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TrustCo Bank Corp. (NASDAQ:TRST)

Q2 2014 Earnings Call

July 22, 2014 9:00 am ET

Executives

Rob McCormick - President & CEO

Bob Cushing - CFO

Scot Salvador - CBO

Analysts

Alex Twerdahl - Sandler O'Neill

Collyn Gilbert - KBW

Operator

Good morning, and welcome to the TrustCo Bank Corp Second Quarter Earnings Call and Webcast. All participants will be in listen-only mode. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. (Operator Instructions).

Before proceeding, we would like to mention that this presentation may contain forward-looking information about TrustCo Bank Corp NY that is intended to be covered by the Safe Harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995.

Actual results and trends could differ materially from those set forth in such statements due to various risks, uncertainties and other factors. Please review risk factors in our most recent annual report on Form 10-K and our other securities filings for detailed information.

The statements are valid only as of the date hereof and the company disclaims any obligation to update this information except as maybe required by applicable law. Please also note this event is being recorded.

I would now like to turn the conference over to Mr. Robert J. McCormick, President and CEO. Please go ahead.

Rob McCormick

Good morning, everyone. Welcome to the TrustCo Bank's second quarter earnings call. As Kate said, I'm Rob McCormick, President and CEO of TrustCo Bank. Joining me on the call today are Bob Cushing, our CFO; and Scot Salvador, our Chief Banking Officer. Kevin Timmons, who most of you deal with regularly is in the room to keep us in line.

We had a very good second quarter at TrustCo Bank. The plan for this call is I will hit the highlights, Bob and Scot will give detail on the numbers, and then we will have time for questions and answers.

Our net income was over $11.8 million, this is over 20% greater than the same period in 2013. We also saw a strong rise in year-to-date net income to over $22.8 million. Our strong net income provided us with a return on average assets over 1% and a return on average equity of 12.5%, all significantly greater than the same period in 2013. Our net interest margin saw an expansion for 3.6. That's up 6 basis points from the same period in 2013.

Total deposits grew to $3.995 billion; this is up over $100 million from June 30 of 2013. We were also very happy to continue the pattern of being less dependent on CDs or higher cost deposits.

Loans grew to over $3.006 billion driven by a residential mortgage portfolio. New application volume is down but so over the payouts resulting in very nice growth. I think we have grown every month this year except for February.

Our capital ratio is over 8.38% at quarter end. The balance sheet is still very liquid with significant investment portfolio for short maturities. And Bob is going to touch on that.

We opened two new offices this quarter Warrensburg, New York and Stuart, Florida. They are just expansions of our existing market place service area. We also relocated our Longwood, Florida branch.

Our non-performing loan and asset ratios have improved to 1.36 and 1.07 respectively. Most of you know we are very proud of our efficiency ratio which improved under 53% down from last year.

Just as a recap, loans were up, deposits were up, net income is up, non-performing loans are down, margin is up, efficiency ratio is down and return on equity is up. I think we had a pretty good quarter.

Bob, would you provide more detail?

Bob Cushing

Sure. Thanks Rob. I will review the financial results for TrustCo for the second quarter year-to-date 2014. The strengths noted in the first quarter continued into the second quarter resulting in a very, very strong first half of 2014. As Rob noted, net income for the second quarter of this year was $11.8 million compared to $9.8 million last year, an increase of 20.9%. Likewise, year-to-date results for 2014 were $22.8 million this year and $18.9 million last year.

These results generated a return on average equity of 12.5% for the second quarter of 2014 and 12.3% for the year. Both the quarter and year-to-date results benefited by a couple of one-time items.

We noted in our press releases this year we had a one-time income item in both first quarter and second quarter 2014. In the first quarter, we had the gain in the sale of Florida proposed corporate headquarters which generated a pre-tax gain of $1.8 million. And in the second quarter we sold a piece of other real estate we had in our portfolio for quite a while at a pre-tax gain of $2.4 million. Also during the second quarter, we had a sale of long term non-performing assets of $1.8 million at a gain of $164,000 which was offset by $151,000 of property taxes we had to pay on these assets sold.

