PNC Financial Services Group Inc (PNC) 2003 Q2 法說會逐字稿

Good morning, and welcome to today's Mercantile Bankshares earnings conference call. (CALLER INSTRUCTIONS). It is now my pleasure to turn the floor over to your host, David Borowy . Sir, the floor is yours.

Thank you Enrique. Good morning everyone and thank you for joining us today. I would like to inform you all that this call is being recorded and will be available for replay along with our earnings release at our Company's Investor Relations website, www.mercantile.com.

With me on the call this morning are Ned Kelly, Chairman, President and CEO of Mercantile Bankshares Corporation, and Terry Troupe, our Treasurer and CFO.

Before I turn the call over to Mr. Kelly, I would like to address some housekeeping matters. The press release announcing our earnings was distributed via PRNewswire at 7:01 AM Eastern daylight savings time. I would like to remind you that during the course of this conference call, we may make forward-looking statements within the meaning of 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. In this call, we may discuss some non GAAP measures in talking about our Company's performance and you can find the reconciliation of those measures to GAAP measures within our news release, which is posted in the Investor Relations section of our website.

I now present to you Mr. Kelly.

Thank you David and good morning. I think this our second conference call in connection with our earnings release and appreciate your participation.

Second quarter earnings were $50 million, up 6.5 percent year-over-year. We reported 72 cents per share versus 67 cents for last year. That's a 7.5 percent increase year-over-year. Book value per share was also up 8.3 percent year-over-year.

The components of that, net interest income is up 2.1 percent. Loan growth was up 6.9 percent and up 2 percent on a linked quarter basis, so actually reasonably strong. Earning assets were up slightly over 10 percent. Deposit growth continued strong, up 11.2 percent. Those growth patterns were offset by a decline in the net interest margin from 4.74 to 4.38 year-over-year and 4.57 to 4.38 on a linked quarter basis.

Those declines as we mentioned in connection with the first quarter call, were driven in large part by the $300 million debt issuance which we completed at the beginning of the second quarter and as you'll recall, we did that 10 year debt deal for two purposes. One was to fund the acquisition of F&M and the other was to complete a capital restructuring at the affiliate level. Given the uses of those funds, we've temporarily invested them short and its generated a 2 cent drag on earnings, which we mentioned in connection with the first quarter call.

The other impact on the margin which is no surprise is the declining value of non-interest-bearing funds. The fact is in this rate environment, the fact that we have as much capital as we do and the demand deposits we do, especially given the strong deposit growth, has created a drag on markings obviously as rates have fallen.

The decline in the net interest margin was in turn partially offset by an increase in returns and other investments, which we mentioned in the press release.

Non interest income was up 23.5 percent to 45.4 million year-over-year and was up 20 percent on a linked quarter basis. In particular, investment in wealth management was up 9.4 percent year-over-year and up slightly more than 10 percent on a linked quarter basis.

We also had investment securities gains that were on a rate basis about 5.5 million. Of the total securities gains, about 5 million was generated from sales of equities and 1.5 million from the sale of bonds. The equities have been securities individual equities that we have held at various affiliate banks and the part of the balance sheet management process, we chose to sell them during the quarter.

The increases in net interest income and non-interest income were offset by a 13.4 percent year-over-year increase in non-interest expenses. The biggest component of that was other expenses, which as you can see from the press release were up 36 percent or roughly $4.5 million. That in turn, consisted of a number of significant items. One was a director's deferred compensation, which on a year over year basis was up about 1,280,000 (ph). Merger-related expenses related to the acquisition of F&M, which were about 775,000; amortization in connection with the acquisition of Boyd Watterson, which is about 422,000 (ph) and then a minority interest which is driven by the performance of our mortgage banking subsidiary which is up about 423,000.

Looking at the other expenses, furniture and equipment was up 19.8 percent or about 1.1 million and that was driven by investments in technology, investments in wealth management but also some technology investments in the banking side in terms of imaging.

Employee benefits were up 15.5 percent driven by higher pension and medical costs and salaries were up 6.6 percent. That was driven by acquisitions and a higher incentive compensation (indiscernible).

