Merchants Bancshares' (MBVT) CEO Geoffrey Hesslink on Q4 2015 Results - Earnings Call Transcript

| About: Merchants Bancshares, (MBVT)

Merchants Bancshares, Inc. (NASDAQ:MBVT)

Q4 2015 Earnings Conference Call

January 22, 2016 09:00 AM ET

Executives

Eric Segal - Interim Principal Financial Officer

Geoffrey Hesslink - CEO

Marie Thresher - COO

Analysts

Alex Twerdahl - Sandler O'Neill

David Bishop - FIG Partners

Travis Lan - KBW

Matthew Breese - Piper Jaffray

Operator

Good morning and welcome to the Merchants Bancshares' Fourth Quarter 2015 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference to Eric Segal, Interim Principal Financial Officer for the forward-looking statement. Please go ahead, sir.

Eric Segal

Good morning. In this call, we will make forward-looking statements regarding future events, including our expectations for 2016. We caution you to consider the important risk factors that could cause the actual results to differ materially from those in the forward-looking statements made on this call.

Additional risk factors include those in our press releases from January 21, 2016 and in our Annual Report on Form 10-K for the year ended December 31, 2014 and more recent 10-Q filings. We caution you against unduly relying on any forward-looking statements and disclaim any intent to update publically any forward-looking statements, whether in response to new information, and future events or otherwise.

I’d like to turn the call over to Geoffrey Hesslink, CEO of Merchants Bancshares.

Geoffrey Hesslink

Thank you, Eric and good morning, everyone. Happy New Year and thanks for taking the time to join us on the call this morning. With me today are Marie Thresher, our Chief Operating Officer and Eric Segal, our Interim Principal Accounting Officer and Finance Officer.

I’ll open with a few remarks. 2015 was a fine year for us. It was the successful year in many ways. By a way of quick review, 2014 was the year of investment. We converted our core system and made numerous other investments in the company, in the team and these investments were intended to build a platform and position the company for growth.

So coming off the 2014 investments, we really had three main initiatives for 2015. The first was to grow our Vermont loan business specifically our commercial loans. The second objective was to recognize the expected benefits of our new core system. Those benefits were enhanced customer service as well as some operational efficiencies. And the last main initiative for ‘15 was, we wanted to expand our marketplace by way of a bank acquisition. And entering the year, it was our expectation that if we had success with these initiatives that 2015 would be a transformative year for us. Our performance would build throughout the year, we felt and believed and it was our objective to end 2015 really well positioned for the future.

Look we’re delighted to report that we delivered on the main initiatives and the expected results were recognized. We grew the Vermont loans, we grew the commercial loans 15% and you can see that sort of stopped solid and growth in our net interest income. We made great strides with our core system, service levels are high. There are a number of initiatives that enabled us to have just very well controlled operating costs throughout the year. And again, the performance is as we thought. The company's earnings in the second half of the year were significantly higher than the first half of the year. And we're very pleased with how the Vermont business performed at the end of the year and the positioning going forward.

On top of that, we close the NUVO transaction on December 4th, you may recall we do expect this acquisition to be modestly accretive to our earnings. So there will be some benefit there but the real value in this field is the opportunity it provides us with the expansion to western Massachusetts. This transaction provides us the opportunity to grow our core businesses, our core competencies in new markets. And there is real value opportunity there for the company. So, we look back, we sum it all up, the work we performed in 2015 made our company better. And, we are well positioned for ‘16 and we are confident that the benefits will carry forward. To conclude my prepared opening remarks, so I’ll you to Eric Segal who will talk a little bit about, give you a financial review of the quarter and the year. And in turn Marie Thresher will talk a little bit about the NUVO acquisition, some of our expectations and plans there. And finally, I’ll provide a wrap up and including there will be an outlook for 2016.

Eric Segal

Good morning. For the quarter, we have $2.31 million of net income or $0.36 per basic and diluted share. There is a bit of noise in one-time events and merger activity in these results and adjusting up the larger items of merger expenses and retirement costs. That brings us to a core net income was $3.94 million or $0.61 per basic and diluted share for the quarter, which is a result in line with our expectations. The retirement incentive accruals were not paid last year, incentives were not paid last year and therefore the accrual was not made. Also had about $900,000 to our non-interest expense line. For the full year, we ended with $12.62 million or $1.98 per basic and diluted share. I’ll take about profitability ratios in a second but just to note that with the NUVO transaction closing December 4th, we have less than a month of the NUVO net income in our P&L and 100% of the balance sheet, so it does impact our profitability ratio to some extent.

