Dorothy B. Wright – Vice President Investor Relations
A. Thomas Hood – President, Chief Executive Officer & Director
R. Wayne Hall – Chief Financial Officer & Executive Vice President
Ross Haberman – Haberman Funds
First Federal Holdings, Inc. (FFCH) F1Q08 Earnings Call January 17, 2008 2:00 PM ET
Ladies and gentleman thank you for standing by. Welcome to the First Financial Holdings quarterly earning conference call. During the presentation all participants will be in a listen only mode. Afterwards we will conduct a question and answers session. (Operator Instructions) I would now like to turn the conference over to Dorothy Wright. Please go ahead.
Dorothy B. Write
Good afternoon and thank you for participating in our first quarter 2008 earnings conference call. Before we begin I have several brief administrative items to address. You should have received our first quarter fiscal 2008 earning release and supplemental information today. For those who did not both are available on our website and that address is www.FirstFinancialHoldings.com . In addition to this teleconference call we will have a listen only live webcast available. This webcast will be available for the next 90 days. Both the live and archived webcast may be accessed via our link on our website and again that address is www.FirstFinancialHoldings.com.
Our president and chief executive officer A. Thomas Hood will make opening remarks on our call today. Wayne Hall executive vice president and chief financial officer will follow and both will take questions at the end. Our presentation today discusses the company’s business outlook and will include forward-looking statements. Those statements include descriptions of management’s plans, objectives or goals for future operations, products or services, forecast of financial and other performance measures and statements about the company’s general outlook for economic and business conditions. We also may make forward-looking statements during the question and answer period following management’s presentation. These forward-looking statements are subject to a number of risks and uncertainties and actual results may differ materially from those discussed today. Information on the risk factors that could cause results to differ is available from the earnings release that was distributed this morning and from the Form 10K for the fiscal year ending September 30, 2007. Forward-looking statements are effective only as of the date that they are made and the company assumes no obligation to update this information. I will now turn the call over to Tom.
A. Thomas Hood
Good afternoon to everyone we really do greatly appreciate your participation on the call and we’re looking forward to your questions at the end of the call. This has been a pretty unusual quarter for most financial institutions. I suppose we won’t disappoint in that regard. We do hope you had an opportunity to take a look at the first quarter earnings. The release was issued early this morning and if you haven’t done that yet then please review the release on our website as DV mentioned. I’ll provide you with some key details as discuss operations for the quarter ended December 31, 2007. We’re very grateful again that you took the opportunity this afternoon to participate in the call. After commenting on the highlights for the quarter I will comment on some continuing strategic initiatives and some other results.
The snapshot for the quarter and if you’ve read the earnings release you know full well we produced a net income of only $2.9 million. Obviously, impacted by a number of one time adjustments all of which we will discuss this afternoon. Diluted earnings per share are up $0.25 first quarter versus $0.44 for the fourth quarter of 2007 and that’s a 43% decline. The decline in earnings was most significantly impacted by the one time charge related to our early retirement program, basically $1.76 million pre-tax. We also provided $260,000 for our share of the Visa USA settlement with American Express and other pending litigations. As I’m sure you are aware, this is occurring virtually in all bank earnings this quarter. We basically recorded a liability in our balance sheet, s very similar liability is on Visas balance sheet. We do expect that we will not get a bill from Visa. Visa has said as much. It’s very likely that the $260,000 will be reversed in the near term future.
We also made an additional loan loss provision related to both specific models and growth in our loan portfolio. We preannounced last week the impact of these items on the quarter. First quarter earnings adjusted for the early retirement and Visa charge decreased 23% over the September 2007 quarter when earnings were approximately $5.2 million. Diluted earnings per share again, adjusted for the early retirement and Visa settlement were $0.35 as compared to the September quarter $0.44. Earnings also decreased from the comparable quarter in fiscal 2007. Earnings in our first quarter fiscal 2007 were $5.8 million and $0.48 cents per diluted share. The significant short fall and our projections in earnings is again directly related to the early retirement programs, the Visa USA litigation and the increased provision for credit losses.
