AMCORE Financial, Inc. Q1 2009 Earnings Call Transcript

AMCORE Financial, Inc. (AMFI)

Q1 2009 Earnings Call Transcript

April 28, 2009 12:00 pm ET

Executives

Bill McManaman – Chairman & CEO

Judith Carre Sutfin – EVP & CFO

Analysts

Chris McGratty – KBW

Brian Martin – Howe Barnes Hoefer & Arnett Inc

Presentation

Operator

Good morning, ladies and gentlemen. And welcome to the AMCORE Financial first quarter earnings result conference call. At this time, participants are in a listen only mode. Later we will conduct a question-and-answer session for analysts only. Please note that this conference is being recorded. This conference call is also being webcast and can be accessed at www.amcore.com, and will be archived for 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 result 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, and Ms. Judith Carre Sutfin, Chief Financial Officer. I’ll now turn the call over to Mr. Bill McManaman. Mr. McManaman, you may begin.

Bill McManaman

Thank you, and good morning. We appreciate the time you’ve taken to listen to this conference call, and welcome questions from our analysts at the end of my comments. We assume that you have seen a copy of the press release we issued last night. If not, you can find the copy on our Web site at www.amcore.com.

We all recognize that this continues to be a very difficult and weak economy, especially for banks. The nation is experiencing one of the worst economic recessions in decades. Unemployment rates hit 25-year highs, consumer confidence has plummeted, and foreclosures are climbing to their highest levels in years.

Our first quarter results reflect the continued deterioration of the economic environment, and our concentration in construction and development loans. Many of these builders and developers carry extended housing inventories in a weak market, placing an escalating strain on their liquidity as conditions have worsened. These conditions have not yet abated and continued to have an impact on our financial performance.

It should come as no surprise that these unprecedented economic conditions demand new ways of operating. The bank’s infrastructure, specifically our operating expenses in relation to the assets we manage, the revenue we generate, and our expected growth rates, was built for more expansionary economy. Put simply, our annualized operating expenses of roughly $175 million were too high for the realities of today’s marketplace.

We made progress in 2008, reducing our cost by $6 million on a gross basis. This involved an 11% reduction in work force, in addition to other administrative and consolidation changes to decrease expenses. Some of these savings were offset by significantly higher FDIC premiums and increased loan collection costs.

We announced significant organizational changes last night that better align the size and management structure of our organization with the current economic environment. We were not able to act sooner with respect to these changes until we had demonstrated that we had made substantial progress in improving our lending processes and disciplines. The changes announced today streamline the organization, but will not compromise the disciplines, controls, and improvements implemented over the past year.

We are working on those things that we can control. From yesterday’s announcement, you know we eliminated an additional 116 positions, including two executive positions, that of Don Wilson, President and Chief Operating Officer, and Rick Stiles, Executive Vice President, commercial banking. The company is grateful for their services and contributions to AMCORE.

We also eliminated merit increases for all employees, reduced executive salaries 5%, decreased the company contribution to the 401-K plan, and modified our branch hours to more closely align with customer usage. In the second quarter we expect to take an estimated restructuring charge of $2 million, for severance and related costs. We expect annual savings of approximately $20 million from these actions.

The total annual cost reductions from changes made during the last five quarters now approximate $26 million. This will have significant benefit for the company going forward.

Our reorganization not only reduces our cost structure, but also eliminates one layer of management and two layers in the commercial line of business. We believe this will serve to accelerate decision making in the bank, and make us a more disciplined, flexible organization, capable of adapting quickly to changing conditions. We recognize that 2009 will continue to be difficult for our nation, industry, and AMCORE, but have been working steadily towards building an organization that is more streamlined and disciplined to weather a variety of economic circumstances.

We believe these actions serve the best interests of our shareholders, our customers, our employees, and our business. Now, I would like to turn over the call to Judy for a discussion of our financial stables.

