WaFd Inc (WAFDP) 2004 Q1 法說會逐字稿

Good morning ladies and gentlemen and welcome to the First Mutual Bancshares first quarter 2004 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 today, Wednesday April 21, 2004. I would like to now turn the conference over to John Valaas, President and CEO of First Mutual Bancshares, please go ahead sir.

Thank you. Good morning everybody. I would like to start by reading our forward-looking statements for this conference call. Our presentation during this conference call will primarily contain historical information that may also include statements concerning prospective operations, trends, expectations, plans, prospects, and our outlook for First Mutual Banc that will be forward-looking statements for purposes of the Safe Harbor provisions under the Private Security Litigation Reform Act. Such forward-looking statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from those expected or implied in this presentation. Factors, which could affect the actual results include economic conditions in the company's market area and nationally, interest rate fluctuations and the effect on our net interest margin, credit risk management, and the ability of the company to control its cost and expenses, products and pricing of our competition, and legislated and 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 in the filings made by the company with 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. I would just like to make a few summary comments and then we will turn it over to rightaway to questions. We are very pleased to have reported our 46th consecutive quarter record year-over-year earnings. I want to focus in my comments on these very strong continued organic growth of the institution. We have had an extended creative time of very strong growth in our loan portfolio, and in fact it grew 17% year-over-year in the quarter ending the 31 of March. We've been talking for the last several years about the accomplishments that we have made on restructuring the asset side of the balance sheet and that a major strategic goal has been to shift the deposit mix on the liability side of the balance sheet, and I'd just like to make a few observations on the various substantial progress that is being made there. Our core deposits grew 38% year-over-year, and if you look at the composition of our deposit mix, time deposits have declined to 64% of our total deposits from 69% a year ago. This is of course driven by very good growth in checking balances, in fact our business checking balances were up 57% year-over-year, and consumer checking balances up 52% year-over-year. So the efforts in investments that we've put in to expanding our banking center network, and adding staff on the business banking side are really starting to pay off in terms of our goal in remaking the liability mix of the bank. We are very pleased with our GAAP position and as we've mentioned in the mini MD&A we have lengthened some of the maturities in our funding side, which has had some modest impact on our net interest margin in the quarter, but we feel very comfortable, particularly in the context that Mr. Greenspan's remarks yesterday about where we're positioned there. The final two observations I would make are that ROE, return on equity, remains strong at 17.7% for the quarter and that credit quality continues to be excellent at 17 basis points. At this point I would like to open it up to questions. We have a very thorough discussion of the quarter in the mini MD&A, which is attached to the back of the press release. JR, if you would like to open it up for questions, we are ready.

Thank you, sir. Ladies and gentlemen, at this time we will begin the question and answer session. If you have a question, please press the star followed by the one on your pushbutton phone. If you would like to decline from the polling process, please press the star followed by the two. You will hear a three-tone prompt acknowledging your selection. Your questions will be polled in the order they are received. If you are using speaker equipment, you will need to lift the handset before pressing the numbers. When I state your name, please respond with your company name and question. Our first question comes from Louis Feldman. Please go ahead.

Hoefer & Arnett. I was hoping to give Jim the honor of the first question. Good morning, guys.

Good morning, Lou.

On the liability side, what is left to reprice and how much flexibility do you have on that downside if rates remain steady through the latter half of the year?

Hi Lou, it's Roger. Really the program for us on the liability side is to grind down the mix. I am not sure that we have a lot of flexibility in terms of repricing our time deposits or even some of our other lines there, money market that sort of thing. I think, really the value going forward in terms of reducing cost of fund is going to have to be the shift money out of the higher cost funds, again, such as time deposits, into our checking accounts, in particular business checking accounts in a very particular order and I think that's probably going to be the focus that we have for this year and we are hoping that that will move, will move this forward in terms of bringing down our cost of funds. That's kind of a glacial process, as you know. I think probably the easy money in terms of repricing the time deposits may be behind us, particularly if we are in a rising rate requirement.

