F.N.B. Q3 2007 Earnings Call Transcript

F.N.B. Corporation (FNB)

Q3 2007 Earnings Call

October 19, 2007 11:00 am ET

Executives

Bartley Parker - Investor Relations

Stephen Gurgovits - President and Chief Executive Officer

Brian Lilly - Chief Financial Officer

Gary Roberts - President and Chief Executive Officer of First National Bank of Pennsylvania

Analysts

David Darst - FTN Midwest

Mac Hodgson - SunTrust Robinson Humphrey

Damon DelMonte - KBW

Charlie Smith - Fort Pitt Capital

Jim Gifulo - Bantar Advisors

Presentation

Operator

Welcome to today's F.N.B. Corporation Third Quarter 2007 Earnings Conference Call. At this time, all participants are in a listen-only mode.

Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. As a reminder, today's conference is being recorded.

And now, I’d like to turn the conference over to Mr. Bartley Parker with Investor Relations. Please go ahead, sir.

Bartley Parker

Thank you, Trisha. This conference call of F.N.B. Corporation and the reports it files with the Securities and Exchange Commission. Often contains forward-looking statements, which are based on current expectations, estimates, forecasts, and projections about F.N.B.

As well as management's assumptions and beliefs, relating to present or future trends or factors affecting the future performance of F.N.B. and the banking and financial services industry. Since forward-looking statements relate to future developments, results, and events. They often -- they involve certain risks and uncertainties.

Actual results may differ materially from historical performance or those expressed or implied in the presentation as a result of future decisions by F.N.B. or by other factors and developments beyond F.N.B.'s control.

Including, but not limited to a significant increase in competitive pressures among financial institutions; changes in interest rate environment that may reduce interest margins; changes in prepayment speeds, loan sale volumes, charge-offs, and loan loss provisions; less favorable than expected general economic conditions; legislative or regulatory changes that may adversely affect the business in which F.N.B. is engaged; technological issues which may adversely affect F.N.B.'s financial operations or customers; changes in the security markets; or risk factors mentioned in F.N.B.'s filings with the Securities and Exchange Commission.

F.N.B. undertakes no obligation to update these forward-looking statements or to reflect events or circumstances after the date of this call.

It is now my pleasure to turn the call over to Mr. Stephen Gurgovits, President and CEO. Steve?

Stephen Gurgovits

Thank you, Bartley. Good morning, everyone, and thank you for joining our third quarter 2007 earnings conference call. With me today on the call is Brian Lilly, our Chief Financial Officer; and Gary Roberts, President and CEO of First National Bank of Pennsylvania.

Before we begin our review of the third quarter, I would be remiss in not mentioning our announcement earlier this week that Robert New, Jr., has been selected as the next President and Chief Executive Officer of F.N.B. Corporation.

Bob comes to us from Houston, Texas, and has nearly 34 years of banking experience. Our recent press release elaborates on Bob's background and experience, which I won't repeat now. Bob will join us on January 15, 2008, as President and CEO-elect, then will become President and CEO on April 1, 2008.

I will remain thereafter on a full time basis as Chairman for the remainder of 2008. Beginning in 2009, I will remain as Chairman and will have a part time advisory role for an additional five years. I wish to thank our Board and in particular our succession committee for their hard work.

I announced my retirement plans well in advance in order to allow sufficient time to select a CEO and execute a smooth, seamless transfer of leadership. I believe our plan will work perfectly. I look forward to introducing Bob New to you on our next earnings call.

Now to the third-quarter review, for the third quarter of 2007, we earned $0.29 per diluted share, comparable to both the prior quarter and the third quarter of last year. We delivered strong profitability with a return on tangible equity of over 26% and a return on tangible assets of 1.25%.

Our returns continue to place F.N.B. in the top quartile of our national peer group. Our results for the third quarter reflect our ability to deliver on key objectives. We grew the average balances of our commercial, direct installment, and consumer line of credit loans by 5.2% over last year.

On a regional basis, Florida production for the first nine months totaled $140 million. Based on our current pipeline, we estimate Florida production ending the year at around $200 million versus the prior projection of $225 million.

