Welcome everyone to the Simmons First National fourth quarter earnings conference call. (Operator Instructions) At this time it is my pleasure to turn the conference over to David Garner.
David W. Garner
I am David Garner, Investor Relations Officer of Simmons First National Corporation. We want to welcome you to our fourth quarter earnings teleconference and webcast. Joining me today are Tommy May, our Chief Executive Officer; David Bartlett, our Chief Operating Officer; and Bob Fehlman, our Chief Financial Officer.
The purpose of this call is to discuss the information and data provided by the company in our quarterly earnings release issued this morning. We will begin our discussion with prepared comments and then we will entertain questions. We have invited the analysts from the investment firms that provide research on our company to participate in the question and answer session. All other quests on this conference call are in a listen only mode.
I would remind you of the special cautionary notice regarding forward looking statements and that certain matters discussed in this presentation may constitute forward-looking statements and may involve certain known and unknown risks, uncertainties and other factors which may cause actual results to be materially different from our current expectations, performance or achievements. Additional information concerning these factors can be found in the closing paragraph of our press release and in our Form 10-K.
With that said, I will turn the call over to Tommy May.
J. Thomas May
Welcome everyone to our fourth quarter conference call. In our press release issued earlier today, Simmons First reported fourth quarter 2008 earnings of $5.6 million, or $0.40 diluted EPS, compared to $0.44 diluted EPS in Q4 2007.
As anticipated, the decrease was primarily attributable to a decrease in margin, an increase in the provision for loan losses in Northwest Arkansas, and a decrease in the premiums from the sale of student loans. We will discuss all of these items in more detail later in the presentation.
For the year ended December 31, 2008, net income was $26.9 million, or $1.91 diluted earnings per share, compared to $27.4 million, or $1.92 per share, for the same period in 2007.
Now while the national economy continues to be under considerable stress, the Arkansas economy has fared much better to date due to the fact that we simply do not have the same highs and lows as seen in many other regions of our country. Considering the challenges in the economy, we are very pleased with our 2008 results.
As we discussed in previous conference calls, during Q1 2008 we recorded earnings of $0.18 per share for non-recurring items related to Visa, Inc. IPO. Excluding these non-reoccurring items, core earnings were $1.73 per share for 2008.
On December 31, 2008, total assets were $2.9 billion and stockholders’ equity was $289.0 million. Our equity to asset ratio was a strong 9.9% and our tangible equity ratio was 7.9%. The regulatory tier-one capital ratio increased to 13.2% and the total risk base capital ratio increased to 14.5%. Both ratios remain significantly above the well capitalized levels of 6% and 10% respectively.
Needless to say, our company remains well positioned with strong capital. As you already know, Simmons First was one of the first banks to apply and be approved for the U.S. Treasury Capital Purchase Program. While we have a very strong capital base, we also believe that during turbulent times opportunities present themselves and we want to be prepared to capitalize on such opportunities.
As such, in October in we applied for and were approved for $40.0 million and we have subsequently requested and received approval up to the maximum of $60.0 million. Under Arkansas law we are required to provide our shareholders 60 days notice, thus our shareholders meeting and subsequent funding will be approximately February 27, 2009.
As we have said publicly, our decision to draw down the approved capital will be based on the terms of usage being the same as originally set forth by the U.S. Treasury.
Net interest income for Q4 2008 increased $259,000, or 1.1%, compared to Q4 2007. Net interest margin for Q4 2008 declined 30 basis point to 3.70% when compared to the same period last year. The decrease in margin was primarily the result of a significant repricing of earning assets due to declining interest rates and our concentrated effort to grow core deposits, resulting in a significant increase in liquidity.
When compared to the previous quarter, net interest margin decreased 14 basis points due to the declining interest rates and the seasonality of our own portfolio. Based on the recent rate reductions we now anticipate additional margin compression during 2009.
As previously mentioned, one of the early objectives this year was to enhance the liquidity in each of our eight banks. Retrospectively, we have been very successful in this effort.