Absent these adjustments considering the general market conditions our first quarter results were, although short of expectations clearly, did include some pretty solid and favorable results. As to the net interest margin, certainly an important element in all of the earnings releases this quarter, both the interest rate environment and residential housing trends had the same significant impacts on our business plan in 2007 that they had this quarter. Both of these challenges impacted our end interest margin which was reasonably stable for most of fiscal 2007. On a linked quarter basis the interest margin was 3.23% compared to 3.31% for the September 2007 quarter, an 8 basis points decline and 3.37% for the December 2006 comparative quarter, a 14 basis point decline. Our net interest margin had stabilized in a fairly consistent range roughly 3.30% to 3.40% over the past several years. In fact the fiscal 2007 net interest margin of 3.36 was very comparable to the fiscal 2006 margin which was 3.35.
While recent fed cuts have lowered the pricing on our loan products very directly, obviously if there prime based. We have not yet experienced a similar reduction in deposit products. Deposit pricing is still very competitive, especially the CD marketplace and hence we really experienced a narrowing of our margin to 2.23% compared to the 3.37% first fiscal quarter in the year 07 and obviously also a decline from a linked quarter which was 3.31%. I would point out too, and Wayne’s going to provide some additional information, a breakdown of where changes occurred specifically in our net interest margin but, I would point out of some significance we expanded our investment portfolio by $56 million over this past quarter. While the additions to the portfolio obviously positively impacted our net interest income it did have the effect of lowering our margin by four basis points. So four basis points of that comparative change really resulted from expansion of the investment portfolio. Compared to the first quarter fiscal 2007 our net interest income has increased about $358,000 and it an increased $368000 over the linked quarter. With recent FED cuts we anticipate that future rate cuts we would expect will eventually see more rational deposit pricing which we will expect improve margin results. Of course, we will still have a negative impact also on asset yields as the FED continues to reduce short term interest rates.
Second area I will comment on is one receiving an awful lot of attention in all quarterly releases of financial institutions is credit falling. We are seeing increases in delinquencies and expect to continue seeing increases in the next few quarters. We have also experienced a slight increase in net charge offs to 36 basis points from 30 basis points in the fourth quarter fiscal 2007. In our press release last week, our pre-release we referred to four residential lot loans. These loans are related to one borrower group and we believe are limited to those four loans. We had been providing data to the market on quarterly basis over our charge offs, excluding charge offs in our mobile home loan portfolio because we know that portfolio has some above average charge offs and obviously also has higher levels of yields. Net charge offs were 32 basis points annualized for the first quarter excluding our charge offs on the mobile home portfolio.
Fiscal 2008 excluding mobile home charge offs compared to 18 basis points in September 2007 quarter. The mobile home charge off rate was only 70 basis points for the quarter. Now that is going against the grain I think, our expectation would have been higher but apparently some of the impacts of employment or other related items haven’t affected at least the mobile home portfolio at least presently. And, at 70 basis points for the quarter annualized that’s extremely good indication in terms of that portfolio. In comparison charge offs in the linked quarter for mobile homes were 126 basis points. Reserve coverage to problem loans is at 164% that’s versus 251% in the September 2007 quarter. The linked quarter was 383% at December 31, 2006 so you can see that there’s been a material change in reserve coverage. Our observation is that the previous coverage ratios almost at 400% were probably excessive.
Quarter ended with a higher non-accrual loans and higher level of real estate owned than the linked quarter. Approximately 50% though of the non-accrual loans are single family and home equity loans which are well secured. The total consumer delinquencies rates have increased to 1.67% from 1.28% at September 30, 2007 quarter. And again, excluding mobile home delinquencies, consumer delinquencies were only 141 basis points for the December quarter. Historically we have found that consumer delinquency rates improved in the March quarter now obviously, we are entering a period where many are describing the potential for recession, so that may not hold true. But certainly in the past we have seen some delinquency cure in the March quarter probably more the result of tax refunds and more timely payments on loans. I would add that the basis of the number of loans in our portfolio, that is of consumer loans only 1% of the number of our consumer loans are delinquent. I want to emphasize again that we do not categorize any portion of our residential real estate loans that we hold in the portfolio as sub prime.
