WaFd Inc (WAFD) 2003 Q2 法說會逐字稿

Good morning ladies and gentlemen and welcome to the First Mutual Bancshares Second Quarter 2003 Earnings Conference Call. [Caller instructions]. As a reminder, this conference is being recorded today, Wednesday, July 23 of 2003. With us today is Mr. John Valaas, President and Chief Executive Office, Mr. Roger [Mandery], Chief Financial Officer. I’ll now turn the call over to Mr. John Valaas. Please go ahead sir.

Thank you and good morning, everybody. I’ll start and beg your indulgence while I read the forwarding looking statement. Our presentation during this conference call will primarily contain historical information but will also include statements concerning prospective operations, trends, expectations, planned or prospects for First Mutual Bank that will be forward-looking statements for the purpose of the Safe Harbor provisions under the Private Securities Litigation Reform Act. Although the Company believes that the forward-looking statements are based upon reasonable assumptions, within the bounds of our knowledge of our business and operations, the actual events or results or developments may differ materially from those expressed or implied in these forward-looking statements due to a number of risks and uncertainties. Factors which could affect actual results include economic conditions in the Company’s market area and nationally, interest rate fluctuations and the affect on our net interest rate margin; results of branch office expansion and the cost for that expansion, credit risk management, the ability of the Company to control cost and expenses, products and pricing of our competition and legislative regulatory changes affecting the banking industry. These and other risks and uncertainties, which could affect the Company and our results, are discussed from time to time and filings made by the Company with the Securities & Exchange Commission. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. First Mutual Bancshares will not have any obligation to update any such forward-looking statements.

Before we open to questions, I might just hit a few points out of the quarter that we’d like to observe. The first is that during the quarter and for the year-to-date we’ve had excellent, excellent loan portfolio growth, 16% annualized, year-to-date, very strong performance by our Sales Finance division and our residential area, primarily custom construction and those are loans that are on the books for about 12 months and turn-over usually roll-out of the portfolio.

A very gratifying 56% growth in business checking account, year-over-year and 19% in consumer checking accounts or a focus on that aspect of the funding mixtures that producing results, in terms of number of accounts, the credit quality remains quite strong. And we have stayed very focused on our core businesses. There’s been no loading up on securities in our portfolio because we had a very strong loan growth, as I pointed out earlier.

By design, very little participation in the re-fi, we don’t see much in the way of gain on sale loans from us. And we view the retail phenomenon as transitory. Of course, for some people who have been participating, it seems like a lifetime at this point, but something that won’t hang around forever. So we’ve just stayed very focused on our core portfolio businesses.

With that, I think I’ll open it up to questions, unless Roger wants to add something. So why don’t we go ahead and respond to questions, if anybody has anything.

[Caller instructions]. Our first question comes from [Bill Dezelem]. Please state your company name followed by your question.

Thank you. I have a couple of questions. First of all, was surprised to see the single-family residential segment of the portfolio show loan growth. Would provide some backdrop there for us? And, then, secondarily, the net interest margin was nicely above the 3.7 to 3.8% range that, I believe, you had given us as guidance last quarter. Hoping you could also shed some light on what happened there.

This is John. I’ll take the easy question and give Roger the hard one. I’ll start with single-family. We have, in terms of strategy over the last several years, very consciously moved away from mortgage banking activities and the conforming single-family loans. And, as I alluded to in my introductory comment, that has also meant that, by design and very consciously, we have not participated in the bulk of the re-fi boom. What we have focused on in the single-family area, are custom construction loans and what we’ll call ‘portfolio loans’ on the perm side, primarily adjustable rate – well, virtually all adjustable rate products.

Both the custom construction, single-family, business line and the perms that we do with those portfolio products, which tend to be non-conforming, earn very attractive ROEs and that’s a business we like from a return on equity point of view. Custom construction loans tend to roll through the portfolio. A few of those stay in the portfolio on completion, but most of them end up as a fixed rate product and moving out of the portfolio.

We focused on it because we saw an opportunity for a niche in this marketplace due to the departure of what had previously been one of the largest regional major players after Washington Mutual and it’s been]a very, very good business line for us. That is the custom construction. Again, I wouldn’t herald this as a return to the thrift status, but it’s a great mixture with a terrific return on equity for us. Does that answer the first part of your question?

