Valley National Bancorp Q3 2008 Earnings Call Transcript

Oct.23.08 | About: Valley National (VLY)

Valley National Bancorp (NYSE:VLY)

Q3 2008 Earnings Call

October 23, 2008 8:30 am ET


Dianne Grenz - Director of Shareholder and Public Relations

Gerald Lipkin - Chairman, President and CEO

Alan Eskow - EVP and CFO


Ken Zerbe - Morgan Stanley

Peyton Green - FTN Midwest Securities

Sandra Osborne - KBW


Ladies and gentlemen, thank you for standing by and welcome to the third quarter 2008 earnings release conference call. At this time, all participants are in a listen-only mode. Later, we’ll conduct a question-and-answer session and instructions will be given at that time (Operator Instructions). As a reminder, this conference is being recorded.

I would like to turn the conference over to our host, Director of Shareholder and Public Relations, Ms. Dianne Grenz. Please go ahead.

Dianne Grenz

Thank you, and good morning. I would like to thank everyone for participating in Valley’s third quarter 2008 Earnings Call both by telephone and through the webcast. If you have not received the earnings release we issued earlier this morning, you may access it as well with the financial tables and schedules from our website at by clicking on the shareholder relations link.

Also, before we start, I would like to mention that comments made during this call may contain forward-looking statements relating to the banking industry and to Valley’s National Bancorp. Valley encourages participants to refer to our SEC filings including those found on Form 8-K, 10-K and 10-Q for a complete discussion of forward-looking statements.

And now I turn the call over to our Chairman, President and CEO, Gerald Lipkin.

Gerald Lipkin

Thank you, Dianne. Good morning and welcome to our third quarter 2008 earnings conference call exclusive on impairment and realized loss on Fannie Mae and Freddie Mac perpetual stock, which we'll discuss. We are pleased with our quarter results. Our avoidance of subprime mortgages, SIVs and other forms of exotic high risk financial instruments allowed us to produce consistent results in a very tumultuous market.

Without the charge, Valley's fundamental business performance and core operating earnings for the quarter were strong and in line with our expectations reaffirming the fact that all financial institutions are not experiencing significant asset deterioration. Our core adjusted return on average tangible equity was 23.92% for the quarter compared to 20.18% in the year ago period. Our core adjusted return on average assets and efficiency ratios were all in line with Valley's historical averages and actually reflected an improvement from the second quarter of 2008.

Our operating earnings for the quarter exclusive of Fannie Mae and Freddie Mac charges were $47.7 million or $0.35 per fully diluted share. The linked quarter increase in earnings is mainly derived from strong loan growth coupled with an expansion of the net interest margin from 3.48% to 3.64%.

As I mentioned earlier, and as we have preliminarily disclosed in Valley's Form 8-K on September 4th, 2008, during the quarter Valley incurred a net after tax charge of $44.1 million associated with 12 separate Fannie Mae and Freddie Mac perpetual preferred securities. We are obviously disappointed with the governments’ decision to forgo their implied guarantee on these securities and suspend their dividends.

While both Fannie Mae and Freddie Mac are not in bankruptcy or receivership and may in the future resume paying the dividends, accounting guidelines require us to write-down the value of these investments at this time. Nevertheless, our prudent and conservative lending philosophy has in part enabled Valley to create a balance sheet in which such a charge were large, it is not fatal and we’ll not have a significant impact on future business operations or strategic decisions.

Within the same 8-K we announced Valley’s preliminary intension to possibly monetize some of the appreciated fair value of specific branch and office properties we own, and provide cash for future company growth through a sale leaseback transaction. Since that release, the Valley’s liquidity and capital alternatives have expanded. We’ll continue to analyze our portfolio of approximately 100 properties and we’ll probably announce a sale leaseback transaction in the fourth quarter, which will generate GAAP gains and cash.

However, the scale of the initial transaction will most likely be less than the 25 properties previously disclosed in Valley’s 8-K. During this time of market dislocation and extreme volatility, we are most pleased to report that credit quality remained strong and continues to be the hallmark of the institution.

We maintain our strategic focus of operating for the long-term benefit of our shareholders irrespective of marketplace credit trends. Valley operates under a traditional approach to banking. Although the landscape and competition may change, determining the viability of a borrower to return his or her principle through various economic and credit cycles remains unchanged. If lenders diligently underwrite each loan from the prospective of lending their own money, credit concerns are reduced and the long-term shareholder profitability is increased. For the quarter, Valley’s credit metrics were outstanding.

