Merchants Bancshares, Inc. (MBVT) CEO Geoffrey Hesslink on Q1 2016 Results - Earnings Call Transcript

| About: Merchants Bancshares, (MBVT)

Merchants Bancshares, Inc. (NASDAQ:MBVT)

Q1 2016 Earnings Call

April 29, 2016 10:00 AM ET

Executives

Geoffrey Hesslink - Chief Executive Officer

Eric Segal - Interim Chief Financial Officer

Analysts

Alexander Twerdahl - Sandler O’Neill

Travis Lan - KBW

David Bishop - FIG Partners

Matthew Breese - Piper Jaffray

Operator

Good morning and welcome to the Merchants Bancshares Incorporated First Quarter 2016 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] This call contains forward-looking statements regarding strategic objectives and expectations for future results of operations and financial prospects. They are based upon the current, believe and expectations of Merchants management and are subject to certain risks and uncertainties. Actual results may differ from the set forth forward-looking statements. Please see the forward-looking statements contained in the earnings release, which identifies a number of factors that could cause material differences between actual and anticipated results or other expectations expressed.

Additional factors that could cause Merchants results to differ materially from those described in the forward-looking statements can be found in the company’s filings submitted to the SEC. All subsequent written and all forward-looking statements attributable to Merchants for any person acting on its behalf or expressly qualified by these cautionary statements. Merchants does not undertake any obligation to update any forward-looking statements to reflect circumstances or events that occur after the forward-looking statements are made. Please note this event is being recorded.

I would now like to turn the conference over to Geoffrey Hesslink, Chief Executive Officer. Please go ahead, sir.

Geoffrey Hesslink

Thank you and good morning everyone. We appreciate you taking the time to join us on the call today. I’m joined by Eric Segal, our Principle Interim Accounting Officer and he is going to speak to you a little bit later about the quarter results.

Little color on the quarter, it was a decent start to the year for us. Highlights in the quarter were – in the end of the quarter we’ve successfully completed the systems conversion of NUVO Bank or West Springfield, Massachusetts business and we’re delighted with the outcome of that project. And we had a – from a customer’s perspective, it was seamless and of course, that was important. And getting the system’s conversion wrapped up will also allow us to recognize some of the expense saving benefits from the acquisition we should see some of those benefits throughout the remainder of the year.

Another highlight, as we mentioned last quarter that one of the opportunities of our transaction with NUVO was to use Merchants core funding to replace about $50 million of non-core funding in the NUVO operation. We pick up about 75 basis points on that funding trade when it’s complete. We had great progress on that in the first quarter, we expect to have – by June 30, we expect to have entire funding trade done and again we’ll see that that is the full benefits of that over the latter half of the year. We certainly saw partial benefits from that funding trade in the first quarter.

Challenges for the first quarter were just intensely competitive loan environment. We had some nice growth in our commercial business but frankly we were a little bit below our expectations for loan growth in the quarter. After Eric speaks I’ll give you some color of how we see the remainder of the year playing out.

Another challenge for us in the first quarter was interest rate environment in the yield curve, just low absolute levels of rates and a flattening on the long end, just presents challenges to us as it does to all spread companies.

And I guess last – part of sales in our asset quality and our asset quality remains excellent. We did have a slight decline in the asset quality and you saw that in some of the credit costs that we incurred in the first quarter.

So, with those remarks, I’ll turn you over to Eric and he’ll again walk you through some financial highlights. I’ll wrap up and give you our perspective and the outlook for the rest of the year and then of course, we’re happy to answer any questions you have.

Eric Segal

Thanks, Geoffrey. Good morning. I’ll provide some highlights which are also probably in the press release but let’s lay among table today so we could talk about them.

First for the income statement, key one is $3.49 million and $0.51 per basic and $0.50 per diluted share. And as in Q4, we’ve just have the larger onetime items merger related expenses and severance cost and that brings us to a core net income of $3.82 million or $0.56 per basic share.

ROA was 0.71% for the quarter compared to 0.49% for Q4 2015 and 0.78% for the same in Q2 2015. Return on average equity was 9.32% compared to 6.73% for Q4 2015 and 10.56% for the same period last year.

