WaFd Inc (WAFDP) 2003 Q4 法說會逐字稿

Good morning ladies and gentlemen and welcome to the First Mutual Bancshares year end 2003 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. (Operator Instructions). As a reminder, this conference is being recorded on Wednesday, January 28, 2004. I would now like to turn the conference over to Mr. John Valaas, President and Chief Executive Officer.

Good morning everybody. I also have with me today Roger Mandery, our Chief Financial Officer and Scott Harlan, the head of our Consumer and Residential Departments. Let me begin with the forward-looking statement.

Our presentation during this conference call will primarily contain historical information, but may also include statements concerning prospective operations, trends, expectations, plans, prospects and for First Mutual Bank, those will be forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act. Although the Company believes the forward-looking statements are based upon reasonable assumptions within the bounds of our knowledge of our business and operations, the actual events, results or developments may differ materially from those expressed or implied in the forward-looking statements due to a number of its uncertainties. Factors which could affect the actual results include economic conditions in the Company's market area and national interest rate fluctuation and the effect on our net interest margin; the results of branch office expansion; credit risk management; the ability of the Company to control its costs and expenses, products and pricing of our competition and legislative and regulatory changes affecting the banking industry. These and other risks uncertainties which could affect the Company and our results are discussed from time to time in the filings made by the Company under the Securities and Exchange Commission. These risks and uncertainties should be considered in evaluating the 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.

Well, again, good morning. I just wanted to hit a few highlights before I open the conference to questions. We're very pleased to report our 45th consecutive quarter of year-over-year record earnings, characterized by very strong growth in our core businesses. It is the fifth consecutive quarter of margin growth. We ended at a margin of 4.09 in the fourth quarter. The loan portfolio grew 16 percent year-over-year. Credit quality is exceptional. Deposits -- very strong growth in our deposits and, in particular, the deposit mix. Business checking accounts grew 52 percent by number; year-over-year, balances grew 37 percent; consumer checking accounts grew 24 percent by number, 38 percent in balances. So we're very pleased with the effort that we have put into focusing on our liability mix, as well as of course the growth of the loan portfolio in our core businesses.

In conclusion, I would say we like the position that we're in as we enter 2004 and we look forward very much to the coming year. And with that I will throw it open to questions.

(Operator Instructions). Ross Haberman, Haberman Funds.

Nice quarter. I wish all of my conference calls were as brief and succinct as you are. I had a quick question on the operating expenses. Were these one-time? And these new bank incentives in Woodinville (ph) and some (indiscernible) -- could you give us a feel on how those are coming along and what kind of breakeven terms you are hoping for?

The onetime expenses, we did have some year-end commission and bonus accruals for loan officer staff and the deposit gathering staff in the banking centers. We are having a very good experience with the new branches in Woodinville and (indiscernible). Very, very strong growth in Woodinville that, in particular, that is -- that opened in July, and that is centered in an area of a lot of small to midsized businesses and we have been very gratified both on the deposit side and the loan side with the business we're getting out of there from those business customers.

Sammamish (ph) just opened in December. Doing well for being opened just a month and opening at the holiday season. It really is a support facility for our Redmond banking center, which has been in business for several decades, probably 20 or 30 years or so. But a lot of growth -- it's up on the plateau east of Lake Sammamish (ph) and a lot of residential growth up there, so doing very well. Another question on breakeven?

We have a hard time of breaking even in a short period of time on our branches and we --

I will settle for seven months. (MULTIPLE SPEAKERS)

(multiple speakers) just eight or nine months.

We find that we need about 25-30 million in balances to -- in order to get to the profit levels that we consider adequate, in terms of return on equity. It will be, it will probably be, I am just guessing, five or six years before we will see balances at that level, so that is kind of our timeframe on those branches.

One other question. I think you you're going to update some of your existing branches. Which ones and how much are you going to be spending in total over the year?