It does. Thank you.

And I’ll let Roger address the manager’s market.

Good morning Bill. Roger Mandery. The cost of funds did a little better than we thought they would in our projections, whenever we’re trying to forecast the future when we were taking a look at all of this in late March and early April. And for that, I guess we were pleased. Rates kind of performed, in terms of wholesale money, those rates were a little better than we thought they would be. And some of our re-pricing on our deposits turned out a little better than we thought.

Also we’ve had a little more favorable results in terms of the deposit funding for us, as that is we were able to fund some of our loans – we have money market accounts and checking accounts, [if you close] the time deposits. So the mix was a little better in terms of what did come in on retail deposits. So, to summarize it, I guess, the cost of funds performed better than we thought it would in the second quarter.

Great. Thank you both.

Thank you. Our next question comes from Jim Bradshaw. Please state your company name followed by your question.

Good morning, D.A. Davidson. A couple of little things, but maybe more important is, it looks like your income property category was down. You have 3 percentage points for portfolio and I mean, you know, the dollar amount was fairly significant. Were there any sales or unusual re-finance activity in there, or could you talk a little bit about that grouping?

Again, this is John. We are an adjustable rate lender, and although we’ll do a three-year deal or, occasionally, a five-year deal, being in the income property area, really our meat and potatoes in that product line is our one-year adjustable. And, at this point, in the rate cycle, there is, of course, on the part of borrowers incredible interest and re-financing into seven-year and, let’s say, 10-year fixed seems to be the product with a great deal of interest and we’re choosing not to play in that game.

We do have some competitors who are out there and very aggressive with 10-year fixed product and, of course, [unintelligible] and other off-balance, out of the banking industry off-balance sheet, sources for 10-year fixed. So we see some – we’ve seen a little bit of erosion. We’ve got a lot of volume in that area but a lot of pre-payments, so that accounts for the slight slippage there.

And in your guidance for the coming quarter, you still say 15 to 20 million loan growth in the quarter, I assume that you’re sort of building some continuation of that trend into the guidance that you saw this quarter, or coming in this coming quarter?

That’s correct.

A couple of other small things. What’s the decision process in recognizing gains, and deciding whether to sell the home improvement loans? You sold a little bit under a million; it looks like, this quarter. But, why didn’t you take those particular loans into the portfolio this quarter?

I think we’re pretty much done selling home improvement loans. We may have had a few that we were still dribbling out, or standing in the course of the quarter, but that relationship has pretty much ended. And we were the [party] [unintelligible] because when we had been selling in the course of last year – it’s just not a very attractive proposition.

So from a strategic point of view, around the beginning of this year, end of last year, we had made the decision to phase out the sale of those loans and to start portfolio-ing those loans because at this point, certainly – the game plan is to portfolio those loans and I would say, looking forward, seeing – I mean in the foreseeable future, anyway, any sale of those loans would be diminished.

Having said that, we do have internal portfolio limits that address what percentage our total portfolio we want to be in home improvement loans, what percentage of the portfolio we want it to be with any single dealer and in geographic areas. So if we reach those ceilings, we would, of course, sell loans. But the basic strategy is the portfolio at this point.

And you’re not close to any of those limits in the coming quarter, so you would expect to sell off – excuse me, retain off-flow this quarter?

I think that would be a correct statement. They’re substantially most of the flow.

Okay, good, and the last question I had was related to the unrealized gains in your available-for-sale portfolio. Roger, dealing with what that number is, at the end of the quarter and what you suspected might be here over the last couple three weeks?

I think our unrealized gains, and I don’t have the number in front of me, but I believe it’s about $650,000 at the end of June of unrealized gains in the available-for-sale portfolio. And we’ve already made one small sale this month and re-selling into August, so we don’t know what the gain is until the transaction sells, but I think it will probably be somewhere around $110,000. And, as you recall, we had an $86,000 gain in second quarter. So probably somewhere in that range would be the kind of gains we would expect third quarter.