Valley’s annualized net charge-offs were 0.18% of average loans, a decrease from 0.22% the prior period. While, Valley’s total non-performing loans as a percent of total loans remain flat at 0.30%. Total loans past due greater than 30 days declined from year end decreasing from 1% to 0.86% this quarter, but increased slightly compared to the prior period.

Just yesterday, the Federal Reserve Bank of New York published their report reflecting 90 day plus mortgage credit delinquency rates, as of the first quarter sorted by State. Nationally the rate was 1.90% and New Jersey was 2.08%. I believe both of those numbers have increased since the first quarter as well. Valley’s ratio for the third quarter was 0.18% while our 30 day plus delinquency rate up 0.53% is only 30% of the national 90 day plus average.

Home equity loans are no exception out of a portfolio of over 15,400 loans only 15 loans are delinquent more than 30 days. We are diligent in our initial underwriting of every credit and active in monitoring each facility. We routinely analyze home equity line usage so far as manually scrutinizing for checks made payable to credit card companies and other financials services businesses.

It’s a virtual we freeze the line in accordance with the terms of our loan agreement. Valley's auto portfolio, which has been an area of concern for many analysts and investors, continues to perform better than the industry and in line with management’s expectations.

As of September 30, Valley's auto loans past due greater than 30 days equaled 1.52% of the total auto loans. This represents approximately 50% of the New Jersey average according to a report from Experian. Origination activity has slowed considerably in the current quarter, as demand within the marketplace has deteriorated, and Valley has increased it’s already lost the credit underwriting standards.

During the quarter, we originated $78 million in new auto loans while declining an additional $511 million in applications. At Valley, we focus on a litany of turns in underwriting each credit as opposed to generically making a decision solely based on the borrowers FICO score.

Of the $511 million in declinations, over a $110 million, or 22%, maintained a FICO score in excess of 700. Once again it is the return of the principle, not the return on the principle, which drives our conservative loan underwriting guidelines.

We refuse to rely on complex automated computer models in making credit decisions, but rather fall back on good old fashioned underwriting criteria, common sense and time tested experience. As a result of the above, our auto loan portfolio decreased approximately $60 million during the quarter.

Commercial loan demand throughout the organization continues to be robust. As the severity of the current market dislocation impacts numerous borrowers to a greater degree many seek banks with strong capital and the ability to provide lending facilities, which enable them to meet their financial objectives.

While in recent year’s conservation with perspective customers focused on rate, the current focal point from the customers’ perspective is whether that financial institution will be a trusted and viable business partner for the years to come. Valley’s stable balance sheet and consistent core results provide an opportunity for Valley to extend its book of business at a spread that encompasses risk adjusted pricing. Valley has the liquidity and capital to grow, however we'll not undermine our credit culture merely to expand the balance sheet. That being said, as quality loan opportunities present themselves we'll attempt to increase our market share.

During the quarter, annualized organic loan growth exclusive of Greater Community Bank was nearly 9%. Growth in Valley's commercial lending portfolio including construction and commercial mortgage grew, on an annualized basis, 23% as a result of new relationships and expanded line usage.

Partially mitigating the growth in commercial lending was an annualized decline in residential mortgage and automobile lending of nearly 9%. Growth opportunities in the commercial lending spectrum will be the emphasis of Valley's balance sheet growth. During the next 12 months, we expect to see continued declines in lending for automobile and residential mortgages, as the economy continues to show signs of weakness.

On July 1st, we closed on our previously announced merger with Greater Community Bancorp, although our current period earnings were negatively impacted. We anticipate the acquisition will be accretive by early next year. All of our initial model assumptions are consistent with the current projections.

Our system, its integration in August went smoothly and we have already begun to realize a large number of our projected cost savings in the fourth quarter of 2008. As a result of the acquisition combined with the non-core impairment and losses on Fannie Mae and Freddie Mac, perpetual preferred securities that are realized during the quarter, Valley’s linked quarter regulatory capital ratios declined slightly.

However, they all remain above the regulatory guidelines for a well-capitalized bank. Although Valley does not presently need capital, we are currently evaluating the Treasury Departments TARP Capital Purchase Program and the benefits that may add to Valley and its shareholders.

Based on discussions we have had with our regulators, we believe that program is an opportunity for healthy banks like Valley to expand lending operations and enhance market liquidity. We view the terms of the program to be favorable and an attractive alternative to other forms of Tier I capital. Maintaining a strong capital base on an absolute basis and relative to Valley’s peers is paramount in providing Valley long-term strategic flexibility in either growing the balance sheet organically or via acquisition.

Although for many within the banking industry current conditions are arduous, the changing landscape has created an outstanding opportunity for Valley to generate lasting shareholder value.

