People's United Financial, Inc.
Q1 2015 Earnings Call Transcript

Published: 16 Apr 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to the People's United Financial Inc., First Quarter 2015 Earnings Conference Call. My name is Kate and I will be your coordinator for today. At this time all participants are in listen-only mode. Following the prepared remarks there will be a question-and-answer session. [Operator instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to Mr. Andrew Hersom, Senior Vice President of Investor Relations for People's United Financial Inc. Please proceed, sir.

[Andrew Hersom:]

Thank you. Good morning and thank you for joining us today. Jack Barnes, President and Chief Executive Officer; David Rosato, Chief Financial Officer; Jeff Hoyt, our Controller as well as other members of management are here with me to review the first quarter of 2015 results. Please remember to refer to our forward-looking statements on Slide 1 of this presentation, which is posted on our Web site, peoples.com, under Investor Relations. With that, I'll turn the call over to Jack.

[Jack Barnes:]

Thank you, Andrew. Good morning. We appreciate everybody joining us today. Our performance this quarter is an encouraging start to the year especially given the persistent low interest rate environment as well as the severe winter weather across our markets. Results once again benefited from the investments we have made and continue to make in talent, products and services within our large and attractive markets. During the quarter, I spend a great deal of time visiting customers across our franchise and came away impressed with the opportunities we have to further deepen these relationships through cross-selling efforts. Our breadth of products and services superior customer service and local knowledge uniquely position us to not only meet the expanding needs of current customers, but also forge new relationships. These visits reaffirm for me the value we provide to customers and the significant opportunities we have before us. Turning to the overview of the quarter on Slide 2, operating earnings increased 12% from a year ago to $63 million making the highest level of operating earnings we have had in the first quarter of any year. Revenues increased 1% from the fourth quarter as non-interest income was higher and net interest income was flat. As a reminder, net interest income along with net interest margin were unfavorably impacted by two fewer calendar days in the first quarter. In comparison to the prior year quarter revenues increased 3% driven by improvements in both net interest income and non-interest income. As expected, operating expenses were modestly higher as compared to the fourth quarter due to traditionally higher first quarter payroll-related and winter-related operational costs. However, we were pleased operating expense levels remained flat compared to the prior-year quarter especially considering the continued impact of strategic investments and increasing regulatory compliance costs. The efficiency ratio increased slightly to 61.9% in the first quarter from 61.3% last quarter reflecting higher revenues and a seasonal up tick in operating expenses. However, the ratio improved from 63.9% in the prior year quarter. While the first quarter is typically a seasonally slower period, we achieved solid annualized loan growth of 5%. This marks the 18th consecutive quarter of loan growth. We are pleased with the success of our deposit gathering initiatives as evidenced by organic deposit growth of $1 billion in the quarter, which represents more than 17% growth on an annualized basis. As we further develop our franchise wide cross-sell and deposit gathering efforts, the deposit base will continue to see growth. Asset quality was once again exceptional as net charge offs and non-performing assets improved from already low levels. With that I will pass it to David to discuss the quarter in more detail.

[David Rosato:]

