment of the Federal Home Loan Bank advances and the impact of EPS.

Since this prepayment expense was recorded as interest expense, it did have a negative effect on the margins.

In fact, it reduced the third-quarter margin by 17 basis points and the year-to-date margin by 5 basis points.

Unizan's margin was also negatively affected by faster-than-projected amortization of the premiums associated with the purchase-accounting adjustments on the former U.N.B (ph) Corp loans.

As we discussed in the release, these loans were mark-to-market at the time of the merger in March 2002 and average lives were determined for each loan type.

With a low rate environment and the refinancing or accelerated payment of principal on these loans, especially our commercial and commercial-real estate portfolios, we had to amortize these premiums faster than originally projected.

This was especially true in the third quarter, when there was considerable decrease in the balances of commercial loans.

The impact the margin was 14 basis points in the third quarter and 4 basis points on the year-to-date margin.

Given the current rate environment, we believe that these prepayments will slow down; however, there are still significant loan balances on these credits.

So additional pay downs could affect our interest margin in the coming quarters.

Finally, regarding items impacting the margin.

We have the impact of faster prepayments and pay downs on our CMOS and mortgage-backed securities.

During the early part of the quarter, we experienced considerable increases in our cash flows as the CMOS and mortgage-backs paid down, with the ending of the refinancing boom and the uptick in mortgage rates.

The mortgages collateralizing these bonds were refinanced in the latter part of the second quarter.

And by late July and August, these loans paid off, thus accelerating our amortization expense.

The impact was 13 basis points on the third quarter's net interest margins and 4 basis points on the year-to-date margin.

We have already seen a tremendous slowdown in prepayments on our investment portfolio, and we're projecting that the margin will not be as greatly affected as it was in the third quarter.

To summarize, September 30th, '03 margin for the quarter was 2.73 percent.

But with these adjustments, it would equate to 3.17 percent as compared to the second quarter's margin of 3.19.

On a year-to-date basis, through September 30th, year-to-date margin was reported at 3.15 percent.

With these three items, it would be 3.29 percent as compared to 3.36 percent through June 30th of '03.

As we project for the fourth quarter, we see a margin for the quarter in the range of 3.12 to 3.15 percent.

Now let's look at non-interest income for the quarter.

Non-interest income, excluding the net security gains, increased from 7.2 million for the second quarter of '03 to 8 million in the third quarter.

Our wealth-management income was $1.7 million compared with $2.1 million in the second quarter.

The $400,000 decline is due to the fact that our tax-preparation fees are taken in the second quarter of the year.

This is about $275,000 of fee income.

The second factor was a decline in our retail-brokerage income.

As part of our overall strategic direction with wealth management -- which Roger mentioned earlier -- the retail brokerage operation was overhauled during the quarter, which led to some reorganizing and restructuring of the department.

Thus, we were not fully staffed for a good part of the quarter, which led to a decrease in revenues.

However, that process is now complete, and we have added additional brokers to our staff and have completed their training.

We are also consolidating all of our brokerage activities (ph) under a single platform, which should be completed by year end.

With that, we believe we are well-positioned to increase our brokerage sales through (ph) our branch network and through our Unizan financial advisers subsidiary.

We anticipate revenues beginning to pick up in the fourth quarter and then continuing to increase as we enter the new year.

Our SBA production and on gain on sale of SBA loans continued at around a record pace in the third quarter.

We took $900,000 of gains in the quarter, versus 791,000 of gains in the second quarter.

Our production continued to be very good, and our SBA pipeline looks very strong as we enter the fourth quarter, which is traditionally our best.

We did see some of the impact of the slowdown in mortgage loan refinancing during the third quarter.

But the full impact will be more fully realized in the fourth quarter.

We took gains of $887,000, compared with $1.4 million of gains in the second quarter of '03.

Going forward, we are projecting our retail production at about 50 percent of our second-quarter levels and a concurrent decline in gain on sales.

On the expense side, of the mortgage loan business, our originators are all commission based.

So as production declines, we will see a decline in our salary expense related to mortgage loans.

We have also been exploring new delivery channels for mortgages, looking at our wholesale loan operation and how to expand our retail-mortgage business in some of our growth markets.

The greatest impact on other operating income was the recovery of the mortgage service (indiscernible) and impairment charge.

Looking now at non-interest expenses, we saw a decrease from $16.8 million in the second quarter of '03 to 15.7 million in the third quarter.

As you recall, during the second quarter, we recognized $1.2 million of benefit expense associated with determination of the defined benefit plan.

If we adjust the second quarter for that expense, non-interest expenses would have been 15.6 million, compared to 15.7 in the third quarter.

