Peoples Bancorp Inc.
Q4 2008 Earnings Call Transcript

Published: 9 Feb 2009

[Operator:]

Good morning and welcome to the Peoples Bancorp conference call. Today's call will cover Peoples Bancorp's discussion of results of operations for the quarter ending December 31, 2008. (Operator Instructions) Please be advised that the commentary of this call may contain projections or other forwardlooking statements regarding future events or Peoples Bancorp's future financial performance. These statements are based on management's current expectations. The statements in this call which are not historical fact are forwardlooking statements and involve a number of risks and uncertainties including, but not limited to, the interest rate environment, the effect of federal and/or state banking, insurance and tax regulations, effect of technological changes, the effect of economic changes, the impact of competitive products and pricing, and other risks detailed in Peoples Bancorp's Securities and Exchange Commission filings. Although management believes that the expectations in these forwardlooking statements are based on reasonable assumptions within the bounds of management's knowledge of Peoples' business and operations, it is possible that actual results may differ materially from these projections. Peoples Bancorp disclaims any responsibility to update these forwardlooking statements. Peoples Bancorp fourth quarter 2008 earnings release was issued this morning and is available at peoplesbancorp.com. This call will include about 15 minutes of prepared commentary followed by a questionandanswer period, which I will facilitate. An archived webcast of this call will be available on peoplesbancorp.com. Peoples Bancorp participants in today's call will be Mark Bradley, President and Chief Executive Officer, and Ed Sloane, Chief Financial Officer and Treasurer. Both will be available for questions following opening statements. Mr. Bradley, you may begin your conference. Mark Bradley Thank you. Good morning and welcome to Peoples Bancorp's conference call. Today Peoples Bancorp reported full year 2008 net income totaling $7.5 million or $0.72 per diluted share versus $18.3 million and $1.74 per diluted share in 2007. Core revenues increased, net interest margin expanded, and expense growth was controlled. But deteriorating economic conditions played an overwhelming role in our lower earnings in the second half of the year, particularly in the fourth quarter when a net loss of $3.1 million or $0.30 per diluted share was recorded. We are disappointed by the results, which were driven lower by higher credit costs and other than temporary impairment charges on certain investments. As described in our 8K filing earlier this month, fourth quarter provision for loan losses was $13.4 million and other than temporary impairment charges on investments were $4 million. Like most financial institutions, we were hit with further declines in commercial real estate values and mounting stress in the financial condition of some of our commercial borrows due to general economic conditions, which led to additional downgrades of loans, an increase in nonperforming loans, and further writedowns on existing impaired loans. In response to everchanging conditions, management, through our systematic loan loss analysis, determined that it was necessary to build allowance for loan losses to $22.9 million or 2.08% of total loans, up from $19.2 million or 1.72% at September 30, 2008. While there were many interrelated factors that impacted our allowance for loan losses, there were two main factors that drove the increase. First, there were downgrades of additional commercial loans within our current portfolio requiring a higher specific reserve for loan losses; and second, there were declines in the estimated value of the underlying collateral on certain commercial real estate loans, causing them to be undercollateralized, which resulted in higher reserve requirements. We also experienced an elevated level of net chargeoffs compare to recent periods. Fourth quarter 2008 net chargeoffs totaled $9.7 million versus $2.1 million in the third quarter of 2008. Much of this increase was due to $8.2 million of writedowns on impaired loans from declining collateral values in the fourth quarter. These writedowns remain in conjunction with our normal quarterly analysis of the loan portfolio and our evaluation of the adequacy of our allowance for loan losses at December 31, 2008. Now I would like to provide some details of commercial loan relationships that deteriorated in the fourth quarter causing the higher chargeoffs and change in nonperforming loans. The first relationship is a $4.7 million group of loans secured by various office complexes and raw land properties in central Ohio, which have been placed on nonaccrual status during the third quarter of 2008. Based on our updated analysis, these loans were charged down by a total of $2.8 million to reflect the new estimated liquidation value of the properties. The second unrelated relationship is a loan secured by a health and lifestyle facility, also in central Ohio, which had been placed on nonaccrual status during the first quarter of 2008. This loan was written down by an additional $1.3 million in the fourth quarter based on an updated appraisal. The worsening economy certainly impacted businesses in our market areas, including some manufacturers, resulting in loans being downgraded in several relationships being placed on nonaccrual status during the fourth quarter. In addition to loans in our primary market area in the fourth quarter, Peoples placed $5.2 million in loans on nonaccrual status, which are secured by land and a retail shopping center in the Phoenix, Arizona, area. The loans were generated through a longtime relationship with an Ohiobased client developing properties in the Phoenix area. Our total loan exposure to Arizona real estate is about $10 million. In regard to consumer loans, our credit quality metrics for personal and residential real estate portfolios remain fairly comparable to prior quarters. We will continue to proactively identify possible problem loans and remain diligent in our collection efforts. Asset quality will remain one of our top priorities in 2009 as we work through extremely difficult market conditions with one of our goals being a reduction in nonperforming loans by the end of the year. The market for selling properties is much slower than years past, so it will take time to work our way through some of these problems, but we have the capital strength for these workouts. I will now turn the call over to our CFO Ed Sloane for his comments on fourth quarter 2008 results.

