First Community Bankshares, Inc.
Q2 2008 Earnings Call Transcript

Published: 22 Aug 2008

[Executives:]

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

[Analysts:]

Mark Muth - FTN Midwest Securities Corp. Brian Klock - Keefe Bruyette & Woods, Inc.

[Operator:]

Greetings, ladies and gentlemen, and welcome to the First Community Bancshares, Inc. Second Quarter 2008 Earnings Conference 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’s now my pleasure to introduce your host, Mr. Bob Schumacher, General Counsel for First Community Bancshares. Thank you, Mr. Schumacher, you may begin.

[Bob Schumacher:]

Good morning. Thank you for joining us this morning for First Community Bancshares’ second quarter earnings conference call. This is just a reminder that any statements made today that are not historical should be considered as forward-looking. Please review the language at the end of yesterday’s earnings release regarding more detail on forward-looking statements, as that same information applies to comments made in today’s call. With us today is President and Chief Executive Officer, John Mendez; Chief Financial Officer, Dave Brown, Chief Credit Officer, Gary Mills, and Chief Investment Officer, John Spracher. At this time, I would like to turn it over to John Mendez.

[John Mendez:]

Thank you, Bob. Good morning to everyone, and again welcome to the second quarter 2008 conference call for First Community Bancshares, Inc. We thank you for your interest in our company today and the research provided by those of you who are analysts, and we also welcome those of you who are owners, investors, and stockholders. We would like to take the time today to discuss our second-quarter earnings release and also touch on a few of the other activities of the company over the last several months. We’ll also provide our insights into overseeing the business climate and the economy in general. Joining me today as you heard, is Dave Brown, our Chief Financial Officer; Gary Mills, our Chief Credit Officer; and John Spracher, our Chief Investment Officer, who will also be available for the Q&A session. I’ll begin with comments on the company, recent strategies in the marketplace, and then I’ll be followed by Dave Brown, who will highlight the financial results. Gary Mills will then conclude with an overview of lending and credits, and then we will take questions from registered callers. I begin this morning with an overview of our results and operational highlights for the quarter and a brief discussion of key trends. As you have noted from our published earnings release yesterday evening, our net earnings for the second quarter were good on a comparative basis at $6.24 million or $0.56 per diluted share. Despite the decline from the same quarter of 2007, we were pleased with some of the metrics underlying those results. In particular, we saw a turn in the direction of the loan portfolio totals, with a slight increase between the first and the second quarter. This is attributed to our new commercial leadership, some of our new lending resources, and to some degree market dynamics, which we are currently seeing. And I’ll touch on that in a bit more detail a little bit later in the call. We’re also very glad to see what appears to be a change in the direction for interest margins. As an industry we have been seeing persistent margin compression over the last two years. You will note from our press release that margin actually improved between the second quarters of 2007 and 2008. This positive trend was accentuated in June as we actually saw our margin move back over the 4% level to about 4.09% for the month of June. This favorable trend in margin reflects recent lending activities, some of our cost control efforts, and the interest-bearing deposit and debt portfolios. Dave will address these, I believe, in more detail in his remarks. Our net decrease in net interest income between the comparable second quarters is linked to a decrease in asset and