The net interest income was up $1.2 million reflecting the addition of the higher yielding NUVO loans and also the replacement of the non-core funding that Geoff has just spoken about and will talk more about that later. The OpEx were $11.5 million reflects a full quarter of NUVO which was not in the prior quarter, and we’ll add some color to that momentarily as well.

Our margin has improved to 3.02% which is an increase of 13 basis points for the last quarter and the drivers are really loan yields coming from the NUVO portfolio and it’ll offset by a slight increase across the funds.

Turning over to the balance sheet, [indiscernible] loan mix to more of a commercial portfolio. We had a $50.9 million growth in commercial loans and that was offset by the clients in the other sectors. Core deposits are flat and as we discussed in Q1, the cash is declined – it’s a planned decline so that we could run off that non-core funding at NUVO.

And finally, tangible book value per share increased $0.68 and that’s driven by the earnings and the mark-to-market gains and securities portfolio offset obviously by the evidence paid.

So with that, I’ll turn it back over to Geoffrey for some color on the other items.

Geoffrey Hesslink

Thank you, Eric. So, again 90 days ago we had given some guidance for 5% to 6% loan growth for 2016 and we were little out planned for the first quarter. We do still see ourselves coming into the lower end of that guidance for the year, we have a nice pipeline of commercial business. We’ll need to make some progress on that pipeline in the second quarter, we’ll need to show some real progress on that. And if we do, we think we’ll still fall within the guidance that we gave on the loan growth.

Margin – Eric mentioned, we had a nice bump, we picked up the NUVO loans and they have nice yields, that’s a nice yielding portfolio. As I mentioned we got some of that funding trade done and the cash went down a little bit so that with the change in the asset mix. We had a nice bump in the margin. If the yield curve stays the way it is today that margin will get pressured and we’ll see modest declines in that margin throughout the rest of the year.

Our fee businesses, we’re going to follow sort of our guidance there, being the trust side and mortgage loans that we originate for sale. We’re going come in a little short where we felt we’d be on that. So I think the first quarter run rate on the fee business is probably a good estimate but it’s probably will continue throughout the rest of the year.

The operating expenses there is – we’ve got the NUVO conversion done, so we’ll see some benefit there on the expense line going forward and we do expect some improvement in that number and be closer to our guidance.

And I guess last, the tax rate was 23% for the first quarter and that seems like a number that’s a pretty good number that should hold for the rest of the year.

I guess my final commentary, again the asset quality is excellent. We have seen a couple of quarters increase in the non-performing loans there, and there is – that number – it’s possible that that number would bump a little bit higher in the short-term. What I can tell you is, we have plans in place for every one of those non-performing loans and we expect some pretty material improvement in that number by the end of the year. And we do not envision that we’ll have that significant or different credit cost going forward.

So, we’ll wrap up the prepared remarks there and again be delighted to answer any questions that you may have.

Question-and-Answer Session

Operator

Thank you, sir. [Operator Instructions] The first question comes from Alex Twerdahl with Sandler O’Neill. Please go ahead.

Alexander Twerdahl

Hey, good morning guys.

Geoffrey Hesslink

Hi, Alex.

Alexander Twerdahl

So a couple of questions here. First off on the loan growth guidance and what you saw in the first quarter, can you help break down sort of what’s coming from the NUVO piece versus what’s coming from the legacy Merchants piece?

Geoffrey Hesslink

Sure, Alex, are you interested in the quarter or the guidance going forward on that break down, because they are different.

Alexander Twerdahl

Well, both.

Geoffrey Hesslink

Okay, yeah so the first quarter what we saw was primarily from our business, we didn’t see much from the Western Massachusetts business. As we look forward, it’s roughly equal Alex, we’d expect half of our growth to come from half from Western Massachusetts, so obviously on a segmented basis the growth rate in Western Mass will be much, much higher than the growth rate we’ve on.

Alexander Twerdahl

Okay, thank you. And then with respect to the funding strategy for NUVO, you said it was about $50 million total funding strategy. How much of that is done thus far, are you about half way through that or less or more?

