Community Bank System, Inc. (CBU) Q1 2012 Earnings Report, Transcript and Summary

Welcome to the Community Bank System’s First Quarter 2012 Earnings Conference Call. Please note that this presentation contains forward-looking statements within the provisions of the Private Security [sic] (Securities)Litigation Reform Act of 1995 that are based on current expectations, estimates and projections about the industry, markets and economic environment in which the company operates. Such statements involve risks and uncertainties that could cause actual results to differ materially from the results discussed in these statements. These risks are detailed in the company’s annual report and Form 10-K filed with the Securities and Exchange Commission. Today’s call presenters are Mark Tryniski, President and Chief Executive Officer; and Scott Kingsley, Executive Vice President and Chief Financial Officer. Gentlemen, you may begin.

Thank you, Anna. Good morning. And thank you all for joining our first quarter conference call. It was a busy and productive quarter for us starting with an operating performance I would characterize as satisfactory. Reported EPS was flat with last year’s first quarter but was up $0.02 or 4%, excluding the impact of the January capital raise in support of the pending branch acquisition. Operating leverage improved with revenues up 17% and operating expenses up 14%, both mostly attributable to the Wilber acquisition closed in the second quarter of 2011. Asset quality remained solid and stable, our wealth management and benefits businesses had a very strong quarter, but the net interest margin contracted 12 basis points over the past four quarters, which Scott will discuss in further detail. Credit demand was down overall and consistent with the seasonality of our historical Q1 experience, with the exception of mortgage lending, which continues to be very strong in this rate environment. We did have a definitive uptick in business lending demand in March and that has continued into April. Our business lending pipeline right now is at a multi-year high, which we hope portends a strong performance there over the next two quarters. We’re also seeing strong and improving demand in our auto lending business. In January, we announced the acquisition of 19 branches across our existing upstate New York footprint from First Niagara Bank and HSBC Bank. We will be assuming approximately $950 million of deposits and $200 million of loans at a blended deposit premium of 3.22%. Also as previously announced in January, we issued and sold approximately 2.1 million shares of common stock for net proceeds of $55 million to provide capital support for the branch acquisition. In modeling this transaction, we used an asset yield of 2.1% on the cash proceeds, which was above the 10-year treasury rate at that time. When the tenure spiked in mid-March during a risk out moment in the market, we purchased approximately $600 million of mostly 10-year treasuries at a blended coupon of 2.32% funded with existing liquidity and $200 million of short-term borrowings that we expect to repay when the transaction closes. We view that as a very good head start on delivering the 4% to 5% EPS accretion we expect on this transaction. Conversion efforts are well underway with an expected closing date in the third quarter. Looking forward, we expect the strength of our first quarter performance to continue. The pending branch acquisition will be additive to earnings, our capital levels are strong, asset quality is sound and we have significant liquidity. We are well-prepared and well-positioned to continue pursuing organic and acquire growth opportunities for the benefit of our shareholders. Scott?