earning asset totals. And this is a function of our balance sheet management and our efforts on deposit control, wholesale funding cost, and also discipline in loan underwriting. The pricing efforts have been largely successful, as noted in our improved margin, and we believe that the foreshadowing of loan growth will lead us to a turn in both earning assets and net interest income. Lastly, we were pleased to announce our follow-on acquisition of REL Insurance agency in High Point, North Carolina. REL is a $750,000 revenue agency, which resides in the same market as our GreenPoint agency. This represents an excellent opportunity to achieve cost savings and other synergies for our agency line of business. Due to the location of the respective agencies, REL will immediately fold offices in with GreenPoint in High Point. Richard E. Lee, principal and owner of REL, will come on board; and he will assume, I believe, for a number of operational responsibilities within GreenPoint. This gives us greater depth as an agency and it frees some additional resources for further pursuit of growth opportunities. Shawn Cummings and Doc Davis will continue their joint responsibilities for agency operations, but they will also be able to devote added time to development of partners and pursuit of further acquisitions. With the addition of REL, GreenPoint increases its annual run rate for agency commission revenue to approximately $5 million annually. With this and other additions at GreenPoint, we feel that we are solidly on track to establish a strong platform for insurance agency revenues. Continuing for a moment on the non-interest revenue track, and you know we are working to diversify our sources of revenue and to reduce our dependency on spread revenues. And we are certainly making progress in this area with the additions in both the wealth and insurance lines. For the first half of 2008, our non-interest revenues, excluding security gains, represent about 31% of net revenues, and that’s up from 23% in the first half of 2007. Now, moving on to lending activities, last quarter I noted that loan demand had slowed and weakened in the preceding months with the decline in residential housing. I am glad to report this quarter that we are now seeing a stronger pipeline and we are quite busy in our commercial department. We did see a slight increase in outstandings for the quarter, and we do have a good pipeline of approved business that we are working toward closing. Much of what we are seeing is the result of recent changes in our commercial department and the strong networks brought by some of our new commercial lending resources. We are also seeing sort of a flood of opportunities, if you will, coming from regional banks who have significantly curtailed their real estate lending due to portfolio issues, and also from smaller banks, which are now faced with capital limitations. We have the benefit today of choosing those deals that, we believe, fit our needs and capabilities best, and those which demonstrate stronger underwriting. And it is our belief that this will lead to further increases in the loan book for the coming quarters. We have also seen an increase in consumer business with some recent campaigns that we have conducted for installment lending and our portfolio mortgage products. So, we are hopeful that that too will contribute to outstandings and future increases in the loan portfolio. Our asset quality remains strong as measured by delinquency, non-performing totals, and net charge-offs. We did make a more substantial provision for the second quarter, and Gary Mills will cover that in his remarks. We are pleased that we are not seeing systemic problems in real estate, mortgage, or the typical suspect areas. And again, Gary should be providing more discussion around those provisions and our overall portfolio performance. With that, I’m going to stop here and turn the call over to our CFO, Dave Brown, who will expand on our first quarter results. Dave?