I guess that leads to another question. Your forecast for operating income – excuse me, other operating income, is down quite a bit from where you were actually in Q2 and it sounds like you have another gain that you’re going to book. So is that numbers still – the 675 to 750 number you’ve got in the press release, is that still a reasonable guess for Q3?

Yes. That’s probably on the conservative side, at this point in time, but we think we’ll definitely get that range for sure.

And you probably assume a lower gain on sales loans, obviously, than in the quarter, as well.

Yes, and a big piece of what happened in second quarter, is that we closed the purchase of the First Mutual Center here, our headquarters building and the rental income was a little better than we thought it was going to be in the second quarter. We’re expecting the rental income to be down from second quarter in third quarter. We had some tenants moving out.

Okay, good. Thanks a lot. The quarter was terrific you guys.

Our next question comes from Ross Haberman please state your company name and your question. Mr. Haberman, your line is open. If you’re on speakerphone, please lift your handset.

Our next question comes from Louis Feldman. Please state your company name followed by your question.

Hoeter & Arnett. We seemed to have misplaced Ross. John, continuing on one of Jim’s questions, and in terms of the sales finance loans, you stated in the press release that they represented 7%. You also stated about a year ago, quite emphatically, that it would not – that you don’t plan to exceed the 10%. Now along those lines, you said you don’t expect to reach that level in the next quarter, or possibly two quarters. At that point, would we see a return to selling these loans or would you place more emphasis on growing the other portfolio to allow that portfolio to continue to grow?

Well, you’ll see a combination of both. As the rest of the portfolio grows, obviously, that 10% number in absolute dollar terms, as you’ve surmised, will also increase, which gives us some latitude. But you would also, undoubtedly, see some activity to bleed off some of those loans. And, at this point, we have not determined, whether we would [flee] outright sale of those loans, which would translate into being on sale, or whether you’d [flee] a sale of participation of those loans with an extremely generous servicing compared to yours truly.

Okay. The other thing, there’s a reference here in terms of your inability to support the current asset growth. You’re relying more heavily on [unintelligible] borrowings. Can you talk about this matched funding and what exposure you believe you’re going to be facing in terms of per-payment risks on the loan and pre-payment penalty risks on the borrowing? Or if these loans pre-pay early what would you do with the excess funds?

Hi Lou, it’s Roger. We try to keep a certain amount of our [unintelligible] advances and day-to-day funding sources, what they call TMA at the slubs and right now, I think that number is at 35 million. So if we were to have a sudden surge in deposits, for example, which would be good news. Or if certain prepayment in loans, there we’ve got a cushion in there to keep those day-to-day borrowings down and not have to sit around with idle time in our bank account. So, I think we try and guard against that on a regular basis.

Okay, and then one last quick one. Can you talk about the fact – despite the increase in overall checking accounts on a percentage basis, it looks like time deposits increased a bit more in terms of total percentages than your checking accounts, despite your best efforts. Can you comment on that?

Well part of that is that we have had good asset growth and [as of date] invest 70% of something in the last quarter and looked at the number this morning but back up to 72% in the second quarter.

Frankly, it’s just, it’s where the money is and we’ve had very strong growth in our core assets, and so that’s what we’ve used to fund part of that. And the business accounts we’re bringing in, a lot of those are these small, what we call ‘community business accounts’. They don’t have huge balances. They accrete over time. It’s not like each account is bringing in $100,000 in balances.

So it’s the path of least resistance to continue to fund the growth?

You mean the time deposits?

Yes.

Yes, I mean the time deposits are, probably, at least for the next few years, be the major source of funding for us. And, quite frankly, we were pretty tickled that we were able to fund so much of our asset growth, or rather, so much of the deposit growth came from something besides time deposits. Because, historically, the funding source for us in retail deposits has been time deposits. So we were kind of pleased with the way things turned out year-over-year.

Okay. I’ll step back. Thanks.

Thank you. Our next question comes from [Darias Braun]. Please state your company name followed by your question.

Hi. [Andecott] Management. Good morning guys, great quarter. Two quick questions, the first a little housekeeping. On the provision level, obviously, it’s higher because of the increased commercial loan growth, but do you envision that being, sort of, on a permanently higher plateau now?

