WaFd Inc (WAFDP) 2004 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the First Mutual Bancshares 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 on your touch tone phone. And as a reminder, this conference is being recorded today, Wednesday, October 27th, of 2004.

I would now like to turn the conference over to Mr. John Valaas. Please go ahead, sir.

Thank you, Justin. Good morning. This is John Valaas. This morning I have with me Scott Harlan, who is in charge of our consumer and residential areas, Kari Stenslie, our Controller, and Charles Smith, Senior Financial Analyst. I'll begin by reading the forward-looking statements disclaimer.

This presentation may include some statements regarding the company's trends, objectives, anticipated growth, and other expectations, which will be forward-looking statements for 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 filings made by the company with the Securities and Exchange Commission. 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 an obligation to update any such forward-looking statements.

Let me begin just by a brief commentary. Some of you may know Roger Mandery, our Chief Financial Officer, had spinal fusion surgery two weeks ago, so he is not joining us on the conference call this morning. We expect that he could be out of the office as much as up to two months, but his recovery is doing well, and he is contact daily with the office and has been working out of home for the last several days. So, we wish him a speedy recovery.

I'm just going to make a few brief comments on the quarter and then open it up to questions.

We're very pleased with the results. Earnings were up 11 percent year-over-year. Credit quality continues excellent, with NPAs at 10 basis points. And looking at other metrics, our return on equity at 17.9 percent, continued very strong. On the liability side of the balance sheet, we continue to see very good growth on checking balances. Our business checking balances are up 57 percent year-over-year, consumer checking balances up 55 percent year-over-year, with a strong continued growth in core deposits. So, from our point of view, a very strong, very solid quarter.

And I'll just leave the comments at that, and turn it over for questions. Is the operator there?

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 1 on your push button phone. If you would like to decline from the polling process, press the star followed by the 2. You will hear a three-tone prompt acknowledging your selection. Your questions will be polled in the order that they are received. If you are using speaker equipment, you will need to lift the handset before pressing the numbers. One moment please, for our first question. Our first question comes from James Bradshaw. Please state your company name, followed by your question.

Good morning. D.A. Davidson. Good morning, John.

Good morning.

I had a couple of question. The first is, as I read your guidance on non-interest expense in the press release, you know, basically 15 percent higher than Q4 last year, as I look at that number, it's roughly $500,000 more than you reported in the third quarter. And as I sort of read through the press release and note the discussion about premises and employee headcount and such, I just don't see $500,000 more of costs, and I wonder, you know, what I'm missing.

Well, I think, Jim, that, you know, certainly that number is going to be our guidance number, or our outlook for the fourth quarter. In part it's based on an estimation of staff additions as well as fixed plant. Nothing really startling in that number that we would have a comment on.

Okay. I guess a second question is, relates to the servicing side of the sales finance loans sold. Are you still servicing that with, you know, just a handful of people, or have you been adding quite a bit of staff now with the ramp-up of, you know, your portfolio, obviously, and then service for others too?

By and large-- this is Scott Harlan-- by and large, the servicing staff is-- they may have added a position or two over the last year, but it hasn't ramped-up significantly. We just passed, I think, on the sales finance portfolio, about 10,000 loans serviced, and about $100 million in total servicing, and that, as you know, has grown fairly significantly over the last 18 months. But to the best of my knowledge, the servicing staff has not grown in direct proportion to that.

And, Scott, while I have you on consumer or sales finance, nice improvement or change in direction on delinquencies and loss ratios this quarter. Any trends you're detecting, given those? Was the last quarter an anomaly and this is the run rate, or is the average of the two or something is the run rate?

I wouldn't characterize it either way. I think, really, these, the claims, especially on the insured portfolio, the claims tend to, when they come up they come up fairly quickly. We submit them fairly quickly. So, frankly, I don't have a good answer for what I would expect for fourth quarter or beyond at this point. It does tend to sometimes vary more from quarter to quarter than one would expect for such a large portfolio.

Do you think the seasonality ought to track like the, say, the credit card industry? Is that what you think the seasonality will be?

Yes. Our best experience at this point says that if a loan is going to go to charge-off or claim, it's typically within 15 to 18 months after origination, and we are certainly in the middle of that time period from our fairly rapid growth a year-and-a-half ago.

And then lastly, Scott, the insurance, the contract renewal for the next year, it's still 60 basis points to 270-basis point range, is that still the premium you're paying?

Yes, that's what they've indicated to us.

Then the bottom, it didn't change at all? It's still 60?

Correct.

Okay. Great. Thank you very much.

Thank you. Our next question comes from Bill Dezellem. Please state your company name followed by your question.

