Peoples Bancorp Inc (PEBO) 2014 Q2 法說會逐字稿

Good morning and welcome to Peoples Bancorp's conference call. My name is Andrew and I will be your conference facilitator today. Today's call will cover a discussion of the results of operations for the quarter ended June 30, 2014. (Operator Instructions). This call is also being recorded. If you object to the recording, please disconnect at this time.

Please be advised that the commentary in this call will contain projections or other forward-looking statements regarding Peoples' future financial performance or future events. These statements are based on management's current expectations. The statements in this call which are not historical fact are forward-looking statements and involve a number of risks and uncertainties detailed in Peoples' Securities and Exchange Commission filings.

These include but are not limited to the success, impact and timing of strategic initiatives, successful completion and integration of planned acquisitions, the competitive nature of the financial service industry, the interest rate environment, the effect of Federal and/or State banking, insurance, and tax regulations, and changes in economic conditions. Management believes that forward-looking statements made during this call are based on reasonable assumptions within the bounds of their knowledge of Peoples' business and operations. However, it is possible actual results may differ materially from these projections. Peoples disclaims any responsibility to update these forward-looking statements after this call.

Peoples' second-quarter 2014 earnings release was issued this morning and is available at peoplesbancorp.com. This call will include about 20 to 30 minutes of prepared commentary followed by a question-and-answer period which I will facilitate. An archived webcast of this call will be available on peoplesbancorp.com.

Participants in today's call will be Chuck Sulerzyski, President and Chief Executive Officer, and Ed Sloane, Chief Financial Officer and Treasurer and each will be available for questions following opening statements.

Mr.Sulerzyski, you may begin your conference.

Thank you, Andrew. Good morning. Thanks for joining us for a review of our second-quarter results. Ed Sloan and I have much to talk about this morning. Our comments will cover the quarterly results, an update on the recently completed Midwest acquisition and pending deals plus our expectations for the remainder of 2014.

We are excited about all we have accomplished in the first half of the year and look forward to building on those accomplishments in the second half.

I will begin with an update on our acquisitions. The Midwest deal successively closed on May 30. All banking systems were converted on the same day and integration efforts are now in full swing which includes adding space to the Jackson, Ohio office for our insurance and investment partners. Ed will discuss later the Midwest transaction in more detail.

Our two pending deals, Ohio Heritage Bancorp and North Akron Savings Bank continues to progress on schedule. Ohio Heritage is expected to close late August and North Akron late October. Systems conversions are scheduled to occur on the same day as the closings. Careful consideration has been given to the timing of each transaction to allow our operations team to fully close one acquisition before transitioning to the other. We are confident in our ability to execute given our talented and experienced integration team.

Looking at our second-quarter results, Peoples reported net income of $3.5 million or $0.32 per share. This included $1.4 million of acquisition costs primarily related to the Midwest deal and $536,000 in pension settlement costs. Combined, these one-time costs reduced earnings per share by $0.12. We also recorded our first provision for loan losses since the third quarter of 2011. Earnings per share were $0.44 for the linked quarter and $0.46 for the second quarter of 2013.

Net income for the first half of the year was $8.3 million or $0.76 per share and included $1.6 million in acquisition costs and $1 million in pension settlement costs. These one-time costs reduced the first-half earnings per share by approximately $0.16.

Excluding acquisition costs, we achieved positive operating leverage though the first half of the year. The total revenue increased 16% while operating expenses increased 15%. Additionally, taking out pension settlement costs, operating expenses increased 12% thus widening the gap further between revenue and expense growth.

Our efficiency ratio continued to improve this year. While our reported efficiency ratio was 75%, removing the one-time cost, it improved to 69% which is within our target range for the year. Expected cost savings from the pending deals should further improve this ratio.

Absent the acquisitions, revenue growth for the year was still very strong at over 8%. This improvement to our core operations was a result of our continued focus on loan growth, an expanding margin and solid contribution from our fee-based revenue. We achieved this growth even with a 50% reduction in mortgage banking income. Our diversified revenue stream enables us to absorb such declines.

