People's United Financial, Inc.
Q3 2007 Earnings Call Transcript

Published: 21 Oct 2007

[Operator:]

Good day ladies and gentlemen and welcome to the People’s United Bank Third Quarter Earnings Conference Call. My name is Carol and I’ll be your coordinator for today. [Operator Instructions]. As a reminder this conference is being recorded for replay purposes. I would now like to turn the call over to Mr. Philip Sherringham Chief Financial Officer of People’s United Bank. Please proceed Sir.

[Philip R. Sherringham:]

Thank you. Good afternoon everyone and welcome to People’s United Financial’s third quarter earnings conference call. I’m Philip Sherringham, the Bank’s Chief Financial Officer and I’m genuinely pleased to be here today to discuss our third quarter results. Before I begin, I’d ask you to please be sure to read the important disclosure statement at your convenience since as you all very well know by now we are going to make some forward-looking statements. Please refer to slides two and three for specifics on our disclosures. Now before we move to slide four. I’d like to start by addressing a topic of relevance to all of us here today, our stock price. As we all know banking sector stock returns overall have been poor of late, for a variety of reasons, most of which have no relevance what so ever to our business model. That doesn’t change the fact of course, that our stock lately, today hopefully is an exception has continued to be a disappointment. I can assure you, in this regard we share with you all your frustration and pain. As you will see however when I walk you through the numbers, I’m happy to report that the bank’s financial performance continues to rock solid. I also want to reassure you that we are committed to doing what can and needs to be done to support shareholder value. In this context, let me reiterate our management teams primary areas of focus. They are, our efforts on the stock buy back front. Our work on ensuring the seamless integration of the Chittenden acquisition, that we expect we’ll close early in 2008 and our sustained focus on driving the bank’s near and long-term financial performance. At some point we believe all this will again matter and consequently that our stock price will again fully reflect our solid financial performance, our impeccable asset quality, the strength of our balance sheet, the value of our franchise, and our earnings and growth prospects. With that said, let us move on to slide four. As I just mentioned earlier, we had a very strong third quarter with net income of $57.6 million or $0.20 a share. This is a 239% increase from $17 million in the third quarter of last year which of course includes an after tax loss of $15.7 million or $0.05 a share from the sale of securities. However, even taking that out of the picture net income would have been up 76%. Return on assets improved to 170 compared to 63 basis points in the third quarter 2006. Average earning assets increased $2.7 billion reflecting an increase in average short-term investments while average loans and average securities declined. Our net interest margin improved as I had indicated it would in our second quarter conference call 5 basis points from the second quarter 2007 and was up 39 basis points from the third quarter of last year. I will provide more detail on the margin a bit later. And on the asset quality front, non-performing assets increased an insignificant $3.3 million from September 30, 2006 levels and by the way, this number includes the $2 million single family residential mortgage which was subsequently cured. Net charge-offs to average loans totaled seven bases point down 11 bases points from the same quarter last year. Our efficiency ratio finally improved to 52.8% in the third quarter of 07 compared to 51.5% in the year ago period. As you can see on the slide five, we saw good steady growth again in our commercial banking portfolio which increased $306 million or 8% from the third quarter 2006. In contrast, and by design our international mortgage portfolio decreased $403 million or 11% reflecting our decision in the fourth quarter last year to sell all newly originated residential mortgage loans given their current profitability levels. Following a nationwide pattern, home equity loans decreased slightly to $1.25 billion. The $600 million or 90% reduction in our securities portfolio reflects our balance sheet restructuring activities completed during 2006 while the increase in short term investments is a direct result of the investment of the proceeds for a second step conversion. Slide six, illustrates changes in the mix of our earnings assets. Average securities and short-term investments increased to 29% of total earning assets compared to 8% a year ago. The increase in average short-term investments resulting from the deployment of proceeds from the second step conversion had the effect of decreasing the relative percentage of other asset categories. As a result, loans now represent only 71% of earning assets compared to 92% a year ago. Commercial banking loans still represent the largest component at 34% of earning assets as was the case last year. Slide seven provides more detail about our commercial banking business. Overall growth of 8% compared to the third quarter 2006 was driven by increases of $205 million or 29% in People’s Capital and Leasing, PCLC. that’s our equipment finance subsidiary; $144 million or 26% international credits and $31 million or 3% in CNI lending. This close was partially offset by $74 million or 5% reduction in commercial Real Estate, while we continue to see some portfolio run off. This is a reflection of our conservative underwriting philosophy and that, while we continue to feel, are overly aggressive underwriting practices, on the part of some competitors. The national credit business now stands at approximately 16% still slightly above therefore our self imposed capital of 15% of the overall commercial banking loan portfolio as a result of many borrowers recently drawing down there lines of credits, as we see liquidity conditions tightening in the market. Now, let's move to the liabilities side of the balance sheet on next slide. As you can see, core deposits, in aggregate are essentially flat year-over-year. Due to the raising of $3.3 billion in net proceeds from our second step conversion, and given our recent strategy of funding loan growth to the run off of our securities portfolio, we will not have a need, for significant growth in core deposits, for long time. The most recent deposit market share data from the FDIC shows that our statewide market share decreased by a mere three tenths of 1% in the 12 month period ending June 30, 2007. However given the funding strategy I just mentioned and the favorable 110 basis points differential in the costs of deposits that we have been able to maintain between us and all banks with assets between $10 billion and $25 billion I’d suggest this is in fact a very