First Community Bankshares, Inc.
Q1 2008 Earnings Call Transcript

Published: 28 Apr 2008

[Executives:]

Bob Schumacher - SVP and General Counsel John Mendez - President and CEO Dave Brown - CFO Gary Mills - Chief Credit Officer

[Analysts:]

Mark Muth - FTN Midwest Securities Brian Klock - Keefe, Bruyette & Woods Carter Bundy - Stifel Nicolaus

[Operator:]

Greetings and welcome to the First Community Bancshares first quarter 2008 Earnings Call. At this time all participants are in a listen-only-mode. A brief question-and-answer-session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded. It is now my pleasure to introduce Bob Schumacher, General Counsel for First Community Bancshares. Thank you, Mr. Schumacher. You may begin.

[Bob Schumacher:]

Good morning. In advance to the conference we would just like to tell everybody that the conference may contain forward-looking statements. These statements are based on current expectations that involve risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, actual results may differ materially. These risks include changes in business or other market conditions, the timely development, production and acceptance of new products and services, the challenges of managing asset liability levels, the management of credit risk and interest rate risk, the difficulty of keeping expense growth at modest levels while increasing revenues, and other risks detailed from time to time in the company's Securities and Exchange Commission reports including, but not limited to the annual report on Form 10-K for the most recent year ended. Pursuant to the Private Securities Litigation Reform Act of 1995, the company does not undertake to update forward-looking statements contained within this conference call. Thank you. John Mendez

[John Mendez:]

