StellarOne Corp. CEO Discusses Q3 2010 Results - Earnings Call Transcript

Oct.21.10 | About: StellarOne Corporation (STEL)

StellarOne Corp. (NASDAQ:STEL)

Q3 2010 Earnings Conference Call

October 21, 2010 11 AM ET

Executives

Jennifer Knighting – Advertising & Communications Manager

Ed Barham – President and CEO

Jeff Farrar – EVP and CFO

Analysts

Will Curtiss – Sandler O’Neill

Allan Bach – Davenport & Company

Jennifer Demba – Robinson Humphrey

Brett Scheiner – FBR Capital Markets

Michael Rose – Raymond James

Operator

Good day, ladies and gentlemen, and welcome to the StellarOne Corporation earnings call. At this time, all participants are in a listen-only mode. Later we will conduct and question-and-answer session and instruction will be given at that time.

(Operator Instructions)

As a reminder, this conference call is being recorded.

I would now like to turn the conference over to our host, Ms. Jennifer Knighting.

Jennifer Knighting

Today we have with us, O.R. Ed Barham, Jr., President and Chief Executive Officer of StellarOne Corporation and Jeffrey W. Farrar, Executive Vice President and Chief Financial Officer. Mr. Barham and Mr. Farrar will review results for the third quarter of 2010. And after we hear comments from Ed and Jeff, we will take questions from those listening.

Please note that StellarOne Corporation does not offer guidance. However, there may be statements made during the course of this call that express management’s intentions, beliefs, or expectations. Actual results may differ from those contemplated by these forward-looking statements.

Now, may I introduce our President and Chief Executive Officer, Ed Barham.

Ed Barham

Good morning to everybody. I will begin today’s earnings call with a brief overview of our company’s third quarter results, asset quality trends and general overall performance. Jeff Farrar, Executive Vice President and CFO for StellarOne Corporation will follow my opening remarks with further financial details and insight.

StellarOne for the third quarter 2010 earned $3.5 million. Net of dividends and discount accretion on preferred stock, net income available to common shareholders was $3.1 million or $0.13 per share. This compares very favorably to a net loss to common shareholders of $9.4 million or $0.41 loss per diluted common share a year ago. It also compares favorably to second quarter 2010 results of $1.1 million or $0.05 per diluted common share.

Third quarter 2010’s results were helped by strong non-interest income from mortgage banking, lower loss provisioning and reduced credit costs associated with foreclosed assets. Third quarter’s net earnings were the highest of any quarter over the last 18 months, which continues a positive earnings trend for the company.

Despite these improved results, we did face higher indemnification losses related to mortgage and lending, reduced banking fees largely related to reduced overdraft charges.

Let me skip (this some) comments regarding asset quality. Clearly, bottom line earnings for third quarter 2010 were bolstered by smaller provision of $3.5 million for the quarter. This compares to $7.4 million provisioning second quarter this year and a $20.1 million provision a year ago. While the reduced level of provision is obviously important to the current quarter results what is equally important, but perhaps not as obvious to the outside viewer is the positive impact being made by and effective internal credit monitoring process and experience work (inaudible). Our efforts to aggressive take writedowns on troubled credit have set appropriate reserve levels are beginning to yield positive results.

As I have stated before, if the economy can remain stable to improving, our asset quality outlook should continue to improve, though our level provisioning will remain elevated for the near term.

Currently our allowance for loan losses as a percentage of non-performing loans increased to 78.2% or an increase of 13.4% from second quarter. The coverage at the end of June 30th, 2010, was 64.8%. The allowance as a percentage of total loans stands at 1.92%, down only 3 basis points from the preceding quarter. Non-performing assets declined by $8.4 million to $62.1 million on a sequential basis, resulting in a ratio of non-performing assets to total assets of 2.13%. This compares favorably to June 30th, 2010’s ratio of 2.36% or $70.6 million in non-performing assets.

Non-performing loans totaled $51.1 million for the quarter, down by $13 million. Of the non-performing loans, roughly $23.3 million are residential development and construction loans. Of the 23.3 million, $13.3 million are located in Smith Mountain Lake, Virginia. Essentially, this level is unchanged from last quarter. I will note we are having active discussions with outside third party professionals to develop plans to move the majority of the remaining non-performing loans at Smith Mountain Lake. Of the $13.3 million, non-performing loan exposure at Smith Mountain Lake roughly $10 million is to one developer, consisting of two large projects, which have some market appeal, (would need a) more comprehensive approach for a successful resolution.