We're going to essentially completely gut and redo four banking centers. Two in downtown Bellevue and one in a location called Crossroads, which is about three miles to the east of downtown Bellevue, and one in Redmond. Those are our oldest banking centers. They are not configured in the new open plan style that we have been using for all of our other banking centers, and certainly the newest banking centers that we're opening. So we don't have any plans currently to open any new banking centers in 2004. That's not to say if an opportunity came up that we would pass it by. But we currently don't anticipate opening any new banking centers in the course of 2004.

How much is it going to run and will it disrupt the business much?

I don't think we have announced publicly how much we intend to spend, but --

You can announce it now.

Most of it will be spread out over the course of a number years, so I would not expect to see a big impact. There will be a modest impact on earnings. As far as disruption goes, we recently went through a similar remodel in our Issaquah banking center. We completely gutted it and redid it, and that was interesting. It sponsored more interest in our customer base as we were going through the process. We kept half of it opened, did half at a time and actually kind of sparked traffic a little bit.

Okay. Thank you. I will get back in queue.

Jim Bradshaw, D. A. Davidson.

Good morning. A couple of items, if I may. Roger, it looks like your non-loan earning assets shrank from about 108 million to 98 or 97 million this quarter. Anything conscious that you are doing there, trying to tighten up excess liquidity, or are you just (indiscernible) spreads you're getting on those kinds of assets?

On the balance sheet?

Correct.

Yes, we try to keep cash as low as we can. And we have expanded our securities portfolio a little bit in this quarter. But in terms of how much we are holding in cash and short-term deposits, we try to keep that as close to zero as we possibly can.

I might just follow-up. Philosophically, we're very focused on our core businesses and being a bond house is not a core business for us.

And the second question I had related to -- if you could give me a little bit more color on sort of what it the commissions and bonus accruals, etc., sort of what changed or what really was the variance in the quarter from your expectations to the actual numbers was quite a jump. Just wondered what the course of events was over the quarter that caused that material difference?

Of the -- let me give you a breakdown on the operating expenses here for a second. Of the 1.2 million that we increased in operating expenses, about 867,000 of that is due to salary and bonus expense. Of that 864, about 340,000 of that is commission and bonus. And of that 340, about 200,000 of that is commission. Most of that or a big chunk of that 200,000 in commission is due to our business banking operations. And we also have to take into consideration when we're dealing with that business line, not only what is going on with loans, but also deposits. And we've seen our mix change in the last couple of quarters pretty dramatically for us. And the incentive program tied to enhancing that mix has increased our commission expense. Of the other 140,000, part of that was the year-end bonus that we felt that was timely (ph) based on the performance of the bank, taking it into consideration everything that's happened so far this year.

A couple of other quick ones if I may. The tax rate was up a little bit in the fourth quarter over the full year run rate. Any guidance on what the tax rate will look like in Q1 and '04?

We sort of moved up in the fourth quarter because the level of income before tax for the bank exceeded certain thresholds for the IRS. So we moved from a 34 percent to 35 percent tax rate. And it will go down a little bit in the first and second quarters, and then we'll see it pop up again next year as the general overall level of the earnings of the bank increase.

Lastly, average shares was up a little bit more than -- diluted shares were up a little bit more than I assumed. Any issuance (indiscernible) looks like the actual shares was not up as much. Anything funky in there that I'm missing?

That is a function of the value of the bank stock shooting up dramatically in the fourth quarter for us, and also third quarter. But it went up a big chunk in the fourth quarter. Just the way you calculate diluted share and its impact on options, that is how that got factored in there. So you saw the number of diluted shares go up as a result of, again, the repricing of the options based on the gain in the stock price.

Got it. Thanks a lot.

Louis Feldman, Hoefer Arnett.

Good morning. Not wanting to leave Scott out -- Scott, would you touch base -- there's a reference in the press release to I think it's five loans on the sales finance that you're going to be -- 15 loans from insurance claim -- is that from the sales finance? And can you talk about your expectations on that as that percentage -- the percentage of the portfolio that is insured increases, what your expected exposure rates are going to be?