Turning to the loan portfolio, we were excited about the growth experience in both the commercial and consumer portfolios. Without Midwest, linked quarter loan growth was 11% annualized exceeding our stated 2014 growth goals of 8% to 10%. This sustained growth trend coupled with an expanding commercial loan pipeline should position us to meet if not exceed this goal in the second half.

Year over year, commercial loan balances increased 28%. We continued to improve the mix of loans within our commercial loan portfolio with a stronger focus on C&I lending. During this period, C&I loan balances were up 38% while CRE balances increased 24%. Our consumer loan portfolio grew 27% from last year. With the addition of Midwest balances in the second quarter, the consumer portfolio crossed the $500 million mark and now represents 41% of total loans.

Asset quality metrics continued to show a normalized trend positioning us at the top of our peer group. Annualized net charge-offs remained very low at 4 basis points while NPA to loans plus OREO increased slightly to 93 basis points. Our allowance for loan losses declined slightly to 1.32% of total loans due to the addition of Midwest loans without a corresponding reserve.

Overall, we are pleased with our first-half results which included a successful close of Midwest, strong organic loan growth, and expanding margin and an improved efficiency within our core operations.

Now I will turn the call over to Ed for his comments on the quarter.

Thanks Chuck. During the second quarter, our management team was focused on closing the Midwest transaction and executing the integration plan. We are excited about welcoming our new customers to the Wellston and Jackson, Ohio markets and now turning our attention to planning the integration of our new Northern markets in the Coshocton and North Akron Ohio areas. These new areas connect our network along I-77 between Cambridge and Cleveland.

Taking a closer look at the Midwest transaction, on the earnings side, we expect to add approximately $0.07 per year in earnings accretion. The earnings pick up does not consider any synergies with our current operations. Cost savings were consistent with our expectations at 45% of Midwest's annual operating expenses. The acquisition will add approximately $450,000 to our operating expense run rate.

Capital dilution was minimal and as a result, the earn back period is expected to be very short, within one year.

In terms of the balance sheet, Midwest added $60 million in loans of which 9% were commercial, 12% nonmortgage consumer and 79% mortgage. The loan portfolio was discounted by approximately 2%. On the deposit side, the transaction added $78 million in deposits of which 80% were interest-bearing and 20% non-interest-bearing DDA. Time deposits comprised 58% of total interest-bearing deposits.

During the quarter, we executed a planned sell of Midwest's 21 million securities portfolio. This is consistent with our 2014 balance sheet strategy to reduce the relative size of our total investment securities. This sale contributed to reducing the overall size of the portfolio from 33% of total assets at year-end to 31% midyear. We will continue to be optimistic with our pending deals as we work toward a year-end target portfolio size of 25% to 30% of total assets.

Turning now to our second-quarter results, revenue growth continued to strengthen with a solid increase in net interest income. Margin was at the upper end of our expected range for the quarter expanding 4 basis points from the linked quarter. Year over year, margin is up 26 basis points. Combined, Ohio Commerce and Midwest have added 13 basis points to the margin.

Loan growth was also a key driver of net interest income growth. Year over year, organic loan growth was 13%. Adding $160 million from the acquisitions, loans increased 28%. This loan growth has been a key driver to improving our overall mix of assets. Since June 30 last year, loans as a percentage of assets increased to 61% from 54%. The growth was funded in part by a reduction in the securities portfolio.

On the funding site, deposits were down 3% from linked quarter if you exclude Midwest. This decline was due to normal seasonal fluctuations as funds from governmental deposits are at their highest point in the first quarter and are dispersed throughout the remainder of the year. Steady growth in non-interest-bearing DDAs was a key contributor to lowering our overall cost of funds and improving margin. We have seen a 31% year-over-year increase in these DDA balances and net new DDAs are consistently growing between 3% to 4%. As a percentage of total deposits, non-interest bearing DDA balances have increased from 23% last year to 26%.

Lo0oking forward, we expect continued margin improvement in the third quarter. We are targeting a range in the upper 330s to low 340s assuming no meaningful change in interest rates. Ohio Heritage's impact on third-quarter margin should be minimal. Beyond the third quarter, we expect Ohio Heritage to add 3 to 6 basis points to margin.