Comparing the second-quarter salaries and benefits expense, adjusted for the defined-benefit plan expense to third quarter, there was a decline of about $100,000.

Management continues to monitor this area, along with all other non-interest expense categories, very closely.

Given the continuing economic sluggishness in Ohio -- in the Midwest and general -- management was pleased with the loan growth we did experience in the third quarter.

Commercial-real estate loans increased by $9.3 million and home equity loans increased by $27 million, including the purchase of a home equity package from another financial institution.

These areas' pipelines continue very strong as we move into the fourth quarter.

Commercial loans decreased 5.5 million from quarter to quarter, and Jim Nicholson is going to address this in his remarks on credit quality and the allowance for loan losses.

Of course, residential real estate loans decreased during the quarter as we continued to sell off fixed-rate products into the secondary market.

We continue to emphasize asset quality, which Jim is also a going to address in detail in a few minutes.

Looking at deposits now, total deposits decreased by $55 million during quarter, with CD's decreasing by 47 million -- of which 25 million were brokers CD's.

We priced our CD's in the middle part of the market for most of the quarter, as we continued our strategy of replacing CD's with our money-market and checking-with-interest products.

As we discussed last quarter, we had a very aggressive money-market and checking-with-interest campaign earlier this year, using rate specials to bring new dollars into the accounts.

We consider this campaign to be a success, as we have retained over 50 percent of the deposits once the teaser rate fell off.

These deposits allowed us to price CD's lower and to continue our repositioning of our deposit mix.

We continue to believe that ordering (ph) our mix of deposits and building relationships with these clients will benefit us in the future.

As we did last quarter, we had very strong growth in our non-interest-bearing checking accounts, with these balances growing by approximately 11 percent on an annualized basis.

Our strategic initiative of increasing our deposit relationships with our corporate clients continues to pay dividends, as we establish new deposit and cash management relationships with our clients.

Our Chief Deposit Officer and our Corporate Bankers will continue to build on this strategy as we move into the fourth quarter and into 2004.

Finally, regarding our borrowed-funds position, we did pay off the $44 million of higher-rate advances during the quarter.

Our overnight fed funds purchased and FHLB (ph) repo advances -- our overnight FHLB borrowings -- increased by $39 million from June 30th to September 30th.

These short-term borrowings are at the Fed funds rate.

Also, the brokerage CDs, which we did not renew, which were at a rate of 1.55 percent.

We took out variable-rate FHLB advances at a current rate of about 1.30 percent.

However, we have the ability to pay off these advances each month without any penalty, so these get (ph) a great deal of flexibility with our short-term liquidity position.

Now it might turn the conference call over to Jim Nicholson to discuss credit quality.

Thank you, Jim.

Good afternoon, everyone.

The credit quality again remained relatively stable, showing some signs of minor deterioration.

At September 30th 2003, Unizan's non-performing loans were 24.9 million, and this compares with 23.4 million at 6/30/03, and 18.7 million a year ago.

Included in the 24.9 million of non-performing loans at the end of the quarter, were 8.6 million of government-guaranteed loans, of which 6.8 million is guaranteed.

Under the surface of the slight rise in the level of FNPL's (ph) provided additional clarity.

Of the 1.5 million increase in non-performing loans, 500,000 is attributable to the guaranteed portions of sold government-guaranteed loans, which have been repurchased from the investor due to their delinquency.

The remaining one million is the commercial real estate.

Of the 24.9 million of non-performing loans at the end of the quarter, 15.7 million or approximately 63 percent are either family-residential loans or the portion of loans guaranteed by the government that I just mentioned.

The liquidation of the guaranteed portion of the SDA (ph) loans has been slow nationally due to the volume of loans in liquidation and complications and uncertainty regarding the SDA's (ph) plans for the administration and processing of loan buybacks in liquidation.

While this has increased delinquencies and nonperforming assets, we continue to believe there is little risk of loss as these submissions are eventually processed.

We believe that the SBA is proactively addressing its external issues.

And we are optimistic that we will see progress in this area.

Adjusting for the guaranteed portion of SBA loans, the non-performing loans to total loans percentage drops 2.94 percent from 1.29 percent.

Also, the allowance coverage of non-performing loans would increase to 135 percent from 99 percent.

Our loss experience during the quarter and year-to-date in the residential portfolio continues to be good as net charge-offs were approximately 2 basis points on an annualized basis for the quarter and approximately 4 basis points annualized year-to-date.

With respect to the overall level of non-performing loans, we believe the risk of these loans is substantially mitigated based upon the previous discussion.

Turning to net charge-offs, net charge-offs declined during the quarter and remained very manageable.