We continue to become more and more familiar with the difficulties in this sector at this time and the lack of a real solution for many of those borrowers. We’re also aware of proposals to increase the requirements related to residential real estate lending. We don’t think that’s going to be a very productive initiative. Obviously, we need to take a look at an opportunity to crash solutions as opposed to providing more requirements on that activity. Although we expect foreclosures to increase we have not really experienced any increase in foreclosures as of December 31, 2007. For the fiscal year 2007 we completed a total of only 12 foreclosures for approximately $2 million or 0.2% of our single family residential loan portfolio. For the first quarter it was kind of in lock step with previous experience. We had three foreclosures, one of which was a large commercial real estate land loan that produced $450,000 charge off that was related to that foreclosure obviously. We believe this charge off was unique to that particular loan, obviously we have considered any number of alternative resources to resolve significant delinquent loans and avoid foreclosure and we continue to do that.
Several companies have reported increased delinquencies on home equity loans and we’re not alone as home equity loans delinquencies have in fact increased, they increased to 1.4%, that’s total delinquencies, from about 1.19% last quarter. Our break down of this sector indicates that we are in the first mortgage position or second lien position to our own first lien in 68% of these loans. Overall line draws to the full line remain around 50% and we believe our underwriting is still very sound. The average line amount is under $70,000. The average home value is approximately $275,000. The vast majority of our home equity lending is really done through our own loan officers, consumer loan officers and other loans officers right here in our market.
Reporting on other operations we’ll first address mortgage banking operations. We were very pleased with the performance from our mortgage banking operations. Despite the extended slowdown in sales in many markets, total revenues for the first quarter were $1.8 million which compares to $1.3 million the same quarter last year and $922,000 the linked quarter. The vast majority of our residential borrowers continue to choose to finance their purchases with fixed rate mortgages rather than adjustable rate mortgages and it’s probably going to be a long term trend given the angst that people are having with some of the adjustable rate product that was offered to many borrowers. We continued our practice of selling most of our fixed rate mortgages in the secondary market we expect this slow market to continue well into 2008 and possibly into early 2009.
Another highlight service charges and fees on deposit accounts. Late in the second quarter of fiscal 2007 as we planned, we did extend our overdraft protection program to additional customers and we’re pleased to see the increase in usage of that product as we continue our strong focus on growth in core checking products. We have continued to experience increased usage of debit/ATM cards. It’s likely the fastest growing revenue source on most income statements for financial institutions. Revenues from service charges fees from deposits accounts were up19.4% over the same quarter in fiscal 2007 and up 4.5% over the comparative linked quarter.
As to insurance operations, insurance operations were up slightly growing almost 3% over the same quarter. At the present time we continue to rewrite business for other carriers that are being replaced. Some of the carriers in South Carolina cancelled coverage in the recent past along the coast. So, we are having an opportunity I think to take a look at the potential of adding new customers. We had a pretty tame south eastern storm season this past season so we are optimistic that availability will improve. We were just informed in the market place in South Carolina, State Farm will cancel wind and hail coverage for some of their customers along the South Carolina coast, we are hopeful that we can find markets and provide solutions perhaps to some of those customers. We continue to look for additional opportunities for growth in our insurance business through acquisition. Obviously, we are very pleased in the insurance group’s performance considering what is an existing difficult market and indeed a pretty slow market in terms of commercial.
Growing other non-interest revenues is a key goal for the company and one where we’ve achieved, I think pretty consistent success. Now, I’ll ask Wayne to comment on other highlights of operations for the quarter and additionally focus on balance sheet changes. Again, we want to try and break down net interest margin and show you where those changes are occurring and then I’ll close with some commentary on market expansion and a brief outlook for fiscal 2008, followed by your questions.
R. Wayne Hall
Before I get started I just want to point out one thing, we have made some changes this quarter reclassifying different items. What we’ve done this quarter is that revenues from our ATM/debit card we now include in deposit service fees and we have reached that in prior years so those numbers will be consistent and we’ve also, in restated the past, write offs from overdraft accounts, we’ve always shown that expense in other operating expenses. We are now showing that in charge offs and loans. So you will see charge offs and loans increasing but again we have restated prior years to be consistent. If you need more information on that please give me a call and I’ll be happy to go over that with you.
