PNC Financial Services Group Inc (PNC) 2006 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Yardville National Bancorp Second Quarter 2006 Earnings Conference Call. [OPERATOR INSTRUCTIONS] It is now my pleasure to introduce your host, Mr. Patrick M. Ryan, Chief Executive Officer of Yardville National Bancorp. Thank you, Mr. Ryan. You may begin.

Thank you. Good morning, and welcome, everyone, to Yardville National Bancorp's earnings conference call. Today we will discuss YNB's operating results for the second quarter of 2006 and for the first half of the year. With me today is Kevin Tylus, our President and Chief Operating Officer, and Steve Carman, our Chief Financial Officer. Today's teleconference is also being webcast live on our website, www.ynd.com. A replay of today's teleconference will be available later this afternoon on our website. There will be brief prepared remarks regarding our financial performance this past quarter, and then we'll open the call for any questions you may have. Before we begin, however, Steve will read our Safe Harbor Statement. Stephen.

Thank you, Pat. The following discussions may contain forward-looking statements concerning the financial condition, results of operations, and business of Yardville National Bancorp. We caution that such statements are subject to a number of uncertainties, and actual results could differ materially, and therefore, you should not place undue reliance on any forward-looking statements we make. We may not update any forward-looking statements we make today for future events or developments. Information about risks and uncertainties are described in our SEC filings which are available on our website or from our Investor Relations Department.

Thank you, Steve. As we reflected in our press release, we had a challenging quarter as our retail-banking sector continued to grow and the commercial loan pipeline remained healthy, despite stiff competition in the marketplace. While we are encouraged by these positive factors, there are a number of other influences that we will discuss shortly. As a result of all of them, net income for the second quarter of 2006 decreased to $5.1 million from the $5.6 million earned in the second quarter of 2005. Diluted earnings per share for the second quarter were $0.45 compared to the $0.51 we earned for the same period in 2005.

For the six months ended June 30, 2006, YNB's net income was $10.2 million compared with the $11.2 million earned in the same period a year ago. Diluted earnings per share decreased to $0.90 from the $1.02 reported in the prior year's first half. The results for the first half of 2006 reflected certain higher expenses, which were anticipated, and lower than expected net interest income improvement. The higher non-interest expenses were from salaries and benefit expenses associated with the bank's retail expansion and new branch openings, the cost of YNB's proxy contest and related litigation, and a higher provision for loan losses. Margin pressure and slower than anticipated commercial loan growth have somewhat restricted improvement in net interest income as well.

Despite vigorous competition for commercial loans and deposits, our tax equivalent net interest margin has remained stable. For the six months ended June 30, 2006, YNB's tax equivalent net interest margin registered 3.04%, the same as reported for the same period in 2005.

As interest rates have continued to rise, both commercial and retail banking customers are avidly shopping for attractive rates and terms. Providing attractive rates and terms in the marketplace have had the effect of tightening spreads on the business we book. Couple that with intense competition to attract deposits, and the result is pressure on achieving margin objectives.

Despite this challenging environment, we remain focused on generating new business and new markets as well as leveraging our established loan relationships. It is clear that increased pricing pressures will be part of the marketplace for some time to come. Our commercial loan pipeline remains healthy, but larger commercial loan payoffs in the second quarter, combined with the strong competition, held our growth level below historical levels. Loans increased 7.3% to $2.03 billion at June 30th compared to $1.91 billion at the same date in 2005. Barring additional large payoffs and further cooling of the real estate market, we still believe the lower end of our targeted loan growth of 6% for 2006 is achievable, and we will continue to see excellent opportunities in our expanded marketplace. We recognize, however, that we must continue to work hard in order to meet our objectives.

An additional element in improving the net interest margin, of course, is attracting lower-cost retail deposits and effectively managing our cost of funds. I'm going to ask Kevin Tylus to discuss with you how our retail strategy, especially the new branch openings and deposit promotions throughout our branch network, have increased deposits during the quarter, and what we have planned for the rest of the year and on into 2007 on that front as we continue to build on our successes. Kevin will also discuss a new program we are launching to address the current challenging bank environment. Kevin?

