Valley National Bancorp (VLY) 2006 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the third-quarter 2006 earnings release conference call.

At this time, all participants are in a listen-only mode.

Later we will conduct a question-and-answer session and instructions will follow at that time. (OPERATOR INSTRUCTIONS).

As a reminder, this conference call is being recorded.

I would now like to turn the call over to our host, Mr. Gerald Lipkin.

Mr. Lipkin, you may begin your conference.

Thank you, and good morning, and welcome to our third-quarter earnings conference.

At this moment, though, I would like to turn it over to Alan to read our forward-looking statement.

Thanks, Gerry.

Today's presentation may contain forward-looking statements regarding the financial condition, results of operations and business of Valley.

Those statements are not historical facts and may include expressions about Valley's confidence and strategies, management's expectations about earnings, the direction of interest rates, effective tax rates, new and existing programs and products, relationships, opportunities, technology, the economy and market conditions.

These forward-looking statements involve certain risks and uncertainties.

Actual results may differ materially from the results the forward-looking statements contemplate.

Written information concerning factors that could cause results to differ materially from the results that forward-looking statements contemplate can be found in Valley's press release for today's conference call, Valley's Form 10-K for the year ended December 31, 2005, as well as in Valley's other recent SEC filings.

Valley assumes no obligation for updating its forward-looking statements.

Thank you, Al.

During the quarter, Valley again produced solid results, earning $41.9 million or $0.37 per diluted share after taxes.

For the initial nine months of 2006, Valley earned $125.6 million compared to $119.2 million in 2005, an increase of 5.4%.

For the quarter, Valley's annualized return on average tangible equity grew from 22.31% to 23.77%, a metric which historically ranks Valley as one of the best performing banks in the country.

Although the quarter may change, the theme remains the same -- Valley's management's focus continues to be on long-term performance.

In doing so, we diligently underwrite our loans and monitor the performance of credits, stressing the customer's cash flow in various interest rate and economic environments.

As a result, during the third quarter, we aggressively encouraged several borrowers with total lending relationships in excess of $50 million to move their relationships elsewhere.

While this proactive strategy may negatively impact current net interest income, we believe shareholders will be rewarded over the long run.

As we have stated repeatedly, this is not the time in the economic cycle to accelerate loan growth with marginal or subprime credits.

Valley's asset quality ratios have historically been among the best in the industry, regardless of the economic environment.

The third quarter was no exception.

As our annualized net charge-off to average loan ratio was 0.09% compared to our peer group average of 0.22%.

Additionally, our non-performing and 90-day delinquency as a percentage of tangible equity and reserve ratio was 3.48% at quarter end, which is over 35% better than our peer's ratio of 4.79%.

With regard to our capital position -- during the third quarter, actively repurchased 474,000 shares.

The combination of declining loan spreads and diminished loan demand, meeting Valley's credit criteria, has encouraged us to repurchase shares.

Although we would rather employ capital in expanding lending relationships, we will balance future repurchases in relation to loan demand and other cash flow needs.

Our current tangible equity to tangible asset ratio is 6.6%, and our tier 1 leverage ratio is 8.24%.

In determining the maximum level of current repurchase activities, we target 5.75% and 7.75%, respectively.

At those levels, both ratios are still within the range of our peer group.

On our linked-quarter basis, net interest margin contracted 4 basis points.

We continue to originate loans with yields greater than current portfolio yields, as evidenced by the third-quarter new loan average of 7.03%.

However, deposit demand continues to shift from low-cost interest-bearing deposits to higher cost certificates of deposit and money market accounts.

As this trend continues, combined with a flat or inverted yield curve, we anticipate further margin compression.

The linked quarter decline in net interest income is partially attributable to a decrease in average investment securities of 3% coupled with a reduction in the spread of earning assets.

In the fourth quarter, we sold approximately $132 million of investment securities, which we have already begun to replace with market yields approximately 150 basis points higher.

