Camden National Corporation (NASDAQ:CAC)
Q2 2016 Earnings Conference Call
July 26, 2016 15:30 ET
Greg Dufour - President, CEO & Director
Deborah Jordan - EVP, COO & CFO
Mac Hayden - EVP & Chief Credit officer
Damon DelMonte - KBW
Matthew Breese - Piper Jaffray
Good day and welcome to the Camden National Corporation Second Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] Please note that this presentation contains forward-looking statements which involve significant risks and uncertainties. Actual results could differ materially from the results discussed. The risk factors are described in the company's Annual Report on Form 10-K and in other filings with the SEC.
Today's call presenters are Greg Dufour, President, Chief Executive Officer and Director; Deborah Jordan, Executive Vice President, Chief Operating Officer and Chief Financial Officer; and Mac Hayden, Executive Vice President, Chief Credit Officer. Please also note that today's event is being recorded.
At this time, I'd like to turn the conference call over to Greg Dufour. Please go ahead.
Thank you, Beyonce. And good afternoon and welcome to our conference call to discuss financial and operating results for the second quarter of 2016. Debbie Jordan will review the financial results and Mac Hayden, our Chief Credit Officer, will provide an overview of asset quality. But first, I wanted to highlight a few of our second quarter accomplishments.
We reported net income on a GAAP basis at $9.6 million for the second quarter of 2016 which brought year-to-date earnings to $18.3 million. This represents diluted earnings per share of $0.92 for the second quarter and $1.76 per share for the first six months. Excluding merger and acquisition related expenses we reported core diluted earnings per share of $0.93 for the quarter and $1.81 for the six months. Through this performance we're pleased that we reach several important targets. Return on average assets on a GAAP basis was 1.01% for the quarter, while return on average equity on a GAAP basis was 10.22%. Our efficiency ratio was 56.53% tracking to our targeted levels. Total revenues of $39 million for the quarter were 9% over the first quarter of 2016.
Before I turn it over to Debbie to provide more background on this performance, I'd like to take a few minutes to update you on several strategic efforts. We are obviously concerned by the downturn in interest rates during the quarter along with a flattening of the yield curve, equally as important as the outlook for interest rates to remain low for a sustained period of time. In some ways, this highlights the strength of our decision to acquire SPM Financial, the parent company of The Bank of Maine last year as we're able to achieve cost savings, position ourselves for grow by leveraging in Southern Maine franchise, as well as benefit from this strong core deposit base in Central Maine. It also though highlights the need to continually seek other ways to expand revenues while controlling costs.
I shared with you last quarter the hiring of Mary Beth Haut as President and CEO of our Wealth Management Subsidiary, Acadia Trust. With about 120 days under her belt, Mary Beth has hit the ground running, meeting with clients and prospects as well as focusing on ways to leverage the expanded franchise. Over the next several months she will lead our effort to broaden our investment, product offerings, including -- improving the wealth management client experience, growing the business and expanding investment offerings. While we don't anticipate significant capital investments, we do expect to make operating expenses and investments in people, products and services in the $200,000 to $250,000 range between now and the end of the year. This is incremental to operating expense estimates we previously provided. We view these expenditures as an investment in both our Wealth Management and Banking businesses and important to our efforts to generate additional fee income in the future.
While we're pleased with the strides we're making to reach our efficiency ratio targets, we also realize we need to continuously search for additional savings. During the quarter we eliminated 14 open positions through attrition reassignments, we've also made the decision to close two branches both in the Bangor Maine area, one in Bangor and one in Orono. Both locations were required to our purchase of 14 branches of Bank of America in 2012. We anticipate employees of those banking centers to be reassigned to other job openings which will result in an FTE reduction of seven positions.
We're seeing a strong increase in customers interact, we offer smart ATMs, a unified user experience in our web and mobile platforms, and online account opening. Since last year we have seen a 33% increase in online mobile users. This is putting additional pressure on physical branch networks which have seen a decline in transaction activities. We'll continue to review branch performance in light of changing customer demands. The greater Bangor Maine market is strategically important to Camden National and our efforts are designed to optimize both our cost structure, as well as reflect change into those customer patterns and the economic environment in Bangor which we are very pleased with.
Finally, we have decided to exit the business of third-party loan servicing, an effort we have done since 2006 for estate of Maine agency. This should be accomplished by the end of the year with minimal impact to 2016, our realized savings in 2017.
As you've seen in our earnings report, we experienced an increase in loan loss provision for the quarter. While we never like to see any of our credits require additional reserves, this was related to two credits; one from the acquired portfolio, and one from our legacy Camden National portfolio. Otherwise, we are very pleased with our asset quality. After Debbie's remarks, our EVP and Chief Credit Officer, Mac Hayden will provide comments on our asset quality.
Now I'll turn the discussion over to Debbie.
Thank you, Greg and good afternoon everyone. We are pleased to report strong financial results for the second quarter of 2016 which exceeded our forecast for the quarter.
