AMCORE Financial, Inc. Q4 2008 Earnings Call Transcript

AMCORE Financial, Inc. (AMFI)

Q4 2008 Earnings Call

January 22, 2009 12:00 pm ET

Executives

William McManaman – CEO

Judith Sutfin – CFO

Donald Wilson – COO

Analysts

Jack Frank – Private Investor

Brian Martin – Howe Barnes

Stephen Geyen – Stifel Nicolaus

Bill Chen – Barrington Partners

Presentation

Operator

Good afternoon ladies and gentlemen and welcome to the AMCORE Financial fourth quarter and year end conference call. (Operator Instructions) This conference call is also being webcast and can be accessed at www.amcore.com, and will be archived for an additional four weeks.

Statements made in the course of this conference call stating the company's or management's intentions, hopes, beliefs, expectations or predictions of the future are considered forward-looking statements. It is important to note that the company's actual results could differ materially from those projected in such forward-looking statements.

Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained from time-to-time in the company's SEC filings and within the press release itself.

Conducting the call today will be Mr. William McManaman, Chief Executive Officer, Mr. Donald Wilson, Chief Operating Officer, and Ms. Judith Sutfin, Chief Financial Officer.

I will now turn the call over to Mr. McManaman.

William McManaman

Good afternoon. We appreciate the time you have taken to listen to this conference call and welcome questions from our analysts at the end of Donald’s comments.

We assume that you have seen a copy of the press release we issued earlier this morning and if not you can find a copy on our website at www.amcore.com. We all recognize that this is a very difficult and weak economy, especially for banks. The economic recession continued to deepen in the fourth quarter and the financial services industry experienced unprecedented pressures.

Our fourth quarter results reflect the continued deterioration of the economic environment which has been particularly challenging for commercial real estate loans, to builders and developers. Many of these builders and developers carry extended housing inventories in a weak market placing an escalating strain on their liquidity as conditions worsen.

As a result an unprecedented number of builders and developers reached their threshold for shouldering that financial strain in the last three months of the year resulting in a significant increase in our nonperforming loans for the quarter.

Overall we are very disappointed with our financial performance for the quarter and for the year especially as a company that has set a high bar with a 98-year history of delivering solid results. Despite the tough economic conditions and our reported losses we are well capitalized with nearly $411 million in regulatory bank capital, and we are committed to meeting the financial needs of our customers during this difficult period.

Aggressive steps have been taken across the board from industry leaders to government officials to right the ship and address this unprecedented business climate. We are hopeful that these actions will help the economy to recover more quickly and the financial industry will rebound with it.

But we also recognize that we have to do everything we can to be resilient in this market by continuously adapting to changing conditions. Rest assured that we are committed to doing whatever is needed during these challenging economic times to provide AMCORE and its customers the stability and security necessary to manage through further market uncertainty,

Before I turn the call over to Judith and Donald, I would like to talk about our strategy for getting us back on track and highlight some of the key actions we took during the quarter. Given the state of the economy today prudent management of capital has been increasingly important and we are focused on taking preemptive action to provide further strength and stability in this uncertain market.

During the quarter we continued to actively manage the bank’s capital and liquidity and added to reserves when loans became further stressed. As you know loan loss reserves and bank regulatory capital provide the cushion against which losses are charged and the two combined now total $501 million.

Given that we are seeing unprecedented changes in the market we are constantly monitoring these changes as we evaluate our probable losses and we are setting aside reserves to give us cushion for the future. As you know we also suspended the quarterly dividend in November to preserve capital.

We are still operating with our shareholders’ interest in mind but our decision reflects a more conservative position. During the quarter we continued to extensively explore capital-raising activity to provide further strength and stability. While we cannot provide specific details on these efforts I can tell you that we continue to actively evaluate all available opportunities and resources and will take actions as appropriate to best serve our shareholders, our clients, and our business.

As new economic challenges emerge, we have also implemented further improvements to the credit processes during the quarter. We enhanced the credit administration and underwriting functions with additional expertise and personnel including the redeployment of personnel to asset protection from revenue production.