positive outcome. I am also pleased to point out that we remain the deposit market share leader in the 50 county Connecticut, one of the most attractive markets of the nation and by wide margin. Our market share in the county is 21% while that of our closest competitor is 14%. Slide nine compares our average funding mix between this year and last year's third quarter. During the third quarter this year, we, on average essentially are 100% funded on our core deposits and stockholders' equity. As you will note, the increase in stockholders equity from the proceeds of the second step conversion also affected the relative percentage mix. Slide 10 illustrates the components of the bank’s core deposits. Demand deposits were 24% of core deposits for the current quarter and unchanged from the third quarter of last year. Consumer DDAs increased 2% year-over-year while commercial DDAs decreased 6%. This is the reflection of the remarkable stability of our deposit base, and the fact that there is essentially no hot money in our deposit mix. Given the increase in rates our the past 2 year, time deposits have increased $223 million or 7% year-over-year and now represent 41% of core deposits, up from 38% a year ago. Most of the growth in time deposits is coming from our savings and money market accounts, which declined $302 million or 9%. However compared to second quarter 2007, time deposit decrease $ 37 million or 1%. Now let's take look at the income statement on side 11. Net interest income is up 40% and than, in this margin improved 39 basis point to 428 as compared to the year ago quarter. The improvement in the margin reflects the investments of $3.3 billion in net proceeds from second step conversion in short term investments as well as the benefits from the balance sheet restructuring activities completed during 2006. And margin also increased 5 basis points over second quarter 2007. The provision for loan losses for the third quarter reflects net loan charge offs, of only $1.05 million and a $1 million increase in the allowance for loan losses. Net loan charge offs totaled $4.1 million in last year’s third quarter which included a $4 million charge-off related to one commercial banking loan. Loan loss allowance now stands at $73.5 million. Non-interest income for the quarter increased $29.7 million or under 45% from third quarter 2006 levels. However, excluding security gains and losses from both quarters non-interest count would have increased only about $1 million or 2%. Now interest expense was $8.4 million higher than the third quarter of ’06, reflecting expenses tied to the re-branding of the bank and an increase in compensation and benefits expense, mostly due to the amortization expense related to a newly implemented employee stock ownership plan. I will provide more detail regarding non-interest income and expense shortly The box shot on slide 12 shows the trend in our margin. The 5 basis points improvements from the second quarter of ’07 reflect a full quarter's benefits from the investment of proceeds from our second step conversion. These 39 basis points improvement on our third quarter of ’06 reflects the combination of investments of net proceeds from the second step conversion, which added 31 basis points in addition to the sale of securities and related balance sheet restructuring completed in the second and the third quarters of ’06 and accounted for 20 basis points improvements. And these factors were partially offset by 12 basis points negative impact from the shift in mix of core deposits between this year’s and last year’s third quarter. All things being equal, we expect the margin to compress slightly in the fourth quarter following the Federal Reserve's most recent move. Slide 13 addresses non-interest income. As discussed earlier, excluding net security gains and losses from both quarters, non-interest income would have increased a $1 million or 2% compared to the third quarter of ’06. Fee-based revenues increased $0.5 million or 1% on a year-to-year basis, as increases in brokerage commissions, insurance revenue and other fee-based revenue were essentially offset by lower service charge on deposits. The 10% increase in brokerage commissions, reflects an increase in trading due to greater market volatility. Security gains, in the current quarter represented the sale of the bank’s entire holdings of MasterCard Class B Common Stock. Gains on residential mortgages were up $300,000 or 60% due to near doubling of mortgage sales compared to third quarter of last year. Indeed, as previously mentioned, we're currently selling essentially all of our newly originated mortgages whether fixed or adjustable owing to the spreads on such loans remaining unpalatable from our perspective at least, in today’s interest rate environment. This quarter also includes $2.3 million in income earned on bank-owned life insurance equivalent to $3.6 million on a fully taxable basis and up 5% from the year ago quarter primarily from improved investment performance. Slide 14 shows non-interest expense highlights. Non-interest expenses are up $8.4 million or 10% from the year ago quarter, and down $200,000 or less than 1% from last quarter. The $1.8 million increase in compensation and benefits from the year ago reflects $2 million on organization expense related to our newly established ESOP as well as high compensation expense reflecting normal net increases of approximately $1.5 million partially offset by lower pension expenses. The increases in advertising and promotion and other non-interest expense for the third quarter of ’06 are primarily costs surrounding the re-branding of the bank. In the fourth quarter of this year we anticipate we'll incur an additional $1 million in re-branding expenses. Slide 15 illustrates the trend in the efficiency ratio over the past two quarters. As a result the drop in non- interest expense the efficiency ratio decreased slightly from the second quarter of 2007 to a very respectable 52.8% Our asset quality, as seen on slight 16 continues to be very strong, non performing assets are up only $3.3 million from last year and 7.8 million from second quarter levels including the $ 2 million mortgage, single family mortgage I mentioned earlier. Net loan charge-offs stood at $1.5 million for the quarter compared to $4.1 million in the year-ago quarter and at $3.7 million in the second quarter of ‘07. Net charge-offs to average loans were only 7 basis points compared to 18 basis points in the third quarter of ‘06. Progression [ph] expense was down $1.6 million when compared to last year’s third quarter and at the risk of sounding like a broken record here let me restate once again, that we have no subprime or Alt-A exposure and that at present we see no cracks in the foundation in terms of our asset quality across all of our loan portfolios. This concludes my review of this quarter’s performance. And now I will be happy to answer any questions you may have. Question and Answer