Despite the potential for further declines in the net interest margin, our outlook remains positive for the remainder of the year and on into 2007.

Our balance sheet is structured to reap the benefits of a positively sloped yield curve, asset quality remains strong, and our franchise is located in one of the greatest economic geographies in the country.

Also, we continue to expand our footprint by opening branches in additional communities within our market.

We opened three new offices in the third quarter and plan to open four in the fourth.

This will bring our total number of branch offices to 171.

We currently have 21 properties under contract in various stages of development.

By year end, we intend to open our first of several branches in Brooklyn, furthering the branch expansion strategy we outlined earlier in the year.

I am now going to call on Alan Eskow to follow up with some financial highlights from the period.

Alan?

I'm going to talk a little bit about some of the linked-quarter data.

I'm going to start with the balance sheet and just some summary items.

One is that our assets did remain relatively flat during the quarter, at about $12.4 billion.

The $50 million in loans that Gerry mentioned before that left the bank during the last quarter, even with those included, we still increased on an average basis, loans by 3%.

And that also takes into account the slowing residential mortgage market, which has been going on for quite some time now.

Our average investment securities decreased on a linked-quarter basis by 12.5% to about $3.1 billion.

And that doesn't include the $132 million that actually got sold, within the fourth quarter.

Our funding liabilities overall remained flat, as we didn't have the need for additional funds during the course of the quarter, based on what happened on the asset side of the balance sheet.

But we will continue to focus on bringing in deposits and matching funds in expectation of increases in assets originated.

We had a decreased dependency, as we have been doing for quite a period of time now, on our municipal deposits.

About a year ago, we had almost 9% of our deposit base in municipals.

And currently, that is down to 4.76%.

And much of the reason for that is based upon the rates that are needed to pay for that, which are in excess of the Fed funds rates today.

Our core deposit retention remains strong as our average deposit in savings account life extended to almost 5.5 years compared to just about five years a year ago.

On the income statement, the net interest income declined $780,000 to $97.6 million.

As Gerry mentioned, the margin contracted 4 basis points, and again, that is mainly from the flat yield curve and also the substantial increase that we are seeing on the cost of deposits.

And deposit costs continue to increase based upon the competitive environment and the continued flat and inverted shape of the yield curve.

Our expectation for the remainder of '06 and '07 is that the margin will continue to remain under pressure based on those things which are affecting the economy right now.

The non-interest income line decreased almost $6 million, which was the result mainly of a $4.7 million loss on an impairment of securities, which we have reported in the press release.

In addition to that, the only other main variance was the reduction in the gain on sale of loans, as well as a slight decrease in service charge income.

Our non-interest expenses increased almost 6% for the quarter, although much of those, if not all of them, were mostly non-recurring.

Our expectation from the fourth quarter is that our expenses will be much more in line with the second quarter at about $61.9 million.

During the last 12 months, we have expanded, as Gerry talked about, our branches.

And those costs are running close to $2 million at this point in time in order to put those onboard.

And while those will have a positive impact as branches, in the short term, we are seeing the impact on our financial results.

In regard to income taxes, as we mentioned in the release, there was an expiration of some statute of limitations.

And that, combined with some recent completion of income tax exams, we had a release after reassessing some of our tax reserve liabilities of $11.2 million.

However, for purposes of normalizing the third quarter and looking forward into the fourth quarter, we still believe that the normalized rate will be 27%.

A couple of other items.

Our capital ratios continue to remain excellent, as Gerry talked about.

As of the middle of September, we bought 1.1 million shares of stock at an average price of $25.73.

Our efficiency ratio, which was reported as 59%, if you remove a lot of the non-recurrings, both on the loss and non-recurring expenses, that number would be much more like 54%.

Also, as Gerry mentioned, our credit quality continues to remain strong and a number of our items on the residential mortgage side, for example, our loan to value ratios have declined based upon payments that have come in and increased property values down to about 40% overall in our portfolio.

So we are very satisfied with that.

