PacWest Bancorp (PACW) 2012 Q3 法說會逐字稿

Good afternoon.

Welcome to the CapitalSource third quarter 2012 earnings conference call.

All participants will be in listen-only mode.

(Operator Instructions)

After today's presentation there will be an opportunity to ask questions.

(Operator Instructions)

Please note this event is being recorded.

I would now like to turn the conference over to Dennis Oakes.

Please go ahead.

Thank you, Amy.

Good afternoon and welcome to the CapitalSource third quarter 2012 earnings call.

With me today are CapitalSource CEO, Jim Pieczynski; CapitalSource Bank Chairman and CEO, Tad Lowrey; and John Bogler, our Chief Financial Officer.

This call is being webcast live on the Company website and recording will be available later this evening.

Our earnings press release and website provide details on accessing the archived call.

We've also posted a presentation on the website, which provides additional detail on certain topics, which will be covering during our prepared remarks though we will not be making specific references to that presentation.

Investors are urged to carefully read the forward-looking statements language in our Earnings Release and Investor Presentation, but essentially they say the following.

Statements made on this call which are not historical facts may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

All forward-looking statements, including statements regarding future financial operating results, involve risks, uncertainties, and contingencies, many of which are beyond the control of CapitalSource, and which may cause actual results to differ materially from anticipated results.

CapitalSource is under no obligation to update or alter our forward-looking statements, whether as a result of new information, future events, or otherwise.

We expressly disclaim any obligation to do so.

And finally, more detail information about risk factors can be found in our reports filed with the SEC.

Jim is up first.

As usual, we will take questions following our prepared remarks.

Jim?

Thank you Dennis and good afternoon everyone.

First and foremost I want to extend my thoughts and prayers to those people on the East Coast who have had to deal with the impact of Hurricane Sandy.

I know it's been difficult for people there.

We do think of you.

I would now like to focus on our quarterly results.

Our third quarter included earnings per share of $0.14.

And once again, demonstrated the earnings power of CapitalSource Bank.

Tad will provide greater detail on the Bank's performance but we were pleased with the new loan production of $623 million, a net interest margin of just below 5%, an ROA of just under 1.9%, a negligible loan-loss provision, and significantly higher pre-tax, pre-provision income.

Our consolidated credit metrics also improved meaningfully, as our deliberate actions to move or solve troubled loans continues.

Our specialty lending platforms continue to produce at a high level.

New lending in the third quarter was broadly spread among our business groups.

But the largest concentrations were in equipment finance, technology and healthcare cash flow, and our healthcare and general real estate groups.

Despite the solid level of loan production, our net loan growth at the Bank in the quarter was only $24 million.

This was due, principally, to $470 million of loan repayments which were high, but that was combined with planned portfolio management actions that further reduced loan growth by just over $160 million.

Tad will provide more detail on those activities.

At the Parent Company, we generated free cash of approximately $63 million in the third quarter, which allowed us to continue our stock buyback program.

We repurchased 10 million shares at a cost of $75 million during the quarter, and then subsequent to the quarter end, we purchased an additional 5 million shares at a cost of $38 million.

We have now returned almost $770 million to shareholders in the form of share repurchases, while we have reduced the outstanding share count by 36% since December 2010.

With the previous plan nearly completed, earlier than expected, our Board of Directors last week approved a new share buyback program to run through the end of 2013, with authority for $250 million of new share repurchases.

Based on our liquidity forecast we could complete that program over the next 14 months, though stock price, stress testing, dividends and the timing of our Bank Holding Company application will be additional factors in our buyback decisions over that period.

The new buyback plan is consistent with our frequently discussed objective of prudently returning excess Parent capital to our shareholders.

While such share buybacks have been the primary means of returning excess capital, and we expect to continue them, subject to market conditions and other developments, we are also considering other mechanisms to return additional capital in the short-term, such as, increasing our ordinary dividend, instituting a variable dividend, and/or issuing a special dividend.

As we look toward 2013, we continue to prepare for the filing of our Bank Holding Company application.

The current very low interest rate environment, which is favorable to our particular deposit gathering model, means there's no immediate need for us to get Bank Holding Company status and convert to a commercial charter.

However, the prospect of lower capital requirements, the ability to offer an array of deposit products and business services, and the ability to make acquisitions are other benefits of the charter conversion, so we still anticipate filing our application next year.