On a quarter-over-quarter basis our non-time core deposits have grown $290.0 million, or 27%, while our timed deposits increased by $137.0 million.
First, in February we introduced a high-yield investment account, which during 2008 generated approximately $146.0 million in new money. In addition, by design, we have moved some of the more volatile expensive CD dollars into this account.
The second strategic move toward building liquidity was to secure about $55.0 million in long-term funding from Federal Home Loan Bank borrowings. Through this process, while we slightly negatively impacted margins, we have been able to reduce our dependency on more costly time and public fund deposits, increase our liquidity, and develop some new relationships.
Non-interest income for Q4 2008 was $11.3 million, down approximately $500,000 compared to the same period last year.
Let me take a minute to discuss some of the items that impacted non-interest income. Service charges on deposit accounts increased by $131,000, or 3.4%, in Q4 2008 compared to Q4 2007, due primarily to an improvement in our fee structure and core deposit growth.
Non-interest income was also negatively impacted by three items. First, as might be expected due to the current economic conditions, income on the sale of mortgage loans decreased by $114,000. The second item is other service charges and fees decreased by $159,000. Commission revenue from a third-party official check vendor decreased by $64,000 as a result of contract expiration and the change in business related to Check 21. The remainder was a result of lower revenues from the other commissions and fees.
Finally, the last item, premiums on the sale of student loans decreased by almost $300,000. As discussed in previous calls, the current liquidity of the student loan secondary market has virtually disappeared. At this time we are unable to sell student loans at a premium.
However, we have committed to continue to serve the student loans of the Arkansas market by continuing to fund new loans with the expectations of holding them until Q2 2009. At that time we expect to sell loans originated and fully-funded during the 2008/2009 school year. Under the previously announced federal student loan program, these loans can be sold to the government at par plus reimbursement of 1% lender fee and a premium of $75.00 per loan.
As a matter of information, while we will be increasing our student loan portfolio by an estimated $50.0 million during the carrying period, we have the option of creating liquidity by selling participation loans to the federal student loan program. At this point in time we do not anticipate the need to do so.
The estimated net pre-tax impact on earnings from student loans for Q1 2009 is a reduction of $385,000 compared to the same period in 2008. Specifically, we estimate a reduction of $625,000 in premium income, partially offset by a $240,000 increase in net interest income due to the increase in student loan outstanding balances during the carrying period. First quarter earnings estimates should be adjusted to reflect this reduction.
Looking to the forward to the remainder of 2009, we anticipate the entire premium on the sale of student loans, currently estimated at $1.6 million, to be recorded in Q3. We will continue to evaluate the profitability and viability of this strategic business unit going forward. Currently there remains way too many uncertainties concerning the roles of government, the secondary market, and the private sector to make long-term decisions.
Moving on to the expense category, non-interest expense for Q4 2008 was $24.6 million, which was a decrease of $170,000, or 7 basis points, from the same period in 2007. If you will remember, during Q4 2007, we recorded $1.2 million in non-reoccurring expenses related to the contingent liability of the litigation that resulted from the Visa, Inc. IPO, which was reversed out in Q1 2008 at the time of the IPO.
Included in Q4 2008 are the expenses associated with the company’s three new financial centers that were opened after Q3 2007. Excluding the impact of these new branches and the non-reoccurring items, non-interest expense increased by a normalized 2.7%.
Although we continue to be pleased with our modest increase in normalized non-interest expense, there are a few items I would like to discuss. First, the deposit insurance expense increased by $217,000, or 201%, in Q4 2008 compared to Q4 2007.
During 2007 the FDIC issued credits based on historical deposit levels to be used in offsetting deposit insurance assessment and Simmons First received $1.8 million of these credits. During Q3 2008 the majority of these credits were exhausted. Based on the recent FDIC insurance assessment projections we estimate a $1.8 million negative impact in 2009 versus 2008.