Donald will provide more insight into these changes in a few moments. An ongoing imperative for AMCORE continues to be expense management. We achieved our expense reduction objective and reduced our pre-provision, pre-FDIC insurance operating expenses by 4% in 2008.

The most significant cost savings compared to a year ago include a $6 million reduction in personnel costs, $1.3 million reduction in advertising and business development expense, and $400,000 reduction in IT processing expense.

We will continue to closely manage our expenses and review the performance of all of our operations. Finally I would like to come back to something I mentioned last quarter which is the reaffirmation of our one bank strategy, we’re serving our customers across all our lines of business.

Put simply, the one bank concept is a focus on leveraging the combined expertise of our organization and our people across all our lines of business to better meet our customers’ financial needs and goals. The best way to understand the one bank concept is to see it in action. For example, the owner’s of a local manufacturer in one of our core markets have been a private banking client for over 20 years.

Through collaboration among our lines of business we have grown that relationship to include credit and deposit services for the business, mortgage services for the owner’s family, retirement planning, and 401-K services for the employees.

One of our key strengths as a full service community oriented bank is our ability to truly partner with our customers especially in challenging economic times. The strength of our customer relationships is one of our greatest assets and there is opportunity to help them across many of our lines of business. This continues to be strategic imperative for us in 2009.

Our well deserved reputation for customer and community service has always been an important driver of our business and a strong competitive advantage. As a result our core customer base remains solid and serves us well going forward as we strive to build consistency across our footprint.

Now I would like to turn the call over to Judith for a discussion of our financials.

Judith Sutfin

Thank you William, the challenges facing our economy and industry today are broad and deep and have not yet shown signs of abating. As you just heard AMCORE’s challenges are concentrated in the commercial real estate sector particularly with development loans to builders and developers.

Our fourth quarter loss per diluted share was $1.42, this compares to a loss of $0.79 reported in the previous quarter and earnings of $0.33 in the same quarter a year ago. The loss for the fourth quarter was primarily driven by a nearly $58 million provision for estimated loan losses related to the decline in credit quality.

First we’re going to start with a brief review of the major components of the income statement and then we’re going to focus our attention on the underlying credit metrics. So let’s look at the margin or net interest income.

Margin income decreased from the previous quarter by $5.3 million and was down $12.2 million from the year ago quarter. There are three primary causes of this reduction. First during the quarter we reversed approximately $2.4 million of interest income which corresponds to an increase in non-accrual loans of approximately $114 million quarter over quarter.

Second, the cost of funding the increased pool of non-accrual loans placed a drag of approximately $3.6 million on the margin for the quarter. This represents and increase of approximately $890,000 quarter over quarter.

Third we have shrunk our credit portfolio by 3% year-over-year and are actively managing our exposure. This reduced our margin income by approximately $9 million. The margin statistic for the quarter was 2.37% down 39 basis points from the previous quarter and down 91 basis points from the year ago quarter. Most of the decline from the last quarter was due to the effects of the funding cost of the large pool of non-accrual loans which amounted to seven basis points and the reversal of interest on non-accruals recognized during the quarter of 12 basis points.

We have also built a prudent level of cash reserves to provide additional liquidity to the organization and this has further weighed on the margin statistic. The next category to discuss is non-interest income.

This quarter’s non-interest income decreased 7% compared to fourth quarter 2007 and decreased 16% compared to the third quarter 2008. There are two primary causes. The first investment management revenues have declined consistent with the deterioration and market values of the underlying portfolios and second service charges have declined as customers started to curtail spending during the quarter.

Additionally the decrease for both periods included higher negative derivative mark-to-market adjustments of $967,000 in fourth quarter which is included in other non-interest income. Moving on to our non-interest or operating expenses, operating expenses were flat compared to the year ago quarter but increased $2.6 million compared to the previous quarter primarily due to credit related costs.

The higher credit costs included higher loan processing and collection expenses of $1.1 million compared to the same quarter a year ago and $888,000 compared to the previous quarter and increased reserves for unfunded loan commitments of $1.4 million compared to the same quarter a year ago and $1.2 million compared to the third quarter 2008.

