Valley National Bancorp (VLY) Q4 2014 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Valley National Bancorp Fourth Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now turn the conference over to our host, Ms. Dianne Grenz. Please go ahead.

Thank you, Josh. Good morning, welcome to Valley's Fourth Quarter 2014 Earnings Conference Call. If you have not read the fourth quarter 2014 earnings release that we issued earlier this morning, you may access it from our website at valleynationalbank.com. Comments made during this call may contain forward-looking statements relating to Valley National Bancorp and the banking industry. Valley encourages participants to refer to the SEC filings, including those found in Forms 8-K, 10-Q and 10-K for a complete discussion of forward-looking statements. And now I'd like to turn the call over to Valley's Chairman, President and CEO, Gerald Lipkin.

Thank you, Dianne, and welcome to our fourth quarter earnings conference call. For the quarter, Valley reported net income of $25.1 million or $0.11 per diluted common share. The quarter included many infrequent items, most of which Alan will provide more detail on during his remarks. For the full year of 2014, the bank produced net income of $116.2 million or $0.56 per diluted common share. With the close of 2014, Valley continued its history of generating positive earnings and creating long-term sustainable growth in equity for its shareholders. As with most commercial banks, Valley's revenues remain under pressure as the result of the continued record low interest rate environment. The good news, however, is that our relatively high-cost borrowings are beginning to mature, and if rates remain low over the next few years, our cost of funds should decline significantly. Also, the amortization expense attributable with our FDIC loss share receivable will drop by several million dollars a quarter beginning at the end of March. During 2014, Valley embarked on multiple significant strategic initiatives to address technological changes affecting the entire banking industry, as well as the demographic and economic changes unique to Valley. A little over a year ago, we announced our branch modernization initiative to incorporate new delivery channels and self-service banking platforms designed to meet the changing needs of our customer base and to remain competitive with the leaders in the banking industry. Our plan incorporated introducing new technologies to enhance the customer experience, while modifying the branch network to rightsize our branches to meet the change in customer foot traffic and services required at each branch. During the past 12 months, we have introduced and enhanced mobile banking platform, providing our customers the capability to deposit checks from their smartphones, and in the next few weeks, we will be adding P2P payments through the use of smartphones. The improvements made in Valley's delivery channels weren't limited to new mediums of interacting with our customers, as we have introduced 85 new teller cash recycling machines in our branch network and are on track to introduce this labor-saving equipment and customer-enhancing experience throughout our branch system during 2015. Another phase of our modernization program is to replace conventional ATMs with new, dynamic, enhanced ATMs. To date, nearly 200 machines have either been modified or replaced within the new technology, and we anticipate completing the entire bank-wide upgrade by the end of 2015. Additionally, we intend to complete the installation of the new ATM technology in Valley's entire Florida footprint by the end of this quarter. With the introduction and subsequent expansion of this strategic initiative, Valley has begun to experience positive operating leverage through the reduction in both staffing and occupancy expense. Since the beginning of 2014, these initiatives have enabled us to reduce branch staff by nearly 10%, representing an annual reduction in salary and compensation expense of over $3.5 million. Further, the new technology has a corollary benefit, wherein the square footage required at most locations has been reduced. Many of Valley's branches currently occupy locations with floor plans in excess of 3,000 square feet. Interior blueprints and designs incorporating the new delivery channels will require far less space and enable Valley to reduce its branch footprint while continuing to fully service our customers. During the quarter, we announced the sale of another branch location in Manhattan for a pretax gain of $17.8 million. We intend to relocate that branch directly across the street in a location which incorporates many of the features consistent in Valley's new branch model. The rightsizing of Valley's branch network is an important strategic initiative and we believe paramount to adapting with the changing customer behavior across the banking landscape. Although the gain on sale is reflected as an infrequent event, Valley continues to own over 100 of its branch locations. Most of these facilities are carried at a cost basis significantly less than the current market value. Therefore, this occurrence should not be considered a unique event, as this is the third such move in the last few years. As we continue to implement Valley's branch modernization program and evaluate our traditional branch network, similar opportunities may manifest, producing gains in the future. The most significant initiative, which took place in 2014, was our expansion into the Florida marketplace with the acquisition of 1st United Bank. The transaction provided Valley an entrée into one of the fastest-growing markets in the United States. The 3-year growth in gross metro product within Valley's new Florida footprint was among the