Chris Spencer - Chief Financial Officer
Patrick Dee - President & Chief Executive Officer
Bain Slack - Keefe, Bruyette & Woods
First State Bancorporation (OTC:FSNM) Q4 2009 Earnings Call February 2, 2010 5:00 PM ET
Welcome to the First State Bancorporation fourth quarter results conference call. At this time all par participants are in a listen-only mode. (Operator Instructions)
I would now like to turn the conference over to Mr. Chris Spencer, Chief Financial Officer. Sir, you may begin.
Thank you very much and welcome everyone to First State Bancorporation’s fourth quarter conference call. First State Bancorporation will provide an online simulcast of this call on our website at www.fcbmn.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 at 866-411-8822.
Your host and conference leaders for this call this afternoon are myself Christopher C. Spencer, Senior Vice President and Chief Financial Officer, and H. Patrick Dee, President and Chief Executive Officer of First State Bancorporation. The Board of Directors of First State Bancorporation has adopted a policy that the company will comply with Securities and Exchange Commission Regulation FD in all respects.
Consequently, this call will proceed under an agenda which I will announce momentarily. Matters outside the agenda items will not be discussed. The subject matter of this 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. This afternoon we will open with some overview comments by Pat Dee, I will then proceed to go over the financial slides that are available on the Internet. Pat will conclude with some summary comments, and then we’ll open it up to questions.
So with that, I will turn it over to Pat.
Thank you, Chris. Credit quality remains the main issue impacting our bank. We are feeling the effects of the continuing migration of problem and potential problem loans through the workout process in what is a very challenging credit cycle. Similar to prior periods, our biggest impact is being felt in the residential land development and construction portfolio.
Although non-performing loans and OREO again increased one bright spot is that our total potential problem loans decreased for the second quarter in a row. Once again, we increased our allowance for loan losses, which now stands at 6.45% of total loans. Of the total of $129 million in the allowance, $103 million is not included in our capital ratios. Despite the large provision that we recorded during the quarter, our bank is still adequately capitalized under the regulatory definition.
However, we certainly acknowledge that our capital level should be much higher, given our current asset quality challenges. Our liquidity improved substantially during 2009, but we continue to monitor and manage it very closely. With a steady stream of payoffs in our loan portfolio and net growth in our core deposits for the year, excluding the Colorado branch sale, we have been able to more than compensate for the decrease in broker deposits for the year.
We will get an additional boost in our liquidity in early 2010 when we receive the $27 million tax refund that will result from our net operating loss carry back of our 2009 loss. The carry back resulted in a $21 million tax credit during the fourth quarter, reducing our net loss by that amount.
We would like to take a minute and provide a little more detail on our charge-off during the quarter. Out of the total of about $31 million in charge-offs, over $28 million came from various real estate categories. The largest category was the roughly $8.6 million in our real estate permanent mortgage portfolio. The two largest single charge-offs there were each about $1.4 million.
One of those on a single family residence, and the other, an industrial condo project, and both of those were located in Arizona. The residential land development category showed about $7.6 million in charge-offs with two of those charge-offs totaling $7.1 million, and both of those coming out of the Utah Market. In the vacant land category, charge-offs totaled $4.4 million, with $3.3 million of that total coming from two Colorado borrowers, who are involved in residential land development.
The commercial land development category showed $4.3 million in charge-offs, with almost $4 million of the total coming from one Arizona project in Show Low area. Residential construction loans accounted for about $3.5 million in charge-offs, with the largest of those being a little over $500,000 on an Arizona borrower.
The C&I category contributed about $2.6 million in charge-offs, with the largest of those being roughly $950,000 on one New Mexico borrower. So you can see that there is some geographic dispersion to the charge-offs. We were a little more heavily impacted than usual this quarter out of Arizona. The quality in our general commercial real estate loans continues to remain fairly stable, especially in the New Mexico market, which has by far our largest exposure.
Our unemployment level in New Mexico at 8.3% remains well below the national level of 10%. In Arizona, it remains below the national average as well at about 9.1%. We are still working with KBW to evaluate our capital position and to pursue any alternatives to improve our capital numbers. At this time, we have no concrete plans that we can report, but we’ll continue to evaluate the opportunities that are available.