[Ed Sloane:]

Thanks, Mark. In addition to a largerthannormal provision for loan losses expense, Peoples also recorded a $4 million other than temporary impairment charge related to our securities portfolio during the fourth quarter. About $2 million of this charge was related to a single bankissued trust preferred security that had no previous defaults or deferrals, while the other $2 million was related to four collateralized debt obligation investments previously carried at $6.1 million. The CDO's charges were based on management's evaluation of the credit quality of the underlying issuers. The fair value of these securities has been affected by the continued liquidity and credit concerns within the financial markets, as well as the downgrading of these securities by rating agencies. After the fourth quarter impairment charges, the carrying value of Peoples' individual trust preferred and CDO portfolios were $20.8 million and $4.1 million, respectively, at December 31, 2008. These securities are currently performing and will continue to be closely monitored. As we have shared before, one of our top strategic priorities is to proactively manage our investment portfolio in order to minimize interest rate and credit risk. During the year, Peoples' systematically sold our remaining Fannie Mae and Freddie Mac preferred stocks, which resulted in onetime losses but prevented exposure to even steeper possible losses. Throughout the year, we also selectively repositioned the investment securities portfolio to move from loweryielding, longerterm securities to other securities with better interest rate risk characteristics. We continued this proactive portfolio management effort during the fourth quarter and recorded a $1.5 million pretax gain as a result. Also during the fourth quarter, we completed the sale of our Grayson, Kentucky, retail office and our merchant credit card processing services, which generated aggregate onetime pretax gains of $775,000. These transactions were part of our ongoing strategy to concentrate our resources in the areas of our business with the most growth potential and to improve our operating efficiency. A positive for Peoples during 2008 was increased net interest income and net interest margin over the prior year. Full year 2008 net interest income was up 8% over 2007, totaling $58.5 million, while net interest margin was up 19 basis points to 3.51%. Fourth quarter 2008 net interest income was $14.7 million and net interest margin was 3.44%. Net interest income was flat, while net interest margin compressed 6 basis points from the linked quarter. A major factor in our decline in margin from the linked quarter was the drop in asset yields, as our prime-based loans repriced downward in conjunction with reductions in shortterm interest rates by the Fed. On the liability side of the balance sheet, we saw limited opportunities to reduce funding costs as competition for deposits in our markets remain tight and constrained our ability to lower deposit interest rates. Fourth quarter net interest income and margin were also reduced slightly by adjustments for loans placed on nonaccrual status, net of interest collected on nonaccrual loans. Without these items, fourth quarter margin would have been higher by about 2 basis points. While the substantial reduction in shortterm interest rates during 2008 produced yearoveryear improvements in net interest income and margin, we anticipate that the current interest rate conditions will challenge net interest income and margin in 2009. Our balance sheet has slowly shifted to an assetsensitive interest rate risk position in preparation for a rising interest rate environment. However, we anticipate net interest margin pressure if the Federal Reserve allows rates to remain at current historic low levels for a prolonged amount of time. We anticipate slight contraction of net interest margin in the first quarter of 2009, due to a full year's impact of the December Fed rate cut and look for margins to be in the mid330s. This guidance excludes the effect of any possible prepayment fees or interest adjustments for nonaccrual loans. We will continue to closely monitor and proactively manage our balance sheet in order to minimize interest rate risk exposure and maintain or improve net interest income levels. Another positive result for Peoples in 2008 has been growth in deposits. Total retail deposit balances, which exclude broker deposits, totaled $1.3 billion at December 31, 2008, up $81.3 million or 26% annualized for the fourth quarter and up $195.5 million or 17% for the year. These yearoveryear increases were due mostly to growth in interestbearing balances, primarily in retail CDs and money markets. Included in the annual deposit growth is $108 million in growth of retail CDs from customers outside our primary market area as a lowercost alternative to brokered CDs and $46 million in money market growth from Peoples Trust customers. The $46 million increase was due to a national investment broker's money market fund, which Peoples Trust Department had utilized for its clients, being closed to investors. As a result, Peoples Trust Department shifted customer funds that were previously invested in the national money market fund to money market accounts held in Peoples Bank. We view these funds as shortterm inexpensive funding for the bank, which could change quickly in future periods. We also saw a $36 million increase in CDARS CD balances for the year, with $18 million of that growth related to a single customer relationship. We successfully grew core consumer and business deposits throughout the year, as highlighted by $10.6 million or 6% growth in quarterly average noninterestbearing checking balances over the prior year quarter. Fourth quarter 2008 average savings balances increased $7.3 million, or 7% over the prior year quarter, while personal money market accounts grew $10.9 million or 11% over the same time period. This strong core deposit growth reflects our ability to attract and retain full customer relationships centered on deposits. Due to the increases in retail deposit balances throughout 2008, Peoples was able to reduce its level of higher cost wholesale funding compared to yearend 2007. In 2008, noninterest revenues were up 2% over 2007. Fourth quarter noninterest income was $7.8 million, up 3% over the prior year quarter. Deposit service charges and insurance revenues were both up 8%, while trust and investment income increased 9% due mostly to declining market values in managed assets. Compared to the linked quarter, noninterest income was down 4% largely reflecting the normal fluctuation in insurance revenues based on the timing of policy renewals. In 2008, Peoples' noninterest income comprised 35% of its total revenues; and we remain focused on growing other sources of income that are not dependent on interest rates. Noninterest expense was $13.5 million for the fourth quarter of 2008, up 2% compared with the linked quarter and 9% over last year's fourth quarter. The increase in yearoveryear quarter expenses was influenced by higher FDIC insurance expense, coupled with the impact of utilizing the $1 million onetime credit received in 2007. Fourth quarter 2008 franchise tax expense was also up over the prior year quarter due to a $782,000 reduction in fourth quarter 2007 expense from the resolution of matters related to Peoples' Ohio corporation franchise tax liabilities. Fourth quarter salary and benefit costs were unchanged from the linked quarter, but increased slightly over last year due to the combination of normal base salary adjustments and higher employee medical benefit costs. We are satisfied that our expense control initiatives are working. For the full year of 2008, total noninterest expense was $53.5 million versus $51.5 million in 2007. Much of the yearoveryear increase was due to higher deposit insurance premiums, additional franchise tax expense, base salary adjustments, and higher employee medical benefit costs. As revenue growth outpaced expense growth, Peoples' efficiency ratio improved from 57.07% in 2007 to 56.3% in 2008. This ratio continues to compare favorably with our peers, and we will remain focused on revenue diversification and expense control in 2009. Now, I will turn the call back over to Mark for his final comments.

