Merchants Bancshares' (MBVT) CEO Michael Tuttle on Q2 2014 Results - Earnings Call Transcript

Jul.23.14 | About: Merchants Bancshares, (MBVT)

Merchants Bancshares, Inc. (NASDAQ:MBVT)

Q2 2014 Results Earnings Conference Call

July 23, 2014 09:00 AM ET

Executives

Michael Tuttle - President and CEO

Janet Spitler - Chief Financial Officer

Geoff Hesslink - COO and Senior Lender

Analysts

Alex Twerdahl - Sandler O'Neill

Matthew Breese - Stern Agee

Travis Lan - KBW

Operator

Hello and welcome to the Merchants Bancshares, Inc. Q2 2014 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. Now I would like to turn the conference over to Michael Tuttle. Mr. Tuttle please go ahead.

Michael Tuttle

Great, good morning everybody, thank you Keith, appreciate you are taking the time to join us this morning hopefully you have had a chance to look at the press release that went out yesterday after the market close. As you can see in there we had a flat quarter from the first quarter certainly it was impacted by reduced margins and our inability to offset that margin compression with ad volume. We have throughout past year been intentionally reducing exposure, price volatility and investment portfolio and have build out liquidity during that same time frame. Net impact of all that as we have sacrificed some current earnings to remain well positioned for rising rates.

At the same time we are making investment in new core processing system that’s also impacting current earnings will for the balance for this year. The opportunities for added income and efficiency will start to be realized later this year and into 2015.

I am going to stop there. I am joined here this morning by Janet Spitler our CFO and Geoff Hesslink, our Chief Operating Officer and Senior Lender. And I am going to let them give you some color and comments and then we would be happy to take questions. Janet?

Janet Spitler

Great. Thanks Mike good morning everyone. So net income for the quarter was 3.4 million and were at 6.8 million year-to-date. We continue to strengthen our capital position during the quarter, tangible equity ratio at June 30th was 7.77% and our book value was increased to $19.75 a share. As Mike mentioned the margin compressed further during the quarter came down 4 basis points. Asset yield decreased further during the quarter and continue to present a challenge.

And we have continued to reposition and strengthen the balance sheet by increasing liquidity and shortening our assets which as Mike mentioned is going to cost us some revenue in the short term but does put us in a better position when rates eventually rise.

We have continued to let the investment portfolio runoff, again reducing exposure to price volatility and further strengthening our capital position, the portfolio expands at about $335 million today and were going to stay in that general range probably $335 million to $340 million or $445 million for the foreseeable future.

Current investment opportunities are not terribly attractive, we don't want to reach for yields, we don't want to expand in the portfolio or take on significant credit risk. So we are absolute looking at a fairly short treasury ladder for reinvestment opportunities in the portfolio. We're looking at the 3 year to 5 year point on the curve.

The current rate stay at where they are and credit risk stay as tight as they are we do expect to see the margins continue to migrate down over the balance of the year as our asset yields will continue to be a headwind. So margin could be pushing 3% towards the end of 2014 or the first half of 2015.

We experienced continued growth in non-interest income during the quarter compared to 2013. We experienced nice growth in our trust income and service charges on deposits combined with our investment in [Bancorp] life insurance. So we are expecting non-interest income to run in the $2.9 million to $3 million range fourth quarter for the balance of 2014.

Non-interest expenses were up for the second quarter and first half of the year compared to 2013, however lower than the first quarter of this year. As we mentioned in the press release included in our non-interest expenses, where conversion costs of $217,000 for the second quarter and year-to-date were just under $400,000 which represents about $0.02 and $0.04 a share after tax.

So after those expenses, non-interest expenses were up about 3% over 2013. And we are expecting our guidance on non-interest expenses staying the same this quarter, we're expecting about $10.1 million to $10.2 million per quarter in the second half of the year; the timing of some of those expenses tends to be loaded more towards the second half of the year.

We will incur another approximately $800,000 in expenses related to the core conversion for the balance of 2014. Most of that will be in the third quarter, we'll see some of that in fourth quarter. The conversion is going to happen at the end of October. And the conversion is going well so far, we’ve hit all our future milestones so far, so we're very much on track to go live at the end of October this year.