The engagement of an outside consultant project manager would likely be structured on a revenue sharing basis to minimize our out of pocket expenses going forward. While most asset quality metrics show marked improved, OREO levels did increases as anticipated as we took control of several troubled real estate projects, one development in particular accounted for over 4 million of the increase in OREO, which at quarter end amounted to 10.5 million versus 6 million at the end of second quarter 2010. This one large addition to OREO, we also believe has an above average market appeal, mainly because it consists of some attractive income producing residential properties in a well-established development. This credit is also being discussed with the same resolution consulting group that I just mentioned.

Also showing a slight negative trend over the past two levels, which had loans between 30 and 89 days past due up by $7.9 million moving from second quarter’s level of $14.1 million to $49.3 million. Some of this increase is a function of matured notes and administrative in nature, which often is caused by extended negotiation to troubled borrowers. Overall, total past dues for the quarter end were 2.49%, which is favorable to our rolling 12 month average of 2.73%.

Our TDRs currently stand at $38.1 million. Of this amount, $26.2 million are a result of our residential mortgage modification program, and the remaining $11.9 million are commercial credit. The redefault rate on the residential mods have been very good with only a 10% to 12% redefault rate. Of the $11.9 million in commercial TDRs, roughly $8 million consist of two credits, $2.8 million to an excavating company with significant corporate and personal assets available for liquidation and the remaining commercial exposure to nationally branded fast food franchise that is under consideration for restructure, which once completed should allow for resumption of amortization under conforming terms.

I will conclude my opening comments by providing an update on our position regarding the redemption of TARP. Since our last earnings call, a series of discussions have been held with our regulators, our state (inaudible) has been concluded in early September and we had our board strategic retreat during the same month. This topic has been vetted quite a bit.

Bottom line, we believe for the current time that our best approach to the repayment of TARP is to improve earnings metrics and asset quality, which would result in capital retention that would replace the TARP capital. No TARP recipient bank can just give TARP back. It must be replaced by earned and new capital or a capital raise.

Given the fact that our capital levels have always been strong and have even increased further this year, we do not see a capital raise merely for the repayment of TARP as a practical approach. If there were to be other developments relative to TARP or relative to attractive growth opportunities, and a modification of our current position to a capital raise may occur, but for now, we are focused on improved earnings through asset quality enhancement, further cost reduction initiatives and revenue growth. As on the side, one constriction factor to the immediate repayment of TARP is that the Treasury does require repayment in increments of 25% of the outstanding amount, which for us would be payments not less than $7.5 million.

I will conclude my remarks now and thank you for your attention and I will turn the call over to Jeff.

Jeff Farrar

Good morning everyone. Thank you for joining us. I have several topics I would like to cover today and would start with some additional color on the revenue results for the quarter. Revenues were essentially flat for us for the quarter, we experienced some contraction in operating non-interest revenues, with such revenues coming in at $8 million, down $397,000 or 4.8% compared to linked second quarter and up $217,000 compared to the same quarter prior year. Expected decreases in retail banking fees associated with the Regulation E changes coupled with an increase in mortgage loss indemnification contributed to this decrease.

Our retail and wholesale divisions closed over $150 million in mortgages during the third quarter, a huge volume for us. The resulted mortgage revenues and profitability were however impacted by approximately $809,000 in accrued indemnification losses in the third quarter. In spite of these charges, the segment still reported aftertax earnings of $146,000 for the quarter and $594,000 for the nine-month period.

Losses continue to be primarily related to 2006 and 2007 production from our wholesale division. It was minimal losses (inaudible) from subsequent production periods. In fact, scorecarding from our investors has been very positive for production that has occurred in the last 24 months. We currently have approximately pending indemnification claims in the pipeline with an aggregate balance of $4.5 million and an allowance on the books of $1.1 million for such claims.