[Dave Brown:]

Thank you, John, and good morning to everyone. I want to give you all some highlights on the quarter and dig into some of the items within non-interest expense, and then expand on the exposures we see in our investment portfolio. To start out with, I’m very happy with the up-tick in margin that we saw in the second quarter. This is largely the result of the great efforts by a lot of people in our company to lower the cost in our CD portfolio and pare out some of our most unprofitable relationships. We finally turned the corner in terms of loan portfolio, and originations are outpacing payoffs. We continue seeing an excellent pipeline and remain cautiously optimistic that we will see credit spreads on loan products align with those that we see in the capital markets. In the meantime, we are preparing for the liquidity needs that will come along with the loan funding pressures. We have moved some of our special rates up in our legacy markets and have seen customer demand. We do not see a need to compete with some of the irrationals in the urban markets and continue to focus on raising deposits in our legacy markets. Very late in the quarter, a $50 million Home Loan Bank advance paying 3.64% was called. We opted to roll that into overnight funds, which saved us approximately 140 basis points. We do expect to firm up that funding sometime in the current quarter. Despite a couple of sour credits, we still see great credit quality metrics, especially in comparison to peers. We did make a $937,000 provision for loan losses, which brought the allowance to 114 basis points of loans at June 30. Some of the highlights in the non-interest income line are deposit service charges, other service charges, and insurance revenues. GreenPoint closed the acquisition of REL in Greensboro early in July, and that acquisition will add about $750,000 in revenues annually and, more importantly, bring some strong administrative resources into our new adventure. REL is moving their operations to GreenPoint’s headquarters and should eliminate some significant overhead. I’d like to move on to the non-interest expense front. Salaries and benefits decreased $201,000 on a linked-quarter basis. Within that increase, actual wages increased to $109,000, and we ended up the quarter with 633 full-time equivalent employees of which 42 were at GreenPoint. We were able to trim some healthcare costs to the tune of about $110,000 compared to first quarter, and we deferred $73,000 more in FAS 91 cost than first quarter, an indicator of a pickup in loan production. With the downturn in the economy and the real estate market, we are feeling a drag on the new branches we put on, as well as the small business lending group. Small business deals are in general probably a little fewer than we expected at this point, but we are confident the overhead of the department will reap benefits as the economy turns. We do now have a solid platform to quickly and effectively underwrite deals under $500,000 in a centralized and controlled environment. Within the other expense line, we saw an increase from last quarter of $168,000. Within that increase, we attribute $88,000 to new account promotions; $76,000 to increased consulting fees; and $193,000 in legal fees. Most of that increase in legal fees came from the abandonment of a deal, an acquisition that would have transformed our company. Although the costs are difficult to stomach, I believe it’s a testament to our discipline in M&A. We walked away from what was otherwise a blockbuster deal and had to eat the costs instead of capitalizing them. Lastly, I want to provide you a little bit of insight into our investments book. As you know, over the last nine months our internal scrutiny and review of the corporate portfolio has increased exponentially. At June 30 we had $56.56 million in single issue trust preferred paper. These are all from the top banks in the nation, and although completely out of favor and not trading, we do not see any indication of impairment. We also have about $108.6 million in nine different pooled trust preferred issues. In all instances we are in single-A rated tranches. Within those, there have been a few collateral deferrals, defaults; but there remained significant credit support beneath this. As such, we have determined there is no other than temporary impairment. We certainly expect to see more volatile quarters, but don’t believe there is a significant risk of loss of principal or material change in the expected cash flows. Additionally, we have $32.7 million in two triple-A non-agency CMOs. Like the trust preferred CDOs, we continue to monitor these deals daily and don’t have any adverse opinion on these. After hitting some of the highlights and some of the non-interest expense and the investments portfolio, I would like to turn it over to our Chief Credit Officer, Gary Mills, who has a little bit more detail on the loan portfolio.

[Gary Mills:]

Thank you, David, and good morning to everyone. The total FCB loan portfolio at the end of the second quarter measured $1.181 billion, as compared to the first quarter posting of $1.179 billion, which represents an approximate $1.8 million increase for the quarter. The growth was generated by a $6.6 million increase in the commercial loan portfolio. As I believe we have mentioned in recent calls, commercial loan activity has been increasing. I attribute some of this increased activity to the retooling of the commercial line. Newly hired commercial staff has nicely complemented the existing staff, and we are beginning to see the benefits of their efforts. Additionally, it would appear that liquidity, concentration, and asset quality issues being experienced by many within the financial sector are presenting lending opportunities for First Community Bank. Total delinquency at quarter end measured 0.91% as compared to 0.65% at March 31, and 0.98% at year-end 2007. Within this category, 30 to 89 days past due totaled $6.7 million or 0.56%; and non-accrual loans totaled $4.1 million or 0.35%. Non-accrual loans increased approximately $1 million during the quarter. This increase was primarily driven by two commercial loans that were identified late in the quarter. Impairment analysis has been performed on both credits, and we have reserved for them accordingly. The Bank continues to diligently manage its OREO, which is reflected in the quarter-end balance of $500,000. Non-performing assets as a percentage of loans remains a very good 0.39%. Net charge-offs for the quarter were $367,000, which when annualized equates to 0.12% of average total loans. This is comparable to first quarter performance of 0.1% and compares favorably to the 0.18% posted in the second quarter of 2007. The allowance for loan losses measured $13.4 million at quarter end, which is 1.14% of total loans, as compared to 1.09% and 1.05% at March 31 and December 31, respectively. At this level, the allowance provides a coverage ratio to non-performing loans of approximately 326%. Primarily driven by the impairment analysis of the previously mentioned two non-accrual loans, a provision of $937,000 was made during the quarter. We believe the Bank’s asset quality metrics remain very good, especially so in this very difficult operating environment. I believe, as John mentioned, the Bank’s mortgage portfolio continues to perform well, as total delinquency measured 0.85% at June 30 versus the national average of 6.35% as published in the Mortgage Bankers Association National Delinquency Survey. Our underwriting and concentration management have thus far served us well, and we will continue to maintain discipline in this regard. With that, I would turn the call back over to John.