And we will see a small benefit during November and December, probably 50,000 to 75,000 from the new pricing related to the core conversion. The provision for this quarter was $50,000 and was $150,000 year-to-date. Second half provision will be very similar to the first half. As you know we have our asset quality continues to be pristine and we're not anticipating that we're going to need to make any large additions to the loan loss reserve.

Our tax rate was 23% for the quarter and it won’t be in that range for the balance of 2014. And lastly, I want to mention the efficiency ratio which is just over [70%] for the quarter. That's excluding our core conversion expenses. We expect that it is going hold there, around there for the balance of 2014 and then we'll have a chance to improve that in 2015. We would like to see that back below 60%.

And I am going to turn it over to Geoffrey now to give you some highlights on loans.

Geoff Hesslink

Thank you Jan. Good morning everyone. I’ll speak about a few things this morning. I’ll touch quickly on the asset quality. I’ll speak to what we saw in the second quarter for loan activity. I’ll provide a summary of what we’re seeing for the loan market conditions and finally I’ll wrap with an outlook for what we see happening in the balance of the year.

Asset quality remains excellent. We have very low levels of delinquency and non-performing assets. Our expectation is that problem loans and credit losses will remain very well controlled in the future.

Moving on to the second quarter in aggregate and as you can see from the release, adjust for the normal temporary reductions in our municipal loans, our loan balances were essentially flat for the quarter. Growth we saw in the commercial loan segments was offset by reductions in residential loans.

To give you a little more color on our loan segments, C&I business remains a bright spot for us. We’re very pleased with the growth we’ve seen in this segment, this loan business is up 12% from December and 15% from a year ago. That growth has been achieved mainly through new customer acquisition and to a lesser extent some increased loan demand.

Our commercial real-estate business is flat in 2014. There are couple factors contributing to lack of growth there so far in the year. First is we are seeing intense bank competition. Credit spreads and loan terms are particularly aggressive in the commercial real-estate market. An additional factor impacting our growth has been some timing delays and some commercial real-estate loan opportunities we have. I will tell you we do expect to close some of that business over the balance of the year and we expect some modest growth in commercial real-estate business this year.

Municipal loans, we saw that the regular decrease that we normally see at close of the second quarter with the schedule repayment of our short-term revenue anticipation loans, that did happen. I will say aside from that temporary reduction, we expect their municipal loan business to be down in 2014, a couple of reasons driving that. First we're converting some of our customers to a more efficient line of credit financing structure and the results of this are lower loan balances, but improved returns for the bank.

And the second factor impacting in municipal loans also has to do with some slippage in the pipeline. We had a few municipal loan opportunities slated to close in the latter half of '14 that they're going to move into early 2015.

And finally, our residential mortgage loan business. That business is down for us it dropped $6 million in the quarter, $13 million year-to-date. This reduction is solely the result of or finance off, that's what we do and it's just driven entirely by significant reductions and refinance activity which as you all know is an industry wide phenomenon. We do acknowledge that the reduction in this business that we've seen year-to-date has been more severe that we anticipated for the year.

So moving on the market condition that's description there is just more intense competition. We're seen reductions in credit spreads or seeing banks take more extension risks in the loan portfolio we are seeing reductions in credit standards again I am sure this will be new to you folks as an imbalance in the market to supply credit exceeds the demand for credit and thus presents very challenging market conditions for banks.

So I guess in summary, let’s what this all mean so we’ve had expect solid C&I growth we expect some modest commercial real estate growth this year, slight reduction in municipal business again obviously there is a loss of customers but changes something as a structure. We will see material and greater than expected reductions in our residential loan business and it’s a highly competitive market. So again what it mean for us, it means we are not going to achieve the loan growth objectives we set for ourselves headed into 2014 we have revised those loan growth expectations to 2% and we acknowledge that this growth rate is below rates we have achieved in the past several years but frankly it’s the right place for us in the present market conditions.