Thank you, Pat. As we have emphasized before, the expansion of our retail geographic footprint continues to be an important element in YNB's strategy to enhance franchise value and, in turn, shareholder value. We have forged ahead in this area in 2006 with excellent results. In the past several months we have opened branches number 29 and 30, both in affluent and rapidly developing Hunterdon County. One was in Ringoes and another in Whitehouse Station, home to Merck's corporate headquarters, as some of you may know. Hunterdon is one of the highest per capita income counties in New Jersey. The commercial business and retail marketplaces are robust. Keep in mind that these 30 branches and the additional planned locations are all in this very attractive, seven contiguous county area that continues to show demand for our style of community banking.

But the proof of the retail strategy is in its results, and I am pleased to report that our new branches are providing approximately $9 million a month in new deposits and have contributed $76 million in new money since December of 2004 when we embarked on our retail banking strategy in earnest.

With 30 branches, this produces an average branch deposit base of over $68 million per branch, and this well exceeds the $35 to $40 million we estimate is required with a branch breakeven point. So to all appearances, this strategy is effective and is working as planned.

Our Board of Directors has approved a number of branches in addition to the ones just discussed, and several others are under evaluation. We are seeking OCC approval for branches in Lawrence Township in Mercer County and Skillman in Somerset County, both adjacent to the greater Princeton market area. And we also are looking to open new branches in Middlesex County in Woodbridge and North Brunswick, possibly before the end of the year or early in 2007.

But physical branches are only a part of the strategy to expand the YNB franchise. In January 2006 we realigned personnel to implement customer segments whereby customer [plates] are managed by specialized teams. We expanded our geographic teams, which combines lenders, business development officers, and retail experts for an integrated approach to attracting and retaining the best customers. One of those geographic teams is the new Middlesex County market team, perhaps the most attractive business county in New Jersey. The team is now active and developing new loan business ahead of the new branches coming to Middlesex. We also hired a banking veteran to head the new Small Business segment, which is a very profitable customer group.

YNB is confronting the challenging the banking environment that Pat described with a proactive plan we call PAR, Profit and Revenue. The initiatives already mentioned, along with expense rationalization and other actions, comprise the PAR program. In conjunction with our financial adviser, [Hubdy] Financial, we are finalizing the PAR program and will have more to tell you at the end of the third quarter. At this time we can tell you that, though some of the initiatives are already in development, we expect the program to position YNB for revenue and expense benefits in 2007.

Finally, as you all know, I was designated by our Board of Directives to lead our compliance activities, and I can report that we are very optimistic that we can achieve full compliance with our regulatory agreement. We have been, and continue to be, in compliance with all of our capital ratios. Progress to date has led to enhancements in our control environment, and all required actions are on schedule. Our next opportunity to demonstrate our compliance with the formal agreement will be after our next regularly scheduled exam in January and February of 2007. Finally, the OCC has approved all branch applications and all dividend requests to date. Pat, I'll turn it back to you.

Thank you, Kevin. As you just heard, we are carefully planning entry into new markets we believe will enhance the value of our franchise.

Now I'd like to talk to you briefly about loan quality. This past quarter, non-performing assets increased to $24.1 million or 80 basis points of 1% of total assets at June 30, 2006 compared to $18.6 million or 63 basis points of 1% of total assets at December 31, 2005. As referenced in our recent 8K filing, during the second quarter, a $10 million credit to New Jersey real estate developer, Solomon Dwek, was placed on non-performing status. Without the Dwek addition to non-performing assets, YNB's non-performing assets would have decreased 12.7% on a linked quarter basis from the $16.2 million reported at March 31, 2006. As we explained in our release and in the 8K, we expect that approximately $7.4 million of this credit will be satisfied during the third quarter.

At June 30, 2006, YNB's allowance for loan losses totaled $23.1 million or 1.13% of total loans covering 97.66% of total non-performing loans. Our net loan charge offs rose in the first half of 2006 to $3.8 million compared to $2 million in net charge offs recorded for the same period of 2005.

Based on information we have today, we are cautiously optimistic that credit quality will improve for the remainder of the year.

Finally, before I turn over to our Chief Financial Officer, Steve Carman, I would like to take a minute to discuss non-interest expenses. Obviously, we are doing our best to keep costs within budgeted limits. Staffing and other expenses have continued to increase as we expand our branch network and address regulatory requirements. And for the past two quarters, we had the additional expenses of the contested proxy election and related litigation. As a result of all these factors, total non-interest expense increased 6.5% on a linked quarter basis. We believe that our linked quarter run rate will be lower in the second half of the year. This is expected to improve our efficiency ratio in the last half of 2006.