Judy Carre Sutfin

Thank you, Bill. And good morning. As you’ve just heard, our economy has not just recovered, our industry is under particular stress, and our organization continues to be challenged by our concentration in the commercial real estate sector, particularly with loans to builders and developers. Because of these factors, and because of our commitment to our customers, our share holders, and our employees, we took strong actions to address the earnings gap.

Our first quarter loss per diluted share was a $1.34. This compares to a loss of $1.42 reported in the previous quarter, and the loss of $1.21 in the same quarter a year ago. The loss for the quarter primarily driven by three factors; number one, a $62 million provision for potential loan losses related to deteriorating credit quality, particularly with construction and development loans, number two, the impact on margin revenues of carrying $402 million in non-performing loans, and number three, margin compression from the cost of maintaining a more highly liquid balance sheet that helps us to better serve our customers by holding over $600 million in cash on hand and other liquid assets.

I will go into each one of these areas in more detail as I review the major components of the income statement, ending my comments with the focus on our underlying credit metrics. Starting at the top of the income statement, let’s look at the margin on net interest income. Margin income decreased from the previous quarter by $405 million, and was down by $14.2 million from the year ago quarter.

There are two main causes for this reduction. First, we actively reduced our credit portfolio by 5% percent, quarter-end over quarter-end as part of an overall effort to reduce our exposure to non-strategic, non-relationship based accounts. The impact of shrinking our balance sheet, reduced our margin income by approximately $2.4 million, compared to the prior quarter.

Second, we built over $600 million in cash equivalents and highly liquid assets as a liquidity cushion. The cost of holding this liquidity and the cost of obtaining term funding further reduced our margin income by $2.2 million, compared to the prior quarter. In times of stress, we believe substantial liquidity is the lifeblood of a banking organization.

The margin’s statistics for the quarter was 1.94%, down 41 basis points from the previous quarter, and down 118 basis points from the year ago quarter, driven primarily by the factors just noted in addition to the cost of funding, the increased pool of non-accrual loans.

The next category to discuss is net interest income. This quarter’s non interest income increased 26% on a linked quarter basis, and increased 20% percent compared to the first quarter 2008. Security gains of $6.9 million accounted for the majority of the increase from last quarter and last year. This gains helped us to improved liquidity, optimized capital usage, and capture gains jeopardized by the risk of prepayment.

Additionally, mortgage revenues increased $311,000 over last quarter, associated with higher production and the lower rate environment. Substantially, all our production is sold to third parties on a non course basis, and therefore consumes neither capital nor liquidity,

Offsetting security gains and increased mortgage revenues, plus a decline in investment management revenues consistent with a deterioration in market values of the underlying managed portfolios. Additionally, service charges have declined 21% or $1.7 million as consumers have curtailed spending during the quarter, especially with overdraft and ATM fees declining compared to the prior quarter.

Moving on to our non interest or operating expenses, these were down by $5.4 million or 12% compared to the year ago quarter, and down by 4% compared to the previous quarter. This reduced level of expense is the reflection of our focus on efficiencies launched at the beginning of 2008. Our objective has been, and will continue to be, to size our expenses consistent with our revenue stream.

To date we have done this through a three-pronged focus on automation, under management, and better resource alignment. Our expenses are down significantly despite higher collection costs and FDIC premiums. From a balance sheet perspective, total period and loans were down $195 million or 5% from the previous quarter, and down $312 million or 8% from the same quarter a year ago.

With commercial real estate loans accounting for the majority of the decrease at $104 million from the previous quarter, and $241 million from a year ago. This reduction includes $26.2 million in commercial real state related charge offs in the quarter. Average bank issued deposit increased 6% over the last quarter, with particular emphasis on the continued growth of intermediate time deposit products in response to customer demands to lock in higher rates in a falling rate environment.

Non-interest bearing deposits also showed growth as a result of an increased focus on commercial balances and our participation in the unlimited guarantee program for non-interest deposits. The 9% year-over-year declined in bank issued deposits is in part due to fluctuations of certain public fund accounts and institutional clients moving from unsecured to secured sweep accounts, which are classified as borrowing.