Pittsburgh commercial loan production for the first nine months was $103 million versus a 2007 full year goal of $125 million. We are especially pleased with the progress we have achieved in this market and attribute our success to the strong customer service focus of our commercial lending team.

With each passing week, one can sense the victories and accomplishments of our Pittsburgh team. In a recent article published by the Pittsburgh Business Times, First National Bank of Pennsylvania was ranked as the sixth largest bank in Pittsburgh as measured by commercial and industrial loans outstanding.

We certainly have established the momentum in Pittsburgh that we had hoped to achieve. Our Harrisburg region has made progress on a goal of $75 million of annual production. A key addition to our lending team from one of our competitors in the capital region, as a result of the disruption caused by recent M&A activity, gives us good confidence about our direction in this important region of the state.

In the third quarter, we maintained a stable net interest margin in a continued difficult interest rate environment. We also increased the total of our key fee income sources, which are bank service charges, insurance, and wealth management, by 1.8% year-over-year.

Additionally, our operating costs are tightly controlled, as evidenced by our positive operating leverage on a sequential basis. While our loan loss provision, non-performing loans, and net charge-offs for the quarter rose in comparison to the second quarter, they continue to be at historically good levels.

It is important to remember that our asset quality metrics have been at all-time lows and are unlikely to remain at those levels.

Let me comment further on credit quality and, in particular, our decision to increase the provision expense this quarter. As we stated earlier this year, we are very much aware of the continued softness in the Florida real estate market.

We have reviewed each and every loan in our Florida portfolio, which, by the way, is comprised of only 51 loans and represents only 6% of our total portfolio, but we do remain very comfortable with our sound underwriting principles on these loans.

However, the softened real estate market has slowed the absorption rate on several projects. While we continue to monitor these projects and the Florida real estate trends closely, we will not overreact.

It is worth noting that our current and expected future Florida production will be geared more toward commercial and retail centers; and therefore, less affected by market fluctuations. Having said this, we did have the opportunity in this quarter to bolster loan loss reserves and considered it prudent to do so.

Let me now turn the call over to Brian to provide some additional insight on our earnings report. Brian?

Brian Lilly

Thank you, Steve, and good morning, everyone. I would like to start with some comments on our loan portfolio. Loan growth was the key contributor to our 6.4% annualized growth in net interest income.

In particular, average commercial loans increased 11% annualized, compared to the second quarter of 2007. This growth reflected our strategy to grow these high-yielding relationship based loans.

Regarding the growth in our direct installment portfolio, a successful sales campaign in late spring and early summer accelerated the normal seasonal strength, resulting in an average balance increase of $28 million or 12% annualized, relative to the second quarter.

In total, our average loans grew 7.7% annualized over the second quarter of 2007. Balances of investment securities were comparable to the second quarter, thereby generating average earning asset growth of 3.9% annualized.

We continue to be comfortable with the level of our investment securities, relative to our total assets. Our growth in net interest income for the third quarter benefited from a stable net interest margin. We are pleased that this marked the fourth consecutive quarter of a stable margin, particularly against the challenges of an inverted yield curve. The yield on earning assets and cost of funds increased 5 basis points on a sequential-quarter basis. On the asset side, yields have been enhanced through growth in commercial loans.

Regarding deposits, which represent 86% of total funding, we've reduced balances of higher-cost CDs and increased our lower-cost core deposits. The acceptance of our innovative banking products continues to help drive increased lower-cost core deposits. With the new development officers in each of our five regions also contributing to these results.

In total, average deposits and treasury management products increased 3.7% annualized from the second quarter of 2007. Period end balances were slightly higher than our average balances, giving us nice momentum heading into the fourth quarter. Deposit rates offered to our customers were relatively flat during the third quarter, but have declined subsequent to the September 18 reduction in the Fed funds target rate.

This reduction, coupled with our slight liability-sensitive position and assumed rational competitor deposit pricing, should position us to maintain or slightly increase the net interest margin in the fourth quarter.

Turning to noninterest income, increased customer volume and seasonality helped our banking service charges and insurance revenue grow an annualized 2.9% and 8.7%, respectively, as compared to the prior quarter.

