William McManaman – CEO
Judith Sutfin – CFO
AMCORE Financial, Inc. (AMFI) Q2 2009 Earnings Call July 28, 2009 12:00 PM ET
Good morning, ladies and gentlemen, and welcome to the AMCORE Financial second quarter earnings release conference call. (Operator Instructions)
Please note that this conference is being recorded. In addition, this 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 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 William McManaman, Chief Executive Officer, and Judith Sutfin, Chief Financial Officer.
I will now turn it over to Mr. McManaman.
Thank you and good morning. We appreciate the time that you have taken to listen to this conference call and welcome questions from our analysts at the end of our comments.
We assume that you have seen a copy of the press release we issued this morning. If not, you can find a copy on our website at www.AMCORE.com.
Our results this quarter demonstrate progress and reflect the benefits of some very tough decisions we made during the past 18 months to improve our business and move our company forward as we worked through the realities of this difficult economic environment.
These actions were essential and focused on rebuilding our credit management practices, strengthening our lending function, reducing our concentration in construction and development loans, improving our overall operating efficiencies, and restructuring our organization. We believe that these actions have positioned the company for recovery and have allowed us to establish a solid foundation to rebuild our company into a successful and sustainable regional community bank.
Specifically, our employees have spent countless hours enhancing our credit and underwriting functions, strengthening our risk identification practices and reducing our non-strategic, non-relationship-based accounts, especially in investment real estate loans. We are beginning to show some progress from their hard work and we appreciate their efforts and dedication.
More importantly, in the second quarter we experienced improvements in key credit quality metrics, including a significant decrease in the rate of growth in nonperforming loans, which was at its lowest level since the third quarter 2007. In addition, chargeoffs were at their lowest level in a year and delinquencies dropped 41% compared to the previous quarter.
In our commercial area we also reduced commitments $74 million or 13% from last quarter. In addition, we continued to build our deposit base and our trust and investment fees also are showing improvement, which is consistent with our relationship building and our one-bank strategy that I have talked about in previous calls.
We continue to make progress on reducing non-relationship credits in our portfolio, which contributed to a 7% decrease in average loan balances from the previous quarter, including a 10% decrease in construction and development loans. Judy will cover this in more detail in a moment.
As a result, our loss for the quarter was two-thirds less than the previous quarter. We are pleased with our progress, taking into account the current economic environment. We do, however, recognize that we have much more work to do to return to profitability. As with any company in a recovery phase, it takes time to rework and to rebuild.
Earlier this quarter we announced significant organizational changes that better align the size and management structure of our organization with the current business environment. This has been completed without compromising the disciplines, controls and improvements implemented over the past year. We are closer to our customers and can act as a single, well-integrated organization to understand and meet their financial needs.
Another key component to improve our efficiencies is better space utilization. We have been consolidating branches to more effectively manage our operations and resources. Last year we announced the sale of four buildings and this quarter we will consolidate operations of three branches to other nearby facilities and will sell those buildings that we own. We are not leaving these markets; we are simply better aligning our capacity and further reducing our costs.
Improving our overall efficiency is a continuing focus of this management team that is critical in this current economic environment. Going forward we will work to further strengthen and improve the bank's financial condition and operations. Rest assured we will carry on with uncompromised dedication and unwavering commitment, taking any and all action to fortify our business and deliver service excellence to our customers.
Now I would like to turn the call over to Judy Sutfin for a discussion of our financials.
Thank you, Bill, and good morning.
Last year we recognized we had much to do and, as you have seen from our results, we accomplished much this quarter. I will now explain how actions we've taken over the past year have translated into our improved financial performance.
Our second quarter loss per diluted share was $0.47. This shows significant improvement compared to a loss of $1.34 reported in the previous quarter and a loss of $0.89 in the same quarter a year ago. The loss for the quarter was primarily driven by three factors - the impact on margin revenues of carrying $416 million in nonperforming loans, margin compression from the cost of maintaining approximately $650 million in liquid assets that help us to better serve our customers, and finally, $17 million provision for potential loan losses related more specifically to the credit quality of certain construction and development loans. 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 a 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 $3.8 million and was down $17.4 million from the year ago quarter. There are two main causes of this reduction compared to last quarter.
First, we actively reduced our credit portfolio by 6% 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 $1.8 million compared to last quarter and $2.1 million compared to last year.
Second, we maintained approximately $650 million in liquid assets as cushion. The cost of holding this liquidity and the cost of obtaining term funding further reduced our margin income by $3.2 million compared to the prior quarter. In times of stress we believe substantial liquidity is the lifeblood of a banking organization.