At this time I would like to ask our Chief Financial Officer, Steve Carman, to update our financial guidance and to share with you what we anticipate for the remainder of 2006. Stephen.

Thanks, Pat. Last quarter I spoke of the importance of generating net interest income. As you've heard this morning, the second quarter has been a challenge from several perspectives. In the second quarter, net interest income was down almost 1% on a linked quarter basis. This was due to the increased cost of deposits. That increase in interest expense is indicative of the competition we are experiencing in our market.

As Kevin discussed in his remarks, we continue to execute our retail strategy. We believe the opening of new branches and new markets, combined with a more stable interest rate environment, will result in attracting a comparably less expensive cost to fund.

The other factor impacting our net interest income level is commercial loan growth. Pat discussed the reasons for our slower than expected loan growth in the first half of the year. We believe, however, that growth will increase closer to our initial guidance on the lower end, which will have a position impact on net interest income.

Our margin continued to perform reasonably well in the second quarter. We anticipate the margin to remain relatively stable between now and the end of the year, based in part that the Fed is reaching the end of its interest rate increase cycle.

I'd like to take a minute to discuss two factors that we believe will be significant in achieving our profit goals for 2006. First and most critical is an improving asset quality profile. We believe NPA levels will decline in the second half of the year, which should translate to a positive impact on our financial performance. Second, we expect non-interest expenses to decline in the third quarter due to a reduction in staff, which contributed to a decline in salaries and employee benefits on a linked quarter basis, in addition to proxy contest-related expenses we will not incur. Based on this data, we still believe meeting net income and earnings per share objectives on the lower end of our guidance are still achievable. Pat, back to you.

As Steve has indicated, as we enter the second half of 2006, we are looking at a variety of scenarios and their likely impact on our bottom line. We have operated effectively in this type of challenging environment in the past, and we are confident that our financial performance will show improvement the second half of the year. We plan to continue doing the things we do well, implementing the retail strategy and using our relationship-based model to sustain commercial loan growth. And we plan to shore up our performance in areas that have not gone as we would have liked them to, such as loan quality and our efficiency ratio. We remain committed to enhancing shareholder value, and we believe the positive financial trends we have established will result in achieving this goal.

At this time, I'd like to open the floor to any questions you may have, and Steve, Kevin, and I will be happy to answer them for you.

Thank you. Ladies and gentlemen, we will now be conducting a question and answer session. [OPERATOR INSTRUCTIONS] Our first question comes from Adam Barkstrom with Stifel Nicolaus. Please state your question.

Hi, gentlemen. Good morning.

Good morning, Adam.

Let's see; jumping around here a little bit. Hey, on the Dwek credit, the $10 million line of credit piece, I read what you have in the K and in the press release. Any further clarification at this point? It looks like roughly, looking at the 8K, that on that $10 million piece, about $8 million of that is okay and it's the remaining two that is in question. Is that sort of a correct translation of that?

Based on current valuations and what's currently in process, Adam, $7.4 million, plus or minus, will be collected here we believe within the next week. Well, to be cautionary, we stated in the third quarter. The balance of the funds, we will go into the unsecured pool such as PMC and all the other unsecured creditors. And from information we have from the fiscal agent, we believe there's a strong possibility that that piece, a substantial amount of that or some of that, will be collected as well. But our current valuation on the $10 million piece, Adam, is about $7.4 million, and that is right as we speak now in the process of being collected.

Okay. Okay. And then you mentioned higher overhead costs this quarter, a lot of that associated with the additional proxy cost, can you guys disclose how much additional costs were with that or how much you think costs are going to go down? Or do you think that they're going to go down relatively in the second half?

Well, first on the proxy cost, Adam. Our number for the first six months, proxy and litigation costs is $600,000, in that range, plus or minus.

Okay.

Steven, do you want to address the second half as to the costs going down?

Yes, Adam, if you really take a look our total non-interest expense for the second quarter of $14.306 million, if you take out that $600,000 for the - or for the second quarter and use that revised number with a 3.5 to 4% run rate from there for the third and fourth quarters, I think that should kind of give you an idea of where we think expenses are going in second half of the year.

Okay. Would you imagine we're going to see that same expense next year in the first half?

