WaFd Inc (WAFDP) 2006 Q3 法說會逐字稿

Welcome to the First Mutual Bancshares third quarter earnings conference call. [Operator Instructions]. As a reminder, this conference call is being recorded today, Wednesday the 25th of October 2006. I'd now like to turn the conference over to Mr. John Valaas, President and Chief Executive Officer of First Mutual Bancshares. Please go ahead, sir.

Good morning everybody. I'm going to make some very, very brief comments but 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 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 any obligation to update any such forward-looking statements.

Well, very briefly, we're very pleased with the quarter, earnings per share up 10%, good strong return on equity at a little over 18%. Credit quality remains excellent. NPA is at 14 basis points and the portfolio mix remained about the same as it was in quarter two, in the second quarter.

I would point out that deposit competition still remains difficult, although we may see some rate competition-- I won't say easing, but maybe a little bit of moderation in the rate of increase in deposit rates in this local market at least. Nonetheless, if you'll look at our outlook we're suggesting that we may see a bit of a decline in our margins in the fourth quarter compared to where we finished the third quarter, which was a little bit higher than what we'd anticipated when we last spoke with you.

So good quarter, good credit quality-- the economy here in Central Puget Sound area remains in very good shape. Again, the hiring of Microsoft, lots of construction activity both in Belleview and Seattle, lots of commercial real estate construction going on in the form of offices and condos. We are starting to see a little bit of a slowdown, a suggestion of a slowdown, in single family residential markets, particularly in the more outlying, lower priced housing tracts but definitely not a pop of the bubble. So it still remains a very good environment for us as a bank. And with that I'll conclude and open the call to questions.

[Operator Instructions] Matthew Clark with KBW.

Just a question on the sales finance business, can you talk about how the housing market slowdown across the country is impacting that business? It appears-- from what we're hearing is that-- and I think it would be expected-- is that a number of builders are starting to pinch their contractors and I'm wondering how that may be, you know to help maintain margins, and I'm wondering how that might be influencing that business? And maybe you can talk about how that portfolio is spread across the country as well?

Sure. I'm going to-- I neglected to introduce who was joining me this morning so let me tell you we have a cast of thousands. No there are actually only four of us, Roger Mandery, our Chief Financial Officer, Scott Harlan, who is in charge of Residential and Consumer Lending, and Charles Smith, our Financial Analyst, and the sales area reports to Scott Harlan so I'll let Scott reply to that, Matthew.

I'll attempt to answer your question this way in that during the refi booms of the last couple years certainly as rates were lower and people were doing a lot of cash back refis, that freed up cash for them to do home improvement projects and we certainly were the beneficiary of that as a lot of people would do replacement windows or upgrades to their house. So the impact on less refi activity, lower available equity within a house on a case-by-case basis may result in lower production in the longer run. Having said that, our production level has been fairly consistent over the last year so we haven't seen an impact on that. The contractors that we use are typically replacement contractors, not contractors that are-- that work with builders in conjunction with building new houses so I think it's kind of a different population than what might be happening on the more macro level on residential construction.

Okay great and then can you talk about the mix or by geography?

Boy I don't have anything off the-- at my fingertips on that other than the mix hasn't changed over the last year or two. We pretty-- we do business in I think 44 states and it comes in fairly consistently from those different regions.

Matthew, we are somewhat active in the southeast. The Texas marketplace has been an active market for us, moderate activity along the East Coast, certainly in the Northeast, a little bit of activity in the Midwest, a fair amount as you might suspect in the Northwest and very little activity in the California marketplace.

Okay great and then can you finally just talk about the rise in delinquencies in both the insured and uninsured portfolios?

Yes. The delinquencies are up. We are devoting more collection resources to that to bring-- to attempt to bring those numbers down. It's not anything that has us overly concerned at this point. It appears to be more of an isolated event rather than a trend and we are attempting to bring those numbers down.

Jim Bradshaw with D.A. Davidson.

Could you talk about the insurance issues? You got a return of the premium and it sounds like negotiations may not be going well for the next policy. I just wonder what your outlook is there and how that might change your business model in the consumer finance if you don't get insurance?

Well, Jim, I don't think we're going to really comment beyond what we covered in the Press Release, which is I think we said we were under discussions on renewal at the current insurance year and we're certainly evaluating whether or not we want to go naked or not. We think-- and we haven't reached any conclusions, but we think that in the last seven years or so we've developed a fair amount of experience and we're now in a position to make a decision on whether or not we want to go naked and a couple of years ago we didn't think we had enough experience under our belt to make that evaluation.

