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Valley National Bancorp (NYSE:VLY)

Q2 2014 Earnings Conference Call

July 30, 2014 11:00 AM ET

Executives

Dianne Grenz – Investor Relations

Gerald Lipkin – Chairman, President and Chief Executive Officer

Alan Eskow – Senior Vice President and Chief Financial Officer

Analysts

Steven Alexopoulos – JP Morgan

Ken Zerbe – Morgan Stanley

Matthew Kelley – Sterne Agee & Leach, Inc.

David Darst – Guggenheim Securities

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Valley National Bancorp Second Quarter Earnings Call. At this time, all lines are in a listen-only mode. Later, there will be an opportunity for your questions and instructions will be given at that time. (Operator Instructions). And as a reminder, this conference is being recorded.

I will now turn the conference over to Dianne Grenz for opening remarks. Please go ahead.

Dianne Grenz

Good morning. Welcome to Valley’s second quarter 2014 earnings conference call. If you have not read the second quarter 2014 earnings release that we issued early this morning, you may access it from our website at valleynationalbank.com. Comments made during this call may contain forward-looking statements relating to Valley National Bancorp and the banking industry. Valley encourages participants to refer to our SEC filings including those found on Form 8-K, 10-Q, and 10-K for complete discussion of forward-looking statements.

And now, I’d like to turn the call over to Valley’s Chairman, President and CEO, Gerald Lipkin.

Gerald Lipkin

Thank you, Dianne. Good morning and welcome to our second quarter earnings conference call. For the quarter, Valley generated net income of $29.5 million, the equivalent of $0.15 per diluted common share. The quarter included an infrequent increase in non-interest expense about which Alan will provide additional information in his prepared remarks.

For the year-to-date net income was $63.4 million or $0.32 per diluted common share. Total non-covered loan growth was among the highlights for the quarter, strong origination volume in consumer commercial real estate and C&I lending was offset by the continued slowdown in residential mortgage activity as reported by most of the industry this quarter. During the quarter we originated over $600 million of new loans approximately 30% consumer and 70% commercial.

Total commercial lending originations of nearly $425 million for the quarter was relatively inline with the activity generated in the prior quarter.

However, unlike the first quarter increase C&I activity dominated the growth. Point in time, C&I balances increased nearly 9% annualized from the prior quarter as record originations of nearly $300 million a new C&I loans were generating.

Activity was brisk in all of Valley’s marketplaces. New York in the aggregate accounted for approximately 60% of the new origination volume. Specifically, New York C&I origination closings expanded over 50% from the prior quarter compared to linked quarter growth in New Jersey C&I originations of approximately 25%.

In addition, the strong origination volume realized in the quarter C&I line usage increased from 37% to 39% resulting in an increasing outstandings of approximately $30 million. The average yield, our new C&I originations was approximately 4% for the period as interest rates on strong credit continue to be pressured.

Commercial real estate outstandings for the quarter increased slightly as originations of approximately $125 million or largely mitigated by portfolio amortization and prepayments. Although, originations for the quarter tapered somewhat from those witnessed in the first quarter, we remain optimistic as improving economic conditions coupled with the low interest rate environment appears to have begun to force to renewed confidence among many of our borrowers.

The commercial lending pipeline remains strong and we anticipate continued growth based on current projections. Commercial lending was at the only bright spot for the bank in the quarter as consumer lending origination activity was brisk. Total non-covered consumer loans expanded over 21% on an annualized basis during the quarter as strong indirect order originations were supported by growth in other consumer lending products.

Valley maintains an expensive indirect dealer network throughout New Jersey, New York and Pennsylvania. Activity for the quarter was strong in all geographies and we envisioned similar performance for the reminder of 2014. Residential mortgage activity continues to decline as the consumer refinance market had slowed to levels not witnessed since before the recession and purchase activity in our marketplace remains tepid.

Typically residential mortgage volume intensifies in the spring. However, second quarter volume lacked first quarter originations and although we have expanded product specific advertising. We do not anticipate a significant change in activity or production levels unless there is a dramatic shift in consumer attitudes towards homeownership. As a result of the contraction in residential mortgage origination volume we continue to reduce staffing levels. In the last 12 months we have eliminated approximately 50% of the departments workforce and intend to further right size the department should application levels remain subdued. We remain steadfast in our efforts to improve operating efficiency.

Although Valley’s reported efficiency ratio for the quarter exceeded 72% the ratio was negatively impacted by both the manner in which we are required to account for changes to the FDIC low share receivable as well as the amortization of tax credit investments. For just these two items our efficiency ratio would have been 65.9% for the second quarter.