There were similar drivers of the 10 percent link quarter increase in non-interest expense. Again, other expenses being by far the biggest component of that with a directors deferred comp being 1.6 million, 1.7 million roughly, F&M 725,000, Boyd Watterson amortization about 287,000, a seasonal increase in advertising and promotional expenses and again, the minority interest as I mentioned earlier driven by the performance of the mortgage banking subsidiary which was about a half a million dollar difference on a linked quarter basis.

Other expenses were by far the driver of the link quarter increase. Other categories were not out of line, but it was other expenses that drove it.

Cutting through it, we have 5 cuts per share in incremental securities gains, which were offset by the following factors looking at it on a link quarter basis -- 2 cents in debt costs -- per share in debt costs, 3/4 of a cent in merger-related expenses, 1.5 cents in director's deferred compensation, about 1/4 cents per share in terms of Boyd Watterson amortization and again, going back to it, about 3/4 quarters of a cent in the seasonal advertising expenses. But even excluding that, the securities gains basically were offset by these items during the course of the quarter.

As an aside, going back to the $300 million debt issuance, as you may recall we did that for two reasons. One was to fund the acquisition of F&M. The second was to think about restructuring the capital at the affiliate bank level and that latter objective had two components to it. One was to try to make the equity capitalization of those affiliates both more uniform and more efficient from a tax standpoint and the second was to the extent we could, to address particular asset and liability management problems with those affiliates and a third outgrowth of it was we are also able as a result of the debt offering and the restructuring to generate some more term liquidity at the holding company level.

In conjunction with our analysis of the capital restructuring program, we've now swapped 1/3 of that debt offering, so we've swapped $100 million of it. So 200 million of it remains fixed; 100 million of it has now been swapped. That will help us to address or at least not to aggregate some of the more asset sensitive banks we've got at the affiliate level. We hope to complete that capital restructuring sometime within the next 60 days, maybe sooner than that and as we mentioned before, ultimately, that should generate a considerable amount of term liquidity at the holding company, which we mentioned in the past will be available for a variety of purposes including share repurchases.

On the credit quality front, nonperforming assets at the end of the quarter were $38.1 million or 50 basis points. That was versus 37 basis points at the end of the first quarter and 64 basis points last year. That increase was driven basically exclusively by one loan moving from monitored into nonperforming. With the one that we added in the monitored category in the first quarter, as you know it's a construction equipment business. They've been adversely affected not only by the slowness in the economy but also by the weather, which was a problem both during the winter and the spring. I am sure I don't have to tell anyone how rainy it was and it took it's toll on that company and it has moved into nonperforming status.

The monitored category stayed flat and the reason for that was that the construction equipment company was replaced by another company. Both of these companies by the way as has been the case, are long-standing customers of the bank. The company that is now on the monitored statues is an environmental firm involved in the sale and management of pollution control systems. It's very reliant on refineries and utilities investing in those systems and as those investments have fallen off, the firm has suffered and we concluded notwithstanding the fact it is current, it should be included in the monitored category.

30 to 89 day past due credits are actually down to 28.8 million from 54.8 million at the end of the first quarter and 33.8 at the end of the second quarter last year. Obviously, we regard that as a positive trend and is in part a function of trying to manage that category more carefully and more efficiently than we have in the past.

Net charge-offs as you know were at 6 basis points, which is consistent with a couple of exceptions, with our past experience. The allowances are at 188. The coverage, the allowance NPA (ph) is at 376 versus 515 at the end of the first quarter and 299 at the end of the second quarter last year. But I think the 376 still compares very well to our peers.

To address a subject of current interest, the securities portfolio is still very short, very conservative. It is 26 percent of earning assets. It's roughly depending on when you take the snapshot, 60 percent treasuries and agencies and 40 percent mortgages. We've basically as you know as part of the restructuring that we have gone through over the last six to nine months, replaced some of these treasuries with mortgages but we have been fortunately, in part having been late to the game and I would like to say fortunately in part to one hopes some foresight, we have been very conservative in how we structured it. The average maturity is still short and we believe our exposure to rising rates is relatively limited. We still have gains in the portfolio and there has been relatively little change from the first quarter to the second, in terms of the risk profile.

