Valley National Bancorp (VLY) 2014 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Valley National Bancorp second-quarter earnings call. (Operator Instructions) As a reminder, this conference is being recorded.

I will now turn the conference over to Dianne Grenz for opening remarks. Please go ahead.

Good morning. Welcome to Valley's second-quarter 2014 earnings conference call. If you have not read the second-quarter 2014 earnings release that we issued earlier this morning, you may access this from our website at ValleyNationalBank.com.

Comments made during this call may contain forward-looking statements relating to Valley National Bancorp and the banking industry. Valley encourages participants to refer to our SEC filings including those found in Forms 8K, 10-Q and 10-K, for a complete discussion of forward-looking statements.

Now I would like to turn the call over to Valley's Chairman, President and CEO, Gerald Lipkin.

Thank you, Dianne. Good morning and welcome to our second-quarter earnings conference call. For the quarter, Valley generated net income of $29.5 million, the equivalent of $0.15 per diluted common share. The quarter included an infrequent increase in non-interest expense about which Alan will provide additional information in his prepared remarks. For the year to date, net income was $63.4 million or $0.32 per diluted common share.

Total non-covered loan growth was among the highlights for the quarter. Strong origination volume in consumer, commercial real estate and C&I lending was offset by the continued slowdown in residential mortgage activity, as reported by most of the industry this quarter.

During the quarter we originated over $600 million of new loans, approximately 30% consumer and 70% commercial. Total commercial lending originations of nearly $425 million for the quarter was relatively in-line with the activity generated in the prior quarter. However, unlike the first quarter, increased C&I activity dominated the growth.

Point in time C&I balances increased nearly 9% annualized from the prior quarter, as record originations of nearly $300 million in new C&I loans were generated.

Activity was brisk in all of Valley's marketplaces. New York in the aggregate accounted for approximately 60% of the new origination volume. Specifically, New York C&I origination closings expanded over 50% from the prior quarter, compared to linked quarter growth in New Jersey C&I originations of approximately 25%.

In addition, the strong origination volume realized in the quarter, C&I line usage increased from 37% to 39%, resulting in an increase in outstandings of approximately $30 million. The average yield on new C&I originations was approximately 4% for the period, as interest rates on strong credits continued to be pressured.

Commercial real estate outstandings for the quarter increased slightly, as originations of approximately $125 million were largely mitigated by portfolio amortization and prepayments. Although originations for the quarter tapered somewhat from those witnessed in the first quarter, we remain optimistic as improving economic conditions coupled with the low interest rate environment appears to have begun to foster renewed confidence among many of our borrowers. The commercial lending pipeline remains strong, and we anticipate continued growth based on current projections.

Commercial lending wasn't the only bright spot for the bank in the quarter, as consumer lending origination activity was brisk. Total non-covered consumer loans expanded over 21% on an annualized basis during the quarter, as strong indirect auto originations were supported by growth in other consumer lending products.

Valley maintains an extensive indirect dealer network throughout New Jersey, New York and Pennsylvania. Activity for the quarter was strong in all geographies, and we envision similar performance for the remainder of 2014.

Residential mortgage activity continues to decline as the consumer refinance market has slowed to levels not witnessed since before the recession, and purchase activity in our marketplace remains tepid. Typically, residential mortgage volume intensifies in the spring. However, second quarter volume lagged first-quarter originations.

And although we have expanded product specific advertising, we do not anticipate a significant change in activity or production levels unless there is a dramatic shift in consumer attitudes towards home ownership.

As a result of the contraction in residential mortgage origination volume, we continue to reduce staffing levels. In the last 12 months, we have eliminated approximately 50% of the department's workforce and intend to further right size the department should application levels remain subdued.

We remain steadfast in our efforts to improve operating efficiency. Although Valley's reported efficiency ratio for the quarter exceeded 72%, the ratio was negatively impacted by both the manner in which we are required to account for changes to the FDIC loss share receivable, as well as the amortization of tax credit investments.

