Chris Spencer – SVP and CFO
Pat Dee – EVP, COO and Bank President
Bain Slack – KBW
First State Bancorporation (OTC:FSNM) Q2 2009 Earnings Call Transcript July 23, 2009 5:00 PM ET
Thank you for standing by and welcome to the First State Bancorporation Second Quarter Results Conference Call. At this time all participants are in a listen-only mode. (Operator instructions).
Today’s conference is being recorded. If you have any objections you may disconnect at this time. I would like to turn today’s conference over to Mr. Chris Spencer, Chief Financial Officer. Sir, you may begin.
Thank you, José and welcome to First State Bancorporation second quarter 2009 conference call. First State Bancorporation will provide an online simulcast to this call on our website, fcbnm.com and an online replay will follow immediately after the call and continue for 10 days. There will also be a replay of this call for 10 days at the 800 number 486-4618.
Your host and conference leaders for this afternoon are myself, Christopher C. Spencer, Senior Vice President and Chief Financial Officer; H. Patrick Dee, Executive Vice President and Chief Operating Officer; and Jed Fanning, Chief Credit Officer of First State Bancorporation.
The Board of Directors of First State Bancorporation have adopted the policy that the company will comply with Securities & Exchange Commission Regulation FD in all respects. And consequently, this conference call will proceed under an agenda, which I will announce momentarily. Matters outside of the agenda will not be discussed.
The subject matter of this conference call will include forward-looking statements. These statements are not historical facts and involve risks and uncertainties that could cause First State’s results to differ materially from those contained in such statements.
Our agenda this afternoon, we’ll have Pat Dee open up with some summary comments, I'll go through the financial slides that are available on the website, then Pat will have a few more comments before we open it up to our questions from the analysts.
So with that, I’ll turn it over to Pat.
Thank you, Chris. Our second quarter was highlighted by the completion of the sale of our Colorado branches on June 26th and also our strong deposit growth. On excluding the Colorado sale, our non-brokered deposit increased about $136 million for the quarter while our loans decreased by $73 million. This has helped to substantially improve our liquidity position.
Asset quality continues to be an issue for us as we again built our reserves to a higher level, now reaching just short of 5% of total loans. That now leaves us with approximately $79 million in the allowance that is not reflected in our capital ratios.
At the bank level, we are once again well capitalized in all three of the critical capital levels with 10.77% in total risk-based capital. We will continue to shrink our loan totals in the months ahead to help maintain acceptable capital ratios. We continue to aggressively assess our loan portfolio, especially our construction loans, even to the point of reflecting some loans that are current on their payments as non-performing credits.
As we've updated the appraisals on the collateral underlying some of these loans, we continue to see current market values decline and again, although some of these borrowers are still able to service their debt and are current with their payments, we are concerned about their ability to continue to do that for an extended period of time. So we have moved some of them to non-performing status and even gone so far as to establish specific reserves in some cases.
In the second quarter for example, we moved approximately $26 million in the current performing loans to non-accrual and established specific reserves of approximately $9 million against those loans.
We will continue to try and be aggressive and stay out in front of potential losses. Reflected in the second quarter results are the effects of an extensive and, we believe, conservative analysis of our non-performing loans in accordance with FAS 114. Based in large part on that analysis coupled with a substantial subjective reserve, we believe the coverage of the allowance for loan losses of our non-performing loans at 52% is adequate.
As of June 30th, another or just under $800 million of our loans are related to residential real estate, either land or homes. Of that amount, we have about 39% that is either classified or on our watch list. The category for residential lots and land has 41% that is classified or watched, while the vertical construction portion, 48% of that is classified or watched.
We are seeing steady paydowns in each of these loan categories as we have been able to collect some of both our non-performing and non-performing credits in those categories. By contrast, our commercial real estate portfolio, which is roughly half of our total loan book, is faring much better. Only 17% of our non-residential commercial real estate portfolio is classified or watched and year-to-date charge-offs in that category are less than 1% annualized.