We have as others have but not nearly as severely, been hurt by prepayments with respect to the mortgages but given recent developments, looks as though that prepayment stream may in fact slow and as I said, we believe our extension risk in a rising rate environment is limited and as you know, the firm as a whole I believe, is well positioned to benefit from rising rates.

A final note on F&M; it's on track, as you know. We've received the Fed approval. There is a shareholders meeting scheduled for August 6th. They reported earnings recently of 7.5 million for the second quarter, which was up 23 percent over the prior year. They have strong loan growth, strong deposit growth and their asset quality if anything, has improved, so we are looking forward to closing that deal sometime this quarter and one hopes, reasonably shortly.

With that, I would be happy to open it for questions.

(CALLER INSTRUCTIONS). Ross Looby of Credit Suisse First Boston.

Good morning gentlemen.

Hi Ross.

A question for you on the margin. You mentioned that you had an increase from other investments that showed up there. Can you talk about what those might be and whether those benefits might recur?

It's hard to say. We hope so but what they are essentially is we have taken roughly, slightly less than 3 percent of the portfolio, it's about $75 million, and invested 25 million in each of 3 hedge funds of funds (ph). Those funds consist of 57 managers in total. Obviously, very well diversified. It is a portfolio management strategy as you know. Also it dovetails into what we have been doing in the investment wealth management front because those funds are being offered to clients as well. Performance in the second quarter was actually quite strong, stronger than it was in the first.

One of the reasons we highlighted it is that we certainly have every hope that it will continue to perform on that basis, but wanted to acknowledge the fact that irrespective of the impact of the debt issuance, it was in part offset by that performance so as not to obscure the fact that like everyone else, we are under some margin pressure in this environment.

Sure, and just to follow up on that obviously, you took some securities gains this quarter. Can you tell us what the unrealized gain or loss was on the portfolio at June 30?

I think my recollection is, somebody correct me if I am wrong, $28 million. Terry, is that right?

After-tax, the fair value adjustment is 45 million down from 52 million.

I'm sorry, I am looking at a different number.

Thanks very much guys.

Robert Lacoursiere of Lehman Brothers.

Robert, how are you?

Yes, good morning. How you doing?

Fine.

This is a question, if you can give us on an update on the aircraft exposure, I think it is still in the monitored section right?

Yes, it is and it is likely to stay there for sometime would be my guess unless there is a significant turn of events. As far as I know, everything is going as it has. It continues to be current. We are still watching it closely as we should with any exposure in that industry, but we're comfortable with where it is right now.

And just going back to the investment securities gains, are you finished with that or should we expect perhaps more disposals that could generate some gains in the coming quarters?

I think probably you can expect some. I think our run rate on the investment securities gains by and large has been around a million dollars a quarter, something like that, sometimes higher, sometimes slower, slightly lower. But I think there are two things to keep in mind on that front. One is we're try to manage this portfolio as dynamically as we can, as there have been circumstances within the last 6 months I can tell you where we looked at certain securities which we had bought and concluded based on the environment, that it made sense to sell them. We did that with some CMOs a while back for example, which did generate some gains but I think was clearly, the right tactical decision especially in light of what's going on, so I certainly would not rule out securities gains. As I mentioned we only had 1.5 million in bond gains. 5 million of it was equities and those equities, as I said were individual equities and have been held for legacy reasons at a number of affiliate banks and it struck me that it didn't really make much sense for us to hold individual equities which is what drove that sale. So I think on the individual equity front, with a couple of minor exceptions, you certainly would not expect to see any more of that, but I would not rule out the possibility of more gains arising as a result of management of the portfolio.

Thank you.

Gary Townsend of Friedman, Billings, Ramsey.

Good morning.

Hi Gary.

You have traditionally have been quite conservative in your approach to s--(indiscernible) purchases. You have the wherewithal to do that going forward. Can you give us a sense as to what the view is now and a sense as to how your behavior might be?

Yes, one of the reasons -- as I mentioned earlier, one of the reasons we did the debt deal was to try to affect a restructuring at the affiliate level, in order to as I said normalize equity capital ratios at each of those affiliates and make them more efficient because the truth is we had equity capital ratios all over the lot at the affiliate level and it made sense to me to make them more uniform with regard obviously to their particular circumstances. The debt issue allows us to do that in terms of pushing down subordinated debt, which doesn't change their total capital position but changes the mix, which makes it more efficient from a tax standpoint if nothing else, and also makes it more efficient in the sense that they don't have to pay us dividends each quarter and by virtue of being able to upstream funds in connection with the capitalization, we get more liquidity at the holding company. That liquidity at the holding company is available for a variety of purposes including share repurchases.