best in the country. The favorable demographic shifts in Florida should provide a catalyst for additional loan and deposit growth while diversifying the bank's income stream. We must emphasize, however, that we still believe that our traditional core base in New Jersey and New York remains the strongest economic market in the United States and continues to generate enormous opportunity for Valley. The addition of Florida to our franchise is viewed simply as a means to accelerate and diversify our growth. Although the acquisition of 1st United just closed in November 2014, we have already begun to witness benefits as linked-quarter loan growth, exclusive of acquired balances, were positively impacted by loans originated in the Florida marketplace. Specifically, Valley's combined C&I and CRE net organic loan growth was $83.5 million, of which nearly 24% was contributed by Valley -- by Florida during the 2-month period since the 1st United acquisition closed. We continue to expect gains in loan origination volume from Florida, as commercial lending synergies are embraced and the consumer lending advertising campaigns are implemented. In addition to loan originations, the Florida marketplace has become an attractive funding source for the bank, at deposit rates equal to or lower than we find in Valley's northern footprint. As an example, Valley introduced its 13-month certificate of deposit throughout the 1st United branch franchise at an interest rate equal to Valley's current offering in New Jersey and New York. Within 6 weeks, the 20 Florida branches originated over $70 million in this deposit product, exceeding the originations of Valley's entire 200-branch northern footprint for this product during the same period. The Florida deposit program has a dual benefit of generating funds at rates equal to or less than Valley's prior capabilities, as well as introducing the Valley brand of consumer loan products, such as automobile and residential mortgage lending. During the month of January, Valley launched an advertising campaign associated with its $499 residential mortgage refinance program. The campaign consists of television, radio and newspaper spots. With interest rates approaching historic lows, we anticipate an increase in second quarter residential origination volume. As a corollary benefit to the media campaign for residential mortgage, our company's name recognition has grown dramatically throughout the areas where the program has been launched. In particular, this name recognition is providing -- proving to be a major benefit to our Florida lenders in their effort to build commercial loan volume. Although the highlight of the quarter was the merger closing between Valley and 1st United, loan activity within Valley's northern footprint was also brisk. Total organic non-covered loan growth, exclusive of assets acquired via 1st United, expanded nearly 6% on an annualized basis. For the quarter, Valley generated nearly $800 million in new loans, roughly equal to the balance originated in the prior quarter and approximately 6% greater than the same period 1 year ago. For the full 12 months, the bank originated nearly $2.9 billion of new loans. Of the 2014 originations, almost $2 billion were commercial, evenly split between traditional C&I and Commercial Real Estate. A disproportionate percentage of CRE originations continue to be sourced from New York City, as real estate construction activity in Long Island and New Jersey remains tepid. However, C&I activity in New Jersey was strong for the fourth quarter, with new loan originations roughly equaling the levels generated in New York. Competition for quality assets remains intense. From our perspective, there is an excessive amount of money chasing a limited supply of borrowers. Although Valley remains competitive on pricing, we continue to be unwilling to expand volume by relaxing terms and conditions beyond our normal prudent underwriting standards. We continue to remain diligent in our underwriting and resist moderating criteria simply to grow the bank. Similar to my comments regarding the commercial loan landscape, Valley's Consumer Lending portfolio mirrors that of the commercial portfolio. For the quarter, Valley originated over $140 million of consumer loans, largely automobile. While the net new yield is lower than Valley's blended rate on total loans, these loans remain attractive based on Valley's expected duration and loss history within this sector. Although total linked-quarter residential mortgage loans contracted, exclusive of the loans acquired from 1st United, origination volume was stronger than the third quarter of 2014 as the drop in market rates, coupled with increased advertising, facilitated growth. For the quarter, Valley originated approximately $110 million in residential mortgage loans, of which 75% were refinances. Application volume improved as well, increasing from $162 million in the third quarter to $256 million in the fourth quarter. Again, we have begun to aggressively market Valley's $499 residential mortgage refinance program in all of our markets and anticipate increased activity as a result. However, many of the applications processed today will not close until the second quarter. The Florida residential mortgage campaign reflects the initial combined marketing efforts of Valley and 1st United. The Florida lenders have begun soliciting larger commercial customers, and as a result, we anticipate recognizing significant activity. The operational merger of our data systems is on schedule to occur by the end of February. We anticipate a seamless conversion and are looking forward to the ancillary benefits of operating the entire bank on one platform. Alan Eskow will now provide some more insight into the financial results.