The net interest margin statistic for the quarter was 1.59%, down 35 basis points from the previous quarter and down 148 basis points from the year ago quarter. The decrease from a year ago is driven primarily by the factors just noted, in addition to the cost of funding the increased pool of nonaccrual loans. Normalizing the margin to exclude the excess cash on hand and bringing nonperforming loans down to a more typical level of 2% to 3% of total loans would result in a margin a little in excess of 3%.
The next category to discuss is non-interest income. This quarter's non-interest income increased 33% on a linked-quarter basis. Security gains of $12.9 million accounted for the majority of the increase compared to $6.9 million and net security gains in the previous quarter. These gains helped us to improve liquidity, optimize capital usage and capture gains jeopardized by the risk of prepayment. Excluding security gains, non-interest income was up $1.2 million on a linked quarter. The increase from first quarter of 2009 was primarily due to higher investment management and trust income and deposit service charges, which were respectively driven by improved stock market performance and increased customer activity.
Moving on to our operating expenses, which were up by $9.1 million or 23% compared to the previous quarter, and were flat compared to the year ago quarter, these results included several one-time costs such as $5.4 million of debt extinguishment costs, $2.4 million in special FDIC insurance assessments, and $1.9 million in severance related to the corporate restructuring announced earlier in the quarter. Excluding these one-time costs as well as regular FDIC insurance premiums, our annualized run rate expenses are decreasing approximately $30 million compared to the year ago quarter.
This is the result of our focus on efficiencies launched at the beginning of last year. At the beginning of last year we had 1,484 employees at AMCORE and at the end of the second quarter we had 1,143, a number that is more in line with our revenues. Our objective has been and will continue to be to size our expenses consistent with our revenue stream while maintaining strong controls. We have done this through a four-pronged focus on automation, vendor management, better resource alignment and a flatter organization.
From a balance sheet perspective, total period-end loans were down $230 million from the previous quarter, with commercial real estate loans accounting for the majority of the decrease at $122 million from the previous quarter. This reduction includes $10.4 million in commercial real estate-related chargeoffs in the quarter.
Average bank-issued deposits increased 4% over last quarter, with particular emphasis on the continued growth of non-interest bearing and intermediate time deposit products. Non-interest bearing deposits showed growth as a result of an increased focus on compensating balances and our participation in the unlimited guarantee program for non-interest bearing deposits. The increase in time deposits is in response to customer demand to lock in higher rates in a falling rate environment.
As we noted last quarter, we do not have an other than temporary impairment charge on any investment we currently hold in our portfolio given that 87% of that portfolio is agency guaranteed or rated Triple A, which is reflective of our conservative investment philosophy. We did not pursue securities backed by subprime or Alt-A mortgages and we did not purchase mezzanine tranches of securitizations. Detail on the portfolio is in the Investor Relations section of our website under Presentations.
We ended the quarter with all our capital ratios exceeding the adequately capitalized threshold, with a total capital ratio of approximately 8.78% for the bank. Bill will cover our capital position and the consent order and regulatory agreement in his closing remarks; however, one item I would like to cover is the credit facility the parent company has with JPMorgan Chase.
We are current with all our payments due under that facility; however, as a result of entering into the order and agreement, a technical default was triggered. We are working cooperatively with JPMorgan Chase to address this technical covenant violation.
Next, as promised, let's turn our attention to credit conditions, their impact on our business and our response.
Given our portfolio's overweighting in construction and land development loans, trends in property values have tended to directly correlate with our portfolio performance. Although construction and development loans, including vacant land, accounted for 20% of the commercial portfolio, these loans comprised 58% or $235 million of the nonaccruing commercial loans and account for approximately 71% of our specific allocations made in the determination of our allowance for loan and lease losses.
It should be noted that commensurate with our efforts to manage down our exposure, the balances in this portfolio subset have decreased by 30% year-over-year. This is illustrated in the charts under Presentations in the Investor Relations section of our website.
As we manage our exposure to construction and development projects, we are encouraged by the stabilization in raw and improved land values, especially in those markets in relative proximity to urban centers. For example, in the Chicago metro market the average price of land per square foot increased $0.21 in 2009 compared to a decrease of $1.20 per square foot in calendar year 2008. While this does not imply a return to pre-2007 property values, it does seem to represent a reversal or a bottoming out of the deterioration largely experienced during 2007 and 2008.
A factor that negatively affects the communities we serve is unemployment. Unemployment continues to rise throughout our footprint. The Rockford Metropolitan Statistical Area, in particular, has experienced higher levels than the national averages. For instance, the national unemployment rate was 9.7% in June compared to 10.5% in Illinois and 14.5% in Rockford. Despite this, our retail portfolio performed significantly better than the retail portfolios of many of our peers.