We have been very well served by our credit discipline, our credit culture our low risk model, this is the point in the cycle where it’s going to be hard for us to grow, this premiums are low credit terms are softening, challenging market conditions, despite that market conditions our model is not going to change we are going to continue to see quality profitable relationships that enhance shareholder value. We will always strive to be adequately compensated for credit and interest rate risk and again this model combined with the industry competition, this competition always exist at this point in the cycle I should say the effect of that is actually going to be lower our loan growth rate. That’s the experience that we will see, frankly it's acceptable, plus it's a right thing for us and it's in the best interest of our shareholders.

So, those conclude my prepared remarks, I'll turn it back over to Michael and happy to answer any questions you might have.

Michael Tuttle

Great. Thank you Geoffrey. So, at this point Keith, if there are folks who have questions, we try our best to answer those.

Question-and-Answer Session

Operator

Yes, thank you. We will now begin the question-and-answer session. (Operator Instructions). And the first question comes from Alex Twerdahl with Sandler O'Neill.

Alex Twerdahl - Sandler O'Neill

Hey, good morning.

Michael Tuttle

Good morning Alex.

Janet Spitler

Hey Alex.

Alex Twerdahl - Sandler O'Neill

First question on the loans that you have that are variable rates, I think you alluded to like $330 million in the release. When rates go up, will those reprice that immediately or is there floors on some of those loans that have to be met before they will repriced higher?

Michael Tuttle

There are some floors Alex I think it's those numbers, it's a very modest amount. You are going to look at most of the, very large majority of those loans will reprice immediately with changes in short rates.

Alex Twerdahl - Sandler O'Neill

Okay, great. And then there just from sort of a macro perspective, what do you think has to happen in Burlington or in Vermont or in the country in general for you as to see loan growth pick up. I mean is it just a point in the cycle or is it something else that’s mentioned out better?

Michael Tuttle

It's a lot of, I will explain the cycle. I mean Alex you know our company well, if you look back 4 and 5 years ago right, we have nice, our models going to tend to have stronger growth rates earlier in the credit cycle right, if you look at 2009, 2010, 2011 and we're double-digits one year high single-digits growth other year so right we're -- that’s the point of cycle where we tend to have the stronger than average growth rate.

But at this point to cycle, we're going to migrate to the mean on growth rates it's going to be harder for us. So I am not suggesting we're hoping for credit event but it's a challenging point of the credit cycle for ourselves.

Alex Twerdahl - Sandler O'Neill

That's right. I mean given the struggles that you are having and I am assuming that a lot of your competitors are having the same sort of struggles I mean if do you get the sense that there is need for consolidation in Vermont and or do you may be better cities, if you get the sense that something could happen?

Michael Tuttle

That's good question Alex. I don't know that necessarily we'll see it happen inside the state but I do think there probably would be some potentially some shift in the players that we'll see happen over time here. We'll -- we're a company for example that's accumulating capital at this point we're going to look to deploy that and where will be most like place for us to deploy that and we have to give there some serious thought about where we can have the best place, the best place to get a return on that money is going to be.

Geoff Hesslink

Alex, and just to add to that when you think about the market share and the state of Vermont be mindful that it's the bigger regional and national, international companies have north of 50% maybe 60% of the market share here. So our competition is for the most part not from smaller banking companies but from larger regional and national banking companies.

Alex Twerdahl - Sandler O'Neill

Great, that’s a good point. Are there any opportunities to purchase loans I mean is that something you’d ever considered doing whether being from elsewhere in the state or from in the northeast or I am assuming you wanted to go national but I mean do those opportunities present themselves at any point in time or do you consider doing at something along those loans?

Michael Tuttle

This is something we’ve talked about for 18 months now, it’s a natural thought to have right to look to get to markets where there is higher levels of loan demand. We’ll certainly look at it just recognizing the challenges there. Our understanding of other markets, our credit culture which and our preference to originate and manage credit ourselves it’s a little different deal when you originate and manage your own credit its whole different deal by the somebody else’s credit. So I can’t tell you that that’s something we’re an actively pursue, we thought about it and can do a little bit but I don’t want to think that’s going to be a big growth avenue for us.

Alex Twerdahl - Sandler O'Neill

Okay. And then just final question in the expense guidance that you gave the $50,000 to $75,000 benefit in the fourth quarter is that included in the $10.1 million to $10.2 million per quarter expense run rate?