Good morning, this is John Mendez. I am President and Chief Executive Officer of First Community Bancshares, and I would like to welcome you to our first quarter 2008 conference call for First Community Bancshares. We thank you for your interest in our company and the research that you provide on our behalf. We would like to take this time today to amplify our first quarter earnings release and to advise you on the activities of the company over the first quarter and recent months. Joining me on the call today is Dave Brown. Dave is our Chief Financial Officer. We also have Gary Mills who is Chief Credit Officer for First Community Bank. I will begin with comments on our company generally, our plans and activities and some of our response to the current operating environment. And then I will be followed by Dave Brown who will highlight the financial results. Gary Mills will then conclude with an overview of lending and credit. Following our prepared comments we will take questions from registered callers. I will begin this morning with an overview of our results and operational highlights for the quarter and a discussion of some key trends. As you noted from the published earnings release earlier this morning, our net earnings for the first quarter fell short of the preceding quarter and the comparable quarter in 2007. Dave Brown will discuss the underlying details later in the call, but I would like to address some obvious areas that are driven by current environmental conditions. The general trends affecting our earnings results include the market focus and our focus on credit quality, a general slowdown in economic conditions, and the rapid decline in the general level of interest rates. In particular, the 200 basis point decrease in New York prime. First, our report that loan demand has been somewhat weaker as expected in recent months. This has contributed to a decline in outstanding loans, which have fallen about $46 million or 3.7% since year end 2007. The declines can be seen in both the commercial and the retail lines. And we attribute the commercial reduction to the decline in residential development, housing construction opportunities and the smaller number of new commercial development projects which have occurred within our region and have produced opportunities and submissions. New and renewed loan volumes for the month of January -- months of January, February and March were $36 million, $51 million and $56 million, respectively. Our total production for the first quarter of 2008 was $133 million and that versus $162 million in the first quarter of 2007. We have also experienced some large payoffs as many of these associated with our success in moving a few targeted substandard loans out of the portfolio. In the first quarter of 2008 we were successful in moving out approximately $17 million of loans in this category, and our asset quality measured by average loan rate has benefited from this process along with our loan loss reserve position which has been and remains strong. On the consumer side, we believe that customers are evaluating economic conditions and making buying decisions that are seasoned with a healthy dose of pessimism over the economy. Refinance opportunities are also more difficult due to new valuations for real estate in certain regions and reductions in existing home sales within our region. Our retail underwriting criteria has not been adjusted. However, in contrast to other lenders who have increased required credit scores and who have taken other required measures to compensate the sub-prime issues. Lower consumer loan demand is seen in a comparison of new loans in March 2008, which were down 22% versus March 2007. However, we remain firmly in the market and hopeful that pullback by other institutions will create new opportunities for us as we continue to pursue retail lending opportunities. Despite the weaker economic conditions and changes in the credit markets we are seeing and developing commercial pipeline, which we believe should boost fundings and outstanding loans in the coming months and quarters. At present our commercial pipeline stands at a very strong $255 million. Portions of this pipeline have already closed since quarter end. Most notably we were successful in closing a $34 million real estate loan in early April. This loan is supported by some very strong sponsors and guarantors and we had retained an $8 million piece of this relationship. And as such we will benefit from, both the strong loan yield as well as good fee revenue on this relationship throughout the term of the loan. This is indicative of some of the new business, which I've alluded to and which is included in that $255 million pipeline. And this is partially attributable to some of our new lending staff and our new commercial leadership. The $255 million pipeline includes several additional loan relationships that will require participation. And it has not been adjusted for pull through percentages. However, it is counted as qualified new business opportunities, and it has been assigned varying percentages of closing probabilities. We actually have about $40 million of that pipeline currently in the underwriting and approval stages of our process today. We believe that this pipeline level is indicative of new opportunities and what we hope is the beginnings of a turn in the direction of our outstanding loans. While lower loan demand and loan portfolio attrition have adversely affected first quarter earnings, it has very positively affected our overall asset quality which remains quite strong today. Even in the face of a difficult economy and poor real estate conditions, we are reporting our best asset quality in years. Gary will cover this later in the call today, but allow me to say that I am very proud of our asset quality metrics, which I would call outstanding. And I am very pleased to be in this position at such a critical time in our economy and the credit cycle. Both our asset quality and our capital measures call attention to the strength of our company and the ability to affect future strategies for success as we move through this credit and economic cycle and as market conditions improve. In regard to interest rates and their impact on first quarter earnings, we experienced the proverbial 200 basis point immediate rate shock, and it did negatively impact net interest income as predicted in our modeling. The rate reductions and the lower prime rate came at us very rapidly, and the short-term effect has been felt. We were able to absorb a portion of this adjustment in the deposit portfolio. However, the combination of falling loan yields and our strong liquidity position during the quarter resulted in a $783,000 reduction in net interest income versus the fourth quarter of 2007, and a $655,000 reduction versus the comparable quarter in '07. I'd like to say a word about our -- and Dave will pick up on the financial results and some of the underlying details, but first, I'd like to say a word about our insurance activities. As you know, we acquired GreenPoint Insurance Group in September of last year. We are very pleased with the initial results for that new business. GreenPoint contributed revenues of $1.3 million for the first quarter and the company also contributed on a net basis with pretax income of $292,000 for the quarter and with cash pretax earnings of $348,000 for the quarter. So that is in line with our forecast for the business and we believe it is on track and growing. We continue to see opportunities to expand in this area of our business and we do expect to see the addition of new agencies over the balance of 2008. Our branch expansion program for 2007 is ramping up with the opening of our newest branch in Summersville, West Virginia, and that should occur early next month. This is the seventh new branch coming online out of our 2007 expansion program. The first of those branches were opened in April 2007 in the Winston-Salem market and those branches are averaging about $7 million in new business year-to-date. We believe that's indicative of prospects for success in those growing areas south and west of Winston-Salem. Our new retail strategy, which we have discussed in previous calls, is continuing to produce success. We continue to open new checking accounts at a rate of just over 1000 per month. That is about twice the rate of account openings prior to the implementation of this new retail strategy. Moreover, we are now opening value accounts or fee-based accounts at a rate of 60% of total new checking account openings, and that is up versus 30% this time last year. And with that, I would like to conclude and turn the mic over to Dave for the financial recap, but I would like to say in closing, while our bottom line results for the first quarter were off from customary levels for our company, our results continue to be among the best in the industry as measured by our peers, and these are strong results by most measures. Further, we believe that we've taken appropriate measures over recent quarters to ensure that we can continue to work from a position of strength, strength in capital and strength in credit quality. This places us in a good position going forward to take advantage of market opportunities as they arise and we are feeling much better today about those measures that we've taken over the last two years in underwriting and measured growth, which have provided that degree of stability and earnings and a solid balance sheet. At this time when strength and safety are critically important to investors and depositors, we are very proud to report these results. And with that, I will turn the call over to our CFO, Dave Brown, who will expand on the first quarter financial results. Dave?