Got it. Is the issue pricing or is the issue something else that they're maybe not even considering this line of business anymore?

No I don't even think I'd want to characterize the issue.

All right. Scott, could you talk about the real estate businesses? It sounds like you're still under some pressure from conduits and others on the income property side and I just want to get your thinking whether that's starting to change? And also, on the non-conforming single-family stuff pretty good jump this quarter in footage if I got my math correct, I just wondered what was the strength there?

Jim, this is John. I'll respond on the commercial side and let Scott respond on the single-family side. He doesn't follow the-- well, he follows it but he's not responsible for the commercial side. Absolutely the conduits are still out there. They're very viable. They're much more aggressive in terms of going down market. By down market I mean in terms of lower loan sizes. Eighteen months ago, two years ago it would be very unusual to see conduits interested in a loan less than $5 million and now you see them reaching down in the $1.5 million to $2 million range and with the [yucur] like it is you'd have to be brain dead if you were a borrower and intended to hang onto your property for a long period of time. You'd have to be brain dead not to look at a ten-year fixed rate loan out of a conduit.

Now the trade offs are that, as you know, you've got pretty stiff prepayment penalties or lockouts and so you've got to be really committed to your property but if you're that kind of a borrower, then you're going to find a conduit product a lot more attractive than First Mutual's one-year adjustable so we have been brokering some loans to conduits to accommodate customers who are looking for that longer term fixed rate financing and so long answer to your question but it's-- the conduits are still very much there and they're going very much down market compared to where they were a couple of years ago. And if you'll-- we've commented over the last few quarters, probably over the last year or so in our quarterly earnings releases about the prepayment speeds and the commercial real estate portfolio and those conduits in particular continue to peck away at that. It's not that we're losing those loans to other banks. They're going to conduits. Now I'll turn it over to Scott to comment on the single family.

The residential portfolio was up about $6 million from the end of the last quarter and we've been very pleased with the level of activity in that business, especially given the overall lower level of activity in the business on a more macro level for all lenders. The pickup in business has been primarily in the perm portfolio business and in residential lot loans. The custom construction balances have been dropping slowly and that reflects the overall lower level of construction activity across the board in the regions that we primarily lend in, which are Washington, Oregon and a bit of Idaho. Like the income property portfolio, we do have a high level of payoffs in that so we do a lot of-- we did a lot of business to grow that $6 million because and for many of the same reasons that John touched on for income property, the residential loans tend to have a high payoff rate as well.

And the last question I had also was around the delinquency rates in consumer finance. I've forgotten how the program works but is part of that delinquency rate that you're seeing higher first or second payment defaults? And then do you have recourse against the originator of the loan if you get a first or second payment default?

I would not characterize the increase in delinquency as being related to first payment defaults. It's-- the rise from the last quarter was pretty much kind of across the board between say 30s, 60 and 90s. We do not, except in very, very limited special circumstances where we do a sort of a side agreement with a very small number of contractors do we have any kind of first payment default protection with the contractor assuming that the contract was delivered to us with all the normal guidelines and that there's no fraud involved and that sort of thing.

Right. Okay thanks, appreciate it.

Sara Hasan, McAdams Wright Ragen.

I was wondering-- you talked about cost initiatives in the last call and kind of having a consultant come in and you were expecting some results from that in the third quarter and I was just wondering what you've discovered?

Sara, we have initiated some restructuring as a result of the consultant's work, primarily in the support areas of the Bank and during the course of the-- actually I guess it was the second quarter-- have made a minor adjustment or two but have just yesterday did another reorganization that will result in some cost savings and efficiencies for us as well. And we have some that we think will continue to occur over the next couple of quarters.

So should we expect to see an improvement in expense or just kind of holding the line?

Well, John and Roger have different views of an improvement of expenses. I view an increase in expenses as an improvement and Roger views a decrease in expenses as an improvement. I forget what we said in our outlook for expenses. I think we had a $1.00 number there but I might turn that over to Roger to comment on but you'll notice that I believe our expenses were basically flat third quarter over second quarter of this year.