[Mark Bradley:]

Thanks, Ed. As the economy worsens, we continue to focus on serving our clients as well as concentrating on maintaining and protecting our capital. We have done that successfully in 2008 despite a decline in asset quality. At December 31, 2008, Peoples' tier 1 and total riskbased capital ratios were 11.87% and 13.18%, respectively, basically unchanged from yearend 2007. These ratios remain well above the levels needed to be considered well capitalized by banking regulations and provide some shelter to weather the storm from current economic conditions. In addition, on January 22, 2009, Peoples shareholders authorized the issuance of preferred shares which enables Peoples to obtain final approval for a $39 million capital investment through the U.S. Treasury's TARP capital purchase program. We expect to issue the entire $39 million of cumulative perpetual preferred shares in the next week or so. The new capital is expected to increase our total riskbased capital ratio upward of 16%. This additional capital will provide us with the strength to continue lending to qualified customers and the ability to take advantage of the right expansion opportunities if presented. We look forward to putting the TARP funds to work through good loans in our communities and serving even more clients. The fourth quarter was an extremely difficult quarter for Peoples Bancorp as we battled commercial real estate loan quality challenges and recognized impairment charges in our investment securities portfolio. We continue to see many positives in our business fundamentals, including net interest margin expansion over the prior year, continued revenue diversification, and cost control. We were also able to grow deposit balances, significantly reducing our reliance on wholesale funding sources and improve overall liquidity. We continue to believe that we are well positioned to handle the challenging economic environment. In 2009, we will continue to focus on the basic fundamentals of our business and our unique advantages in this time of unrest, making good loans, serving our customers' needs, and working together across business lines to leverage our universal financial services offerings. We believe that capital is still king in the financial services industry, and our participation in the TARP program will bolster our already strong capital ratios. We expect 2009 to be another challenging year in terms of asset quality, as the economy looks for direction. We have the people and processes in place to deal with challenges as they arise. We remain optimistic about the future and believe that our focus on the long term will serve our shareholders, clients, employees, and communities well in these challenging times. This concludes our commentary; we will open the call for questions. Once again, this is Mark Bradley and joining me for the Q and A session will be Ed Sloane, Chef Financial Officer. I will now turn the call back into the hands of our call facilitator.