The second item, a new accounting pronouncement EITF 6-4 required a change in the method of accounting for the post-retirement benefits related to bank-owned life insurance effective January 1, 2008. In Q4 2008 we recorded a $70,000 expense due to the accounting change compared to no expense for Q4 2007.
As of December 31, 2008, we reported total loans of $1.9 billion, an increase of $83.0 million, or 4.5% compared to the same period a year ago. The growth was primarily attributable to a 10.4% increase in the consumer loan portfolio and a 2.8% increase in the real estate portfolio.
The growth in consumer loans was primarily in the student loan portfolio. The growth in the real estate was entirely in the single-family residential and commercial real estate loans.
Overall, loan growth was somewhat mitigated by a 13.8% reduction in real estate construction and development loans due to the permanent financing in completed projects. Like the rest of the industry, our loan pipeline remains soft. Considering the challenges in the economy, it is important to note that we have no significant concentrations in our portfolio mix. Our construction and development loans represent only 11.6% of the consolidated portfolio and we have no sub-prime assets either in the loan or investment portfolio.
Now let me give a brief update on credit cards. The portfolio’s outstanding balance increased in Q4 2008 by $3.6 million, or 2.2%, compared to the fourth quarter last year. This continues the trend set in 2007, as we have now seen quarter-over-quarter growth in credit card balances for nine consecutive quarters.
The increased balances can be mostly attributed to the increase in new accounts. As we have discussed in detail in previous conference calls, after several years of net new account losses we introduced a number of new initiatives that reversed the trend. Although the account growth has slowed during 2008, the positive trend has continued with the addition of over 5,000 net new accounts in 2008.
Although the general state of the national economy remains volatile and despite the challenges in the Northwest Arkansas region, we continue to have relatively good asset quality. In fact, we continue to enjoy good asset quality in all the other regions of Arkansas.
At December 31, 2008, the allowance for loan loss equaled 1.34% of total loans and 161% of non-performing loans. Non-performing assets as a percent of total assets were 65 basis points, up only 2 basis points from the previous quarter. Non-performing loans as a percent of total loans were 0.83%.
The annualized net charge-off ratio for Q4 2008 was 50 basis points, flat when compared to the third quarter. Excluding credit cards, the annualized net charge-off ratio was 36 basis points compared to 38 basis points for the third quarter.
The preponderance of the charge-offs are associated with the challenges in Northwest Arkansas, which will be discussed later in the presentation.
Q4 2008 annualized net credit card charge-offs were 2.02%, an increase in 22 basis points over the previous quarter, and still more than 400 basis points below the most recently published credit card charge-off industry average. As you will remember from previous conference calls, we expected that the credit card charge-offs would gradually return to a more historic level, in excess of 2%.
During Q4 2008 the provision for loan losses was $2.8 million, an increase of $1.0 million from the same period in 2007. The increase is the result of a special provision for the Northwest Arkansas region.
Because of the uncertainty in the overall economy we will continue to be aggressive relative to the adequacy of our loan loss reserve, specifically in the Northwest Arkansas region. While there remains some uncertainty relative to that region’s market recovery and the state-wide impact from the national recession, we currently anticipate that the 2009 provision for loan losses will approximate the same level as in 2008, excluding the Q4 special provisions. Obviously this depends on credit card charge-offs, loan growth, and overall asset quality trends.
Let me take a minute to reiterate what we have previously said and what we continue to see in the Northwest Arkansas region. While bankruptcy and foreclosure filings associated with the residential real estate market in that region continue to be a challenge and while we believe there are likely more to follow, at the current time there is a general belief that there may be some return toward normalcy by the latter part of 2009 or early 2010. Obviously, that can change but it is what we see at this point in time.
On a positive note, Washington and Benton counties continue to have population growth, thus absorption rates are likely to improve since new developments and construction have slowed significantly.