[Operator:]

[Operator Instructions]. And your first question comes from the line of Mark Fitzgibbon. Please proceed.

[Mark Fitzgibbon:]

Good morning, fellows, or good afternoon, fellows. First question I had is on credit. First off, you had one large commercial real estate loan that looked like it went sour this quarter. Could you give us sort of the general issue there, what’s going on, do you see any other issues on the commercial real estate state books?

[Philip R. Sherringham:]

Good question. First of all, let me quantify this, when you say large, it’s relative. It's a $3.6 million loan, it’s a commercial real estate loan and it’s just, all we have is onesies and twosies. If take a look at this loan plus a $ 2 million mortgage, single family mortgage reacceptance [ph] secured, the accounts were essentially 70% to 80% increase in the non performing assets from second quarter to the third quarter. So it’s really, no it’s nothing to give anything, it’s just one loan .

[Mark Fitzgibbon:]

So the size of the provision this quarter, was that a function of this particular credit and we should expect a lower level, going forward?

[Philip R. Sherringham:]

No, as we said many times before, we have formal line [ph] that we follow when it comes to provisions or loan losses of adequacy, I should say, and depending on, give us a little flexibility, not very much but we made the decision this time to increase the provision $1 million, we didn’t have to.

[Mark Fitzgibbon:]

Okay. And then the other question I had on Chittenden, we are getting close to completion that year I guess early next year, and they have about $1 billion in securities and you guys have been truly vocal in saying you don’t like the business, the wholesale business right now. Are we likely to see Chittenden run that down in advance of the deal or post closing would you guys likely be selling/ restructuring that book?