[John Mendez:]

Thank you, Gary and David, both of you for those remarks. At this point, that concludes our prepared remarks and I’d like to turn the call back to the conference operator, and we will move into a Q&A session.

[Operator:]

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. (Operator Instructions). Our first question comes from the line of Mark Muth with FTN Midwest Securities Corp. You may proceed with your question.

[Mark Muth - FTN Midwest Securities Corp.:]

Good morning, guys.

[John Mendez:]

Good morning.

[Dave Brown:]

Good morning, Mark.

[Mark Muth - FTN Midwest Securities Corp.:]

First, on the REL acquisition, I assume pricing was not disclosed. But could you tell us whether it was a cash or stock deal, or give us a sense of what kind of consideration was paid?

[John Mendez:]

You’re right. We did not disclose the terms on that. That was a closely held company. But it was a cash deal.

[Mark Muth - FTN Midwest Securities Corp.:]

Okay.

[John Mendez:]

The structure was similar to that that we’ve used in the past. Although, it was all cash, we do have substantial earn-out or hold-back provisions within there. So, it will be a structured cash deal.

[Mark Muth - FTN Midwest Securities Corp.:]

Okay. And then Dave, in your comments you talked about having to run some more aggressive CD specials in the legacy markets to boost deposit growth. With that in mind, how much of the CD portfolio can still re-price lower at this point?

[Dave Brown:]

Mark, I think that we have probably on the order of – I think about a third of the portfolio coming due over the next couple of quarters. Depending on the customers’ appetite for the new special rates, which are getting high – they are in the upper range of some of the specials that are out there. But if they go ahead and take that, they are going to lock in longer and not re-price down as much and as quickly as we’ve seen over the second quarter.

[John Mendez:]

Yes, those specials are largely longer-term CD offerings.

[Dave Brown:]

Right.

[Mark Muth - FTN Midwest Securities Corp.:]

Okay. And then finally, John, in light of the charge you had to take on the investment banking fees for the deal that I think you described as a blockbuster deal. Could you just talk about your deal appetite going forward, and what kind of things you are looking for at this point?

[John Mendez:]

Well, our strategic plan remains in place and we are still focused on growth in those markets in Eastern Virginia along I-64, and in North Carolina I-77 and I-40. We continue to look at opportunities there. We are seeing a fair number of opportunities today, but we are being extremely cautious because of the market. We would like to see some more definition around the real estate environment and particularly the portfolios for some of these potential partners. Our appetite remains good. We’ll just be moving very, very cautiously.

[Mark Muth - FTN Midwest Securities Corp.:]

Okay. Thanks, guys.

[John Mendez:]

Thank you.

[Operator:]

Our next question comes from the line of Brian Klock with Keefe Bruyette & Woods, Inc. You may proceed with your question.

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

Good morning, gentlemen.

[John Mendez:]

Good morning, Brian.

[Dave Brown:]

Good morning.

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

Yes, I guess it’s nice to go through this part of earnings season and be a bank with 12 basis points of charge-offs and 39 basis points of NPAs. You don’t see that many of them out there, guys, so good quarter on credit again.

[John Mendez:]

Thank you.

[Dave Brown:]

Thanks.

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

And I guess, probably this may be a call that no one asks any questions on credit, so I will talk about a little bit follow-upping on Mark’s question. John, you did mention that I guess an increased pace of deal inquiry, I mean I guess are you, given your asset quality, your credit underwriting, your capital levels, are regulators coming to you with deals? Or I guess maybe you can talk about where the flows of deals are coming from.