We’ll now call on Alan Eskow, who will now provide a little more insight into the financial results.

Alan Eskow

Thank you, Jerry. Good morning, as indicated earlier in Jerry’s comments an exclusive of the impact of the Fannie Mae and Freddie Mac preferred securities. We are quite pleased with Valley’s third quarter core operating results.

Valley’s conservative lending philosophy, coupled with our balance sheet management strategies, have proved valuable in creating and preserving the shareholder value, while providing a foundation and opportunities with which to capitalize on current market conditions.

Reported net income for the quarter was $3.6 million, or $0.03, per diluted share and included a number of significant items which impacted the results. Also affecting operations in the third quarter was the acquisition of Greater Community Bancorp.

While the newly issued over $8.7 million shares of Valley stock to Greater Community Bancorp shareholders are immediately added to Valley’s outstanding share account. Many of the cost saves and synergies anticipated from the merger will not be realized until the fourth quarter of 2008 and into the first quarter of 2009.

In August, we converted all of Greater Community Banks back office operations and presently run the entire bank on one network managed and operated by Valley. Until the completion of the combined back office functions, many of the redundant operations at Greater Community were necessary resulting in the third quarter non-interest expense, which should decline in the fourth quarter of 2008.

On a sequential quarter basis the net interest margin expanded 16 basis points in addition to the 13 basis point increase in the second quarter. The increase is mainly attributable to a reduction in the cost of deposits and borrowings combined with higher new loan origination rates which exceed the existing portfolio.

Additionally, $25 million of federal home loan bank advances were prepaid during September, resulting in a one-time reduction of interest expense equal to $1.8 million, or six basis points on the net interest margin. Valley maintains an asset sensitive balance sheet and the recent and probable future declines in the target Fed funds rates will likely have a negative impact on the net interest income and margin in the near term. However, to the extent Valley is able for originate loans with an incremental spread in excess of Valley's current margin, we anticipate the Fed actions to be largely mitigated.

Non-interest income on a linked quarter basis declined $50.1 million mainly due to the other than temporary impairment and realized losses on Fannie Mae or Freddie Mac perpetual preferred securities totaling $70.9 million and trading losses of $6.1 million on specific securities held in Valley's trading account. Partially offsetting the decline was a market value gain of $20.8 million on the change in market value of Valley's junior subordinated debentures and $3.4 million of gains on certain available for sale securities which were sold during the quarter.

Non-interest expense increased $9.7 million to $73.8 million for the third quarter. As previously indicated, operational expenses associated with Greater Community Bank and penalties of $1.2 million associated with the aforementioned prepayment of Federal Home Loan Bank advances negatively impacted the current quarter.

In addition, during the last 12 months, Valley has opened nine de-novo branches, which during the third quarter directly added over $1.1 million of non-interest expense and indirectly resulted in the short-term decrease of interest income nearly $40 million of capital has been allocated to these de-novo branches and others currently in various phases of construction and Valley's current earning asset yield the annual foregone interest income is over $2 million.

The linked quarter growth in the balance sheet was attributable to assets acquired via Greater Community and strong organic loan growth, which was partially mitigated by a decline of the investment portfolio. Gross loans increased over $200 million, or nearly 9% annualized exclusive of those acquired from Greater Community.

Loan demand for the quarter was brisk as Valley's vendors originated over $1.5 billion in new loans despite a sequential quarter reduction in automobile and residential mortgage originations of $110 million and $75 million respectively. Commercial line usage was up slightly during the quarter as many of our New York lending customers prepare for the forthcoming holiday season.

Exclusive of investments acquired via Greater Community, the securities portfolio declined over $230 million from the second quarter as loan demand remains robust. Valley intends to actively utilize the investment portfolio as a source of liquidity rather than solely competing on rate for price sensitive deposits.

Linked quarter total deposits increased $691 million inclusive of $714.9 million in deposits acquired from Greater Community. The decline is mainly attributable to some initial decay of Greater Community deposit typical in any acquisition. The slight decrease in Greater Community Banks deposits is in line with management’s expectations and was forecasted in management's acquisition analysis.

Valley continues to focus on matching the duration of newly originated assets with that of their funding source. As a result, Valley typically offers higher rate certificates for extended maturities, where demand for deposits is not sufficient or the cost of each deposit is prohibitive management utilized wholesale funding as an alternative to match duration.

Although in the short-term Valley's funding costs will be higher and core deposit funding as a percentage of overall funding maybe less than our peers. We believe this is a prudent strategy in managing interest rate risk as can be seen in our margin analysis across as all deposits declined from 1.83% to 1.77%, factoring in our large base of non-interest bearing and savings deposits.

