UnionBanCal Corp. Q4 2007 Earnings Call Transcript

| About: UnionBanCal (UB)

UnionBanCal Corp. (UB) Q4 2007 Earnings Call January 25, 2008 10:00 AM ET


Philip Flynn – Vice Chairman, CEO

David Matson – Vice Chaiman Chief Financial Officer

JoAnn Bourne – Exec. VP

Masaaki Tanaka – Chief Exec. Officer, Pres, Director Nominee

Masashi Oka – Chief Risk Officer, Vice Chairman of Admin


Andrea Howe - Lehman Brothers

Steven Alexopoulos - J.P. Morgan

Red Chris - BoxIt

Thank you for joining us on our Union Bank Corporation Fourth Quarter Earnings Conference Call.

Here this morning with us are Phil Flynn, vice chairman and chief operating officer of the company. David Matson, vice chairman and chief financial officer, David Anderson, executive vice president and controller is here as well. Mr. Matson will review fourth quarter’s financial performance and provide guidance for full year and first quarter 2008. Mr. Flynn will then provide significant details about performance in our loan and deposit activities with detailed focus on credit quality. Please note that the press release for the quarter ended December 31, 2007, was released yesterday after the close of market and has been posted in the Investor Relations Portion of the company’s website at www.unionbank.com.

That press release contains certain non-GAAP financial measures which we will discuss during today’s call together with the most directly comparable financial measures calculated in accordance with GAAP and the specific items excluded in the calculation of each non-GAAP financial measure.

Before we begin, this conference call includes forward looking statements and involves risks and uncertainties. Forward looking statements can be identified by looking at the fact that they do not relate strictly to historical concurrence facts. Often they include the words believe, expect, anticipate, intend, plan, estimate, project, continue, forecast or words of similar meaning or future conditional verbs such as will, would, should, could or may. A number of important factors could cause actual results to differ materially from those in the forward looking statements. A complete description of the company including related risk factors is discussed in the company’s public filings with the Securities and Exchange Commission. All forward looking statements included in this conference call are based on information available at the time of the call and the company assumes no obligation to update any forward looking statement.

Thank you and now, Mr. Matson with fourth quarter financial review and first quarter in 2008 guidance.

David Matson

Thank you Jack and thank you for joining us on the call this morning. Fourth quarter earnings from continuing operations were $0.78 per share. This included a $0.05 per share charge for the company’s proportionate share of VISA litigation costs. Continuing operations does not include the $61 million or $0.44 per share after tax gain we generated from the sale of our retirement record keeping business. The gain is classified in discontinued operations.

Compared with the third quarter, total revenues rose nearly 1% with net interest income of 3%. Noninterest income was down nearly 4% primarily due to lower trading account revenues and lower gains on private capital investments. Net interest income increased 3% on a sequential quarter basis primarily due to robust loan growth and lower borrowing costs. Net interest margin grew 2 basis points primarily due to declining title and escrow related loan balances and slowing of the mix shift of deposits from noninterest bearing to interest bearing. For the quarter, average noninterest bearing deposit was nearly 31% of total deposits and our annualized average all in cost funds remain compatibly low at 273 basis point.

Sequential quarter loan growth was nearly 4% and was spread very evenly across the portfolio. Noninterest expense in the fourth quarter was 434 million excluding the VISA litigation charges and the process reengineering expenses. Noninterest expense was consistent with our normalized run rate of 420 million per quarter. At year end, our capital levels were very strong. For the tangible common equity ratio of 7.73% much higher than our peer averages.

That will provide our financial outlook for the full year and first quarter of 2008. As you all know, this is a tough operating environment with significant uncertainties and elevated risks. This makes forecasting our financial performance more difficult that usual. We will provide our estimate of the full year and first quarter results based on the best information available to us today.

We currently expect full year 2008 earnings per share to be in the range of $4.05 to $4.30 per share. This forecast assumes that there will slow economic growth and weaker conditions other than last year. The forecast assumes a said funds rate of 2.5% at year end. We expect 2008 at interest income to increase 4 to 5% versus 2007. This reflects our expectations of the following:

7 to 9% growth in average loans.

4 to 6% decline in average noninterest bearing deposits excluding title and escrow deposits.