So the loan sale did not result on any meaningful impact on the P&L, but it did help to reduce non-performing assets. These gains allowed us to remain highly liquid while at the same time post meaningful increases in both net income and other performance criteria. Complementing these one-time items as the quarter reflects our progress in expanding our balance sheet to quantify the growth and increases in residential retail loan customers.

On average total deposits increased by $55 million for the first quarter of this year and by $116 million over the second quarter of last year's average balances. The average cost of interest bearing liabilities continue to decrease by 2 basis points in the quarter to come in at 38 basis point as compared to 40 basis points for the first quarter of this year and 41 basis points for the second quarter 2013. Average loans have increased by $45 million from the first quarter of 2014 to the second quarter and by $239 million over the second quarter of 2013 average balances.

These are both very significant increases in average balances and reflect our determination to continue to capture loan volume. The expansion in net increase margin for the quarter from 3.13% in the first quarter to 3.16% in the second quarter of this reflects hard work on both the earning asset side and the deposit side of the balance sheet.

We continue to look for and identify opportunities to reduce or control the cost of deposits. We have also undertaken a program to encourage customers to extend the terms of their CDs by contacting maturing CD customers early and offering them relatively attractive longer terms renewal rates this. Has helped increase the average term to maturity of our CD portfolio by almost 25% for the period from year end 2013 to June 30, 2014. This is a pretty substantial change when you think about the $1.1 million we have in CDs.

The impact, with the growth of the balance sheet, coupled with the changes we have made in net interest margin and had a pretty significant impact on tax equivalent net interest income. For the second quarter of this year, our tax equivalent net interest income is $35.5 million, which is an increase of almost $2 million over 2013's second quarter. That is a very sizeable increase on a quarter-to-quarter basis and represents the most significant driver for the increase in net income in the future.

Let me also note that for the quarter we retained approximately $607 million an average over net investments, which is an increase of $31 million in the first quarter of this year. So we continue to believe that there is true value in entertaining our opportunities to invest these overnight bonds and longer-term securities and loans as rates change. In addition to liquidity sitting on the balance sheet, we expect that we will have $450 million of total loan payments coming in over the next 12 months along with $150 million in investments, securities, cash flows during the same time period.

Let's move to non-interest income which came in at $4.5 million for the quarter, which is in line with prior quarters when you ex-out the one-time items and the security gains. As you know our business model does not rely on significant sources of other non-interest income. The most significant recurring source of non-interest income is derived from our financial services division which $878 million of assets under management.

Non-interest expense came in at $19.4 million through the second quarter of this year, but you need to keep in mind that there was a gain in the sales of other real estate of $2.4 million netted against ORE expense. Likewise, we had additional property tax expenses totaling $500,000 as a result of the loan sale and the annual property taxes that we pay on nonperforming loans. Our efficiency ratio is 53% for the quarter down slightly from a year ago second quarter. If you remove the effect of the property taxes paid in non-performing loans efficiency ratio for the quarter would have been 51.8%.

I know that this gets a little tied up with the one-time items, but let's look at the total non-interest expense for the second quarter. Total non-interest expense was $19.4 million. If you take out the effect of the $2.4 million gain on the sale of the ORE property and the $500,000 in added property tax expense to be paid, the adjusted total non-interest expense would have been $21.3 million, which would include ORE expense of approximately $700,000. We've said for some time now that we are most comfortable with recurring non-interest expense in the $20.2 million to $20.7 million range and with ORE expense adding another $500,000 to $1 million per quarter of additional expense.

Our result through the second quarter falls clearly inside these ranges and we continue to feel comfortable with these ranges moving forward. Individual components of non-interest expense changed primarily based upon volumes and some seasonality. Salary and benefits are up from the first quarter, but right in line with our expectations for the year.

Equipment expense is up slightly due to the adding cost of converting our PCs from the XP operating system to the Windows based operating system. Professional services were up slightly, but that is due principally to a loan sale this quarter and our annual meeting expenses. FDIC and other insurance expense up through the increased deposit balances and other non-interest expenses up through the added property taxes we have already been talking about so overall non-interest expense is in line with our expectations for the year.

Capital ratios continue to improve. The tangible equity asset ratio of 8.38% at the end of the second quarter compared to 7.83% a year ago. Now, Scot is going to review the loan portfolio and nonperforming loans.