That we will file pursuant to FRB guidance, which we expect to receive in the near future, about when our filing should take place and consistent with our judgment about the time that will best facilitate their prompt review.

Tad is up next.

Thank you, Jim.

Good afternoon everyone.

The third quarter at CapitalSource Bank was solid in all respects.

I'll turn first to the Bank's income statement.

Net interest income increased 4% from the second quarter to $84 million, while operating expenses declined, producing pretax, pre-provision income of $58 million, which was 17% higher than last quarter.

Our net interest margin was up, slightly, at 4.97%, which is the top end of the range that we've been projecting of 4.75% to 5%.

The net loss position was negligible in the third quarter compared to $13 million in the second quarter, as we benefited from a $5 million recovery on a restructured loan that we sold in the quarter.

Of more importance than the low provision, our total nonperforming assets are now below 1% for the first time in nearly four years, since shortly after the Bank's formation.

The biggest factor in this achievement was a 37% decline in non-accruals, resulting from payoffs, pay downs, loan sales, and a reduced rate of new non-accruals in the quarter.

Despite the very low provision in the quarter, our allowance for loan and lease losses as a percentage of non-accruals still increased to 153%, compared to 100% in the second quarter.

Charge-offs were also down.

Trailing 12 month charge-offs dropped below 1% to 79 basis points.

The Bank continues to carry elevated capital levels with a risk-based capital ratio at 16.7%, and a Tier 1 leverage ratio of 12.8%.

Both of these metrics increased from the prior quarter, and are well above our current regulatory requirements and fully phased in Basel III minimums as currently proposed.

Our high capital levels give us balance sheet strength, as well as the capacity to grow and pay future dividends.

We were also quite pleased with our ROA, return on average assets, of 1.88% and our return on equity of 12.75% in the quarter, despite those high levels of capital.

Although these were assisted by the very low loan loss provision this quarter.

Moving to the liability side, deposits were up by 3% and now stand at $5.5 billion.

While our deposit costs declined another 2 basis points to 93 basis points, new and renewed deposits added in the quarter came in at 86 basis points.

The high level of loan repayments, also caused our cash and investments to increase of $177 million, but we hope to utilize that excess liquidity in the fourth quarter to fund loans.

As a result, we intend to curtail raising additional deposits until the pace of loan repayments subsides or we have sufficient net growth to warrant proactively raising deposits again.

Before closing, I want to talk a little bit about the portfolio management actions that Jim referenced earlier that we took in the quarter to reduce classified assets and lower our hold sizes.

Classified assets at the Bank were reduced by $94 million, and we cut our largest borrower relationship by more than 50%, reducing the outstanding commitment from $127 million to $59 million.

As a result, classified assets at the Bank are now stand at $161 million, and we have only one remaining individual loan in excess of $80 million.

We are very pleased with this progress, as we do not expect our portfolio management activities in future quarters to be of similar magnitude.

Although, our focus on credit manage will continue.

The third quarter loan repayments were elevated due to a high level of payoffs, as certain of our borrowers refinanced for lower rates, while others had their businesses acquired.

In several cases, we chose not too participate in the renewal or the refinancing for the new loan due to credit or pricing concerns that we believe are reflective of the current lending environment, which Jim will describe in more detail in his closing remark, remarks, excuse me.

John will now provide his perspective on the quarter, followed by Jim's closing remarks.

John?

Thank you, Tad, and thank you to those listening to our earnings call this afternoon.

My remarks today will focus on third quarter earnings, taxes including utilization of the DTA, operating expenses, Parent liquidity, and consolidated credit performance.

Our consolidated earnings per share of $0.14 in the quarter was reasonably straightforward without one-time items.

It would be fair, however, to strip out a $0.01 net tax benefit resulting from tax adjustments, including an additional release from the valuation associated with tax basis mark-to-market adjustments on legacy Parent debt and equity investments.

We indicated at the time, that our large deferred tax asset valuation allowance was reversed last quarter, that we would experience a 41% GAAP tax rate going forward.

Our effective rate for the third quarter was 41% at the Bank, while a small net tax benefit reduced the consolidated rate to 37%.

We continue to view our consolidated effective tax rate as 41%, since any future tax basis, capital gains or losses associated with Parent debt or equity investments are uncertain.