With the sale of the majority of our Colorado loans where we kept the classified and virtually all the construction loans, our asset quality metrics have been negatively impacted when it's measured against that – the entire portfolio. For the remaining Colorado portfolio, 46% of the loans are either classified or watched. In Utah, which we exited in 2008, we are winding down our residual portfolio and have a similar situation with 43% of the loans either classified or watched in that market.
The allowance is now 52% of our total non-performing loans, which again we believe is sufficient in light of the real estate collateral that we have that backs approximately 94% of those loans. One factor that works in our favor is the level of unemployment in our markets. With the national rate at 9.5%, New Mexico is only 6.8% and Arizona is 8.7%. We believe that will be a major factor in both controlling the effects of the recession and also providing a somewhat quicker rebound than other parts of the country.
As we've said before, we have very little exposure to consumer loans and have almost no credit card exposure. Accordingly, we expect to see little impact in the future from general consumer credit defaults such as those that are affecting many banks in this current cycle.
Now, Chris will run through some of the detail on our results for the quarter and then I'll summarize a few thoughts.
All right, thanks, Pat. If you have the slides available on the website, I'll go through those now. Total deposits at June 30th were $2.197 billion, down $529 million from March 31st with the Colorado sale accounting for $509 million of the decrease. In addition, $156 million in brokered deposits – I’m sorry, I jumped to the deposits.
To total assets. Total assets declined by $557 million in the second quarter in the net $2.992 billion. The decrease was primarily due to the Colorado branch sale, which accounted for approximately $480 million of the decrease. The remaining loan book was also reduced, accounting for the majority of the difference.
Now to total loans. Total loans at June 30th, 2009 were $2.245 billion, down $458 million from March 31st due to the Colorado sale, which accounted for $392 million of the decrease. In addition, loans decreased from payments in excess of new originations by approximately $73 million including a reduction of $8 million in mortgage loans available for sale.
Mortgage loan activity continues at a brisk pace and is beginning to include more purchase related activity as well as refinancing transactions. However, the mortgage activity going forward will decline, starting in the third quarter, due to the closure of the mortgage division in Colorado in conjunction with the Colorado branch sale. We continue to focus on reducing not only our non-performing numbers, but also the overall loan portfolio to strengthen our capital ratios.
As far as the total loans by state, the Colorado sale is evident in the Colorado loan totals with the remainder of the decline in the total seen in New Mexico and Utah, while Arizona stayed relatively unchanged. Loans by product type, while Colorado – the Colorado sale reduced the overall loan totals that resulted in a slightly higher concentration in real estate construction loans. As Pat had indicated, we retained all of the Colorado loans in this category and slightly reduced the percentage in all other categories.
Now to total deposits. Total deposits at June 30th were $2.197 billion, down $529 million from March 31st with the Colorado sale accounting for the $509 million of the decrease. In addition, $156 million in brokered deposits matured and were not renewed including $98 million in CDARS Reciprocal deposits.
Since the bank was in the adequately capitalized category for regulatory purposes during the second quarter, we were precluded from renewing or accepting new brokered deposits. In pursuant to the formal agreement with the regulators, we will be formulating a plan to further reduce brokered deposits and FHLB borrowings in the future.
On a positive note, our non-brokered deposits increased $136 million during the second quarter, which follows the $160 million increase we experienced in the first quarter. Similar to the loan totals by state, the Colorado sale drove the significant reduction in the Colorado deposits. The remaining deposits in Colorado were primarily CDARS accounts, which could not be transferred based on the program agreement with the sponsoring entity. We anticipate that these deposits will eventually leave the bank as these mature and the customers seek another banking relationship in Colorado.
While the New Mexico deposits saw a net reduction due to the reduction in CDARS accounts, which could not be removed, Arizona did see a nice increase. Utah continues to gradually decline as we no longer have a presence there. Much of the remaining Utah deposits are tied to the remaining Utah loans and will continue to decline as the loans run off.
Non-interest bearing deposits declined by $98 million, which included $84 million sold in the Colorado transaction. The non-interest bearing deposits to total deposits remained stable at 18% quarter-over-quarter. Excluding the Colorado impact, the remaining decrease in non-interest bearing deposits was inconsequential on a state-by-state basis.
