PNC Financial Services Group Inc (PNC) 2003 Q1 法說會逐字稿

Good morning, welcome to today's Mercantile Bankshares earnings conference call. All parties have been placed on listen only mode. To queue in for questions, do so by pressing 1, followed by 4 on your touchtone phone. To remove yourself from queue, You may do so by pressing the pound key. It is now my pleasure to turn the floor over to David Borowy, director of investor relations for Mercantile. Sir the floor is yours.

Good morning, everyone, and thank you for joining us today. I would like to inform you that this call is being recorded and will be available for replay along with our earnings release and our company's investor relations web site, www. www.mercantile.com. With me on the call are Ned Kelly, chairman, president and CEO. And Terry Troupe, our treasurer and CFO.

Before I turn the call over to Mr. Kelly, I would like to address housekeeping matters. The press release was announcing our earnings distributed during PR news wire at 7 a.m. eastern savings time. During the coercion of this conference call, we may make forward-looking statements within the meaning and pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

A forward-looking statement encompasses any estimate, prediction, opinion or statement of belief and the underlying management assumptions. Forward looking statements are based on current expectations and assessments of potential developments affecting market conditions.

Interest rates and other economic conditions and results may ultimately vary from the statements made during this call call. Now I present to you, Mr. Kelly.

Thank you, David, good morning. This is American teal's inaugural earnings conference call and we're delighted to be able to do it. We thought it might be helpful to get everyone together and walk through the highlights of the quarter.

As you know from the release this morning, we reported 71 cents per share for the first quarter, in part, that was driven by weighted average shares being down by about 1.3 million shares year over year. Loans were up 6.2% year over year, Gross were up 11.5% and earnings were up 7.6%, all of which, in my view, represent a very strong performance given the environment in which we're all operating in this stage.

On the margin front, margin was up two basis points to 457 to 455, and the fourth quarter 2002 , and that was driven by a shift in the mix of earning as assets and in particular, using more optimally liquidity that's been generated for us over the last few quarters.

On a year over year basis, not surprisingly given the feds actions the margin was down by 15 basis points. One thing I would point out is for the first time the decline in the yield and investments securities portfolio has decelerated from where it was last year. That's been part of our objective in terms of insulating ourselves from the current rate environment. One thing I would say and I know there will be questions about this, my own view is, virtually every bank out there is asset sensitive at this stage. We're no exception in that respect and we'll continue to be asset sensitive and will benefit if and when rates rise. On the asset quality front, good news in my view. Nonperforming assets decreased $ $6 million down to .37 percent, period end loans 37 basis points down from 46 basis points at the end of the fourth quarter. Monitored loans are up.

This is a category that we have used in the past, and may use with some frequency going forward, principally because I think it's important to give you a sense of what concerns us and to give you a sentence of the loans that are concerning us before in fact they migrate to nonperforming. There is one loan which is driving increase in monitored it's to a long-standing commercial customer who is involved in the construction equipment business, who has been adversely affected by muted economic conditions and frankly a very harsh winner. The balance is about $11.8 million.

As many of you know, there has been historically, and I suspect going forward there will not be either any linear connection between nonperforming assets and net charge-offs net a-- the fact is we structure own loans with personal guarantees and strong collaterals. Whatever the nominal amount may be in general as we work through things, whatever loss we may have tends to be considerably less than the nominal amount. This is in monitor status. It is not nonperforming, but we are concerned about it, which is why we put it in monitored. The bulk of the monitored continues to be the aircraft related roans loans that we talked about at the end of the fourth quarter.In fact, they are current and

performing at this stage. They are in better shape than they were at the end of the fourth quarter. To some extent, that's reflected , as you know, in the improvement in the 30 to 89 day past due loans which have declined from $104 million to $54- $55 million at march 31st. As we predicted, we thought that number, $104 million was due to seasonal and technical factors. They have taken care of themselves and as a result the number is down considerably over the quarter.

The allowance remains steady at 1.89%, net charge-offs were down to 6 basis points annualized and the provision exceeded charge charge-offs by $1.8 million. Non-interest income was up, excluding the securities gain which was realized in connection with repositioning of portfolio, it was up 6.3%. We were helped by acquisitions in that regard, Boyd water son, as you know has been closed and was included in the quarter for one month, and has been -- and we believe will continue to be a very good acquisition for us. It has increased our assets under management, which on an apples to apples basis are down very marginally, but with Boyd water son on a quarter basis are up.