And our delinquency levels that are about 23 basis points on residential loans; home equities are running at 4 basis points; autos at 89; and commercial at 91.

So overall we are very happy with our credit quality as it is right now.

Thank you, Alan.

At this point, we'll open it up for any questions.

(OPERATOR INSTRUCTIONS).

Bob Hughes, KBW.

Let me start off with -- first question on expenses.

Looking for fourth-quarter expenses to be a little bit more in line with where they were in the second quarter.

I was wondering if you could give us a sense for where we might see the drop?

You're going to see it, I think we indicated a number of different items -- salary and benefit numbers.

Probably some other expenses, some utilities expenses, I think -- occupancy.

Most of those areas -- and advertising, I think are the big areas that you will see.

Is advertising a big piece of it?

I know you had some programs running earlier in the year -- given the options for growing assets right now -- is it just not a priority to be out there?

Well, we spent a lot of money on corporate identity in the first three quarters of the year.

Some of that will be cut back -- or we've already begun cutting some of that back.

There's some product advertising that we did in the middle of the year that we will not be doing toward the end of the year.

Historically, we generally pull back on advertising in the fourth quarter.

This year the pullback, I think, will be a little bit more dramatic there; you will see a little bit more because of some of the other factors.

Gerry, it has been a very tough quarter for a lot of banks so far; a lot of margin compression across the board.

What is your best guess as to when we see an inflection point?

I wish I could give you an answer to that.

I do think that the interest rate structure that we see right now is somewhat of an anomaly.

And I believe it will re-normalize.

And I think it is going to re-normalize probably some time in the first half of next year.

I don't think it is going to re-normalize itself, certainly, over the next 30 days.

And I guess finally, I thought I would ask for your thoughts on the M&A environment, given how challenging the fundamentals are out there right now.

Can you give us any color on what you are seeing in the marketplace and --?

I think you are going to see increased activity in M&A.

That is almost a given.

I think everybody is seeing it already.

And given that you are expanding out in Kings and Queens county, would you contemplate buying something yourself to fill in some of (multiple speakers) --?

We would always consider it.

Obviously, we are not going to turn a deaf ear or blind eye to anything.

We look at everything.

Adam Barkstrom, Stifel Nicolaus.

It's Adam.

You guys mention in your press release -- you have already, as I read it, repurchased another 654,000 shares in 4Q; is that right?

Yes.

Yes.

Do you still have some remaining capacity for fourth quarter?

And kind of looking out into '07, are we going to have some share repurchase capacity?

We have some more capacity in the fourth quarter.

I don't know what '07 is going to bring.

I don't like to predict or forecast that far in advance on something like share repurchases.

But we will be doing some more in this quarter.

Okay.

Would it be the remaining capacity -- and I'm not asking to predict how many shares you could buy, but just the capacity itself -- what's left that you could repurchase in 4Q?

You know, I think, Adam, what we mentioned earlier was the fact of where some of our ratios are.

And so I think we are going to keep a keen watch on the ratios and as long as those ratios remain above the levels that we indicated, I think which was 575 and 775 on the tier 1 leverage, that we would be comfortable.

But that still doesn't mean we are going to go to those levels.

That is the lowest levels that we would go to.

I got you, I got you.

Could you -- and I hopped on a little bit late on the call so if you talked about this, I apologize if I'm covering it again, but the securities losses -- I guess you took an impairment in Q3 and then subsequently sold those securities in Q4 --

Correct.

Why not just sell them in Q3 and be done with it?

What's sort of the -- behind the scenes or something?

It was really an execution issue, Adam; it was when we felt it was the appropriate time to sell.

So we had earmarked the securities that we felt we did not want to hold any longer.

And then depending on execution, we did that in the fourth quarter.

Were these -- you said they were lower-yielding mortgage-backed securities?

Yes.

I think the average yield we talked about was a little over 4.5%, or under 4.5% (multiple speakers).

What was sort of the time period between the impairment and when they were sold?

Because those are fairly liquid securities, right?