Geoffrey Hesslink

Little over half way Alex, and you know what, in throughout the quarter there was a meaningful piece of it in March but yeah, it’s – that’s going to work out nicely for us. And again so we’re just seeing increasing benefit from that as the second quarter builds out and then full quarter benefits in the third quarter and the fourth quarter.

Alexander Twerdahl

So even with that extra benefit on the funding side do you think that in this interest rate environment will see the margin trend a little bit lower or do you say that pressure remains and then maybe it’ll be offset by some of this improved funding cost mix?

Geoffrey Hesslink

My guess is on balance, the margin could trend down slightly Alex. You’re right, we’re going to offset some of that with this funding trade but there is a lot of pressure on asset yields on both of loans and investment side.

Alexander Twerdahl

Okay. And then I think I just missed the expense guidance that you gave, you said that the conversion and NUVO should –cost phase will come, you should get closer to the expense guidance, but what was that exact guidance going forward?

Geoffrey Hesslink

Yeah, we talked about the core number for – we were looking at sort of what the core run rate was for the fourth quarter, and again this is 90 days ago but the guidance we gave is take a look at that core number and all in it should grow 2%, so that’s the guidance. So it will – the core number of a 11.5% for the first quarter, we envision it being lower than that in the future, that’s – we’ll make some improvements there.

Alexander Twerdahl

Okay. And then just the final question, and credit is never been a concern for you guys, it’s always been great but you did add some commentary about how you think that maybe NPLs could go a little bit higher before further resolutions later this year, is there anything, any specific type of loan that has gone bad or are there loans from the Springfield market that have become a concern or is there anything that we can point to sort of a specific driver of NPLs going up even if they only go up slightly?

Geoffrey Hesslink

Yeah, so the majority of the run up we’ve seen in the NPLs up in the last two quarters relates to the West Springfield operation and we saw roughly $700,000 increase in the last quarter and I think there were three credits in that Alex, so we’re talking about relatively very small credit.

So as we work our way through in deep [indiscernible] and getting our credit cultures along, this potential for couple of the modest, maybe some modest increases but again that would be very short-term, longer term we’ll get that – we expect material improvement on that line.

Alexander Twerdahl

Okay, that’s all my questions for now. Thank you.

Geoffrey Hesslink

Thank you, Alex.

Operator

The next question is from Travis Lan with KBW. Please go ahead.

Travis Lan

Yeah, thanks. Good morning, everyone.

Geoffrey Hesslink

Hi, Travis.

Travis Lan

Hey. On the margin it popped pretty big in the quarter and obviously you’ve given some color on the dynamics there, but was there anything from either prepayment or purchase accounting perspective in there that we should know about?

Geoffrey Hesslink

No, really modest impact on that. It was really all the asset deal pop that we got from NUVO and the margin actually was little bit higher than we envisioned to and part of that is, we just able to use our cash to get this funding trade on two things ready to lower the funding cost but also shrunk the balance sheet, right. So, that had a powerful impact on that margin.

Travis Lan

Sure, okay. And then just following up on Alex’s last question on the non-performing loan increase, the portfolio you acquired from NUVO was say a $140 million and non-performance were about $3.5 million in the last two quarters and then you say there could be a little bit more pressure there. So is there anything that’s kind of surprised you or maybe worries you in terms of the credit quality there versus what maybe your initial expectations had been?

Geoffrey Hesslink

No, not significantly. No, we had – again it’s just about bringing the two cultures together and there had not been any big surprises in it and it’s – I think it’s all well manageable and again we do not anticipate significant change in our credit cost history.

Travis Lan

Okay, and I guess that was my next question, I just missed your last comment Geoffrey on the outlook for the provision in your state of remarks. Could you just repeat what that was?

Geoffrey Hesslink

Yeah, I think it could run pretty consistent with where we were in the first quarter and I think that’s a good way to look at it for the rest of the year.