The other thing that drove non-interest income, we had lower write-downs as equity investment. We have a relatively small portfolio of equity investments which incurred write-downs in the 4th quarter and they were smaller this quarter. Non-interest expenses were flat quarter over quarter. And we continue to focus as we always have here on expense discipline, not with standing the investments that we've made in the investment of wealth management business, and we will continue to do so. A couple of final comments away from the earnings release itself itself, as many of you know, we issued $300 million in fixed rate debt for 10 years. That debt, assuming no other actions on our part, to commit mitt gait it, has a negative carry associated because it is fixed, it is 10 years.

Again, with no actions to offset it, it would cost us after tax about, 2 cents this quarter in order to carry it. We believe it was a great opportunity, however, given the rate environment to issue fixed rate debt and to issue it for 10 years. We in fact are going to make it subordinated and it gives us the opportunity to further rational rationalize the capital structure of the affiliate banks in particular and replace equity with subordinated debt. It will generate term liquidity, which puts us on sounder foot as you know that can be used for a variety of purposes, including share repurchases, if it comes to it, when we are free to do so as a regulatory matter.

Again, we thought it was a good opportunity to take advantage of conditions in a dead market, and we did so and while it does have negative carry associated with it in the near term, just in a straight analytical basis in the absence of any other actions, we thought it was well worth doing. A few comments on F&M, we're going to announce a senior management team at F&M within a few days if not tomorrow. That may slip a day or show but it's going to come shortly. The various filings are on track on the regulatory and the security front.

F&M announced it’s first quarter earnings and they were at 66 cents per share against a street expectation of 60 cents a share, good performance by them. In general, we're feeling very good about the deal, the integration continues to move forward well, move forward at pace.

I think the relations between the two firms are quite strong and we continue to be encouraged about the prospects With that, we would be happy to open up the questions. With that, Terry is here with me and we appreciate your participation.

Thank you, the floor is now open for questions. If you have a question or comment, please president president the numbers 1, followed by 4 on your touchtone telephone at this time. If at any point your question has been answered, you may re remove yourself from the queue by pressing the pound key. Questions will be taken in the order they are received. And we do ask that when posing your question, you please pick up your handset to ensure proper sound quality. Please hold the line while we poll for questions.

The first question is coming from Christopher Marinac of Robinson Humphrey.

Fine, good morning. Question for you on the overall continuation of prepayment and early repayment of both loans and securities. Do you suspect that there is more of a certificate of a negative tend towards margin continually this quarter even if they are status quo on the external rate front?

Let me respond on the long portfolio week, see that in the spreads, particularly, as you know, we do not carry long-term fixed rate mortgages in the banks mortgage portfolio. There is a lot of runs refinance activity. We are holding our own in terms of outstanding balance, but you see the spread -- basically the yield on that portfolio going down. Mercantile, we're benefiting in the fact that we're late getting into mortgage backed securities. Some securities that we bought in 2001 had prepaid, and we have been tracking that closely, but frankly , we've only started building that portfolio in the fourth quarter and at the yields that we're generating, should reduce our prepayment risks somewhat.

Chris, as you know, and as you can tell, I there are numbers -- there will be numbers that reflect this in the queue. The fact is we're still very heavily weighted treasureries in the investment securities portfolio. Terry said we've been, if you will, only recently building a mortgage portfolio, and we have not done it, Frankly, any -- we have done it to a considerable degree, but not in excess. We were helped by the fact that we were late in respect to premiums and issues like that. What has hurt us most on the margin front, as you know, on this rate environment is the fact that our free funding, full full, the capital and the non-interest bearing deposits simply have less value in this rate environment, which has caused the margin issue for us. I think in general, it's been pretty good at managing the spread given the environment. But the fact that what we regard as very valuable as a general matter is less so in a persistently low rate environment.

Your higher cost time deposit deposits, how quickly do you think those can refinance here in the next couple of quarters?