The loan loss provision for the quarter was $6.9 million, an increase of $1.1 million from the prior quarter. Net charge-offs were $4.4 million approximately $2.5 million less than the provision. As a result, the allowance for credit losses as a percentage of total loans increased from 0.84% in June to 0.89% in September.

Valley’s provision is determined, based on multiple factors, including Valley’s expectations relating to loan growth and the current economic environment. In the press release, Valley included a table outlining the allowance allocation by loan category. Exclusive of Valley’s residential mortgage and home equity loan portfolios, Valley’s current allowance coverage ratio is 1.18% up from 1.13% in the prior quarter. We believe our current reserve allocations are adequate based on the current composition of loans, current delinquency rates, loss history experience and expected future losses.

Future period loan loss provisions will continue to reflect actual and expected delinquency rates and net charge-offs, as well as economic conditions prevalent in the marketplace. Additionally, continued strong loan growth is another variable, which will directly impact the future provision levels as that is included in our methodology.

The linked quarter increase in non-performing assets of $5.7 million is mainly attributable to five commercial properties and does not reflect a systemic change in Valley’s overall credit quality. The non-performing asset to total loan ratio for the quarter was 0.42% is in line with managements expectations given the current economic environment and it is microscopic compared to many of our peers.

As of September 30th, the Bancorp’s Tier I risk-based capital ratio was 8.94% and the total risk-based capital ratio was 10.65%. Valley’s capital ratios were impacted during the quarter, as a result of the impairment and realized losses on the Fannie Mae and Freddie Mac perpetual preferred securities.

These losses reduce Valley’s ordinary earnings generation, which ordinarily sustains capital levels and balance sheet growth. Valley’s anticipated normalized earnings during the fourth quarter are expected to increase current capital levels and allow for balance sheet growth in line with managements expectations.

Internal minimal targets for Tier I risk-based and total risk-based capital are 9% and 11% respectively. As a result of the Greater Community acquisition, Valley realized a $114 million of goodwill, which had an immediate negative impact on Valley’s tangible equity ratios.

For the period Valley’s tangible common equity to tangible asset ratio was 5.50% and the tangible common equity to risk weighted assets ratio was 6.90%. As stated above, Valley’s normal operating earnings provide sufficient income to generate capital required to expand these ratios and the management’s growth targets.

With this, I conclude my prepared remarks and we’ll now open the floor to questions.

Question-and-Answer Session


Thank you (Operator Instructions). Our first question comes from Morgan Stanley's Ken Zerbe. Please go ahead, sir.

Ken Zerbe - Morgan Stanley

Thanks. The first quarter has been increasing funding through CDs, but a number of firms this quarter have seen a decline in the core checking and savings and they have been offsetting through CDs and it seems the Valley is no exception there. Can you just talk about A, I guess the duration of the CDs that you’re putting on? And how sticky those are? And this is something that is sustainable at where you want to be over the long-term by shifting more into CDs? Thanks.

Gerald Lipkin

We always look to bring in the core deposits as our first source of funding. We like to match funds against our loan portfolio or assets to the extent that we can. To the extent we get in longer term CDs then we are happier because most of our term lending is for more than a three or six month period.

The competition in our area continues to be very stiff especially with regards to certificates and deposit and the pricing that we’re facing is what we're adjusting our rates too. I'd be very happy if the competition in this area, where to drop a bit and we’ll be able to drop it.

We did experience, as I'm sure many financial institutions did, a lot of concern on depositors with regard to their deposits being in amounts in excess of FDIC insurance and initially we did start to see some withdrawals of funds. That seems to have reversed itself though ever since the FDIC has increased its limits I think there is more comfort on the street, I hope that when [the street] recharge numbers and they see the level of our performance that will further fortify the confidence of the depositor base and we'll continue to see deposit inflows.

Ken Zerbe - Morgan Stanley

Then what was the duration of the CDs you’re putting on during the quarter, the average duration?

Gerald Lipkin

Nine months is probably on the average.

Ken Zerbe - Morgan Stanley

I see. Okay. The second question, I had, was under the assumption that where the de-novos of your auto portfolio is still holding up very well relative to the industry. I guess, when you look going forward, I mean, obviously the economy is weakening. What do you look at that’s being sort of the potential drivers of that? I mean is it just as easy as raising unemployment, if that goes up by 100 basis points then auto your losses are likely to pickup or are there other things that you also look out for?

Alan Eskow

I think you have to look at the geography of where we do most of our lending. People need their car to get back and forth to work. They need their car for survival. It’s not a luxury item. So I think the fact that they continue to pay is heavily driven by that factor.

