NewAlliance Bancshares, Inc. Q3 2008 Earnings Call Transcript

NewAlliance Bancshares, Inc. (NAL)

Q3 2008 Earnings Call Transcript

October 29, 2008, 10:00 am ET

Executives

Judith Falango – First VP, IR

Peyton Patterson – Chairman, President and CEO

Donald Chaffee – EVP and Chief Credit Officer

Merrill Blanksteen – EVP, CFO and Treasurer

Analysts

Christopher Marinac – FIG Partners

Collyn Gilbert – Stifel Nicolaus

Damon DelMonte – KBW

Presentation

Operator

Hello, and welcome to the NewAlliance Bancshares third quarter 2008 earnings conference call. All participants will be in listen only mode. There will be an opportunity for you to ask questions at the end of today’s presentation. (Operator instructions) Please note this conference is being recorded.

Now, I’d like to turn the conference over to Ms. Judith Falango. Ms. Falango, please begin.

Judith Falango

Good morning. I’d like to remind you that statements in this conference call, if any, concerning future results, performance, expectations or intentions are forward-looking statements. Actual results, performance or developments may differ materially from forward-looking statements as a result of known or unknown risks, uncertainties and other factors, including those identified from time to time with the company’s filings with the Securities and Exchange Commission, press releases, and other communications. Actual results may also differ based on the company’s ability to successfully maintain and integrate customers from acquisitions.

The company intends any forward-looking statements to be covered by the Litigation Reform Act of 1995, and has included this statement for purposes of Safe Harbor provisions. Listeners are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this conference call. Except as required by applicable law or regulation, the company undertakes no obligation to update any forward-looking statements to reflect events or circumstances that occur after the date when such statements are made.

Now I’ll turn the floor over to Peyton R. Patterson, Chairman, President and Chief Executive Officer.

Peyton Patterson

Good morning and thank you for joining our third quarter earnings call. I am pleased to report solid third quarter results, which were characterized by continued strong credit quality, healthy loan and deposit growth, and strict expense control. This focus on our fundamentals while navigating through this unprecedented economic environment is the cornerstone of our 2008 business strategy.

But before I get into the details, I’d like to remark on two fundamental strengths, which set us apart: High capital levels and extremely strong credit quality. In fact, one well known Wall Street analyst writes NewAlliance as being in the top 15% of all banks nationally for asset quality. And with regard to capital, we remain a well capitalized institution, with a tier 1 leverage capital ratio of 11.03% and our total risk based capital ratio is 19.87%, both are well above the regulatory definition of well capitalized.

The tier 1 ratio for the bank alone is 9.42% and the bank’s risk based capital ratio is approximately 17.15%. Our credit culture is also a hallmark strength, reflected in the excellent credit quality you see today. We have historically practiced conservative underwriting and never entered into the sub prime business. As a result, at the end of the third quarter, our ratio of nonperforming loans to total loans was just 71 basis points. And our reserve coverage to net charge off is significantly better than industry averages.

This morning I’ve asked Don Chaffee, our Chief Credit Officer to provide you with additional details on our assets quality and loan portfolio, and Merrill Blanksteen, our Chief Financial Officer, will give you an update on our investment portfolio. Following our remarks, we will be happy to take your questions.

Now let me review our business strategy this year. Understanding the threat, this financial climate would pose, we focused early on improving revenue streams and seizing market opportunities. This is evidenced in the continued year-over-year improvement in our margins and focused on originating loans like residential mortgages where we are seeing historically higher spread. In addition, our sales focus has been on generating core deposits, which have shown impressive growth throughout this year.

NewAlliance has certainly benefited from customers flight to safety brought on by the instability of a number of our local and national competitors. Specifically, total deposits were up 3% year-over-year with core deposits increasing by 12%. On a linked quarter basis, total deposits were up slightly. The largest increase year-over-year was savings account, which were up 56%, and quarter over quarter regular saving increased by 4%. Total loans were up 6% year-over-year, mostly from residential mortgages and this quarter’s loan origination activity was second only to the record quarter experienced in the second quarter this year. While we were able to grow our net interest margin over last year by 14 basis points to 2.63%, we were down slightly by 4 basis points on a linked quarter basis.