However, those opportunities appear to be fairly limited at this point in time. Although our bank remains adequately capitalized, our holding company is now significantly undercapitalized under the regulatory definition. At this point, the holding company’s reduced capital level has no immediate impact on our day-to-day operations, as the bank’s capital position is far more important in that regard.
We’re close to beginning an arrangement with some outside experts and we think will help us assess the remaining risk in our loan portfolio. We think that information should be very helpful, both in our day-to-day management of the portfolio, and also in determining how much additional capital we might need. We continue to work closely with our regulators, regarding our formal agreement, and believe that we are in or at least very near to being in compliance with almost all of the provisions of that agreement.
We have very regular communications with them to keep them informed and to provide whatever information they might need. Although, we can’t disclose the schedule for examinations by our regulators, it’s generally known that banks with our level of asset quality issues have fairly frequent visits from their regulators. One thing that we think is extremely important for us is to identify problem loans and to not rely on our regulators or any outside party to do that for us.
Because of our approach to credit quality, we’ve been very successful in doing just that in the past, with a success rate of probably around 96% to 98% or so. From time-to-time, we do have minor differences in how severe we see the problems with individual loans, but we rarely disagree on whether a loan is a problem or not.
The calculation of what constitutes an adequate allowance for loan losses can be very subjective and we have worked very closely with our regulators during the past year and-a-half to make certain that we maintain an adequate allowance and believe that we have been more progressive in that regard than many banks.
Now I’ll have Chris run through some of the detail on our results for the quarter and then I’ll come back and summarize a few thoughts.
Thanks, Pat. We ended the year with total assets of right at $2.7 billion, which is down $142 million from the third quarter, and $671 million less than the year end 2008. The majority of the year-over-year decrease is attributable to the sale of our Colorado operations in the second quarter, which included approximately $400 million in assets. The decline in the fourth quarter is due primarily to the reduction in loans.
Total loans at December 31 were right at $2 billion, down $108 million from September 30. We continue to focus on reducing the overall loan portfolio, to strengthen liquidity and capital. While we continue to meet the needs of our core customers, the minimal activity in real estate construction and acquisition and development loans has resulted in a net reduction in loans of approximately $25 million a month.
The decline in the fourth quarters was also increased by $31 million in net charge-offs, which was partially offset by a $5.6 million increase in mortgage loans held for sale. We continue to experience decreases in loans in all four states, with Colorado, Utah and Arizona each decreasing 8% to 9% in the fourth quarter. The largest dollar decrease was in New Mexico which saw a $49 million decrease in loans.
Earlier in the year, we explored the potential sale of loans for capital and liquidity purposes, but we have not been able to find buyers at what we believe are reasonable prices. Our liquidity has improved significantly during the last half of the year, and, therefore, we ceased actively looking to sell large Blocks of loans.
Total deposits at December 31 were right at $2 billion as well, which were down $117 million from September 30. Significant portion of the decrease in the fourth quarter in deposits is attributable to maturity of approximately $74 million of broker deposits, including approximately $40 million in CDARS reciprocal CDs.
These broker deposits are not being renewed in compliance with our agreement with the regulators. The remaining decrease in the fourth quarter was heavily concentrated in deposits of public entities, much of which is seasonal. From a liquidity standpoint, the reduction in public entity deposits is neutral as they are currently all 100% secured through the pledge of investment securities, which then become freed up as available sources of liquidity if those public deposits leave.
Core deposits remain fairly stable across all markets. Remaining broker deposits at December 31 total approximately $200 million and mature fairly ratably over the next 12 months to 18 months. Subsequent to year end we began utilizing two different deposit listing services which have begun to gather CDs, primarily in 12 month and 18 month maturities.
These are from various entities across the country in amounts that are fully insured by FDIC which will help offset the maturity of broker deposits, and these deposits are not considered broker for regulatory purposes. For the month of January 2010, we gathered approximately $40 million in CDs through these listing services. Drilling down to the state level, give some additional color to the overall change in deposits for the quarter.