What's stickiness - - how much stickiness do you think you have in terms of some of these core deposits as rates go up? How much for this do you think could flow away from you? You know, move out of the some of the money markets' stuff into other instruments either with you or with other institutions?

Obviously, we are hopeful that it doesn't go outside the bank. We do feel that some of the money that has flowed into money market accounts could very well move back into time deposits. So we do run some risk on that. The pricing on money market accounts has been in many cases competitive with some of the real short-term time deposits, so there's some risk there. Not everyone in the bank feels that way and I think, we'll probably wait and see what happens if rates begin to edge up. At this point in time, I think we are not unduly concerned about that. I think the other thing that occurs in a rising rate environment is the lagging effect, which we were hoping, we see the lagging effect. In that, the assets, the price pretty much indexes. So as we see the LIBOR rates move up with money market rates, then obviously we'll see our assets repriced in concert with that. But because time deposits and money markets, as they grow tend to move with whatever the local market does, and the local market tends to always be a lagging indicator, we'll kind of sit around and wait and see what everybody else is going to do and we are hopeful that we may get a impact just from that lagging process and widen the margin out a little bit possibly in a rising rate environment.

Lou, this is John. I'll just offer a slightly different view than Roger on the money market front and that is that, my concern is not so much that they would shift the time deposits but the possibility that they may shift into the stock market, if in fact the economy picks up and the stock market rises. I think - - clearly what the stock market does is pure speculation and one might argue that it has already got its rise built in and if that were the case, I wouldn't see the temptation to leave money market funds and go into this stock market or alternative investments like real estate at that point. Where our seven months and twelve months time deposits are priced, they are more attractive than our money market funds right now.

And one quick one. Is the pricing - - is deposit pricing rational in the area?

In my view, deposit pricing has never been rational in this area. If you look at, particular for time deposits and I am serious, if you look at deposit pricing compared to nation-wide averages, we generally always seem to be and I look at California, I look at other national averages, we always seem to be, this region always seemed to be 25 to 35 basis points higher, something in that range than other regions in the country.

Lou, I'd like just to add to that a little bit. The area has traditionally been kind of an asset-rich area, that is, it's easier for us to pick up assets than it is liabilities as opposed to, say Eastern Oregon, Eastern Washington or the Midwest where you tend to have liability-rich areas and asset-poor areas. So, again I think, as long as institutions are able to raise assets in this area, then it just puts a lot of pressure on the funding side in terms of cost and money.

We also have one of the largest credit unions, I believe the fourth or fifth largest credit union in the US here in the Boeing Employees Credit Union and -- I know this will shock all of you listening, but that they don't pay taxes and they tend to be more aggressive on their pricing certainly on the deposit side.

John, just glad that you are not working in long view, I'll step back.

Things can always be worse.

Thank you.

Our next question comes from Bill Dezellem. Please go ahead with your question.

Thank you, Davidson Investment Advisors, and a couple of questions. First of all, walk us through what you saw in terms of the non-performers jumping this quarter, what was behind that?

Basically a couple of single family homes.

And if we saw correctly, it appears as though you do not anticipate any loss on those?

That is correct.

Okay. What's the time frame to work those out of the non-performing category?

No. Sometimes you can run them through during the course of a quarter.

Is it something you would anticipate by the end of the June quarter that would be out and gone or given these particular circumstances, would you anticipate it to be longer than that?

I would anticipate this being a forward-looking statement of course, at the second or third quarter of this year.

All right, that's helpful and then on a more positive note.

Bill, I just might add they are well located in very good locations, we believe. So, it's not an issue of saleability.

Great. That's helpful. Thank you. And then relative to loans receivable, which increased dramatically more than your original guidance, walk us through what contributed to that positive surprise.