The Colorado sale had very little impact on the distribution of our deposits by type. As I noted earlier, we still have approximately 18% in non-interest bearing deposits. This slide also shows the reduction in CDARS and traditional brokered deposits since March 31st where we now have CDARS Reciprocal as approximately 5.1% of total and the brokered at 8.1%.
We'll look at the quarterly net operating income and earnings per share. We are reporting a net loss for the second quarter of $6.2 million or $0.30 per share, inclusive of a $23.3 million gain from the sale of the Colorado branches. The loss excluding the gain was $29.5 million, driven primarily by the $31.1 million provision for loan losses. Pre-provision, we would have had income for the quarter of approximately $1.5 million.
Our net interest margin declined from 3.27% in the first quarter to 2.96% in the second quarter. The quarter included non-recurring expenses directly related to the Colorado sale of approximately $1,250,000, which included $900,000 in severance payments and $350,000 of legal fees.
Non-interest income was stable quarter-over-quarter. However, the second quarter did not include any gains from the sale of securities as did the first quarter. As I noted earlier, our mortgage division continues to generate and sell loans into the secondary market at a good pace and sold $106 million in loans during the quarter compared to $103 million in the first quarter of this year and $76 million in the second quarter of 2008.
The gains from the sale of mortgage loans is expected to drop in the third quarter. Again, as I mentioned, the Colorado mortgage division has been closed down. Approximately half the volume in recent quarters has come out of Colorado.
Salaries expense also includes approximately $370,000 in severance and stay bonuses for just the mortgage employees. Again, that division was not sold to Great Western, but it was shut down in connection with the sale. In addition to the severance for the Colorado employees and the legal fees related to the Colorado sale, non-interest expenses were also impacted in the second quarter by significantly higher FDIC premiums, which included the 5 basis points special assessment, which totaled approximately $1.2 million.
The net interest margin compressed in the quarter by 31 basis points from the first quarter due to two main factors. First, the impact of additional non-performing loans in the first quarter and the second quarter and secondly, lower yields on our increased cash balances for liquidity purposes.
Absent the impact of non-performing loans on interest income, our loan yields and deposits costs remained fairly stable. Assuming there are no significant changes in the Fed target rate, changes in the net interest margin in the near term will be heavily dependent on whether there are additional non-performing loans and the ability to move out of low-yielding cash balances into higher-yielding investments.
The Colorado sale enabled us to increase the capital ratios for the bank and the holding company and return the bank to the well capitalized category. At June 30, the bank's total risk-based capital ratio was 10.8% and the Tier 1 leverage ratio was 6.3%. The leverage ratio did not get the immediate lift for the Colorado sale as the total risk-based ratio did, as the denominator for the leverage ratio is average assets for the quarter and the Colorado sale did not close until June 26.
All else being equal, the passage of time will increase the leverage ratio. Using quarter-end asset totals instead of the average for the quarter, the Tier 1 leverage ratio would have been 7.4% at the bank level.
At the holding company, the total risk-based capital ratio for the parent company was also raised back above the 10% threshold. However, the Tier 1 leverage ratio was still below the 5% mark necessary to be considered well capitalized. Like the bank, the passage of time will also bring the Tier 1 ratio of the holding company up when the period-end assets are used instead of the average for the quarter, the Tier 1 ratio would have been 5.5%, above the well capitalized threshold.
The efficiency ratio increased fairly significantly in the second quarter as the margin compressed slightly and the non-interest expenses increased due to the costs related to the Colorado sale and the significant increase in FDIC premiums from the special assessment. In addition, the first quarter included gains on sale of investment securities of $2.7 million, which did not recur in the second quarter.
As Pat indicated, we experienced an increase of approximately $60 million in non-performing assets from March 31st including a $12 million increase in other real estate owned properties. Again, we continue to be very aggressive in addressing problem loans and the increase in the non-performing classification includes $26 million in performing loans, which are still performing that Pat was talking about earlier, but may not be able to perform for an extended period. The increase in other real estate owned properties is primarily related to single family related construction and land loans.
The large increase on the non-performing loans in the second quarter came primarily from the real estate construction segment of the New Mexico portfolio. At March 31st, the non-performing loans were 39% New Mexico, 28% Colorado, 25% Utah, and 8% Arizona. Non-performing loans by type remained fairly consistent with real estate construction being the major contributor at 70% of the total.