Travis Lan

Okay. And then just last one from me as obviously there is a recently announced deal in Springfield that could create some disruption to be capitalized on but it seems based on your loan growth guidance that you maybe don’t think that’s key catalyst for you or maybe it is, I don’t know, but have you identified any specific opportunities there to either I think about talent additions or opportunities to grow the loan or deposit book based on that Springfield disruption?

Geoffrey Hesslink

Yeah, we have the same perspective that you do on that right, so there is some disruption in the market that we’re new too but like a lot and we envision some growth opportunities and to the extent that this disruption will enable us more opportunity to grow the customer base and recruit some talent, that’s favorable to us, so we’re paying close attention to that and are hopeful like you are, maybe there will be some benefit to our company.

Travis Lan

Got it. All right, thank you guys very much.

Geoffrey Hesslink

Thanks, Travis.

Operator

The next question is from David Bishop with FIG Partners. Please go ahead.

David Bishop

Hey, good morning, gentlemen.

Eric Segal

Good morning, David.

Geoffrey Hesslink

Hey, David.

David Bishop

Hey, Geoff. The question for some of the growth and some of the commercial lines there, just curious on the residential run off, was that picked up NUVO, legacy Merchants, just maybe some color on what was driving the run off on the residential mortgage side.

Geoffrey Hesslink

Yeah, and it’s just a continuation of a trend. We saw all throughout 2015 and it’s one that we expect we’ll continue in the future. We’re – as you know, we’re primarily really from 2003 to 2014 we were a portfolio mortgage lender and we grew that book of business significantly, primarily as a result of the refinance market that there was a strong refinance market that we sold 10, 15 and 20 year amortizing first mortgage loans through that book of business. In 2013 that refinance – those refinance volumes were off I think 75% nationwide and we experience that.

So, really for the last better part of two years now our portfolio origination volume has been less than our scheduled amortization of what our normal prepayments of 70% in that portfolio, so the combination of that is we’re losing balances and we do envision that we’ll continue. And that rate of reduction will continue through 2016.

David Bishop

Got it. And then I think in the preamble you noted maybe continued probably [indiscernible] but pretty much flat in terms of fee income, you noted wealth management a little bit of pressure there. Anything from that was just market condition, I don’t know if assets under management during losses there, just maybe commentary on some of the fee income drivers this quarter and expectations.

Geoffrey Hesslink

Yeah, so the trust business is it’s all about, a lot of is driven by the absolute levels of the market and we have – to answer your question, we’ve not seen significant reductions in asset under management or any province there. It’s really on the growth side and getting new customers were running a little bit behind our plans there. And the other fee income item that I mentioned was gain on sale of mortgage loans, we’re just – we’re behind plan there and we’ll be for the rest of the year. But everything else – the service charge income and debit card stuff that’s all in line for us.

David Bishop

Got it, and then one question and I’ll hop off. Any update on the hunt for new CFO?

Geoffrey Hesslink

Yeah, so we’ve engaged [indiscernible] national firm to help us, they’re identifying candidates, they were deep into that recruiting and interviewing process now and so obviously an important initiative for us and we spend a lot of time and attention on it.

David Bishop

Got it. Great, thanks Geoff, I’ll hop off.

Geoffrey Hesslink

Thanks, David.

Operator

[Operator Instructions] Next question is from Matthew Breese with Piper Jaffray. Please go ahead.

Matthew Breese

Good morning, everybody.

Geoffrey Hesslink

Hi.

Matthew Breese

Geoff, just hoping to the margin, one more question there, obviously it was stronger than expected quarter. And I know you talked about the flattening with the yield curve but on the fourth quarter call you gave some guidance for the full year of 2.90% to 2.95%, that’s so intact or given the better than anticipated margin, is that up a little bit?

Geoffrey Hesslink

That’s up a little bit. That’s up a little bit I would say.

Matthew Breese

Okay. Do you care to quantify that a bit more, I mean as 3.02% could we see one or two basis points a quarter kind of compression, is that what you’re guiding to?

Geoffrey Hesslink

Yeah, that’s probably – that’s a good estimate Matt, and I think that would be a good estimate for you there, yes.

Matthew Breese

Okay. And then on the loan growth side, I know you reiterated guidance of 5% to 6%. Can you quantify the size of the pipeline that gives you confidence by hitting that number or where is it relative to – where was it at year end?