Adjusting for just these two items, our efficiency ratio would have been 65.9% for the second quarter. Further, the ratio's usefulness in determining operating efficiency is at times antiquated and inconclusive in providing a comparative basis to past performance.

For example, at Valley just in the last seven years, we have seen expenses ramp up over $40 million annually to meet regulatory demands. These costs have an immediate negative impact on our efficiency ratio. However, the regulators offer little tolerance for noncompliance.

Additionally, in today's operating environment, maintaining strong regulatory compliance is crucial for a bank to participate in mergers and acquisitions. At Valley, we intend to strategically incorporate acquisitions in conjunction with organic growth as an avenue to establish scale and improve profits.

During the past few years, we have been saddled with over $2 billion in borrowings, costing us on average approximately 4%. These borrowings were intended to offset higher rate longer-term loans and investments. As a result of the protracted record-low interest rate environment, most of those loans and investments prepaid. But due to onerous yield maintenance prepayment requirements, the borrowings remained.

Beginning in 2015 and continuing over the next few years, most of those borrowings will mature and we should be able to replace them with much lower costing funds; thereby, improving profits in many of our key financial metrics in the future.

Also, we have some derivative instruments that were put in place several years ago as a hedge against potential increases in funding costs. Currently those instruments have a negative impact on interest expense and our earnings per share, but those will also mature and no longer be a cost to us starting in 2015 through 2017.

Anticipating potential higher rates in the future, we have entered into forward starting derivative contracts on a portion of the maturing debt, in order to lock in reductions in interest expense ranging from 130 to 230 basis points, depending upon the instrument. The expected interest expense savings are significant, and we believe the benefit will drive improved profitability and earnings at Valley.

In May we announced our initial foray into the Florida market with the acquisition of 1st United Bancorp. In emerging with 1st United, we are not only obtaining a profitable commercial bank with a seasoned and talented management team, but we are gaining entree into a strong growth market. Approximately 63% of Florida's population and much of the business growth is aggregated in the MSAs in which 1st United is currently situated.

The personal income and population growth in these demographics is staggering and equally integral in Valley's decision to partner with 1st United. The decision to expand Valley's branch footprint beyond the New Jersey and New York Metropolitan marketplace was not taken lightly. Over 10 years ago, we made the strategic decision to enter the New York marketplace.

Although a natural geographic extension, many of the challenges encountered in entering New York resonate with our expansion into Florida. We have proven unequivocally that Valley's approach to traditional relationship-based commercial banking is both portable and effective when executed appropriately. We believe the execution risk associated with this transaction is similar to other acquisitions, yet the growth prospects are superior to current alternatives.

In addition to the traditional synergies obtained by merging a larger commercial bank with a smaller one, such as increasing lending limit and operating efficiencies, Valley's expanded product offering provides ancillary benefits. Presently, consumer lending in the form of low closing cost residential mortgages and indirect automobile lending account for almost 30% of Valley's loan portfolio.

Internally, we view these businesses as complementary to Valley's core commercial lending competence. Since these products and services have not been emphasized by 1st United, we believe there is significant opportunity to expand and integrate these consumer business lines through 1st United's branch and lending network.

Further, the integration and conversion process at both institutions is well entrenched, and we anticipate a seamless transition upon closing. We intend for the management team at 1st United to play a crucial role in both assimilating the organizations and expanding Valley's Florida footprint.

Although the transaction has not yet closed, Valley executives have already met with a few 1st United customers in an effort to enhance relationships through additional products and services.

During the quarter we participated with First United on several larger commercial credits, and we intend to offer Valley's consumer lending products within a short order after the transaction has officially closed. We have submitted all required regulatory applications and just this week disseminated the proxy statement. Shareholder meetings have been set for September, and we seek to close the transaction in the fourth quarter.

In general, merger activity appears to be increasing within the regional and community bank space. The regulators appear to be supporting these efforts, assuming the surviving entity isn't in the penalty box for prior missteps. Although seller expectations are elevated, for many the pricing multiples do not appear to be prohibitive.