That's to be determined, Adam. I can't answer that at this time.

Okay. How about deposit service charges? Nice rebound in 2Q. Is that just off of seasonally low 1Q levels or is there anything more to that for second quarter?

We've initiated a couple of in-house programs to be a little more active on collecting those service charges and fees, Adam. Kevin, do you have any specific comments you want to make? I know that [Steve Walker] and some of that team has been on top of that situation.

Yes, and just tighter management I think through the commercial lending area with the customers to make them responsible, Adam. And it's in part from a lower base, as you mentioned, but also tighter management of the areas led to the pickup.

Okay. And then, Steve, tax rate. What's sort of the good, what's a good run rate for the tax rate for the second half?

As you saw in the second quarter, Adam, our effective tax rate again moved a little bit lower. We would expect that to trend up slightly in the 27 to 27.5% level by the end of the year. So I would expect it to be somewhere around 27% in the third quarter, moving up to 27.5% by the end of the year.

Okay. All right, great. Thank you, gentlemen.

Thank you.

Our next question comes from Jennifer Thompson with Oppenheimer. Please state your question.

Hi, good morning.

Good morning.

A question just to clarify the guidance, the previous guidance on EPS growth. The last I saw was 5 to 8%, is that correct?

That is correct.

Okay. And that's off the $1.89 base in 2005?

That is also correct.

Okay. Because it -- where would you say the biggest improvement is going to be? If you look at the first half of the year, the run rate, you've got $0.91 that you earned in the first half of the year. Just to break even, you'd have to average something like $0.50 a quarter in the second, in each of the next two quarters. It sounds like the margins may be flattish. Non-interest expenses, it sounds like you're saying it's still growth, right? It's not going to decline from here, is that correct?

No. We're looking at some decline in the non-interest expense.

So down from - okay, yes, right. So down from the 14.3 to maybe 13.7, growing that at 3.5 to 4%?

Well, we have implemented some expense reduction programs in-house here, Jen, that we look to see some improvement in the third and the fourth quarter as we go forward. And the other opportunity I see is if we get can, in fact, achieve improving credit quality, there could be some opportunity in the allowance for loan loss provision, Jen.

Okay, so potentially not over providing as much, and then some -

Yes. A big swing there will be the $2.5 million, plus or minus, that we're still pursuing collection on on the Dwek loan because we have fully, in the allowance, provided for that loan, Jen.

Okay, all right. So that's - all right, got it.

So you can see we put in our provision for loan loss $2.5, $2.6 million, give or take, against that unsecured loan as we work with our regulators on that. And if we are able to collect most or all of that, that's where we see an opportunity, Jen.

Okay. That makes sense. And then the - can you just talk a little bit about deposit growth? Obviously the competition is - sounds to be intense buying everywhere. Where are you seeing the incremental competition? Is it from the local community banks? Is it from the bigger banks in your markets? Is it - any color there?

Jen, this is Kevin. It's really a little bit of every place, including non-bank financial institutions through some of the Internet products and so forth. So it's really from a little bit of everywhere. We have not tried to pay the highest rate on the shorter-term deposits, even though the consumer has a tendency to go shorter term CD. And we've had some success in the 21-month term. And we've also seen some nice movement in the Simply Better Money Market product is what we [determine], but money market as opposed to CDs. So that's helped us manage the cost a bit. So while we've seen an uptick in our costs, I think if we were paying at market you would have seen a higher uptick. So we brought in some nice new money. And, by the way, complementary to bringing in the new deposits, we've had a very strong cross-sell rate into other products. So all in all, more expensive, yes; probably less expensive than what market was and some other good underlying factors of strengthening customer relationships.

Great. Okay, thank you.

Our next question comes from [Larry Simon]. Please state your question.

Yes. Good morning.

Good morning, Larry.

How are you doing? In reference to the Dwek loan, I read the 8K when it came out, and I have a question. At the time - when was that loan made?

Well, those loans --

I'm just talking - sorry. I'll clarify my question. I'm just talking about the $10 million loan secured by the stock and the CD.

Yes. I believe it was made early 2005.

And at that time, was there a policy the bank had concerning making loans on securities that are either concentrated positions or fairly illiquid?

You mean to small community banks?

No, no. To Dwek secured by the stock of more community banks or illiquid or concentrated positions.