Yes, but sometimes you don't get the best execution on the last couple days of the quarter.

Okay, I see what you mean.

Because everybody else is doing the same thing?

Yes.

I mean, you are up against -- who knows in the rest of the world who wants to do those kinds of things on the last day or two or three.

And we would rather wait and not be pushed into bad pricing.

The 300 million in swaps expiring that you mentioned -- what kind of a margin effect is that going to have?

It is already in our numbers;

I think we indicated it was I don't know, about 4 basis points.

But obviously, while that is helping us, what is going on in the rest of the deposit environment is really going the other way.

So these expired when?

August 1st.

So we got a little bit of benefit, two months of benefit during the third quarter that will get the full benefit in the fourth quarter.

And Gerry, I am sure you talked with this already, but maybe give us some additional colors -- the loans that you pushed out, the $50 million, what is the thinking there?

It is credit quality.

One of the things that I guess -- one of the advantages of having been in the bank for 31 years is that I've gone through an awful lot of economic cycles.

And once burned, twice stupid.

So you've got to learn a little bit from what you saw and what you've learned.

This economic environment in many ways is not different, at least from what we're seeing, from the late '80s, at least as far as lending is concerned.

We see some of our competition just getting extremely aggressive in their desire to put on credits to show everybody that they are able to grow loans.

We always look at that as an opportunity to go through our loan portfolio, pick out situations where we feel under adverse conditions, further stressed conditions, some of these credits may not survive.

So this is a good opportunity to encourage them to find another home.

And as we reported, over $50 million of them were able to find another home.

Virtually all of these were encouraged by us, by our lenders, to find another home.

We do a very careful loan review, going through all our credit on a continuing basis.

We see banks doing things, making types of loans.

As you know, we have never made a negative am. residential mortgage, because we do not believe in that.

We don't have any in our portfolio.

We just don't believe in making them.

Others have felt differently, and now I'm starting to read from the regulators' publications that they are really starting to come down on institutions that did it.

Well I think that is only going to compound the problem of the institution that did it.

So the $50 million that you pushed out -- what is that, commercial real estate?

Is it --?

It was a combination of commercial loans.

I really don't want to get too specific on any individual credit.

Some of it was real estate.

Some of it was working capital lines.

Most of it was C&I related.

All were accruing, they were all current.

They were not loans that on the surface were having an apparent problem.

Some of them looked like their earnings were having some difficulty going forward.

We felt this was an opportunity.

And as I pointed out, some of our competition is so aggressive that they are willing to put on almost anything today -- well, good.

That's an opportunity for us.

So of your competition, the more egregious offenders, are they the smaller community banks?

Or are they the --?

I don't want to start identifying who they are.

Because then they may stop buying things when we want to get rid of them.

I guess what we have heard is the bigger national banks have remained fairly rational as far as credit terms go.

And where I guess the competitiveness comes in is sort of the smaller community banks and then --

Not always!

Well there is one particular bank that is growing rather dramatically that I guess it is --

I do not want to get into any specifics.

I try every quarter and you never --

So last thing, how about some more color on what is going on with the tax?

I mean, $11 million -- that is pretty big recapture.

There is really nothing more to go through, Adam.

We have told you what it is.

To the extent I can tell you, we had some reserves out there.

We had some exams during the year that have been closed out.

And we look at those reserves as are required all the time by the various FASB's that you look at those.

And you make sure that those reserves match up to what you're supposed to have on your books.

And at this point in time, with those things -- exams going by the wayside, and other statutes expiring, there are things that we were entitled to take into income and reduce those reserves.

You would be criticized the reverse way if you left the reserve out there that you're not supposed to.

But this probably -- for quite some period of time, takes care of any of our reserve issues.

That doesn't mean there are not reserves out there, but I don't expect you'll see any major changes for quite some time.

Actually, one last thing.

Gerry, I mean with the pushing out of the $50 million, obviously -- you, perhaps, relative to others that I've referred, might have a bit more of a negative or conservative, or maybe even forward-looking view on credit quality here.