The other portion of the decrease is due to customers’ change in behavior. The average balance of the investment portfolio decreased approximately $121 million during the quarter, but increased by $111 million on a period end basis. The increase of period end was driven by very short term Treasury bills purchased as a short-term store of liquidity. We expect the size of the investment 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 another than temporary impairment charge on any investments we currently hold in our portfolio, given that 86% of that portfolio is agency guaranteed or rated AAA. This is reflective of our improvement investment philosophy, we did not pursue security backed by subprime or alternative aid mortgages. And we did not purchase mezzanine tranches of securitization. Details on the portfolio is in the presentation section of the investor relations section of our Web site.

We ended the quarter with a total capital ratio of approximately 8.8% for the bank, which is categorized as adequately capitalized. Because current regulatory rules limit the amount of loan loss reserves and deferred tax assets includable in these ratios, they do not reflect AMCORE’s full ability to absorb potential future credit losses. We are limited to the inclusion of reserves of only 1.25% of risk weighted assets, and only one year of usable spurred taxes. If these amounts we added to our regulatory calculations, our total capital ratio would be closer to 13% as illustrated in the presentation section in the investor relations portion of our Web site.

In recent weeks, the American Bankers Associations and various government officials have called for the loan loss reserve limitation to be removed. We remain adequately capitalized under applicable regulatory guidelines. As the result of this designation, we will be subject to increased borrowing and funding costs, and access to certain wholesale funding will be limited. Our treasury management group has been implementing a funding strategy over the past few quarters to strengthen our liquidity position, and we currently maintain over $680 million in cash equivalents and other liquid access to respond to these constraints over the short term.

Next, as promised, look to our attention to credit conditions. As we did last quarter, we will address three major topics. First, what type of deterioration have we seen in the market conditions? Second, how has that deterioration manifested itself in our credit portfolio? Third, how well we’ve responded to this deterioration?

We have continued to order updated property evaluations, and we conducted more than three times our normal volume for the quarter to ensure that we continue to properly value our real estate portfolio. This translates to an additional $269 million and real estate’s evaluation and appraisal, on top of the $1.6 billion executed during 2008. As a result, we have seen approximately 10% to 40% deterioration, and average appraised values across the residential development market in our footprint over the past five quarters, and approximately 10% deterioration in the broader non-residential commercial real estates sector.

As a result of these conditions, we saw non-performing loans rise $89 million on a net basis from the previous quarter. Construction and development loans represent approximately $577 million or 21% of total commercial loans outstanding, and 16% of total loan. Of these loans, approximately 40% or $227 million are currently on non-accrual status.

This portfolio represents almost 60% of our non-accrual commercial loans, and almost 80% of our specific allocation made in the determination of our loan loss allowance level. Commensurate with our efforts to manage down our exposure, the balances in this portfolio have decreased by 24% year-over-year. This is illustrated in the chart under presentations in the investor relations section of our Web site.

In response to this deterioration, we charged off $34.6 million during the quarter, which was offset by the recovery of $1 million. Approximately $16.8 million of these charged off loans were to construction and development borrowers. Even at today’s depressed value, the demand for residential development loans continues to be weak. Although we have started to see pockets where the deterioration has slowed. This is evidenced by the settlement of approximately $21 million in commercial non-performing assets at a slight gain of $500,000. While the renewed interest has not yet translated into significant sales, activity in the first quarter exceed the pace and settlements executed in all of 2008.

Our increased provisions bring our ending reserves to 4.61% of total loans compared to 3.6% in the previous quarter, and 2.48% in the year ago period. The resulting reserve levels continue to recognize the deterioration and loan quality that developed during the course of the quarter. The foreclosed property balances were $15.2 million, a decreased of $1.9 million from the previous quarter. This represents the amount we expect to realize upon the sale of the port's [ph] properties.

Delinquencies, which include loans more than 30 days past due, are up $22 million quarter-over-quarter. Of these increased, two relationships accounted for $30 million. Without these two relationships, delinquencies would have declined by $8 million.