Net charge off for the third quarter were 1.3 million compared with 1.4 million for the second quarter of '03.

Annualized net charge-offs to average total loans were 27 basis points for the third quarter of '03 versus 29 basis points for the second quarter.

We continued to experience higher levels of charge-offs in consumer loans and, more specifically, the indirect portfolio due to the down economy and increased bankruptcies.

This has been occurring for more than a year now.

It is possible that we may experience a slight increase in charge-offs levels during the fourth quarter, primarily in the consumer and commercial real estate portfolios.

While our charge-offs levels are up from very historical levels, they are still quite manageable.

Annualized net charge-off percentages by portfolio for the quarter were residential -- 2 basis points, commercial -- 8 basis points, commercial real estate -- 17 basis points.

There were no charge-offs in the aircraft portfolio.

Government guaranteed was 33 basis points.

Consumer-direct was 168 basis points, consumer direct -- 163 basis points.

And the home-equity portfolio was at 5 basis points.

Delinquencies increased during the quarter.

The delinquency ratio for all loan portfolios was 1.65 percent at the end of the third quarter, versus 1.52 percent at 6/30/03 and 1.42 percent a year ago.

Notes of interest regarding the delinquencies during the quarter were increases in residential and commercial-real estate loans and decreases in commercial and aircraft.

Residential delinquency trends are consistent with Ohio and national trends.

Bankruptcies are up, and are a significant part of numbers.

Again, while this has resulted in continued higher levels of delinquencies and non-performing assets, we continue to see very little translation into losses.

We continue to remain cautious as economic uncertainty in Ohio and the Midwest extends and record levels of bankruptcies continue.

I would like to highlight that our strategy communicated approximately a year ago to shift our aircraft focus to light twins and singles and away from small jets, has been executed quite nicely and is producing positive results.

Delinquencies in the aircraft portfolio were our only 6 basis points at the end of the quarter.

Also, we have are starting to see growth in the portfolio while the risk profile is changing.

Jet aircraft loan balances currently total approximately 42.5 million or 31 percent of the aircraft portfolio.

This compares with approximately 38 percent a year ago.

The allowance for loan losses remains consistent.

The allowance for loan losses to total loans ratio was 1.27 percent at the end of the third quarter, relatively consistent with the prior quarter's ratio of 1.29 percent.

During the quarter, the provision for loan losses totaled $1 million -- the same as the second quarter of '03 and consistent with the approximately 930,000 provided during the third quarter of '02.

During the quarter, two large classified credit relationships, totaling approximately 15 million, were successfully worked out of the commercial portfolio through financing outside of Unizan.

This more than accounted for the decline of approximately 5.5 million in the commercial portfolio during the quarter.

As a result, we believe that we have prudently reduced our risk profile in this portfolio through the exit of these credits.

Also, we continued to ship the mix of the consumer portfolio away from indirect and into home-equity loans.

During the quarter, the indirect portfolio declined approximately 10 million or 28 percent on an annualized basis.

In summary, while we have experienced some increase in delinquencies in non-performing assets during the quarter, we continue to not see any evidence of this translating into significantly increased charge-offs levels.

This is consistent with the nature of our portfolio, being real estate-secured and government-guaranteed, as well as our prior communications.

At this point, I will turn to call back to Roger.

Thank you, Nick.

To conclude, we continued to be cautious regarding the prospect of a rapid Midwest economic recovery in the fourth quarter and in 2004.

Margin compression is a given.

But we will continue to focus on credit quality, balance-sheet strategies, driving non-interest income and focus on events for increasing future earnings and franchise value.

At this time, we will be pleased to take questions.

(OPERATOR INSTRUCTIONS) We will pause for just a minute to compile the Q&A roster.

Steve Alexopoulos of Sandler O'Neill & Partners.

Hey, guys.

A couple of questions.

First, given that you provided less than charge-offs in the quarter, what is your comfort level today with the reserve?

Is it possible that you could under-provide going forward?

Steve, this is Jim Nicholson.

We continue to develop our migration analysis and other data to really facilitate the substantiation of -- the adequacy of our loss ratios and percentages -- both by classification and by portfolio.

Really, that is to help us measure the inherent risk profiles of portfolio and evaluate the allowance.

And I think what we see is that -- we do believe that the allowance is adequate, as we sit here today.

I think it is possible that as we continue to evaluate the unallocated portion of our -- (indiscernible) I really should not say unallocated -- but the -- I will say the qualitative factors in helping us determine our adequacy of the allowance -- it is possible that we will have an ongoing situation of providing less than charge-offs but I would say not substantially.