North Akron is expected to add another 4 to 6 basis points of margin starting in 2015. The added margin from acquisitions does not consider any potential loan accretion income. We believe opportunities exist for some accretion income in each transaction.

Moving to fee-based revenue, we continue to see solid performance with a year-over-year growth rate of 9%. The growth has been balanced between all business lines. Insurance revenue was up 24%; trust and investment revenue up 9%; and e-banking revenue up 4%. We continued to experience a decline in mortgage banking income due to a sizable drop in refinancing activity during the year.

On a linked-quarter basis, fee-based revenue was down due to a drop in annual insurance contingent income. Approximately 75% of this income is recognized in the first quarter. So excluding the contingent income, fee-based revenue was up 16% annualized from last quarter.

Absent the one-time costs, operating expenses were slightly better than expectations for the quarter. Salaries and employee benefits showed the largest increase from the linked quarter as we continued to see a rise in medical insurance costs due to an increase in claims activities.

Other expense categories were generally flat or down compared to the first quarter. For the rest of 2014, we see the quarterly run rate for our core expenses to be around $18.8 million to $19 million. This range does not consider any additional pension settlement charges or the impact of the pending acquisitions. We expect pension settlement costs to be significantly lower in the second half of the year.

As Chuck mentioned earlier, asset quality trends continued to be positive. Our annualized net charge-off rate for the quarter of 2 basis points remains well below our long-term historical averages. Like the second quarter, we should see some modest provisions for loan losses in the coming quarters given our expected loan growth and as we anticipate our net charge-off rate to move closer to precrisis level of 20 to 40 basis points.

I will now turn the call back to Chuck for his final comments.

Thanks Ed. Absent the acquisition costs, we achieved positive operating leverage with a focus on strong revenue growth and expense management. The gap between revenue and expense growth through midyear was 1%. For the second half of 2014, the gap is expected to grow as we layer on the pending deals.

The pre-provision net revenue to asset ratio is a good indicator of our improving core earnings. Without acquisition costs, this ratio improved to 1.38% from 1.25% last year. Strong organic loan growth and positive impact from the completed acquisitions were the key factors that drove the improved performance. We anticipate continued improvement in this metric.

As we wrap up the first half of the year, we are pleased with the momentum we carried into the second half. We expect to sustain strong revenue growth trends in the second half due to our improved sales across all lines of business and from our acquisitions. Our commercial loan pipeline has been consistently strong and includes over $200 million in new loans of which $60 million are expected to close and fund over the remainder of the year.

Consumer lending activity continues to grow at a steady pace. Non-mortgage production was up over 26% compared to last year. Indirect lending was the biggest contributor to this growth with production up 53%. Mortgage production levels in the first half of the year were one-half of the prior year. In June, however, we experienced an uptick in production which we expect to continue for the next couple of months during the peak home buying season.

Given our strong loan production, we expect to achieve our point-to-point loan growth target of 8% to 10%. This growth does not include Midwest or our two pending acquisitions which combined will add approximately $360 million in loan balances this year.

As Ed mentioned earlier, the Midwest acquisition will be immediately accretive to our bottom-line results, strengthening our balance sheet, margin and operating leverage. We are excited to move our banking operations into this market and partner with our existing insurance team to provide expanded capabilities to our new customers.

In the second half of the year, our attention will shift to our two pending acquisitions in our new northeastern Ohio markets. Similar to Midwest, we expect these transactions to have a positive impact on earnings. Combined, capital dilution should be minimal given the mix of cash and stock. Earnings accretion for Ohio Heritage should be over $0.10 per year and North Akron over $0.06 per year.

In terms of integration, these two transactions are relatively low risk and easily digestible given their size. Our experienced management team has the capacity to successively integrate these acquisitions while still maintaining the same level of care around our daily activities.

Lastly, I am excited to build on our accomplishments as we move to the second half of the year. Successful completion and integration of our pending deals will be our top priority. We will also remain focused on our day-to-day business. We expect to see strong production levels and improving sales execution across all lines of business by creating an extraordinary client experience.

