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Hudson Valley Holding Corp. (NYSE:HVB)

Q4 2013 Earnings Call

January 28, 2014 10:00 am ET

Executives

Wendy Croker – First Vice President Shareholder Relations

Stephen R. Brown – President, Chief Executive Officer, Treasurer, Secretary & Director

Michael J. Indiveri – Chief Financial Officer & Executive Vice President

Analyst

Analyst for Mark Fitzgibbon – Sandler O’Neill & Partners

John V. Moran – Macquarie Capital, Inc.

Travis Lan – Keefe, Bruyette & Woods

Welcome to the Hudson Valley Holding Corp fourth quarter 2013 earnings conference call. All participants will be in listen only mode. (Operator Instructions) After today’s presentation there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Wendy Croker.

Wendy Croker

Welcome to the Hudson Valley Holding Corp. conference call to discuss the company’s results for fourth quarter and 12 months ended December 31, 2013. If you have not read the earnings release we issued after market close last night you may access it along with financial tables and schedules on our website at www.HudsonValleyBank.com using the investor relation’s link at the top of the screen and going to the news and marketing information drop down.

Before we begin, I would like to remind everyone that today’s presentation may contain forward-looking statements regarding the financial condition, results of operations, and business of Hudson Valley. Those statements are not historical facts and are based on assumptions and expectations of future events and performance. Those statements involve certain risks and uncertainties and may include expressions about Hudson Valley’s management, expectations about the New York metro area economy and real estate values, management’s confidence and strategies, management’s expectations about earnings, new and existing relationships, opportunities, and technology as well as general market conditions. Actual results may differ materially from those the forward-looking statements contemplate.

The factors that may cause results to differ materially from those contemplated by the forward-looking statement are identified in the cautionary statement contained in the Hudson Valley earnings press release as well as the risk factors section of our most recent Form 10K and subsequent reports on Form 10Q. No unauthorized recording or transcription of this call is permitted.

Presenting the results today are Steve Brown, President and Chief Executive Officer and Mike Indiveri, Executive Vice President and Chief Financial Officer. At this time I would like to turn the call over to Steve.

Stephen R. Brown

Thank you for joining us today on the call. I’m going to deviate somewhat from our typical approach to these calls today and basically not use a script, but just talk to you about where we are with the business, what we’ve accomplished in 2013, and what we see heading into 2014. 2013 was a year of transformation and accomplishment for us. I want to recap some of those achievements because I think they are important to remember as well as set the direction for the company going forward.

We completely satisfied the OCC and had the order lifted in 18 months. It was lifted on October 31, 2013, an extremely short timeframe from a regulatory perspective. We’ve built an infrastructure to support growth and diversification in a competitive marketplace and in a tough regulatory climate. We hired several new executives with substantial experience. Mike Indiveri is our CFO, John Swadba is our Chief Credit Officer, and most recently Mike Finn is our Chief Risk Officer. Mike comes to us with more than 25 years’ experience as a regulatory with field experience, policy and oversight responsibilities.

Early in 2013 we shared with you that we were targeting loan originations or purchases to be $200 million. In fact, they were actually $402 million in 2013. We targeted growth in the investment portfolio of $100 million and we achieved $93 million of that. We targeted a 5% reduction in non-interest expense compared to 2012, we achieved 4.5% excluding one-time charges and non-recurring fees. We rerationalized our branch system and exited an unprofitable market while retaining almost 90% of those deposits and I believe that speaks to the strength of our deposit building and relationship building capabilities.

During 2013 we reduced classified assets to 21% of tier capital plus the allowance from 36% at the end of 2012, and we increased coverage of non-performing assets by the allowance from 76% at the end of 2012 to 111% at the end of 2013. We increased or maintained our capital ratios and tangible book value per share. We’ve added an asset based lending team that is already producing results for us.

One disappointment is our asset management subsidiary. A loss of clients in 2013 resulted in a lower contribution to earnings than we expected, and that trend continues as well as an accounting impairment charge. As I said before, we like the asset management space and the potential to diversify our revenue. However, to keep this in context, this business line added $0.05 per share to our earnings in 2013 and $0.01 per share in the fourth quarter. It simply is not material to our existing earnings and our near term earnings capacity. We’re addressing this area and evaluating our options with an eye to maximizing the value potential.

18 months ago the board management set out a path to transform Hudson Valley to a more diversified lender, to recruit new executive talent and add to the existing talent, to preserve and strength our core deposit base, and to return the company to the high earning potential that had been achieved for many years prior to the financial crisis. We believe we have laid out that path in 2013 and continue down that road today.