Further the ratio’s usefulness and determining operating efficiency is that kinds antiquated and inclusive in providing a comparative basis to past performance. For example at Valley just in the last seven years we have seen expenses ramp up over $40 million annually to meet regulatory demands. These course have an immediate negative impact on our efficiency ratio. However, the regulators offer little tolerance for non-compliance.

Additionally in today’s operating environment maintaining strong regulatory compliance is crucial for a bank to participate in mergers and acquisitions. At Valley we intend to strategically incorporate acquisitions in conjunction with organic growth as an avenue to establish scale and improved profits.

During the past few years we have been settled with over $2 billion in borrowings, costing us on average approximately 4%. These borrowings were intended to offset higher rate longer term loans and investments. As a result of the protracted record low interest rate environment most of those loans and investments prepaid. But due to owners yield maintenance prepayment requirements the borrowings remain. Beginning in 2015 and continuing over the next few years most of those borrowings will mature and we should be able to replace them with much lower costing funds thereby improving profits and many of our key financial metrics in the future.

Also we have some derivative instruments that we’re put in place several years ago as a hedge against potential increases in funding course. Currently those instruments have a negative impact on interest expense and our earnings per share but those will also mature and no longer be a cost towards starting in 2015 through 2017. Anticipating potential higher rates in the future, we have entered into forward starting derivative contract on a portion of the maturing debt; in order to lock in reductions and interest expense ranging from 130 to 230 basis points depending upon the instrument.

The expected interest expense savings are significant and we believe the benefit will drive improved profitability and earnings at Valley. In May, we announced our initial foray into the Florida market with the acquisition of 1st United Bancorp. Emerging with 1st United, we are not only obtaining a profitable commercial bank with a seasoned and talented management team, but we are gaining on entrée into a strong growth market. Approximately 63% of Florida’s population and much of the business growth is aggregated in the MSAs in which 1st United is currently situated.

The personal income and population growth in these demographics is staggering and equally into growth in Valley’s decision to partner with 1st United. The decision to expand Valley’s branch footprint beyond the New Jersey and New York metropolitan marketplace was not taken lightly. Over ten years ago, we made the strategic decision to enter the New York marketplace.

Although a natural geographic expansion many of the challenges encountered in entering New York resonate with our expansion into Florida. We have proven unequivocally that Valley’s approach to traditional relationship based commercial banking is both portable and effect that when executed appropriately. We believe the execution risk associated with this transaction is similar to other acquisitions yet the growth prospects are some period to current alternatives.

In addition to the traditional synergies of paying by merging a larger commercial bank with a smaller one such as increasing lending limit and operating efficiencies. Valley’s expanded product offerings provide ancillary benefits. Presently, consumer lending in the form of low closing cost residential mortgages, and indirect automobile lending account for almost 13% of Valley’s loan portfolio. Internally we viewed these businesses as complementary to Valley’s core commercial lending confidence.

Since these products and services have not been emphasized by 1st United, we believe there is significant opportunity to expand and integrate these consumer business lines through 1st United’s branch and lending network.

Further, the integration and conversion process at both institutions as well entrenched and we anticipate a seamless transition upon closing. We intend for the management team at 1st United to play a crucial role in both assimilating the organizations and expanding Valley’s Florida footprint, although the transaction has not yet closed, Valley executives have already met with a few 1st United customers in an effort to enhanced relationships through additional products and services.

During the quarter, we participated with 1st United Bank on a larger – on several larger commercial credits and we intend to offer Valley’s consumer lending products within a short order after the transaction has officially closed. We have submitted all required regulatory applications and just this week disseminated the proxy statement. Shareholder meetings have been set for September and we seek to close the transaction in the fourth quarter.

In general merger activity appears to be increasing within the regional and community bank space. The regulators appear to be supporting these efforts assuming the surviving entity isn't in the penalty box for prior missteps.

Although seller expectations are elevated, for many of the pricing multiples do not appear to be prohibited. At Valley, we intend to further pursue additional merger candidates that are strategically attractive in both Florida and our current marketplace. Enhancing the scale and ultimate profitability of the bank is vital to building long-term sustainable shareholder value.

In summary, we are guardedly optimistic about the continued opportunities in the coming quarters. Alan Eskow will now provide some more insight into the financial results. Alan?

Alan Eskow

Thank you, Gerry. Net interest income in the second quarter totaled $117.4 million, an increase of approximately $3.4 million from the first quarter. The growth is largely attributable for loan expansion coupled with increased accretion on purchased, credit impaired loans. We anticipate additional accretion in future periods from the purchased credit impaired loan portfolios as the credit performance has improved resulting in higher cash flows and an increase and expected collections as compared to the previous estimates.