As Tom described, details of the depositing credit environment are confronting First Financial and I imagine that it’s a similar environment for most of the banks that you follow. We are pleased with our growth in loans and non-interest income and we continue to emphasize the importance of growing our customer base. In spite of the recent FED cuts we continue to face strong deposit competition although we have experienced an increase in past due loans and charge offs our credit standards remain strong and we are confident that our credit quality will also remain strong.
Next let’s look at the net impact on interest income. What I’ll do first is discuss the financial impact of these dynamics over the linked quarter. While our margin has slipped some we have been able to grow our loan portfolio by more than 10% annualized during the first quarter. We have not been unfortunate with our positive growth. Average loans grew almost $47 million while average deposit balances actually decreased to $33 million. We have not experienced any significant decline in positive pricing despite the recent FED cuts. We expect a 50 basis point cut at the FED January meeting. Our strategy is to continue to focus on core account relationships and to be competitive in the CD market.
Our funding costs remain steady with a slight increase of 2 basis points while our yield on earning assets decreased 8 basis points. We have expanded our investment portfolio by approximately $56 million costing us approximately 4 basis points in our margin but adding to net interest income. Other changes in our margin came from our shift in our core deposits. As we mentioned our deposit balances have decreased. We have seen some decrease in core deposits that shift in borrowing book has impacted us by about 2 basis points. We also have seen the increase in our borrowing book also impacting us about 2 basis points. We are currently liability sensitive and we had anticipated the recent FED rate cuts would have gone a long way to reversing the margin compression experienced in the fourth quarter. However, continued higher levels of CD deposits appraising has prevented that from occurring. We do not believe these pricing patterns can continue and we should see some benefit of lower deposit costs in upcoming quarters.
We have experienced growth in all but one loan category. As Tom mentioned earlier, we are very pleased with the growth in our first quarter. Compared to the linked quarter manufacturing housing loans increased by 3.5%, home equity loans rose about 2.6%; commercial loans were up about 11.3%, commercial business up 1.2%, land loans up 6.5% and mortgages up 1%. Construction loans declined about 11.7%. Construction loans only represent about 3% of our total portfolio. Overall, loans grew about 2.6% from September 30, 2007. Market value of the available for sale portfolio on December 31st was above book value by approximately $654,000. There was a small gain of about $100,000 on sale of investments done at quarter and as mentioned earlier, we did expand our investment portfolio by about $56 million.
Looking at asset quality Tom mentioned earlier we have seen some increase in past due loans and charge offs. However, our charge offs were impacted by one commercial real estate loan for about $452,000. Net charge offs for the quarter were about $2 million or about .36 of loans outstanding. Adjusted for this one large loan net charge offs would have been about .28%. The allowance for home losses at December 31, 2007 was $16.7 million or .76% of loans outstanding compared to $15.4 million or .72% as of September 30, 2007. Loan assets have increased $5.3 million to $12.9 billion or 59 basis points of total loans and real estate owned. Of this increase $4 million was in non-accruals and $1.2 million was in other real estate owned. Although our charge offs and overall past due loans have increased our credit standards remain steady and we continue to monitor closely end loans that are past due. We believe that early detection is key to minimizing our losses and as such we have placed increased emphasize on the monitoring of past due loans. As many in our industry are predicting past due loans and foreclosures to continue to increase, we continue to be confident that the markets in which we operate will be stronger than many other areas of the country.
Now, let’s take a look at non-interest income and non-interest expense. We had a good quarter of fee growth associated with deposit accounts as service charges and fees on deposit accounts grew to $6.1 million or 4.5% from the linked quarter and 19.4% increase from the same quarter last year. This increase is a result of increased usage of our overdraft protection program and a higher usage of our debit and ATM cards. Despite the difficult mortgage market, mortgage banking income increased over $900,000 to $1.8 million from the linked quarter. Net gain on sale of loans was $729,000 compared to $547,000 for September 30, 2007 quarter. Although our loan sales of $45 million were approximately the same with last quarter, we have experienced approximately 60 basis points higher price on average for those loan sales. Revenues from loan servicing operations have also increased gaining 8% from the linked quarter.