Our wealth management, comprised of our securities commissions and trust income, was essentially flat on a linked quarter comparison, but represented 10.8% increase over the third quarter of last year.

The progress we are making in growing our fee income does not show up in the performance of our total noninterest income this quarter, which declined $330,000 or 1.6% relative to the same quarter last year. The decline was primarily due to two factors totally totaling around $1 million.

First, as I shared in last quarter's call, we do not see opportunities for bank stock gains going forward. In the third quarter of last year, we realized $0.5 million in bank stock gains.

Second, the third quarter's other non-interest income includes a loss of approximately $500,000 on the pending sale of a headquarters building acquired in a prior merger. This sale is under agreement to close early in the fourth quarter.

Noninterest expense declined from the second quarter. The linked-quarter decrease was primarily driven by lower other operating expenses, for items like annual director stock reports, legal fees, and other costs that I mentioned in last quarter's call.

Looking at our revenues and expenses together, we had positive operating leverage. This is shown by the improvement in our efficiency ratio to 57.4% for the third quarter, from 58.3% for the prior quarter.

We are looking for expenses to be flat to slightly lower in the fourth quarter in comparison to the third quarter of 2007. For income tax expense, we recorded a $900,000 net benefit this quarter. We reversed tax reserves that were established in the spin-off of our Florida operations at the end of 2003. Without this item, our tax rate would have been 29.6%, consistent with the second quarter.

Looking at our asset quality, as Steve mentioned in his remarks, key credit quality metrics continue to be at very good levels on a historical basis. Annualized net charge-offs for the third quarter of 2007 were 27 basis points of average loans, representing a 3 basis points increase from the second quarter and a 4 basis points rise from an all-time low in the third quarter of 2006.

For some perspective the full year ratio of net charge-offs to average loans was 46 basis points in 2005 and 29 basis points in 2006. Our ratio of nonperforming loans to total loans was 57 basis points at the end of the third quarter, a 1 basis point linked-quarter increase, but a 12 basis points improvement versus the same quarter of last year.

With regard to the increase in the provision for loan losses, first, we covered net charge-offs as our allowance modeling has reached a balanced position where new loss factors are consistent with the historical costs in our models.

Second, we added to the reserves for loans in Florida in recognition of the sustained weaker real estate market. Going forward, we would expect our provision expense to cover net charge-offs.

At quarter end, the allowance for loan losses was 1.2% of total loans, a 1 basis points increase from the second quarter, and represents an amount of over two times our total nonperforming loans. Our period-end capital ratios remain solid as we continue to meet all well-capitalized measures.

Steve, that concludes my remarks for the quarter.

Stephen Gurgovits

Thank you, Brian. In terms of our earnings guidance for the remainder of the year, Brian has highlighted a few of the important components. As a result of our expectation of covering our net loan charge-offs with our provision, we now expect earnings for the full year 2007 to be in the range of $1.16 to $1.17 per share.

This represents expected earnings growth of 2% to 3% over the full year 2006. We are pleased with this performance given the interest rate and credit quality challenges faced by the financial service industry.

In closing, we are proud to have announced a 2.1% increase in our dividend in August. We believe this reflects the Board's confidence in the outlook for the Corporation's earnings and capital position. This also puts us on track to make 2007 the 35th consecutive year of growth in our cash dividend.

We believe our sound strategy of profitably managing our businesses and providing value to our shareholders in the form of a low risk profile and strong cash dividend makes us an attractive investment choice. We thank all of our shareholders for their continued support.

Well, that concludes our formal remarks for the call. I will now ask the operator to poll the audience for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) And we’ll go first to David Darst with FTN Midwest.

David Darst - FTN Midwest

Good morning.

Brian Lilly

Good morning, David.

Stephen Gurgovits

Hi David.

David Darst - FTN Midwest

Do you feel like the run-off that you were managing in the indirect in the residential portfolio is complete? Is that going to translate into a little bit better loan growth for the overall portfolio going forward?

Brian Lilly

I think, let me take those one at a time. On the mortgage portfolio, as you know, we continue to sell most of our production; but there is a component that is reaching in there that is stabilizing.