Scot Salvador

Okay, thanks Bob. As far as the loan portfolio is concerned total net loans grew a strong $65 million or 2.2% in the quarter. This follows upon approximate growth of $32 million in the first quarter and equates to year-over-year growth of $243 million or 8.8%. Over $62 million of the quarter's growth was in the residential portfolio with commercial loans increasing just over $2 million.

Home equity loans grew by $1.7 million with remainder of the residential increase occurring in our first mortgage product. Our Florida market continues to show strong activity with a growth in Florida accounting for approximately 40% to 70% of the second quarter's net loan growth.

Overall, loan activity grew steadily in the second quarter as is typical for the time of the year. We are pleased with our results and we ended the quarter with a backlog of approved loans larger than both the first quarter and the corresponding second quarter of last year.

With regard to non-performing loans, virtually all asset quality indicators showed improvement on both the quarter and the year.

Nonperforming assets dropped from $53.9 million to $49.2 million this quarter. On a year-over-year basis, nonperforming loans to total loans dropped to 1.36% from 1.57%, a year earlier.

Included in the second quarter results as it was noted earlier was the sale of approximately $1.8 million of nonperforming assets to a third-party at a small net gain. Early stage delinquencies remained strong in all markets and further improved quarter-over-quarter to levels we have not seen in quite some time. We consider as a positive future indicator with regards to non-performers. Rob?

Rob McCormick

We're pleased with the quarter and that's our story and I guess I'll turn it back over to Kate to get the questions lined up.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Our first question is from Alex Twerdahl from Sandler O'Neill. Please go ahead.

Alex Twerdahl - Sandler O'Neill

Just looking at the balance sheet it looks like you've put about $100 million of cash to work during the quarter. A good chunk of it went into the securities portfolio. Can you just give us a little more color, Bob, on what you are buying in the securities portfolio in terms of duration, rate, et cetera?

Bob Cushing

Okay, Alex. Really it's actually -- really the second -- the first quarter really was the kind of the odd quarter if you really look at it. At the end of the first quarter, we had about a $120 million of securities that either matured or were called back into cash. So if you look at the end of the first quarter, you'll see that the security portfolio was lower than the average balance it was for the first quarter and the cash position went up by about $120 million.

Early in the second quarter, we reinvested that back into similar securities, which for us represents call latencies in the five year or under final maturity and mortgage-backed securities, again with average life, mortgage-backed securities under five years. The yield on those portfolios are in the 2% to 2.5% range. And if you look at the average balance for the second quarter, you'll see the average balance of the second quarter is pretty much in line with the end of quarter balances. So the rest of the second quarter, we really didn't do any purchases.

Alex Twerdahl - Sandler O'Neill

Great. And then for the ORE property that you sold during the quarter that you kind of had hedged in your portfolio, are there any more of those that could be sold in the next couple of quarters?

Rob McCormick

Nothing exactly like that, Alex. We certainly have other ORE property, but that was a long-term holding was unapproved and unimproved vacant land it took a very, very, very long time to sell. We took a wait and see approach for quite some time and then it was on our books for nothing and the right buyer came along and finally was able to put something together. So nothing like that.

Alex Twerdahl - Sandler O'Neill

Right. And then, Scot, just in terms of the pipeline you said is larger than it was at the end of the first quarter and the year ago. Could you just give us some color on what the rates are on that portfolio today versus what's on your books already? Not on the portfolio, on the pipeline today?

Scot Salvador

Sure. Alex, today we're originating today at 408, that's on a 30 year loan obviously. And the backlog is probably in that range, may be a little bit higher on an average, if you average it all together, little bit higher than 408 in the background, more in the 4 in a quarter. It's a backlog; it might be more in the 4 in a quarter, the 4.5 range.

Alex Twerdahl - Sandler O'Neill

Okay. That's great. And then just finally a couple of quarter ago, Rob, you mentioned that you're going to get back into the card business. And is that something that's still going on or we haven't have really heard much about it, and I guess in a couple of quarters.

Rob McCormick

Yeah Alex, we're about to issue our first test card this month. And they will be branded MasterCard. There will be four separate cards including a corporate card. And again, we're not trying to conquer that business or compete with the big guys, but we have a lot of customers who like to deal with our branches one on one, I think you know that like to be able to make their payments in the branches and we have had some outcry for a card. So we are going to dip our toll back into that water very shortly.