In addition to the effective GAAP tax rate, it is important to remember that our cash taxes will be significantly lower until such time as we have fully utilized the substantial Federal NOL on the Parent balance sheet.

The only cash taxes we paid in the third quarter were approximately $3 million for state and local taxes, which produced an effective cash tax rate of only 6%.

The difference between our GAAP and cash tax liabilities is effectively free cash at the Parent.

Because of the tax sharing arrangement between the Bank and the Parent, which resulted in the Bank paying up to the Parent the full tax amount due as if it were a standalone filer.

Parent cash flow was strong in the third quarter.

Unrestricted cash at September 30 was $156 million, a decline of only $35 million from the end of the prior quarter, despite our expenditure of $75 million for share repurchases, and $23 million to redeem the remaining outstanding 7.25% convertible debentures.

Loan repayment in the non-secured type portfolio of $65 million were the principle source of cash in the quarter.

We expect cash generation during the fourth quarter of $50 million to $75 million from that portfolio, which had a balance of $316 million at quarter end.

Included in that estimate, is $40 million in loans moved to held the sale in the quarter, which we expect to sell by year-end.

Following retirement of the last converts in July, we have no Parent Company recourse debt maturities until the first trust preferreds mature in 2035.

The annual debt service on those securities of approximately $10 million at current interest rates will be paid with available cash flow.

With regard to operating expenses, which we define as excluding debt extinguishment, operating lease depreciation, provision for unfunded commitments and REO expense, we are well on our way to achieving the year-over-year savings we projected as 2012 began.

Consolidating operating expenses declined by $9 million in the third quarter, due largely to decreased loan servicing expense and a one-time office lease termination charge incurred in the second quarter.

Loan servicing expense is a bit uneven from quarter to quarter, but we continue to spend less on third party workouts and servicing related fees, so we expect that item will come down a bit further over time.

Operating expenses for the first three quarters of this year were approximately $140 million, compared to $154 million for the first three quarters of last year, a 9.2% reduction.

We are confident, therefore, that we will meet our targeted range of $190 million to $200 million for total consolidated operating expenses for the full year 2012.

In fact, we now expect our full year operating expenses will be at the low end or below that projected total, but that savings will be at least 10% this year, compared to last.

Turning now to credit.

Tad spoke a bit about the credit performance at the Bank this quarter.

Our consolidated metrics were equally strong as non-accruals declined by $40 million, and are now only 2.7% of total loans.

Our consolidated loan loss reserve of $127 million, or 2.1%, should continue to decline over the next two to three years to what we project will be a normalized level of approximately 1.5%.

Net charge offs were also down significantly in the quarter, and over the past 12 months decline to just 2.1% of average loans.

The quarterly loan loss provision at $9 million was within our expected range.

While the credit performance for the quarter was very positive, and consistent with our overall trends through the last several quarters, we remain cautious on the long-term macro environment.

As a result, we took the steps already mentioned during the quarter to reduce problem assets and lower hold sizes on larger legacy loans still in our portfolio.

Though the number of loans for which we might take similar action in the future is getting smaller, we remain focused on prudently reducing credit exposure across our loan portfolio, both as a prerequisite to filing our Bank Holding Company application and consistent with the underwriting standards we applied to new loans since the formation of the Bank in July of 2008.

In short, credit discipline is an ongoing focus for the entire organization, both in terms of our existing portfolio and new loans we are making.

Jim will now conclude the prepared portion of the call.

Thanks, John.

Before taking questions, I want to talk briefly about the lending environment, as we see it today.

With the first month of the fourth quarter already behind us, loan production has been positive and the strength of our pipeline across our business segments is encouraging.

Though we are seeing a heightened level of deal activity, much of it is related to refinancing, as there is a tremendous amount of liquidity chasing deals.

Not surprisingly, that is manifesting itself in persistent pricing pressure, which we are now seeing more broadly across our business segments than we did earlier in the year.

This increased activity is at least in part a byproduct of the Fed's actions to keep interest rates artificially low.

With those low rates expected to stay in place for some time, it is likely that pricing pressure will continue and may intensify.

Though we will be competitive on price, we are walking away from deals that do not meet our return thresholds or which carry certain leverage multiples, covenant like terms, or PIK toggle features that we find objectionable.