New Mexico experienced the largest dollar decrease in deposits, however, all of our national broker deposits are accounted for in New Mexico, and the majority of CDARS are related to New Mexico customers, so a large part of that decrease in New Mexico is due to the broker and CDARS deposits. The majority of our public entity deposits are all in New Mexico as well. Colorado and Utah deposits continue to decline as we no longer operate branches in those states.
Colorado experienced an $8.6 million drop, which is almost entirely due to the runoff of CDARS reciprocal deposits which were not transferred with the sale of the Colorado branches in June. Arizona deposits increased modestly during the fourth quarter, and have increased $2.4 million for the year 2009. The majority of the Utah deposits remaining are certificates of deposit which are expected to leave the bank as they mature.
Non-interest bearing deposits decreased significantly in June of 2009 related to the sale of the Colorado branches and to a lesser extent in the fourth quarter, but remain consistent with December 2008, at approximately 17% of total deposits. The majority of the decrease in non-interest bearing deposits in the fourth quarter was concentrated in New Mexico, consistent with the overall deposit decline.
Although Arizona experienced a large decrease in non-interest bearing deposits during the fourth quarter, they did have an overall increase in deposits for the quarter and the year. We are reporting a net loss for the fourth quarter of $28.4 million, or $1.37 per share, driven primarily by provision for loan losses of $45.7 million.
The quarter includes a tax benefit of $21.4 million, relate to the carry back of tax losses to prior years that Pat mentioned earlier, and therefore, the slide reflects the loss before tax to compare to previous quarters, which also exclude other one time events such at the write-off of goodwill back in 2008, the valuation allowance for deferred taxes at the end of 2008, and the sale of the Colorado branches in June of 2009.
In November, the tax laws were changed to extend the carry back period from two to five years. There were no other significant unusual items during the fourth quarter. However, gains on the sale of investment securities were down $3.1 million from fewer sales. Occupancy expense in the fourth quarter was down approximately $0.5 million, due to impairment on leased space, taken in the third quarter, which did not recur.
Legal accounting and consulting expense decreased $1.3 million in the fourth quarter, again, due to a third quarter adjustment for settlement of a consulting contract. In addition, other expenses were down roughly $0.5 million, due primarily to the nonrecurring redemption penalty in the third quarter.
Most expense categories decreased quarter-over-quarter however, we did experience a sizable increase in other real estate owned expense, related to write-downs on various properties based on updated appraisals, and a real estate taxes on those properties. We continue to work diligently to control and decrease non-interest expenses, and have identified approximately $2.1 million in annualized expense reductions that will begin in the first quarter, centered primarily around salary and employee benefit reductions.
The net interest margin increased in the fourth quarter to 2.62% from 2.52% in the third quarter, due primarily to the $1.5 million write-off of accrued interest in the third quarter on the Colorado municipal district bonds that did not recur otherwise, the margin quarter-to-quarter would have been fairly similar. The margin continues to be impacted significantly by the movement of loans to non-accrual status and the overall level of non-performing loans.
Based on our improved liquidity position, we anticipate going forward that the margin will be helped by moving excess cash balances currently earning 25 basis points or less into investment securities earning roughly 2% to 2.5%. We also anticipate being able to invest the $27 million we will receive from a tax loss carry back into investment securities as well and we would anticipate being able to get that tax refund back late in the first or early in the second quarter.
However, the margin will continue to be sensitive to the changes in non-accrual loan activity in both directions. If we see a decline in the rate of loans going on non-accrual, we will see an additional improvement in the margin, on top of that, that could come from moving cash into investment securities and likewise, it could worsen if we see more non-accrual activity going on.
Risk based capital at the bank as Pat mentioned remains within the adequately capitalized category at 8.3% at the end of December. Risk weighted assets continue to decline and are expected to continue to do so as we further deleverage the balance sheet. The parent company capital, also as Pat mentioned, is now considered significantly undercapitalized for regulatory purposes, although there are currently no significant ramifications as a result, since there are no operations at the holding company other than the investment in the bank.
The efficiency ratio continues to run extremely high, ending the year at 93.4%, due to the significant margin pressure and increased expenses related to other real estate owned and FDIC assessments. Non-performing assets increased $33 million during the fourth quarter, including a $4.4 million increase in other real estate owned.