This is Roger. To put the positive view on it I guess we've held steady for the last four quarters at about 7.7 million. However, having said that we made an indication in our outlook in second quarter that we thought we might see a little more improvement this quarter and that didn't occur. But we're hoping for maybe a little more improvement in fourth quarter but I think whatever change in operating expenses will probably be [placial]. Currently we're taking the position that if we could continue to hold operating costs level on a sequential quarterly basis that that would be a great improvement over what we've done in prior years and so we would consider that successful. In the coming quarter we're looking for something in the nature of either flat to this quarter or up a little bit because the fourth quarter is typically the end of the year for us and if our performance is successful and we can afford it, then sometimes we'll do a little extra approval for employed bonuses and that will often show up in fourth quarter.

Chris Stulpin with Cohen and Company.

One of my two questions have been answered but the one remaining pertains to deposit competition. You say it has been moderating a little bit recently. What do you think is causing that? Is it one or two larger players lowering rates or other factors involved there?

This is Scott who normally talks about sales finance in this call but I also have a responsibility for the Pricing Committee where we discuss deposit pricing. I don't know that I have a very specific answer to your question because I look at-- I tend to look at the overall market and not individual competitors when we're doing our rate setting but I have been amazed at the last-- for about the last four to six weeks. One of the reports that we get shows on a week-to-week basis what the competition is-- which competitors are specifically going up or down and how much and there has been almost no movement in the last about four to five weeks. It seems like middle of the summer most of the competition or the competition set their rates at what-- at certain levels and then they just haven't-- it's a level they're comfortable with. They just haven't been moving them so that's been kind of a-- that's been a pleasant surprise in an environment where one might expect a lot of one upsmanship and have some big competitor come in and really try and buy the market. That has not necessarily been the case although we do see kind of goofy specials out there from time to time from different banks trying to do specific funds acquisition at a particular term.

Adam Parker with the Endicott Group.

I just have a quick question on the sales finance and the prepayments fee and I was wondering what you guys were thinking you'd see in the upcoming quarters, if you expect that to slow down or even pick up a little bit more, or if you could provide me other detailed information on that I'd appreciate it.

This is Scott again. With the exception of really the height of the refi boom, I want to say in 2002 or 2003, other than that very short period of time sales finance prepayments fees have been extremely consistent between running between 30 and 40%. It does not-- they do not seem to be driven by the overall level of interest rates, short-term, long-term, anything like that other than again, in that one case of a just a lot of refis. So that would be my guidance is 30 to 40% and that seems to be very consistent in that range.

Okay and if I could also ask on non-performers if there's anything in the watch list you can discuss coming up? Do you expect the NPAs to tick down come fourth quarter?

We typically have not given guidance on that. We had a very, very modest increase in NPAs this quarter. The number still remains relatively low and we certainly don't see anything out there in the form of the economy or what's going on with any of our borrowers that would cause us any alarm as far as NPAs.

[Operator Instructions] Ross Haberman with the Haberman Fund.

Roger, just a quick thing-- you were looking around for a new CFO. How is that search coming along?

I'll let John answer that.

Yes Roger is not looking. He's retiring.

I know that.

Let's get this straight. Yes the search is going on. We are talking to candidates and I would say it's going well.

And when-- what's your timing there?

Well, I would ideally like to have somebody on board sometime in January so we have a good consistent overlap.

Okay and just-- an going back to one of the earlier questions regarding the insurance for the consumer loans, if I understand the description you're going to keep the insurance for one pot of your receivables or loans and you might or might not renew it for the second one. Is that depending on price? Is that because the prices have gone up so or is it for the premiums?

Let me clarify. Through the years we have insured loans up through-- well, up through today, and the only thing that we're talking about changing perhaps is the insurance on new loans originated after this point so that's what we're negotiating right now and that would not change the status of any of the insurance that was written, especially prior to August of 2006, for instance.

And the variables or the parameters involved with making that decision or why you're rethinking the possibility is because I guess the new premiums are significantly more than your old ones?

I would characterize it this way. The decision would be based on price and the amount of coverage offered by the insurance companies so I'm trying to give an answer without giving an answer. Those are-- I mean it comes down to the basic metrics that you would expect us to be looking at.

Roger, just a bigger picture question for the consumer loans, how big would you like to see that portfolio if you continue to see the good demand you've seen?

If we're talking about sales finance loans and--

Yes.