Yes, I would think we would probably see something in the 200 to 300,000, perhaps a little more, range. Just judging by what we feel about it right now.

[unintelligible] that decision is always made near the end of the quarter and [multiple voices] inherent in the loan portfolio.

And then the next question, from a more strategic level, given the recent acquisition activity in your area, has that had any impact on your expansion plans?

Well, yes. It’s had an impact from a [picas] point of view. We’ve had a very good competitor, Pacific Northwest Bank, agreed to be acquired by a very large competitor and we have talked to a number of borrowers who indicate that while that large competitor is acquiring banks that they were more interested in a relationship with a community bank.

So we think that will open opportunities for banks our size with the lending limits that we add, I think it’s also going to open some opportunity for acquisition of lending officers in the business banking area or in that – you know, nothing happening in that respect at this point. But, I think, eventually, there will be some shakeout there.

And will your limits on your legal lending limits, do you think that’s going to come into play?

Well we’d love to have a larger lending limit to pick up some of those very good clients that I think really play – will be to find -- there are plenty in that zone where we can win.

So, for this year you’re comfortable with the 18% in guidance on the increase in non-interest expense, but, potentially, you could see some increased expense activity related to acquiring more commercial loan officers next year?

Well if we do, it’s only going to be one or two commercial loan officers and we actually are looking out into 2004, through the course of 2004 – this is really a forward-looking statement – to see the growth in staff tapering off fairly significantly.

We’ve built the back office that we want pretty much. Any additions that we’re looking at, at this point, are primarily volume related, i.e., the continued expansion in the rate of growth with Sales Finance. There’s a lot of small loans that require a lot of servicing, so, of course, there would be people added there in volume related expansion in the business banking area. But we’re starting to see a little bit of tapering off if we look out through the end of – through the 2004, in terms of head count which is the main driver of that expense number, of course.

I’ve got to ask you the, sort of, the generic question on the trend in the region – economic trends and what you’re seeing.

Well, let’s talk about commercial real estate first. Class A office space in Bellevue is probably 25% vacancy rate. Not much change there. Probably 15 to 17% vacancy in Class A space in Seattle. Not much change there.

I think the big change is, there just seems to be more, I think, a little more optimism on the part of borrowers, other banks, other financial institutions, our financial institutions. No big turn in the economy but the sense -- what I hear more and more is, if there is no major national crisis, terrorist attack or something like that, that there seems to be kind of underpinning under the economy at this point, that people weren’t talking about six months ago.

But it’s still a – as long as it’s announced they’re going to lay-off a few thousand more people, it’s still a tough market. We’ve got Microsoft as an employer here in our market place, First Mutual’s market place with very stable -- adding slightly to employment and very good pay, also. That’s been a plus for us through this but nothing – no dynamic upturn.

Great. Thank you.

Thank you. Our next question comes from [Senil Swamee]. Please state your company name and your question.

Hi. Delphi Management. Just a couple of quick questions. ON the non-interest expense, you indicated 18%, but for the first six months I’m getting 13. Am I making a calculation error here? From 8.6 million to 9.7. Is that –

-- I don’t know off the top of my head here.

I’m just wondering if the expenses are scheduled to go up much higher in the second half given that they were up 13% in the –

Yes, I think when we get to the end of the year, we’ll probably be seeing numbers that are close to the 18% figure, so I don’t look for it to significantly tail off on our operating expenses, you know, year-over-year, other than what we’ve projected here.

Okay. The second question was on the provision for loan loss, as you indicated, this will be on a higher base now. But going forward it I was to model it, would you see it in line with the growth in loans as opposed to the huge jumps we’ve seen year-over-year?

I think right now we’re probably looking for something in the, like I said, 200 to $300,000 range. We have to go through a whole slug of factors to include looking at the growth in the loans, as you point out –

-- I’m sure there’s lumpiness in it, but I wouldn’t expect the deep jump going forward.

Well, at the end of the quarter we have to take a look at where we are on a non-performing assets and what were the charge-offs we had during the quarter, what’s the watch-list look like. Also, what’s the growth, what categories did the growth come in? Did it come in business, did it come in consumer, so on and so forth.