Now let me turn the call over to Bill to discuss the action steps that we are taking.

Bill McManaman

Thank you, Judy. Now I would like to talk about the progress we have made related to significant challenges that we have been addressing.

Our focus during the past five quarters has been in three primary areas. First, improving and strengthening our lending practices and disciplines in order to respond to deteriorating economic conditions, and to meet the requirements under the formal agreement our bank entered with the OCC in May 2008. Second, large loan loss provisions resulting from a loan portfolio with a heavy concentration in construction and development loans. And third, our capital position.

I’d like to review the beginning progress we made during the first quarter of 2009. First, our task in 2008 was to improve our lending processes and disciplines and swiftly implement these new practices across a portfolio that was nearly $4 billion in size and 10,000 loans. This was an extensive process and the topic we discussed frequently in our past conference calls is, we enhance credit and underwriting functions, strengthen the risk identification practices, and added expertise and resources.

Thanks to the efforts of our teams, the bank now has improved its funding, disciplines, and practices and is executing to them, both for the existing home portfolio and for the new loan originations. We, of course, view this as an ongoing process and will focus on continued improvement and development. We continue to work diligently to reduce the risk profile of our loan portfolio and continue to develop long, deep customer relationships.

Two, during the past five quarters, we have set aside over $265 million of provisions for potential loan losses, primarily due to concentration in construction and development loans. We also have made significant progress and substantial – substantially lowering our concentration in construction and development loans, primarily from our efforts to reduce our non-strategic, non-relationship based accounts, especially in investment real estate loans. Since last year, our exposure to these types of loans has decreased by $181 million or 24%.

And three, capital levels at many financial institutions this year, including AMCORE have declined as credit losses have increased and significant reserves have been established. As we reported, AMCORE’s capital ratio following the regulator’s rules and limitations indicates the bank is adequately capitalized. However, as Judy noted, a significant portion of the loan loss reserve and related taxes are excluded from the regulatory calculation of capital ratios. Without these limitations, AMCORE’s pro forma total capital ratio would be about 13%. Simply put, AMCORE’s capital position plus reserves remain substantial at over $500 million.

We continue to actively and aggressively pursue new capital opportunities to further build our capital base, although market conditions today make the timing of such opportunities uncertain. We recognize the current environment as traumatic for our shareholders, our employees, and the communities we serve. While we cannot control the economy, much less real estate valuations, we are committed to managing what we can control.

Strong balance sheet management, effective cost controls, and a focus on meeting the objectives of our customers, are the cornerstones of these efforts. We have begun to rebuild our deposit base, which increased at average balances of more than 6% in the first quarter and ties directly to our relationship building exercises. In addition, we originated $113 million in first mortgages that helped 710 customers to purchase or re-finance their homes during the first quarter.

We have a dedicated and experienced team devoting their time, talents and expertise to serve our shareholders, our customers, and employees, and we are taking action to turning this company around. At this point in time, I would like to open the lines for questions from analysts. Thank you.

Question-and-Answer Session

Operator

Thank you. We’ll now begin the question-and-answer session. (Operator instructions) Standing by for questions. Thank you. We have a question from Chris McGratty from KBW. Please go ahead.

Chris McGratty – KBW

Hi, good morning guys.

Bill McManaman

Good morning.

Chris McGratty – KBW

First question is on the deferred tax asset. I just find I need a little bit more explaining on slide seven. What is the current dollar amount of the DTA, and then was there an impairment this quarter? I see that you guys are excluding it from your capital calculations. Could you walk me through your math?

Bill McManaman

Chris, this is on slide seven?

Chris McGratty – KBW

Right.

Judy Carre Sutfin

Yes. Our deferred tax asset total is $80 million, Chris. And the regulatory rules for calculating these capital ratios limit us to what we could use in the – in a one year time period. Even though, GAAP and tax laws will allow us to go forward by 20 years.