Do you anticipate that is going to necessitate that you guys start building reserves looking out into '07?

Well, if we are able to get the kind of the clients that we are concerned with to move out of the bank, we don't have to reserve for them.

Those are the ones that would require the reserves.

The people who took them on may find that they are going to have to build bigger reserves a lot sooner than they thought.

We do a pretty thorough review of our loan portfolio on a regular basis.

It doesn't mean that we don't have loans that can go bad; that is obviously a truism.

When you make loans, some of them go bad.

But we monitor our credits very closely.

And we try to hold onto the ones that we feel are going to remain good.

And those that aren't, we encourage others to take advantage of their opportunity to grow their loan portfolio.

Adam, remember what I said earlier, too, about some of our credit quality issues.

We've got very low delinquency levels.

When you have low delinquency levels and you don't have high growth levels, and you've taken care of some of these types of credits Gerry just mentioned, there isn't a lot of need to be growing your reserve position.

John Pancari, JPMorgan.

Just wanted to see if we can get some more color on your expectations for loan growth here going into the fourth quarter, into '07.

Just assuming that we see some continuing moderation in real estate-related type of credits, wanted to see where you are seeing some good demand.

And what your expectations are around commercial or around C&I specifically.

For this quarter, I didn't see a seasonal pickup in your New York-based C&I.

It's not evident, and I'm just wondering what you're seeing there?

We saw some pickup in our New York line utilization.

We continue to see opportunities that we are comfortable with.

We have expanded some of our lending staffs, looking for credits.

The trouble is, from a pure growth standpoint, that we have standards that must be met, and that eliminates an awful lot of credits, unfortunately.

Anybody can grow their loan portfolio.

I know a lot of companies have decided that this is the time to get into subprime lending, and they're happy to make -- to show good loan growth.

But when you dig beneath the coverage, you find out they're putting on subprime loans.

Well, we don't do subprime lending.

We never had.

And we don't intend to begin doing that.

So that makes it more difficult to show double-digit loan growth at this point in the economic cycle.

John, just to go back on your question just for one minute.

The line usage in New York is actually up pretty significantly in the quarter.

We expect that to continue to do well into the fourth quarter.

And it is actually higher than it was a year ago.

So we are doing very well in New York.

And of course, after the fourth quarter, you will begin to see that paid down.

And New Jersey has been picking up as well.

So we see the C&I business doing okay.

And can you give us a little bit of flavor around the auto business and what you're seeing there in terms of demand?

The demand is off.

Auto sales are off, so the demand is obviously off.

Although we seem to be holding our own.

We have been putting on somewhere in the $10 million a week category -- that has been our production.

I would like to see it somewhere in the $12 million, $15 million a week level.

But again, we're only doing that thin slice in the market -- that "A paper" slice, so it is kind of difficult.

And when you look at the delinquencies and our loan losses in that portfolio, it bears out the fact that we are putting on only "A paper."

There is a reason why our losses and our delinquencies are so much lower than the rest of our peer group.

Everybody here gets excited because we move up 1 basis point or 2 basis points.

But when you look at how much -- what our total delinquencies are, they're nil.

As a percent, our [reach] could go up wildly because it went up by 1 basis point.

Peyton Green, FTN Midwest Securities.

Gerry, I was wondering if you could comment -- has there been a significant change in the movement of graded credits in terms of the bank, that you are now more focused on pruning?

And so should we expect there to be more of this pruning that happened in the quarter going forward?

Or is it just going to be a little lumpy depending on how things fall out?

I think the little more lumpy as things fall out is a better description.

We are not looking to throw out large-scale numbers of loans at our bank.

We identified a number of credits in the last three to six months that we were not comfortable with.

And sometimes you have to give them a little time.

But we encouraged them to leave.

And pretty much most of them have gone and found other homes by now.

That doesn't mean that we won't identify other credits that we're not happy with, but we have no wholesale purge taking place within our loan portfolio.