Total average noninterest bearing deposits will decrease 10 to 12%. However for the year, average noninterest bearing deposits are expected to be above level with the fourth quarter of 2007. We expect noninterest income to be flat for 2007. We expect noninterest expense to increase 2 to 3%.

Total provision for credit loses expected to be $80 to $90 million for the year. This compares with $90 million for 2007.

The full year 2008, effective tax rate is expected to be approximately 34%. Average fully diluted shares for the year is expected to be approximately $139 million.

Now let us turn over to the first quarter forecast. Our expectation for the first quarter earnings is at $0.94 to $0.99 per share. For the first quarter of 2008 compared to the fourth quarter of 2007, we expect net interest income to be flat. We expect total average noninterest bearing deposits in the first quarter to decline about 3 to 5 % versus the fourth quarter. Excluding title escrow deposits, we expect to decrease an average noninterest bearing deposits of approximately 1% which reflects the usual first quarter seasonal trend. Average total loans are expected to grow between 1 and 2% on a sequential quarter basis. Average title and escrow related loans are expected to be flat.

We estimate noninterest income will decrease 2 to 4% compared to the fourth quarter due primarily to a lower merchant banking fee. We forecast noninterest expense of approximately $425 million for the first quarter. This includes the customary seasonal increase in first quarter payroll taxes and 401k contribution expense. We estimate total provision for credit losses to be approximately $20 million for the quarter. We estimate an effective tax rate of approximately 34% for the first quarter. Our first quarter forecast assumes approximately 139 average shares outstanding. That completes my section and on to Phil Flynn.

Phil Flynn

I will provide additional details regarding fourth quarter results, our outlook for 2008 and I will talk at some length about the quality of our loan portfolio which I anticipate is of particular interest.

We had earnings from continuing operations of $0.78 for the fourth quarter well outside the range we provided last October of $1.07 to a $1.12 with the most significant difference being the $60 million total credit loss provision we announced two weeks ago. This provision which I will discuss in more detail later had the effect of reducing our results by $0.20 per share. The remaining significant differences are severance and relocation costs related to our process reengineering efforts and litigation reserves totaling about $19 million or about another $0.08 per share.

Excluded from our continuing operations results of course is the $0.44 per share gain resulting from the sale of our retirement record keeping business. Our net interest margin was up slightly from the third quarter at 351 basis points but stabilization in the deposit base and widening loan spreads both contributing to that results. It has been along time since we could talk about an improved net interest margin.

Noninterest bearing deposits did dip in the fourth quarter. The decline was just outside the range we forecast. It should be noted however, that total customer deposits remain stable during the fourth quarter. Our loan growth remains strong across the entire portfolio. We grew average loans 3.6% or about $1.4 billion over the third quarter, about $700 million more than we had anticipated.

Excluding loans to title companies and loans held for sale commercial loans increased about $800 million, residential mortgages about $500 million, commercial mortgages roughly $400 million and construction loans less than $100 million. As expected loans to title companies declined by about $400 million driven by much lower activity from our title customers.

As mentioned our average noninterest bearing deposits declined by about an average of $700 million, a bit more than expected. We did see interest bearing customer deposits increase by over $650 million mostly offsetting the noninterest bearing decline. Overall, customer deposits were about flat. As we all know, our preference would be to have as many noninterest bearing deposits as we could gather, however, in the current environment, we are pleased to be retaining our customer base which allows us to continue to strengthen and deepen those relationships and provides relatively low cost upon it.

Noninterest income declined as expected due to the large private capital gains booked in the third quarter of more than $12 million. The fourth quarter gains were a little more than $2 million. Noninterest expense was significantly higher than the prior quarter in about $13 million higher than our $420 million target. As mentioned we booked $13 million in litigation reserves driven by our share of VISA related litigation costs and $6 million in process reengineering restructuring costs.

Without these charge, a run rate for the fourth quarter was under our target. We continue to have a strong focus on expense control. Finally as previously announced, we took a $60 million total credit loss provision significantly more than we had anticipated in October. Given the very difficult environment space in our homebuilder clients, we felt that this reserve increase is prudent. We are now well reserved against further deterioration in this portfolio.

Turning to the loan portfolio, we continue to have extremely strong credit metrics with only $3 million net charge offs in the fourth quarter and only $57 million in nonperforming assets, an increase of only $4 million from the third quarter. I would like to focus in on two areas of the loan portfolio, homebuilders and residential mortgages.