The part of that was that we had a little better participation on from our commercial real estate in our business banking areas, which had lagged a little bit last fall. And last fall our main source of asset growth was coming out of our sales finance, our consumer area, and out of our residential lending in particular out of our custom construction area, which has been kind of a niche area for us, which has done very well. And that in fact not only had we seen that process last fall but we had pretty much seen it throughout 2003. The other areas contributed, but at a much slower pace. And then in the first quarter we'd had -- on a comparative basis, we had dramatic growth coming out of both business banking and our commercial real estate area. Those areas, I would only caution, at least not on banking that those areas tend to kind of come and go a little bit. So, we were frankly surprised that all the stars lined up and we are able to close all those loans, you know, whether or not will see that same level of success. The second quarter remains to be seen, however, a kind of, based on our forecast in talking to all our production people. You know, we are in some ways expecting a kind of a repeat of what we saw in first quarter to be honest.

And just because that the stars did line up, that's why your guidance isn't actually up there for $40m increase in the loans?

Yes. I mean, when we are forecasting, we're trying to be a little bit conservative, in terms of -- I mean that's what we think we will see in second quarter. Now, if we had a $40m quarter, we would be static again, that would be a dramatic growth rate. I mean the first quarter in terms of asset growth was up 22%. If you annualize it, we are up almost 19% on loans, if you annualize it. So that's the blistering pace, whether or not we could maintain that level of growth you know, might be a little optimistic. Again having said that, we are still looking for a pretty decent quarter with the guidance that we have given.

Sure, we have our annual meeting tomorrow, so we are looking at some numbers in terms of loan portfolio growth for First Mutual over the last several years versus national averages for all FDIC insured institutions and we have consistently far exceeded national averages in respect of loan growth, which given the economy here particularly in the Northwest we're very pleased with.

And I'll just add one last comment, Bill. If you look back ten years, you kind of smooth the asset growth for the bank, it averages about 13% compound per year.

However things are picking up a little bit this year, and I think to a degree some of the business lines that we have put a lot of effort and energy into, I think are restarting to pay off. So, if we can exceed that average growth of 13% per year, obviously that would be pretty decent, and we think maybe that might very well happen this year.

I might just also add that sales finance, which is our nationwide home improvement consumer lending business, seasonally always has a fairly slow first calendar quarter. So, and we start that again this quarter, so that gives us some comfort about, you know, the seasonal aspects of that particular business line gives us some comfort in terms of thinking about prospects for loan growth in the balance of the year.

Thank you, and then two additional questions. Bring us up to speed in terms of what you are seeing in terms of general economic activity and therefore do you see robustness of the area, as we are hearing that the national economy is improving? And then that's a picky question for you. On page 7 in the release in the GAAP analysis, and in the simulation model you folks were using February 29 as the day that you highlighted what your GAAP was and the impact on the simulation model. Why the end of February rather than the end of March?

All right, Bill this is John. I'll respond to the easy question, and let Roger respond to the GAAP question, since that's his area. The general level of economic activity in the area, I think is picking up modestly. I think that our expectation is that as a region we will lag the rest of the US, assuming the rest of US continues to pick up. I was talking to a customer earlier this morning who is in a distribution business and he has noted that he is starting to see increases in prices come true from his suppliers, and they are sticking where they have not stuck in the past, and this relates particularly to things where the peak stock is well related to the things like plastics, and things like that. So, we are starting to see price increases come true, we are -- I believe trying to see those stick somewhat, but I don't think you are going to see a dramatic level of increase in the economic activity here certainly in a very short time future, but it just feels better than it did a year ago, and I know in terms of retail sales particularly here in the Bellevue area, we get a pretty good insight into how retail sales are doing here, and they have continued to be very, very strong and growing. So, the consumer is still there, I just think on the manufacturing side it's going to be a bit more of a delay primarily driven. And now I will turn it over to Roger to respond on the GAAP question.

