WaFd Inc (WAFD) 2005 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the First Mutual Bancshares first quarter 2005 conference call. At this time all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. If anyone needs assistance at any time during the conference, please press the star followed by the zero. As a reminder, this conference is being recorded Wednesday, April 27, 2005. I would now like to turn the conference over to Mr. John Valaas, president and CEO. Please go ahead, sir.

Thank you, Angela, good morning, everybody. Also participating in the call this morning are Roger Mandery, our chief financial officer; Scott Harlan, in charge of residential consumer lending; and Charles Smith from our Treasury area. I'll begin by reading the forward-looking statements disclaimer.

This presentation may include some statements regarding the company's trends, objectives, anticipated growth, credit quality and other expectations, which will be forward-looking statements, for the purposes of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from those expressed or implied in this presentation.

Additional information concerning the risks and uncertainties are discussed from time-to-time in the filings made by the company with the SEC. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. The company does not have any obligations to update any such forward-looking statements.

I'll be very brief. We had a quarter we were very pleased with. Our earnings per share were up about 12%. Return on equity -- I'll just hit some of the highlights. At 17.2%, and that would be return on equity. Credit quality was good, the NPAs ended the quarter at 9 basis points. In our outlook, I would draw your attention to our expectation that we may have a somewhat diminished margin in the second quarter, but we did have a good, strong margin in the first quarter at 4.08%.

A few comments on the local economy -- looking relatively good in this area. Many of you have seen announcements in the news over the last few weeks about the number of orders that Boeing is obtaining for its 787. It's actually also having very good sales success with the 777, and they are hiring at the rate of about 500 a month. There was a story in "The Puget Sound Business Journal," the last issue last Friday, about machine shops in this area being so busy that they cannot hire -- there are not enough machinists in this area to fill all the vacancies, so the economy does seem to be perking up. Residential market for single-family homes remains strong, as it has in many parts of the U.S.

In summary, we thought it was a good, solid quarter. I'm ready to take questions now and, Angela, I'll turn it over to you, and you can proceed with the Q&A.

Thank you, sir. Ladies and gentlemen, at this time, we will begin the question-and-answer session. [OPERATOR INSTRUCTIONS] Louis Feldman, please state your company name followed by your question.

Good morning, Hoefer and Arnett. Roger, can you touch on what your sales finance production is like and what that pipeline is going -- actually, this is probably more for Scott -- and what kind of pipeline you're seeing there?

Hi, Lou, this is Scott. The sales finance production for 2005 at this point looks very, very similar to the production that we had in 2004 -- no significant surprises on the upside nor on the downside.

Last quarter you were talking about efforts to improve the overall credit quality. Can you give us some color on your progress there?

Those efforts continue. We are continuously tweaking around the edges both in terms of our operations and the process that we go through to service and collect our loans as well as the underwriting criteria. Nothing significant to report other than we are constantly looking at it and constantly making adjustments where they seem appropriate.

Bill Dezellem, please state your company name followed by your question.

Thank you, I had two questions -- I guess our company name is Davidson Investment Advisors. The first one is relative to business banking, if we look back to 2004 and [audio break] curious from a qualitative perspective, would you anticipate given what you [audio break] the bottom or the biggest loss that you all experienced there, and there should be improvement from this point, going forward.

And then the second question relates to the changing of these [audio break] servicing rights amortization period. Would you walk us [audio break] the issue behind that and the impact, please.

Bill, are you on a cell phone?

I'm sorry, I am, yes.

You were cutting in and out. What was the essence of your question on business banking?

Loss last year was $400,000. Is that basically as bad as it gets, and do you improve from here?

Well, the anticipation would be that we will see improvement, but I don't know that we're expecting anything dramatic. This is a business line we are committed to invest in, and from a strategic point of view, it's a very important business line for us, as it is a driver of demand deposits, in particular, and it's a relationship business, which is somewhat different than a lot of our other businesses, which tend to be originated more on a wholesale basis. So we are prepared, at the same level of losses, continue to invest in this business line.

Bill, I will turn your question on servicing rights over to Roger.

A couple of things on the servicing fee income -- it jumped from $23,000 in the first quarter of last year to $300,000 this year. The first thing is that the servicing portfolio itself almost tripled. It went from $16 million up to $44 million, so that was a big piece of it.