Although, we anticipate continued future benefits to net interest income, the blended rate on new loans originated during the quarter of approximately 3.40% will likely pressure the aggregate future portfolio yield. The loan yield on new loans is a function of the interest rate environment increased market competition and a reduction of duration of new assets originated.

During the period automobile loans accounted for approximately 25% of Valley’s originations. The yield on this portfolio was approximately 2%, which will though low provides a positive return based on a 28 month to 30 month average duration in conjunction with Valley’s low loan loss experience in this asset class.

Partly mitigating the current linked quarter increase in net interest income within the loan portfolio was an acceleration of investment premium amortization of approximately $1 million. Mostly, as a result of the increase in amortization, the yield on the taxable investment portfolio declined 21 basis points from the prior period, as mortgage-backed securities cash flow increased approximately 19% from the prior quarter.

Based on initial cash flows received in July, we anticipate a further increase in premium amortization and accordingly further contraction in both portfolio yield and investment interest income.

Mainly, as a result of the aforementioned discretion on loans, the yield on earning assets expanded 7 basis points from the prior quarter to 4.35%, and the yield on loans increased 13 basis points to 4.63%. Funding course during the same period remain relatively flat as the total cost of funds increased 1 basis points from 1.08% to 1.09%. The small increase in funding course in mainly attributable to one extra day during the quarter, coupled with a marginal increase in certificate of deposit expense associated with the introduction of consumer based special pricing applicable to certain geographic markets and products.

With the completion of the second quarter, as Gerry previously mentioned, we move closer to recognizing a likely reduction in interest expense related to the contractual maturities within Valley’s high course long-term borrowing portfolio of 3.98%. In 2015, approximately $400 million of borrowings with an average cost of 4.48% will come due. In the two years, that follow an additional $1.1 billion will mature with an average cost of approximately 3.90%. We’re approximately one-third of these maturities Valley has locked in a significant interest expense savings with the execution of forward starting derivative transactions.

We also have higher course certificates of deposit amounting to $640 million maturing in 2015 to 2017, which are likely to be renewed or replaced with lower cost funding. Lastly, there are other derivatives that we have in place to protect against rising interest rates that have been adding to interest expense, as a result of the current low interest rate cycle which expire between 2015 through 2017. We believe there will be reduction in interest expense that will materially reduce our cost of funds and moreover increase Valley’s key financial metrics, as a result of the above maturities and expirations.

As I previously mentioned, during the second quarter Valley reforecasted cash flows associated with its purchased credit-impaired loan portfolio. The loans in this portfolio were mostly acquired through the State Bank merger in 2012 and FDIC-assisted transactions in 2010. Due to Valley’s loss share arrangements with the FDIC, the prospective change in the projected cash flows impacts interest income, as previously discussed as well as the provision for loan losses on covered loans and the change in FDIC loss-share receivable, which is reported in total non-interest income.

Although not a direct one for one correlation, the $5.7 benefit or credit realized on the covered loan portfolio as a result of the reduction in provision for loan losses was largely indicated by the corresponding reduction in the FDIC loss share receivable. Exclusive of the current period charge total linked quarter non-interest income was relatively unchanged from the prior quarter.

Total non-interest expense during the quarter was $94.2 million a decrease of $650,000 from the first quarter. The decline is significant as the second quarter included approximately $2.7 million of infrequent items related to the acceleration of amortization related to tax credits and merger expenses associated with the 1st United Bank transaction.

Exclusive of these charges non-interest expense would have equaled $91.5 million, which on a comparative basis reflects a 4.0% reduction in operating expense versus the same period one year ago. Valley also remains on target and instituting its branch modernization program which we believe will continue to enhance the bank’s operating efficiency. Through the first six months of 2014, we have upgraded the technology in over 50 branches resulting in the direct reduction of staff of over 28 employees.

We intend to update an additional 25 branches by year-end, which we anticipate will result in a similar staff decrease. In the last 12 months, we have reduced headcount by nearly 250 employees roughly 8% of the bank’s entire workforce. We will continue to focus on operating efficiency in further streamline Valley’s delivery channels through the implementation of new technologies.

Credit quality for the quarter was excellent, as net recoveries of approximately $2.3 million on non-covered loans led to an increase in the allowance for non-covered loans they’re nearly $102 million. The allowance now exceeds total non-performing assets which declined over 15% from the prior quarter to $96.9 million. Similarly, total accruing past due loans declined to $35.9 million from $43.3 million in the previous quarter.