We currently have a homebuilder portfolio at $850 million in outstanding loans down to the pay offs by about $100 million this past quarter. We have increased the attribution in our unallocated reserve for these loans to about $50 million and we hold approximately another $50 million in our allocated reserves. And as of now we have the amount of about $14 million. The portfolio is comprised of a diversified pool of loans to primarily privately held California homebuilders. Less than 15% of the loans are to public homebuilders. All of the loans are back.

All of the loans are backed by contractual financial support from the sponsors and during the past year over $150 million in re-margin proceeds were collected. Our top 10 customers in aggregate represent about half of the portfolio spread over a number of individual projects. This are a mix of Northern and Southern California developers most of whom have very long standing relationships with us. Geographically, the project 01:17 breakdown to about 1/3 in the Bay Area, about 1/3 in the greater LA region including the Inman Empire, about 10% in the San Diego area and the rest was between other parts of California and out of state. Turning to the residential mortgage portfolio. We continued to have very little concern.

During the fourth quarter, we have over $800 million in originations at increasing spreads. The average loan to value of fourth quarter originations was 65%, the average debt income was 33%, the average FICO score was 753%. At the end of the year, the portfolio totaled $13.8 billion. Delinquencies were up modestly to $49.9 million or 51 basis points compared to $33 million or 39 basis points from the previous quarter around.

This compares a very favorably to the MBA average California prime index of 328 basis points at September 30. We had only 18 loans and for closure totaling $13 million compared to 13 loans totaling $9 million a quarter ago. The whole portfolio has average loaned value of 64% and weighted average FICO scores of 742.

Our loans are almost entirely in California with about 40% in the LA and Ventura areas, 20% in the Greater Bay Area, 20% in San Diego County, 10% in the Inland Empire, and 10% in Orange County. Our Hillock balances at year end are 2.4 billion with balances at year end are $2.4 billion with 3.4 billion of additional under on commitments. The average FICO score there is 737 and the average LTB is 60%. The average outstanding loan balance is about $60,000.00.

Net charge offs for the quarter amounted to two basis points of the entire portfolio against the September 30 AVA average, industry average of 39 basis points and total delinquencies rolling at 34 basis points against the California industry average about 175. The portfolio concentrations roughly mirror the residential mortgage loans. We continued to hold a CLO portfolio of just under $2 billion. We did experience an additional mark on this portfolio of about 40 million during the quarter bringing the total to $207 million pretax.

We believe that the downward pressure on the portfolio is tributable. The continued widening of spreads driven by selling pressure from financial institutions managing CLO exposure on their balance sheets, we believe that these institutions are selling CLO’s, the most liquid of the CDO acid class. Our CLO portfolio are consisted of 98% A or better rated investments. None of which have been downgraded in this period of market turmoil.

There is no subprime or other mortgage exposure in our CLO’s they are invested exclusively in corporate loans. We continue to believe there are portfolio as well diversified and structured to minimize our potential loss exposure. The rest of Union Banks loan portfolio continues to perform well with no significant pockets of concern. We expect that due to our disciplined underwriting and avoidance of riskier asset classes that we will remain in a strong position relative to our pears as the year unfolds.

Turning to 2008, you are anticipating some spread expansion in our loan portfolio as credit spreads widely. The overall portfolio growth is anticipated to be almost 10% excluding loans to title companies, which we expect to average less than half of last year’s balances and similar to the growth we experienced in 2007. For the first quarter, we expect overall loan growth to be about 2% or about $750 million.

We anticipate commercial loan growth to actually be slightly hire than the 10.6% growth we had in 2007 and will represent about half of the loan growth in the first quarter. Construction loan growth should decline to less than half of the level seen in 2007 with an average outstanding increase by approximately $200 million, all that in income properties.

In the first quarter we expect to see about a 2% reduction in our construction loan totals. The commercial mortgage portfolio is expected to increase by about 9% or $600 million over the year. A ray of about 2% less than the prior year with only about 1% of the growth occurring in the first quarter. Residential mortgages are expected to grow at rate very similar to 2007, a little under 10% on average to about 14.3 billion. The first quarter increase in this portfolio is anticipated to be 3% or roughly $360 million.