Concerning our company, as we have stated previously, we have one of our most seasoned management teams in this market. We have been proactive in the identification and resolution of problem assets and we have significantly increased the loan loss reserve based on the challenges of the region.
Accordingly, as previously mentioned, we have made another special provision to the loan loss reserve. We fully recognize that the challenges remain in this economy and there is likely to be further deterioration in this region before a return to normalcy. To put things in perspective, the total loans originated in the Northwest Arkansas region represent only 10.5% of our consolidated portfolio.
One final thought, we do believe that the Northwest Arkansas economy will work through the challenges related to an overbuilt real estate market and will once again be one of Arkansas’ most attractive markets. We must all remember that the influence of Walmart, Tysons, J.B. Hunt, and the U of A remains a powerful attraction for new job growth.
Bottom line, quarter-over-quarter we experienced moderate loan growth of 4.5%, margin compression of 30 basis points, increased provision expense in Northwest Arkansas but good asset quality corporate-wide compared to the industry, a continuation of relatively low credit card charge-offs of 2.02%, excellent growth in our core deposits of 21%, and most importantly, strong capital of 9.9% equity to assets which will even get stronger.
Like the rest of the industry, we expect 2009 to be a challenge relative to meeting our normal growth expectations. However, Simmons First is well positioned based on the strength of our capital, asset quality, and liquidity to deal with the challenges and the opportunities that we face through 2009.
Our conservative culture has enabled us to engage in banking for 105 years. To reiterate, Simmons First does not have any sub-prime loans in our loan portfolio, nor do we have any sub-prime assets in our securities portfolio, with mortgage-backed securities making up less than ½ of 1% of our total securities portfolio.
We rank in upper quartile of our national peer group relative to capital, asset quality, and liquidity. There has never been a greater time to have these strengths. We continue to believe that the Arkansas economy will better sustain the economic challenges because as primarily a rural state, we have not and likely will not, experience the same highs and lows that will challenge much of our nation.
However, we will not be lulled to sleep since there is always some concern relative to the lag effect that might occur in a major economic downturn. We remind our listeners that Simmons First experiences seasonality in our quarterly earnings due to our agricultural lending and credit card portfolios and quarterly estimates should always reflect this seasonality.
This concludes our prepared comments and we would like to now open the phone lines for questions from our analysts.
(Operator Instructions) Your first question comes from Matt Olney – Stephens, Inc.
Matt Olney – Stephens, Inc.
You gave a lot of good details on the credit quality, especially with Northwest Arkansas and in credit cards. Could you give more color on the credit trends in Arkansas, outside those two things, and maybe specify the agri loans as well?
J. Thomas May
I would tell you, first of all, that just looking at it from our prospective, which would be our eight banks, we’ve already talked about the Northwest Arkansas region and the challenges there. You know that but I will be glad to answer any other questions there that you might want.
Beyond the Northwest Arkansas region, when we look at the Northeast, we look at the Central, we look at the western part of the state, and the central part of the state, and then the South Central and the Southeast, we believe the asset quality numbers in our particular institution are still holding up very well.
While we are seeing some challenges, they are very minor in nature compared to the national economy. So that is very much a positive.
In looking beyond the regions or drilling down into types of loans, let me address the issue, or the question, of the agri industry. In our company we have three regions where we have agri lending: Northeast, South Central, and Southeast. The portfolios in aggregate, relative to row crop, would probably be a little bit north of $100.0 million, so for a $3.0 billion holding company you realize we do not have a lot of concentrations there.
The bulk of our lending on the agri side is, in fact, row crop lending. This last year the challenges that we would have had would primarily have come from the input cost, number one. Number two, would have been from the hurricanes. If we look at it right now, retrospectively, I think you will see that all of our farmers, or most of our farmers, will have paid out. Most of them would have had a year in 2008 equal to, or slightly less, than 2007 with the exception of possibly the cotton farmers.