The largest impact from mortgage banking came from our hedging program. The value of our mortgage servicing portfolio net of the hedging gains increased $362,000 compared to a decline of $205,000 for the linked quarter. Our revenues from our insurance operations remain steady at $4.3 million from the same quarter last year increasing by $110,000. We are down as expected in the linked quarter due to insurance segment cycles. We are pleased with these results considering the very difficult market we are currently operating in.
Now let’s turn to operating expenses which were reported $26.6 million dollars adjusting for the voluntary early retirement program of $1.76 million and a $260,000 accrual for the Visa USA litigation operating expenses were $24.6 million compared to $22.8 million for the linked quarter. First we show a $1.6 million increase in salaries and employee benefits. We reversed our management incentive accrual in the first quarter 2007 as we did not reach our fiscal 2007 targeted goals. Excluding this adjustment our salaried employee’s benefits showed only a slight increase from the prior quarter. Occupancy expenses increased $224,000 from the linked quarter. We are in the process of renovating the adjacent office building next door that the company owns and as such the rental space is currently vacant. We expect to complete the renovation work in early 2008 at which time we’ll begin to lease this vacant space. We did not buy back any common shares in the quarter and at December 31, 2007 there were approximately 102,000 shares remaining in the current plan. I’ll now turn the floor back over to Tom.
A. Thomas Hood
We continue to have great results at our in store locations and in store expansion and diversification will continue during fiscal 2008 with the February opening of our 13 in store sales center at a Lowes Food Store in Murrells Inlet, South Carolina. Three additional in stores sales center in Lowes Food stores along with two additional Wal-mart in store sales centers are expected to open in late fiscal 2008 and in fiscal 2009 respectively. Our in store operations as we’ve reported in the past, produced a very significant number of our new deposit account relationships. In fiscal 2007, in the first quarter of fiscal 2008, 56% of our new retail demand deposit account relationships were opened in store platforms. Our overall checking account growth rate during fiscal 2007 was 9% while our in store locations grew demand accounts by 34% over 2006 comparable levels. Our in store locations now represent approximately 25% of our total sales offices. Historically, over the last four years our average new checking growth has approximated 15% growth annually and we expect this trend to continue. We also continue to review potential new branch sites in nearby coastal markets and after a very lengthy approval process here in Charleston we’re pleased to announce that a new office in downtown Charleston will be open this February, it’s across the street from a large medical complex in South Carolina.
Technology initiatives during the quarter and recent past include merchant capture systems which are in the process of being implemented. We have continued progress on our company wide that includes our subsidiaries company wide document imaging system. We believe as we move into the next phase which is a process where we will achieve many of our cost savings that will recognize some significant benefits from document imaging. New enhancements to our customer experience and our retail sales offices will include some teller assisted and self service systems that are under development and several which have been introduced on a trial basis in several branches. Many of these initiatives once fully implemented will produce additional operational efficiency improvements.
Board of directors approved the early retirement program that we discussed earlier. It will have a favorable impact on future compensation expense. We are estimating that over $1 million annually in compensation savings will occur from this program an equivalent of approximately $0.06 per share. As to our outlook for the remainder of fiscal 2008 we believe that our interest spread should improve with the expectation that the FED will continue to reduce short term rates and that more rational deposit pricing will follow. We our projecting our net interest margin to continue to be in a range of 3.3 to 3.4% for fiscal 2008.
Although credit quality may be under some pressure we believe that our historically and continued strong underwriting standards will lessen the impact in fiscal 2008. We are not reaching for loan goals that would compromise our strong credit culture. Loan growth is very, very difficult to predict, obviously although we are very, very pleased with our first quarters growth. As many of you know we have been transitioning our loan portfolio to a much more bank like portfolio over quite some period of time and we think we’re making great strides in terms of increasing the component of commercial in commercial business and real estate in our portfolio and we think it’s an exceptionally good market in coastal South Carolina to do that. The present slow conditions in residential real estate lending may prevail as we indicated earlier through 2008 and perhaps even into 2009 could spill over to other sectors, we haven’t seen any significant evidence of that in our market places as yet. We are well staffed and we intend to take advantage of the disruption in the mortgage brokerage community. We are gaining a good deal more of our originations through that community of relationships with brokerages. We also remain focused on a number of retention strategies for our existing loan portfolio. We believe that there are great opportunities that continue to exist in the markets that we serve. We have stable employment rates, increasing per-capita income levels. South Carolina recently announced that they had the strongest job growth a year in history. So our expectation is that South Carolina is going to continue to be a very good place to offer banking services. Household growth, expansion of our business base and core relationship expansion, these are also key metrics or these markets.