[Dave Brown:]

Thank you, John, and good morning everyone. I want to get into a little bit of information about the first quarter, tell you about some current and planned positives that are in there and let me just get straight into the color of the quarter. We began the first quarter with a pretty positive outlook on the year. We knew there were some significant headwinds facing the entire industry but we remained optimistic. Then we were hit with prime dropping by 125 basis points in January and another 75 basis points in March. We weathered the surprise cut pretty well, and we were able to make some dramatic changes in deposit pricing to compensate. In response to the end of January cut, we again made some dramatic cuts but we were not able to have nearly the same impact as we did earlier in the month. In March, we again took action, but we were not able to match the decrease in rates point for point. All told, though, we were able to come in with a three basis point increase in margin over fourth quarter 2007. The continued decline in the loan portfolio was something we had not -- the continued decline in the loan portfolio was not something we had expected though. We had modeled very modest growth through the first quarter and accelerated throughout the year and average loans actually decreased over $33 million in the first quarter. When the rate cuts combined with the declines in the loan portfolio, you can see that interest income really took quite a beating. The bright spot in the average balance sheet came from [interest] deposit cost savings. We decreased rates on savings and money market accounts by 29 basis points and pushed CD yields down 14 basis points. We have been very aggressive and let CD rates down in all of our markets. The lower offered rates led to a decrease of $19.39 million in average balances, but loan payoffs far outpaced CD declines and we remained in a very liquid position. We were also very successful in lowering the yields on our retail repo portfolio. Those accounts are customer repos and business cash management accounts. The yield on our wholesale portfolio was reduced somewhat during the first quarter. Early in February, we prepaid a $25 million to FHLB advance that had a fixed rate of 5.47%. That prepayment resulted in a penalty of approximately $1.65 million. Credit quality remains historically strong and we made a $323,000 provision for loan losses, which brought the allowance to 109 basis points of loans at year end. Gary is going to have a little bit more detail about the credit activities here in just a minute. There were some positives in our non-interest income area as well. Deposit service charges were up compared to first quarter last year and in line with last quarter considering seasonality. Other service charges were up $130,000 from last quarter and $251,000 from a year ago. GreenPoint continues to be an excellent venture and commissioned revenues were $1.34 million for the quarter. Wealth management revenues were down compared to a year ago. Difference comes mostly from the trust side of the business as they basically just had a fantastic first quarter in 2007. IPC generated top line revenues of $436,000 for the first quarter and were $88,000 ahead of last year. Included in other non-interest income for the quarter are securities gains of about $1.82 million. The bulk of that gain came from the sale of one Fannie Mae security to pass its onetime call about one week before the surprise rate cut in January, and we were able to monetize the gain seen when the rate environment changed dramatically. Non-interest expenses grew significantly from last quarter, and I want to give you all some more detail about that increase. Salaries and benefits increased $1.06 million on a late quarter basis but actual wages only increased $90,000 and we ended with 619 FTE at the end of March. We had $127,000 in greater incentive compensation accruals and an additional $160,000 in payroll taxes as the tax based for those reset at the beginning of the year. We also saw an increase in healthcare costs of approximately $161,000, of which about $65,000 was due to bringing GreenPoint on board. We had an increase in retirement accruals over the last quarter of around $344,000, which is basically due to the accruing to match on 2007 incentives paid early in the first quarter. And fourth quarter is generally reduced by forfeitures that come about at the end of the plain year and we can use those forfeitures to offset current contributions and accruals. The lower than anticipated loan production resulted in deferring $165,000 less in salary costs than we did fourth quarter of 2007. Other operating expenses increased slightly over the fourth quarter. Within that increase there were some items heading in different directions. First we saw an increase of $161,000 in marketing and new account promotions. Most of that increase came from the new account promotions with the retail initiatives and direct-mail campaigns, as well as some promotion of the new branches. Our courier network expenses were up by $77,000, but that is a onetime blip as we converted to an outsourced courier environment. Travel costs were up by about $49,000, and OREO expenses were up by about $51,000. But we were able to decrease general service fees that we incur across the company by about a $117,000. In the first quarter of 2008, we repurchased 67,300 shares of treasury stock. The repurchase program was approximately 37 basis points accretive to first quarter earnings. The share repurchases slowed late February, and we are now figuring on completing the current program around June at current pace. With that, I would like to turn it over to Gary Mills, our Chief Credit Officer.