The second half will be a challenge. I am confident our talented, experienced employees will embrace the challenge and take us one step closer to becoming the Best Community Bank in America.

This concludes our commentary. And we will open the call to questions. Once again, this is Chuck Sulerzyski, and joining me for the Q&A session is Ed Sloane, Chief Financial Officer.

I will now turn the call back to the hands of our call facilitator. Thank you.

(Operator Instructions). Scott Siefers, Sandler O'Neill.

Hi Chuck, hi Ed. This is Brandon on the line for Scott. Just wanted to ask you a few quick questions. First, it seems like insurance income was down a little more than we are looking for looking back to line items a little more volatile in 1Q historically. Was the variance here just seasonal? Or was there something else in there? Can you give us a little sense for what you guys are looking for going forward?

We were actually comfortable with the insurance results. Historically we get the contingent income in the first quarter or the majority you know, 75% of the contingent income in the first quarter. So you expect that little bit of a decrease. I think the real driver on the fee income side on the negative side was the 50% reduction in mortgage fee income.

Great. Thank you very much. And then just one more. You guys mentioned in the release that you are committed to positive operating leverage in 2014. But you guys do face the challenges of costs associated with pending deals. Are these costs that you guys speak to more the one-time charges associated with the deals or are you talking more to challenges with realizing expected cost savings?

No, I think we will see positive operating leverage if you exclude the one-time costs associated with the deals. We continue to improve our efficiency. We tried to show that in the script and are optimistic with the pending deals that you will see greater efficiency. We stated that the efficiency ratio minus the one-times was 69%. You know I think at this time next year, it will be meaningfully lower than that.

That is great. Thank you very much.

[Michael Pareto], KBW.

Hey, good afternoon guys. Quick question on the expenses. Ed, I believe last quarter you guys gave kind of like a I think it was $18.4 million to $18.5 million quarterly run rate ex the deals which we came in a little below that. And then if I heard you guys correctly, you were expecting about $450,000 of annual run rate from Midwest. So is that -- are you guys comfortable that if we just layer those two together then obviously you have to take in the Ohio Heritage deal which will close in August, but is that a good way to think about the core expense run rate going forward?

Yes. Yes, the $18.8 million to $19 million again it includes Midwest but it does not include the Ohio Heritage and North Akron transaction. So you would have to layer those on top of it. Yes, that is a good way to look at it.

Okay. And then I apologize if I misheard, but the Heritage impact, I believe last quarter you guys said it was 6 to 8 basis points potentially accretion. Did you guys mention 4 to 6 this quarter? I just want to make sure I heard that correctly.

Yes. That is correct. And we are being conservative with that number mainly because when we bring the balance sheets together we have to think about how much of that investment portfolio we are going to retain and there are also some long-term borrowings that are sitting out there with Ohio Heritage that what we bring it all together we just want to make sure that we are benefiting our asset structure within our Company.

Okay. All right, thanks for clarifying. And one last one on the asset sensitivity. You guys screened pretty positively in your 10-Q that you guys just released. I think it was about 5.5% increase to NII for 100 basis points move in rates. How if at all do you expect these deals to impact your rate sensitivity going forward? You know looking out maybe six months once all three are on the books, do you think it will lessen your benefit or is there an potential benefit that could be greater?

Really we spend a good bit of time looking at that as you can expect and kind of layering everything on top of one another. And it really turns out to be very neutral to that impact moving forward.

So you would expect a similar impact as previously disclosures even after the three transactions are closed?

Correct.

Okay, all right. Great. Thanks for taking my questions.

(Operator Instructions). Daniel Cardenas, Raymond James.

Hey guys, how you doing? So I mean nice loan growth on an organic basis. You seem pretty optimistic that you can hit your targets out there. Maybe a little bit of color as to in terms of the growth that you have seen, how much of that has been a marketshare grab versus maybe folks starting to come off the sidelines and investing for future growth?

And then maybe as you look into the second half, what are you seeing in terms of economic improvements that gives you confidence that you can continue to hit those numbers that you have been hitting?