[John Mendez:]

Yes, what we are seeing today are an increased number of opportunities. It’s in my belief that with our capital position, our strength and asset quality, and what we believe has been strong earnings performance over the years. We are seen as an exit strategy today for a number of smaller institutions. That would include an array of banks in varied sizes and different profiles. So, we are getting opportunities. We are seeing those. There are banks who are struggling with capital issues, and there are those who have had a hitch in performance, so they are struggling with net interest margins and the pressures that they have seen there. But, I think the restriction on growth is probably one of the things which has weighed heavily on them, that along with the regulatory burdens. Yes, we are seeing those opportunities today. I think the regulators will be looking much harder at processes and policies, and credit infrastructures, compliance matters. And some of these banks may not have the infrastructure in place to adequately deal with that. So, that is yet another reason that I think some of these may be looking for exit strategies. We certainly are happy to look at those. We think it does create some opportunities.

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

Okay. I did miss a little bit of your question – Mark’s question you answered about where you’re looking. I think you said in North Carolina. Is that where you are looking for the next, I guess, deal to expand in? Is it in North Carolina or –?

[John Mendez:]

Well, the markets that we define as our expansion markets or growth markets, Eastern Virginia, and that would include a stretch of I-64, Charlottesville to Richmond, and then in North Carolina, the I-77 and I-40 corridors. We have sort of delineated that as the triad or the Piedmont triad region. So, those would be primary on our list. We also have a pretty good operation in East Tennessee, and we would certainly look at good opportunities that would help us flesh out or fill in that market and build our network. So, those are the primaries. There also – there could be fill-in opportunities that stretch along 64 in particular in the River Valley in Virginia. So, those are our primary markets that we are interested in.

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

Okay. And again, it sounds like you’ve got a turn in the corner on both loan origination volumes and the margin expansion was strong in the quarter, plus it looks like it’s continuing to expand, and where you’ve mentioned 4.09% for June NIM. So, I guess is the expectation that you’re seeing better pricing? And then should we read into the third quarter that, given where you were in June, that we should see some more margin expansion?

[John Mendez:]

We are seeing some improvement in pricing and loan submissions and opportunities there. It’s still not where we believe it needs to be, and we continue to work with our lending staff trying to set expectations there. The marketplace hasn’t come along as quickly as we think it should have in terms of recognizing new credit spreads. But we are seeing some movement there. We continue to do our part to try and bring that adjustment about. We are seeing some pickup.

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

Okay, great. And I guess –

[John Mendez:]

The improvement did come in large part, the margin improvement did come in large part from the CD portfolio re-pricing, adjusting some of those higher-cost customers out of the portfolio, and also the reduction in cost of our wholesale debt, short-term funding.

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

Okay. Dave, actually you’ve answered most of the questions already that I usually have in the fee income and expenses. But maybe just to talk about the single-issue TruPS, the full TruPS, and the non-agency CDOs, you gave the dollar balance for those. I guess, with the OCI mark you took then in the quarter, what are those being carried at as a percentage at par at June 30? So, what kind of haircut did you take on those, the $56 million, the $108 million, and the $33 million?

[Dave Brown:]

Brian, I’d have to get you the exact numbers, and we can do that on an 8-K release. But that is going to be on a weighted average across that whole portfolio in the mid to lower 70s range.

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

Okay, okay. So, it probably is fair to say most of the move in OCI in the quarter was on those three pools?

[Dave Brown:]

It was. Yes, exactly. Almost all of it came out the pooled trust preferred CDOs.

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

Okay, all right. Thanks, guys.

[Dave Brown:]

Thank you.

[Operator:]

There are no more questions in the queue. At this time, I will turn the floor back over to management for closing comments.

[John Mendez:]

This is John Mendez. And again, I would like to thank everyone for joining us today. We appreciate your interest, and we look forward to reporting to you in coming quarters. And with that, I hope everyone has a great day.