During 2010, we anticipate significant movement from non-performing loans to other real estate owned, as many of the problem loans are expected to result in foreclosure on the related real estate. Although the foreclosure process is lengthy and expensive, it is often a positive step toward ultimate resolution in and turns a non-earning asset into an earning asset.
The other real estate owned activity in the fourth quarter included approximately $14 million in new additions, $5 million in sales, and approximately $5 million in write-downs to net realizable value. So even though we are seeing a lot of movement into OREO, we are being able to move some of it out.
Non-performing loans increased $29 million from September 30. While this increase was higher than the third quarter increase of $17.3 million, it was significantly less than the $45.4 million and $47.7 million increases in the first and second quarters of the year respectively.
As Pat mentioned, we did see a decrease for the second straight quarter in our potential problem loans, which are loans with identified weaknesses and often a precursor to non-performing status. Potential problem loans totaled $173 million at December 31, compared to $206 million at September 30, 2009.
By State, the most significant change in non-performing loans was a $22 million increase in Utah, and of that increase $18 million was in the real estate construction category. Overall, there’s no significant change in the non-performing loans by type.
The construction portfolio continues to decline the drop in $80 million in the third quarter, with decreases experienced in the fourth quarter with pro rata decreases in each category. The construction portfolio decreased $250 million in total during 2009, with the largest decrease by state being New Mexico, which accounted for $129 million of the $250 million decrease, and the largest decrease by category coming in the one to four family vertical constructions, which decreased by $116 million, and within that decreases in all four States.
The overall exposure by type remains relatively unchanged from September 30. Delinquencies increased in the fourth quarter by $15.9 million to 3.3% of total loans, with the majority of the dollars continuing to be concentrated in real estate construction, and land acquisition, and development loans.
Delinquencies increased significantly in New Mexico, after showing a large decline in the third quarter. However, New Mexico continues to have the lowest delinquency rate of the four States right at 2% of total loans. Arizona and Colorado experienced declines in the quarter, while Utah reflected a sizable increase.
The allowance for loan losses ended the quarter and the year at $129.2 million, an increase of $14.6 million and that represents 6.45% of loans held for investment and provides 50% coverage to non-performing loans. The allowance at December 31, is comprise of approximately $29 million of specifically identified potential loss, $50 million based on historical loss rates and $48 million based on subjective factors.
This $98 million based on historical loss and subjective factors represents 76% of the allowance at December 31, compared to 68% at December 31, 2008 and again as Pat mentioned $103 million of the allowances is currently disallowed the regulatory capital purposes.
Net charge-offs for the first quarter totaled $31.1 million, down $16 million from the third quarter and continues to be primarily related to construction and land loans. Net charge-offs for the year were 4.3% of total loans. In the provision for the four quarter was $45.7 million resulting in the total provision for 2009 of $162.6 million. The provision for the fourth quarter is down from $52.5 million in the third quarter, but historically high levels due to the significant charge-offs taken during the quarter.
That concludes the slides. With that, I’ll turn it back to Pat for some summary comments before we open it up for questions.
Thank you, Chris. Recently we had two significant changes in the leadership of our Board and our company. Our new Board Chairman is Garrey E. Carruthers, very well known and highly regarded former Governor of New Mexico. He is currently the Dean of New Mexico State University’s College of Business and he has previous experience as the President and CEO of Cimarron HealthPlan.
Our Former, Chairman Leonard J. DeLayo, served our company well during a rapid growth period. We appreciate his past efforts and look forward to his continued contribution as he will remain on our Board.
Also, with the retirement of Mike Stanford, I have assumed the role of CEO for both our bank and our holding company. We sincerely appreciate the leadership that Mike provided during the company’s past growth and success, and will definitely miss his involvement in our bank. Fortunately, Mike assembled an outstanding team of very experienced individuals in our senior management group at the bank, who will help guide the company’s future.
We undoubtedly will continue to face many challenges ahead in this tough operating environment, although we have made significant progress in overcoming many of those. We continue to increase the resources devoted to resolving our problem asset portfolio and that is the single most important focus for us in the near term.