Bob Hughes, KBW.

Alan, looking at fee income, I was wondering if you had any commentary on the gain from sale of loans this quarter?

It was considerably lower than where it's been.

Well, there's been a lot less volume, and I think based upon the volume, it is all residential mostly.

And we are doing less residential volume and, therefore, compared to where it's been in the past, less volume typically would mean that we are getting less gains than we would have gotten in the past.

Is it solely volume related?

Yes, I think so.

And then what do you think about service charges and fees in the quarter?

They were just slightly off.

I don't think they were off by very much and I don't have any real color on that specifically.

You know sometimes, the customers they get a little smart about things.

And they don't want to be charged for [NSS] and things like that and they smarten up.

But other than that, there's nothing else special going on there.

Some of that a function of shrinking transaction accounts?

I don't think so.

No.

A lot of it comes from the fact that over the last year to two, virtually all banks, not only Valley, have gone to free checking accounts.

Well, you're going to see a diminishing service charge income coming in from that.

You know, when you start giving it away free, There goes your income.

I know your credit track record speaks for itself and your current credit metrics look great, but this quarter -- reading the release last night, I couldn't help but feel like you guys are going into bunker mode right now.

Is this more of a reflection of you feeling like we're at the end of what has been a very extended and strong credit cycle?

Or do you see issues on the horizon that worry you?

I think we are reaching the latter portion of a boom, a credit cycle.

Remember, this country goes in cycles.

And I see a lot of things taking place now that remind me of the late '80s, as a result of which, we have tried to fortify our loan portfolio so that it will perform in the years ahead exactly like our portfolio performed in the early '90s.

When most of the financial institutions were having massive problems in the early '90s, we had relatively few.

That was because of how we handled our credits in the late '80s.

So I think we are doing now a preparation that if the economy does -- and I say if, because nobody really has a crystal ball, but if the economy does contract and companies start to have difficulties, we want to be holding loans to those companies that are going to have the least negative impact as a result of that.

And if I could ask you one follow-up on my question regarding the M&A environment -- it's been quarter after quarter, we hear the usual suspects or the buyers in the markets say that sellers, earnings expectations and pricing expectations are too high.

And I know we have continued to see some transactions in the market.

But I wonder if we are facing a little bit of a buyer strike.

What do you think it will take to break the logjam there?

I think that is a question of supply/demand, desire to get into a particular location.

You can't standardize a value for what a financial institution is worth.

I think you have to look at each institution based upon their geography, their potential, their asset mix, the quality of the Company when you determine what it is worth.

It would be easy to put it through a computer and have everybody come out and say, okay, you should be able to buy a bank for x times earnings.

But I think there are so many variable factors that have to go into that, that that becomes an impossibility.

I think you have to look at each individual -- each institution individually.

I definitely understand.

Do you think there are specific concerns regarding the outlook for fundamentals, whether it is continued margin pressure, a function of competition -- the potential for credit to turn that might keep buyers at bay as well?

Well, I think what would keep buyers -- would keep me at bay more than anything else was the quality of the assets the institution held.

That, to us, is number one.

You never want to buy into major problems.

Because whatever you project you're going to earn, that is going to destroy it.

We have been very fortunate over the years, [at check] we bought 20-some institutions.

Fortunately for us, everyone of them came with a clean portfolio.

As a former regulator, I know what it takes to turn around a bank that has asset problems.

And that is a major undertaking.

And while you think you are going to make a lot of money real fast with that type of institution, it's just not going to happen.

So like I say, I think that what may slow down some of the M&A activity will be institutions that are fraught with problems -- not enough to put them out of business, but they have problems.

And that is going to slow down their attractiveness -- reduce their attractiveness.

I am showing no further questions at this time.

Well, we thank everybody for coming.

We will speak to you in three months.

Ladies and gentlemen, that does conclude our conference for today.

Thank you for your participation and for using AT&T Executive Teleconference.

You may now disconnect.