I didn't hear the last part -- what our expected --

Exposure rates, in terms of what you stated in -- what was stated in the press release was that -- if I can find it -- the average charge-offs were running significantly higher than your overall -- the historical bank's levels, somewhere in the 60-75 basis point range.

I think that is primarily a function of the portfolio that we have out there that is not credit insured, becoming a little more seasoned than it has in the past. Initially obviously when loans first go on the delinquency and the charge-off rate is lower than it will be when there are a bit more season, so I think that explains the charge-off rate kind of getting into the 60-70 basis point range. In terms of the older (MULTIPLE SPEAKERS) the insurance claims, that has tended to -- we have -- when we first started that program over a year ago, claims were fairly rare. And again, as that portfolio started to season, we're seeing some of those loans go into default. And when they approximately after 90 days delinquency, then we submit the claim to the insurance company and the insurance company pays us usually within 25-30 days after the claim. Not if I answered your question, but.

In terms of -- I guess what I'm looking for are your expectations in terms of the exposure and the utilization of this insurance, are you expecting this to increase as the portfolio -- both as the portfolio grows and as it becomes more seasoned?

Yes. Strictly because of the seasoning, and just the makeup of the portfolio in general and as the loans become more seasoned, I would expect to continue to see -- both because the portfolio is growing, but also just because of the seasoning of higher level claim activities than what we've seen in the past.

Any opportunities for a recoveries when these things go south?

The insurance company pays us for the full principal and a portion of the interest due us. And we then assign the loan to the insurance company and they collect on it. But any collections that they receive are obviously kept by them since we've been paid in full.

So you essentially turn it over to the insurance company?

Yes.

John and Roger, can you talk about your expectations? Loan growth exceeded deposit growth for the year, and you talked about how you finance it with additional borrowings and the issuance of additional trups (ph). Can you talk about what your expectations are for '04, in terms of funding potential loan growth and what your expectations are in that area?

Hi, Lou. Our strategic positioning there is that we would like to use about 30 percent of our -- we would like to fund about 30 percent of our assets with wholesale money. So we will probably continue to fund loan growth, security growth, that sort of thing with wholesale money. And this year kind of felt pretty much within those parameters. And we would expect next year to be along that same level. So I think you'll probably see '04 look a lot like this year, in terms of funding mix coming from wholesale money.

Are you matching -- are you locking into longer-term contracts on that money, or are you trying to match fund?

When we look at the asset liability parameters, we put all of our assets in one bucket and look at the duration of all of the assets, which include securities, everything that we're funding. Then we do the same thing on the liability side and then we begin to make decisions in terms of do we lengthened out a little bit on deposits, do we for example have a little more attractive rate on say 15 month than we might on 9-month deposits, try and push that out if we need a little bit longer duration. Of course, we have almost unlimited ability to make selections when we're talking about federal loan bank advances, because they don't care what periods you pick. So we try and sort of manage everything at a macro level and not try to micromanage on a per-loan level or even a type of loan level.

Okay, I'll step back.

(Operator Instructions). Bill Dalsman (ph), Davidson Investment Advisers.

Thank you, I have a few of them. First of all, the marketing costs were higher than the guidance. What ended up happening that was different on the marketing front?

I don't think there was anything different on our marketing front. Our marketing costs have been running this year at about the same pace. Now they are up dramatically over last year, but that was by design. And our forecast for 2004 is that we will not see much change in our level of spending on marketing costs. But they were up substantially, as you noted, versus last year. But the run rate has been reasonably consistent from quarter to quarter this year.

During 2003, Bill, we ramped up our -- as Roger is suggesting -- ramped up our marketing expenses considerably. And one of the things that we have been doing is spending on radio and a little bit more in print, but more on radio, trying to develop name recognition as we sense an opportunity in the Central Puget Sound marketplace with the disappearance of Pacific Northwest Bank to step into somewhat of a void.