The construction loan portfolio continues to decline, dropping $47 million in the second quarter, despite that fact that no construction loans were included in the Colorado sale. The exposure by state remains unchanged from the first quarter with 53% of the total being in New Mexico, 20% Colorado, 19% Utah, and 8% Arizona. The largest change by type of loan was seen in the wonderful family vertical construction category, which decreased by $32 million from March 31st.
Although delinquencies are up from March 31st, they are below the level we saw at December 31st of 2008. Now, the delinquencies are somewhat concentrated in the construction related loans. The largest increase in delinquencies were experienced in the New Mexico market, which increased by $22 million, although New Mexico has the lowest delinquency rate at 1.7% as compared to the other states.
The allowance for loan losses ended the quarter at $109 million, an increase of $17.8 million. The allowance represents 4.89% of total loans held for investment and 52% of non-performing loans. Our allowance that is not being accounted for regulatory purposes, again as Pat indicated, is $79 million at June 30th.
Net charge-offs for the second quarter totaled $13.9 million with approximately 60% coming from construction and vacant land loans. Annualized net charge-offs for the first half of 2009 were 2.03% compared to 0.88% for all of 2008. The provision for the quarter again was $31.1 million and was the main reason for the loss in our second quarter.
And with that, I'll turn it back over to Pat for some summary comments.
Thank you, Chris. Clearly, this quarter had some good news with the Colorado sale and our solid core deposit growth and some bad news in our asset quality numbers. We believe that we continue to be more aggressive in both identifying and reserving for problem and potential problem loans than many banks do.
We will continue to work to improve our capital ratios, but in the current market the capital rates makes very little sense for our existing shareholders and is not something that we intend to pursue in the near term.
Our management team is focused on controlling and eventually, reducing our problem asset totals and controlling our expenses wherever possible. We believe that the second half of the year may see some continuing challenges in our loan portfolio, but we will maintain an offensive posture in addressing those challenges.
With that, we will open it up for questions from our analysts. So José, I think we are ready for questions.
(Operator instructions) One moment for the first question please. The first question does come from Bain Slack, KBW. Your line is open.
Bain Slack – KBW
Hey, good afternoon.
Bain Slack – KBW
I was wondering, do you have the 30 to 89 past due data available and if so, give I guess some indication of what the linked quarter trends look like and any color there that might give us a better sense of the challenges that you spoke of in the second half of the year.
The overall past dues are up at the end of the second quarter. And again, as the chart that Chris had showed, there was an increase in New Mexico, but New Mexico is still the best of the markets. I think the trend in past dues is that there really hasn’t been much of a trend over the past few quarters. They have jumped up and down; they were high at year-end 2008, lower at the end of the first quarter, and then back up somewhat at the end of the second quarter.
A lot of those delinquencies, again, are concentrated in the construction portfolio, one type or another of the loans there. We've got a fair number of borrowers that from time to time struggle with their cash flows. At this point, we don’t see anything in those delinquencies that gives us too much of a concern about what will happen in the rest of the year, but there are a few borrowers in there that certainly have the potential to continue to experience either delinquency problems or potentially even could go to non-accruals.
So I think what we expect in the back half of the year is some continued kind of wealthiness in our asset quality numbers and the past due numbers as well.
Bain Slack – KBW
Okay, all right. And I guess in the markets in general, has there been any, I guess, when you are getting evaluations on these properties, any trends there may – clearly I assume from the provisioning that the appraisals are still coming in lower than they were previously, but is there any sense that this is accelerating and I guess on the other side, has there been any interest or pickup on interest of buyers, maybe at some of these properties where the bid has – maybe has heightened up a little bit?
I think what we see is a wide variety that really depends on the location and the type of the property. For example, in certain parts of the Albuquerque metro area, we are again seeing some pretty good activity in residential lots at the lower end of the market. Certain locations are not doing as well as others, but by and large, I think across all of our footprint in general, the best part of them, the residential housing market, right now is the lower end with the middle and upper end are still experiencing very slow sales volume.