At Valley we intend to further pursue additional merger candidates that are strategically attractive in both Florida and our current marketplace. Enhancing the scale and ultimate profitability of the bank is vital to building long-term, sustainable shareholder value.

In summary, we are guardedly optimistic about the continued opportunities in the coming quarters. Alan Eskow will now provide some more insight into the financial results. Alan?

Thank you, Gerry. Net interest income in the second quarter totaled $117.4 million, an increase of approximately $3.4 million from the first quarter. The growth is largely attributable to loan expansion, coupled with increased accretion on purchased credit-impaired loans. We anticipate additional accretion in future periods from the purchased credit-impaired loan portfolios as the credit performance has improved, resulting in higher cash flows and an increase in expected collections as compared to the previous estimates.

Although we anticipate continued future benefit to net interest income, the blended rate on new loans originated during the quarter of approximately 3.40% will likely pressure the aggregate future portfolio yield. The low yield on new loans is a function of the interest rate environment, increased market competition, and a reduction of duration of new assets originated.

During the period, automobile loans accounted for approximately 25% of Valley's originations. The yield on this portfolio was approximately 2%, which although low, provides a positive return based on a 28- to 30-month average duration in conjunction with Valley's low loan loss experience in this asset class.

Partly mitigating the currently linked quarter increase in net interest income within the loan portfolio was an acceleration of investment premium amortization of approximately $1 million. Mostly as a result of the increase in amortization, the yield on the taxable investment portfolio declined 21 basis points from the prior period, as mortgage-backed securities cash flow increased approximately 19% from the prior quarter.

Based on initial cash flows received in July, we anticipate a further increase in premium amortization, and accordingly further contraction in both portfolio yield and investment interest income. Mainly as a result of the aforementioned accretion on loans, the yield on earning assets expanded 7 basis points from the prior quarter to 4.35%, and the yield on loans increased 13 basis points to 4.63%.

Funding costs during the same period remained relatively flat, as the total cost of funds increased 1 basis point from 1.08% to 1.09%. The small increase in funding costs is mainly attributable to one extra day during the quarter, coupled with a marginal increase in certificate of deposit expense associated with the introduction of consumer-based special pricing applicable to certain geographic markets and products.

With the completion of the second quarter, as Gerry previously mentioned, we move closer to recognizing a likely reduction in interest expense related to the contractual maturities within Valley's high cost, long-term borrowing portfolio of 3.98%. In 2015, approximately $400 million of borrowings with an average cost of 4.48% will come due.

In the two years that follow, an additional $1.1 billion will mature with an average cost of approximately 3.90%. For approximately one-third of these maturities, Valley has locked in a significant interest expense savings with the execution of forward-starting derivative transactions.

We also have higher cost certificates of deposit amounting to $640 million maturing in 2015 through 2017, which are likely to be renewed or replaced with lower cost funding.

Lastly, there are other derivatives that we have in place to protect against rising interest rates that have been adding to interest expense as a result of the current low interest rate cycle, which expire between 2015 through 2017. We believe there will be a reduction in interest expense that will materially reduce our cost of funds, and moreover increase Valley's key financial metrics as a result of the above maturities and expirations.

As I previously mentioned, during the second quarter Valley reforecasted cash flows associated with its purchased credit-impaired loan portfolio. The loans in this portfolio were mostly acquired through the state bank merger in 2012 and FDIC assisted transactions in 2010.

Due to Valley's lost share arrangements with the FDIC, the prospective change in the projected cash flows impacts interest income as previously discussed, as well as the provision for loan losses on covered loans and the change in FDIC loss share receivable, which is reported in total non-interest income.

Although not a direct one-for-one correlation, the $5.7 million benefit or credit realized on the covered loan portfolio as a result of the reduction in provision for loan losses was largely negated by the corresponding reduction in the FDIC loss share receivable. Exclusive of the current period charge, total linked quarter non-interest income was relatively unchanged from the prior quarter.