We’re determined to lower our operating expenses as much as possible in the quarters ahead and we’ll continue to look for every possible opportunity to do that. I recently asked and our Board approved 20% reduction in my salary from the level that I previously received at the company’s Chief Operating Officer.
I wanted our shareholders and our employees to understand that I’m committed to improving our operating numbers. I felt this was a very visible and significant way to demonstrate that. I’m very pleased with the determination and commitment that our employees have shown in working through the problems that we face, while still maintaining an excellent overall level of service to our customers.
With that, Melanie, we’ll open it up for questions.
(Operator Instructions) Your first question comes from Bain Slack - Keefe, Bruyette & Woods.
Bain Slack - Keefe, Bruyette & Woods
I guess one quick question, just kind of on the tax benefit received. If I recall, back in the fourth quarter when I think this was first announced, the expectation was closer to around $10 million. Maybe could you explain some of the dynamics as to why it was almost double the amount?
Bain, this is Chris. The 9.8% was our estimate through September 30, because it’s based on tax loss, not book loss, not knowing exactly what our tax loss would be, and that’s driven a lot by charge-offs. That 9.8% estimate was just through 9.30. So clearly with the charge-offs that we experienced in the fourth quarter that significantly impacted what we were able to carry back for tax purposes.
Bain Slack - Keefe, Bruyette & Woods
I guess just trying to get some color on the movements of loans as they kind of go from performing potential problem and maybe non-performing. I think as you all noted, you’ve had two quarters of decreasing potential problem loans. It looks as if non-performing loans are, I guess starting to rise at maybe a slower pace. Could you give us some color on the migration within the potential problem loan, with regard to new entries versus which ones are going out and maybe kind of an expectation?
Bain, I think it’s pretty clear that the number of new potential problem loans has been much slower in the last couple of quarters than what we saw previous to that. There are still some loans that are migrating from the performing status and are graded past credits that are moving into some degree of difficulty, but clearly again, the pace has slowed considerably in the last six months.
I think a lot of that speaks to the nature of our problems being centered so heavily in the land development and construction portfolios. Those portfolios have declined significantly over the past year to year, and a half as we’ve worked through the process with those. I think we’re finally starting to see a slowdown, again both in the migration, as well as the severity of some of those problems.
Clearly we haven’t reached a point where we can say that we would expect non-performing loans to moderate in the months or quarters ahead, but even if you take into account the charge-offs that we recorded and the migration into those more severe problem categories, it does seem pretty clear that we’re starting to see a moderation of the severity of the problems.
We are experiencing at this point is a continued very heavy impact from the appraise values of some of these problem assets coming down and in particular of that is leading to the classification of some of these that previously didn’t have problems that have borrowers that had a certain of cash flow to maintain those credits for a period time, but their liquidity is now either totally or close to being totally tapped out.
So they can support them anymore and we have to take some of these write-down to recognize this decrease in the appraise value. We’re seeing a few encouraging signs especially in the Albuquerque market of some of these land development loans. Towards the lower end of the price spectrum for residential properties where there is some activity in lot sales as several builders have geared back up are starting to produce product again.
The higher end of both the land the residential housing market continues to be very, very soft, so that’s going to continue to provide some problems for us, but overall, again we’re starting to get through these land and development loans to the point where in certain instances of the majority of them, for example in Utah are already identified as problems. Some more of those are potential problems and we’re just not expecting to see continued migration into the migration into the potential problem loan category.
That’s going to depends to some degree on how strong the economy is going forward. Again, we’re fortunate in that the largest part of our loan exposure is in New Mexico and this economy here is better than most and much better than quite a few areas. So we’re seeing a mixture of results right now. I think our charge-offs for this quarter are an indication that we’ve had some more serious problems of late in Arizona.
The good news there is that we have our smallest loan exposure of any state in Arizona, so we think the potential for further problems is somewhat limited there, but we’ve got some work yet to do, but we are very pleased with some of the progress that we’re seeing, migrating these credits through the process, again, as Chris mentioned, sometimes the foreclosure process drags out much further than we would like for it to, but I think our special assets folks are doing a good job of pushing those as much as they can, and we have increased our staffing in that area and we’ll probably continue to increase it in the near term.