Geoffrey Hesslink

Pipeline today is pretty consistent with where it was at year end, I’m trying to remember. Actually it’s probably up slightly, we’ve had some transactions that we thought were going to happen in the first quarter fall out and some move into later periods, but we’ve also picked up some new business. So it’s – we have all sorts of levels of pipeline Matt, but we have $25 million to $35 million of high probability stuff in the pipeline but the total commercial pipeline is probably triple that number, so it never happens by precision. But what I can tell you is that the pipeline of commercial business we have with reasonable expectations for closer rates will get us to that guidance that we gave you last quarter. We just need to have success this second – and I think we will, I think we will and if we do, I think we’ll be in a position to deliver on that. If we don’t have success this quarter then we’ll be having a different conversation in 90 days.

Matthew Breese

As it relates to transitioning pipeline loans to closed loans, what are some of the difficulties that might push things out 30, 60, 90 days from one quarter of the net that you’re facing?

Geoffrey Hesslink

Pushing stuff out is – would just be technical, getting documentations done and valuations completed and rates of work completed. Those are things that are causing extensions, the bigger fundamental challenge is pricing pressure from the market. When things slide in the pipeline that’s okay, we prefer to get loans closed as fast as possible to get that interest income accruing. If we’re 30 days delayed on something that’s not ideal but it’s okay, the real challenge is when they fall out of the pipeline all together and the most comment reason that would happen to us would be pricing, competitive pricing, Matt.

Matthew Breese

Got it, okay. And then hoping to the tax rate, 23% for the rest of the year, what does that mean for your ability to find additional low income housing tax credits, has that been easier or harder or is there anything that read into there with flat tax rate for the rest of the year?

Geoffrey Hesslink

I’m going to let Eric to tackle that one for you.

Eric Segal

Hi Matt. I think we have a good slow growth of tax credits. Pricing is in competitive markets, we’ve been able to do a few deals in the quarter. Obviously that take some times before the projects come online and we start realizing the benefit. But remember Matt, there is – most of these tax credits earn out over 10 year period, I think there may be some that ran out of a shorter period at times. So there are credits we have purchased that will naturally run out over time, we do have to always find new projects and new deals to replenish that, but there is some level of tax credit that we’ve already purchased and will naturally happen.

Matthew Breese

Got it.

Geoffrey Hesslink

And Matt, just to add some additional color, I think they’ve been in the last quarter for opportunities which one we were priced out and three we got.

Matthew Breese

Okay, okay. On the expense commentary, I know you said at the end of the quarter you had the systems conversion. What kind of immediate benefits do you expect in 2Q from that conversion?

Geoffrey Hesslink

From a cost perspective?

Matthew Breese

Yes.

Geoffrey Hesslink

Yeah, so we – again going back to the original there was 25% cost saves forecast that we think we’re going to recognize those 25% cost saves. We think we’ll expect to see the full benefit of that in the second quarter and we only had a partial benefit of that in the first quarter. So it’s pretty immediate and it’s material for us.

Matthew Breese

Got it. That’s all I had, I appreciate it. Thank you.

Geoffrey Hesslink

Thank you, Matt.

Operator

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Geoffrey Hesslink for any closing remarks.

Geoffrey Hesslink

Sure. Thank you all for joining the call and thank you for your good questions about our company. I guess just to wrap it up, it was a decent start to the year and our outlook for the remainder of the year is favorable frankly. We do think our performance were built throughout the year. We get the loan growth that we expect to have and get the benefits of this funding trade we talked about, and some of the expense saves we do expect directionally to have for the performance in the earnings to build throughout the remainder of the year, and we’re looking forward to executing on that.

So, once again, thank you for your time. Thank you for your support and your investment in our company and we look forward to getting together again in 90 days.

Operator

Thank you, sir. To access the digital replay of this conference, you may dial 1877-344-7529 or 412-317-0088 beginning in approximately 12 PM Eastern Time today. You will be prompted to enter a conference number, which will be 10068680. Please record your name and company when joining.

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

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