[Gary Mills:]

Thank you, David, and good morning. Asset quality continued to be very good during the first quarter. Total delinquency improved to 0.65% at quarter end as compared to 0.98% at year end 2007. The reduction in total delinquency was primarily influenced by 30 to 89 day delinquencies improving to 0.38% at the end of the quarter versus 0.74% at year end. It is also noteworthy that non-accrual loans remained relatively flat at $3,137,000 or 0.27% as compared to year-end non-accrual loans of $2,923,000 or 0.24%. The Bank had zero loans 90 plus days past due. Net charge-offs for the quarter were $293,000 or 10 basis points on an annualized basis as compared to 38,000 or one basis point in the first quarter of 2007. I would note that first quarter 2008 gross charge-offs were only $73,000 higher than the first quarter of 2007. However, the Bank had extremely good recovery experience in the first quarter of 2007, which resulted in very low net charge-offs. OREO at quarter end stood at $400,000 as compared to $545,000 at year end. This coupled with non-accrual loans resulted in total non-performing assets of $3,537,000 or 0.17% of total assets, which is comparable to year end postings of $3,468,000 or 0.16% and represents improvement over the first quarter '07 of $4,707,000 or 0.22%. The allowance for loan and lease losses stood at $12,862,000 at the end of the first quarter, which equated to 1.09% of total loans. The reserve at this level also provides a strong coverage ratio to non-performing loans of 410%. At year end the reserve measured $12,833,000 or 1.05% of total loans and provided a non-performing loan coverage ratio of 439%. Our provision for loan losses of $323,000 was made during the first quarter. I believe we are operating within a very difficult credit cycle, the likes of which we haven't experienced since the '80s. The impact of the declining housing sector, the continued fallout from the sub-prime debacle, the slowing of the economy to what many are labeling recession. And continued inflationary pressures driven by fuel are making this a very challenging lending environment. We continue to exercise discipline in the management of the Bank's loan portfolio, both during underwriting and origination as well as the ongoing monitoring of the portfolio. As a result of this diligence, there has been some downward impact on loan balances. As previously noted, the Bank's portfolio declined approximately $46 million during the quarter. Within this total, I think it is noteworthy that approximately $17.5 million were loans that the Bank had identified as at risk and successfully managed out of the Bank without loss. The Bank's retail mortgage portfolio continues to significantly outperform the national average as published by the Mortgage Bankers Association. Total delinquency within the FCB mortgage portfolio at quarter end was 0.91% as compared to the national average of 5.82%. The Bank's A&D portfolio continues to perform well at total delinquency at quarter end measured $122,000 or 0.26%. Thank you, and this concludes my prepared remarks, and I will turn it back over to you, John.

[John Mendez:]

Thank you, Gary and Dave for those comments. At this time that concludes our prepared remarks, but we would be happy to take questions from registered callers and turn it back to our conference operator to slip in some questions.

[Operator:]

(Operator Instructions). Our first question is coming from the line of Mark Muth with FTN. Please proceed with your question.

[Mark Muth - FTN Midwest Securities:]

Good morning, guys.

[John Mendez:]

Good morning, Mark.

[Dave Brown:]

Good morning.

[Gary Mills:]

Good morning.