Additionally we had increased FDIC premiums of $1 million compared to the same quarter a year ago and $154,000 compared to the previous quarter. On the positive side our efficiencies continued to be a major focus. Last year we set forth an objective for a 3% per year reduction in our pre-provision, pre-FDIC insurance operating expenses for 2008.

We reached a 4% reduction in expenses when you exclude the unusual items in 2008 such as the $6.2 million write-off for goodwill, a reserve for unfunded commitments of $4.8 million, and FDIC insurance premiums of $3.6 million.

Our objective is to continue our cost savings initiative toward the goal of sizing our expenses to be consistent with our revenue stream. From a balance sheet perspective average loans were flat from the previous quarter and down $132.2 million from the same quarter a year ago. The ongoing effort to decrease our exposure to commercial real estate continues to be a significant headwind to any growth in earning assets, specifically commercial real estate loans declined $136 million from a year ago and $11.5 million for the quarter.

This reduction was net of the $44.2 million commercial real estate related charge-offs in the quarter and the addition of approximately $55 million of converted letters of credit backing up variable rate demand notes previously off balance sheet.

Average bank issued deposits fell $159 million during the quarter. The decline in bank issued deposits is due to fluctuations in certain public fund accounts and institutional clients moving from unsecured to secured [sweep] accounts which are classified as borrowing.

The average balance of the investment portfolio decreased approximately $35.9 million during the quarter but increased by $30.5 million on a period end basis. The increase at period end was driven by a very short-term treasury bill purchased to hold over the year-end period. We expect the size of the portfolio to be flat to declining in the current market environment although it may fluctuate a bit quarter-to-quarter primarily due to timing of settlements.

Additionally we do not have an impairment charge on any investments we currently hold in our portfolio given that 80% of the portfolio is in agency guaranteed or rated AAA. Detail on the portfolio is under presentations in the Investor Relations section of our website.

The increased [inaudible] in the economy and financial markets make the retention of capital a key consideration that we take very seriously. We ended the quarter with a total capital ratio of approximately 10.14% for the bank. All of our current capital ratios remain above the well-capitalized levels.

Next, as promised let’s turn our attention to credit conditions. There are three major topics to address. First what type of deterioration have we seen in market conditions? Second, how has that deterioration manifested itself in our credit portfolio? And third how have we responded to this deterioration through our charge-off levels and reserve balances?

We have been actively reappraising our commercial real estate portfolio getting new appraisals on $1.6 billion of property value during 2008 with the majority being done in the last six months of the year. We have seen approximately a 20% to 40% deterioration in average appraised values across the residential development market in our footprint and approximately a 10% deterioration in the broader non-residential commercial real estate sector.

While initial underwriting standards built in a loan to value cushion at inception these new appraised levels have forced a recognition of not only the decreased values, but also the liquidation cost associated with expected resolution of the properties. Additionally there were several circumstances of developers who had been supporting their payments through personal resources who no longer decided to maintain such support during the quarter.

As a result of these conditions we saw nonperforming loans rise $121.7 million from the previous quarter. Construction and land development loans represent about $364 million or 12% of total commercial loans outstanding and 10% of total loans. Of these loans approximately 25% or $92 million are currently in non-accrual status.

Vacant land loans represent about $254 million or 9% of total commercial loans outstanding and 7% of total loans. Of these loans approximately 26% or $66 million are currently on non-accrual status. Together these two portfolios represent 52% of our non-accrual commercial loans and 50% of our specific allocations made in the determination of our loan loss allowance levels.

This is illustrated in charts under Presentations in the Investor Relations section of our website.

In response to this deterioration we charged off a net $55.9 million during the quarter which was $29.2 million more then the previous quarter’s level and $51.1 million more then was charged off in the year ago quarter. Approximately $35 million of these charged off loans were to developers of residential real estate properties.

Our increased provision brings our ending reserve to 3.6% of total loans compared to 3.54% in the previous quarter and 1.35% in the year ago period. It is important to note that we built reserves by $83 million from a year ago and this increase was after taking almost $100 million of charge-offs during the year and despite a loan portfolio reduction of $147 million.

The resulting level of reserves recognizes the deterioration in loan quality that developed during the course of the year. We provided for this deterioration as events unfolded during the year although the nonperforming metrics did not fully reflect these weaknesses until the fourth quarter.