Thank you, Jack. On Slide 3, we provide detail behind the linked quarter change in net interest income. Higher average balances and strong originated loan growth increased net interest income by $3.4 million and $2.8 million respectively. The largest offset to these increases was a $3.3 million reduction in net interest income due to two fewer calendar days in the first quarter. Additionally, a decline in accretion from runoff in the acquired loan portfolio and increased deposit volume lowered net interest margin by $1.7 million and $1.1 million respectively. As mentioned on previous calls, growth in net interest income from the originated portfolio outpacing lost accretion on the acquired portfolio is a positive sign looking to the quarters ahead. On Slide 4, net interest margin for the first quarter was 2.91%, a decline of 9 basis points from the fourth quarter. As we mentioned on our last earnings call, fewer calendar days impacted the margin by 5 basis points in the first quarter. Additionally, new loan volume negatively impacted the margin by 2 basis points as new business yields remained lower than the total loan portfolio yield. We continue to expect the full-year 2015 margin to be within the range of $2.85 to $2.95 as outlined in January. Slide 5 provides a breakdown of the increase in loans. The loan portfolio grew $337 million or 5% annualized. Originated loan growth for the quarter totaled $430 million. As in previous quarters, growth was well-balanced from a product and geographic perspective. C&I contributed $240 million of the total originated loan growth while commercial real estate contributed $118 million. Within C&I, we experienced particular strength in our mortgage warehouse lending business. The commercial portfolio remains broadly diversified with respect to loan type, geography and industry. Residential mortgages contributed $129 million of originated loan growth in the first quarter. Approximately 90% of the residential mortgage originations held for investment were high-grade adjustable-rate mortgages. In addition, the residential mortgage pipeline is strong and ended the quarter at the highest level in two years. We experienced acquired loan runoff of $93 million this quarter compared to $129 million in the fourth quarter and $114 million in the prior year quarter. The balance of the acquired portfolio at quarter end was $958 million. Slide 6 shows the growth in deposits by segment from the fourth quarter. Deposits increased over $1 billion or 15.5% on an annualized basis as commercial and retail deposits grew $635 million and $377 million respectively. Brokered deposits ended the quarter at $2.6 billion unchanged from the end of the fourth quarter. As such, the deposit growth in the first quarter was organically driven. We experienced strong growth across all geographies and all business lines. Just as a reminder, the first and fourth quarters are typically our strongest quarters for deposits. It is worth noting that our loan to deposit ratio was 99% at March 31 and our cost of deposits came down 1 basis point in the quarter. Overall, we are very pleased with the progress we are making gathering deposits. We firmly believe that deposits are an integral part of customer relationships and we continue to focus on organic deposit growth. On Slide 7 we take a closer look at non-interest income. Non-interest income grew 3% from the fourth quarter and was primarily driven by strong commercial banking lending fees, higher customer interest rate swap income as well as gains on the sale of loans, which was primarily driven by the sale of one loan from the acquired portfolio. The increase in non-interest income was partially offset by the absence of security gains and lower bank service charges. As you will recall in the fourth quarter, the net security gain resulted from the call of a single acquired security. On Slide 8, we illustrate the key components of changes in non-interest expense during the quarter. Non-operating expenses increased over $5 million, which is mainly attributable to branch closure costs. We closed eight branches during the first quarter as we continue to optimize our branch delivery channel. Since the beginning of 2011, we have closed 44 branches which were mostly traditional branches. During the same period, we opened 24 branches many of which are more cost efficient in-store branches. We expect to close approximately 10 more branches during the remainder of the year as well as to look for opportunities to reduce real estate costs further by consolidating other facilities. We are committed to branches as they provide valuable support to revenue generating activities across all of our business lines. From an operating perspective, expenses increased $4.5 million from the fourth quarter. Compensation and benefits increased $6.6 million primarily due to traditionally higher first quarter payroll related and benefit costs while occupancy and equipment costs increased $2.4 million of which approximately half was due to higher snow removal costs. As we have mentioned before, we continue to tightly control expenses while investing in revenue producing initiatives and covering the higher cost of regulatory compliance. The next Slide details our efficiency ratio of the last five quarters. While the ratio ticked up slightly in the first quarter, the results are still generally consistent with recent quarters and improved from the first quarter of 2014. An important area of focus for the organization is to continue to improve operating leverage through revenue growth and effective expense management. Slides 10 and 11 are a reminder of our excellent credit quality. Once again, we did see an improvement in non-performing assets this quarter. Originated nonperforming assets as a percentage of originated loans and REO at 80 basis points remains below our peer group and top 50 banks and has improved from 100 basis points in the first quarter of 2014. Looking at Slide 11, net charge offs remained low at 11 basis points and improved from 13 basis points last quarter and 12 basis points one year ago. These levels reflect the minimal loss content in our non-performing assets. Slide 12 highlights our ability to grow both sides of the balance sheet. We continue to make progress on loan and deposit growth on a per-share basis while maintaining excellent asset quality. Over the past year, loans per share and deposits per share have grown at compound annual rates of 9% and 14% respectively. As shown on slide 13, operating return on average assets decreased 4 basis points from last quarter but improved 2 basis points from the first quarter of 2014. Our return on average assets continues to be impacted by the persistently low interest rate environment and the effective initiatives that have not yet attained expected levels of operating leverage. Progress will be driven by continued loan and deposit growth, fee income growth and an ongoing disciplined approach to expenses. Slide 14 illustrates our return on average tangible equity. As profitability improves, we expect to see continued progress on this metric over time as we have seen in recent quarters. Turning to Slide 15, we are comfortable with our capital structure and balance sheet strength. Capital levels at the holding company and the bank remain strong especially in light of our low risk business model. Effective this quarter, our capital ratios are calculated in accordance with Basel III capital rules. Additionally, our leverage ratio benefited due to our charter change as the denominator changed from period end total assets to quarterly average assets. Slide 16 illustrates our interest rate risk profile for both parallel rate changes and yield curve twists. As you can see, we are a bit more asset sensitive as compared to last quarter primarily due to our loan mix trending towards floating rate loans as well as the strong deposit growth that we achieved in the quarter. Now I'd like to pass it back to Jack to wrap up.