Transforming the company takes time. We believe, if you truly want to build on your strengths, which we have many of, and establish a culture and infrastructure to drive the business forward – we believe we have done all of that over the last 18 months. We entered 2014 with a stronger than ever executive team with the depth and experience to lead the company to achieve our goals. We have strong capital, abundant liquidity with expanding lending channels to continue to deploy that liquidity effectively. We have a deposit base that is the cornerstone of our franchise and that fuels our earnings potential today and into the future as we have a balance sheet that benefits from rising interest rates.

We believe we began 2014 well positioned to grow revenue, to grow profitability in a highly competitive market and industry. I’m proud of the steps we’ve taken as a company in 2013 and late 2012, they’ve been directed to maximizing shareholder value, to building a franchise with a team of management, with a board, that understands our marketplace. That understands over time the best way to build shareholder value is to capitalize on our strengths. We’ve positioned the company to do that. We’ve laid out the path together, we’ve gone down that road aggressively. At time there has been bumps, there are surprises, and there are issues to deal with when you try to reengineer an organization while preserving some very high quality strengths at the same time.

So, I am pleased with where we are and I am very encouraged as we go into 2014 with our ability to continue to deploy our capital and liquidity. The hires we have made of quality people in many different areas of the company, I think speak a lot to the future of the company and the potential that many see here. With that, I’m going to turn the call over to Mike and will be back to you later.

Michael J. Indiveri

I’d like to spend a few minutes to touch on some of the key items before we move on to taking questions. Steve talked about the accounting charge for the goodwill, there were a number of reasons that drove it and I will say we took a very conservative approach when we did our analysis. In addition to the impairment charge, you read that we also elected to sell our entire portfolio, $10 million of trust preferred securities with a net loss of approximately $726,000. We elected to dispose of this small portfolio to eliminate uncertainties that community banks may face in the future from the [inaudible] implementation.

As we well know, in mid-January the industry received regulatory clarifications on the exemptions. But given the small size of the portfolio we’re happy to have cleared the deck of any future uncertainty. The move also improved the company’s tangible equity and risk based capital ratio while reducing the bank’s classified assets. While we concluded the sale in 2014, in January, I want to clarify that there will not be an accounting gain recorded in January. Without going into an extensive accounting discussion, the unrealized loss of $7 million was already built into the company’s equity in other comprehensive income. The unwinding in that transaction resulted in the loss running through the December financials and the unwinding running through equity at the same time. So, we do have a net pick up to equity but there will be no gain recorded in the financial statements in ’14.

We also elected to prepay $16.4 million of federal home loan bank borrowings in early January. The $16. 4 million constituted our entire portfolio of borrowings with the federal home loan bank. They had a weighted average rate of 4.36% and we will recognize approximately $712,000 in interest expense savings in 2014. We timed it, or we got close to a high for the 10 year treasury as an opportunity to reduce the amount of prepayment penalty that we paid when the borrowings were paid off.

As Steve summarized, our banking business is going strong and we continued to deploy liquidity throughout the last three months of the year. The fourth quarter of 2014 saw our highest level of originations in some time totaling $94 million. This compared favorably to $64 million during the third quarter. This reflects the fundamental structure and cultural changes made by Hudson Valley since 2012, as Steve described earlier. Fourth quarter originations included $59 million in commercial real estate loans, $22 million in business loans, and $13 million in residential [inaudible] loans.

During this quarter we also saw $29 million of runoff in that portfolio. $9 million or 31% was due to refinancing and approximately $7 million represented payoffs on problem loans. We also purchased nearly $143 million worth of high quality residential loans in 2013 including a little more than $28 million in the fourth quarter. The loans purchased in the last three months of the year are all high quality in footprint residential mortgages. The purchases comprised almost exclusively of 15 year fully amortizing secondary market conforming loans with the following characteristics: an average loan-to-value of 59%; an average [D-to-I] ration of 31%; and average FICO score of 768.

They carry an average yield of 3.14% and as with our prior purchases we executed a thorough and detail credit and compliance review of each loan to ensure they continued to meet our high quality credit and risk standards. While the purchased loans were booked late in the quarter, the originated loans were booked throughout the quarter. The benefit of the $28 million purchase in the average balances in the margin will materialize itself in the first quarter of 2014.

For the securities group book, we’ve grown it by more than $93 million in 2013. $12 million of which came in the fourth quarter. All the securities are high quality US government agency securities and New York state municipal securities. Fourth quarter purchases of $31.6 million were predominately agencies with the balance in New York municipals. At December 31st, fully 90% of our $93 million municipal securities portfolio were issuances by New York state entities. All of the municipal securities continue to remain investment grade. Our going forward tax equivalent yield after considering the full quarter impact of the recently purchased securities is about 2.37% with an effective duration of approximately 4.3 years.