There has been in a lot of cases I think a shrinkage of the spread between the prices being offered for properties and what the market is expecting to receive. Again, in certain areas there is very little spread at all, but in other locations there certainly is still a large spread and that drives the sales activity or the lack of the sales activity.
We are continuing to see in just about all of the markets, some further decrease in appraised values on the properties that we are seeing. Some of those, again, in certain locations, are very nominal decreases. Others are still pretty substantial. So I think we are seeing certain parts of the market that look like they are stabilizing pretty well and again, that tends to be generally at the lower end of the market and some others that are still pretty soft.
So it's really hard to generalize other than to say it's definitely a mixed bag with some good news and some bad news pretty much across the board.
Bain Slack – KBW
Okay. And I guess, just the last question, I was wondering – when I look at the expenses and I think I heard Chris discuss – I thought he said $300,000 in severance. Could you clarify that? I mean, just – I guess I'm just trying to figure out what's going on in Utah, Colorado and the shutting down of the mortgage.
Where expenses in general do you think a run rate for the second half of the year and I guess specifically within the salary line, kind of what's the range that we should be expecting there on a normalized – I mean, I guess on a basis excluding all these extraordinary items?
Yes, Bain, this is Chris. Relative to the severances, about $900,000 in severance for the Colorado branches in personnel that were sold to Great Western. There was about another $370,000 in severance for the mortgage personnel alone. That's kind of – they are two different pieces. So in total, it's about $1.25 million in the second quarter that will be not reoccurring – recurring.
With that, going forward into the third quarter, we should see salary expense come down by about $3 million relative to the sale would give you a pretty good run rate I think going forward.
In total, right now we are seeing the non-interest expenses, estimating that they are going to come down due to the Colorado sale and the mortgage closure by about $6 million for the quarter including the salary decrease. That includes about $1 million in occupancy, that's another one of the big expense saves; in the FDIC insurance premium probably about $600,000; and then a $200,000 a piece probably in equipment, data processing and maybe even some in telephone, but big picture risk (inaudible) about $6 million saves per quarter in non-interest expenses going forward.
There maybe a little bit more as time goes on as we reassess the operation, sending a lot of the backroom stuff that supported Colorado to tune, in New Mexico and try to get some more efficiencies over the next six months. But – does that give you a pretty good feel?
Bain Slack – KBW
Yes and that helps a lot.
Hey Chris, this is Derick [ph]. Could you also talk a little bit about the margin given that it was – the margin for the Colorado branch sale was still in the second quarter?
Yes, the – really, we see the margin, absent anything else, being fairly flat, the depth in the second quarter, primarily from the non-accrual activity. We think the margin for the Colorado piece itself was a little over 3% and if we – if you clear out all the non-accrual activity, I think the overall margin would have been back over 3%.
So we may get compressed a little bit without Colorado, but not by much. It's – it will be fairly flat going forward even without Colorado, again absent additional non-accrual activity or ability to lower deposit rates further or anything else like that.
Bain Slack – KBW
There are no other questions in the queue at this time.
Okay. We may give it just another minute if there are any other questions that anybody needs to ask.
(Operator instructions) One moment for the next question please. There are no other questions in the queue at this time.
All right. I guess, with that we will go ahead and wrap it up. Again, I think just to summarize, we are pleased with the improvement in our capital ratio at this point. We realize we've got a lot of hard work to do the rest of the year from the asset quality front. Again, we are being very thorough in how we review our loan portfolios and early identification of problems and working to reduce our losses on those.
Our charge-offs, again, have gone up slightly during the year, but the second quarter was not much different than the first quarter. We'll see what develops with the non-performing numbers the rest of the year. Again, our sense is that we are getting closer to the bottom of the barrel so to speak in the residential land and residential construction area. It's a little lesser on some of the – those land loans, as well as a few commercial credits that we continue to keep an eye on.
So we beefed up our special assets area a little bit during the year and we'll continue to do that. We'll just continue to work on reducing as many of those problem assets as we can and hopefully be able to show a little better progress the remainder of the year.
With that, again, we appreciate your time and attention this afternoon. And we look forward to talking to you again next quarter. Thanks.
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