As noted in the earnings release, the impact of Reg E compliance begin to show up in the third quarter. The revenue impact based on initial results would indicate an implied impact of $1.5 million to $1.8 million annually. We continue to have success with (inaudible) for our higher users with approximately 50% of such users now opting in. A couple of other mitigators include some solid achievements in debit card penetration and DDA account acquisition. Debit revenues have essentially doubled since the first of the year on a month-to-month basis and we have averaged over 1000 new DDA accounts per month for the last three months. These success should begin to mitigate the impact from the regulation change over time.

Wealth management also experienced some revenue contraction associated with reduced fee realization, but did contribute aftertax earnings of almost $100,000 for the quarter, and $360,000 for the nine-month period. We have seen a rise in new business acquisition during the quarter, which should become more apparent in the coming quarters.

Our growth net interest income amounted to just over $300,000 sequentially and $1.4 million compared to the same quarter prior year. We continued to see some reduce funding costs that drove some margin improvement up 4 basis points to 3.63 basis points for the quarter. And that is our fourth consecutive quarter of expansion albeit at a slower pace.

As discussed in last quarter’s call, we continued to get some improvement on the cost of liabilities associated with CD repricing was about 22.5% of the total portfolio repricing during the quarter. In addition, we experienced some continued improvement in cost of funds associated with our non-maturity deposits and wholesale funding.

This improvement coupled with the CD repricing resulted in a 16-basis point reduction in funding cost for the period. With another 192 million of CD’s repricing in the fourth quarter at a blended rate of 2.07 and repricing on average about a 100 basis points downward, we would expect that margin to continue to be relatively stable as these funding cost continue to mitigate the impact of loans repricing in the current rate environment.

Let’s switch gears and talk about noninterest expense. We experienced some acceleration of overhead growth on a linked quarter basis, but still compare favorably to same quarter of 2009 with a modest 4% growth rate. Off the $875,000 or 3.8% of increased overhead on a linked quarter basis, approximately $247,000 relates to increased commission and overtime costs associated with the higher mortgage production and another $295,000 relates to increased FDIC insurance cost.

The efficiency ratio came in at 71.8%, which is 276 basis points higher than the second quarter, but 587 basis points lower than the same quarter prior year. The increase in the third quarter is a function of the aforementioned increase in overhead and relatively flat revenue results for the quarter. Overhead as a percentage of average assets came in at 3.16%, again elevated by cost associated with record mortgage production and increased FDIC insurance cost.

Our effective tax rate came in at 23.6% for the third quarter and now stands at 14.8% for the nine months period. The effective tax rate for the quarter is reflective of the earnings improvement experienced this quarter as compared to our levels of permanent tax differences which are predominantly tax exempt income and bank on the life insurance.

A few quick comments on the balance sheet. Our regulatory capital levels showed growth for the quarter as a result of earnings retention and reduced risk weighted asset base. Tier 1 risk-based capital came in at 14.49%, excluding the top investment the ratio still is a healthy 13.19%. Tangible common equity was 9.96% at quarter-end, with tangible book value per share of $12.25.

We continued to see some slight balance sheet contraction with average assets decreasing $7.3 million or less than 0.35% sequentially. Average loans were down $24.3 million or 1.1% sequentially, while average deposits were down $16.2 million or less than 1% link quarter.

Average securities grew to $397.9 million for the quarter and finished the quarter at $403.4 million. Cash and cash equivalents at quarter-end amounted to a $108.9 million, down $17.4 million from the second quarter.

That concludes my prepared remarks and I’ll now turn it back to Jennifer for the Q&A discussion.

Jennifer Knighting

Thank you, gentlemen. Now, we will move to the question-and-answer portion of this conference call. At this time, I’ll ask our operator to open the call for your questions. Shannon?

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Will Curtiss with Sandler O’Neill. You may begin.

Will Curtiss – Sandler O’Neill

Good morning.

Ed Barham

Good morning.

Will Curtiss – Sandler O’Neill

You guys mentioned the impact of the Reg E. Can you talk a little bit about the methodology behind that 1.5 to 1.8? I guess my question is how do you come up with that?

Ed Barham

We really just looked at the revenue stream reduction, post implementation, and just kind of applied it if you will on annualized basis. That number’s going to move around obviously as our opt-in rates continue to build. And we obviously feel that there is some other areas that we got some lift and that will reduce that impact as well.

Jeff Farrar

I just to add that, I think that’s the worst-case scenario as we analyzed it.