We are willing to sacrifice production volume and loan growth, if necessary, in order to feel secure about the structure and credit quality of the loans we do make.

It is incredible to us that the memories of others are so short with the depths of the last cycle less than four years in the rear view mirror, particularly in light of the macro economic uncertainty around the fiscal cliff, Europe, China, and more.

We do, however, believe that our very diverse and national specialty lending franchise uniquely positions us to find the right lending opportunity that will produce the returns we seek, while meeting our growth and profitability targets.

As a result, we intend to stay the course, maintain our pricing and underwriting discipline, and stick to a credit first mentality.

Operator, we are now ready to take questions.

(Operator Instructions)

Aaron Deer, Sandler O'Neill.

Good afternoon guys.

Jim, I'd like to start by following up on your ending comments with respect to, kind of, the pipeline.

I was wondering if you could give us a sense of where, in terms of how you measure that pipeline and where that stood -- where that stands today, versus where it was three months ago.

Also, just with respect to your comments on pricing pressures.

Maybe if we could get a sense of where current yields, or current loans are being priced today, versus loans that are coming off the books.

Well, first of all, when I look at the pipeline, the way I measure the pipeline, is I look kind of by the deals that we have approved.

So, you know, the deals that we have got approved are deals that I know are going to be happening and it's just a matter of time.

I would say that when I look at that pipeline, I think it looks very similar to where it was, say three months ago.

However, when I look into the -- beyond this next quarter, that's when you get a little concerned about what's the pipeline going to be looking like.

So, that's where the jury is still out a little bit.

In terms of pricing, again, I look at what's the pricing coming in on the deals that we see in our pipeline.

To put it in perspective, this quarter -- the average yield on our -- for new originations was at a 6.17% yield, which was slightly down, which was down four basis points from where we were in the second quarter.

If you look at where we are seeing in the fourth quarter, right now, the number is lower than that and, quite honestly, I can see that being below the 6% level when we are in the fourth quarter.

So, that's where I see, kind of, the pricing pressure manifesting itself.

Okay.

That's helpful.

And then, on a related point, I guess the securities yield looks like that actually improved sequentially.

Just wondering if that was because it was a slower level of prepayments, or if there was something new added?

What might be helping giving that some boost in the quarter?

No.

There were no significant adjustments to the investment securities yield during the quarter.

We continue to add some investments, but for the most part, those in the duration are in the 3.5 or 4 year.

As you know, and the agency market is fairly low yielding.

In the second quarter, we had a little bit of change in prepayment fee assumptions which pushed the second quarter down just slightly.

But, not material quarter-over-quarter.

Okay.

That's great.

I will step back.

Jennifer Demba, SunTrust.

Thank you, good evening.

I was wondering if you could just elaborate on the competitive environment a little bit more.

Are you seeing this tougher competition from new entrants into these niches?

Or is it the same competitors that you have been seeing for a while?

No.

I would say that the competitors are still the same.

We are not seeing any new entrants coming into the space.

Okay.

And, just wondering if you can -- I'm sorry -- housekeeping question.

The expense guidance that you gave before.

Could you repeat that and just give some color behind the moving parts that you are expecting?

Yes.

In the second quarter, we had a $2.3 million charge for an abandonment of a lease associated with some office space that we had.

We also had some increased expenses associated with loan servicing and workout.

In the third quarter, we did not have those items that repeated.

So, as we go forward, what we -- what we look to see is the continued benefits of integrating the back office operations of the Parent and the Bank.

That will be the primary benefit I think we will see as we go into the fourth quarter.

Thank you very much.

Mark DeVries, Barclays.

Thanks.

First I just want to go back to the last comments on the competitive landscape.

Can you talk about what the implications are for the pricing pressure for what your NIM guidance has been?

That's a good question.

I think, you know, the advantage that we have is we do have a fair amount of liquidity and as Tad had mentioned in his remarks, we are going to be holding off on growing our deposits because of the fact that we've got a significant level of cash that we can invest.

So, when we are looking at our NIM and the NIM guidance we've had has been in the 4.75% to 5% range, we think despite the fact that we will see some lower yields on the loans that we originate, we still expect to stay in that 4.75% to 5% NIM range.

Okay, great.

And then on a separate note, when we think about buybacks going forward, should that match the cash flow that you have coming into the Parent?