Secondly, the loan prepayment speed slowed down, and at the end of each quarter we evaluate what we think the expected life is going to be for the portfolio, and we try to adjust the amortization for the servicing asset to match what we think the life is going to be. And as we looked out over what we think the servicing portfolio life will be, we felt that we needed to change that and, as a result, we extended that life, and that slowed down the amortization that we were writing off.

So the rise in interest rise -- short-term rise in interest rates actually improved our service fee income, and we'll come back and look at that at the end of the first quarter -- excuse me -- I misspoke -- we'll look at that again at the end of second quarter and see where we are. But our expectation now is that our service fee income will run at a rate of about $300,000 a quarter based on the servicing portfolio and based on what we think the expected life will be using the current prepayment speeds.

And with that increase in the amortization period, what was the corresponding increase in income in the servicing that you had this quarter?

We were anticipating that servicing income would be about $150,000 when we were looking at it before, and it jumped from that to $300,000, and that's a combination of two things. One, a change in the life, and then, secondly, we saw the servicing portfolio increase about 20% over where it was at the end of 2004.

Louis Feldman, please go ahead.

Good morning. I guess not too many people of us get up this early. Can you touch on how you got to a negative GAAP position this quarter, given the overall anticipation of rising rates, the telegraph signals that the fed has been sending for several quarters? How you reached this position?

Hi, Lou, it's Roger Mandery. It was negative 2.3% --

Switching from a positive 2-something in the fourth quarter.

Right, so to some degree that's not a real major change. However, having said that, it's the first time it's been negative, I think, since September of 2001, where we've generally been positive.

A couple of things affected that and also affected where we think the margin is going to be in the second quarter. One, the FHLB dividend -- it appears that we are not going to receive one in second quarter, at least we're not anticipating one in second quarter. Secondly, customer preference has changed on our deposit side; that is, and most of last year we were seeing core deposits come into the bank in terms of new money in the 50% to 70% range, and in first quarter of 2005 most of the money was time deposits; in fact, all of it was time deposits. And then, lastly, our security portfolio, which is about $133 million, $134 million, is mostly fixed-rate at this point in time, at least for the next couple of years.

So if you add all of those things together, it tended to degrade the margin a little bit and certainly had an impact on the GAAP.

Okay, thank you.

Ross Haberman, please state your company name followed by your question.

How are you, gentlemen? Ross Haberman, Haberman Brothers. Roger, a question -- could you talk about the loan demand on those consumer construction loans, and what's a reasonable expectation on -- in your verbiage, you said you were going to probably sell less than the $10 million you sold this quarter, and what kind of margins are you getting in terms of those sales?

Hi, Ross, it's Roger. I'll take a crack at part of that, and then I'll let Scott add to it, if you don't mind. Our goal, I think, is to sell about $6 million to $8 million, that's kind of the sweet spot for us in sales. It varies from quarter-to-quarter in terms of what we think is appropriate for managing a consumer loan portfolio. Like I say, the sweet spot is $6 million to $8 million. We are anticipating that we will be in that $6 million to $8 million range, and I think we mentioned that the anticipated gain off of the consumer loan sales in second quarter would be considerably less -- probably in the 50% range of what we saw in first quarter of this year. So you can kind of see that the sales are down.

As far as the specific margin that we're receiving on them, of course, varies from quarter-to-quarter. I don't think we have mentioned exactly what the margin is that we're receiving on servicing fee income anywhere, unless I've -- I guess not. The gain, however, as you probably have noticed in terms of dividing the net gain by the loan sales is in the 4.5% to 5% range. So that's kind of the gain itself. Scott, do you want add to that?

No, the only thing I would add is that through, at least, the current period, the demand from other institutions in those pools has been healthy to the point where we feel we've gotten pretty good execution on the sales, and the execution is measured by the pass-through that the purchasing institution requires -- pass-through interest rate from the purchasing institution, and that rate has been well within our expectations over the last several quarters, and I think reflects relatively good demand from the purchasing institutions.

Could you give us a flavor of what your expectations are as the rates are going up in terms of the origination of these types of loans -- the volume of loans, what your expectations are?

These tend to be not very interest-rate sensitive transactions -- certainly not anywhere near the kind of variability you see in residential lending when home mortgages go up a 1/4 or 3/8 or 1/2, and it dramatically affects volume. These transactions are usually initiated in the home as part of a purchase of the home improvement products, purchase and installation of home improvement products and because of the lower loan amounts and the shorter terms -- changes in interest rates usually have very small effects on the monthly payment that the customer is going to pay. So, for that reason, we haven't seen a serious change in volume based on rising interest rates.