Yes. Good question Bill. We outsource our simulation model to Darling Consulting which is a firm that does I believe over 500 banks, some of them are a lot bigger than we are. We're a little too small right now to do that in-house. They are a little pricey, but the quality of their work is just outstanding. That's the good news. The bad news is that it takes our folks a while to put that model together and run the simulation model for us to check all the data. We have to provide them a rather extensive list of information that tailors their model to our banks, such as our prepayment fees, and we have to download all of our loans. I mean the simulation model moves in and looks at every loan, looks at every deposit, and figures out it's duration and everything else. And so anyway that's kind of a lengthy process. Sometimes, we have the information in time that we can insert it into the press release, other times we don't. And when we were putting this thing together on Monday and having all the folks to take a look at it such as the Independent Auditors and the bank's Legal Council and so on, so forth. We simply didn't have any information available then.

Thank you very much.

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

Good morning, guys.

Good morning, Jim.

Just two or three quick ones, if I may. Is there anything expected in the June quarter in your headquarters building in terms of either new leases or expiring leases?

Jim, we are not aware of any expiring leases at this point in time. There has been a little bit of improvement in leasing. We had one tenant that took a little extra space to expand their operation and I want to say that occurred late in first quarter here. So we will see a little timely pickup in rental income in second quarter, but nothing of any significant value.

And I'm always confused, you say you occupy 39%, so the other 61%, is that roughly half leased or is 52% of the 61% leased?

Of the 61% that's available for occupancy, we currently leased 53% of that, roughly half of what's available is leased out right now.

Got it. Okay, thanks. A couple of other things, you talked a lot in the press release about extending maturities on liabilities. I just wonder if you are done with that or whether you continue to just step through into the second quarter now?

A little bit of the bad , our duration on our asset is about a year and we have approximately a similar duration on our liability side. So we are pretty well matched and I think you see that reflected in the numbers in the gap report and simulation report. So, kind on the basic part of the bank is pretty well evened out but last fall, late last fall we started to pick up some securities because the slope of the curve was such that it seemed to be a compelling case to pick up some of the desperate and the assets that were out there, particularly the three-year, five-year, seven-year. But we were uncomfortable with putting those instruments on the books. It was rated a 45 year low. So, at that same time that we picked up those securities and we've been kind of a steady buyer through last fall, even through first quarter, and each time we did that we went out and matched the duration on our funding sources. And in order to do that, of course, we had to go out a little further than what we would normally do a favor just funding routine assets, and that whole process locked in the -- if you will, kind of hedged in those securities that we picked up, that's the good news. The bad news is when you sort of throw that into the mix with all the other assets and liabilities it narrowed the margin a little bit and obviously, extended duration on our liabilities little further than we would normally have there.

Okay, good. Just a couple of other quick ones, if I may. Your DDA and cash on hand balances were $13.5m or so and up $7m, $8m from your - - is that just sum some float issues or you are not given up on state funds, I guess. How safe these rates are?

Yes. We are just a net borrower on short-term money and that's just money that we will wait for somebody to send us a check on that so.

Okay.

Money in transit.

And then, just my last one is, capital ratios crept up a little bit this quarter. Just wonder what you sort of would consider to be an ideal Tier 1 in total capital numbers?

Ideal Tier 1 ratio would be 1%. You know, regulators have a different view. The primary capital ratio that we look at is risk-adjusted ratio. Our range - - comfortable range is somewhere between 10% and 11.5% on that, although we do all things been equal, we are try and target 11.5%, is our risk adjusted ratio. So, we are above that. The reason we are above that is, in the fourth quarter we decided that it might be a smart move to take down around $4m of trust preferred securities because this whole topic, as you know is up in the air and we didn't know there would be the possibility of grandfathering whenever it was on the books and under whatever new accounting treatment might be or the new regulatory treatment, we knew what the accounting treatment is and so we've added a little more capital than we would normally be carrying on the books.

It sounds like and looks like that levering the balance sheet would sort of be - by growing the balance sheet would be your preferred sort of use of the capital at this point rather than a boost in the dividend or even a buy back?

Absolutely right. Given the strong growth, Jim, as John has given the strong growth that we have had, that's definitely our preferred mode of operation.

Okay, great. Thanks a lot guys.

Thank you. Our next question comes from Ross Haberman. Please go ahead with your question.