Thank you, Mark, and good morning, everyone. As Mark mentioned, our first quarter earnings of $0.48 per share were negatively impacted by $0.02 a share from our decision to complete the capital rate necessary to support our pending branch acquisition. We felt strongly that it was important to eliminate any potential market uncertainty relative to our ability to timely capitalize the deal. We believe the successful execution of the common stock offering in January validated that decision, despite the $0.01 per month EPS dilution that it would entail. I’ll first discus some balance sheet items. Average earning assets of $5.89 billion for the quarter were up $114 million from the fourth quarter of 2011 with all of the increase in investment securities. Ending loans were down $10.3 million from the end of the fourth quarter, comprised of $9.1 million of net organic loan growth offset by $19.4 million of contractual and other principle reductions in the acquired Wilber portfolio. Solid results in consumer mortgages offset soft but improving demand in business lending and seasonal declines in installment products. The decline in our business lending portfolio in the first quarter was related to the previously mentioned contractual and other principle reductions in the acquired Wilber portfolio, as well as the continuation of modest demand conditions for most business lending products. Asset quality results in this portfolio continue to be stable and favorable to peers with net charge-offs of under 30 basis points over the last 12 quarters. Our total consumer real estate portfolios of $1.56 billion, comprised of $1.25 billion of consumer mortgages and $318 million of home equity instruments were up $17 million from December. Consistent with the fourth quarter of 2011, we continued to retain in portfolio most of our mortgage production in the first quarter and we’re able to productively add to our outstandings at blended yields of nearly 4.5%. Asset quality results continue to be very favorable in these portfolios with total net charge-offs over the last four quarters of $1.0 million or under 7 basis points of loss. Our consumer indirect portfolio of nearly $543 million was down 2.6% from the end of the fourth quarter consistent with seasonal expectations. A byproduct of the improving but still comparatively low new vehicle sales rates has -- has been stable and favorable used car valuations where the largest majority of our lending is concentrated. Net charge-offs for the last four quarters were $1.1 million or 20 basis points, which we consider exceptional. With our continued bias towards A andB paper grades and the very competitive market conditions in this asset class, yields have trended lower over the last several quarters. Although, we’ve continued to report very favorable and favorable net charge-off results, we have experienced an upward trend in non-performing loans since the second quarter of last year comprised of both legacy and acquired loans, and ended the first quarter of 2012 at $31.7 million of non-performers or 0.92% of total loans. Of that total $20.6 million or 65% are business lending related and $11.1 million or 35% were consumer real estate products. Our reserves from loan losses represent 1.30% of our legacy loans and 1.21% of total outstanding. As of March 31, fair value based loan marks related to the $395 million of outstanding balances acquired in the Wilber transaction approximated $19.3 million or 4.9% of the total acquired balances, which are not reflected in the allowance for loan losses. As of March 31, our investment portfolio grew to just under $2.8 billion and was comprised of $625 million of U.S. agency and agency backed mortgage obligations, or 23% of the total, $714 million of municipal bonds or 26% and $1.33 billion of U.S. Treasury Securities or 48% of the total. The remaining 3% was in corporate and other debt securities, including our holdings of pooled trust preferred instruments which continue to fully perform. The weighted average life to maturity of the portfolio is approximately 6.9 years with an effective duration of 5.3 years and reflects our late first quarter 2012 decision to pre-invest approximately $600 million of our existing and expected liquidity in U.S. Treasury Securities with a blended yield of 2.3%. Net unrealized gains in our $2.04 billion available for sale portfolio were $78 million at the end of March. In addition, there were approximately $55 million of unrealized gains in our $730 million held to maturity portfolio. Average deposits in the first quarter of $4.82 billion were $41 million above the fourth quarter of 2011 and 22% above the first quarter of last year. Core deposits or everything other than CDs for us now represent 78% of total deposits, a very stable and favorable funding mix. Our capital levels in the first quarter again improved and included approximately $55 million of net proceeds from the previously mentioned January common stock offering to support the pending branch transaction. The Tier 1 leverage ratio stood at 9.37% at quarter end and tangible equity to net tangible assets was 7.70%, a 134 basis points improvement from last March and 58 basis points higher than the end of the fourth quarter. As a reminder, we did also issue an additional 3.4 million shares of common stock or $82 million of equity in conjunction with the Wilber acquisition last April. Our improvements in equity over the past several quarters have been generated from consistently strong operating earnings. As I have mentioned before, consistent with regulatory instructions, our calculation of the company’s tangible equity ratio includes adding back to both the numerator and the denominator, $25.2 million of deferred tax liabilities associated with tax deductible goodwill created from several of our asset acquisitions, primarily branch transactions. Exclusion of this differential would render our comparisons to peers and complete and since we expect to close another branch transaction in the third quarter, which will create additional tax deductible goodwill, I will keep saying it. Shifting to the income statement, our reported net interest margin for the first quarter was 3.96%, down 12 basis points from the first quarter of 2011 and 10 basis points lower than last year’s fourth quarter. Proactive management of deposit funding costs continue to have a positive effect on margin results and productively offset a meaningful portion of declining asset yields. About half of the late quarter margin decline to 10 basis points was a result of the $600 million of U.S. Treasury purchases in mid-March. We do expect the full quarter impact of the treasury pre-investing strategy to add approximately $2.0 million of additional net interest income, yet push our blended net interest margin down another 15 to 20 basis points. First quarter non-interest income was up 12.6% from last year’s first quarter. The company’s employee benefits administration and consulting businesses posted a 9.7% increase in revenues, principally from the CAI Benefits acquisition completed in December. Our wealth management group including activities from the Wilber acquisition generated a 44% revenue improvement from last year and included solid organic growth, which benefited from more favorable market conditions. Compared to the last year’s first quarter, the company generated $0.7 million increase in deposit service fees or 7.1% as the addition of the Wilber relationships and solid growth in debit card related revenue more than offset the continuing trend of lower utilization of overdraft protection programs. First quarter operating expenses of $49.4 million were $6.1 million or 14.1% above the first quarter of 2011 and reflected the additional operating costs associated with the Wilber and CAI acquisitions completed in 2011. On a linked-quarter basis, operating expenses included a full quarter of the CAI related costs of approximately $1.0 million and seasonally higher payrolls taxes and occupancy expenses. Our effective tax rate in the first quarter of 2012 was 28.5% versus 26.5% in the first quarter of last year reflective of a higher level of income from fully taxable sources. On a trailing 12-month basis, our earnings were $2.09 per share, excluding $0.08 of acquisition expenses. Our ability to generate incremental capital and reward shareholders with a meaningful and growing cash dividend annually stems directly from the commitment to a disciplined and balanced approach to our business, regardless of the market conditions. I’ll now turn it back over to Erin to open the line up for some questions.