Bill McManaman

The deferred tax assets that we’re talking about here, in large measure, relate directly to the loan loss reserves. Obviously, for book purposes, you book the losses as you estimate their occurrence. But, for tax purposes, you’re only allowed to deduct your charge-offs.

Judy Carre Sutfin

Right. So this is not GAAP. This is the regulatory calculations.

Chris McGratty – KBW

Okay. Maybe this is more color in terms of being able to use – we’ve seen a lot of companies increase their DTA given the losses. I was wondering, how are you thinking about – for you to realize that going forward is that – you’ll have to return the profitability. What’s your feeling on impairing the DTA going forward?

Judy Carre Sutfin

Absolutely. And that again, GAAP and tax rules will allow us to carry that forward. And, this will require us to return the profitability. This is the reason why we are taking the aggressive action on our expenses. This is the reason why we’re trying to reposition our portfolio and focus on customers with a wide variety of relationships that we can serve.

Chris McGratty – KBW

Okay. I guess my second question is on the changes that you made this quarter, the executive comp decline, headcount reduction? What are you going to speak to the broad speaking on the elimination of merit increases across the firm and just how the effect on morale, and how are you keeping these talented people?

Bill McManaman

Well, we have now decreased our total workforce 323 positions since the beginning of 2008, which is a substantial number in a service related organization. I don’t have to tell you that the banking industry today is in a crisis mode, and you have to move quickly.

As Judy indicated in her comments, the assets that we manage have shrunk, the revenue that we’re generating across our lines of business has declined, and these are actions that are difficult decisions to make, but are absolutely required in the situation that we find ourselves in, and the situation that the financial services industry finds itself in. It’s never happy to have reductions, to have 401-K reductions, to have merit increase eliminations, but it’s a sign of the times.

Chris McGratty – KBW

On that note, in terms of the changes, if – can you comment on whether these were exclusively your decision or were there any regulatory discussion, in terms of restriction?

Bill McManaman

There was no input at all with regard to the regulators, with regard any of these decisions. This was not – these were not performance based decisions. This was not the lack of performance by these individuals. This was in – steps taken to streamline the organization, to reduce it to the size requirements of today’s business.

Chris McGratty – KBW

Okay. And then in terms of replacing the senior management that was – the changes, how are you thinking about that?

Bill McManaman

We’re not thinking about that.

Chris McGratty – KBW

So you’re eliminating the CEO position?

Bill McManaman

That is correct.

Chris McGratty – KBW

My last question is on the comment on the ability to grow wholesale deposits. What – is this a dollar or a proportion portfolio that you can’t grow in excess of because of the adequately capitalized status? Can you help me with that?

Judy Carre Sutfin

Yes. No, there’s no clarity right now on that front, but there is no limitation on the dollar amount. We are exploring the brokerage market though, to understand what the implications here are.

Chris McGratty – KBW

Thanks.

Bill McManaman

Thank you.

Operator

Thank you. We have our next question from Brian Martin from Howe Barnes Investment. Please go ahead.

Brian Martin – Howe Barnes Investment

Hi guys.

Bill McManaman

Hi.

Judy Carre Sutfin

Hi Brian.

Brian Martin – Howe Barnes Investment

Hi Judy. Just going back to that capital, the $8.8 million, that’s the actual reported regulatory capital, right?

Judy Carre Sutfin

Exactly.

Brian Martin – Howe Barnes Investment

Okay. All right. Second, just a couple of quick questions, the balance sheet shrinkage that you guys saw this quarter, can you talk about what you’re expectations are? As far as for further shrinkage going forward and maybe what’s on the table there?

Bill McManaman

I think we’re – Brian, we’re going to continue to try to shrink those relationships that haven’t been a broad relationship across all of our business lines. Some of the loans that were generated while we were growing our footprint across Chicago land involved what I would call, event driven transactions.

Single events that we entered, that at that time were appropriate, but really weren’t what this bank was all about and the relationships that we have built with our customer base across all of our lines of business. So we’re going to continue the process of shrinking the loan portfolio in certain regards.