Davidson Investment Advisors. I actually also had a question relative to the non-interest expense. It had been relatively flat from, in Q2 and Q3, and if you'll allow some rounding, basically at 6.050 million. And walk us through again what's different in the fourth quarter relative to the last two quarters where we've been roughly flat, and I think your guidance works out to something closer to $6.6 million.

Well, we've had continued additions to staff, and expect to be adding a few more in the-- we have a couple of vacancies in the loan officer category, and those tend to be higher-paid positions. Expect to be adding some more in the collections area to support the sales finance collection effort. I would say primarily in the area of staff adds, although I would also observe that we expect staff additions to, in our business banking and income property areas, to start to level off in the first quarter of next year.

And so when you're talking about staff additions, these are really professional staff members as opposed to entry level?

Correct.

Okay. And then you had mentioned that you do anticipate in a couple of the areas to see a leveling off in the first quarter. What would you --

Of staff additions. We're not making a forecast of non-interest expense.

Fair point. That's actually going to be my next question, though. At what point would it be reasonable for us to see or look for the non-interest expense to slow its rate of growth and get down under the 15 percent, maybe even under 10 percent, or are you just simply in a mode where you are growing a business and that is not something that we should expect?

I don't think that's something you necessarily should expect. We do anticipate opening a couple of banking centers, new banking centers per year, and as we do that, to continue to try and build our footprint here on the east side of Lake Washington. We'll have expenses there, both for, you know, the facilities as well as the staff adds. And as business banking continues to grow, we would expect to continue to make investments there, and those tend to be expensive investments. And, quite frankly, compared to income property, they also require more skilled support staff, not that the support staff in the income property business is unskilled, but just that the business banking loans, as you know, are more work intensive with monthly and quarterly follows. And so it's a little different in that respect and more expensive to support than income property.

That's helpful. And then one additional question, please. Relative to your branch build-out, walk us through or characterize as you see it the competitive landscape with branches on the east side there, and to what degree saturation is being reached versus your perspective of wanting to add additional branches.

All right. Well, first of all, there are new entrants to the market. We have some banks that are start-ups that have focused on the east side. As we do, they view it as an attractive market. So, we have several banks, two, three, that are on the east side now that are new within the last five or six years. And then we have new entrants to the market who are in the process of opening branches or offices over here. These are existing banks who are just trying to put their flag down on the east side of Lake Washington, again, because they view it as an attractive marketplace. And then there are the new start-ups, and there are several new start-ups, both of whom are either starting on the east side or intend to open on the east side fairly quickly and have started on-- in Seattle.

A lot of those facilities are upper story, if you will, banking centers, so they're competing more on the business banking side than on the retail side. We want to compete on both fronts, and therefore are interested in establishing a street-level presence that offers convenience both to the community business banking customer, or the business banking customer, as well as the retail consumer. It's part of our strategy to change our deposit mix or our liability mix, and we think that is succeeding quite well, as you'll see, you know, noted by the mix, or the continued shift in the mix of our deposits. And we would like to have a physical presence for First Mutual in an arc from say Bothell on the north side of Lake Washington, around the east side and down to the south side as far south as Renton or Kent. And we're not there yet, and we think we can profitably establish branch presences there and take shares primarily from the larger banks in those marketplaces. Some of those other banks, the newer start-ups are strictly business focused, and I suspect that they will probably only have a limited number of branches.

So, in terms of saturation, yes there are certainly more bank branches in total on the east side today, and I don't have a count, but anecdotally, there's certainly more today than there were five years ago, and there are probably going to be more five years from now than there are today, but we think we have an opportunity to take share and do so profitably-- if that answers your question, Bill.

It does. And also part of what's happening here is that the east side is growing and is a very attractive market for you all and competitors also.

Right. It's certainly the most dynamic marketplace in terms of population growth, and in terms of household income and household net worth, compared to Seattle.

And then, finally, relative to the vibrancy of the east side, we were recently in Bellevue and thought that we saw the big hole near your building, that there's actually some activity taking place there. Is that, in fact, the case? And if so, is that an indication that the vacancy rates have really improved and that basically the growth trajectory is returning?

The big hole near our building, if you're speaking of the one kitty-corner across the intersection from us, there is no activity there, and I have heard no rumors about that. Having said that, vacancies for Class A space in downtown Bellevue have gone from about 28 percent, almost 30 percent, a year-and-a-half ago to around the 10 percent level today or slightly under 10 percent. A lot of that was consumed by the Safeco spinoff of their life and investment business, which is taking about 250,000, 260,000 of Class A space in downtown Bellevue. That leaves a vacuum in Redmond, but we believe that may be absorbed fairly quickly also. So, Class A space has filled up very quickly in downtown Bellevue, and the dynamic has changed considerably just in the last nine months or so here in this marketplace.

Thank you.

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

Hoefer & Arnett. Good morning, guys.

Good morning, Louis.