John, does that explain -- I think in the 10-Q -- that you had targeted Q4 marketing costs to be approximately 230,000, and it came I think closer to 290,000. Is that differential largely due to accelerated advertising with the closing of that transaction?

It did pick up the pace of our radio advertising, in particular, in the fourth quarter. Probably back off a little bit in the first quarter of this year.

Alright. And then the second question that I have relates to the branch openings or lack thereof in the '04 year. I had been thinking that the 10-Q again last quarter said you would be opening two new locations in '04, but this really says that you will be just focusing solely on the remodels. Could you walk us through what the thought process was and what went into that change?

I will come back and address Ross Haberman's question, as well (indiscernible). We would anticipate spending 3-3.4 million, let's say, on remodels. And of course, most of that will be depreciated over some period of -- quite some period of time. The number is relatively high because in one case, we are -- we have a very small facility in our Crossroads area of Bellevue, an area that has grown quite a bit, and it is the home of both a lot of small retail businesses, but also residential. And in that case, we are completely demolishing the facility. It is a facility that we own and it's not a very large piece of property, so we're going to be able to build the new facility, keep the old one open, and then demolish the old one once the new facility is built. So, that drives that number up somewhat.

Our thinking is that we have been extremely pleased with the, what I will call the open format of the -- all of the new banking centers that we have opened or remodeled to date, and that is, there is no teller line. There are what we call teller pods or teller towers generally in a circular layout in the middle of the banking center, but we do not have tellers stationed behind the teller line barrier. We think that what that gives us is a much closer relationship with the customer, better opportunity to get the know the customer better; it just removes the physical barrier between the bank staff and the customer and better opportunity for cross-selling.

So we decided to go back and redo the older banking facilities that we have, which were looking rather tired anyway in the course of 2004. Where we are positioning ourselves demographically reflects the demographics of the east side of Lake Washington, and so we needed to do something with these older banking centers, in any event. Some of them have been in the same format for 20-25 years. In the case of Redmond, I think it has been that way for about 30 years. And we're also doing an extremely substantial remodel there, both exterior and interior. We want all of our retail centers to project the same image, whether you're driving by on the street or whether you are inside.

Now having said all of that, we are certainly aware of the possibility of disposal of excess branches as a result of recent merger activities and we are going to be looking at those. And if there is if there are any opportunities to acquire excess branches that are being disposed of and they fit our strategy in terms of where we want to be, which is primarily in an arc on the east side of Lake Washington from (indiscernible) down to say Canton (ph) in the south -- if there are some opportunities that come up that fit our strategy, then we're certainly going to give them a good, hard book. So I would not want anybody listening to this call to be surprised if we did pop up with a new branch location as a result of an exercise like that sometime during the course of the year. Probably more that you wanted to hear, Bill, but that is our view.

That is helpful. And the Sammamish (ph) plateau facility that you opened -- that synonymous with the Issaquah plateau facility?

We don't have an Issaquah plateau facility, we have a facility in Issaquah. The geography there is that you have kind of roughly at the south end of Lake Sammamish, which lies to the east of Lake Washington, you have the south end of Lake Sammamish, or Issaquah banking facility; in the north end, our Redmond banking facility. The plateau, which runs along the east side of Lake Sammamish, has been the site of tremendous residential expansion in the last 10 years and continues to hold the prospect for considerably more residential expansion over the next 10-20 years. And so we located the Sammamish facility up at the north end of that plateau. Probably over the long-term, we would consider another facility at the south end of that plateau as well.

Thank you. My final question for now would be -- sales finance insurance runs approximately 2 percent of loan balances, and yet the highest charge-off rate that you folks have had was back in 2000 at three-quarters of 1 percent. And notwithstanding the discussion that took place earlier about expecting those charge-off rates to go up, you would still need a very significant increase to bump up to the 1 percent. So ultimately, the question is -- is the insurance really worth it, or are you paying more than you need to, given the experience on the charge-off front?