Retail portfolio loss rates, including first mortgages, second mortgages and indirect automobile financing are all lower than the industry averages as reported in the first quarter by the Risk Management Association. Our better-than-peer performance is attributable to an experienced and disciplined underwriting and collections staff, effective use of predictive scoring and underwriting tools and continuous updating of policy requirements and risk acceptance criteria.
In response to economic conditions in our markets, we charged off $21.7 million during the quarter and had recoveries of $1 million. We are starting to obtain considerable traction in resolving nonperforming loans, as evidenced by the increasing ability to negotiate paydowns or resolutions of problem accounts.
In the first half of 2009 we resolved $43.4 million in nonaccruing loans compared to $26.1 million in the preceding half-year period. This represents a 66% improvement. The $43.4 million in paydowns and resolutions does not include loan reductions attributable to the values of foreclosed properties that are still owned by the bank. Foreclosed property balances were $24.1 million, an increase of $9.1 million from the previous quarter. The increase of $9.1 million is associated with five residential construction projects. In total, we have 39 properties in other real estate owned.
It is the bank's general practice to foreclose on properties where control enhances overall recoverability. Diligent portfolio management has considerably curtailed the rise in nonperforming loans. Nonperforming loans rose only $14 million on a net basis from the previous quarter. Our current provision stands at 4.81% of total loans compared to 4.61% in the previous quarter and 3.44% in the year ago period. The bank is confident that the provision is adequate to support current loss expectations.
Delinquencies, which include loans more than 30 days past due, declined by $44 million quarter-over-quarter, a 41% decrease. The drop in delinquencies was entirely attributable to the commercial portfolio. This is the lowest level of delinquencies since third quarter 2007.
In summary, there were several positive developments during the quarter that evidence our progress. Decreases in the rate of growth in nonperforming loans as well as declines in delinquencies and chargeoffs are the result of our hard work to rebuild our credit management practices, strengthen our lending function and reduce our concentration in construction and development loans.
We are encouraged by the second consecutive quarter of deposit increases, which ties directly to our initiatives to further deepen our relationships with our core clients. We have a dedicated and experienced team devoting their time, talents and expertise to serve our customers, and we're taking action to turn our company around.
Now let me turn the call over to Bill.
Thanks, Judy. Now I would like to talk about our capital position and the recent agreements with our regulators.
First of all, the order and agreement did not come as a surprise. In fact, we anticipated them and reported in our 10-K filings in March that we were discussing with our regulators an appropriate level of capital. Our relationship with our regulators is cooperative and they are supportive of our efforts to improve our company.
Capital levels at many financial institutions this year, including AMCORE, have declined as credit losses have increased and significant reserves have been established. As Judy reported, the company at both the bank and consolidated level, remains adequately capitalized as of June 30th of this year.
Primarily, the regulators are looking for a cushion greater than the 10% minimum for well-capitalized banks due to the level of our nonperforming loans and our concentration in construction and development loans. In addition, they requested that we revise and maintain a liquidity risk management program.
AMCORE has $307 million in regulatory bank capital as of the end of the quarter, which does not include $123 million of loan loss reserves and $71 million of currently expected future tax benefits associated with loan losses. These amounts provide additional capacity to ultimately absorb potential future credit losses, but current regulatory rules limit their inclusion for calculation purposes. AMCORE's regulatory capital plus the excluded amounts of its reserves and deferred tax assets totaled $501 million at June 30th.
With respect to the regulatory agreements, our next step is to coordinate with our regulators as we work to achieve the requirements prescribed. The company has recently submitted its capital plan to the regulators.
There are many variables that can affect our capital ratios, including our operating results, the size and the mix of our assets, raising outside capital and future trends. AMCORE management is focused on each of these variables to help us reach our goal. We have pursued and we will continue to actively pursue all capital raising activities available in today's marketplace.
In closing, our entire management team will continue to take actions to stabilize and strengthen our business. Our one-bank strategy is continuing to move our business forward and is our blueprint for the future to grow our business and serve our customers by leveraging the expertise of all employees throughout the company. We are working through our challenges and we recognize it is the drive and passion our AMCORE team has for our business and our customers that will allow us to succeed.
With that, [John], you may now open the lines for questions from the analysts.
Thank you. (Operator Instructions)
At this time I show no questions.
Okay, [John], thank you very much.
And hearing no questions, Judy and I must have dazzled you with all kinds of detail. So thank you very much for your attendance today and we look forward to talking to you soon.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may all disconnect.
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