ROI was 49 basis points and 71 basis points for the three months and year ended December 31, 2015 respectively. And this compares with 59 basis points and 73 basis points for the same period.

ROE was 6.73% and 9.69% for the three months and year ended December 31, 2015 respectively and compared to 7.95% and 9.84% in 2014. I think it’s worth mentioning, although we can’t do the calculations for you that calculating the full year profitability ratios using the Q4 core net income instead of the book net income of 2.31 might produce depending on your calculations competitive profitability ratios in line with our historical trends. And again those one-time events and noise cluttered up the quarter quite a bit.

The balance sheet with the duty to carry large cash position which we plan to use throughout the first quarter to fund loan growth and replace the higher cost CDs at NUVO and also to augment the investment portfolio. The NUVO acquisition added $150 million in loans and $132 million deposits into the balance sheet. We also acquired 2.7 million book value of nonperforming assets in the transaction. We believe that they carry appropriate credit marks and I know Geoff will talk about - more about those later in terms of how we have planned to deal with those.

In terms of tangible equity, we are obviously impacted by the goodwill and core deposit intangibles which are new to our balance sheet and which [indiscernible] out of the acquisition. We don’t’ really see anything on the horizon that’s going to change our opinion that we talked about before between half-year earn back there from the NUVO transaction.

And with that I look forward to your questions later and I will turn it over to Marie Thresher to talk about operations in the rest of the bank.

Marie Thresher

Thanks, Eric. Good morning, everyone. The report on NUVO that I have is positive and straight forward and to quick refresh Geoff mentioned we closed on December 4. A key part of our strategy when we are targeting a bank is how to enter into a new market and geography after we have strong asset generation platform and also to find skilled management that want to help grow the bank.

The NUVO deal hit on each one of these targets. We are now in Massachusetts increasing our presence in New England market. We have a strong business commercial focus which is very attractive to us, that’s in our wheelhouse. We also have a knowledgeable management team in the community that wants to help us grow the business. So with these hits, since we have everything on target, we can now focus on maximizing our deal.

So going into 2016, we’ve got four key objectives. We will grow and invest in the business. We will also optimize our fund and benefit. We have a strong core deposit base which offers a low cost of funding to grow and meet any loan demand. We are also going to convert our core processing systems in the first half of the year and then lastly we will recognize the cost savings that we set out at the start of the deal.

The cost savings are going to be approached in a thoughtful and conservative manner that’s consistent with our bank culture. We are going to balance growing this bank and also trying to achieve the right operational efficiencies. So we are well prepared for this and as Geoff mentioned we’ve laid a solid foundation to complete this work over the year. We’ve been working on this for year and a half in the background.

So, one of the key things about successfully converting our core system is that it makes it easy to scale as we acquire new business so we have an increase in our customer volume. So even with the addition of NUVO we will have plenty of capacity to grow and be ready for future. This allows us to really focus on managing customer expectations and continue to look at our strong credit process and continue to be a solid bank that we are.

So with that I am going to turn it over to Geoff for the 2016 outlook.

Geoffrey Hesslink

Thank you, Marie. Before jumping into the outlook, just a little color on the non-performing loans. So we had one loan in Vermont that migrated to non-accrual in the fourth quarter. And as Eric mentioned, we acquired some non-accrual loans in the NUVO transaction. There is no major change in the asset quality or problems. We will – we have plans in place for all of these nonperforming credits and we expect to take make great progress on that number throughout the year and move it back down to more historical numbers for us.

So moving to 2016, in terms of the outlook, we anticipate growing the loan book 5% to 6%. That will be again focused in the commercial sector for us. Investments will hold pretty stable to where they begin the year. Margin, we envision in the 290 to 295 range, asset yields have been the biggest challenge for us regarding the margin and they were the biggest challenge in 2015. We expect that pressure to continue in 2016, we expect it will be -- continue to be intense competition for us and pressure on the asset yield front. Offsetting this little bit is – we are going to optimize the – we’re going to utilize our cash balances, we’ll grow our loan portfolio and fund – we are going to fund – use some of the cash to fund our loan growth and we also have an opportunity to replace some of the CDs, the higher priced CDs that came about as a NUVO transaction with cash. So opportunity is, our cash will be accretive to our margin we think in 2016 and that’s what where we – how we expect it to land in that 290 to 295 range.