[Mark Muth - FTN Midwest Securities:]

Dave, how much contingent income was in the insurance this quarter, do you know?

[Dave Brown:]

Mark, I think that about 10% of what we saw in this quarter's income was contingent. It is about $200,000, $250,000 for this quarter.

[Mark Muth - FTN Midwest Securities:]

Okay and then John, you talked about the pipeline earlier and gave a lot of detail there. I was just hoping you could give us a sense of any specific geographic areas where you're having more or less success and thinking about the upstate South Carolina where you recently opened an LPO. I know it is a relatively strong market. Just curious what kind of success you're having there so far.

[John Mendez:]

We are certainly seeing submissions from Greenville, South Carolina area. We have had success there and we have a pipeline, a smaller pipeline in South Carolina. But I think the bigger numbers and the greater number of deals continue to come out of Virginia. We are seeing larger opportunities there and more of those and I would say the biggest portion of the pipeline is coming out of Virginia.

[Mark Muth - FTN Midwest Securities:]

Okay. Thanks, guys.

[Operator:]

Our next question is from the line of Brian Klock with KBW.

[Brian Klock - Keefe, Bruyette & Woods:]

Hi, good morning guys. How are you doing?

[John Mendez:]

Good morning, Brian.

[Dave Brown:]

Good morning.

[Brian Klock - Keefe, Bruyette & Woods:]

Well I mean I guess you guys covered a lot of my details, questions already, but John and Dave maybe I guess on the securities portfolio, it continues to run down the available for sale securities portfolio was down about $65 million from the end of the year. What do you guys think going forward? Is there any opportunity for you all to add to the securities portfolio? Are you seeing opportunities there yet or are you going to continue to let that run down?

[Dave Brown:]

Yeah, I think Brain, a lot of the rundown that show on the portfolio came from the bond sales we did in January, as well as -- if I remember right in an unchanged rate environment we were expecting about $115 million to come off the portfolio in 2008. In terms of opportunities, they are out there everywhere, and we are constantly evaluating them. I don't know if this is the most opportune time to be putting on new securities, but we will always look, and we will always consider that.

[Brian Klock - Keefe, Bruyette & Woods:]

Okay, and I guess. I apologize, I have been bouncing around on another call; how much was the principal of the bond sales in the quarter?

[Dave Brown:]

We sold about $25 million or $26 million worth in principal.

[Brian Klock - Keefe, Bruyette & Woods:]

Okay. I know you went through the details of the variant linked quarter on personnel expenses. I guess, thinking about the $7.8 million here in the first quarter, is that a good run rate or are some of those items going to come out in the second quarter? Obviously the FICA, FUTA, the [OEM] compensated cost should come down. Wondering I guess, if you can give us the guidance around -- could we expect a little bit lower number going forward?

[David Brown:]

Yeah, I'd hate to give a whole lot of guidance about that, Brian; but I think historically, you see that those accruals tend to tail down through the year as we make -- as we get to highly [comp] limits through the year and limits are met in terms of contribution, not retirement contributions. The health care is just an unfortunate situation, I think, for everybody in the country and in turn, you just continue to see huge, huge increases across the board. We do our best to mitigate those and we have plans to look at our health insurance but I'm not sure I can tell you anything.

[John Mendez:]

And Dave, that's an area where we had been trending down. We're having some favorable experience and I think the first quarter was a bit of a surprise. And hopefully we will see better experience in following quarters. But again, that is something that is very difficult to project.

[David Brown:]

Yeah. We were actually able to -- over the course of the last two or three years, we've been able to keep our health insurance premiums on a per person basis for insured basis about level for 2.5 years now. And so now we're just back into the standard increases and I do want to correct what I told you earlier, Brian. We sold $28.5 million worth of principal in January.

[Brian Klock - Keefe, Bruyette & Woods:]

Okay, okay. I don't have my notes in front of me from the fourth quarter, but what was your FTE headcount at the end of the year? I know you said it was 619 at the end of the first --

[David Brown:]

It was 615.