We do look to make our loans to people, who have strong FICO credits, strong clear TRW Experian credit reports. Also we’re seeing the price of gasoline drop materially in New Jersey and particularly the price of gasoline since we’re lot lower than the rest of the country, where we've been well below $3 for sometime now. So I think that's what helping it. But I think most of it has to do with how we underwrite. I think that has more to do with the fact that our loans tend to perform.

Ken Zerbe - Morgan Stanley

Great. All right. Thank you.


Thank you. (Operator Instructions) And our next question comes from FTN Midwest Securities, Peyton Green. Please go ahead Sir.

Peyton Green - FTN Midwest Securities

I was wondering if you could comment maybe on how your collection process is a little different maybe because it seems like there is a lot of art in getting paid back on loans, so….

Gerald Lipkin

This is Jerry. I’m with the bank for almost 34 years. We’ve always had more people collecting loans and making loans. The squeaky wheel is one that gets the [large]. We jump right on a case if somebody goes couple of days delinquent. We’re already on the case. The card has been setout there very long. We’ll reposess the card certainly by 60 days and maybe in some cases 45 days. So, we really monitor it very closely. Again, it’s grinding our business; you’ve to keep making phone calls, getting in touch with the borrowers.

Peyton Green - FTN Midwest Securities

Okay. And then on the commercial end, you are not seeing anything not necessarily in non-performing obviously, but in terms of your credit classifications are you seeing any change in grades that concerns you more about the credit outlook six to nine months down the road?

Alan Eskow

No, no.

Peyton Green - FTN Midwest Securities


Gerald Lipkin

Our experience has really been in fact and I said this repeatedly that we’re facing more a crisis of confidence than anything else. The economy in our part of the world still is pretty robust. We’ve got rising unemployment, but you’ve to look at what levels. I was at a restaurant in New York City last night and it’s a pretty big restaurant and they didn’t have an empty table. So people are still going out. They’re still spending money in this part of the country.

Peyton Green - FTN Midwest Securities

Okay. Going forward and at least the quarter go anyway, there seem to be a pretty good opportunity for you all to take business just because (inaudible) turned off in a lot of places, is that still trading?

Gerald Lipkin

That is very true.

Peyton Green - FTN Midwest Securities


Gerald Lipkin

More so now than I think, we call in the last 15 years?

Peyton Green - FTN Midwest Securities

Okay. And I guess, have you all changed your underwriting criteria or is it it’s just the markets move towards to you?

Gerald Lipkin

No. The market moves to us. We’ve continued to take good care of our existing customers. A lot of times people are having problems with banks they talk to their friends and they say Jerry we bank at Valley and they never told me no. When I needed money obviously as long as the customer has the capacity to handle the credit, we’re anxious to lend them the money.

Peyton Green - FTN Midwest Securities

Okay. All right. Great. Thank you.


Thank you. And our next question comes from Sandra Osborne of KBW. Please go ahead.

Sandra Osborne - KBW

Thanks. I was just wondering if you could talk briefly about the sustainability of the net interest margins especially given the limited pricing flexibility that you have in deposits and also the….

Gerald Lipkin

That’s a good question because what we’re seeing now is return to rational pricing on the asset side, while we’re still facing a lot of competition on the deposits and funding side for rates. We’re seeing now a much better margins coming in our loans even above the higher pricing of deposits. The marketplace is starting to price risks back into loans again and we’re starting to see a much more rational pricing.

Sandra Osborne - KBW

Should the better asset yield completely mitigate deposit pricing?

Alan Eskow

Well, it is going to largely mitigate it. I think there is no doubt about it. And remember that even in the environment, we just coming through, where rates were unreasonable on the deposit side from some of the depository institutions out there. Our margins still increase. So I think we’ve already seen that. I think if anything, we might see some of those deposit pricing start to come down as we go further out into the end of the year and into '09. So I think the margin should hold up.

Sandra Osborne - KBW

Right. That's all I have. Thanks.


Thank you. We have no more questions in queue. Please continue.

Gerald Lipkin

Well, if there are no other questions, we thank everybody for tuning in on our comments today. I look forward to speaking to you at the end of next quarter.


Thank you. Ladies and gentlemen this conference will be available for replay after 1 pm Eastern Time today through the midnight October 30th, 2008. You may access the AT&T replay system by dialing 1-800-475-6701 and entering the access code 960018. International participants may dial 320-365-3844. Those numbers again are 1-800-475-6701 and 320-365-3844, access code 960018.

And that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service.

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