Net income of $9.6 million for the quarter increased 11% compared to the first quarter of this year, and diluted EPS of $0.92 per share was up 10% compared to the previous quarter. Our return on average assets was 1.01% and our return on average tangible equity reached 14.5% for the second quarter. The major drivers of earnings growth for the quarter included a 33% increase in fee income, operating expenses were 3% lower, and net interest income was up 2% compared to the previous quarter. These favorable items were partially offset by an incremental $2 million in loan loss provision.
Our fee income growth was driven by an increase in commercial back-to-back loan swap income of $937,000 combined with an increase in mortgage banking revenue of $898,000. Commercial real estate swap activity was breathed with over $73 million transacted during the quarter as our borrowers benefited from locking in low long-term interest rates. Mortgage banking revenue more than doubled during the quarter as we sold $56 million of production. We are experiencing the benefit of our expanded mortgage reach in southern Maine and Braintree Massachusetts with almost $90 million in the pipeline.
During the second quarter we also recorded $394,000 of life insurance benefits. We are very pleased with our long growth for the quarter of $93 million at 15% annualized growth rate over March 31. Our commercial real estate portfolio was up $65 million and our commercial portfolio grew $44 million during the second quarter, while we experienced a $13 million decline in our retail lending portfolio. Average core deposits which exclude certificates of deposits and brokered deposits of $2 billion grew $35 million between quarters or an annualized growth rate of 7%. Our reported net interest margin was 3.34% for the second quarter of this year, down one basis point over the previous quarter; however our core net interest margin was down five basis points between periods to 3.09% when excluding purchase accounting activity.
The decline in our core margin is the result of the current rate environment, as well as the level of commercial loans swap completed in the first half of this year. Our core operating expenses for the quarter which excludes one-time merger cost amounted to $22.2 million, a decline of $112,000 from the previous quarter. Core operating expenses exceeded our previously forecasted second quarter target by $453,000 or 2% primarily due to an increase in both our short-term and long-term incentive compensation of $416,000 driven by a strong revenue growth for the quarter.
Between quarters, we experience lower operating costs in most line item categories with the exception of higher compensation due to incentive, higher regulatory assessments resulting from asset growth, and higher consulting and professional fees which includes $217,000 of cost that won't be incurred for the remainder of this year. We are still driving towards an efficiency ratio of 58% for 2016 but anticipate our operating expenses to run higher than our previous guidance of $21.7 million per quarter. Compensation in benefits is the major driver and part due to incentives but also general wage inflation in both new hires and existing talent from the tight labor force in competitive markets.
Additional costs not factored into our initial core operating expense forecast includes estimated one-time cost of closing two branch locations of $225,000 as well as the investment in our wealth management division that Greg mentioned up to $250,000 by year-end. We also have trailing merger-related cost of $273,000 to be expensed by the end of the year. The banking center closures will translate to over $0.5 million expense reduction in 2017.
During the quarter, we adapted the new accounting standard related to stock compensation which results in tax windfalls and shortfalls flowing through income taxes versus shareholders equity. This was applied effective as of the beginning of the year, resulting in the restatement of our first quarter financial statements. The impact of adoption was an increase in diluted earnings per share of $0.03 for the first quarter of 2016 with an effective income tax rate of 28.5%. Our income tax rate for the remainder of 2016 should run at 31%.
During the second quarter, we increased our loan loss provisions by $2 million due to a combination of factors including loan growth, seasonality and the weakening of two larger commercial credits. We have Mac Hayden joining us today to provide an overview of Camden's asset quality.
I'll turn it over to Mac.
Thanks Debbie, and good afternoon, everybody. Just briefly, as Greg mentioned, asset quality remains stable in the second quarter launched 389 [ph] days past due we're at $7 million or 27 basis points. In addition, net charge-offs for the quarter at just 7 basis points on an annualized basis. In the second quarter total criticized and classified assets declined by $8 million or 8% since March 31 to $93 million. And this occurred despite the deterioration of one previously identified non-performing loan and then the downgrade of a large commercial real estate loan during the quarter.
Management views these two circumstances as events rather than a systemic issue, both caused by specific issues at the individual companies and not by economic or market conditions which we believe remain favorable. They did however contribute to the increase in the provision expense previously mentioned by Debbie. These two credits represent approximately 50% of the bank's non-performing loans at the present time as of 6:30 and net of them credit quality metrics continue to improve across the board.
And with that, I would turn it back over to Greg.
Great. Thank you, Mike and thank you Debbie for your comments. We'll now open up the call for questions. Operator?
We will now begin the question-and-answer session. [Operator instructions] And our first question comes from Damon DelMonte with KBW. Please go ahead.
Good afternoon, everyone. How are you doing?
Good, Damon. How are you?
Good. Thanks, Greg. I guess my first question -- we talked a little bit about the margin. Overall, the reported margin was pretty flat quarter-over-quarter. The core margin I think was down and you said five basis points on the quarter. Can we just give a perspective as to what to expect going forward? And how much credit yield are you expecting in the margin? And how do you see the core margin trending going forward?