Lastly a word on our expenses discipline. Non interest expenses remained well controlled and flat on a linked quarter basis. Also embedded in our third quarter expenses was the launch of an important profit improvement initiative aimed at identifying incremental revenue and expense opportunities and well as investment priorities for 2009. Overall, our earnings for the third quarter of 2008 were $10.9 million or $0.11 per diluted share.

Year-over-year the key components of our results this quarter were our net interest margin increased 14 basis points to 2.63% compared to 2.49% a year ago, driven by growth is core deposits and loans. Average loan balances increased by $308 million or 6.6% with most growth coming from the residential mortgage portfolio in our footprint. Deposit cost were reduced by $8.2 million as more expensive time deposits shifted to regular savings or were repriced downward. Average balances of core deposit grew by $287 million or 12%. Non interest expenses were basically flat after taking into account the effect of a reduced incentive accrual in 2007 and the cost of the profit improvement project in 2008.

We were pleased with the improvement we saw in the year-over-year per common share data. Book value increased to $13.08 from $12.71. Tangible book value increased to $7.72 from $7.45. On a diluted basis, weighted average shares outstanding declined by $4.5 million as a result of share buyback activity.

Now comparing the linked quarters, we were very pleased to see the net interest margin remain stable at 2.63%, and while average balances of core deposits increased $17 million, deposit costs decreased by $195,000. Loan growth also continued as evidenced by the average loan balance increasing by $88 million. While non interest income decline by $1.1 million, primarily due to reduced partnership income and fewer loan sales, we were happy to see the increase in depositor service charge income. And as I mentioned before, non interest expenses remained flat from the prior quarter, inclusive of the $500,000 profit improvement initiative expense.

On a linked quarter basis, earnings were down $846,000 or $0.01 per share from the $11.8 million or $0.12 per share, largely due to the $500,000 increase in the loan loss provisions and the profit improvement initiative I mentioned earlier.

I would now ask our Chief Credit Officer Don Chaffee to speak about asset quality.

Don Chaffee

Thanks, Peyton, and good morning to everyone. It’s very nice to be with you today.

Given the environment , we are very pleased that our total delinquencies meaning everything 30 days plus came in only at 1.05%. Last quarter they were 89 basis points. Nonperforming loans increased to 71 basis points as Peyton mentioned during the third quarter up from 53 at the end of Q2. The increase includes two CRE loans, a retail office facility for $2.3 million, and an industrial warehouse facility for $3.5 million, both of which came from prior acquisitions. I say that so that you understand that they were not done according to our normal underwriting, and so that you don’t think that there is any spreading of the problem to CRE, which we don’t see at this time. And we had a condominium construction project for $4.1 million.

I mentioned here last quarter that we have a small residential subdivision portfolio. This portfolio is now around $53 million or slightly above 1%. As most of you know, we put limits on any activity we think is riskier even in good times. Having said that, several of the projects are experiencing slow sales. The total nonperforming loans for condominium projects is $11.4 million and the total portfolio is down to approximately $21 million. We have established specific reserves and/or have already charged off the projects where we’ve identified any problems or losses. So we feel the problem is small and contained.

The rest of the CRE portfolio has excellent delinquencies at 1.13% and charge offs year to date of only $652,000 or 9 basis points. Our net charge offs to the third quarter were $2.8 million or 23 basis points annualized. Last quarter, they were $1.3 million. Year to date, net charge offs are 4.2 or 12 basis points. These remain relatively low numbers. $1.4 million of the quarterly charge offs were two condominium projects and $727,000 came from a write down of the retail office facility that I mentioned before. We were really pleased to be able to sell a CRE non performing loan note of $950,000 for $0.90 on the dollar.