The negative provision for loan losses reflected in our income statement is largely attributable to the change in positive cash flows on FDIC covered loans. The provision for non-covered loans was zero during the quarter based in part on the net recoveries I previously mentioned.

Valley’s regulatory capital ratios remain strong as the Tier 1 common capital ratio increase to 9.43% from 9.35% in the prior quarter. The increase is largely a result of growth in Valley’s total equity, both book value and tangible book value per share have increased over the last year providing increased returns to shareholders coupled with the return from our current $0.11 quarterly dividend.

This concludes my prepared remarks and we’ll now open the conference call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question will come from Steven Alexopoulos with JP Morgan. Go ahead please.

Steven Alexopoulos – JP Morgan

Hi, good morning, guys.

Gerald Lipkin

Good morning, Steve.

Steven Alexopoulos – JP Morgan

Just to start, regarding the scheduled maturities that you outlined, I know we discussed this partially last quarter. First question, do you expect to replace all of the $1.5 billion of the borrowings maturing, or is there room to just reduce that and shrink the size of the balance sheet a bit?

Gerald Lipkin

I don’t think we’ve come up with an absolutely plan, I mean we do have nine months before it even begins and then from that point forward we have another couple of years. So we’ll continue to monitor that based upon deposit growth, asset growth and so forth and see what make sense for us going forward.

Alan Eskow

I think loan demand also will have big role in determining how much we have to fund.

Steven Alexopoulos – JP Morgan

Is there any plan to expand borrowings now at low rates and maybe pre-fund some of the maturities, or are you only using derivatives?

Gerald Lipkin

You can’t its not linear the pre-funding it costs you more than let’s just writing it out and since we’re so close to the maturity we are far better of writing it out.

Alan Eskow

And I think the other point that we made was that we do have some forward starting swaps in place so those have effectively locked in rates today or when they begin maturity.

Steven Alexopoulos – JP Morgan

That was the one-third you referenced, right, Alan?

Alan Eskow

That’s correct.

Steven Alexopoulos – JP Morgan

What is the term on that?

Gerald Lipkin

Those are – they are three to five year terms. We are looking again at various terms and again it’s cheaper to do what we did, and then to have negative carry by virtue of paying of these early and ending up a reducing capital.

Steven Alexopoulos – JPMorgan

Great, okay.

Gerald Lipkin

Or by just carrying extra debt on the books, this is just our way of doing that without adding debt for no reason.

Steven Alexopoulos – JPMorgan

Right, okay. And separately on the commercial real estate loans, how did the $125 million in originations compare to the prior quarter? Maybe could you discuss scheduled maturities of these loans in the second half?

Gerald Lipkin

Yes, it’s down somewhat from the prior quarter, we do have fairly significant pipeline, but again I think as we’ve discussed in prior quarters. We can control when those loans are going to close. So we may have had less closings during the course of the second quarter then the first, but our pipeline remains fairly significant.

Steven Alexopoulos – JPMorgan

And just a final one. The yield on those new commercial real estate loans, can you talk about that? Other banks are talking about that being very good.

Gerald Lipkin

In the 4% range Steve?

Steven Alexopoulos – JPMorgan

The 4% range, okay. All right, thanks for taking my questions.

Gerald Lipkin

Great.

Operator

Thank you. Our next question will come from Ken Zerbe with Morgan Stanley. Go ahead please.

Ken Zerbe – Morgan Stanley

Thanks. Gerry, your comments on the economic activity in your existing footprint, so Jersey in particular, seemed to be a little more optimistic than what I thought I heard as part of the rationale for why you are moving to Florida. What has changed?

Gerald Lipkin

Well, we are seeing activity particularly in the New York City marketplace. There we are seeing activity of all types manufacturing, retail, wholesale businesses. We are seeing a little more activity in Northern New Jersey, but still Northern New Jersey is not as robust as we see in New York City and Long Island. Florida I don’t have to tell you just keeps growing.

Ken Zerbe – Morgan Stanley

Got it. But I guess I was just thinking, because part of the rationale for going to Florida was just that you didn't have the growth opportunities up here in the Northeast.

Gerald Lipkin

We don’t, we would like to be growing a lot faster than we are.

Ken Zerbe – Morgan Stanley

Got it, okay. So it is growth, but just not as much as you want. Understood. All right, thank you.

Operator

Thank you. We’ll go next to Matthew Kelley with Sterne Agee. Go ahead please.

Matthew Kelley – Sterne Agee & Leach, Inc.