[Operator:]

(Operator Instructions) Our first question comes from Jason Werner – Howe Barnes Investments. Please go ahead.

[Jason Werner:]

My first question, Mark, as you were going through the individual nonperforming discussion, you were going pretty quick and I didn’t get everything written down. You talked in your preannouncement and the end of quarter press release that during the quarter there were three loans, I think about $10 million net, that were moved to nonaccrual. Can you give a little more color on those three loans? What they were, how much each one was, what they were for, and where they were located?

[Mark Bradley:]

One is that Arizona property that I described earlier. Those are the retail strip centers or center and raw land. Those were moved to nonaccrual in the fourth quarter. I am trying to think of the other properties off the top of my head.

[Ed Sloane:]

There were two other properties, Jason, one was for $3.1 million and that's located in central Ohio and another one in southeast Ohio for $2 million.

[Mark Bradley:]

The last two that Ed just mentioned were manufacturingtype firms, not directly related to commercial real estate. Those were the three. A lot of the other writedowns in the fourth quarter were loans that were already in nonaccrual as updated appraisals came in.

[Jason Werner:]

Looking at the whole commercial portfolio, I was kind of curious if you're seeing any trends in the industry in terms of where things are getting weak, retail is a weak spot. But looking at your portfolio, where are you guys seeing weakness?

[Mark Bradley:]

The biggest weakness, if we lined up our top ten problem credits, would be commercial real estate. It’s not just geographically driven. I think it's universal throughout the entire United States. We have a couple of manufacturers as we just mentioned that had some issues in the latter part of the year. Most of it for us is commercial real estate. On the personal and residential real estate side, we haven't seen a huge deterioration in that segment of our portfolio. It's really commercial real estate for us.

[Jason Werner:]

Within that commercial real estate, are there any particular industries that are weaker than others?

[Mark Bradley:]

It's across the board, Jason. We have a hotel in there. We have a retail strip center. We have an apartment complex. There isn't one industry that's driving it. It's more global. Obviously, we have the health and fitness center in central Ohio that's been on our list for several quarters. It really is across the board. There's not one industry.

[Jason Werner:]

What did your delinquencies look like this quarter? 30 days? What did they do compared to the previous quarter?

[Mark Bradley:]

They were about the same, 30 days ticked up a hair, but not a lot, really no change from yearend 2007. I am excluding business loans, for example, looking more at the residential and personal side. We have not seen major changes there. They've been pretty comparable to previous quarters, which I think is a testament to the underwriting that we have done in those areas.

[Jason Werner:]

If that hasn't changed much, what's your thoughts and obviously a pretty dramatic slowdown in the economy, you’ve seen rising NPAs in the last several quarters. What's your kind of thoughts going forward on NPA levels? Near the bottom here, what's your thoughts?

[Mark Bradley:]

One of our focuses in 2009 is to lower NPA numbers. Obviously, that's very dependent on economic conditions and how fast properties can be moved. Unless the economy really takes a turn for the worse, we don't see any significant increase coming in NPAs. We have our eyes on a few loans, but we plan to work with clients on the residential and personal loan side. I think we're focused mostly on reducing nonperforming loans in 2009. Are we at the bottom? I don't know. Our focus this year is to reduce that number.

[Jason Werner:]

Okay. I will step back in the queue.

[Operator:]

We have Jason Werner of Howe Barnes to rejoin.

[Jason Werner:]

If nobody else is going to ask anything, I will keep going. I didn't catch if you said it or not, but in previous years, you gave some guidance on what you thought for income growth, expense growth, that sort of thing. I know it’s kind of next to impossible to give a full number because of the provision, but did you mention anything? If you didn’t, can you mention something on those two categories.