Can you comment on what your objectives are for business banking, which has definitely been a slower growth area for you? You know, it certainly moves significantly slower than a lot of other areas, yet it's a sector that you stated that you wanted a bigger presence in. Given this new competition, what do you think your opportunities are? What do you think your growth, you know, the growth potential is at this point in time going forward?

Sure, Lou. We have said, and publicly and internally, that over a five-year period we would like to see business banking reach the level of 20 to 25 percent of the portfolio, and we feel that it can. We like to think that we are taking major steps at growth there. We have all the products that we need, both in terms of loans and cash management for the market segment that we are approaching in the business banking area. And we actually divide the business banking market into two markets. One we call community business, which is company with credit needs up to $200,000, and the other is business banking, with credit needs in excess of $200,000, and they tend to demand a different product set and a different level of attention, and also different risk metrics. We primarily bank the community business banking ones out of our branches, although credit decisions are all centralized and the risk is monitored centrally.

Even with the new entrants in the marketplace, we think that there are ample opportunities to reach our growth goals. We do have a lending limit that positions us nicely-- legal lending limit that positions us nicely in terms of the start-ups, in terms of our ability to take on, you know, the mid-sized credits in the marketplace. And we're generally quite competitive with the larger banks, who tend to ignore companies with credit needs under five million, certainly under $3 million, so we think there's a nice niche in the marketplace that we can fill and feel fairly optimistic that over time, over the next five years we'll reach that goal.

I would certainly add that as investors, you should be concerned if growth in the business banking area were incredibly dramatic because generally one does not achieve incredibly dramatic growth in business banking loans without consequence to issues, credit issues in particular.

Is there any actual growth in the sector? I mean, certainly CNI [?] growth has lagged construction lending over the last several quarters. Do you see that changing?

No, I don't see a huge dynamic in terms of growth in the business banking market. First of all, the economy here, although while doing okay, is not robust, but it's doing okay. Secondly, as you point out, if you look at bank balance sheets overall over the last five years or so, the industry as a whole has seen CNI lending drop to I think something like 16 percent of the bank portfolios in all in the U.S. So, banks have lost-- either lost market share or picked up assets in other segments.

Having said that, we believe very comfortably that there is opportunity to take share in this market, even without robust economic growth, and we can do so safely and comfortably at a measured pace.

Okay. Shifting gears, could you give us some color as to what kinds of exposure you felt, what kind of interest rate risk you felt you would have been facing if you had not taken the moves mentioned on page seven of your mini MD&A?

You mean in terms of lengthening some of the maturities of our liabilities?

Lengthening the maturities, you know, the match funding, et cetera. What risks did you feel you, you know, do you feel you are facing and would have faced in terms of your net interest margin? You know, certainly you would have seen some better-- you state that you would have seen some better up side without some of these moves. I'm wondering-- what I'd like to get is a little color on what you felt the down side was that caused you to take these moves?

Well, I think that would be primarily speculative on our part. I would just make the observation that we try to manage the balance sheet without taking a view as to where rates will go, whether up or down, and that prompted the moves that we made both in terms of lengthening liabilities, and, of course, match funding the securities that we purchased.

Okay. And then one last quick one. To what percentage of the increase in your net interest margin do you feel is attributable to prime-- to the moves in the prime rate, and to what's, you know, to other, on the volume gains?

You know, I-- the prime rate move has certainly helped, but we do not have a huge portion of the portfolio based on prime. So, I would say it's not a significant contributor. Definitely it helps, but not a significant contributor. And primarily, the prime-based loans we have, virtually all our construction loans, like single-family spec construction loans, those are only two percent of the portfolio. Commercial real estate construction, those are three percent of the portfolio. And business banking lines of credit only, not term loans, and the home equity loans, so, you know, Lou, it's not a significant piece of the portfolio. Every move helps, of course, but it's not like 50 percent of the portfolio is prime based.

Okay. Thank you. I'll step back.

Thank you. Our next question comes from Ross Habermann. Please state your company name followed by your question.

How are you, John?

Good morning.

A quick question in terms of your expectations on loans which I think you said [inaudible] 15 million. Could you break-- give us a rough breakdown of how that's composed? And, could it be somewhat higher than that if we don't see a lot of refis or your payoff assumptions are too conservative, are overly conservative?

Yes. Certainly payoff assumptions are key, and we, as I know many of our peers, certainly in this area, have seen a very high level of prepayment fees, particularly in commercial real estate, so to the extent our expectations there are not met, then it's certainly conceivable that loan growth, portfolio growth could be higher. The mix, I don't think we would care to characterize it at this point, but you can see from the portfolio mix, you know, where our growth has occurred over the last few quarters, and you see single family has become a slightly larger percentage of the portfolio and income property has become a slightly smaller percentage, and business banking and consumer has stayed about the same, so you can kind of draw your own conclusions from that.