Hi, so the $5.3 million increase in interest income in the quarter, that was entirely attributable to PCI, or how much specifically was the PCI benefit in 2Q?

Alan Eskow

Up $3 million.

Matthew Kelley – Sterne Agee & Leach, Inc.

Okay. And what was that in the first quarter?

Alan Eskow

That would be the incremental increase over where we were in the first quarter I said.

Matthew Kelley – Sterne Agee & Leach, Inc.

Okay.

Alan Eskow

We had just reforecasted, so this is the increase you saw over the previous quarter.

Matthew Kelley – Sterne Agee & Leach, Inc.

And what is the absolute dollar amount of that interest income?

Alan Eskow

It is on the whole portfolio of loans that are PCI loans. So we have close to $700 million of loans. And those loans have all been reforecasted. And at this point, we recorded a portion of that interest in this quarter and there will be additional interest as we go forward, depending on how those loans performed.

Matthew Kelley – Sterne Agee & Leach, Inc.

Let me ask you this then, the 327 margin, what would that have been without any of the PCI accretion, to give us a sense of the core margin? And just talk about what you think the core margin will do in the back half of the year.

Gerald Lipkin

Yes, I don’t think, yes, it becomes core, but I mean I don’t think we really break it out to that point Matt to tell you exactly would have been et cetera. I think what we’re telling you as it going forward, even though we have this accretion and it is adding to our interest income, you have to look at where real rates are today and what is happening with that, the average of 3% to 4% on loans.

Matthew Kelley – Sterne Agee & Leach, Inc.

Okay, got you. And then your reserve coverage on non-covered loans looks like it has kind of troughed out, you know, 85 basis points, 90 basis points. Is that kind of where you want to hold it? As you continue to grow the portfolio, should we expect that level will be maintained?

Alan Eskow

I think as we’ve said before we continue to run our model and that model right now our delinquencies are down, our non-accruals are down, we have loan growth. But that being said on lot of those portfolios are showing very good low levels of, again, delinquencies and so forth, and we’re comfortable where it is. I don’t know exactly where it is going to drop out. We were talking about at this morning probably the lowest level I think I’ve ever seen was around 80 basis points give or take so we will have to wait and see how that shakes out as we continue to do our modeling and we see our growth.

Matthew Kelley – Sterne Agee & Leach, Inc.

Okay.

Alan Eskow

We always do when we look at loans coming from even different geographies or different types of loans we might be providing more on those loans then we would on loans that are much more similar to what we see in our portfolio. So that will get’s modeled.

Matthew Kelley – Sterne Agee & Leach, Inc.

Got you. And then just last question, what should we be using for a tax rate going forward?

Alan Eskow

I think we said in their 27% to 29% in that range.

Matthew Kelley – Sterne Agee & Leach, Inc.

Okay, thank you.

Alan Eskow

You’re welcome.

Operator

Thank you. We have question from David Darst with Guggenheim Securities. Go ahead please.

David Darst – Guggenheim Securities

Hi, good morning.

Alan Eskow

Good morning, David.

David Darst – Guggenheim Securities

So within direct growth this quarter, are you expecting that we should see similar volumes going forward, or would it accelerate or decelerate based on maybe you entering Florida before closing on the acquisition?

Gerald Lipkin

I think you’re going to see pretty much similar to the current rate for the rest of the year. If we start to accelerate in the fourth quarter as a result of our acquisition it wouldn’t really show up in our numbers. And so after the loans close and that probably wouldn’t happen till January do you follow what I’m saying?

David Darst – Guggenheim Securities

Yes.

Gerald Lipkin

We closed in October or November. The loans don’t really go on the books usually it takes 30 to 60 days before a loan is approved and it actually closed.

David Darst – Guggenheim Securities

Okay. Alan, can you give us a sense of what expected life is or duration of the $700 million in PCI loans is?

Alan Eskow

It’s probably three to four years. It’s a little hard to give you an exact number, what we are estimating in the three to four year range.

David Darst – Guggenheim Securities

Okay. Did that just change with these revaluations?

Alan Eskow

Well, it usually does change every time you do the reforecasting and as you see loans paying down or whatever they are doing, yes, it does and yes we did see a drop somewhat.

David Darst – Guggenheim Securities

Okay, you drop. Okay, great, thank you.

Operator

Thank you. (Operator Instructions) We have no other callers in queue Mr. Lipkin. Please go ahead with any closing remarks.

Gerald Lipkin

Well, thank you. I appreciate everybody’s time.

Dianne Grenz

Thank you for joining us for the second quarter conference call. And have a great day.

Operator

Thank you. And ladies and gentlemen that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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