I am now turning to deposits. None interest during deposits will decline on a year-over-year average by about 1.5 billion. About $900 million related to lower title company deposits, another $400 million in business deposits and about $200 million in consumer deposits. Interest there in core deposits will increase year-over-year by about 200 million for the first quarter we are expecting to see a decline of about $500 million in non interest bearing deposits from the previous quarter, $400 from title companies and $100 in other business deposits. Retail demand deposits for the quarter should be flat against the fourth quarter. Interest there in court deposits will drop about $700 million largely drive by a spike way experienced in the fourth quarter driven by seasonal increases and government tax deposits, which were larger than normal. As I mentioned, we expect to see some positive impact from widening credits spreads off of that somewhat by the competitive environment for interspearing customer deposits. We expect our net interest margins to hold a close to our current level of about 350 days points throughout the year.

Turning the none interest income as you will recall in 2007, we experienced a very sizable private equity gains of about $44 million. We do not anticipate a repeat of this performance in 2008. Therefore for a year we are expecting a decline in none interest in less than 1% with deposit fees about flat. Received and strengthening with some of our other fee based with trust fees for example expected to increase about 7% to 8% or about 10 million dollars.

The first quarter noninterest income is expected to decline about 3% from the prior quarter mainly due to low emerging banking fees. None interest expense were related expected a benefit not only from our ongoing process reengineering projects but also lower professional service costs as we need for outside support for BSANA and now that she slows down and from less litigation cost.

Our FPIC assessments in line in the industry will show us significant increase overall seven off setting some of these positive trends. We expect none interest expenses to increase about 2% to 3% in 2008 or about 3 million with a run rate of $420 to $425 million per quarter. The loan loss provision will be in that $80 to $90 million range that David mentioned assuming that the economy does not fall into a severe session.

We are expecting a first quarter provision of about $20 million. Given our desire to maintain a conservative posture during these turbulent times, we have not anticipated any stock fly backs in our plan for 2008. Even with the challenges that are facing us in the upcoming year, we anticipate that our total revenue will return to 2006 levels and we will continue to exercise discipline to expense control.

This will result in positive core earnings, positive net income, and positive EPS growth without stock by back compared to 2007. As you know, we have a very strong capital position an important consideration for investors and customers as they examine a financial services industry that is facing a year of challenge. Thank you for your time and we would be happy to take your questions now.

Question and Answer session


Our first question comes from line up Andrea Howe with Lehman Brothers, please go ahead.

Andrea Howe - Lehman Brothers

Good morning gentlemen. My first question is on the impact of lower interest rates on your customers willingness to hold low costs deposits but also on their earnings credit and therefore service charges? What events are seeing right now do you see that you being a benefit sooner rather than later?

Philip Flynn

You know we have just had a rather dramatic movement and interest rates these weeks and as you heard David say we are anticipating rates to drop down about another 100 basis points to 2.5% dead funds by the end. It is very hard to predict what is going to happen to our deposits Andrea. In previous times of lower interest rates you have seen our demand deposits run up quite dramatically and you have seen pressures come off of the rates that would pay on interest rate deposits.

You have also seen our deposit fees tend to rise as earnings for credit, allowances drop, and customers have to pay for their services in either increased deposits or increase fees. Whether all of that is going to happen this time or not. It is hard to predict right now. I think as we get further into the year we will have a better sense and can guide you a little bit more directly on that. The competitive environment out here is a little different than it used to be. There are banks competing still with very high rates for interests during deposits and how quickly were able to ratchet down our own rates that we are paying on this deposits is yet to be seen.

Andrea Howe - Lehman Brothers

My next question is if in 2006 you are putting down ROEs in the mid to highting that obviously came down in a more challenging in 07. How quickly do you think the possibility of metric scale ramp back up?

Philip Flynn

I am sorry what was the metric that you were referring to?

Andrea Howe - Lehman Brothers

ROEs were much higher than they were in 2007, can we expect the gradual ramp up back to the height in 2008 or maybe we need to wait for 2009 to see that.

Philip Flynn

Well, you know we have given you some guidance on where we think EPS is going to come in. We have also you told you that we are not likely to stock buybacks so I would not anticipate anything dramatic this year. Unless things really, change with our deposit base as David said it is probably a shard right now to look into the future at it has been for a very long time.


The next question comes from line of Steven Alexopoulos with J.P. Morgan, please go ahead.