As you know it's been our view in connection with the pending acquisition we have not been able to be in the market on the share repurchase front. But I would certainly, reasonably expect us to use that as a tool in terms of our capital management. My recollection is we still have a substantial authorization left and that is available to us as we go forward. One of the things that we have not been able to do since we announced the F&M deal is to be in the market. I certainly would not rule out the possibility of our being in the market in future on that front.

Okay --

Gary, if I could -- just one thing actually --

Sure.

The other thing I might add which I did not is we increased the dividend as you know by 10 percent --

Right.

-- at the end of the second quarter and historically, I think the view here has been that our earnings were really sort of a 40-30-30 formula. In other words, in terms of retained earnings, dividend payout and share repurchases. The fact is we have been light on the share repurchase front. Our dividend payout ratio is now up to 45 roughly and as we look at it pro forma, it's likely to stay, even assuming reasonable increases going forward, in the sort of low to mid-40s. We have substantial room to do share repurchases and I wanted to add that because obviously related to the dividend issue.

So for reasons of having restructured your subsidiaries capital, it sounds as though you could be more aggressive than you have in the past?

We certainly are going to be capable of being more aggressive.

Okay, thank you.

Todd Hagerman of Fox-Pitt, Kelton.

Todd, how are you?

Good morning. Fine, thank you. Ned, if you could, just give a little bit more color just in terms of the wealth management maybe, what the Boyd contribution was this quarter and also if you could give us a flavor for in terms of the line item there, just in terms of the benefit from say an increase in asset values in the quarter versus say, net new client wins?

I could Todd. I think, let me take those in order and if you will remind me if I miss any of them. On the Boyd Watterson front, it is cash accretive. We also obviously have an amortization of intangibles, which I mentioned, which I think still generates on a GAAP basis, a marginally positive contribution. Being fixed-income oriented, obviously, they've had some issues around that as have all fixed income oriented managers. But the fact is, and there has been a slight revenue shortfall compared to what we would have expected. Having said that, I continue to believe both from a performance standpoint and a business synergy standpoint given the nature of their business, the deal is a very positive one for us.

On the wealth management front, I think if you look at the assets under management, especially on the personal side on a linked quarter basis, you'll see a reasonably substantial increase. My recollection is its 10 percent on a linked quarter basis although I may be wrong about that but I think that's the right number. I think that reflects a couple of things. Obviously it reflects market movements in terms of our having a good quarter. I think it also reflects, one hopes some momentum in that business just in terms of new sales which are necessary for us frankly, to offset terminations with respect to the legacy business.

We are as you know, still predominantly fixed income in the asset management business, so we are less likely to get a pop on assets than someone who is more equity oriented. I think the ratio is still predominantly fixed income, although we do have obviously, equity assets under management but that will mean that we won't necessarily track market movement on that front.

I was encouraged by the increase in revenues. That is driven in part as you know by acquisitions but overall, we are working very hard to establish momentum in that business and working very hard to ensure that our performance is up to participants.

Great, thank you very much.

Buck Rualin Miller of Benning and Scatter.

Scatters good. I heard something about hedge funds of funds going in the investment portfolio in connection with offering to the wealth management. Are you all investing capital as a general partner or as a limited and does that mean there is a carry?

We have three hedge funds of funds, which we are offering to clients. We're the sponsor of those funds. They have been structured so that smaller pieces can be offered to clients as is normally the case in connection with hedge funds. There are 3C7s (ph) on there -- known as 3C7 funds. In order to establish the funds, we had to feed them and that required us to put $25 million into each fund. That generated a total of 75 million which has been mentioned as roughly less than three percent of the investment portfolio as a whole. We have sold those funds to clients. There is now approximately 40 million of clients funds in those funds as well. We have chosen to keep our investment in those funds on an ongoing basis which is in turn, what generated the gain or the increase that you saw on a linked quarter basis.