For the quarter, we took a provision of $4.2 million following our philosophy that as assets quality indicators deteriorate, the reserve should grow as a percentage of loans. Our reserves stands at $49.2 million or 99 basis points, up 12% from year end, with year to date losses of $4.2 million against a reserve of $49.2 million, we feel we are good coverage against losses embedded in the portfolio.

With all the news lately, let me go over briefly our other portfolios, which we conclude are looking pretty good. Keep in mind, the 51% of the portfolio is one to four family residential loans, primarily owner occupied with very low delinquency, i.e. 68 basis points, and minimal losses for several years. The weighted average FICO is 750 and the current LTV is 48%. These are updated scores and portfolio LTV. To determine higher risk loans, we segment our portfolio into a 3D matrix of LTV, FICO and volume, which I affectionately call our Spiderman chart. Currently we have only 61 basis points of the residential portfolio designated as higher risk under this analysis.

Home equity and again I’d like to point out that all these loans are originated only in our footprint continues to have good results with only 41 basis points in delinquency, well below state and national averages. The FICO scores remain strong at a weighted average of 748, and the cumulative loan to value is 47%, so there is a lot of equity protecting us. We actually had our first charge off in this portfolio in a long time.

C&I looks good with total delinquencies of 1.69 %. Net charge offs for the C&I portfolio year to date are only 9 basis points. That’s an exceptionally strong number at this point in the cycle. We continue to believe that our historical conservative underwriting will serve us well during this challenging period. However, as we’ve consistently advised investors, we will not be immune to increasing delinquencies and provisions. We believe that we will continue to outperform. Based upon what we see right now, we would not expect to see the need for a provision as high in Q4 as we took this quarter.

Thank you, Peyton.

Peyton Patterson

Thanks, Don. Now I’d like to ask Merrill Blanksteen, our Chief Financial Officer to talk about our investment portfolio. Merrill?

Merrill Blanksteen

Thank you, Peyton. During the quarter we had four securities that were in the news or that we are watching particularly close. First, we took an impairment charge on our Freddie Mac preferred and wrote it down to market value immediately upon notice that the company was placed in conservator ship by the government. That charge was approximately $800,000.

Second, we wrote off our investment in Lehman immediately upon its bankruptcy filing. That charge was approximately $200,000. Third, we took an OTTI charge on a $4.8 million investment in the fixed maturity trust preferred stock of a regional US bank. That charge was approximately $1.6 million. This particular investment is rated A minus and is fully current. We believe the investment will continue to cash flow on schedule. However it’s depressed market price indicated that this particular issue was trading at a wider spread than other similar names with similar ratings. We therefore concluded that other market participants exuded [ph] enhanced risk as the timely payment of our cash flows on this security and that an OTTI charge was appropriate.

Fourth we evaluated our previously disclosed investment in AIG fixed maturity trust preferred stock. When all the details of the government loan that AIG were available, we were able to assess the impact on our particular investment. Our investment is in a regulated insurance subsidiary of AIG that remained outside the hedging arrangement related to the government loan. The insurance subsidiary carries a rating of A from A.M. Best and our investment is still rated A. The investment is current and given the strength of the insurance subsidiary is expected to cash flow on schedule. We concluded no OTTI charge was appropriate on this security.

The OTTI charges of $2.6 million that I mentioned above were partially offset by gains on sale of agency mortgage backed securities. As we have stated previously, we are fortunate to have net unrealized depreciation in our securities portfolio. We will have further details on our trust preferred securities in our third quarter 10-Q, which will be available in a few days, but as previously disclosed, all such investments are non perpetual and rated A minus or better.

Now, I’d like to comment on the preferred stock portion of the government’s Troubled Assets Relief Program or TARP. The TARP would restrict continued share repurchases, place restrictions on common dividend increases, and dilute our existing shareholders to grant them warrants [ph]. The taxable equivalent cost of this money is well above the rate at which we will invest at short term, thereby reducing both EPS and ROE. Further, we still have excess capital available for acquisitions.