Most of that, Chris, has really passed through and we've been shortening the duration, especially our large $100,000 and over portfolio as part of our overall plan to manage interest rate risk. So, I'd say in the first quarter this year, we had a few CDs that matured, but now we don't see much of a change in that going forward.

The other thing, Chris, as you can tell from these numbers, which I think has been generally true, but certainly we've been beneficiaries of it, liquidity continues to be very strong, deposit growth is frankly in my view, extraordinarily strong and continues to be so. As I said, it's 11-1/2% year over year. I think rough calculations I did and you all can do them better on an annualized basis, 10% link linked quarter. So it continues to be strong.

Last question is on loan growth. Any sign of a change in the last couple of weeks?

You know, Chris, it's sporadic Sometimes you see signs of improvement and other time you are frankly less encouraged than you were a few days before. I think it's about the same, frankly. No marked pickup, but having said that, it's also not dreadful.

Great, guys, thank you very much.

Thank you.

The next question is coming from Claire M. Percarpio of Janney Montgomery.

Hi couple questions, The debt impact of 2 cents, are you suggesting that next quarter could be -- could have the 2 cent impact or have you sort of offset that for going forward? It's 71 cents in this quarter, is that a run rate?

Claire, as you know, I'm loath to predict where we might be and we have not done that. All I wanted to point out, with respect to the $300 million, if you look at it in terms of what we paid for it and what we could goat get, assuming that we kept it short, there is a negative carry associated with it. That's not to suggest there that there aren't things we can't do to mitigate it, for full disclosure purposes, I wanted to point out which would have been obvious to you, anyway, what is a negative carry. There aren't ways in which we can overcome that.

Was the timing of it late in the quarter or -- you know

It was mid-to late, April 15 15th.

April 15th was the --

I'm sorry, the settlement, it was early in that respect, I'm sorry.

When was it?

April 15th.

All right.

Is when it closed.

So it didn't really impact the first quarter.

No, it did not.

And it could impact the second?

Precisely.

Claire. $125 million will be marked for F&M cash transaction which will close hopefully in the third quarter.

All right, I see.

We're doing it for a couple of different reasons one, we wanted to obviously fund the cash portion, which we thought we could do at favorable rates at a fixed 10-year basis. The second was, we began to look at the capital structure, the affiliates, which is not uniform uniform. We wanted to think about whether we might be able to substitute subordinated debt for equity and generate greater liquidity on a term basis at the holding company.

Right.

The only reason we raise it in this call, not because it has any bearing because it doesn't, but if you look at it on its face going forward and assume that we take that debt and invest it short, it does have a negative carry. Having said that, there are steps we can take to mitigate that. So as I said, all we were doing was just pointing out, I think, and maybe we shouldn't have, but what is the obvious, which is if you issue a 10-year debt in this environment on a subordinated basis and invest it short, you've got a negative carry.

You want to invest it short.

Or there are other steps to make sure that it doesn't have the nominal impact.

Okay, all right. You don't want to give any earnings guidance going forward at this point? Are you sticking with that?

I'm sticking with the review of what you all have to say in any given point.

Let me just ask one or two more things, if I might. Why did F&M beat by as much as it did, and is it sustainable?

I will let F&M's earnings speak for themselves for reasons you might understand. They have issued the release, and I don't want to comment on their earnings.

All right.

What I will say, and you've heard me say this, there was some questions following the conference call about why it is that we assume 9-1/2% growth with respect to F&M. I think there were several reasons for that. One of those was we had seen what it was they were thinking about. The second was, we compared it to how our affiliates are doing in similar markets and believe they had growth rates that were at least equal if not in excess of that, and therefore we're comfortable with the growth projections. I think The 66 versus 60 without commenting at all on the details of those, because I'm not in a position to do so, seems to validate the assumption we made at the outset.

Okay. Last question, any guidance at all on the net interest income and net interest margin?

The margin is up two basis points which I suspect comes as a surprise to some. My crystal ball is only as good as the rest of yours. I think if things remain the way they are, we should be okay. Having said that, as you know, there are periodic suggestions in the market that the fed may decide to cut again, and as I said earlier, everybody is asset sensitive as us. So we're doing our best to pre preserve that margin.