So you do get this movement from quarter-to-quarter. If our loan portfolio was 100% homogenous and our asset quality never changed from one period to the next, then we could just look at [loans for all itself]. Unfortunately, it doesn’t quite work out that way.

The numbers that we deal with move around from one quarter to the next. Even when I’m thinking here right now, not knowing anymore, just sort of guessing where I think the quarter will end at third quarter, you know that number is pretty much a guess at this point. We won’t know till we get to the end of September.

Not a very satisfying answer, but it’s one we have to live with.

And it’s also given by how we feel about the economies in which we operate. Obviously, in our Sales Finance area, we’re nationwide. That’s one consideration. How’s the consumer doing? Locally, how is the local economy doing and if we are an adjustable rate lender, what’s happening with the overall level of interest rates? I don’t expect it to happen, but a sharp spike in interest rates in the third quarter could put some pressure on some our borrowers because they think there loans adjust in pricing.

Our next question comes from Ross [Haberman]. Please state your company name, followed by your question.

How are you gentlemen. Ross Haberman, Haberman Funds. A quick question. You guys are doing a terrific job on the loan side, growing the loans and diversifying them away from the one to fours. Could you give me maybe a bigger picture, question why you’re not putting the emphasis on diversifying the deposit side and get it away from the CDs?

Well, we are – I know it’s not evident from the results, but we are putting a fair amount of emphasis on the deposit side and we did had a year-over-year 56% increase in number of business checking accounts.

Was that a number or does that include dollars?

In numbers of checking accounts, but, you know, eventually the dollars grow. And there’s a strong, strong focus on both the consumer side and the business banking side, which will be the deliverer of that change in deposit mix.

And, frankly, most of that, because that’s where the bigger dollars are, will come from the business banking side. So as that business line continues to grow, we will see continued growth there. It’s a major focus.. It’s a major focus and a component of incentive plans for all the business banking loan officers and for the folks in our banking centers at the consumer level.

And, by the way, we are not interested in the business market in renting money, so we’re not bringing on loans unless we get the deposit relationship as well.

Okay, and two other quick questions. Your building – you made mention you’re losing a tenant of two over the next quarter or two? Are you going to use this space or are you going to look for other high paying tenants?

We’ll be looking for – we don’t have particular needs for some of that space and we’ll be looking for, and are looking for, other tenants. We’re not [unintelligible] building. But we feel that a certain – down and dirty market [unintelligible] and we do have interest in that space.

One tenant that’s in the process of moving out, we’re already in discussions, pretty serious and committed discussions, with a tenant who will take most of that space that’s being vacated. So we think there’s an interest. We’re projecting anticipating a longer hang period between when somebody vacates and we get it re-leased.

Is there a lot of, I guess, construction or capital improvements, what you have to do to bring in the new tenant or basically improve the space before you can attract a new tenant?

Well, yes, there is a negative to amortize over the life of the lease, so it’s generally not a major impact on what you see at the end of the day in terms of rental income.

One final question. Would you say – could you give us a sense of the overall pipeline and the overall backlog in terms of loans and overall loan demand, putting aside, say, the residential?

Well, actually we can’t put aside residential because, again, bear in mind, in residential we’re not talking re-fi stuff. We’re talking either portfolio perm loans, but mostly custom construction, and we’re continuing to see a very good demand in the custom construction area. That’s been a component of our loan growth in the first half of this year.

The only significant component of loan growth in the first half of this year is Sale Finance and we’re continuing to see a good pipeline there. The pipeline’s a little harder to maintain there because of [technical difficulty]. There could be [unintelligible] but there’s not a lot of lead-time. They just kind of roll in. But that activity continues to do very well.

Income property, this pipeline – very high pre-paying fees in the existing portfolios, as I mentioned earlier, a lot of demand for 10-year fixed rate product and we’re not a provider of that.

Business banking, a [latch] robust demand reflecting, of course, the economy in general. Having said that, we continue to find interest from very good borrowers moving from the larger national financial institutions to a community bank such as ours. So we continue to see demand and loan growth there.

That’s kind of the portfolio. So I would characterize the pipeline as something that we feel pretty good about.

Thank you.