[Philip R. Sherringham:]

Well, I suppose right now you should ask them what they plan to do. I can relate the reasons they have, securities portfolio they have is because their core deposits exceeds their loan portfolio. That to me by the way is the one temporary acceptable reason for having a securities portfolio. I will state, you've got core you don’t want to run them down, you want to invest in something you plan somehow and if you don’t want to lose on your credit standards the best thing you can do is by securities, and I'm definitely with them there, within reason of course and limits. When the time comes, and the transaction closes early in January, we'll reassess the situation on what we want to do, depending on them… the reassessment of all their businesses.

[Mark Fitzgibbon:]

Thank You.

[Philip R. Sherringham:]

Sure.

[Operator:]

And your next question comes from the line of Thomas McGowan with Lehman Brothers. Please proceed, sir.

[Thomas McGowan:]

Hey, Phil, how are things going?

[Philip R. Sherringham:]

Hey Tom, how are you?

[Thomas McGowan:]

Good. I just had a question on… I know you guys don’t really need to aggressively grow your deposits right now. But in terms of the overall deposit market I think we had kind of seen it rationalizing a bit. And then over this quarter you have mortgage lenders now offering these very high CD rates. Do you kind of see where things are going in terms of competition in that area?

[Philip R. Sherringham:]

Yes, your observation, of course, I would concur with. We have seen just that. Frankly those mortgage lenders are offering us very high rates on issues that we simply don’t have. We don’t feel particularly compelled at this point given our overall liquidity posture to follow suit. Generally speaking of course, we try to remain competitive and frankly, ideally we are looking for this magic efficient frontier terms of managing our cost of funds on the one hand and holding on to our market share, growing it if possible. And in my comments I alluded to the most recent FDIC data. Frankly from my perspective we are basically there. We have managed to hang on to our market share. In the year by the way we have seen an influx of a huge number of competitors, a number of new branches in accounts is astounding. I think it’s 31 new branches in that past 12 month period. We had Washington Mutual, HSBC, Commerce piling in. And in fact it would essentially, from our perspective, limited success. Meanwhile we are trying to hang on to our market share and keep a cost of funds dramatically lower than anybody else. To me that defines success.

[Thomas McGowan:]

Great thanks.

[Operator:]

And your next question comes from the line of Jared Shaw with KBW. Please proceed.

[Jared Shaw:]

Hi, good afternoon, Philip.

[Philip R. Sherringham:]

Hi, Jared, how are you?

[Jared Shaw:]

Good, thanks. Just if you could give a little more detail again and update on the home equity portfolio and if you are seeing an increase in the usage rates or if it’s just a actual declines in the number of loans and also if you can just give us an update on the combined loan to value and why it's worse?

[Philip R. Sherringham:]

Right, the home equity portfolio continues to do wonderfully well, thank you for asking. And the dollar decline is due again to the nationwide trends. People have been paying some of those loans out. The overall loan to value ratio on a combined basis remains at an astounding low 59% for the entire portfolio, and the usage remains very, very static I mean generally fluctuates between around 50% and so forth there, maybe dropping a little bit.

[Jared Shaw:]

Great, thank you, good quarter.

[Philip R. Sherringham:]

Thanks.

[Operator:]

And your next question comes from the line of Collyn Gilbert with Stifel Nicolaus, please proceed.

[Collyn Gilbert:]

Thanks, good afternoon Philip.

[Philip Sherringham:]

Hi, Collyn, how are you?

[Collyn Gilbert:]

I am good, thanks. Just when you has said that there are no cracks in credit quality, what goes into your assessment to make that statement?

[Philip Sherringham:]

Good question. Well I mean all banks we have a slew of reports and measures and credit quality is something we pay attention to, on a very close basis, you might imagine especially today. And this assessment or statement is based on the fact that we don’t see any migration, we don’t see any trends and delinquencies that could lead to non-performance later. Everything and where we look and as hard as we look… of course as I often have said in the past, every once in a while a loan goes bad, we're a bank and it happens. But we are talking about onesies and twosies at this point, and there is simply, whether it's on the mortgage side, domestic side, the commercial side, there is no indication of broad based deterioration in credit as far as we can tell. And that’s the basically on all the internal measures that we have which are very detailed, I can assure you.