Will Curtiss – Sandler O’Neill

Okay. And then, just in terms of the Smith Mountain Lake, can you provide any additional color? I think in the past you guys have done some auctions. Are you guys going to do that?

Ed Barham

Well, we’re kind of out of the auction season right now, and that’s why we’ve taken a little bit of a different tact, if you would or the two large credits I referenced are oversized and magnitude that we felt we needed a little more comprehensive, professional involvement beyond our staff, our employees to handle and to develop a plan for eliminating that particular nonperforming loans or lose that particular nonperforming loans. So the jury is still out, several scenarios are being discussed. And, at this time, really we’re not at a point where I could share that with you. Hopefully by next quarter, we’ll have some more color around that. But, again, the intent here is to try to move those along as quickly as possible.

Will Curtiss – Sandler O’Neill

Okay, thank you.

Ed Barham

You’re welcome.

Operator

Thank you. Our next question comes from Allan Bach with Davenport. You may begin.

Allan Bach – Davenport & Company

Hi, good morning. Congratulations on the good quarter.

Ed Barham

Thank you.

Jeff Farrar

Thank you.

Allan Bach – Davenport & Company

Just wondered if you – I guess you had mentioned that earning out of the TARP preferred, could you talk a little bit about the timeline that you expect there? Do you think you’ll wait to hopefully accrue a few more good quarters before starting that process or is that more of an immediate process start there?

Ed Barham

Well, as I referred to, you’re required by the treasury to make 25% payment minimum, so that would require that at a minimum I will have to pay $7.5 million. And, of course, I’ve got the shareholders to pay trust preferreds and all the rest. So there is some need to continue to continue to accumulate retained earnings, to be able to make those sort of payments. That’s why I referenced it in my comments it’s sort of not an immediate thing, but hopefully not too far in the future.

Allan Bach – Davenport & Company

Got you. Okay, thank you very much.

Ed Barham

You’re welcome.

Operator

Thank you. Our next question comes from Jennifer Demba with Robinson Humphrey.

Jennifer Demba – Robinson Humphrey

Thank you, good morning.

Ed Barham

Good morning.

Jeff Farrar

Good morning.

Jennifer Demba – Robinson Humphrey

Ed, just kind of I wanted to get your thoughts on acquisition opportunities or what you may be seeing out there in the market right now and your own ability and willingness to do a transaction right now.

Ed Barham

Well, I would say the ability is there if we wanted to. But the desire is somewhat muted Jennifer, just because it is still a very uncertain environment out there, and the markets that I most desired obviously as I’ve alluded to earlier is the Richmond market I haven’t given some thoughts to perhaps maybe even some [inaudible] Virginia activity at some point, again keeping on the same of needing to go to higher growth markets.

So I’m still at a point where I’m trying to practice patience here, because I think the further that things move down the line of the coming quarters, I think the opportunities are going to be more evident and they’re going to be possibility of having more attractive acquisitions. I’m very sensitive as is my Board and so I am that anything we do really is accretive and beneficial to us. There is less room in my opinion to make mistakes.

The other thing I would say, I don’t care how good our due diligence team you’ve got. In this environment, it’s next to impossible to be able to go and do diligence and feel like you’ve really covered yourself. And so that’s another reason I can tend to kind of want to wait and see where the economy is heading to give us a little bit of at least of indication, an arrow point that things are getting better, and maybe if we have an opportunity, then we’ll be looking at it a little more seriously.

Jennifer Demba – Robinson Humphrey

Thank you for those thoughts. Are you seeing any acceleration in inquiries?

Ed Barham

Absolutely, Jennifer. I – I’m having a lot of ongoing conversations. I’ve been invited to a lot of dances and we just sort of sitting on the sideline right now, because I think those situations don’t go away, they’re still there. And they’re getting more attractive from a buyer’s perspective quite honestly. So I think that patience prevails.

Jennifer Demba – Robinson Humphrey

Thanks a lot.

Ed Barham

You’re welcome.

Operator

Thank you. Our next question comes from Brett Scheiner with FBR Capital Markets. You may begin.

Brett Scheiner – FBR Capital Markets

Hi guys, good quarter. Just real quick, the $12 million to the one developer on Smith Mountain Lake, have you released what’s that carried at net of the allocated reserve?