Very good question. I think partially addressed in comments earlier from Scott about the seasoning of the portfolio, we've been in this business now eight years in 2004, seven years or eight years -- seven years. We are developing our own experience base. We like the business, we are very pleased with what we have achieved in it. And I think the only thing I would say at this point in response to what is implicit in your comment is that we're always going to be, as our experience builds, looking at ways to maximize our profits in the business.

I might add -- the insurance is targeted towards a tier of loans that has on average a lower credit, lower credit experience than what we have seen in the past as a weighted average on our entire portfolio. So we really only have a year of experience on that tier of loans and really another two or three years of expense will be necessary to find out what the inherent charge operate is in that tier.

Thank you.

Louis Feldman.

I think we lost Ross there. Would you comment on your margin expectations? You state you're expecting it business the 4 and 4.1 percent range for the first quarter. Do you feel comfortable in saying that you have broken the 4 percent barrier for at least the time being? And do you have a longer-term goal of reaching an even better margin?

I think our expectation for next year is that our margin will gradually improve throughout the year. We are counting on the mix continuing to be favorable. When we do our forecasting, we don't try to guess which way rates are going, and we'll leave that to someone else. But if rates will stay kind of in the range they are today and if our mix will continue to improve for us, then we would expect our margin to slowly increase throughout the year.

Okay. In times of deposits, then, are you -- obviously, you're looking for a greater and greater percentage of lower cost or no cost deposits and you continue to have success on that, yet you continue to have a high level of timed deposits as a percentage of your overall deposits. What is your goal, in terms of trying to bring those down at this point in time? And what do you think your possible exposure is on a mild increase in rates later in the year, since the Fed is not expected to act today?

Let me take the last question first, (indiscernible) what happens if rates go up. Based on our current balance sheet, if rates were to go up one a couple of hundred basis points, it would not have much effect on us, about 1-1.5 percent, which probably gets lost in the rounding, in terms of trying to forecast that kind of change in rates.

What about it less than 200 basis points?

We go down 100 because we are not sure how to model down 200. But it drops 100, then it is also virtually no impact on us. From our standpoint, we are kind of ignoring rates, again, that is based on how our balance sheet is made up today.

What I meant was an increase of 100 basis points or less?

Of 100? Well then, it would be -- it's obviously less than going up 200, which is almost a nonevent for us, based on what we know today and based on our simulation models, prepayments, that sort of thing. In terms of addressing the time deposit mix in the bank here, we have had a long history of having more than our fair share of time deposits, and it is down a little bit versus prior years. Prior years, we were running in the 70 percent, 73-74 percent range. We're down into the 60s now. But in terms of getting down towards the national averages, I think that is going to be a number of years. Because we have almost -- I'll round up, say, to 600 million in deposits here, being charitable. And we brought in 80-some million this year; we hope to do something like that next year. At that rate, even if we had 100 percent checking accounts, in terms of new money coming in, it would take a number of years before we could move the mix down closer to the national averages. So we think it is a long-term projection. Obviously, we're going in the right direction. We hope we're able to continue that next year.

Just as a follow-up, when you asked about goals, we are more focused and we have some goals that I'm not going to characterize today, but more focused on margin that we want to achieve this year and over the next several years. And I think the deposit mix, just obviously stating the obvious -- it is a combination of both assets and liabilities, but the deposit mix, the change in the deposit mix kind of falls out of those changes.

Back along the lines of you spent the 10 years redefining the asset side and you continue to redefine the liabilities side?

Correct.

Let me correct myself -- I said 60 -- time deposits were 75 percent at the end of the year. So I misspoke.

Okay, thank you.

Gentleman at this time, we have no further questions. Please continue with any further remarks you would like to make.

If there are no further questions, I want to thank you all for your time and interest today. Again, we remain very pleased with our fourth quarter in the year and also very pleased with the position we're in as we look forward to 2004. Again, thank you for joining us and we look forward to talking to all of you.

Ladies and gentlemen, this concludes the First Mutual Bancshares year-end 2003 conference call. If you'd like to listen to a replay of today's conference, please dial 303-590-3000, using the access code of 562991.