Where interest rates do tend to affect us is when residential mortgage rates are very low, and we get into a refi boom. It tends to be -- our loan tends to be a loan that customers are paying off as part of a debt consolidation loan when they get a cash-out refi. But in terms of the origination, we don't see a high degree of variability. Does that answer your question?

Yes, it does, thank you.

Louis Feldman.

can you give us some color on the other non-interest income -- what your expectations are on rental income, loan fees, and late charges? The assumption is that rental income will be slowly trending down as you occupy more and more at First Mutual Center, but how sustainable are some of the loan fees, or what made that difference on a year-over-year basis?

Hi, Lou, this is Roger. Rental income was flat, you know, with last year, and we have about -- I think we mentioned that in our fourth quarter press release. We have something in the neighborhood of around 30% vacancy in the building, and that's been true for a year or so, and we're going through a pretty good-sized remodeling effort, and you saw that reflected in non-interest expense here in the first quarter as we move various departments around the bank and reorganize this building so that it's more functional for our use and also makes greater opportunity, if you will, or space available, for other tenants. So we're anticipating somewhere along the line here that we'll be able to fill this building.

The good news is that the vacancy rate, in general, on the East Side here for the office buildings has come down rather dramatically here, and so that should help us somewhere along the line impact the rental income. Obviously, that would be a pleasant surprise in terms of second, third, and fourth quarter if we could get this building filled up.

In terms of --

I'm looking more towards loan fees, which have the 214% change year-over-year.

Yes, that went from, what, $22,000 up to $69,000, so a $47,000 change for the quarter. In talking to the loan folks, what they're seeing is the people who have adjustable rate loans are paying those loans, and they're moving into fixed-rate loans, anticipating that rates could go up, particularly on adjustable rate loans. So we're seeing a lot of prepayment fees come into us as a result of those loans prepaying. So our anticipation is that's probably something that could cease real quick here, and if people were to change their minds and/or we would run -- supposedly, I guess, we could run out of adjustable rate loans, but the last few quarters we have seen a lot of activity in terms of prepayment fees, and that's been a boon as far as first quarter is concerned.

The prepayment fees have primarily been on the loans that we've had on our books that are greater than one year in maturity, and even though they were done at attractive rates at the time the loans were originated because of the very low rate environment we're in now, and the flat yield curve, as Roger was suggesting, we're seeing borrowers continuing to want to move out of those and into typically a 10-year fixed on commercial real estate, in particular.

Okay, and what about the late fees?

Late fees were up, what, $12,000 -- so from $36,000 up to $48,000. In terms of looking at our non-performing assets, it's been pretty stable here. I think we're like 9 basis points or something this quarter and down a little bit from fourth quarter at 12 basis points. So even though late charges have appreciated a little bit there, we're certainly not seeing it reflected in our credit quality.

I might also add on that, the sales finance portfolio over the last year has grown from about $79 million to about $110 million in terms of total loan service, and I don't know the exact number, but a good portion of the late charges come from the sales finance portfolio. So I think part of it is due to portfolio growth.

So you believe that that is a somewhat sustainable number?

Yes, to the extent that we've been selling loans. So even though the portfolio for our sales finance area has been relatively stable for the last quarter or so, the amount of loans that we've sold to others for which we collect late charges has gone up almost threefold. So that number should -- I mean -- one would expect that number to be about the same in second quarter, I believe.

Ross Haberman.

John, could you give us a flavor, given your negative GAAP, how you see the margin progressing? If we continue to see, on a 50 to 100 basis points, continue to increase with this continued flat yield curve, what your expectations for the margin are with that scenario?

In our outlook, Ross, we've suggested that we're looking for a margin in the range of 390 to 400 basis points in the second quarter, and we're not giving an outlook beyond that.

And that expectation builds in, what, another 25 to 50 basis points over that period of time?

Ross, I think the things that change from fourth quarter to first quarter that sort of got reflected in second quarter because of the lag effect would certainly be the FHLB dividend, and that's 2.5 to 5 basis points, depending on if you're comparing against fourth quarter or first quarter of last year.