As we move into 2009, we still see that the biggest challenge, the input costs are obviously lower. We are seeing the prices in the grains and so forth are at a level that there obviously could be some good profits if they could book their profits. And that hedging process is still going to be a little bit of a challenge with the grain elevators. They obviously can do it in the futures market. That requires lots of capital.
So going into 2009, I think they go into it with a least a net worth that started 2008 with. And we look for it to be a good year.
David L. Bartlett
One of the things that our banks in the ag market are talking about with these farmers is with the good crop yields and the cash that they generated from the crops in 2008, quite frankly, they’re probably looking at a slower borrowing uptick and using their own cash first going into the 2009 cycle. So we feel pretty strong about the ag industry and the customers that we’re dealing with in that particular area.
J. Thomas May
We have some catfish farmers and certainly that’s an area that we’re continuing to monitor. They’ve had three good years but certainly that could be a challenge for us. Not for us as much as for the farmers. And we believe that will be okay, also. I guess moving over to the next area, if you would like for me to talk a little bit about the credit card piece.
Matt Olney – Stephens, Inc.
That would be great.
J. Thomas May
On the credit card piece, as you know, as we have mentioned in the press release, and in our conversation, that our loss ratio, we have gone from 1.8% to 2.02% and you will remember from our previous discussions that we have expected to see that increase begin to move north. Quite honestly, it did not for a good period of time. And with our portfolio of $165.0 million that is nation-wide, we fully expected this to happen.
In fact, we are reserving at a level of about 2.4%. As we have gone in and we have tested the portfolio, meaning when we have a bankruptcy, when we have a loss, and we have gone in and we have tested that, what we have determined is the metrics we have been using are still very sound, still very solid and we think that our underwriting standards will hold us in good stead, even through this period of turbulent waters in the recession.
We are certainly not burying our head relative to that portfolio but I would remind you, which I know I don’t need to do, that you know about it, but we have been in this business since the mid-1960’s and the reason that we have been able to maintain the loss ratio, we believe, in the low to mid-2s over a period of historical time is because that we don’t just credit score, that we in fact do underwrite. And that has been a big part of our success, we believe.
Now I guess from there, I’ve talked about the regions, I’ve talked about the two niche pieces of the portfolio, I guess I would stop to see if you have anything else you would like for us to expound on.
Matt Olney – Stephens, Inc.
I think you provided good detail but I want to transition that over to another comment you made in your prepared remarks regarding the provision in 2009. I believe you said we should expect a provision in 2009 similar to provision in 2008, excluding the special provisions allocated to Northwest Arkansas in 2008. Did I hear that correctly?
J. Thomas May
I think you heard it all except the part I may have mentioned is that if you were trying to anticipate what that provision might be in 2009 that in all likelihood you could take that 2008 number minus the special provision that took place in the fourth quarter in 2008 and that would be a number to look at.
Matt Olney – Stephens, Inc.
And that includes an assumption made by you that charge-offs in the credit card portfolio will continue to increase throughout 2009, is that correct?
J. Thomas May
I think that the assumption would be that the provision would have taken into consideration that the credit card charge-offs could move up as high as 2.2% to 2.4% from where they are right now at 2.02%.
Matt Olney – Stephens, Inc.
And if I could transition over to the TARP discussion. I believe you mentioned that you plan on taking the TARP capital assuming that you can use those funds for M&A purposes. Is that still an assumption that you feel is fairly accurate, that once you are eligible to receive the capital from your shareholders that that is something you will take?
J. Thomas May
That’s right. And we have certainly said publicly, even in the news media, that our plans relative to the use of funds for TARP, a big part of that would be believing that there would be some merger and acquisition opportunities along the way and that we want to position ourselves to take a good hard look at that. And we have provided the 60-day notice. February 27 is the day that we have our special meeting. If that were approved we would be able to draw down the TARP money. We don’t like to say TARP, we like to say the CPP money, the Capital Purchase Plan. We would be able to draw that down, I think sometime between seven and ten days after that so that would put it in the first week of March.