[Collyn Gilbert:]

Okay, okay. And can you just talk a little bit about the SNC portfolio, it looks like the growth rates have been increasing in the last couple of quarters and just remind us again of the limits that you have there and just have the… what the credit quality looks like on that portfolio?

[Philip Sherringham:]

Sure. That portfolio, I'll answer about limit first is the cap internally, the self imposed cap has 15% of the total commercial banking portfolio outstanding. I just mentioned at the end of the third quarter, it was a little bit above that for the only reason that again quite naturally as you would expect, given what’s happened in the financial markets overall, liquidity crunch et cetera, many of those commercial borrowers have started rediscovering that a way to get that liquidity was actually to go down bank lines, surprise, surprise. So anyway, that’s what we are seeing, so it's 16%. The credit quality of this portfolio since inception really goes back about five, six, seven years now. It has been totally outstanding and frankly, as possible we can tell it remains this way so far. Now that’s not a guarantee of future performance necessarily. It could be said of a lot of portfolios, but certainly it’s helpful to note. This is the portfolio that performed better than any other we have so far.

[Collyn Gilbert:]

Okay, great. And then just if you could give us a quick update on how the Westchester branch is doing?

[Philip R. Sherringham:]

I would be happy to. The Westchester branch is doing extremely well. We have now opened a second one by the way, I can’t tell you about the second one, but the first one is way ahead of schedule in terms of deposit growth. I think after the first few months, four months or so, it’s up to $15 million in deposits.

[Collyn Gilbert:]

Five-zero?

[Philip R. Sherringham:]

No, one-five.

[Collyn Gilbert:]

Oh, one-five okay. Okay, great and then just finally, you guys got the approval on RP today, is that right?

[Philip R. Sherringham:]

Correct.

[Collyn Gilbert:]

Okay. When can you start buying back for that?

[Philip R. Sherringham:]

Tomorrow.

[Collyn Gilbert:]

Okay. And then any update on where the OTS stands?

[Philip R. Sherringham:]

No, we are still talking to them. As you know, we can’t realize whether they will give us the approval or not, we can't start buying stock until the close of the Chittenden transaction.

[Collyn Gilbert:]

Right, but they haven't given you any clarity as to where they may be going?

[Philip R. Sherringham:]

No, I mean, at this point, I think it is fair to say no. We suspect, this is pure speculation on my part and unqualified as such, I would suspect that they are unlikely to give us an approval, so we can't do anything with it. So my sense is they'll probably wait until we actually close the Chittenden deal and then thereafter address the issue. If we addressed it earlier, it wouldn’t be helpful.

[Collyn Gilbert:]

Okay, all right, thank you very much.

[Operator:]

And your next question comes from line of Matthew Kelley with Sterne Agee. Please proceed, sir.

[Matthew Kelley:]

Hi, guys. Just a question on the margin going forward, the pro forma, now that Chittenden's margin came in pretty strong as well this quarter. You had mentioned that yours might be down a little bit in the fourth quarter, I mean pro form, put these two companies together not going to much in the way of wholesale funding, which in terms of franchise value will be pretty positive, but in terms of the margin trajectory, with additional Fed re-cuts potential, what was the magnitude of the potential combined margins compression in a way.

[Philip R. Sherringham:]

That’s obviously, we cannot tell you exactly in terms of what the Fed is going to do or what period of time, if we can, please go ahead, I am sure, I will be interested. But absent that, I mean clearly, given the fact that all the proceeds of the second step are currently invested in short term securities, essentially Fed funds or equivalent, on paper they fairly asset sensitive. Now remember, some of that cash doesn't go away quickly here in terms of, in combination of the Chittenden acquisition closing, and then buybacks. So we see that going down. But my sense is… and you're right, Chittenden's margin came in pretty strong. When you combine the two, I'd say, on the safe side, depending entirely on what the Fed does, it could compress by, I don’t know up to 3% to 5 % maybe.

[Matthew Kelley:]

Okay. And then just to follow up on Collyn's question with the national credits. What is the unused lines of credit there? What’s the drawdown rate on that $ 700 million portfolio, what is the capacity left for those borrowers?