Bain Slack - Keefe, Bruyette & Woods
I guess when thinking about the, those comments with potentially a slowdown in the potential problem loan build and hopefully that would also imply a slowdown in the non-performing asset growth rate that we’ve seen. If we’re starting to get sort of to a slowdown of the second derivatives and then looking at a reserve right now, almost 6.5% of the total portfolio, I guess is from here the driver of the reserve just the appraisal process or and I guess if it weren’t, I mean, assuming everything’s kind of appraise as low as it’s going to go, is this a level that maybe we could sort of, expect to be sort of flat from here in terms of reserve to loan level? How should we think about that?
I think that’s possible. My sense is we probably haven’t quite hit the peak of that level for the allowance, but you’re right, it’s going to continue to depend on the appraised value, some of the underlying collateral, and we have seen in the last six months in particular a much more significant decline in the appraisals of certain properties in particular residential land that again is in areas where there little or no current sales volume, so the appraiser are pretty hard-pressed to come up with.
Any reasonable current comps so, they have to estimate as they can what the market value of these properties is based on resumption in some cases several years in the future to normal absorption rate. So those appraisal values have continued to come down, we do have very large portion of the allowance that is purely subjective at this point. We do have some specific reserves less than $30 million in specific reserves. So we’ve got close to $100 million in the allowance that is based on either historical loss factors or a purely subjective reserve.
Certainly, 6.5% of the loan portfolio seems like a very large allowance level, it’s more than our total charge-offs in the calendar year 2009, and recognizing that we change mid-year at the request of our regulator how we charge-off certain collateral dependent loan reserves, but again we feel that the current level of allowance is adequate given our current loss exposure, we’ll just have to see how that residential land market goes going forward. In some cases, it’s really difficult to image how those values could go any lower than they are.
Currently, but we now, we’ve still got some properties out there that haven’t been appraised within the last six or nine months that possibly come through that cycle again. We’re probably going to continue to see some write downs there, so we’re definitely not completely out of the routes yet, but we are starting to see some encouraging signs.
Bain Slack - Keefe, Bruyette & Woods
Last question promise, I guess with the last comment you just made, not all the properties being appraised in the last six to nine months. Can you give an approximate percentage of how much has been appraised in the last six months versus how much was not?
I’m not sure.
Bain Slack - Keefe, Bruyette & Woods
50/50 or kind of 70/30?
Right now, my sense is we’ve got probably close to three quarters at least the land or land dependent loan book that’s on an annual appraisal process, and that’s been fairly well staggered throughout the year. I would say we’re probably in the 50%, plus, range at this point. I’d hesitate to guess that it’s a whole lot higher than that just given the annual nature of it.
I think the good news is, though, in some cases in New Mexico in certain markets, we’ve seen properties selling recently for higher than what they were you appraised at in the last appraisal cycle. That’s certainly not true of everything in New Mexico. It depends in large part on the location, but for example, we’ve had some land deals that were reappraised within the last year with little or no sales activity.
Now we’re seeing a resumption of sales activity that is probably going to bring some of those appraised values in New Mexico up a little bit. We’ve also got some others that are in different locations that are going to continue to decline, but I think the biggest write downs percentage wise that we’ve seen in kind of reverse order have certainly been in Arizona and Utah, and we’re seeing both of those markets in terms of our exposure there go down steadily over a period of time, and again, our largest dollars are not in those markets.
So a lot’s going to depend on what happens in New Mexico and it’s clearly at this point, I think a little bit of a mixed bag.
I’m currently showing no further questions from the phone lines. (Operator Instructions)
I think if there are no further questions, we’ll wrap up the call now. Again, it’s been a very challenging year for us in 2009. We’re working very hard to try to improve our financial performance in terms of the provision for loan loss. Certainly, have a lot of efforts dedicated to reducing our problem asset portfolio. We’ll continue to explore whatever opportunities might be there in terms of additional capital sources, but we’ve clearly got our work cut out for us in the near term.
We do have, though, I think an outstanding group of people who are working very hard to make the most of the opportunities that we have and control our down side. So we certainly hope that 2010 will provide much better results for us. We will continue to work very hard to try to accomplish that. Thank you.
Thank you for your participation.
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