[Jack Barnes:]

Thank you, David. During the quarter we received our National Banking Association Charter. We believe this Charter is best aligned to our Commercial Banking model. Additionally, we are pleased to announce the Board voted to raise the dividend to an annual rate of $0.67 per share. This marks the 22nd consecutive year the dividend has been increased, which reflects our continued commitment to delivering value to our shareholders through the consistent return of capital. While the first quarter was an encouraging start to the year, the focus will remain on our most important objective, which is improving profitability. We feel terrific about the progress made in recent years in growing the company and look to build upon this momentum to enhance returns while continuing to successfully position the franchise for the long-term. This concludes our presentation. Now we would be happy to answer any questions you may have. Operator, we are ready for questions.

[Operator:]

Thank you. Ladies and gentlemen, we are ready to open lines up for your questions. [Operator Instructions] And the first question in the queue comes from Ken Zerbe from Morgan Stanley.

[Ken Zerbe:]

Great. Good morning.

[Jack Barnes:]

Good morning, Ken.

[Ken Zerbe:]

Couple of questions for you. So first one in terms of the deposit growth, obviously very strong this quarter. You did mention the first and fourth quarters were typically the strongest. When you look at the deposit growth that came in this quarter, is there any let's call it large potential outflows that you would expect going into second quarter?

[David Rosato:]

No. We actually had – we are really pleased that the growth was really across the footprint in terms of geographies and business lines, really nice growth in both commercial and retail and certainly no type of concentrations or anything that we would expect to be volatile in terms of in and out.

[Ken Zerbe:]

So next quarter we actually could see deposit balances actually be up maybe not as much but up from this level?

[David Rosato:]

Well, we would certainly like to see that. We do have, as we pointed out, first and fourth quarters historically for the company had been stronger so that typically has revolved around things like tax payments in the second quarter and the like. So that's the goal.

[Jack Barnes:]

Yes, the seasonal pattern, Ken, that you saw last year or the year before exclusive of the broker deposits is what we would expect.

[Ken Zerbe:]

Okay, understood. And then just second question on C&I, you mentioned that the strong growth was driven by the mortgage warehouse. Are you expecting C&I balances to actually stay at this level, or warehouse I guess moderates a little bit. Could we actually see C&I – negative C&I growth next quarter?

[Jack Barnes:]

We don't expect negative C&I growth next quarter. Mortgage warehouse was up and a lot of activity at the end of the year. It has moderated a little bit through the month here but it is holding up pretty nicely. So I think there is just a lot more volume right now in the business given what's gone on in the market and we have also been very successful in supporting a large number of our customers with increases in lines and an opportunity to grow those relationships. So the combination of what is going on in the business and kind of growing the business, if you will, has benefited us.

[Ken Zerbe:]

And have those warehouse balances actually stayed fairly healthy going into this quarter?

[Jack Barnes:]

Yes, they have.

[Ken Zerbe:]

Perfect. Okay, thank you.