[Ed Sloane:]

Just in operating expenses, efficiency will continue to be our primary focus, cost control, into 2009. Keep in mind that we will be pressured by increase in FDIC insurance. I think employee medical expense also should start to, should continue to build in 2009 as it did in 2008. Again, on the expense side, cost control efficiency is going to continue to be primary focus for us during 2009. In the noninterest income piece, we would expect to see service fees or service fees on deposit accounts continue about the same trend as what we saw in 2008. Electronic banking fees was also another area of growth for us in 2008, expect that to continue. Trust and investment income, we would expect that to be somewhat flat to maybe slightly down as that's going to continue under pressure with market value of trust assets. Those are a couple of things to highlight for you in there. I wouldn't expect to see much growth out of either of those areas on interest income or noninterest expenses.

[Jason Werner:]

What about the insurance? And what do you expect in terms of fees in the first quarter?

[Mark Bradley:]

It's still a soft market out there, Jason, but we're seeing some turns that it's hardening up a little bit. We do not expect to go backwards in insurance income. The first quarter we obviously have, as you know from following us, it’s when we recognize most of our what's called contingency income. There's really no way to know what that number will be. We haven't heard any overly negative or positive news there. I expect insurance to hold the line, maybe see a slight increase in 2009. The real, as you know, the biggest unknown is what loan loss provision or chargeoffs will be. We don't expect to see 2008 levels again in 2009. We're not going to make predictions or projections on 2009 earnings because that is such a big unknown.

[Jason Werner:]

And then with the fee income, going back to the selling of the merchant processing, does that effect the e-banking line, what's the impact on that. I know you guys said it wasn't going to be material in terms of bottom line, but I would imagine there would be some lost revenue and loss expense offsetting that. Where does that show up on your income statement?

[Mark Bradley:]

A little bit in the ebanking income area, and it's spread out through the expense side. It's not really material from a line item perspective. It was basically a breakeven process for us. In the end, we should see improved bottom line performance, I’ll call it, by not owning that process anymore. Really no line item I can say that's going to change. It's really across the board through the income statement.

[Jason Werner:]

Then on the TARP capital, when you do get that, where do you initially plan on putting that? Is that going to go in shortterm securities initially and redeploy?

[Ed Sloane:]

It will be deployed right out of the securities portfolio.

[Jason Werner:]

What kind of a rate do you think you can get on that initially?

[Ed Sloane:]

Four, 4.5%, 4% to 5%, somewhere in that area.

[Mark Bradley:]

Our goal with that money is to make loans, good loans that bank examiners like to see. Obviously, with the economy the way it is, it's going to take a while to deploy those funds totally into loans. But we are continuing to make loans each and every day, and we plan to continue to do that.

[Jason Werner:]

Do you anticipate adding any leverage to kind of offset the cost of that?

[Mark Bradley:]

As you saw from our balance sheet at the end of the year, we have leverage already. Our goal is not to add more leverage. Our goal is to probably keep the balance sheet at about where it is at this point and keep this at the high point. Meaning yearend would be the high point of the year for leverage.

[Jason Werner:]

Going back to the idea of putting that into loans, obviously, going back the last couple of years, getting positive traction, it hasn’t been easy for you guys. Seems like you take a step forward and couple back in terms of having customers pay off. What are your thoughts on loan growth going forward? Do you anticipate additional payoffs in the portfolio?

[Mark Bradley:]

I don't anticipate a lot of payoffs, Jason, I do anticipate continued challenge to gain that traction as you describe it as we produce residential and 1-4 family loans that are sold to Fannie Mae, for example. So balance sheet growth will be a challenge this year. We continue to make those loans. we're looking for different avenues to make business loans. Some of our reduction in 2008 is obviously from chargeoffs. We have kind of had a flattish year from a production perspective in 2008. The balance sheet number went down because of the chargeoffs. Obviously, if we don't have the same number of chargeoffs in 2009, we have a better chance to gain some of that traction. It is a very difficult environment to predict loan growth. But it is our plan to keep, stay after it, and try to get those loans in the door the best we can.

[Operator:]

At this time, there are no further questions. Sir, do you have any closing remarks?

[Mark Bradley:]

I just want to thank everyone for participating in the call. Thank you, Jason, for your good questions. Please remember that our earnings release and webcast of the call will be archived on peoplesbancorp.com in the investor relations section. Thanks for your time and have a good day.

[Operator:]

This will conclude today's conference call.