Total non-interest expense during the quarter was $94.2 million, a decrease of $650,000 from the first quarter. The decline is significant as the second quarter included approximately $2.7 million of the infrequent items related to the acceleration of amortization related to tax credits and merger expenses associated with the 1st United Bank transaction.

Exclusive of these charges, non-interest expense would have equaled $91.5 million, which on a comparative basis reflects a 4.0% reduction in operating expense versus the same period one year ago.

Valley also remains on target in instituting its branch modernization program, which we believe will continue to enhance the bank's operating efficiency. Through the first six months of 2014, we have upgraded the technology in over 50 branches, resulting in the direct reduction of staff of over 28 employees.

We intend to update an additional 25 branches by year end, which we anticipate will result in a similar staff decrease. In the last 12 months, we have reduced headcount by nearly 250 employees, roughly 8% of the bank's entire workforce. We will continue to focus on operating efficiency and further streamline Valley's delivery channels through the implementation of new technologies.

Credit quality for the quarter was excellent, as net recoveries of approximately $2.3 million on non-covered loans led to an increase in the allowance for non-covered loans to nearly $102 million. The allowance now exceeds total non-performing assets, which declined over 15% from the prior quarter to $96.9 million. Similarly, total accruing past-due loans declined to $35.9 million from $43.3 million in the previous quarter.

The negative provision for loan losses reflected in our income statement is largely attributable to the change in positive cash flows on FDIC covered loans. The provision for non-covered loans was zero during the quarter, based in part on the net recoveries I previously mentioned.

Valley's regulatory capital ratios remain strong, as the Tier 1 common capital ratio increased to 9.43% from 9.35% in the prior quarter. The increase is largely a result of growth in Valley's total equity. Both book value and tangible book value per share have increased over the last year, providing increased returns to shareholders, coupled with the return from our current low $0.11 quarterly dividend.

This concludes my prepared remarks, and we will now open the conference call to questions.

(Operator Instructions) Steven Alexopoulos, JPMorgan.

Good morning, guys. Just to start, regarding the scheduled maturities that you outlined, I know we discussed this partially last quarter. First question, do you expect to replace all of the $1.5 billion of the borrowings maturing, or is there room to just reduce that and shrink the size of the balance sheet a bit?

You know, I don't think we have come up with an absolute plan. I mean we do have nine months before it even begins, and then from that point forward we have another couple of years. So we will continue to monitor that based upon deposit growth, asset growth and so forth, and see what makes sense for us going forward.

I think loan demand also will have a big role in determining how much we have to fund.

Is there any plan to expand borrowings now at low rates and maybe pre-fund some of the maturities, or are you only using derivatives?

It is not linear, the pre-funding. It costs you more than let's just riding it out. And since we're so close to maturity, we are far better off riding it out.

I think the other point that we made was that we do have some forward starting swaps in place, so those have effectively locked in rates today for when they begin maturing.

That was the one-third you referenced, right, Alan?

That is correct.

What is the term on that?

They are 3- to 5-year terms. We are looking again at various terms, and again, it is cheaper to do what we did than to have negative carry by virtue of paying more for these early and ending up reducing capital, or by just carrying extra debt on the books. This is just our way of doing that without adding debt for no reason.

Right, okay. And separately on the commercial real estate loans, how did the $125 million in originations compare to the prior quarter? Maybe could you discuss scheduled maturities of these loans in the second half?

Yes, it is down somewhat from the prior quarter. We do have a fairly significant pipeline, but again I think as we have discussed in prior quarters, we can't control when those lines are going to close. So we may have had less closings during the course of the second quarter than the first, but our pipeline remains fairly significant.

And just a final one. The yield on those new commercial real estate loans, can you talk about that? Other banks are talking about that being very good.

In the 4% range, Steve.

The 4% range, okay. All right, thanks for taking my questions.

Ken Zerbe, Morgan Stanley.

Thanks. Gerry, your comments on the economic activity in your existing footprint, so Jersey in particular, seemed to be a little more optimistic than what I thought I heard as part of the rationale for why you are moving to Florida. What has changed?