In short, the financial case for the fund is difficult to make. Nevertheless, we are still assessing this programs and what further opportunities it may afford us, before we conclude with certainty.

Peyton Patterson

Thanks, Merrill. I will wrap up by saying that I remain confident in the quality of our underwriting and the strength of our loan portfolio. For the remainder of the year, we will be focused on maintain credit quality while continuing to build business momentum both in terms of our deposit and loan generation. And as we prepare for 2009, we will be focused on maximising revenue opportunities and gaining operating efficiency.

We’d now all be very happy to take your questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Christopher Marinac of FIG Partners.

Christopher Marinac – FIG Partners

Thanks, good morning. Peyton, I wanted to ask you and Merrill just a follow up on the comments about the TARP. If you were going to make an acquisition , what would be sort of I guess a way to look at how you would fund the acquisitions today with other money if you were not using the TARP at this point than more traditional sources?

Merrill Blanksteen

Well, we still have tangible capital ratio of over 11%. We have ample liquidity, and we have been highly capitalized when we went public in 2004. We still are in the process of deploying that initial capital received from our IPO. So at the moment, we’d look to our existing capital resources to fund an acquisition.

Christopher Marinac – FIG Partners

Would you argue that those resources are less expensive or about the same all in with what you are – how you are looking at the all in cost of the TARP?

Merrill Blanksteen

We believe they are less expensive.

Christopher Marinac – FIG Partners

Okay, very well. And then just one other sort of more mundane question, this has to do with sort of deposits in your footprint. Have you seen any difference in deposit flows as it relates to other banks struggling or just this happening in the environment in September?

Peyton Patterson

Good morning, Chris. This is Peyton. No, we’ve definitely seen a flight to safety at NewAlliance Bank, I think prompted by all of the national competitors, many of which have had something happen to them and they are in this marketplace, but also a couple of our local competitors seem to be having some problems. So we benefit from that. Our sales force is very much on top of that, and quite frankly customers in all marketplaces are concerned about FDIC coverage and NewAlliance really represents I think a great place to park the money, and I think that’s really helped with our deposit growth this year.

Christopher Marinac – FIG Partners

Okay. Great, Peyton. Thank you very much.

Peyton Patterson

Thank you.

Operator

Our next question comes from Collyn Gilbert of Stifel Nicolaus.

Collyn Gilbert – Stifel Nicolaus

Thanks, good morning.

Peyton Patterson

Good morning.

Collyn Gilbert – Stifel Nicolaus

Mell, could you just a little bit about your outlook for the margin and maybe some of the deposit pricing pressure or release that you are seeing?

Merrill Blanksteen

Well, we continue to be very focused on the margin and on pricing. We are expecting another fed cut as we are reading the same new releases as everybody else or same news. We do have loans tied to prime, which will come down undoubtedly with the fed cuts. We are looking at what we can do to manage deposit cost to try to offset some of that, and that’s the discussion we are actively conducting right now. I think it will be – we are still seeing relatively expensive deposit pricing in the market, but we will be looking for opportunities and try to offset the effect of the fed cut. I can’t really say what we are going to be able to – what we will be able to do with certainty yet, but we are working on that.

Collyn Gilbert – Stifel Nicolaus

Okay. Do you think there is room to lower your deposit cost, I mean --

Merrill Blanksteen

Yes.

Collyn Gilbert – Stifel Nicolaus

Assuming that some of the high payers are now out of the market or hopefully will be out of the market soon enough?

Merrill Blanksteen

Yes, we do.

Collyn Gilbert – Stifel Nicolaus

Okay.

Peyton Patterson

I think selectively speaking – Collyn, it is Payton – that I think there is some opportunity there. And also I would just add to what Merrill said on the home equity side based on our prime base pricing, there is opportunity to reprice new business going forward with more rational pricing to help compensate for this specific reason in the prime rate.