Thanks.

Thank you.

The next question is coming from Christopher Mutascio of Legg Mason.

Good morning, gentlemen.

Hi, Chris.

Three quick questions. What did Boyd add to the quarter? in terms of revenues on the wealth management side, two, piggybacking on Chris's question about loan growth, you said it was somewhat sporadic, it was actually a decent clip, so maybe a little more flavor on that, and three, share repurchases were light. Was that because of the F&M deal deal? What can we expect going forward forward.

Let me take those in reverse order. With respect to the share re repurchases, they were light and that was by and large attributable to F&M. Because as you know, not with standing when it was announced, when we got out of the market, we've been frankly talking to them for a while, so they were light. But frankly with respect to share repurchases going forward, we currently can't do them principally because we've got the acquisition pending. We wouldn't rule them out going forward.

On the Boyd water son front, my recollection is roughly $650,000 in revenues for that part of the quarter during which it was a part of us. We would be hesitant to annualize those because we're not in the business of and annualize anything. It was a significant contributor for the time it was there. We continue to be excited about that deal not only because they have a core business, but also because of what we believe they can bring to us and we can bring to them as we drive the business forward. And then on the final point, you're right. Loan growth has not been bad in the grand scheme of things. My sense of it is, though, it is more sporadic than you would like to see, less consistent that you would like to see in terms of each week, seeing the same size packets. We look at loans here at holding company every week, and there is a difference from week-to-week in terms of how thick those packets are, but to say that I'm displeased with loan growth would be wrong, because I'm not. Having said that, would I like it to be stronger? For sure. I think what holds it back are the conditions that hold people back just in our market but in markets throughout the country.

It seems like it's been more in the commercial real he is estate and commercial construction. Are you seeing any pick up in the C and I?

In my view, that's where it's soft softest, and consumer soft as well, but, see, and what I think that reflects is just un uncertainty. You know, which we talked about before. I don't think that all of the un uncertainty that people felt out there has been completely re resolved at this point.

Thank you.

Thank you.

The next question is coming from Gary town Gary Townsend of Friedman, Billings, Ramsey. Please pose your question.

Thank you, good morning. I think it's been answered but just for clarification, the change in the composition of your investment portfolio was the addition of mortgage backed securities; is that right?

That's right. As I said, they've been relatively recent. And we've done that for a couple of different reasons. One is because we think it makes sense, because as you know, we had been an outlier with respect to the concentration of treasure treasureries, that we had in the portfolio. As you can tell, we still have a lot more treasureries than most people, and a lot more mortgage backed agencies than most. So we're still very conservative conservative. We've been conservative in the approach we've take to try to reposition it, but obviously in the relatively near past, it has served us well, but we are not and we never would, the only way out on the risk factor, we just don't do that.

There are lots of flavors of MBS, what do you like?

What we've been buying are primarily the adjustable rate product, 3-1s, 5-1s, but some 7-1s, but staying in the shorter -- to mitigate and give us the student opportunity if rates move up to reposition the portfolio.

This might surprise you, but my standards in terms of re repositioning has been that we not increase duration substantially and that we not affect credit risk at all. Consistent with that, if they can raise yield, it's fine.

The duration is currently?

In the 2, 2-1/2 range, Terry.

Thank you.

Actually, I'm told it's short shorter than that, it's 2-22.

The next question is coming from Robert Lacoursiere with Lehman Brothers --

I was wondering if you could tell us what you would suggest or would you consider putting in the excess from the bond into MB MBSs is that what's planned to keep this transition going?

No, not by its terms. We wouldn't do that. The fact is, we've got an ongoing repositioning. We've got a bunch of liquidity. One of the things that helped us in the quarter basis was we took the fed funds sold and deployed those more optimally. I think given what we see as trends, there may be opportunities to do that in this case without drawing a direct link with what we are doing in the bond and what we're invest investing in. My strict standards with respect to repositioning the portfolio have been not to appreciably increase duration and not to incur credit risk. Within that, I think we've got a fair amount of room. Historically all we did was ladder treasureries. We're not doing that anymore. Having said that, we're behaving very conserve conservatively. There will be ways as we go through the next quarter to mitigate the impact of what is the number nominal negative carry associated with the debt.