[Operator:]

Thanks for your question. The next question comes from David Hochstim, Buckingham Research. Please go ahead.

[David Hochstim:]

Yes. Hi. Good morning. I wonder could you give us an update on your merchant services joint venture. Is that contributing much to revenues or reducing expenses at this point?

[Jack Barnes:]

I apologize. It is a little hard to hear you. You wanted to know about merchant service joint venture?

[David Hochstim:]

Yes, correct. I wonder if it is making a contribution to revenues yet or reducing expenses in any way.

[Jack Barnes:]

Kind of the combination of both. As we transitioned into the joint venture we did consolidate the back rooms so we moved through that phase early on in the announcement. And on the revenue side we are basically on plan, but very encouraged about the way things are going. We are finding, I think I mentioned this in prior calls and it is continuing, that our customer base is responding very well to the improvement in the technology platform and just the scale and expertise in the business that Vantiv is bringing to the dialogue. So we are winning business. We are finding that the capabilities allow us to move many of our larger commercial customers into the merchant service business. So very nice steady progress so far.

[David Hochstim:]

Okay, thanks. And on the Commercial Banking lending fees, is this a new sustainable rate or was there something unusual in this quarter that caused that to spike up?

[Jack Barnes:]

There was a small increase in prepayment – commercial prepayment activity in commercial real estate. So we would expect that to moderates as the year unfolds. We are encouraged with the interest rate for the customer, interest rate swap income. That is running higher than our expectations. Again, we would expect it to moderate a bit, but we are encouraged that from the fact that we seem to be gaining deeper penetration across our customer base in that product.

[David Hochstim:]

Okay, thanks. And then just finally –

[Jack Barnes:]

I would like to point out because we talked about initiatives of all sizes and the investments we are making strategically. We two years ago, had one person would bring the expertise around swaps into the customers with the relationship managers. We now have three. And much more focused sales and support effort on that and I certainly believe that some of the increase in our revenues is related to bringing better capabilities to the customer.

[David Hochstim:]

Okay, thanks. And then on the charter change, are there other benefits besides the calculation of the capital ratios sort of simpler or less costly oversight compliance expenses, perhaps?

[David Rosato:]

No, not from the Charter change. Regardless of regulators, the calculations are complex and that's enough said about it. But the change in the denominator that I referenced in the script, so that is a one-time change and that is the only change that's from a capital ratio perspective that is specific to the charter change.

[David Hochstim:]

Okay, thank you.

[Jack Barnes:]

Just for clarity again, we have been regulated by the OCC and the Fed since the OTS was dissolved and we went through that change and regulatory framework. So we have been under the same regulatory oversight since that time, which has now got to be four years and if my memory is right. So you won't see any change as David indicated.

[David Rosato:]

And I would just follow that up with, so this is the first quarter that we were not subject to the QTL, or the commercial asset test. So if you look through the financials you will see less leveraging at 12/31. There was some leveraging of Fed funds purchased offsetting some short-term investments and we were able to take that off the balance sheet. That's in neighborhood of about $500 million. But again, that is now – that is a one-time change.

[David Hochstim:]

So that is done. So you won't be doing that.

[David Rosato:]

Yes.

[David Hochstim:]

Okay. Thank you.

[Operator:]

Thanks for your question. And the next question comes from Casey Haire from Jeffries. Please go ahead.

[Casey Haire:]

Hey, good morning. How are you doing?

[Jack Barnes:]

Good morning, Casey.

[David Rosato:]

Good morning, Casey.

[Casey Haire:]

So just wanted to follow-up on the deposit growth, which obviously pretty good this quarter without the help of brokered deposits. Was wondering, it sounds like it was just green and organic, but did want to check to see if there was any deposit promotions involved, or whether you guys are now incentivizing the workforce to deposit gather?