And on the deposit side, what are you doing differently, in order to grow those core deposits? What are you emphasizing?

Well, one of the keys, I think, is that we have a very good incentive system in the banking centers that is focused on a team basis in each banking center, both on deposit growth and loan growth or loan referrals to other areas of the bank. And in particular, there is an emphasis on core deposits, checking accounts and money market accounts. And we are also-- we will also offer some incentives to customers, whether they be time deposit or money market customers, provided they have a checking account with us. So, there's a focus on relationships, and relationships in particular that are tied to the checking account.

But I think one of the keys is the incentive system, and the management we have on the retail side of the bank, Joe Sabalyas [ph], has done an excellent job of structuring incentives and attracting staff both at management and the assistant manager and the personal banker level in those banking centers that's very focused on that core deposit growth. We have had, I think, seven or eight out of our 12 banking center managers have turned over in the last 12 to 18 months or so, but we are-- we have a very, very skilled set of personnel in those banking centers now, so that's been a huge part of it.

Community business, those companies, those small business companies with credit needs less than $200,000 have also been a very, very key part of that deposit growth. We will not make a loan there without the full deposit relationship. And again, those are under Joe Sabalyas responsibility, and again, he's done a very good job of developing incentive systems there that get the community business banking and loan officers focused on bringing in those relationships, which again bring in the total deposit relationship.

Would you expect to see this type of core deposit growth over the next couple of quarters?

Well, it's-- we're not making-- that's not our-- that's not in our forecast, Ross, but--

Okay.

--it's certainly a goal.

And just one follow-up question from the initial questions about the increase in non-interest expenses. How much of that directly is going to additional lenders? And how many have you brought on specifically over the last quarter or two? And I guess what I'm trying to get a sense of is how quickly the revenue associated with these expenses will catch up and more than cover the expenses.

Well, some of it has gone for additional lenders, but also, I mean, we have invested, and will continue to invest a lot on the support side, as I mentioned earlier. For example, gosh, probably about six months ago, we had the opportunity to hire a very, very high level, very skilled business banking-slash-commercial loan credit administrator, somebody who had both marketing experience but also extensive credit administration experience at a very senior level, and also loan policy development experience. This was an expensive addition, but we did go ahead and hire this individual, and it's making a significant impact on our ability to look at more complex credit and do so comfortably.

So, it's not just at the front end or the sharp end of the pencil, it's at the support side as well. I think, again, a lot of that is behind us and we'll be focusing more on hiring on the origination side, and we do have some openings, as I said earlier, both in the income property and the business banking area that we hope to fill.

No, I asked the question trying to get a feel for are we seeing, I guess, front and expense costs, and what kind of delay or lag will we see in terms of the revenue catching up with that expenditures?

You're seeing front end costs, and you will see a very major growth from us in business banking in particular because we just don't want to go out pile on a bunch of loans for the sake of adding assets. We want to be very careful about what we add to the balance sheet.

And just one final question. How many new offices are specifically planned for calendar '05?

We would anticipate one new one.

Okay. Thank you.

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

Yeah, in terms of your non-interest expense, can you give us some more color on what you're seeing in terms of health care costs for employees? You did-- you talked a bit about that in the MD&A, but what are you seeing and what are your expectations here? And what steps are you taking to try and control that?

Okay. Steps to try and control it, we work through a group plan that's part of the Washington Financial League, so we shifted several years ago from a plan that was First Mutual only to a much larger group. Having the larger group, of course, helps the experience base in terms of rate increases. We have looked at other vehicles like plans that involve health savings accounts. We are in the process of looking those. Haven't made any conclusions. Probably won't make any changes this year. So, the real, and I'm just guessing, I haven't seen the final numbers, but I'm thinking that there may be health insurance costs increasing in the range of 15 percent or so. That's just a guess, not even a solid projection. So then the question becomes--

Is that for '05, or is that for in Q4?

That's for '05, for the year, just year-over-year, just in terms of benefit plan, health insurance benefit plan increases. So then the question becomes how much of that do we expect the employee to absorb and how much will the bank absorb, and we have not finalized that.

Okay. Thank you.

Thank you. [Operator instructions.] Gentlemen, it appears there are no further questions at this time. Please continue.

All right. I want to thank you all for joining us on the Conference Call this morning, and wish you all a good day. Bye.

Thank you. Ladies and gentlemen, this concludes the First Mutual Bancshares Conference Call. If you would like to listen to a replay of today's conference call, you may do so by dialing 303-590-3000, or 1-800-405-2236, followed by the pass code 11009985. Once again, if you'd like to listen to a replay of today's conference call, you may do so by dialing 303-590-3000, or 1-800-405-2236, followed by the pass code 11009985.

Thank you. You may now disconnect. And thank you for using AT&T.