Or, is there some additional cash that you have in there that, where your buybacks could actually exceed that?

No.

What we've indicated, in terms of the new buyback program, the $250 million buyback program, that's intended to match the cash that we expect to generate at the Parent, including any excess cash that we currently have.

So, the combination of those two represents the amount of cash that we would be able to return to shareholders.

Okay.

For the tax sharing agreement, the contribution that that generates on a quarterly basis, is that roughly your 41% GAAP tax rate less that 6% or so cash tax that you're paying?

Is that how we should think about what that contribution is?

Yes.

The net contribution, that's correct.

I would modify that just a little bit, because the 41% is our GAAP tax rate and so our, kind of our federal and state tax rate, the cash taxes that we would actually pay could be slightly different from that.

That's the normal book tax type differences.

Okay.

And then, did you also indicate that at least next quarter you expect, on top of that, $50 million to $75 million of cash coming in, and that includes the $40 million of loans that you have held for sale now?

We expect that the non-securitized portfolio -- out of that we would expect between $50 million and $70 million associated with loan sales, of which $40 million fits in the held for sale bucket as of the end of the third quarter.

Okay.

So that's just $50 million to $75 million from loan sales alone?

Not necessarily any other repayments that might come in?

No it is inclusive of that, as well.

Okay.

All sources from that portfolio, but the biggest component is the loan that's held for sale.

Okay, got it.

One other question.

Was there any material P&L impact from the portfolio management activities in the quarter?

No.

The portfolio management activities were concentrated in the Bank.

There were some charge offs impacts.

But, those charge offs were primarily execution on previous, specific valuation allowances.

So, that net provision at the Bank was near zero.

It was $13 million in the prior quarter.

We did experience charge-offs, as a result of that.

But, very little P&L affect.

Okay.

Thank you.

Henry Coffey, Sterne Agee.

Good afternoon, everyone, and thanks for taking my question.

If you were trying to, sort of, put a finger at where we are in the cycle, I mean, I know in the past, it starts with, you know, banks don't want to make loans to your customers and threaten them at gunpoint, then there's sort of a stabilizing cycle and then suddenly banks, they're doing what they're doing now.

They come rushing in on pricing, eventually they drop credit, and then one day they wake up and instead of trying to steal a few loans away from you, they try to buy the whole commercial finance entities.

I mean, that's the cycle of the past.

Is there any reason to believe that we won't wake up one day and find out that the banks that wouldn't buy a commercial finance business if their life depended on it, are suddenly out making acquisitions and then towards the end of the cycle M&A activity picks up, and it gets kind of frothy again?

Or do you think we're in a more disciplined environment this time?

Well, I think, this time, we are -- where it will ultimately end I don't know.

What I can see is, earlier this year we started to see it more on the pricing side of it.

I said, okay, I understand that.

Rates are dropping.

So, we understood the pricing side.

What we've been seeing more, now, of late, is leverage multiples are creeping up.

You know, you are seeing more covenant like deals.

You are just seeing kind of the structure that's changing, right now.

When I look at it, I worried about the pricing before.

Now, you look at the structure and you say okay, I get a little bit worried about that.

Where that ultimately goes, I don't know.

But, it's clear that there's a lot of liquidity in the system, right now.

You've got a lot of banks that are really trying to put that liquidity to work in some way, because, as we know, any yields you can get on any of those securities portfolio are miserably low right now.

So, today, the volume leaders, the lucky price takers are the banks?

Not the hedge funds, not the [RIK] BDCs, or is it sort of across the board?

I think it's a little bit -- I think it's a little bit across the board, because, although you've got the banks that are certainly leading the way, you still have the BDCs out there that are able to get attractive re-discount lines from banks on their own.

So, they are getting the benefit of a lower-cost environment, as well.

I can't imagine, Henry, that the next step is not acquisition.

When you have these banks with excess capital, excess liquidity, and some of the targets, credit metrics have improved dramatically, and then all the pressures with the regulatory compliance and the Dodd-Franks stuff.

If you put all that together, it's hard to imagine those who are competing very hard on price, at some point, wouldn't turn towards acquiring -- (multiple speakers)

Are we in a regulatory environment -- I mean, you are dealing with bank regulators, right now.