I will say that that margin outlook is based on stable interest rates, and when I say stable rates that were towards the end of 2015. So while we did not project or envision any benefit to the margin from a more favorable rate environment, conversely we did not project a more challenging interest rate environment. And thus I suspect you all know, we’ve seen some – the Fed moving that short-end up and borrowing end coming down a little bit, and then flattening yield curve, will absolutely present challenges and pressure our margin.

In terms of operating expenses, the best way to look at that is we expect a 2% growth on the combined expenses from our Vermont operation, NUVO operation. As you know, Marie mentioned, there are some operational cost saves factored in with – to the NUVO deal. But this is about growth, and that money will get spent in revenue producing positions. Over time, we expect those revenue producing positions to be accretive to our profitability and our efficiency ratio. But that spending will contribute to 2% growth in the operating expenses.

And lastly on the tax rate, the tax rate have bumped up a little bit, there really is some inflection of higher overall income levels. So that’s going to conclude our prepared remarks on 2015 and how we see 2016 laying out. We would be delighted to answer any questions you may have.

Question-and-Answer Session

Operator

Thank you, Mr. Hesslink. [Operator Instructions] And our first question will come from Alex Twerdahl of Sandler O'Neill. Please go ahead.

Alex Twerdahl

Hey, good morning. Couple of questions here. One, talking about the NUVO transaction a little bit and now that you’re in Western Massachusetts and Springfield, do you plan to allocate additional resources to that market to help support their growth or is it really the guys that you acquired there are going to continue doing what they are doing, but underneath your umbrella?

Geoffrey Hesslink

We’re going to grow it Alex, it’s – we are going to make some investments in there and you will see that in the – as I mentioned, in the operating expenses. It’s all in our core competencies. We expect investments in commercial banking, mortgage banking, trust to government banking. As I mentioned before when the deal was announced, there is 25% operational cost saves, but that money will get spent on the revenue side. This is a – this transaction is all about growth for us.

Eric Segal

And Alex, this is Eric Segal. We are also anticipating that that growth will result in larger average loan size as we bring on increased competencies in the – have that look more like the historical Merchants Bank going forward as it grows out.

Alex Twerdahl

Okay. And then just back to your margin commentary, you talked about replacing some higher cost CDs acquired with the deal and it looks like from the balance sheet that you brought on somewhere in the $50 million to $60 million range of CDs, can you give us a sense for where those prices are – the pricing on those CDs are today versus your historical CD rates? And then also just kind of how quickly those will roll off?

Geoffrey Hesslink

Yeah. Sure, Alex. It's going to be a nice trade for us, Alex. So you're good on it, it's $50 million or $60 million of I think the average price, it's just under 120 basis points. So we'll move our cash in to that. It rolls off pretty quickly, Alex. A lion's share of that will come in the first half of the year. So again, that's why we allowed that cash to build in the fourth quarter. You saw that margin compression there. We're going to get some of that back as we use this cash to replace those expenses.

Alex Twerdahl

Okay. And then just to clarify, Eric, in your prepared remarks, you were talking about $900,000 of incentive accruals, was that something that happened in the fourth quarter of 2015 that didn't happen in the fourth quarter of 2014 or can you just...

Eric Segal

Yeah. Let me break that out a little bit for you. The retirement cost that we referenced in the press release and the incentive accruals totaled to about $900,000. So that's 400 for the incentives and 500 for the retirement, 540 for the retirement cost. Neither of those happened in '14.

Alex Twerdahl

Okay.

Geoffrey Hesslink

And a way to look at that incentive accrual, Alex, is it was all in one quarter and it could be thought it was spread evenly across four quarters as well.

Alex Twerdahl

Okay. Thank you for clarifying that.

Geoffrey Hesslink

As you're modelling out your expense run rate there.

Alex Twerdahl

Okay. All right. That's it for me right now. Thanks.

Geoffrey Hesslink

Alex, thank you.

Operator

The next question will come from David Bishop of FIG Partners. Please go ahead.

David Bishop

Hey. Good morning, gentlemen.

Geoffrey Hesslink

Hey, David.

David Bishop

Hey. A quick question, just following off, in terms of the new market Massachusetts, Vermont, are you noticing anything different in terms of on the pricing front on the loan side or deposits as well, just curious how pricing shapes up at the two markets versus each other.