Brian Martin – Howe Barnes Investment

Okay. And as far as the expenses go, just the – what’s falling adequately capitalizes, maybe Judy can just comment a little bit on the increase in cost expected related to that? And then just, what the cost savings is, as far as layering in these savings? I know you talked about $2 million impact next quarter to the negative.

Will we see the full impact of these reductions in dollar terms, what we should be thinking about? I’m assuming it’s maybe more of a third quarter event, as far as when you get down to a realistic run rate but, can you give us some sense for what a realistic run rate is or what you’re looking at, and timing of when that would be?

Judy Carre Sutfin

On a run rate basis, it’s going to be $20 million. We have to work our way out of this $2 million charge that we’re going to be incurring in the second quarter associated with this restructuring, but on a run rate basis it will be $20 million for the full year.

Brian Martin – Howe Barnes Investment

Okay. And as far as what – does that just take a $5 million haircut from this level in the third quarter? That’s what you’re on, on a quarterly basis?

Judy Carre Sutfin

Absolutely.

Brian Martin – Howe Barnes Investment

Okay. Okay. And as far as the expected cost related to just falling below the well capitalized, is there a way to quantify what your expectations are there? What impact that has?

Judy Carre Sutfin

No, not yet. We’re working through all of that as we speak. And part of the cost of that is borne in our liquidity position.

Brian Martin

Yes.

Judith Carre Sutfin

So that’s already been quantified.

Brian Martin – Howe Barnes Investment

Right.

Judy Carre Sutfin

Now the question is how much longer we are going to have to keep that level?

Brian Martin – Howe Barnes Investment

Okay. Okay, that would – the next question is the margin, with the excess liquidity, what – can you give some color on your expectations on the margin? If you keep carrying this excess liquidity, there’s no reason to assume the margin’s going to deviate significantly?

Judy Carre Sutfin

I would say that’s fair, that’s fair.

Brian Martin – Howe Barnes Investment

Okay, in the intent – with your deposits strategy in place, how long do you expect to have to carry this excess liquidity?

Judy Carre Sutfin

It will shrink as we go through the year. We do expect that to shrink, but we don’t know in terms of an exact timeframe of how long we’re going to have to. We do expect it to shrink over time.

Brian Martin – Howe Barnes Investment

Not significantly near term. Or for that matter, you’re not comfortable quantifying that so – you talked about the 30-day, 90-day bucket? I didn’t get that. Can you just go over what happened there from last quarter to this quarter?

Judy Carre Sutfin

Let me get to that one.

Brian Martin – Howe Barnes Investment

Okay.

Judy Carre Sutfin

You’re talking about delinquencies?

Brian Martin – Howe Barnes Investment

Yes. 30-day, 90-day past dues. Where those were at it?

Judy Carre Sutfin

Quarter-over-quarter, they increased $22 million. Of that increase of $22 million, we’ve said that two relationships accounted for the $30 million, $30 million of that increase.

Brian Martin – Howe Barnes Investment

Okay. Two credits. Okay. And then one thing, you talked about the reduction in the construction book over the last year being about $180 million, how much of that was charged off versus just resolved? Do you have a – can you quantify that?

Judy Carre Sutfin

Yes. Let’s look that up. We’ll get to that in a second. Do you have another question? We’re looking that number up.

Brian Martin – Howe Barnes Investment

No. I think I’m good so I can just hang up and wait for the answer. That would be perfect.

Judy Carre Sutfin

Okay.

Brian Martin – Howe Barnes Investment

Thank you.

Judy Carre Sutfin

Will do. We’ll get to that.

Operator

Thank you. (Operator instructions).

Judy Carre Sutfin

Brian, I do have the answer to that now. We have approximately $16.8 million of the charged off loans due to construction and development borrowers, and that’s of the $35 million approximately that we charged off this quarter.

Operator

Thank you. This is the operator, we have no further questions at this time.

Bill McManaman

Well thank you very much for attending our conference call, and we look forward to talking to you soon. Thank you.

Operator

Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating and you may all disconnect.

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