Collyn Gilbert – Stifel Nicolaus

Okay. And then just a question on the TARP, what are some of the factors that you are considering as you are looking at perhaps participating or not participating in the TARP?

Merrill Blanksteen

I think what we need to consider is whether or not short term, would see an acquisitions opportunity that exceeds our current capital resources, where the incremental funds that are available would be important to us. And given the amount of excess capital we have now, we’re after [ph] fairly significant acquisitions, and of course in our market we are not seeing a lot of problem there. So we have to include that as part of our assessment.

Collyn Gilbert – Stifel Nicolaus

Okay. And what would your appetite be to go out of market, or your appetite for kind of a less traditional type of acquisition?

Peyton Patterson

Well, I am not sure what you mean by less traditional. I think we’ve always maintained and stand firm with that now in terms of our M&A strategy, in terms of where we go. Clearly the benefit of doing M&A in the market would be the maximizing cost synergies, but we remain focused on banks just around Connecticut, whether it be Rhode island, whether it be into Massachusetts, and whether we head south down to Fairfield County and to new York. So really nothing along those lines of change. If there is a possibility of doing a deal with a company that has also branches in New Jersey, we are open to that as well. The bottom line is really, does it deliver on shareholder value and do we know what we are buying in terms of asset quality.

Collyn Gilbert – Stifel Nicolaus

Okay, because also too if you did decide to go with the TARP, and that would forbid you from doing share repurchases, correct? And that’s been a pretty active use of your capital base?

Peyton Patterson

That is correct. And we haven’t closed the door on the TARP. As Merrill was pointing out, we’ve scrutinized it in the short term, and I think we will just reinforce that the excess capital that we have now is at a fairly healthy level, but we continue to see what our competitors are doing and to evaluate our relative position in the M&A space as a result of what others might be doing. So, we remain open, but in the short term, it’s not something that we are immediately considering.

Collyn Gilbert – Stifel Nicolaus

Okay, that’s helpful. Thank you.

Peyton Patterson

Thank you.

Operator

(Operator instructions) Our next question comes from Damon DelMonte of KBW.

Damon DelMonte – KBW

Hi, good morning.

Peyton Patterson

Good morning.

Damon DelMonte – KBW

I was just wondering, could you go over your total construction exposure again? I believe you said there’s about $53 million in residential development projects, is that correct?

Merrill Blanksteen

That’s correct, $53 million.

Damon DelMonte – KBW

And how about if you include commercial construction?

Merrill Blanksteen

If you include commercial construction, the number is approximately $130 million, and the deliquincies on the remaining commercial construction are zero.

Damon DelMonte – KBW

Okay. So that other call it $80 million of commercial has zero delinquencies?

Merrill Blanksteen

That’s correct.

Damon DelMonte – KBW

Okay. And then with respect to the profit improvement project, you had referenced that there’s some incentives in the third quarter, is there anything that we should be excluding for modeling sake going forward?

Peyton Patterson

I am sorry, excluding from what? I didn’t hear that last sentence?

Damon DelMonte – KBW

From modeling perspective, like if you had higher professional fees related to that, is there something we could back out going forward, or is this quarter’s non interest expense total a good run rate?

Merrill Blanksteen

We will have it expensed in the fourth quarter (inaudible) as well of about a $1 million.

Damon DelMonte – KBW

Okay, that’s all I have for now. Thank you.

Peyton Patterson

Great. Thank you, Damon.

Operator

(Operator instructions) We show no further questions at this time, I’d like to turn the conference back over to Ms. Patterson for any closing remarks.

Peyton Patterson

Great, thank you. I want to thank everybody for joining us today. As you know, we do remain confident in being able to tackle the headwinds, and we are really on focused fundamentals and really benefiting from this profit improvement project as we enter into 2009. So, thanks very much for joining.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.

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