Janet Spitler

That will be outside of that.

Alex Twerdahl - Sandler O'Neill

Okay. As additional, okay great. Thank you very much guys.

Janet Spitler

Yes.

Michael Tuttle

Thank you Alex.

Operator

Thank you. Your next question comes from Matthew Breese with Stern Agee.

Matthew Breese - Stern Agee

Good morning everybody.

Michael Tuttle

Hey Matt.

Matthew Breese - Stern Agee

Just wanted to touch on the liquidity build this quarter and get a sense for what inning we’re in there? I mean should we expect liquidity to continue to build for the remainder of the year?

Michael Tuttle

So the answer is, you will see some added liquidity build in that and that’s impart again due to the municipal cash flows, because those will be more heavily weighted towards the last four, five months of the year, we'll see a lot of inflow there so that will build some added liquidity for us. So you should see that go up. If you look at our average liquidity levels over the past four quarters, most of the build from June of last year to June of this year happened as we started to unwind investment portfolio when the biggest chunks of that were being wound down that's when we added the most liquidity back. And we didn't actually add that much average liquidity back between the second and third quarter, excuse me first and second quarters of this year.

So I suspect we'll see a similar situation as become into the end of this year. We'll see more liquidity build in the three and four. We're going to redeploy some of those investment cash flows. But again we're not looking to grow that asset significantly, again unless the market conditions change. But the spreads are too tight and we really don't think it's worth and the price volatility is too great potentially.

Janet Spitler

But significant liquidity build in the fourth quarter as Mike said, because that's when there is some fairly heavy municipal cash flows are coming during the fourth quarter.

Matthew Breese - Stern Agee

Okay. So but it won't come from the securities portfolio. Where that portfolio is now is probably where it's probably the way it will go. Is that correct from your earlier comment, Janet?

Michael Tuttle

I’d just caution you, yes, if rates stay where they are, but if rates move down significantly, we may choose to take more volatility after table and lightening up that portfolio even more, that's a possibility that could happen. But all things being equal, yes, we’ll be in that range.

Matthew Breese - Stern Agee

Okay. And then Geoffrey, going back to some of your loan commentary, you implied that you said that some of the loan spreads have been tightening. Could you just give us some better insight as to what extent spreads have tightened over the past year?

Geoff Hesslink

Over the past year, yes, 50 to 75 basis points.

Matthew Breese - Stern Agee

Okay. And those are over…

Geoff Hesslink

Yes, over a LIBOR curve and again it’s -- and every once in a while you see an outlier that’s a real thin credit spread.

Michael Tuttle

I can tell you 2009, we were running commercial deals at 300-350 basis points spreads and today 200 is a good number in there, what’s demonstrated an ability to go significantly below 200 in fact.

Geoff Hesslink

I think maybe safe to say, we are seeing spreads as low as we have seen them since or almost as low as they were in ‘06.

Michael Tuttle

Yes, we are at that point, the last low point of cycle. I think you are right. And it’s dynamic, Matt, it’s -- we get new information every day, right. There is an imbalance between supply of credit and demand for credit and that puts an awful lot of pressure on price and risk premium.

Matthew Breese - Stern Agee

And who is pushing spreads lower? Do you find it’s from regional banks, community banks, credit unions and insurance companies?

Michael Tuttle

We are all going to point fingers at each other, right. I am going to say, it’s our competitors; if you talk to them, they’ll probably say it’s us. Everybody is in it, right? Everybody plays the game and if it’s a quality asset, everybody wants to win it and that impacts the price and the credit spread.

Matthew Breese - Stern Agee

Okay. And then going back to your M&A commentary, it sounds like maybe your position on being an acquirer or has changed a little bit. And I'm just curious as to what geographies you would look with those, would that be contiguous markets or non-contiguous? Give us a sense of directionally where you’d like to be.

Michael Tuttle

I think for us, we're looking at contiguous market opportunities, Matt. I think that's and we’re looking for markets that may have greater density, more opportunities to increase the size of the loan portfolio, higher activity levels, maybe even some larger loan opportunities. Those are the something that we have some appeal to us definitely.

Matthew Breese - Stern Agee

And what about size of targets, parameters around the deal?