Geoffrey Hesslink

Very similar on both fronts. We don't see a measurable difference on deposit pricing or the loan pricing in the two markets. Again, if you looked at it, NUVO has the higher asset yield than Merchants Bank and that really speaks to Eric's comment, it speaks to mix of loans, and we’re in Western Massachusetts, we'll start to make some much bigger loans, which will have competitive pricing and also it will bring the average loan yields closer to what we see in Vermont. So no difference in pricing in the markets from what we see so far.

David Bishop

And then in terms of legacy loan growth, you're sort of backing out the acquired loans, looks like organic loan growth cleared a little bit, just curious what drove the slowdown and maybe talk about the loan pipeline, heading into the first half of 2016?

Geoffrey Hesslink

Hey, and it's a great question. Right. We grew just under 7% in 2015, 6.7% I think was the loan growth. Again, driven by the commercial 15% growth in our commercial business in Vermont and that was all, it happened to be majority front-end loaded. It was slower in the second half of the year. That's not a reflection of any problem, David. We have got a nice pipeline, entering 2016 and the fact that there are some material deals that we expected to close in the end of '15, migrated into '16. So it's going to be 5%, 6%. We envisioned 5%, 6% loan growth for the year and it will be driven by that commercial sector.

David Bishop

Got it. And then just one final question, if you want tangible capital, I mean you guys have always sort of operated in this range here, you guys are pretty comfortable with the capital levels relative to your growth prospects here.

Geoffrey Hesslink

Yeah. That tangible capital, that's the restricting capital measure for us obviously and we'd like to see it above 7%. We knew this transaction was going to have, the NUVO deal was going to create some dilution there and that 3% dilution of that tangible capital, and it’s the 3.5%. That hasn’t changed. We did have a change in our mark-to-market on our investment portfolio that impacted our tangible capital in the fourth quarter, but we're comfortable with it, I think that tangible capital reflects the low risk of balance sheet that we run, but yeah, it's our objective to move that back up again.

David Bishop

Great. Thanks for the color, Geoff.

Geoffrey Hesslink

Thank you, David.

Operator

[Operator Instructions] The next question will come from Travis Lan of KBW. Please go ahead.

Travis Lan

Yeah, thanks good morning everyone. Most of the questions have been answered. But I just wanted to ask a follow up on the expenses. Did the -- I assume the incentive accruals and the retirement cost ran through the compensation line in the quarter, is that right?

Geoffrey Hesslink

Yes.

Travis Lan

Okay. And then just kind of getting a sense, I know you gave good guidance on taking legacy merchants and NUVO, and saying 2% growth of that combined. When we’re thinking about the NUVO portion of that equation is that cost save adjusted NUVO or just the baseline kind of $1 million a quarter that they were running at?

Eric Segal

Yes, the cost savings we announced when the deal was announced was related to NUVO’s expense run rate, so they’re running roughly $4 million of expense and it was the cost saves a model of 25% of that. But again, that -- we’ll recognize some of that savings, but that money will be invested in growing the business, and just it will be a reallocation of that cost really is a way to think about that.

Travis Lan

Got it, okay. And then, just kind of changing gears, fee initiatives have been kind of a goal heading into ’15. What is the outlook there is there the opportunity you think to kind of put some of the products that you guys offer onto the NUVO customers and grow fees or just kind of a broad outlook for fees?

Geoffrey Hesslink

So, Travis I’m delighted you’ve asked that question because I am a remiss, I forgot to provide an outlook on the fee growth. Yeah that’s -- you are spot on in every regard. We see 7% to 8% growth in that fee line for 2016 that’s our outlook. And that will be across the board, we will get a little more traction in our mortgage business but yes, selling commercial services in western Massachusetts and right across the board we expect to have growth in the fee businesses.

Travis Lan

Last one is just on the mortgage business; do you guys see any impact from trade in the quarter on the expense side or the pace of volumes?

Geoffrey Hesslink

We’re trade compliant, we can tell you that, and I’m not going to blame any of our performance on regulation, it’s a competitive business, volumes are down and we’re fighting for those commodity products like everyone else, so. I don’t think we can look to that and use that as an explanation for our business, any impact on our business scale.

Travis Lan

All right, thank you guys very much.

Operator

Our next question will come from Matthew Breese of Piper Jaffray. Please go ahead.

Matthew Breese

I just wanted to get a little bit more clarification on the margin and its trajectory. So to be clear, as the CDs kind of roll over and cash deployed, we’ll see that margin creep up as the year progresses?