The big question that we're working with now, and we hope that we won't see this continue in second quarter or later on this year is this kind of shift in customer preference that is core deposits being flat or negative a little bit while we're seeing all the new money that we're raising to fund asset growth coming out of time deposits, which is more expensive. We're hoping that we can get back on the trend that we saw in prior years. So that's the big question that we're facing right now.

And then, I guess, lastly, you know, the securities portfolio at $134 million out of $1 billion in assets is a drag just because it's fixed rate. So to the extent that short-term rates go up, and we get benefit on the asset side from our loan portfolio, which is 91% adjustable, so that's offsetting some of these other trends. But probably the real big question is this customer preference thing right now. What we see is the same trend in second and third quarter that we saw in first quarter, and that's an unknown, but our expectation is that that's not going to occur.

Should we expect to see -- you had reasonable loan growth. What's your expectation on loan growth and your pipeline?

Roger Mandery again -- our expectation for loan growth, net loan growth, in second quarter is $15 million to $20 million.

And just a final question -- could you talk a little bit about local competition -- give us a flavor of what you're seeing there, both on the deposits as well as the loan side?

Ross, this is John. Let's start with the loan side. First of all, let's talk about commercial real estate markets. We're seeing exceptionally low cap rates -- a lot of liquidity in the market and chasing deals; very strong demand for particularly multi-family, and what we're seeing is certainly some lenders willing to lend at extremely aggressive rates; that is, narrow margins, long-term fixed; what I would characterize as very lax credit standards. So a lot of activity in the commercial real estate market, not necessarily very good lending practices from our point of view.

Single-family continues to be very strong, and I think in our custom construction area and single-family perm loans that we do, we're still having very good experience with our product out there, and that has continued fairly consistently through the refi boom and on past the refi boom.

Business banking -- a little bit the same kind of characteristics, I would say, a lot of fairly aggressive pricing on the part of bank lenders for business banking deals. We think we can get business that is good for us at prices that make sense to us, but it's not easy pickings.

On the deposit side, and I think Roger has alluded to this a little bit -- what we're seeing is, first of all, a shift in customer preferences as the short end of the yield curve has moved up, and customers have moved from liquid accounts, money market accounts, and things like that, and attempted to lock in slightly higher yields by moving toward time deposits, typically, in the nine-month to 15-month range; very aggressive bidding on the part of all financial institutions for those deposits here in this marketplace, and I think that's probably true from what I'm reading in "The American Banker," across the U.S.

So fairly competitive, fairly aggressive market on both the asset side of the balance sheet and the liability side of the balance sheet in terms of competition with other financial institutions. Does that answer your question, Ross?

And that, you're saying, is putting a crimp on the loan growth?

Well, we think that loan growth in the range of $15 million to $20 million in the second quarter is fairly respectable. We'd love to have it higher, but that's where we think we can grow the portfolio and still have the returns we want at the risk level we want. But if competition for assets among financial institutions weren't as intense, clearly, I'm stating the obvious -- loan growth will be higher than what we're giving in our outlook here, and we'd certainly be looking for better yield.

This is Roger Mandery again -- I'd just point out that we had loan growth of $13 million in first quarter, and that is taken into consideration that we had loan sales almost $11 million.

Louis Feldman.

Yes, in terms of your time deposits, et cetera, is there a particularly large slug that reprices in the second quarter or is that part of the reason for the margin decline? Also, in terms of a follow-up to Ross's question, you allude quite thoroughly within your text about having to move up your cost of funds to maintain an equilibrium with your competition. To what extent is that impacting the margin as well?

Your question on time deposits maturing in the second quarter -- we don't have a particularly large slug. Again, Louis, just intense competition as we grow the funding base to accommodate loan growth, and we are anticipating funding costs being considerably higher, certainly, than they were in the first quarter. I'm sorry, what was the second part of your question?

It escapes me at this point in time. I'll have to circle back with you.

[OPERATOR INSTRUCTIONS] Mr. Valaas, there are no further questions at this time. Please continue.

All right, hearing no further questions, thank you all for taking the time to join us this morning, and we'll conclude the call. Thank you.

Ladies and gentlemen, this concludes the First Mutual Bancshares first quarter 2005 conference call. If you would like to listen to a replay of today's conference call, please dial 303-590-3000 or 800-405-2236 and enter the reservation number 11027234. Once again, if you would like to listen to a replay of today's conference call, please dial 303-590-3000 or 800-405-2236 and enter reservation number 11027234. Thank you for participating. You may now disconnect.