Yes. We looked at that loan pretty much as a private banking-type loan due to -- that we made to a high net worth individual, along with the real estate loans we made, Larry. So all those factors were considered, sir.

Okay. Maybe I'm not making my question clear. I just want to know if the bank had a policy; you know, you lend 75% on real estate. Was there a policy?

As I stated, Larry, it was a loan to a high net worth individual, a private banking type loan. So those are looked at based on an individual's net worth and the collateral proffered for the loan, sir.

Okay. So therefore part of it was really deemed to be unsecured when you made it?

No. At the time we made the loan, we had stock valuations, a certificate of deposit, and a money market account in excess of the $10 million, sir.

Okay. And in reference to the - I think Jennifer's question, just a follow-up to understand what was said. The guidance was $1.89. So when Steve answered the, I think Steve answered the a question, are you saying that your guidance is, you think, you'll still make $1.89 by year-end, meaning that you'll earn approximately $0.53 or $0.54 per quarter going forward.

That's the objective that we're still focused on at this time, sir.

Based on the information you have now, do you think that you're going to be able to make that objective?

That's the objective that I, we have determined. That's still our goal, and that's what the Board wants us to focus on, sir.

Okay. Thank you.

Thank you. Our next question comes from Frank Schiraldi with Sandler O'Neill. Please state your question.

Good morning.

Good morning, Frank.

I just have one additional question that hasn't been asked on the Dwek loan. This is probably difficult to say, but is there some sort of timetable that you would have where this thing will all get cleared up and you could maybe get a jumpstart liquidating some of these things and paying back the secured and unsecured borrowers?

Yeah, Frank. Actually the judge - the judge indicated when this first started, maybe six, eights weeks ago, that he was looking to have it all wrapped by Labor Day. The fiscal agent was even more optimistic in that. I will tell you that our corporate counsel working with our outside counsel have informed me that they believe a realistic time to resolve the unsecured portion would be sometime this year, Frank. So they're not as optimistic as the original timeline. But properties are being sold. They're being sold as values higher than the loan amount and the appraisal amount. And as I understand it, the Sephardic Syrian Orthodox Group, has been very involved in those purchases. So it seems to be coming together, but timeline, the best I could tell you cautionary would be this year, Frank; hopefully sooner than later, sir.

Okay. Thank you very much.

Thank you. [OPERATOR INSTRUCTIONS] Our next question comes from [Mike Shafir] with [Stern A.G. Leach]. Please state your question.

Actually all my reasons have been answered. Thanks a lot.

Thank you.

Our next question comes from [Karen Hilson] with Sandler O'Neill. Please state your question.

Hi. Just on the $2.5 million that is still - will be still remaining after the payment from the securities, I guess, in the next few weeks, do you anticipate charging that off in the third quarter, or would that remain a non-performer - [inaudible] resolved?

By regulatory rule, Karen, we're allowed 90 days. So it will be - we'll have to have an updated result by September 30, 2006, Karen.

And if it's not, then it'll be included in the charge off [inaudible]?

Yes. As I stated before, we have fully provided for that amount in our provision. But we want to see it, obviously, resolved and collected this quarter. But we are working closely with our regulatory agency to make sure we follow all of their guidelines and rules.

Because I guess, I guess that if you had to, if you had to charge it off, assuming it is in the allowance, that would bring your allowance down well below 1%, probably even below 75 basis points.

Yes. But I did a little math, Karen, and that as the 7.4 comes in, our allowance covering current total non-performing loans will jump back up to 138% of coverage.

Right.

And that's before, obviously, then we have to address the 2.5 or 2.6 number.

I guess it's how come - how low are you comfortable taking your reserves down, anticipating some sort of charge off?

Well, yes. The total reserves we've maintained in the 113, 114, 115 range, and we reviewed and analyzef this, believe me , very thoroughly on a quarterly basis, based on the overall credit quality in the portfolio, Karen. But I personally, in 37 years of banking, like to see the total allowance coverage in the numbers I just mentioned.

Okay. Thank you.

Thank you. There are no further questions at this time. I will now turn the conference back over to your host to conclude.

Thank you. Ladies and gentlemen, at this time we conclude today's teleconference and we appreciate your interest this morning in the bank and look forward to talking with you again in the next quarterly call. Thank you very much.

Thank you. This concludes today's conference. Thank you all for your participation.