Yes Damon, I'd be happy to take that. In regards to the credible yield, it's certainly running higher than what we anticipated, and when we look at the rest of the year we think it's roughly about $1 million a quarter for the next two quarters. Related to our core margins, the level of swaps that we recorded in the second quarter certainly hasn't cycled through for the quarter. So with that lower-yielding asset coming on the books in the third quarter, I would anticipate the margin to take another hit in the third quarter and then we'll start seeing it stabilize thereafter. Of course, that really depends on the level of swaps that we do in the third and fourth part. The second quarter was extremely strong and I'm not sure we're going to track to that level going forward for the rest of the year.
Got you, okay. And then as you kind of look at your overall loan growth expectations for the back half of this year, does the sudden part of the footprint continue to be the growth engine and providing you the best opportunity?
Damon, what I would say is it is very oriented to southern Maine, as well as activity that we're seeing in New Hampshire and Northern Massachusetts. Recall that in February 2014, we opened up a long production office in Manchester that has done extremely well for us. I think all of that reflects really the economic environment of Maine and actually northern New England, it goes south to north and that's what we're experiencing even though we do see some openings north of the Portland area as well especially in the legacy area of mid-coast Maine.
Okay, that's helpful. I'll just hop out right now and then I can come back in the queue after. Thank you.
You're welcome. Thank you.
The next question comes from Matthew Breese with Piper Jaffray. Please go ahead.
Thank you. Good afternoon, everybody.
Good afternoon, Matt.
Just staying on the margin, I know it was a strong quarter for swap-related commercial loans. Could you just give us an idea of the yield you received on those swap loans and the difference on those loans versus existing yield on the book?
Sure. On average the swap transactions are priced at LIBOR plus 1.8% to 2%. And then I know our -- of all the production that went on the books for the quarter I think it was roughly average yield of 3.45%. So we're definitely seeing even the existing -- not just the swap piece but the other pieces come on at a lower yield.
Right. And then have you seen any pressure on the deposit side from local -- the mutual in Maine or any of the larger banks as well?
Yes, from the mutual. I would say the municipal public deposit market has heated up and some banks are chasing that business. So we're getting little pressure on that side. We've been trying to hold our rates and keep our cost to funds roughly at that overall 50 basis points cost to fund.
Got it. And so as we think about the margin, obviously some near-term pressure but perhaps some stabilization after that. Where are you seeing the stabilization is? Should we see like a mixed shift in the loan book or do you think things will just settle out?
I think it starts -- new production starts pricing up the current yield as part of it. I think the other thing is when we look at the investment portfolio to total assets we're at 24% right now. I think it's an opportunity to perhaps those cash flows to reinvest in the rosy mortgage side on a book basis. So changing the net asset makes a little bit -- should help us.
Got it, okay. And then the swap fee income this quarter, it was very strong as well. How much of that is sustainable in your view and should we take then to forward earnings?
Yes. You know we had budgeted $250,000 a quarter and I think that's probably a reasonable run rate.
Got it, okay. Just curious on the elimination of third-party loan servicing, how much did that save or how much did that save you on expenses?
The expense is probably about $1.3 million of expenses that we have in that business line but it's essentially a breakeven business bottom line.
And that's reflective just the volume that we've seen within that. Obviously the economics of it is less favorable than what it was when we entered that arrangement in 2006.
Right, okay. And then on the credit front, obviously your couple of isolated events -- is that how you would describe them? Isolated events and then thinking about the provision, how would you have us thinking about the provision going forward?
Sure. We do view them as isolated events. We're happy with everything else that we're seeing in the portfolio. With the provisioning, we expect that to settle down. Probably I would just use a rough estimate and maybe probably close to what we saw in the first quarter level.
I would say maybe 15 basis points to average loans going forward would be a good number.
I would add in with Matt -- this is Mac Hayden -- that subsequent to that large real estate loan being downgraded in the second quarter, many of us took a deep dive and up -- host of credits over a million dollars, it were a week past, special mention or substandard and we came up with nothing that we didn't already know about. It was a good exercise it made us feel a little better.
Got it, okay. And then my last question. In terms of overall loan growth for the year, this is a very solid quarter in terms of balance increases. Is a high single digit number in terms of loan growth still the right figure that we should be baking in?
I would probably -- I think based off what we're seeing Matt, with a competitive environment pricing, albeit some structured issues there, we're happy to have what we had in the second quarter. I would have an expectation that would retch it down. I think we've given guidance over a range of 6% to 8% or 9%. I think we'll be within that range. Definitely the second quarter has not set a new floor of growth expectation. I think it was a jump up.
Yes, and I will say our mortgage pipeline is bigger than our commercial pipeline like today and so we've got to build that pipeline back up.
Okay. That's all I had. Really appreciate you taking my questions. Thank you.
Good. Thank you, Matt.
[Operator instructions] As have no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Greg Dufour for any closing remarks.
I'd like to thank on behalf of all of us here at Camden National, everyone who signed into the call and for your interest in the company and for your tine today. Thank you and we will talk again in few months with our next quarter results. Take care.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines.
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