Sure, I think more of it is a marketshare grab than it is necessarily a change in underlying demand. But I would say there is a small change in underlying demand. Keep in mind, Dan, over the last couple of years, we've continued to invest in hiring top quality lenders where we can pick them up and we have got more capacity in the field, more capacity in the Company in terms of revenue generating people as a percentage of total FTE. So those lenders have brought some of their portfolio to us but have also helped us penetrate new markets.

In terms of economics, and what is going on particularly in the eastern portion of our footprint, the oil and gas boom continues to have an impact. Right now unemployment in Ohio is lower than the US average. Unemployment in Washington County is lower than Ohio average. That is really unusual and the eastern portion of our Appalachian footprint is really doing quite well and helping us. So we think that those conditions will allow us to continue the results that we are having. We think that continuing to add proven lenders is a strategy that we will continue working on. And then collectively as an organization, we get better with each quarter at being able to make quality referrals across lines of business.

So we are seeing more retirement plan sales coming from our commercial bankers and our insurance professionals. We are seeing good commercial loan referrals from insurance professionals. And we really have a lot of things to be happy about and optimistic about in our future in terms of just overall improved skills and knowledge across the lines of business.

Okay. And then I guess once everything is said and done with your acquisitions this year, what does that do to your legal lending limit and your in-house limit? And then maybe if you could talk about your discussion to go after larger credits. Because I am assuming the legal lending limit is just going to go up, correct?

Yes, the legal lending limit is going to go up. We are not going to change our house limits. By and large, we do not go north of $15 million on new deals. We tend to prefer to stay under $10 million and we don't go north of $20 million on relationships. And as we get bigger, we will probably keep that limit in place for a while. I think historically this Company has had an appetite for loans that are relatively large to the size of its asset base.

I think that we will more than double the size of the Company before I'll take a look at increasing those limits. Those limits are not preventing us from doing business. I think $20 million takes care of 99.5% of the credit demand for the American businesses. So there is not a lot of need for us to go much further north than that.

Okay. Good to hear. And then one last question and I will step back here. I know you still have a lot of your plate in terms of digesting and completing acquisitions but what is your appetite for another bank transaction here in the second half of the year?

Well, I guess I would say a couple of things. First off, I am very grateful for the team that we have here. We have a lot of proven experienced capable people that are allowing us to do an acquisition a quarter and I think that is a bit unique.

You know we continue to have discussions. We continue to knock on doors. We continue to review books that are distributed. I would say I would be disappointed if there wasn't something announced in the second half of the year but to tell you the truth, I am equally interested in doing insurance acquisitions and doing investment acquisitions.

Our story with the high fee income, the story that we go out to customers with around being able to provide a full-service answer to financial service needs really requires us to do more insurance acquisitions than investment acquisitions.

So we are looking. We are being mindful of what we are doing. I think we are maintaining good controls. I'm excited about the increased efficiency. I'm excited about the new markets. I'm excited about our ability to attract talent into the institution that allows us to do more on these markets than perhaps some of the companies that we have acquired have. So we are pretty bullish.

Great. Good quarter. Congrats guys.

Thank you.

Thanks.

Michael Pareto, KBW.

Hey guys, thanks for taking the follow up. Ed, really quickly on the securities portfolio. In your prepared remarks you mentioned that you guys sold down some of the securities you brought over from Midwest. Can we anticipate similar action from the two deals you have set to close later in the year?

Yes. Most definitely. We put some guidance out there about 25% to 30% investments to total assets and we are sitting at 31% today and we will continue to work at that. We think that is an important part of our strategy as it relates to stabilizing asset yields and remixing our balance sheet. So, it will be a focus in the second half.

And is that 25% to 30%, is that longer-term or is that a back half of the year?

That is back half of the year.

Okay. All right, thanks a lot guys.

At this time there are no further questions. Sir, do you have any closing remarks?

Yes, I want to thank everyone for participating. Please remember that our earnings release and a webcast of this call will be archived on peoplesbancorp.com under the investor relations section. Thanks for your time and have a good day.

This will conclude today's conference call. You may now disconnect your line.