Continued loan deposit funding costs again, helped to partially offset lower yields resulting from our excess cash position. The yield on interest earning assets was 314 in the fourth quarter of 2014 compared to 319 in the linked quarter and 350 in the fourth quarter of ’12. During the fourth quarter of 2013 we were able to replace seasonal municipal deposits with approximately $38 million of core customer business related products, many of which are tied to our cash management products.

Turning to margin, while we are making progress on growing assets net interest margin continued to reflect the excess cash position. Cash and cash equivalents totaled $699 million at the end of 2013 down from nearly $828 million in the prior year end. The net interest margin was 295 in the fourth quarter, down four basis points from the third quarter.

I’d like to turn to credit and asset quality. Asset quality continued to improve reflecting an improving marketplace and improving economic trends in general, and improvement in our loan book in particular. Non-performing assets improved to their lowest level since the third quarter of 2008 totaling just $23.5 million or 0.78% of total assets at the end of 2013. Net charge offs also improved to their lowest level since 2007, totaling just $3.1 million or 0.21% of average loans in 2013. For the fourth quarter of 2013, net charge offs were just 13% of average loans. Provision expense was $648,000 in the fourth quarter and $2.5 million for the full year, and our allowance stood at 1.59% of total loans at December 31, 2013.

Like Steve and the rest of the leadership team here at Hudson Valley, we’re pleased with the work completed in 2013 that position the bank and our balance sheet to be in a strong place for the future. But, we also acknowledge that work remains to be done to move more excess into earning assets and to improve our earnings. We believe the building blocks are now firmly in place that will allow us to be successful and to move forward.

With that, I would open up the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mark Fitzgibbon – Sandler O’Neill & Partners.

Analyst for Mark Fitzgibbon – Sandler O’Neill & Partners

I’ll just start with one question and then get back in queue. I was wondering if you guys could share with us the size of your loan pipeline?

Michael J. Indiveri

We don’t typically disclose the amount of the pipeline so we’re not going to really go into that. But what I will say to try and put it in some scope and perspective is as we move throughout 2013 and now into the beginning of 2014 the loan pipeline continues to grow and so the loan pipeline today is higher than it has been in the last 12 months.

Operator

Your next question comes from John V. Moran – Macquarie Capital, Inc.

John V. Moran – Macquarie Capital, Inc.

Thanks for clarifying the gain or not gain actually on the [CO] sale that was a little unclear in the press release. But I wanted to just kind of circle up on investment management. If I look at kind of the fee stream there, it was pretty stable over ’13, granted down a bunch from where it was in ’12. If I think about that line going forward just in light of the impairment charge, is it fair to assume the revenues out of that piece of the business are heading down if you choose to stay in it?

Stephen R. Brown

In the near term the revenues in that business are heading down. So, we’re evaluating. What we do, as I mentioned earlier, we have said in the past we like that space, we think there’s going to be good opportunity there. It’s a changing environment. We are looking at all our alternatives. In the near term I think our expectation is it’s a sideways move in revenue at the better scenario and potentially trending down a little bit.

John V. Moran – Macquarie Capital, Inc.

Okay, so trending down a bit on revs and not a hugely material contribution at the bottom line?

Stephen R. Brown

No.

John V. Moran – Macquarie Capital, Inc.

Then sort of an unrelated follow up, if maybe we could just talk about liquidity deployment expectations for ’14? I know you guys were really clear about kind of what you expected for ’14 and you delivered on it on the loan side and kind of just missed on the securities side. Would your expectation be to kind of continue to deploy at a quarterly clip kind of like what we saw over say the back half of ’13?

Stephen R. Brown

I’m not going to peg by quarter what we expect loan growth to be, but it’s been trending significantly up particularly in the second half of ’13 and we do have a more robust pipeline that we’ve had at any point in the last 12 months or more. As we added the ABL team, which is just beginning to produce, and as I talked about I am hopeful in being able to disclose in the not too distant future the addition of an equipment financing team. So, I expect based on all of that unless there’s something dramatic that happens in the marketplace or the economy, recognizing that we are in a competitive marketplace and that’s simply light at the moment, I expect loan growth while it may not be a straight trajectory up, but loan growth to continue to increase over the course of 2014.

Operator

(Operator Instructions) Your next question comes from Travis Lan – Keefe, Bruyette & Woods.