[Operator Instructions] Sir, I have Damon DelMonte. Damon DelMonte, your line is now open. 53466603

Scott, I think, I may have missed little bit what you said about the timing of the securities investments this quarter. You said it was mid-March?

It was, Damon.

Okay. And then, about half of the 10 basis points impact to the margin was as a result of that.

That’s correct.

What did you say the full quarter impact we can expect for the second quarter was?

I think what we said is that we would expect incremental investment income from the $600 million strategy to be another $2.0 million of net interest income. But that will effectively push the margin down another 15 to 20 basis points on a blended basis.

Okay. Okay. That’s helpful. And then have you guys quantified what the impact is to your expenses with the addition of the new branches?

Damon, we are not 100%, I think what we said is that, when we -- we are adding 19 branches that we would add, the proportional cost attached to an additional 19 branches as it exists within our system. So if the average costs of our existing 170 branches correlates into x, 19 more on top of that. So, that works out to roughly a 10% to 12% expansion of that base number.

Okay. All right. That’s helpful. And then, I guess lastly, you talked little bit about indirect auto lending, recently there was announcement First Niagara is going to make that a priority of theirs. What are you guys seeing the way of competition on pricing, we have heard from some others that things appear to be heating up pretty good and just kind of wondering what your experiences have been?

I would agree with that Damon, I think that there -- there are more banks being more aggressive in the indirect lending and that’s a business that we’ve been in for a long, long time and I think, we have a very good foundation across the dealer relationships in our market. We’ve seen over different cycles many competitors kind of come and go. We’ve been very consistent in our execution, in our presence, in our expectations out of these markets right now. You are seeing an influx of competitors, you are seeing downward pricing pressure, you start to see some of the capitals and other large banks reengage after their absence because of the credit crises. So, it’s clearly becoming more competitive in terms of the rate expectation. On the other side the volume is improving, as you follow just the general trends in auto sales that’s improved -- it’s improving significantly. So, I think it will be an offset there, the volumes likely to improve and the yields are likely to decline.

Okay. What is new production coming on that for rate right now?

Damon pretty good question I don’t think I actually have that in front of us. My guess would be in the mid-4% range.

[Operator Instructions] I have David Darst. David Darst your line is now open.

Good morning. This is Rahul Agarwal for David. I just had a quick question on the blended yield of 2.3% for the $600 million in securities. What was the blended duration on that?

Pretty close to 10 years.

10 years. Okay. Great. That’s all I had. [Operator Instructions] At this time, I have no questions in queue, sir.

Thank you all for joining on the call. We’ll talk to you again in the next quarter. Thank you.

Thank you.

That concludes today’s conference. Thank you for your participation. You may now disconnect.