Thank you, Gerry. The fourth quarter financial results included the November 1 acquisition of 1st United Bank, as well as other infrequent items, which significantly impacted the reported net income and associated performance metrics. In direct association with the 1st United transaction, Valley incurred merger expenses during the fourth quarter, totaling approximately $1.5 million of professional and legal fees, and also, $7.6 million of aftertax valuation adjustments to Valley's deferred tax asset. The combined negative impact of these 2 items on Valley's diluted earnings per share for the quarter was $0.04. While the merger charges reflect customary transaction fees synonymous with an acquisition, the adjustment to the valuation of Valley's deferred tax asset is unique and is largely attributable to the difference in state income tax rates and income allocations between New Jersey, New York and Florida. On a prospective basis, Florida's lower effective state business tax rate will be a benefit to the bank. However, the value of the previously recorded deferred tax assets is immediately reduced as a result of the difference in tax rates between the states, and therefore, a direct result of the merger. Other infrequent expenses recognized during the quarter consisted of $15.5 million in noninterest expense, including $10.1 million attributable to the extinguishment of $275 million of long-term debt and a $5.4 million increase in the amortization of tax credits due to new credits immediately recognized as a tax benefit in the fourth quarter. The aftertax impact of these items on Valley's fourth quarter diluted earnings per share was approximately $0.04. Partly mitigating the combined negative impact of the aforementioned infrequent items was a gain of $17.8 million related to the sale of a Manhattan branch location, as discussed in today's press release. The aftertax increase to diluted earnings per share related to this transaction was approximately $0.05. As indicated earlier, many of the core metrics used to assess performance were significantly impacted due to the acquisition of 1st United. Linked-quarter, non-covered loan growth of $1.1 billion included $954.3 million of non-covered loans acquired from 1st United Bank. Exclusive of these loans, Valley organically generated linked-quarter annualized loan growth of 6.2%. This loan growth was a major variable in the expansion of Valley's interest income on loans from $135.1 million to $150.3 million. Of the -- excuse me, of the $15.2 million increase, approximately $9.9 million was the result of our new Florida operations. The average yield on loans during the quarter increased from 4.54% to 4.61%, largely due to the assets acquired as the yield on new loans originated by Valley in the quarter averaged only approximately 3.55%. Although the average yield on aggregate loans increased for the quarter, the blended rate on total earning assets contracted 3 basis points to 4.24%, largely due to the increase in short-term liquidity, coupled with the contraction in yield on taxable investments. The cost of funds declined to 1.03% from 1.11% in the prior quarter, as on average, the bank utilized deposit funding sources to a greater degree. The shift in funding composition was attributable both to the balances acquired from 1st United, as well as strong organic deposit growth witnessed in Valley's New Jersey and New York branches. Of the $2.2 billion in deposit growth realized between the third and fourth quarter, approximately $750 million was generated organically, excluding the effect of the assumed 1st United deposits. As a result of the increases in deposits, Valley's non-covered loan-to-deposit ratio as of December 31, 2014, stood at 94.5%, with over 30% of the deposit base being noninterest-bearing demand. The cost of deposits remained flat from the prior quarter at 41 basis points, as 1st United's cost of deposits largely mirrored Valley's. As a result of the decrease in Valley's cost of funds, partly mitigated by the contraction in blended earning asset yields, Valley's linked-quarter net interest margin expanded 4 basis points to 3.20% from 3.16% in the third quarter. As previously referenced, Valley extinguished $275 million of long-term debt during late December. The average cost of the borrowings was approximately 4.52%, and from a funding perspective, was replaced with excess liquidity, earning Valley approximately 25 basis points. We anticipate the full savings from the debt prepayment to impact both the first quarter net interest income and margin. Total noninterest income increased approximately $14.8 million from the prior quarter, as Valley recognized a $17.8 million gain on the sale of a branch location in Manhattan. Partly mitigating the gain was a reduction in noninterest income of $5.4 million, resulting from the decrease in the FDIC loss share receivable from the third quarter. As of quarter end, the FDIC receivable equates to just under $14 million in the aggregate, of which $6.9 million was assumed with the acquisition of 1st United. The commercial portion of Valley's legacy loss share with the FDIC expires at the end of the first quarter of 2015, after which a small percentage will be left to cover future exposures arising from the single-family component of the loss share arrangement. As a result, the quarterly amortization related to the receivable will materially contract in the first quarter of 2015 and be negligible thereafter. Total noninterest expense during the quarter was $121.3 million, an increase of $29.8 million from the prior quarter. The increase is largely attributable to the $10.1 million prepayment penalty incurred on early extinguishing of debt, the increase of $5.4 million in the amortization of tax credit investments, merger expenses of $1.5 million and the additional operating expense incurred related to the acquisition of 1st United Bank. As Gerry indicated earlier, we are on schedule to complete the operational phase of the merger by the end of February, at which time many of the identified cost saves are expected to be recognized. Credit quality for the quarter was very positive, although net charge-offs on total loans increased to $4.3 million, largely the result of a write-down to one impaired construction loan. Total nonaccrual loans declined $4.2 million or almost 7% from the balances reported as of September 30. The December 31 balance of $55.8 million reflects a 41% contraction from the same period 1 year ago. Total accruing past due loans remained relatively flat with the prior quarter at $31.2 million compared to $46.9 million as of December 31, 2013. The improvement in Valley's credit quality, coupled with the acquisition of $1.2 billion of loans accounted for as purchased credit impaired, were key variables in the linked-quarter reduction in Valley's allowance for the non-covered loan losses as a percentage of non-covered loans. At quarter end, Valley's purchased credit impaired loan portfolio equaled $1.7 billion, net of approximately $105 million of fair value accounting marks remaining. While these fair value marks are specifically earmarked against each of the various loan pools, it is appropriate to incorporate the balance when assessing Valley's overall reserves for potential bad debts. Similarly, unlike the allowance for credit losses, which under current regulatory guidance is a component of Tier 2 regulatory capital, the fair value mark to the PCI loan balances is excluded from the calculation. Although from my view, both the fair value credit mark and the allowance provide a cushion against future loan losses, the inconsistency in which the regulators account for each, and the resulting impact on capital ratios appears uneven. Irrespective of this contradiction, Valley's regulatory capital ratios remain strong as Valley's Tier 1 common capital ratio increased of 9.22% in the third quarter to 9.40%. During the same period, Valley's Tier 2 equity declined slightly from 11.44% to 11.42%, in large part due to the risk-weighted assets acquired from 1st United. The elimination of their allowance for loan loss under purchase accounting and the aforementioned inability to apply the new fair value loan mark. We believe, as of December 31, Valley's capital ratios are appropriate for the bank's risk profile. This concludes my prepared remarks, and we'll now open the conference call to questions.