You mentioned revenue pickup from the one month of void. What was the expense, associated expense for the one month and the second question is related to the increase in your large CD CDs, if you could comment on that.

Let me -- on the expense side side, the bottom line contribution was minimal, because of some of the first one one-time expenses and costs for the first month. So minimal contribution was less than $100,000 to the bottom line line.

So we do expect, Terry we're thinking of $100,000, we expect that deal to be a force during the year.

Correct. The second question?

On the deposits, the comment on the increase in the over 100 100,000 deposits.

That was done at Merc-safe. We were into that fed funds market and buying more heavily than we would like to be, so we went out and issued some investor CDs in order to reduce our dependence on fed funds purchase.

it was a Merc-safe specific Issue.

They are short duration?

Yes.

The next question is coming from Brian Haggler(ph) of Banc of America capitol.

My question has been answered answered, thanks.

Thanks question.

If there are further questions or comments at this time, please press the numbers 1 followed by 4 on your touchtone telephone.

The next question is coming from Todd Haggerman (ph). Please pose your question.

Good morning, everyone.

Good morning.

If you could, provide more color in terms of the problem as asset portfolio. You really saw some marked improvement in the quarter. Particularly, if you could comment in terms of the sharp drop in the lease financing, as well as the commercial real estate linked quarter.

Well, I think, you know, I hope that we can put in a category of doing what we said we would do. As you know, the last year, I guess, actually week, announced we would get out of the leasing business and work through it as aggressively as we could. I think we have done that. I think with respect to the rest of the portfolio, it's reflective of the discipline that's persisted here for years in terms of trying to work through credits and make sure we get out of them on as optimal a basis as we can, once we have a problem. Given the environment, you could argue that you would be surprised by the fact that it declined to the extent that it did, but again, I think it's testimony to how effective people here are at working through problem credits. I don't know that there's any more -- that there is any over overall discernible trend in it other than the fact that we've been able to work through some specific credits pretty effectively.

And, you know, just getting back to your earlier comment, just in terms of the monitored loan portfolio, is there anything within the portfolio that you could kind of in terms of a takeaway there, in terms of the up tick or gross up up tick versus the trends here that we saw, particularly again in the lease or the commercial real estate?

No, because I think the fact is, if you look at that monitor monitored portfolio, with the vast, vast majority of it is two loans. The aircraft related loans and this new one that we put in from the construction business. The balance beyond that is only $2 or 3 million. And that's frankly -- I don't even know if there are any lumpy ones in there. I think it's smaller ones by and large where the affiliates are concerned about them and therefore we've put them in the category. So, again, I don't think there is a trend there. I think we've got two particular credits that we're concerned about and that's why they are in the monitored status status, but I don't I -- I don't see any under did this lying trend. The watch list which is the internal watch list is flattish basically on a linked quarter basis. So nothing dramatic going on there.

Okay, great. That's very helpful.

The next question is coming from Gerard Cassidy of RBC Capital Markets. Please pose your question.

Hi, how are you

Gerrard, how are you.

Good. Getting back to the mortgage backed portfolio, I know you are focused on preventing prepayment risk and insulating yourself against accelerated prepayments. If long-term interests rates due to the recovery go to say the 10 10-year goes to 5-1/4% therefore prepayment risk is reduced to everybody, what kinds of extension risk do you have in that portfolio in how far out would those mortgages backed securities go?

There are a couple things about that. One is not much. You know, based on the analysis we've done, and I don't have the precise numbers at my fingertips fingertips, but it is not a lot. I think -- the other things are, the first part of your question, let me just think about it for a second. Remind me what the first part of the question is. The extension risk is not long.

Let me add, we've been doing a lot of modeling to stay on top of this issue, and some of the securities that we bought in 2001 that we were expecting to see a 7-year duration are obviously a lot shorter. That kind of movement back up in rates will result in getting us back, not back to the 7-year duration that we were looking for, but it'll actually help us out by extending a little bit.