How are you gentlemen? Haberman Brothers.

Good morning, Ross.

Very nice quarter. Just two quick questions. The spreads you have seen on the, I guess what's called your construction loans, are those coming down or what do you see there, in terms of the ones you are selling?

Are you referring to the home improvement?

Yes, I'm sorry yes. The home improvement ones, I'm sorry.

I'll let Scot Harlan who runs that area, respond to that, Ross.

The yields on those loans have remained pretty much flat throughout the last, at least the last three months.

As well as the sale prices when you are selling them?

The sales price is usually driven on the investor side more by their cost of funds plus a margin and in the first quarter because the rates were lower, the ultimate capture rate of the investor dropped from fourth quarter in 2003 to first quarter 2004. It is to be seen what will happen in terms of second quarter of 2004.

There was some mention I think that the price of the insurance had gone up for part of the portfolio. Could you just elaborate a little more on that?

The premium that we paid did not change. The actual premiums went up because the portfolio went up.

Okay.

As a percentage of the portfolio the premiums remain the same.

And are you happy with the portion of the portfolio, which you are insuring as opposed to not insuring today, or would that

insured portion go up in the future?

As a proportion of the portfolio, I believe that it will edge up only in that we are adding - the insurance activity has really been fairly active throughout the last year and a half, and if that continues the proportion will increase in, I believe it was in the

last quarter of the -- in the first quarter I believe about 40% of the loans that we booked were insured. My guess is that over time the insured portion of the portfolio will come to equilibrium somewhere in that range. You are asking if I am happy with the portfolio in what way?

In terms of the mix of what's insured and what's not insured, I think you gave a breakdown of I guess the credit scoring on the insured as well as the uninsured portion.

Right. I would say that the percentage of portfolio that was insured in terms of new production was a tab higher than what we originally forecast when we went into this program. We made some pricing adjustments, some underwriting adjustments here in the beginning of the year that have resulted in that proportion coming down to the 40% that we saw in first quarter. That's an area that's - that's a little closer to our initial projections when we went into the program.

Okay. Just a final question for Roger. Could you tell us - you did a pretty good job I think in your construction loans, regular construction loans. Again, is that driven by - you've just seen higher price deals or you've taken a little more risk in terms of some of these construction loans?

And in terms of doing a higher long value.

And actually we might let Scott respond to that.

Yes. The jump in construction loans is almost, I think, primarily driven by what's happening in custom construction loans, where the loan is made to the end borrower to build their home. The increase in activity in that area is not directly related to the lower rates that we saw in 2003 and in parts of 2004. It's more directly related to increase in market share in this area as we had a significant competitor leave the market in 2003, and we are also expanding geographically beyond the immediate Puget Sound area into generally speaking the Portland metro area. As that activity increases, obviously the loan activity increases.

Again, these are not spec loans.

No, I understand their custom, but I was wondering if the average sized loan has gone from $700,000 to a $1m now.

No, I don't believe there's any significant change in the average - the unit count is what's going up, not the loan amount.

Okay. And just, John for you, are you fully staffed currently on the loan side and are you planning to bring on any new lenders over the coming quarters to supplement your current staff?

We had a departure in our commercial real estate area and we would like to replace that individual and kind of like the Marines we are always looking for good people. We are actually reasonably well staffed and I wouldn't expect to see large additions. But if we can selectively add people who have the ability of bring with them access to significant portfolios, particularly in the business banking area, we would do so in anticipation of continued expansion in business banking. We did during the first quarter add a very, very seasoned and Senior Credit Administrator on the business banking side as well. So, we are pretty well staffed on the support side.

Okay. Again, a very nice quarter. Thank you.

Thank you.

Thank you. Our next question is a follow-up question from Mr. Feldman. Please go ahead with your question.

Thanks. Scott, I thought last quarter that you had indicated that your intention was to start trending towards these lower score loans in terms of the consumer finance, and that's the intention, not necessarily the intention but the trend was leading towards that, which would imply a higher overall insurance cost. Is that correct?