I think we will continue to see the $8 million a quarter, barring some unusual opportunities, to slide off.

On the indirect portfolio, David, I think we have stated in the past the credit quality continues to be excellent. We are happy with the yields that we're getting there. But it’s not a long-term strategy for us. But certainly, that is a place of liquidity as we continue to build the commercial portfolio going forward.

David Darst - FTN Midwest

Okay. Then, on the securities portfolio, do you expect to grow that a little bit to maintain the ratio, you said 80, 20 to loans to securities average earning assets?

Brian Lilly

Well, the ratio should be relatively steady going forward, although we’ll look for opportunities to keep a little investment securities as possible. We build that need up from the bottom based on our liquidity needs and our pledging requirements and our interest rate risk needs.

David Darst - FTN Midwest

Okay. And then, could you give us the balance of your residential construction portfolio? How much of that is in Florida, and how much is in the Pennsylvania market?

Stephen Gurgovits

Well, actually, David, we have very little residential construction in the north at all. I mean, we may have an occasional owner-builder, but we don't have any tract residential development or anything of significance in the north.

David Darst - FTN Midwest

So, is that the residential properties that are in Florida that are giving you concern?

Stephen Gurgovits

Well, to make a comment about Florida, David, about a third of our involvement in Florida, in terms of development is commercial in nature and two-thirds would be residential.

And we’re obviously aware of the softening in the market. We think that may slow the absorption rate on some of these developments. But having said that, as I have mentioned in previous calls, they were well underwritten. A lot of these have 50%, 60% loan-to-value ratios, often with guarantors. Most of them have pretty good personal liquidity.

So. But having said that, we are aware that the market has softened and so we’re looking pretty closely at all 51 loans in the portfolio and in making sure that we are where we need to be.

David Darst - FTN Midwest

Steve, are your loans, the infrastructure like the roads and the pipes? Or are you also doing the actual houses?

Stephen Gurgovits

No, not really. We’re not doing the tract building down there. We have, I would say, David, I would carve this into three buckets if you will, and they're almost equal. One is, outright land acquisition while an accumulation, while this real estate is being permitted and going through that process.

And if you are familiar with Florida, that is a pretty extensive, lengthy process. Then, we have another bucket that I have always referred to as horizontal construction, which is the roads and the infrastructure, utility, sewers, that sort of thing, curbing, paving.

And then the other third of the portfolio is pretty much the commercial projects, office buildings, retail centers, that type of thing.

David Darst - FTN Midwest

Okay. And then…

Stephen Gurgovits

But no housing construction.

David Darst - FTN Midwest

Okay. And last quarter, you indicated that there were no past dues or NPAs. Is that still the case in Florida?

Stephen Gurgovits

Well, actually as of September 30, David, that is not the case. We did have one loan, one of the 51, that was delinquent as of September 30; and in fact we put it on non-accrual. It happens to be a $2.6 million loan that has a $650,000 specific reserve assigned to it, which we think is adequate to cover the risk of any loss in that particular credit.

Brian Lilly

David, as you see, we were able to cover that with improvements in our other portfolios, so it really didn't move the non-performing assets all that much.

David Darst - FTN Midwest

Okay. Great. Thank you.

Operator

And we’ll go next to Mac Hodgson, SunTrust Robinson Humphrey.

Mac Hodgson - SunTrust Robinson Humphrey

Good morning.

Stephen Gurgovits

Good morning, Mac.

Mac Hodgson - SunTrust Robinson Humphrey

Some of my questions were already answered. I guess staying on Florida for a second, what are the total outstanding balances on the loan balances for the Florida portfolio?

Stephen Gurgovits

On September 30, they were about $246 million.

Mac Hodgson - SunTrust Robinson Humphrey

Okay, $246 million; and you had mentioned?

Stephen Gurgovits

Actually $246.5, to be specific.

Mac Hodgson - SunTrust Robinson Humphrey

Okay, great. You mentioned about two-thirds of that is related to residential?

Stephen Gurgovits

No. Two-thirds of that is related to, well, if you put all three buckets together, you about two-thirds would be about residential, about one-third would be commercial in nature.