[Operator Instructions] And our first question comes from the line of Collyn Gilbert with KBW.

Alan, could you just give a little bit more color as to the increase on the tax credit investments during the quarter and kind of what your outlook is from here on that?

Yes. I mean, I think the way you really need to look at it, Collyn, is that we're going to run a 27% to 29% effective tax rate. That rate will incorporate the tax credits that we may invest in during the course of the year, as well as everything else that comes into play. So there's not anything specific. I mean, we do have tax credits that we put on all the time. It obviously causes some increase, as we talked about of -- this particular quarter of $5.4 million of amortization of those credits. But that $5.4 million is not going to carry forward quarter-to-quarter. It's almost like a onetime amount offsetting some of those credits.

Okay. Okay, that's helpful. And then just in general, but let me back up for a minute, did I hear you correctly in your comments on what 1st United did in loan originations during the fourth quarter? Did I hear you when you said $980 million of non-covered loan growth?

No, no, no. That was the amount of loans we acquired.

Why is that non-covered then?

Because those are not covered by the FDIC. So...

Oh, you're just talking about...

I think there was about $180 million of loans that were covered by the FDIC transactions that they had participated in, and those that were not part of that were the $900-plus million.

Oh, okay. Okay. Okay, got it. And then...

We would have been very happy with $984 million...

Well, I was like, "Wow, they've really turned on the origination engine," if that were the case. Okay. And then just, obviously, some movement here on the expense side in the quarter. Can you just give us a little bit of color as to what you're kind of thinking once it settles out what a normalized expense run rate is going to be in the coming quarters?

Yes. I mean, obviously, it's going to be a lot less than we're talking about here. I think we gave you, first of all, a lot of the, what I'll call, infrequent or onetime kind of charges, we think those numbers are going to head down south from where they are, obviously. They should run in the area of about $105 million, beginning in the first quarter, and then we think they'll trend down somewhat from there. I don't want to pinpoint anything specific other than saying that that's a ballpark of where we think the numbers will run. They're going run down from there because, as you know, first quarter generally sees things like snowplow costs and high FICA costs, so tax costs are higher. Plus the fact that the reduction in cost from 1st United, as we said, as we get off of their platform of computer systems and some people, will tend to trend those expenses down as we get into the second quarter.

Okay, okay. And then just, do you have the amount of what the amount of accretable income came in through the margin this quarter?