We are planning to expand our market presence in fiscal 2008. We’re examining opportunities to refine our branch system including branch locations and consolidation of some offices where it makes sense from a customer service perspective. We know that improving productivity will translate into lowering our efficiency and will result in better returns to investors and we’re going to achieve those two outcomes. I guess we would want to open the call for any questions that you may have.
Thank you. (Operator instructions) There are no questions at this time. I will now turn the call back over to you. Please continue with your presentation or closing remarks.
A. Thomas Hood
Perhaps we haven’t provided a lot of information about this early retirement program, our purposes for providing that option for employees. We have had a very stable senior group of managers in our company for quite some period of time and we have been developing people in various operations for quite some period of time also. We arrived at the conclusion in encouragement to have some of these gifted managers retire and therefore allow some of these very talented people in the ranks that were part of our planning in the future, to really give them an opportunity. And to develop, I think a better more productive process in terms of people moving into management throughout the organization. We did have 26 of our folks that are doing that. A large number of those because of consolidation efforts, rolling up specific areas where managers were consolidated, will generate a significant savings and provide a real opportunity for other mangers looking forward to the opportunity of moving into the management team. I think there were a variety of very positive results from the eerily retirement program and I think obviously some significant benefits to the program in terms of costs savings.
(Operator Instructions) Our first question comes from Ross Hagerman. Please proceed with your question.
Ross Haberman – Haberman Funds
I was wondering if you could talk a little bit about your competition, starting on the deposits and then the loan side? And if we do see some rate cuts do you really think you’re going to realize the total benefit off the deposit side given what I am hearing in other cities that the big banks have really been keeping the rates up higher than what you would have otherwise thought?
A. Thomas Hood
I think we will recognize some of those changes, particularly if the FED is aggressive about future interest rate changes. Where our anticipation is a 50 basis point and I - certainly if you read commentary it could be even possibly greater. I think lots of financial institutions would like the opportunity of taking advantage of these lower rates in a positive market place. In terms of competition you are clearly right on the mark, both relatively small institutions and very large institutions are being very, very competitive in the market place for CD’s. I think one of the issues there, is that even after some of the larger banks, and we have seen some reduction in CD pricing over the last several weeks, but we do expect smaller banks to probably continue their emphasize on higher CD pricing because of perhaps the lack of opportunities to obtain funding in other ways.
Ross Haberman – Haberman Funds
Are you particularly referring to the couple of de novos in your market? And, could you address them specifically in terms of overpaying on deposits and being overly aggressive on loans?
A. Thomas Hood
You know it’s difficult to presume what their practices are with regards to pricing loans and make a connection to the quality. We don’t share many borrowers with the smaller banks. Press releases in the local market place relative to smaller or start up banks don’t provide a lot of detail but we have not noted any really significant charge offs or discussion about charge offs with smaller banks. We do have a very strong new entrant in the Myrtle Beach Grand Strand area, they are offering CD rates at 5% and above. We have some existing, although they are newer financial institutions, that are offering probably deposit rates that range from 4.4% to close to 5% in virtually all our markets. But I think those financial institutions have the same kind of experience that we have. We have seen deposit rates fall and obviously if you’ve got reasonable portfolio prime rated loans then you’ve seen those automatically decline adjusting to the new prime rate while much of the deposit market continues to be priced at levels that are well above what the levels should be. I think for the new banks, the new entrants, I think that is going to continue. But, I do think for the other banks I think there as interested as anybody else is in improving their margins.
(Operator instructions) There are no questions at this time. I will turn it back over to you.
Dorothy B. Write
I think that completes our call.
Thank you ladies and gentleman that does conclude the conference call for the day. We thank you for your participation and ask that you please disconnect from the line.
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