And I guess the home equity loans, which we classify as consumer loans, that'd what, about 12, 13% I think of our portfolio now. I think from time to time we discussed something in the 10 to 15% range as maybe being the ideal mix for us so it's probably about there. The consumer portfolio or the work that Scott's done is probably more important to us in terms of loan sales and servicing fee income. Servicing fee income runs roughly $100,000, $100,000 to $125,000 a month so that's a nice little annuity so I guess what's-- or the more important question for us is are we able to continue to originate volume? Can we increase the volume and whether it continues to be good appetite in the marketplace for investors to buy this stuff?

And just one final question, are you continuing to get the premiums that you've historically gotten in terms of these loan sales?

The premium is driven by the pass through rate that investors are willing to take stating the obvious and that relationship changes as the really kind of the shape of the yield curve changes and so it's been in a range historically say roughly between 4 and 5.5% of the principal balances and that, again, within that range it really kind of depends on the difference between very short term interest rates and the medium term interest rates.

Brian Martin with Howe Barnes Hoefer & Arnett.

Say I wanted to just get an idea the commercial, the prepayment penalties that kind of offset some of the margin pressure this quarter but can you just give a little color on what that contribution was to the margin, kind of a core margin if you were, maybe if you expect similar contribution going forward?

This is Roger. In the outlook or I mean our forecast for third quarter I was looking for prepayment slow down a little bit and, as a result, the fee income that gets capitalized every time we originate a loan and then when a loan pays off shows up as interest income. I had expected in my modeling for that to slow down so when we combined that element if you will with the flat yield curve I expected the margin to narrow. Well, I think we had all the forces working on the margin in terms of the flat yield curve that we expected but the loan prepayments continued along at about the same rate in third quarter as it did second quarter so we had a boost to interest income from these loans paying off and that fee income being dumped into interest income. Going into fourth quarter I'm still I guess a little bit pessimistic that prepayments are going to continue along at the rate they have been so I'm looking for a little margin compression. And then another unexpected item that we really didn't discuss in the Press Release, which did work to our advantage and Scott commented on that, is that we didn't have quite the pressure on interest expense that we had forecasted as people were a little better behaved or we were a little better behaved and the competitors were a little better behaved in terms of pricing for deposits. All of that kind of came together and gave us a pleasant surprise in third quarter and but we're not quite as optimistic for fourth quarter.

Okay and can you-- I mean I guess that actual amount of the contribution of the prepayment penalties, you said it was similar second to third but I guess how much of that contributed to the margin? You know, was it a couple of basis points? Was it-- ?

The mechanics of it is and when we-- it's usually around commercial loans. We make a commercial loan, which is usually say a 1 or 1.5% fee that gets capitalized at the time we make the loan and it gets accreted into interest income over the life of the loan. Well, if the loan pays off early then whatever remaining fee income that hasn't been amortized into interest income dumps immediately into interest income so if you have a greater level of prepayments on commercial loans than you expect, your interest income is going to be boosted a little bit from that activity.

Jim Bradshaw.

Scott, in the insured portfolio it's I think the balance on your balance sheet is about 30 million if I remember correctly and if I'm adding up the totals the current loan balance is about 57 million through the various vintages. Is what's in your portfolio distributed about the same as the sold and the combined portfolio? Does that make sense?

Well, I'm not following the math but I think I can answer your question and say that we do our absolute best to sell the loans to investors in the same proportion so that very similar credit characteristics to what we originate overall.

So, for example, if the '02 - '03 vintage it's about 7.5 million I think is the remaining balance so about half of that roughly would be yours and half sold to investors?

The 7.5 million in that first pool year we own 100% of that.

Got it. Okay that's-- but the vintages after that is more evenly distributed?

Yes, sir.

[Operator Instructions] Gentlemen, there are no further questions at this time. Please continue with any closing comments.

All right thank you and, Michael, we will close the conversation now. Thank you all for your time and attention and we'll look forward to if we don't see you in the interim to speaking with you in-- I guess it will be January. Enjoy the day.

Ladies and gentlemen, this does conclude the First Mutual Bancshares third quarter earnings conference call. If you would like to listen to a replay of today's conference call in its entirety you may do so by dialing 303 590-3000 or 800 405-2236 using the access code 11071801. Those numbers again, 303 590-3000 or 800 405-2236 using the access code 11071801. You may now disconnect. Thank you for using ACT Conferencing. Have a very pleasant day.