Operator

The next question comes from Travis Lan from KBW. Please go ahead.

Collyn Gilbert - KBW

This is actually Collyn Gilbert calling for Travis. Good morning guys.

Rob McCormick

Hi, Collyn, how are you?

Bob Cushing

Hi, Collyn, how are you?

Collyn Gilbert - KBW

Good thanks. So just to circle back on the CDs that you did this quarter. What were the kind of the terms that you were looking for and I'm just trying to get an understanding of where customer behavior is that they are willing to extend. So just on yield and duration I would be curious to know about that.

Bob Cushing

What we were doing is we are reaching out to customers before their maturities to see that we can get them to either roll into the existing terms they had or to some slightly longer terms that we were offering. So we had actually at one point made a five-year CD out there that we were trying to get people interested in and we did get some people to move out to that far. The rate even out that far was not -- was not a very large rate from if you look at historical numbers but in 1% to 1.5% range. What we have now is 18 month in a 24 month type of term that we are trying to entice people into and again it is the 1% range.

Collyn Gilbert - KBW

Okay. Okay. That's helpful.

Rob McCormick

That's the way Collyn that works to Bob's point. The 18 month to 2-year seems to work best for our customers.

Collyn Gilbert - KBW

Okay. And it seems like the trigger has to be somewhere above that 1% level to get them to come in?

Rob McCormick

Certainly 1.

Bob Cushing

1 is the magic number.

Collyn Gilbert - KBW

Okay, okay, that's helpful. And then just given your comments on credit and your outlook seems pretty positive there, how should we think about provisions going forward? I mean do you anticipate them to match the net charge-offs or do you want to see reserves may be start to fall, or how should we think about the provision from here?

Bob Cushing

From what, we tend to be pretty conservative individuals and we look at a long-term horizon relative losses and 2008, 2009, and 2010 are still in our memory from that perspective. So we like the idea of having reserves in the levels we're at right now in the total dollar amounts. So we see ourselves pretty much providing at the level of net charge-offs and in that range we're -- we're in that $1.5 million range and that's about what we think is appropriate.

Collyn Gilbert - KBW

Okay, okay, that's helpful. And then just one final question, do you guys have a sense for what you average annual operating expenses are for your branches? How are you thinking about kind of breakeven now in terms of level of deposits?

Bob Cushing

Our deposits -- we look at a new branch operation to be on a breakeven mode in that $8 million to $10 million range of deposits and again sooner than normal distribution of loan growth in the same time from that same operation. So we like that 60:40 split between loans and deposits, I'm sorry between loans and investments. So we can get about 60% of the deposit flow back in the form of loans. The other 40% we will invest with Fed funds and securities portfolio.

So as operating costs are concerned we continue to drive down operating costs as you know we kind of look at the smaller branch footprints they are 1,800 square foot to 2,200 square foot locations with the drive through end cap those types of things and from a staffing model we've been driving -- there has been a little bit of overstaff at the beginning of a branch when a branch first comes on board, so that we have a lot of splash, and lot of opportunity to market in the community, but as they stabilize those operating costs come down. Those costs probably are in the $250,000 to $300,000 range.

Collyn Gilbert - KBW

Okay. That's helpful. That's all we have thanks.

Rob McCormick

You know we've opened -- you know Collyn for years we have opened for people are opening now. We open, as Bob said smaller branches open floor plans and very customer friendly set up. So --

Collyn Gilbert - KBW

Got it.

Rob McCormick

That certainly helps us with our cost basis.

Operator

The next question is a follow-up from Alex Twerdahl from Sandler O'Neill. Please go ahead.

Alex Twerdahl - Sandler O'Neill

Hi, guys. I was just looking through my notes and I'm not sure I got what you guided for expenses going forward. Can you just repeat that?

Bob Cushing

We continue to look on to it. That's $20.2 million to $20.7 million operating expense range with another $500,000 to $1 million in ORE expense reaffirming where we were.

Operator

(Operator Instructions)

As there are no questions at this time, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. McCormick for any closing remarks.

Rob McCormick

Thank you for your interest in the bank and thanks for taking the time this morning. Have a great day.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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