Now, obviously, one of the things we know in this process is that we do not have to draw it down. And probably the only thing that would keep us from drawing all of it down would be if there is some change relative to how you can use those dollars. We’re pretty comfortable and pretty confident that we’ll be okay in that respect.
I would also say that if we take those dollars down and we do not find an M&A opportunity, we feel like another big piece of that is obviously having high levels of capital that we can continue to do what we have done very, very well and that’s to continue to loan money.
One of the things that those TARP dollars will allow us to do is to continue to serve the students throughout Arkansas. As you know, we underwrite $50.0 million in student loans every year and right now our plans are to sell those to the government in September of next year. But again, having those TARP dollars gives you opportunities, if you wanted to do something with those, would be to expand those activities, which I think is very important.
So M&A is a big part of it. Certainly expanding and meeting loan demands in different areas, including the student loans would also be an important use of it.
Matt Olney – Stephens, Inc.
As far as the margin outlook, you mentioned near-term pressure. Can you give an idea of the rates of the CDs that are maturing, that are rolling off your books, and maybe kind of the dual rights that you have out there right now that are being renewed? And also the Federal Home Loan Bank or some other forms of fundings, what the rates are of a security like that.
J. Thomas May
The CDs that are maturing right now are probably in the 3.25% to 3.5% range. The CDs that are currently maturing in our portfolio. The problem on the deposit side is that outside of those CDs, when you look at the other deposit accounts that we have, those have pretty much been priced down to the floor that the market will allow. Not only in our bank but probably most the banks around.
And then on the CD side, while there is more a return to rational pricing, that rational pricing still could range from 2.25% to 3.25% depending on whether it’s a community bank or a regional bank doing business here. So the cost side is still pretty expensive when you can only invest your excess liquidity at a 50 basis points or so.
From the margin standpoint and the squeeze that we’re talking about, I think it can be summed up this way. I think from the standpoint of the loan pipeline, while we are projecting a loan pipeline to approximate the same level as last year, a large portion of that comes into the student loan piece of that, which carries a lower net yield.
I think also as with interest rates being at, I can’t even remember how many year lows, but certainly beyond 50 years, what we are also on the good side is we’ve got a floor on our floating rate loans, which is about 35% of our loans, we’ve got a floor on the floating rate loans and I think about the bulk of everything has already gone as low as it’s going to go there.
So the loan side is not as challenged as it is the security portfolio side. And in the securities portfolio it’s not the normal maturities. It would be the calls. If we have a significant level of called securities and then we start having to reinvest those, then those securities are coming off the books. As you can see, our investment portfolio yields about 5%. But if they’re coming off of that 5% or 4.5% but based on calls and having to be reinvested, you’re looking at 165, 170 with a three month call, that’s not very exciting.
So that’s where we see the real compression. The calls may not all take place and it might work out a little better than we have projected. We do see margin compression for that reason, as far out as we can see in 2009. But certainly we don’t necessarily see that being at the same level as the Q4 2008 over Q4 2007. Somewhere probably south of there.
Matt Olney – Stephens, Inc.
The student loans in Q3 2009, do you still expect those to be sold? Are we still thinking about $130.0 million?
J. Thomas May
We would not sell that much. We keep about $90.0 million in the portfolio. We are holding over $50.0 million. So we will end up somewhere $130.0 million and $140.0 million in the portfolio. So we will only be selling about $60.0 million of that. The rest we will continue to hold because it has not gone into payout. The only thing that we can really sell are the things that we originated in 2008 and 2009.
Robert A. Fehlman
We typically originate about $50.0 million to $54.0 million a year. Next year we are projecting an increase, probably $65.0 million for the 2008, 2009 school year. And as Mr. May said, that’s what we can sell next in the third quarter of 2009.
There are no further questions in the queue.
J. Thomas May
Thank you very much. We appreciate you taking time to be with us.
This concludes today’s conference call.
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