Michael Tuttle

A good deal, we are not going to discriminate on size there. We find a good deal, we are interested, I’m sure there is a limit on the upside, right, as to how much we could take on, but we're certainly not going limit it on the downside there. So, we don't have a specific dollar target in mind there.

Matthew Breese - Stern Agee

That's all I had. Thank you.

Michael Tuttle

Thanks Matt.

Geoff Hesslink

Thanks Matt.

Operator

Thank you. The next question comes from Travis Lan with KBW.

Travis Lan - KBW

Thanks and good morning everyone.

Michael Tuttle

Good morning, Travis.

Geoff Hesslink

Hey Travis.

Travis Lan - KBW

Hey. Most of the questions have been answered but just a couple of big picture ones. First, just kind of from a strategic perspective, you talk about how limited loan growth opportunities and liquidity is obviously building. How are you thinking about your own kind of deposit gathering efforts, is it something that you are still really targeting deposit relationships or are you willing to kind of step aside, because you have built so much liquidity, how you feel about that?

Michael Tuttle

Good question. I can tell you this. We are targeting the positive opportunities to have fee income attached to them. Those are the ones that are getting the greatest emphasis from us right now. And we will continue to target those. So as management opportunities we're always looking to acquire transaction accounts. That will not stop for us but I would say obviously the least attractive piece for us right now is in time deposit category and you can see the migration again we're obviously tracking rest of the industry there on what's happening in that category for us.

Travis Lan - KBW

Great, okay. And then Janet obviously you guys are extremely conservative particularly on the credit side. How do you feel about the potential to take a negative provision? I don't -- I guess I should rephrase that. Would you be willing to take a negative provision if credit remains as strong as it is and loss rates remain de minimis?

Janet Spitler

It's not something that we're currently anticipating but we are evaluating the level of the reserve so we've been sort of targeting making sure that that stays over 1% and actually I think we are like 107 at the end of the second quarter. So we may be looking at potentially having a lower ratio of reserves total loans, I don't expect that we're going to take a negative provision but we're going to probably provision at a lower level.

Travis Lan - KBW

Okay, that's helpful. Right that's all I have thank you very much.

Michael Tuttle

Travis may be another way to state that is our expectation’s there will be some growth to take up something that we might, absent some growth may be the reserve could be turned back, but we expect to see some growth at the same time.

Travis Lan - KBW

Got you, okay. All right thank you very much.

Michael Tuttle

Thanks Travis.

Operator

Thank you. (Operator Instructions). All right, there are no more questions at the present time. So I would like to turn the call back over to management for any closing comments.

Michael Tuttle

Great, thank you Keith. Thank you all for joining us on the call this morning. We appreciate your interest in our company and certainly look forward to reporting to you in future quarters.

This is a time as Geoffrey said this is going to require some discipline on our part. We would -- we’re not going to chase yields and earnings at this point in the cycle, we don’t think it’s prudent or the right thing for us to do. We have some good opportunities in front of us with our core conversion project to become more efficient to be able to increase our sales and service levels. We think that’s going to benefit us again very modestly maybe in the fourth quarter, but certainly into next year.

The margin is a big question. And that’s going to be largely a function of rates and spreads and as we came into the year expecting rates to keep marching up and then have them retrace their steps, so basically where they were a year ago as we finished the second quarter was disappointing and it’s going to challenge us if we have rates just stay where they are or even move further down that would be a challenge for us. Conversely we have an opportunity if we start to see the curve steepen out a little more here and see rates move up.

So, we’ll have to see what the direction provide for us there. I’ll remind everybody that just one point on that margin is worth $150,000, $160,000 to its pre-tax. So every basis point we can get back there is a big for us and we are looking forward to a point in time hopefully where that will start to be the case. But we’ll see what the rate environment hold for us going forward.

Again thanks for joining us and have a great day.

Operator

Thank you. To access the digital replay of this conference you may dial 1-877-344-7529 or 1-412-317-0088 beginning at about 11 am Eastern today. You'll be prompted to enter a conference number which will be 10037007. You'll be prompted to record the name the company you are joining. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect. Have a nice day.

Michael Tuttle

Thank you, Keith.

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