Geoffrey Hesslink

You bet that 2.90 to 2.95 is what we expected to average for the year and you’ll see it; our expectation is that that margin will grow throughout the year quarterly. We’ll invest that cash into loans and replace the CDs, so it will be incrementally and markedly improved throughout the year.

Matthew Breese

And is there any impact from accretable yields?

Geoffrey Hesslink

You know what there is very little factored in for yield accretion from that NUVO pooled loan book. So, I’m going to tell you very little factored in on that front, Matt.

Matthew Breese

So, more or less core margin trajectory upwards throughout the year?

Geoffrey Hesslink

Yes.

Matthew Breese

Also, I know you said the tax rate will bump up a bit. Can you be a little bit more specific as to what it might bump up to in 2016?

Eric Segal

Yeah Matt, we’re currently running effective tax rate around 20, we’re looking 25, 27.

Matthew Breese

And is any of that related to your ability to find tax credit investments and how is that pipeline?

Eric Segal

Spot on. We’ve only been here a few weeks but we’re sort on a mission to find cash credit investments. We’re working on tax; on a strategy to actually find those. But assuming that we have modest success where -- that’s why we’re up in the 25, 27 [ph] range.

Geoffrey Hesslink

That market is more competitive, Matt that’s good a market, there is more buyers, the pricing is tighter.

Matthew Breese

And will that be an immediate bump to 25% come the first quarter?

Geoffrey Hesslink

No.

Matthew Breese

I am sorry, I missed that, was that a yes?

Geoffrey Hesslink

No, that’s a no.

Matthew Breese

Okay. So it will be a gradual increase towards those levels.

Geoffrey Hesslink

Yes.

Matthew Breese

Okay. And then Geoff, I was hoping to – could you give us an update on the CFO search and when you hope to have a permanent replacement in-house?

Geoffrey Hesslink

Sure, it’s hard to predict that. What we can say is – so we have Eric Segal here, so you have heard from him today and so he is acting as an Interim Principal Accounting Officer and Financial Officer, so we’re pleased to have him here and delighted with the team. You know, I really can’t predict it Matt. We will – I’d tell you, we will get – we’re going to get some help, we’re going to use some recruiting firm and we are going to hopefully attract a deep candidate pool and – but I just can’t envision – I can’t predict for today, we’re just at the very beginning of that process and I can’t predict for you how long it might take, I just don’t know.

Matthew Breese

Okay, understood. And then my last question. What’s a good average diluted share count to use for the first quarter of 2016?

Geoffrey Hesslink

I am sorry, could you repeat that.

Matthew Breese

What’s a good average diluted share count to use for the first quarter?

Geoffrey Hesslink

Do you have that number Eric? I do not have that number. Matt, can we get back to you over that, I think – Matt, we’ll have to get back to you on that.

Matthew Breese

No problem. That’s all I had. Thank you.

Operator

And our next question is a follow-up from David Bishop of FIG Partners. Please go ahead.

David Bishop

Yes, I just had a quick follow-up, maybe some more color on the legacy Vermont non-accrual loan that went on to non-accrual, if you have some color on that credit?

Geoffrey Hesslink

Sure. It’s a piece of investment in commercial real estate, again pretty modest, it’s highest given the size of our company, just things had happened and it will – again, resolution plans are in place and we expect some material progress on our entire non-accrual loan, and plans are in place to get that number down.

Eric Segal

That Vermont piece is less than a $1 million.

Geoffrey Hesslink

The noise that comes out of our non-accruals is mostly about the numbers of loans that we never had before and not about the dollar value, small dollars relative to our size, but the bank has never experienced a significant uptick in non-accruals, so we want to report it.

Eric Segal

At least these are perspective that with NUVO acquisition, there are two main credits that represent the large majority of the non-accrual loans, so we will – and again, plans are in place for those two.

David Bishop

Got it, thank you.

Operator

At this time, we will conclude the question-and-answer session. I would like to hand the conference back over to Mr. Hesslink for his closing remarks.

Geoffrey Hesslink

Well, thank you all again for your time this morning and thank you for your support. Thank you for your investment in our company and we wish you all a great start to the year. And look forward to connecting with you again in 90 days. Thank you.

Operator

To access a replay of this conference, you may dial 1-877-344-7529 or 1-412-317-0088 beginning at approximately 11:00 AM Eastern today. You'll be prompted to enter a conference number which will be 10068671. Please record your name and company when joining. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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