Ed Barham

It’s $10 million. And is your question, are we adequately reserved that we could let it go for what we’ve got it reserved and written down to?

Brett Scheiner – FBR Capital Markets

No, I think it is yes.

Ed Barham

Yes.

Brett Scheiner – FBR Capital Markets

Okay, thank you.

Ed Barham

That’s a brief enough answer.

Brett Scheiner – FBR Capital Markets

All right, thanks guys.

Operator

Thank you. (Operator Instructions). Our next question comes from Michael Rose with Raymond James. You may begin.

Michael Rose – Raymond James

Hi, good morning, guys.

Ed Barham

Good morning.

Jeff Farrar

Hi Mike.

Michael Rose – Raymond James

You know if you were to contemplate an acquisition, would you consider a capital raise to repay TARP at that time?

Ed Barham

Yes.

Michael Rose – Raymond James

Okay. And secondly, on the expense base, is there anymore incremental opportunities to reduce the cost structure here? Do you kind of feel like you’re at a good rate here?

Ed Barham

I would tell you that there’s some opportunity as it relates to just the asset quality area and some of the fires that we’re fighting there. We continue to have a lot of elevated costs associated with just managing the problem assets. And so as that begins to normalize, certainly I think there is some opportunities to see some of the reduced professional fees and that type of thing foreclosure, costs, holding costs, what have you. And so, certainly, that is an area that comes to mind.

The FDIC insurance costs I do think we’re going to give them a list there once the FDIC figures out how to calculate the premium. And so, I heard Speaker this week say that they’re still noodling with the formula and the process, and so we’re still kind of patiently waiting to figure out what the timing on that’s going to be. But I’m still hearing 33% decrease in FDIC insurance premiums, so at some point, that certainly will be a major component.

And then, the indemnifications on the mortgage, obviously that is an area that we’re spending a lot of time with right now. Again, that’s order production. At some point, you’d like to think as if you’re continuing to see some improvement in the economy and what have you. At some point, the frequency with which those are coming at us it’s going to vain. And, therefore, we’ll get a little bit profitability and grows revenue on that mortgage unit, which will obviously help.

Michael Rose – Raymond James

Okay. That’s helpful. And one follow-up if I can. In terms of a competitive landscape and I know loan growth is tough right now. But are you seeing any green shoot so to speak in terms of maybe a pickup C&I activity or anything like that?

Ed Barham

No, I can’t tell you that we really are. Anything I could really brag about. I’m reading a lot about Northern Virginia market, beginning to – the commercial real estate market actually is beginning to come back and people are putting money into that market, but that’s a little bit north of us. But it does have a trickledown effect somewhat delay that hits us a little later. So I’m hoping it’s true. But, so far, we’re not seeing a great deal of it.

Michael Rose – Raymond James

Has your pipeline increased at all?

Ed Barham

We tend to keep it pretty good pipeline and it is increasing. And, the only issue we’ve got really is that the run-off some of it planned is greater than our – than the pipeline build. And the only difference is really nothing more than real estate and we’ve made a conscious effort in many cases not to chase real estate to the extent that we did in the past.

If that were available to us, if it was a normal market, we would be doing much better on a pipeline basis if you could say that real estate was doing better and it was available to us. But the real problem is that’s kind of in the dot rooms. But if you look at C&I, consumer lending is up, over the last 12 months was up. So we’re encouraged by what we’re seeing.

It is competitive, but our guys and gals are working hard and having success. We’re doing a few more interest rates swaps. We’ve kind of gotten into that and having some success with that and obviously some nice fees that we can take in on an immediate front with that. And that’s getting us to the lot of a tables for opportunities that we haven’t here before and able to take advantage of.

Michael Rose – Raymond James

So, maybe the better way to think about it is, loan production has improved maybe modestly over the past few quarters.

Ed Barham

I would say that’s a fair way of putting it, yes.

Michael Rose – Raymond James

Okay, thanks guys.

Ed Barham

You’re welcome.

Operator

Thank you. I’m showing no further questions in queue. I now like to turn the conference back over to Jennifer Knighting.

Jennifer Knighting

Everyone thank you for joining us today and for your questions. We appreciate your participation. This concludes today’s teleconference. Thank you.

Operator

Ladies and gentlemen, this concludes today’s conference. Thank you for your participation. Have a wonderful day.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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