Do you typically measure that related to loans or NPA's to sort of justify it -- how adequate the reserve is?

No.

We really each month and each quarter measure the risk profile.

And as you know, that changes each quarter based upon loan classifications and some other qualitative trends.

For instance, this quarter we saw a couple of large, classified credits that we were able to work out of the portfolio, and in doing that, decrease some of the allocation requirements.

Okay.

Second question -- probably for Roger.

With the efficiency ratio near 55 percent in the quarter, are there any initiatives to become maybe a little bit more aggressive on the expense front?

Steve, one of the things -- you know, we're just a little bit over a year in half old now, and I think we're starting to get a pretty good handle on what I will call our run rate.

And we are -- as we move into next year, we have some initiatives that I think could impact positively the efficiency ratio.

We will be entering into our strategic planning session here in the next couple of weeks both with management and the Board of Directors.

And I think we will be laying kind of a formula as we enter into 2004, Steve, that I think is going to help with that ratio a bit.

Okay.

Hey, Steve.

This is the James Pennetti.

Just looking at that -- as you break down that efficiency ratio.

We do see that being an impact and obviously more on the revenue side than we are right now on the expense side.

As I said, we continue to look at expenses very closely here -- very carefully.

But, as we break down the elements of that efficiency ratio, right now we are, of course, really being impacted with this margin compression.

But no less that we continue, as Roger said, to look forward here and possible reduction in expenses wherever we might -- (multiple speakers)

Yes, and some of these initiatives that we've got -- that we're planning -- impact the revenue side, Steve, certainly as well as the expense side.

Okay.

Finally, Roger, you had said originally that you wanted to focus on putting the Companies together before considering additional acquisition opportunities.

Just wondering, one, are we there yet where you would consider an acquisition?

And if so, what markets would you consider attractive?

Steve, I really -- and I have said, I think, for the last year and a half -- I really want to make sure all the t's are crossed and i's are dotted.

You know, I think we're getting there.

I think we have made -- specifically in the last three or four months -- some significant improvement in some of our technology areas -- some of the continued automation of our technology and some of those things.

I think that I would feel more comfortable, quite frankly, getting through the fourth quarter and tying up some of those projects and then as we get into the conference call in January, kind of reviewing that, if we may.

Great.

Thanks a lot.

Your next question comes from Bill Covington of Stifel, Nicolaus & Co.

Steve?

Hey, guys, this is Steve Covington.

We figured that.

Hey, appreciate all the detail.

I had had one question, Jim Nicholson, as you were going through this stuff that I might have missed.

Did you say -- what was the balance of the classified assets that you said you moved out?

Those two particular credit relationships were approximately $15 million.

15 million.

Okay.

And secondly, what would -- I think you indicated that you did a == or maybe James Pennetti indicated -- that you did a bulk purchase of some home-equity loans during the quarter.

Can you give us just general characteristics of that portfolio and then what -- if you have -- what the total size of that portfolio was?

Yes, I do.

Steve, the size of portfolio was about $13 million.

Let me grab some other detail here.

In general, Steve, the profile of that portfolio as very similar to what we do here and what we originate.

They are tied to prime floating rate.

Is the collateral a Midwestern collateral?

Yes.

Midwest -- exclusively Midwest collateral.

Loan-to-value of about 83 percent -- something like that.

So it's very close to what we do here locally.

Okay.

Lastly, and this might be -- to go back some of Roger's comments about your planning sessions that you have coming up.

But what are kind of your long-term goals from a capital perspective?

You've had some capital build-up over the last couple of quarters.

Where do feel comfortable running the Corporation -- the tangible capital levels?

Our capital plan right now -- we have put that together, and it's been approved by the Board.

We have a minimum on the regulatory capital, Steve, of being 50 basis points above well-capitalized.

And then moving up from that, based on the risk profile of the Corporation, as we measure that through our risk management process -- but our minimum would be 50 basis points -- and moving up to as much as 125 basis points over that regulatory minimum.

We are moving forward, looking at the risk profile of the Corporation, and then based on that risk profile, looking at our capital levels to be in that range, as I said for the regulatory capital.

That's great.

Okay.

Thanks guys.

At this time, there are no further questions.

Mr. Pennetti, do you have any closing remarks?

This is Roger.

Once again, I would like to thank everyone for joining us and for your continued interest in our Corporation.

We look forward to keeping you updated on our franchise development and financial performance.

And as always, if you have any questions, please do not hesitate to call us.

We will be happy to take your calls.

Thank you again very much for your continued support of our company.

And we wish you a great day.

Thanks a lot.

This concludes today's Unizan Financial Corporation third-quarter earnings conference call.

You may now disconnect.