[Brian Klock - Keefe, Bruyette & Woods:]

615, okay. Is that -- should we expect -- I know you talked about the new branch coming online next month, but their headcount is probably already in your first quarter number.

[David Brown:]

I'm sorry?

[Brian Klock - Keefe, Bruyette & Woods:]

The Summersville West Virginia branch that's coming online here next month, their headcount is probably already in your 619 FTE.

[David Brown:]

Yes, for the most part. I think we may have to hire a few tellers to staff up that one branch, but that's largely going to be -- we are moving -- we're transferring out to a better part of the city, out on the main highway corridor.

[Brian Klock - Keefe, Bruyette & Woods:]

Okay, okay. And just one last question, John, for you. I know you talked about the pipeline. Can you give us color about where most of that strength is coming from, which geography?

[John Mendez:]

Well, yeah. And following Mark's question along those lines, I did refer to the pipeline report. And looking by region, in Eastern Virginia, I'm seeing $67 million pipeline. I have, in North Carolina, which is a bit of an anomaly because we have some lenders there who are working in both North Carolina and Virginia, but out of that group we are seeing about a $115 million. And that is going to be really skewed. It's probably going to be split between North Carolina and Virginia. So between those two states it is certainly leading the way. In the Richmond to Charlottesville corridor, that's probably where some of the biggest investment is coming. We are also seeing some opportunities around Charlotte, North Mecklenburg, the Lake area; recent fundings as well as some loans that are in the pipeline today. So it is spread pretty well between North Carolina and Virginia but there is a pretty good concentration in that I-64 corridor, Richmond to Charlottesville. And Petersburg, we actually went a little bit south of Richmond, as well, to Petersburg area where you may know that there is a good bit of development starting up around the Fort Lee base expansion.

[Brian Klock - Keefe, Bruyette & Woods Inc.:]

Okay. Alright, great. And I guess I have no questions on credit. It is probably one of the strongest quarters I've seen in the region so far on credit. So good job on the asset quality, guys. Alright, thanks.

[John Mendez:]

Thanks.

[Operator:]

Our next question is from the line of Carter Bundy with Stifel Nicolaus. Please proceed with your question.

[Carter Bundy - Stifel Nicolaus & Co:]

Hello everyone.

[John Mendez:]

Morning, Carter.

[Carter Bundy - Stifel Nicolaus & Co:]

A couple of quick questions. Most of mine have been answered. John, could you remind me of those, the GreenPoint numbers? I was writing them down and didn't catch them all.

[John Mendez:]

Sure. The revenue line for the quarter, let me just go back, $1.3 million for the first quarter. And that did include a portion of the contingency revenues that come in -- early part of the year. There's some discussion here whether that is $130,000 or $250,000, but let's call it $200,000 in contingency revenues included in that $1.3 million. On a pretax basis, the pretax net was $292,000 for the quarter and their cash pretax earnings was $348,000.

[Carter Bundy - Stifel Nicolaus & Co:]

Okay. And then, another question, if you look at yours -- accumulated other comprehensive loss in the quarter, it was pretty substantial in your equity bucket. Is that temporary, or is that something that we might need to think about? I just -- Just give me a little color there. Maybe I'm missing something here, but that was a pretty big decline, about $16 million.

[David Brown:]

That is something in the quarter that we currently consider to be temporary.

[Carter Bundy - Stifel Nicolaus & Co:]

Okay. Thanks, guys.

[Operator:]

Gentlemen, there are no questions at this time; I would like to give everyone a final opportunity for everyone to ask a question. Gentlemen there are no questions at this time. I would like to turn the call back to management for any closing comments.

[John Mendez:]

Thank you. We would like to, again, thank everyone for joining us for the call this morning. Just to reiterate, we think it was a solid quarter. It was not a record quarter, it was a solid quarter. We managed to deal with the rate environment. We are very pleased with asset quality and where that is going. We continue to work on that hard and our focus now is to regenerate that loan production and again, we think that we have a pipeline in place to do that. Thank you for joining us, and we look forward to seeing you again next quarter.

[Operator:]

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.