We have a client, a private client, who has had the same situation.

They finally just gave up.

But, the bank regulators seem just as crazy as always.

No offense.

And, are they willing to allow these kind of acquisitions to go forward?

Or is that kind of a later stage development?

Well, first of all, let me say our particular bank regulators are not crazy.

We love them.

I know, of course.

Second is, yes, I think they will.

I think the regulators -- they have to be agnostic about this stuff.

If you have two companies combining and reducing expenses and reducing pricing pressure, I would have to think they would be in favor of that, particularly if these companies are both regulated financial entities.

If you mean outside of regulated entities, I think they will continue to look at those very closely.

They would approve sort of what we'll call club mergers.

Mergers inside the banking industry as long as it reduced risk and exposure?

I think those are slam dunks, yes.

What about the hedge fund community?

I can remember in the sort of '06, '07 cycle, walking in and there were always two guys with the Bloomberg that were about to start a CDO.

Is that -- that door hasn't opened up yet, has it?

No.

We are not seeing that at all.

Thank you.

This is very interesting.

Thank you.

Amy, do we have another question?

Daniel Furtado, Jefferies.

Good afternoon everybody.

Thank you for the opportunity to ask a couple questions.

The first is, and I'm sorry if I missed this, but could you speak to, or give some color around the movement in first stage delinquencies in the quarter?

Yes.

It's fairly complicated.

We have a fairly significant loan -- equipment loan that became delinquent.

I'm trying to figure out how I can summarize it.

It's a loan secured by a number of pieces of equipment.

The company is in bankruptcy and they are paying on most of the pieces of equipment.

The portions they are not paying on, we've already taken our hit.

We've already provided for the expense of that.

We are reporting that entire credit as a delinquency, although we are collecting payments on the greater portion of that and we are reducing the principal by those payments.

So, we think we are treating it conservatively.

But who's to say what -- how long that will continue, how long those payments will continue.

So, that's an asset that has already -- all the troubled categories that recently became delinquent.

Got you.

The takeaway is, it's one specific issue as opposed to anything --

Yes, we're not seeing -- if your question was more trend-based, we are not seeing -- almost all of our credit indicators are positive from this quarter, from last quarter.

The one that we think is a better leading indicator for us are classified assets.

Right.

As opposed to delinquencies.

Understood.

Understood.

And then the other one was just really more of a modeling and I'm not sure if you even have this number in front of you, but what CPR was on that securities portfolio during the quarter.

No.

I don't have that information in front of me.

I can get back to you on that.

Excellent.

All right.

Thank you, nice quarter everybody.

Thank you.

Scott Valentin, FBR Capital Markets.

Good afternoon and thanks for taking my question.

Just with regard to the originations.

Any portfolio purchases in there or bulk purchases in that $623 million?

No.

No, okay.

And then on the payouts, any benefit to the margin at all from some of the repayments, any early repayments?

Yes, in terms of the loan yields that we had for the quarter, 70 basis points of that came from all forms of amortization of discount and FAS 91 costs, as compared to 65 basis points in the prior quarter.

Okay.

So about a five basis point benefit from the higher prepayments, okay.

Yes, but that's just on the loan yields.

You'd have to translate that to NIM, and so then you're talking probably about 3 basis points, 3.5.

Okay.

All right.

Thank you for that.

Last question.

I know you guys with the liquidity you have you don't have to press as hard on deposit growth, but CD rates are up a little bit linked quarter, I think three basis points.

I'm just curious if that's a reflection of the competition you're seeing in the market.

No, if you see our rates going up, it's probably just an indication of how aggressive we want to be in the market.

We thought -- we would have told you a quarter ago that we were going to be very aggressively raising deposits.

Because we didn't forecast this high degree of loan repayments and portfolio activities.

We did exceed our target on origination, but the net growth is all that needs to be funded.

So it's just a reflection of how aggressive we are in the local market.

We've not seen indications of pricing pressure there.

Okay.

Thanks very much.

Steve Alexopoulos, JPMorgan.

Sir, this is the operator, you can go ahead with your question.

Amy, it looks like we lost him.

Are there others in line?

There are not.

All right, well thank you everybody for listening today, and a replay of the call will be available on our website later this evening.

Thanks very much.

The conference is now concluded.

Thank you for attending today's event.

You may now disconnect.