Mac Hodgson - SunTrust Robinson Humphrey

Okay. The increase in the reserve, obviously, I think you just mentioned $650,000 is a specific reserve allocated to that $2.6 million credit. Was there kind of just unallocated reserves? Or are the other increase in reserves related to specific credits down there that have deteriorated?

Brian Lilly

No, not to specific credits. But in our loan modeling, we do have economic and general allocations. We saw it prudent to allocate some to the Florida economy, if you will. And so we had, and our specific reserves actually netted out with all of our portfolios. So, the increase was primarily driven by us putting some to a general Florida condition.

Mac Hodgson - SunTrust Robinson Humphrey

Okay, got you. What about, I know it’s a small piece of the overall portfolio, but how is the Regency portfolio performing, any weakness there?

Stephen Gurgovits

I would not call it a weakness, Mac. But if you recall, just for the history, back in the fourth quarter of '05, with the new bankruptcy law, it went into effect, I believe, in October of that quarter. And that accelerated a lot of their charge-offs into the fourth quarter of '05. And then in '06, they had a, for Regency, a below normal run rate of delinquency and losses.

We had fully expected that to return to normal levels at the beginning of this year, which as a matter of fact it didn't, it was still running below their historical averages. But our prediction for Regency is that their portfolio will return to more normal levels.

Brian Lilly

Just, Mac, to give you some numbers on that, we see our normal levels to be in the 4s, on an annualized net charge-off basis; on a quarterly 4.5, low 4s.

Mac Hodgson - SunTrust Robinson Humphrey

Okay.

Brian Lilly

And for the last couple of quarters, we've been averaging right about 3%, with the third quarter getting up around 3.5%. So we think the trend is to get us back up into the 4s as we look forward.

Mac Hodgson - SunTrust Robinson Humphrey

Okay, got you. It's a pretty small portfolio, right? What's the total outstanding on that?

Brian Lilly

About 150.

Mac Hodgson - SunTrust Robinson Humphrey

150? Okay. And on the -- any kind of tax rate expectations you can give us for the fourth quarter? I think you mentioned and without the benefit this quarter it would have been about 29.6%.

Brian Lilly

I would say you're right in that same range, somewhere around 30% number.

Mac Hodgson - SunTrust Robinson Humphrey

Okay. Okay, great. Thanks, guys.

Operator

We'll next go to Damon DelMonte with KBW.

Damon DelMonte - KBW

Hi, good morning. Most of my questions have been answered. Just a couple of detail questions, could you just go over the numbers again on the Pittsburgh production that you've seen so far this year?

Stephen Gurgovits

Yeah, the production is $103 million versus annual goal of $125 million.

Damon DelMonte - KBW

Okay, great. And then with respect to the Florida operations, I believe there was a few vacancies that you had down there. Were you guys able to fill those yet?

Gary Roberts

We filled one -- this is Gary, we filled one position in the Tampa area.

Damon DelMonte - KBW

Okay. And any further thoughts on actually opening up branches for deposit-gathering efforts down there or are you still solely looking at the Florida operations as LPOs?

Stephen Gurgovits

At this moment, we have just the LPO operation, but as I've stated on other calls, we do from time to time study what our next opportunity should be. But at this particular moment, we're only focused on building out the LPOs and adding some additional services like treasury management and so forth through those LPO offices.

Damon DelMonte - KBW

Okay, great. Thank you very much.

Operator

We'll go next to Charlie Smith with Fort Pitt Capital.

Charlie Smith - Fort Pitt Capital

Good morning.

Stephen Gurgovits

Good morning, Charlie.

Charlie Smith - Fort Pitt Capital

I'm kind of glad, actually glad to hear that you guys didn't meet your loan targets in Florida. We may be overly focused on Florida. Are there any segments of your PA markets in terms of your customer list, certain industries, where you're seeing any signs of weakness?

Stephen Gurgovits

Not really, Charlie. Just to -- and I don't want to go back to Florida necessarily, because that wasn't your question, but I'll do that in order to lead into your question.

When we started this year, we had a target in Florida with about $350 million. And with the softening in the market, early on in the first quarter, we said we really don't want to do $350 million. So we cut it back to about $225 million, and we'll probably be at or around that this year as we tightened our underwriting substantially.