Gerrard, I know what I was going to say. When you raised the -- implicitly where you're also raising of re reinvestment issue, if you will, depending on one's point of view view, one of the biggest problems we had was we had huge reinvestment risk in a falling rate environment. They are not spinning off any cash. We've got big maturities coming due and you’ve got to figure out what to do with them. So even though they were on the face of it, pretty conservative, the fact is we had to do something to mitigate that. Because we've got a similar dynamic, thank frankly, in a rate environment like we're in where we had to redeploy all of it. Now, again, as I mentioned earlier, whether on a percentage basis or in terms of the kinds of securities we're buying, we're not doing anything dramatic, but what we're trying to do is get securities that have got higher yield out too much longer duration which helps us draw the cash to deal with reinvestment issues as we go forward.

Good. The other question was on the deposit side, can you give us some color, your year-over-year deposit growth was quite good, and a bunch of it came into the non-interest bearing checking accounts. Are you finding out that, you know, your companies are being required to put more down for compensating balances to offset the lower rate environment? What's -- what are some of the reasons for the success there?

You're right on point. Even throughout the lead bank and the affiliate bank structure structure, a number of our commercial accounts are on account analysis. The lower earnings credit that they get generates higher deposit balances, but it's also led to higher fee income in our fee zone deposit, surprisingly. And then the balance has been, I'd say, primarily retail in flow into the demand deposit, some degree, it's demand deposit but more so into the money markets and interest checking products.

And you can see that during the link quarter basis. If you look at the composition of the in-flows. I don't think it's wildly different although you can argue that it may be slightly better than what's going on generally.

Great, thanks.

Thank you.

We have a follow-up question coming from Claire M. Percarpio–Please pose your question.

On F&M, do you want to say anything or -- I hope you didn't say it and I missed, it but on the timetable for closing, you said it hadn't changed the contract?

We're still trying to get it done by the end of the third quarter, if we can.

End of third, okay. So what for timing of share re repurchase. How quickly after that?

As soon as we close, we're free to do it.

Okay, thanks.

The next question is coming from Robert Lacoursiere of Lehman Brothers.

Going back to the monitor of loans, can you give us a sense of timing, whether good or bad

Robert, I can't give you a sense of timing here, because the fact is for example, even though the airline loan is on much sounder footing than it was at the end of the fourth quarter in terms of it's being performing and current, I'm not inclined to take it out of the category for a while given overall pressures in the industry. That may be there for quite sometime. On the construction equipment loan, assuming that business picks up and obviously, we're through through a very harsh winter. It may migrate out of there or it may migrate to nonperforming. I can't give you a sense of time time. Those are the two principal loans. The other one is smaller. In general, it's hard to say. When we've got circumstances like that, we do our best to work them through is about all I can offer, I'm afraid.

And just another question. I don't know if I missed the explanation, but what was behind the linked quarter decrease in other expenses? Was that the reduction in the write-offs?

The largest piece was we had some significant charitable contributions in the fourth quarter last year

That was about a million- million-three, Robert.

Right.

So that wasn't in this quarter.

Professional fees were down slightly.

So this rate subject to the fourth quarter bump up for charitables? Is this a good run rate to look at?

Yeah, exactly, by and large.

Okay. Thank you.

The next question is coming from Matthew Teek (ph) of Davenport and company.

Good morning.

Hi, Matthew.

I had one question for you. I was wondering if you could comment on the direction of the profit margins in the invest investment and growth business relative to the fourth quarter and the out outlook for the rest of the year in that business.

I think, Matthew, direction of profit margins has been down. My hope is, as you know, as we've discussed with others, is they will stabilize during the course of this year and improve next year. The reason they are down as you know, is because of the nature of the investment and the size of the investment that we have to make. We're in the process of trying to realize on that investment, and that's going be something we're very intent on during the course of this year and next. So I think what I would hope for is that there having been down that they'll begin to stabilize and begin to track back up. Certainly not to the levels that we enjoyed historically. We were in a harvest mode at that stage, but back to more normalized levels.

Great, thanks a lot.

Sure enough.

At this time, there are no further questions, so I'd like to turn the floor back over to management.

Thanks very much. Appreciate your participating. We'll try to do this to the extent that people have found this useful, we'll try to do this each quarter. Thanks again.

Thank you for your participation. This does include conclude this morning's teleconference. You may disconnect your lines at this time and have a great day. Thank you.