That was the trend that we are seeing, correct. Hence, the move that we made to target a tad higher on the higher credit quality loans and a little bit less emphasis on the lower credit scoring loans.

Louis, what we were stating is a trend, may have been perceived as an intention, but it wasn't really an intention.

So your intention, that is to try and to keep the cycle higher than where it is currently, did you to try to move the cycle back higher?

In terms of a true weighted average of the entire portfolio, I think that will be a true statement. The activities that we saw in the first quarter, generally speaking mirrored what we have considered to be a good representation of the types of loan that we will see from our customers across the board.

Therefore, is it to say reasonable run rate on the insurance costs?

In terms of percentage of the overall portfolio?

Yes.

I believe it's pretty close here.

Okay. And then two questions for Roger, if I may. Can you talk - I think you touched on it, the current mismatch in duration, because you made a reference within the mini MD&A about moving the duration closer and you said you're about a year on each. Is that where you are looking to go or are you looking to shorten that a little bit?

Our mismatch in our duration will run about the ranges from month to month, but from about 18 to 22 basis points. We are awfully tied on our match between our assets and liabilities, and we sort of see that reflected in our simulation with 200 basis point ramp up and a 100 base point ramp down with these -- where we are right now on the low end of rates and we don't see a lot more having 73 basis points, where the 200 basis point move is not a whole lot. So, we feel we are pretty close to where we would like to be on our match between assets and liabilities right now. I'm not sure we can realistically improve that, I don't think zero duration necessarily is where you want to be either.

Okay, and then one last question, while a significant portion of your loans are variable rate and you are -- you've classified yourself as being asset sensitive, to what degree have you modeled the potential risk and what is the timing issues of some of these assets repricing before rates move where you could get stuck with some of these, you know, especially if you got like a five-year variable rate that reprices on a three-year or a five-year basis and it's going to reprice down here at a lower level and they get locked in for that period of time? To what extents have you looked at that risk and can you provide some color on it?

Yes, when we modeled, we actually modeled each loan, and in fact one of the simulation models we have run is all the way out to five years and that's stretching credibility and I think probably most people would feel that a one year forecast is

Probably as accurate or reasonable as you are going to get, but we do run it all the way out just to see what happens, but when we look at it, we look at it loan by loan and we assume that rates will move up in some kind of reasonable fashion. We don't assume we're going to wake up tomorrow and interest rates are going to be a few hundred basis points higher than they are today. So, we assume a ramp over a one-year period and so we've got the repricing throughout that period and we have the same thing going on in our liabilities, and so we just sort of run that whole mix through and it sort of takes into consideration the issues that you brought up which are, you know, what happens when one item reprices in May and another one doesn't reprice till November and vice versa, what happens in that process. But like I said after we run those projections, because things tend to flow on a fairly even basis, that is we got roughly one-twelfth of all loans repricing throughout the year. We have approximately one-twelfth of all our liabilities repricing throughout the year, and like I said you run that mix everything seemed to kind of work out pretty much where they are today to be honest.

So, you don't feel that there is any significant risk to some of the stuff repricing, just prior to a rate increase and you'll be stuck with it at the lower rate?

Yes, but then we got another crack at it a year from now. But it depends on which side it happens, if you have a liability reprice right now that's great, then you have a loan that reprices next summer, then you get a wind fall on that and vice versa, but that stuff tends to even itself out over time.

Okay. Thank you.

At this time there are no further questions.

All right. Well, given the fact there are no further questions, we do appreciate all of you taking the time to listen in again. We're very pleased with the quarter, very satisfied with the very strong continued organic growth in the company and particularly the accomplishments, not only we've made on the asset side of the balance sheet, but the very significant shift that we are trying to see in the mix and on the liability side. So, again thank you all and we look forward to talking to you again next quarter.

Ladies and gentlemen this concludes the First Mutual Bancshares first quarter 2004 conference call. We appreciate your participation on today's teleconference. You may now disconnect.