[Jack Barnes:]

I think the biggest piece of it is our continued focus on deposit gathering and cross-selling and we have, as we've said in the past, changed and strengthened the incentives around deposit gathering across the company. So that has been in place. Was no unusual move this quarter or even last, so those things are taking hold, I would say. And I think that is a big part of the progress we have made. We do have and have had a campaign around CDs across the markets and we have gathered a modest amount of CDs from that campaign I would say kind of in expectations and not a big part of the increase. And we have also – we always have some type of sales campaign and focus. Right now we are promoting opening of checking accounts and offering customers $100 for that and we have a e-checking campaign that is going out to appeal to folks that are more technology oriented to use a low-cost checking account. So we are always working at that and on both ends I guess, incentives and campaigns, but I think it is more a result of progress that results from that over time.

[Casey Haire:]

Okay, understood. And just following up on that, the branch closures I think you said there was 11 this quarter and there's more on the way. That what I would think would kind of hurt your organic deposit growth. What is the sense there in terms of – are you able to overcome that, the loss of – like what are deposit attrition assumptions around the branch closures?

[Jack Barnes:]

Yes. They are actually – so I think in the script, we had the number of branches over the last four years and we have been working at closing branches within close proximity to other branches for a while now and we have been watching attrition and we watch the traffic pattern of customers. So if you originated your deposit at branch A, but you actually do business and branch A, B and C and what percentage of the deposit base is going where and so we plan out the transitions and communicate with customers very well. And we have experienced very little fallout so far. As we go on through the continued effort to optimize the branches, the question will become at what distances branch to branch does that strain the retention of that customer? So far we are doing very, very well and our assumptions is that and our experience has been that we are retaining in the 80% to 90% range on those deposits.

[Casey Haire:]

Okay, great. And just this last one, you mentioned the snow removal costs. What was that number again as well as the amount of the prepay penalty in commercial fees?

[Jack Barnes:]

Just on the snow removal, we spent a little time on this in the quarter. Interestingly, we spent about the same amount on the snow removal this year, 2015, as we did in the first quarter of 2014 and welcome to the Northeast, I guess. But the reason we mentioned it is because if you compare to the fourth quarter, it is up. But if you compared it to prior winter, it is actually pretty similar despite Boston being as crazy as it was.

[David Rosato:]

So Casey, that occupancy and equipment was up $2.4 million in the quarter and just a little over half of that was snow removal.

[Casey Haire:]

Okay, great.

[David Rosato:]

The prepayment, the commercial prepayment fees that I referenced are in the Commercial Banking lending fee line.

[Casey Haire:]

Right. And what was that amount?

[David Rosato:]

That number was just a little over $2 million.

[Casey Haire:]

Okay, thank you.

[Operator:]

Thanks for your question. [Operator Instructions] And your next question comes from the line of Collyn Gilbert, KBW. Please proceed.

[Collyn Gilbert:]

Thanks. Good morning, gentlemen.

[Jack Barnes:]

Good morning, Collyn.

[Collyn Gilbert:]

Not to beat a dead horse on the deposit issue, but I'm sorry if I missed it. Did to say, Dave, what the brokered deposits were this quarter?

[David Rosato:]

They actually fell $4 million, so there was no brokered deposit growth.

[Collyn Gilbert:]

Okay. And what is the outstanding balance of those now?

[David Rosato:]

It is just about slightly over $2.5 billion.

[Collyn Gilbert:]

Okay.

[David Rosato:]

It's the volume that we did last year.

[Collyn Gilbert:]

Got it. Okay, great. Thank you. And then just as you guys were talking about, just kind of circling back on the continued branch closures and the way you guys are looking at the overall network, are you able to sort of give us some financial impact as to what some of these initiatives will be as we look out?

[David Rosato:]

We have not done that yet and it ties into the statements that we make about continued ongoing expense management and then this quarter we also mentioned that we are looking at some other real estate expenses for opportunities to consolidate.

[Collyn Gilbert:]

Okay. Outside of branches? Or you are talking about branch consolidation?

[David Rosato:]

No, that's a reference to outside of branches.

[Collyn Gilbert:]

Okay. And then just, Dave, on your NIM outlook, I know it is unchanged from what guys laid out back in January. But I think that outlook assumed a Fed funds increase mid year, if I am not correct. Can you just kind of update us on your thought on the NIM if we don't – sorry, go ahead.