No. That number -- hold on 1 second. Yes, 1st United was about $10 million. So again, because of the fact that we had the 1st United loans, as well as our own loans, all of that impacted the accretion during the course of the quarter. And on the case of 1st United, we only saw 2 months of that. So we'll see an additional month coming in next quarter. So that number actually should go up a little bit.

Okay. So that $10 million that you're talking about, that is accretable income versus just interest income that's been generated on the additional loans coming on to the balance sheet? That's up and above that number, is that right?

Well, we account for everything, so that's accounting for the whole thing. So all of it is accounted for as accretable income, the 1st United as well as what we have coming through Valley's PCI loans or covered loans.

Okay, okay. And I know you guys don't like to give NIM guidance. But just kind of thinking big picture here, is the messaging, the fact that the loan origination yields coming out of Florida are obviously a lot higher than your current portfolio and that should drive the NIM higher throughout the year?

You know what, I don't think, Collyn. Remember, we acquired them and they did have some FDIC loans again, we indicated about $180 million. So part of that is driving their yields higher, plus the fact that they are getting slightly higher yields than us. But remember, their numbers are not 100% of Valley's numbers up north. So we don't expect necessarily that we're going to see a large increase. But we do expect some increase, first of all, because the borrowings went away. So the NIM should be positively affected for the balance of the year. And -- but we don't expect that the loan origination volume coming out of Florida is necessarily going to largely offset the loans coming on in New Jersey at an average of, say, $355 million, which I think we indicated -- which we indicated. I'm sorry, I'm losing my voice.

[Operator Instructions] And our next question comes from the line of Ken Zerbe with Morgan Stanley.

Gerry, you mentioned -- you were talking about the unrealized gains that you have on the 100-plus branches that you guys actually own. Can you quantify that? What -- I mean...

We, in the past, indicated that we felt we have a gain of between $150 million and $200 million. I know that's a wide range, but they are significant, what we hold in the branches. And they change depending upon market conditions. New York City got very hot, and I think a lot of the gains that we've seen coming out of the offices that we've sold in Manhattan are a reflection of that. They're probably higher than what we thought they would be worth several years ago. As to some of the other real estate, we don't do a daily reevaluation on it. So -- but it is significant, obviously.

Understood. Okay. And then just you talked a lot about the ATM network and the mobile -- your mobile initiatives. But when you think about the timeframe that it takes to bring down headcount, obviously, shrink your branches, can you just help us give a better sense of, are we talking over the next 1 year, 5 years? Is it -- I'm trying just to put some numbers around the benefit.

Well, in 1 year, we shrank the expense by 10%.

But is that sustainable, that 10% a year? That's what I'm asking.

Yes, I think so. We're focused on wherever we can save money. Obviously, as I made in the remarks I made, the entire industry is being squeezed because of the prolonged low interest rate environment. So we have to look every place to where we can cut back on expenses to help offset that. The drop in interest income isn't only experienced by Valley, it's every bank that makes loans.

And our next question comes from the line of Frank Schiraldi with Sandler O'Neill.

Just on the -- sorry if I missed this, but the long-term borrowings that are paid off, how is that getting? Is that just getting laddered back out into FHLB borrowings? And what's sort of the pickup there?

No. No, we use cash on hand.

Okay. So it's just a shrinking of that, of the FHLB advance book. And as now, we're sort of approaching additional high-cost borrowing maturities. Is it reasonable to think there's a good chance we'll see additional prepayments even ahead of maturities here?

Yes. I think that that's going to be a little opportunistic, so to speak. We have not a lot remaining. We have about $100 million this year coming due, which is some sub debt, that'll probably wait until it actually matures. In '16, we have a fair amount coming due in the first quarter. It'll obviously be reviewed, and if it makes sense to do that, then we'll prepay it. But that being said, we don't want to take large charges that are going to offset our -- or reduce our capital position in advance.

Yes. As we pointed -- I pointed out in my remarks, this is Gerry, we reduced the debt without hitting our capital, in essence, because we had excess funds when we sold the building. They were -- those funds were never counted in our capital by anybody to begin with. So we were able to extinguish the debt without hitting capital.

Yes. And I think, as Gerry said and as he talked about before, we have 100 other buildings. We are looking to rightsize our branches. We're looking to take advantage where it makes sense. If in fact we were to possibly sell another building and there was a gain there, then as he just pointed out, we wouldn't be invading capital if I had a gain, and we might be using that to prepay some additional borrowings.

Josh, are there any further questions?

We have no further questions at this moment.

Okay. Thank you for joining us on our fourth quarter conference call, and have a great day.

That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.