Travis Lan – Keefe, Bruyette & Woods

First question, just as we think about to John’s point the liquidity deployment timeline, how do you think about future deposit growth? Obviously, that’s your core differentiating factor so do you think deposit growth is going to continue and then need to be offset further?

Stephen R. Brown

That’s a great question. Yes, we are looking for continued core deposit growth. We’ve talked about, over the last 18 months, how we’ve managed down some of our deposits with strong customer relationships where they’ve actually taken out some of their excess funds at our request while we’ve retained the relationship. But we do not want to send any kind of signal that we are not still seriously in the deposit gathering business, and we are. At 18 basis points all in cost of the deposits, I can afford to build strong deposit relationships without much incremental cost to do it and cover with overnight funds if that’s the name of the game for the short term.

Prior to 2013, a 10 or 12 year growth rate in our deposits was over 12% per year. I don’t see any reason why we wouldn’t be targeting strong deposit growth on a go forward basis. It will add to liquidity but our focus has always been relationship based deposit gathering and we’re still prepared to do that.

Travis Lan – Keefe, Bruyette & Woods

Then just bigger picture, given all the progress you laid out in terms of building up the management team, putting substantial cash to work, and the regulatory resolution which were all clear positives for the year, how do you think about kind of the longer term fully deployed earnings potential for the bank? Whether it’s a normalized our way, or any other metric, just kind of big picture longer term, don’t need to put a timeframe on it but at optimal capacity what do you think this bank can produce in terms of normal ROI?

Stephen R. Brown

Well there are a lot of things that are going to go into that equation, interest rate environment not the least of which would be an impact. We’ve looked at the marketplace, we look at what do high performing banks achieve in the way of ROI. We see high performing banks in today’s world 85 basis points, 100 basis points ROI. I think we are focused on how do we get to that place. Don’t know the exact timeframe, some continued liquidity deployment gets us there I think and interest rate environment change would help. We’re still slugging through an environment where our low cost deposits have lost some of their ability to power earnings even though they are still the cornerstone of what we do. If we’re going to put a stick in the ground that’s kind of what we’re looking is where are high performing banks comparable to us achieving results and that’s what we’re striving towards.

Travis Lan – Keefe, Bruyette & Woods

Mike, just two quick questions for you. First of all, the tax rate going forward is still kind of 30% to 31% a good number to use?

Michael J. Indiveri

No, I would be inclined to take a normalized rate closer to 40%. There’s a lot of noise in the tax rate this year.

Travis Lan – Keefe, Bruyette & Woods

Then just on maybe the pipeline or what you saw in the fourth quarter just in terms of what kind of origination yields you’re seeing maybe on the commercial side? I mean, obviously you laid it on the resi purchases but you know, just kind of with the way yields are trending in the commercial portfolio?

Stephen R. Brown

The different segments, the commercial real estate side excluding multifamily is in the fours, really ranging from the very low fours to as much as 475. Multifamily is a very different story and we’re not doing a lot of multifamily at the moment. The ABL team is bringing in paper based more on LIBOR or prime so the today’s yields for most of what we’re originating is from around 350 to as much as just under 5%. It’s a pretty wide range but it’s reflective of the different lines of business right now in the market.

Operator

(Operator Instructions) Your next question comes from John V. Moran – Macquarie Capital, Inc.

John V. Moran – Macquarie Capital, Inc.

Just maybe a quick follow up on operating expenses. Do you see any additional leverage there? I mean, obviously you took some steps up in Connecticut, rationalized the footprint a bit. Anything more you can do on that side or is it just kind of as we bring in teams and kind of continue to redeploy we’ll expect some increase there on the op ex line?

Stephen R. Brown

I think that’s exactly right. We did a lot of reengineering on the expense side in 2013. I do expect we will be spending more directly on team based and origination based capacity in 2014. I don’t see a lot of pressure in other areas today in non-interest expense. I also don’t see huge opportunity to make further reductions. So, we’re really looking at two things: investing in teams; and we are investing in technology as well to support both deposit and loan growth.

Operator

There appears to be no further questions at this time so I’d like to turn the call back over to management for any closing remarks.

Stephen R. Brown

Thank you all for joining us today. We really had a year of accomplishment in 2013. I am really just delighted going into 2014 with a strong management team, a great balance sheet, and really a good reputation in our marketplace. We’re starting to turn the corner on getting the marketplace to understand we are a very different lender today than we were two years ago. I think all of those things will go towards helping us grow both topline revenue and profitability throughout 2014. Thank you all again for your participation today.

Operator

The conference is now over.

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