Well, we are seeing activity, particularly in the New York City marketplace. There we are seeing activity of all types -- manufacturing, retail, wholesale businesses. We are seeing a little more activity in Northern New Jersey, but still Northern New Jersey is not as robust as we see in New York City and Long Island.

Florida, I don't have to tell you, just keeps growing.

But I guess I was just thinking, because part of the rationale for going to Florida was just that you didn't have the growth opportunities up here in the Northeast.

We don't. We would like to be growing a lot faster than we are.

So it is growth, but just not as much as you want. Understood. All right, thank you.

Matthew Kelley, Sterne, Agee.

So the $5.3 million increase in interest income in the quarter, that was entirely attributable to PCI, or how much specifically was the PCI benefit in 2Q?

About $3 million.

Okay. What was that in the first quarter?

That would be the incremental increase over where we were in the first quarter. I said -- we had just reforecasted, so this is the increase you saw over the previous quarter.

And what is the absolute dollar amount of that interest income?

It is on the whole portfolio of loans that are PCI loans. So we have close to $700 million of loans, and those loans have all been reforecasted. And at this point, we recorded a portion of that interest in this quarter, and there will be additional interest as we go forward depending on how those loans perform.

Let me ask you this then, the 3.27% margin, what would that have been without any of the PCI accretion, to give us a sense of the core margin? And just talk about what you think the core margin will do in the back half of the year.

It becomes core, but I don't think we really break it out to that point, Matt, to tell you exactly what it would have been, etc. I think what we are telling you is that going forward, even though we have this accretion and it is adding to our interest income, you have to look at where real rates are today and what is happening with that, the average of 3% to 4% on loans.

Okay, got you. And then your reserve coverage on non-covered loans looks like it has kind of troughed out, you know, 85, 90 basis points. Is that kind of where you want to hold it? As you continue to grow the portfolio, should we expect that level will be maintained?

I think as we have said before, we continue to run our model, and that model right now are delinquencies are down, our non-accruals are down. We have loan growth, but that being said, a lot of those portfolios are showing very good or low levels of, again, delinquencies and so forth, and we are comfortable with where it is.

I don't know exactly where it is going to drop out. We were talking about it this morning. Probably the lowest level I think I have ever seen was around 80 basis points, give or take, so we will have to wait and see how that shakes out as we continue to do our modeling and we see our growth.

What we always do when we look at loans coming from either different geographies or different types of loans, we might be providing more on those loans than we would on loans that are much more similar to what we see in our portfolio. So that all gets modeled.

Got you. And then just last question, what should we be using for a tax rate going forward?

I think we said in there 27% to 29%, in that range.

Okay, thank you.

David Darst, Guggenheim Securities.

Good morning. So within direct growth this quarter, are you expecting that we should see similar volumes going forward, or would it accelerate or decelerate based on maybe you entering Florida before closing on the acquisition?

I think you are going to see pretty much similar to the current rate for the rest of the year. If we start to accelerate in the fourth quarter as a result of our acquisition, it wouldn't really show up in our numbers until after the loans close, and that probably wouldn't happen till January. You follow what I am saying?

Yes.

If we closed in October or November, the loans don't really go on the books. It usually takes 30 to 60 days before a loan is approved and it actually closes.

Okay. Alan, can you give us a sense of what expected life is or duration of the $700 million in PCI loans is?

It is probably 3 to 4 years. It is a little hard to give you an exact number, but we are estimating in the 3- to 4-year range.

Okay. Did that just change with these revaluations?

Well, it usually does change every time you do the reforecasting. And as you see loans paying down or whatever they are doing, yes, it does; and yes, we did see it drop somewhat.

Okay, great. Thank you.

(Operator Instructions) We have no other callers in queue, Mr. Lipkin. Please go ahead with any closing remarks.

Well, thank you, appreciate everybody's time.

Thank you for joining us for the second-quarter conference call, and have a great day.

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and choosing AT&T Executive Teleconference. You may now disconnect.