The foreclosed property balances were $17.1 million, an increase of $6.5 million from the previous quarter. This represents the amount we expect to realize upon the sale of the properties.

Finally delinquencies which include loans more then 30 days past due, are down 1% or $482,000 quarter over quarter. We have been disappointed to find in this unprecedented economy that declining delinquencies have not been a reliable indication of an expected pipeline for nonperforming loans.

I would now like to turn the call over to Donald Wilson.

Donald Wilson

Thank you Judith, today I would like to talk about several operational strategies and also give you an update on some of the ongoing projects that I have talked about on our prior calls.

First we are substantially lowering our exposure to non-strategic, non-relationship based accounts. Far too much of our balance sheet has been concentrated in single service accounts, especially in investment real estate loans. We are committed to a material reduction in these balances over the next few months.

Second we have redeployed one of our senior commercial managers to a special assignment to materially enhance our portfolio management efforts and credit monitoring processes. He reports directly to the Chief Credit Officer.

Third we also continue to add staff and resources to the special assets or workout unit, to assure that we are relentlessly pursuing successful resolution of nonperforming credits. While we are pleased with the activities in this unit the cost of resolution and more specifically the time to resolution continue to be higher and longer then during more stable times.

Fourth we have continued to right size the organization with more then an 11% reduction in full time equivalent positions since the beginning of 2008.

Fifth going forward we will only hire for essential positions critical to our operations.

Sixth, as William mentioned, we are actively pursuing opportunities to enhance our capital position through a variety of means including the reduction in non-relationship assets mentioned earlier.

Seventh we have elected to participate in the FDIC transaction account guarantee program which gives additional piece of mind to our deposit customers by providing unlimited insurance on non-interest bearing transaction accounts through the end of this year.

Eighth consistent with our emphasis on deep customer relationships we have integrated our trust and investment group into the main bank charter. This added more then $8 million of capital to the primary banking unit and more efficiently uses the capital of the organization while allowing us to serve our customers with greater operational clarity.

Ninth we have built liquidity reserves ending the year with more then $75 million of excess liquidity to maximize funding stability as the environment continues to shift. We are managing the process of restructuring this balance sheet, substantially improving the disciplines and culture of the organization, identifying, and dealing with weak asset quality in an environment that continues to deteriorate.

We cannot predict the future but remain steadfast in our commitment to supporting our customer relationships and their financial needs through this difficult environment.

We are now ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Jack Frank – Private Investor

Jack Frank – Private Investor

Are we expecting to receive any government funds to help stabilize to the issues that we have?

William McManaman

Let me try to take that one and I’ll make comments across the board with regard to both capital and TARP. I think we said in our comments that we have been and we continue to actively and extensively pursue all capital raising activities available in today’s marketplace. And let me reemphasize the words actively and extensively and all in that comment.

Let me also say that we like most public companies have not made public any comment regarding TARP or TARP applications or TARP discussions. Most banks as you probably know have considered the terms and conditions of TARP and looked upon it very favorably in today’s marketplace. There have also been many announcements by banks regarding TARP that have been made and have been concluded but there are also many that are still pending in today’s marketplace.

Those are really all the comments that I can make with regard to our capital raising activities and TARP or any other government program.

Operator

Your next question comes from the line of Brian Martin – Howe Barnes

Brian Martin – Howe Barnes

The absolute level of regulatory capital, do you have what that is? The $411 from the press release is that bank only or is that holding company?

Judith Sutfin

Its bank only.

Brian Martin – Howe Barnes

Do you have what the holding company is as well?

William McManaman

Not right in front of us. I don’t have it in terms of dollars right now.

Brian Martin – Howe Barnes

In percentages, it is 10% as well?

William McManaman

It is north of 10%, yes.

Brian Martin – Howe Barnes

Can you just talk about the reduction in assets going forward, you talked about the single service accounts and maybe give a little color on what you’re looking at there and quantify that to some degree and maybe just talk a bit about any type of asset sales that would may be likely or are you even considering them at this point or a possibility.