[Philip R. Sherringham:]

I am sorry, I may have to get back to you on that, that’s a number I don’t have handy.

[Matthew Kelley:]

Okay, all right, thank you very much.

[Operator:]

[Operator Instructions]. Your next question comes from James Abbott with FBR Capital Markets. Please proceed.

[James Abbott:]

Thanks for taking the question here , it’s also great to see the expenses perform this quarter. Could you give us this sense going forward on that number, do you, other than the $1 million, you said that there would be $1 million additional expenses in the fourth quarter. Does that $1 million of re-branding go away starting in 2008?

[Philip R. Sherringham:]

Yes, the re branding will cost us some more $ 4 million this year. That will go away in 2008. We are not ready frankly, to give much indication on 2008. We are not there yet. And so I don’t want to comment too much on the expenses in '08. The one thing I will mention is, as someone observed, we got an approval today for the RP plan and the stock option plan. That has an expense implications obviously, which I'd ask you to think about, and it's probably going to start impacting fourth quarter of '07.

[James Abbott:]

Okay, we will model that in. But you don’t see any issues coming up in the fourth quarter such as incentive accrual catch ups or reversals of incentive accruals, or anything like that. I don’t know exactly how the incentive accrual plan is planned.

[Philip R. Sherringham:]

Nothing major there. I can’t comment with any high degree of certainty on incentive accruals but it’s not going to move the needle, I don’t think either way.

[James Abbott:]

Okay, so the third quarter is good run rate, you think into the fourth quarter?

[Philip R. Sherringham:]

I cautioned you about the additional re-branding expense, unusual expense tied to the RP and stock option plans.

[James Abbott:]

But the re-branding, the $1 million was already there in the third quarter. So it just continues or is that in addition to the third quarter level, there will be an addition $1 million?

[Philip R. Sherringham:]

Yes, there will be additional. And as we have discussed in prior calls, we are working very diligently on this technology infrastructure update. If you look at the release, you will see that the $1.6 million I think in the quarter tied to technology project, that’s going to continue and it’s going to increase particularly in '08. Again I don’t want to… I'm giving you a directional statement here, nothing in dollars yet. But that will come later.

[James Abbott:]

Okay, thank you. And then the follow-up question I had is on non-interest bearing deposit balances. Was that some end of quarter volatility? I know that they were down on a linked quarter basis.

[Philip R. Sherringham:]

Yes, I never really… I think if you look at average balances, they are not really down very much, and that’s really what's important. End of quarter, anything could happen to impact those, I don’t think very meaningful.

[James Abbott:]

Okay, you didn’t see then, it wasn’t a widespread exodus in that sense, it was just sort of more of the…

[Philip R. Sherringham:]

Not at all, not at all.

[James Abbott:]

Okay. All right, thank you very much.

[Philip R. Sherringham:]

Sure.

[Operator:]

And your next question comes on line Michael Collin with Sunova Capital. Please proceed.

[Unidentified Analyst:]

Hi, good quarter. Quick question, I didn’t get the clarity on the net interest margin, I have [inaudible] some guidance, but sort of impact from the Fed, did you say 3% to 5% meaning--?

[Philip R. Sherringham:]

The margin was 428, absent Chittenden, by the way. This is strictly I talking about… People United Bank, remember that the Chittenden deal's only going to close in early '08. So for the fourth quarter this year at this point in time, I would say margins likely to compress between 3% and 5%; if you take for 428, 3% to 5% of that.

[Unidentified Analyst:]

Okay, and that’s including Chittenden. I guess, you haven't made full decisions about you might want to reposition their balance sheet?

[Philip R. Sherringham:]

No, I want to be a little cautious here at this point.

[Unidentified Analyst:]

Great, thank you.

[Operator:]

And there are no additional questions at this time. I would now like to turn the call back over to Mr. Sherringham for closing remarks.

[Philip R. Sherringham:]

Excellent. Well, hope you enjoyed the quarter, we certainly did. And, looking forward to many more like this, and better. And see you all, I guess, I'll talk to you all next year, if not before. Thank you very much.

[Operator:]

Thank you for joining in today's conference, you may now disconnect, and have a wonderful day.