But if you go up to the North, and the different regions in Pennsylvania and Eastern Ohio that we're in, we feel pretty comfortable with not only our production, but our asset quality is really holding up, and then we're meeting our production goals.

So, Harrisburg should be pretty close to their goal, Pittsburgh be close to maybe slightly over. And the rest of the northern franchise is pretty much where we want it to be.

Gary Roberts

I think the M&A activity up here has helped us some, and we've had some micromarketing, what we call micromarketing campaigns in those particular areas. And we've met, as Brian noted in his comments of growth, we've met with some success in growing core deposits and loans.

So, the North is really what we call the North, and the basic footprints really carried the year for us.

Charlie Smith - Fort Pitt Capital

Okay. Assuming that it's going to be at least four to six quarters for real estate to sort things out, both commercial, I think we're just starting to see some signs of pain around the edges in commercial real estate in some places. Assuming six to eight quarters from now, we bought them out, where do you think your net charge-offs percentage could be?

Brian Lilly

Oh wow, Charlie. I think you would be asking us to speculate under a whole bunch of assumptions. I don't think we can go there.

Charlie Smith - Fort Pitt Capital

Okay, so --

Stephen Gurgovits

But Charlie, remember as I said earlier, on these loans in Florida, particularly the residential loans, we're often in there at 50% or 60% of what the appraised value was. Now we understand if the market softens, the appraised value can soften as well.

But in addition to that, most of these loans have personal guarantees and the guarantors on these loans. We look at them for not only their contingent liabilities on other projects, but specifically to the liquidity on their balance sheet.

So, I'm not going to sit here and say, well, I don't know what the future holds. But I can tell you that the best thing you can do in administering credit is to stay on top of these things, and believe me, our guys are tracking these 51 credits. Yeah, the good news is it's only 51 credits.

Charlie Smith - Fort Pitt Capital

Yeah, exactly. Okay, thanks a lot.

Stephen Gurgovits

Sure.

Operator

(Operator Instructions) We'll go next to Jim Gifulo with Bantar Advisors (ph).

Jim Gifulo - Bantar Advisors

Gentlemen, I missed the very first part of the conference call, and I was hoping you could give a little more detail on Mr. New's credentials and what he has been doing up until now.

Stephen Gurgovits

Well, I don't have his resume in front of you. I would refer you to our press release early in the week for probably more specifics. But at the beginning of the call, I just mentioned that we did hire Mr. New. This week, we announced it Monday afternoon.

He is, I think will be 56 years old next week. He has been in the banking business, literally his whole life he has about 34 years, going on 35 years experience. He is a California native.

He has been in the Texas banking market, starting out with Texas Commerce Banks where he was a CEO of several of their different affiliate banks. Once was with NationsBank, which became, as you know, Banc of America. With Coast Bank, which was acquired by Hibernia, he was Executive Vice President of that bank.

For about the last 18 to 20 months, he joined an investor group, who enticed into joined them and start a bank that is called Green Bancorp in Houston, Texas. It was a startup. It's up to about around number, $250 million or so in assets.

And he was not looking for a job. He was contacted by Heidrick & Struggles, who we had retained as a recruiting firm and after several contacts, they got him to at least sit down and talk to us, and it went from there.

But he and his wife are moving to the community and he expects to be active in the community and I think he has got a good background of operations and lending. He has had the mix of the larger bank any the smaller community bank and I think personality-wise and experience-wise, he will fit the culture of this company pretty nicely.

Operator

(Operator Instructions) And we've no further questions left in the queue. I would like to turn the call back over to Mr. Gurgovits, for any additional or closing remarks.

Stephen Gurgovits

Thank you. And thank all of you again for joining us today. Telephone replay for this call will be available through November 2nd by calling 888-203-1112 and entering the confirmation number 1434076.

As usual, the transcript of today's call will be posted to the investor relations section of our website, which can be reached at www.fnb.corporation.com. Thanks again for your participation and have a great day.

Operator

Thank you, ladies and gentlemen, for your participation on today's conference call. You may disconnect at any time.

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