William McManaman

There’s a range of things. As, actually we’ve talked about for several quarters we’ve been clear that one of the problems with managing through this balance sheet and this environment is a grossly excessive concentration in commercial real estate and even more specifically in resi development loans as a subsector.

Obviously we’ve not been making more of those particularly on the resi development side, but really it comes time to make sure we actively pursue moving out of those things. Where you don’t have a relationship with the customer, you’ve made a loan that you’re excessively concentrated in, you want to make sure that you do everything you can in order to rebalance the portfolio. So you saw there was a loan sale back in the third quarter. We are always looking at that. Right now that environment is not particularly attractive.

But nonetheless we always look at that. At the bottom line right now is where we’re trying to do is find ways to best maneuver the balance sheet in order to reduce the proportion of concentration in commercial real estate and particularly investor based commercial real estate so that we can make sure that we are always having the capacity to meet the real needs of our ongoing relationship customers which is why we’re actually in business.

Brian Martin – Howe Barnes

Can you give a little color on the charge-offs in the quarter, just the concentration. I thought you said, was it $40 million that were commercial real estate?

Judith Sutfin

It was $44 million that were commercial real estate related of the total $56 million. And we also have the holding company regulatory capital number for you, its $408, and its also north of 10%.

Brian Martin – Howe Barnes

Okay and these mark-to-market adjustments, can you give a little color as far as are those non-recurring in nature or just as you look forward is that kind of a one-time in this quarter or, the derivatives marked.

William McManaman

Yes, that’s actually one of those things where the economic hedge is solid. You’re going against its actually a hedge against a portion of BOLI portfolio.

Judith Sutfin

One side is marked, the other side is not marked.

William McManaman

Exactly right, so economically the hedge is in pretty good shape but unfortunately accounting you get some volatility one way or another. So no I can’t promise that it never happens again but its as likely to revert over time, it actually has to at this point, revert over time to par because of the economic value being of a pretty good hedge.

Operator

Your next question comes from the line of Stephen Geyen – Stifel Nicolaus

Stephen Geyen – Stifel Nicolaus

Over the last couple of quarters the 30, 80, 90-day delinquencies were coming down, I’m just wondering if you could quantify where the big jump in NTLs came from, was it delinquencies, migration of lower credits or just some loans dropping on the doorstep so to speak.

William McManaman

Yes.

Judith Sutfin

All of the above.

William McManaman

Judith’s remarks mentioned that we have not seen that delinquency as particularly good forward indicator of things. It obviously has some value in that regard but clearly in the fourth quarter we gave you a couple of examples where we talked about some developers who had been supporting the credit beyond the level of cash flow of the project coming to the conclusion in the fourth quarter that they were no longer going to continue to do that.

And so you have all three of the categories that you just referred to that are occurring so some of it is potentially at least the passing of the calendar with regard to the delinquencies, but it also fits in with the other two categories as well.

Stephen Geyen – Stifel Nicolaus

The consumer loans were up again this quarter, I guess it’s a trend if you look back over the past year, what [part] of the consumer loans are you seeing the growth in.

William McManaman

Some home equity, there’s also been some indirect auto business. All not only prime but very solid prime business.

Stephen Geyen – Stifel Nicolaus

And the customer service fees, was there one type of fee that was down more then the other during the quarter?

Judith Sutfin

Yes, it was primarily ATM and ODCs that were down.

Operator

Your next question comes from the line of Bill Chen – Barrington Partners

Bill Chen – Barrington Partners

In terms of brokered CDs could you give some color how much you have, what percentage of deposits, etc.

William McManaman

We think about brokered CDs as an important component of funding of any balance sheet. What we’re trying to do is make sure that we’re using them as a long-term source of funding so we’re not in very short-term brokered CDs and we’re also making sure we price that competitive with what’s available in our local markets. So you’re not out there paying a high premium for them so you want to be cautious in terms of people’s, how they think about the use of brokered CDs. Essentially you’re renting somebody else’s distribution channel in order to be able to distribute those CDs at attractive rates.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

William McManaman

I want to give you the answer, a total brokered CD and wholesale deposits in aggregate comes to $1.081 billion. So hopefully that answers that question.

We appreciate everybody taking the time for the call. We thank you for your attention. Good day.

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