[David Rosato:]

Sure. And actually it did not, Collyn.

[Collyn Gilbert:]

Okay.

[David Rosato:]

When we built our budget, we made the assumption that in 2015 there would only be one Fed tightening of 25 basis points and we made the assumption that that would occur in the middle of the fourth quarter.

[Collyn Gilbert:]

Okay.

[David Rosato:]

So rates today are pretty much where they were at year end when we finalized our budget. Now the reality is they kind of went lower in January, backed up in February and have come halfway down again and we are unchanged from when we built the budget. So that gives us the comfort that our margin guidance should remain intact.

[Collyn Gilbert:]

Okay, okay. And then just kind of overall, Dave, how you are thinking about the balance sheet. Is the objective to try to maintain this, I mean you kind of have hovered in that mid to high single-digit range of NII pickup I guess in like in up 200 scenario? Is that sort of where you want to keep the balance sheet? Are there certain triggers that would cause you to go one way or the other on how you are managing your interest-rate risk?

[David Rosato:]

No. I would say our overall goal is to keep a moderate amount of asset sensitivity and we would define what we have today as a moderate amount. We don't talk much about long-term risk to changes in interest rates, but we are neutral to about the first 150 basis point of rate increases from a mark to market basis. So long-term we are neutral. Short-term we are trying to remain asset sensitive and we are not looking today to drive our asset sensitivity substantially higher.

[Collyn Gilbert:]

Okay, okay. That's great. And then just one final question. Any change in the competitive environment? Are you seeing increased pressure in certain asset classes or certain structures or just a little bit of color there? That would be great. Thanks.

[Jack Barnes:]

Yes. Sure, Collyn. I would say no real change at all. There are some modest changes from different competitors. The biggest thing I guess that comes to my mind is in the commercial real estate we are seeing more competitive pressure that comes from the larger institutional lenders that are doing longer fixed-rate loans than we have an appetite for. So we lose business there competitively. And on a smaller impact dollar wise, we continue to see pressure from smaller banks in certain local markets that are willing, again, to do longer-term fixed-rate deals than we have an appetite for.

[Collyn Gilbert:]

Okay. That's great. Thank you very much.

[Jack Barnes:]

Thanks.

[Operator:]

Thank you. Your next question comes from Tom Alonso, Macquarie. Please go ahead. Please go ahead Tom Alonso from Macquarie, you are live at call. Please ensure your line is unmuted.

[Tom Alonso:]

Yes. Sorry about that. So just one quick follow-up on the Commercial Banking fees and then one on the swap income. On the Commercial Banking fee, is that $2 million or a little over $2 million in prepays that you referenced earlier, is that the total prepays for the quarter or is that sort of an increase?

[David Rosato:]

No, that is the delta.

[Tom Alonso:]

Okay. So that was up. Okay, okay. And then on the swap income, you noted that rates kind of moved around a little bit during the quarter. Was that part of the driver as well for the increase there, just kind of the volatility we saw this quarter?

[David Rosato:]

I'm not sure, to tell you the truth. I think it has more to do with our commercial RMs being more comfortable introducing our swap experts to their customers. I also think just the lower level of interest rates is prompting more activity customers want to hedge and lock-in lower rates for longer and are willing to embrace interest rate swaps as the mechanism to do that. And that works for us so that we are doing less fixed rate, long-term fixed rate lending in this environment. So it suits our interest rate risk profile that we are trying to maintain.

[Tom Alonso:]

Okay, great. Thanks. And I just – can you just – what was the total prepay number then in this quarter in that Commercial Banking line?

[David Rosato:]

We don't – we haven't been disclosing that number and we are still not going to.

[Tom Alonso:]

Fair enough. Okay. Thanks guys.

[David Rosato:]

You are welcome.

[Operator:]

Thank you. Ladies and gentlemen, since there are no further questions in the queue, I would now like to turn the call over to Mr. Hersom for closing remarks.

[Andrew Hersom:]

Thank you, again, for joining us today. We appreciate your interest in People's United. If you should have additional questions, please feel free to contact me at 203-338-4581. With that have a great day.

[Operator:]

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.