Thank you. [Caller instruction reminder]. Our next question from Bill Dezelem. Please go ahead with your follow-up question.

Thank you. I wanted to touch on a couple of other areas. The other income – in the other operating income section, the other income line, specifically, there’s a pretty significant increase there. Would you help us out understanding what was behind that please?

Yes, hi Bill. It’s Roger. Most of that, or a big chunk of that, is the rental income from the First Mutual Center, the old 400 building.

We’re world headquarters, Bill.

Now the building closed in the first quarter is that right?

Yes, in March.

Okay, so that would explain the sequential change. And then, I had an interruption, so I hope I’m not doubling up on a question here, but the gain on sale of investments dropped sequentially and just going off memory here, I was thinking there was an expectation that there would be additional investments that would be sold and so that that number may, in fact, go up sequentially or at least hold flat. Did I miss something there? Did something change? Could you shed some light there please?

Yes, on the sale of the securities out of the securities portfolio, that’s pretty much opportunistic. We sort of take a look at where the market is on a given day. For example, we sold a little the other day because we thought rates were going up and we had some gains and security and thought we might go ahead and lock those gains in, in a right rate environment.

But, generally, those decisions are made spur of the moment depending on where the market is. And rates had gone up there a little bit so we'd be less enthusiastic about selling now than we might have been three weeks ago. So, there’s no plan to those sales.

Again, we’re constantly looking at the issue of convexity, in terms of, you know some securities are in the money today that were out of the money a while back because the yield on those securities is so high that the pre-payment penalties made it attractive. For somebody to buy them is more attractive for us to own the security and so as rates move up and down the spectrum there, different securities are in the money and out of the money and present different opportunities to sell or hang onto.

It’s pretty tough for us to figure out what we’re going to do on those securities until we just sort of look at a market on any given day. That’s the one area that we, quite frankly, don’t know from almost week-to-week, to be honest.

That’s helpful. Then the final question that I had is very nit-picky, but I’m curious. The temporary help expense was pretty high in the first quarter. What was the level in the Q2?

I think that dropped to – we quoted that in here somewhere. I think it’s on Page 8. Let’s see, temporary help -- $70,000 in second quarter. That’s down from $102,000 in first quarter. We’re looking for it to drop a little more in third quarter into the 40 to $60,000 range.

Thank you. Our next question comes from Louis Feldman. Please go ahead with your follow-up question.

Thank you. World headquarters is such a great building. It’s home for you guys. I can’t imagine you any other place. How’s the hole across the street?

Well, interestingly, they took the tower crane down. Roger and I were in the office this past Saturday and they put up a new tower crane. So I started beating the jungle drums to figure out what was going on. To make a long story short, they are going to shore up the walls in the hole to avoid the neighboring buildings tumbling into the hole and then cap it off. They’re going to take it on up as –

Hey, new underground parking deck.

Very likely.

The more serious question, staying on page 8, would you talk about the four business loans, of which you expect could be a total loss within these loans – talk about how seasoned they were, the length of time and whether these represented a different style of underwriting than exists now or is this something that we could see some more off going forward?

Let me answer that question first. I don’t know that you’ll see more of that going forward and I don’t know that you won’t see more of that going forward. But it wasn’t a change in underwriting. It was a business loan, primarily a business loan to a professional, who turned out not to be very professional. And we would probably make those loans again today based on our underwriting parameters – not to that same person.

Can you give us better guidance in terms of the potential for the loss?

Well, as indicated, we anticipate there may be a total loss and I think that’s a pretty accurate statement.

It’s the may be I’m trying to nail down.

You can look at that as fairly affirmative.

Thank you.

Mr. Valaas, there are no further questions at this time. Please continue.

Okay, if there are no further questions, thank you all for your interest and taking the time to join us. We’ll talk to you again next quarter.

Thank you sir. Ladies and gentlemen, this concludes the First Mutual Bancshare’s Second Quarter 2003 Earnings Conference Call. If you would like to listen to a replay of today’s conference call, please dial 303-590-3000 and enter access code 544217 pound. Once again, if you would like to listen to a replay of today’s conference call, please dial 303-590-3000 and enter access code 544217#.

You may now disconnect.