Steven Alexopoulos - J.P. Morgan

Hi good morning guys! I am curious if the GSC caps are indeed raised what impact do you think that is going to happen to your business and they would measure could pressure asset yield a bit?

Philip Flynn

We are a portfolio lender so I do not really care about what those caps are. We are in the jumble loan business and we make loans to hold them.

Steven Alexopoulos - J.P. Morgan

We need to apply those from your customers will probably refine into a conforming loan. At a lower yield?

Philip Flynn

Maybe, again very difficult to predict how that is going to play out we are anticipating obviously with these types of rates that we are thinking about a fairly big increase in refinancing activity, but I should tell that our origination volume and our piplines are very strong.

So, it is likely that the loan growth we called for is going to continue and remember that we are largely talking about a fixed rate loan portfolio since these loans are still in their fixed rate periods largely and with lower cost of funds. Our spreads are going to widen pretty dramatically on our residential mortgage portfolio. Even with a bunch of revise are happening.

Steven Alexopoulos - J.P. Morgan

I am curious what person interviewed your 05 and did your mortgage loans the expected the reset this year. They have given a decline of mortgage rate will you look at that vintage do you think there is a meaningful risk their. Are you thinking about that?

Philip Flynn

I do not think there is meaningful risk in any part of this portfolio I really do not. Our metrics are so good compared to the industry that we have tremendous cushion whether if it is the 05 image 04 or 06. We only have about a billion and half dollars that is reseting in 08. I am not sure how much of that comes out of 05, probably not alive because the bulk of this portfolio tends to be waited in that 51 area.

Steven Alexopoulos - J.P. Morgan

And just a final question, I appreciate all the guidance on provision, but I am curious how you are thinking about charge off. Can we stay at this level? Where we are through the year are you thinking it starts to move up through 08, what are you thinking there?

Philip Flynn

We charged up a net of $10 million in 07. It is going to be more, but I cannot predict charge ups. It is so much varies dependent on what is going on with the individual credit. You have seen us grow our reserve quite substantially in the fourth quarter we believe that the only area the portfolio will have any significant concern about it is homebuilder portfolio. We think we are quite well reserved for the current situation their plus some more deterioration so we will certainly generate some charge offs, but I cannot tell you how much, but I do think will reserve against it.


In the next we have the line Heather Wolf with Merrill Lynch

Heather Wolf - Merrill Lynch

So, can you tell us a little bit about what you are seeing in commercial and commercial real estate portfolios or fraying yet?

Philip Flynn

I see that we are talking about the income properties now homebuilders. We are not really seeing much. There is a few down grades. They are starting to pop up and you would expect that given what is going on in the economy but nothing that is really in the level of significant concern.

Heather Wolf - Merrill Lynch

Your provision guidance, can you give us a little bit of color surrounding what you expect in CNI and CRE behind that provision guidance?

Philip Flynn

We are anticipating that this homebuilder situation and home prices are going to be very tough and so most of what is going on with our provisioning right now is being driven by that portfolio. That is why you saw us step the reserve in the fourth quarter. I am sure that we are going to start to see declines in other parts of CRE and we are probably start to see some issues with CNI as we get deeper into this year, but that is not the big drive or what the provisioning that was taking in the fourth quarter in what were anticipated in LA.

Heather Wolf - Merrill Lynch

But it will be more of a driver in 2007

Philip Flynn

Oh, sure. I mean 2007 right now was completely driven by the homebuilders.

Heather Wolf - Merrill Lynch

And this might be a move point even with real estate out there, but if the writer strike impacting on the economy in Southern California at all.

Philip Flynn

I do not know I am sure it is some how, but it is hard to see it in any kind of objective numbers that you could look at.


We have a question from the line of Red Chris with BoxIt

Red Chris - BoxIt

Good morning when you mentioned that the by back is on hold and I guess what would hold for now and I guess what would change your posture on that?

Philip Flynn

I would say we will have to see how the credit situation plays out and how we are feeling about potential loses and provisioning most likely.

Red Chris - BoxIt

It is just a matter of timing and seeing how. That plays out.

Philip Flynn

I am really happy not to be out raising capital of the prices that other financial institutions are paying for capital right now.

Red Chris - BoxIt

Just a quick question on the income statement guidance are those numbers are groceries that you provided exclude the impact of the retirement business that you sold this quarter. So in other words you want me to look at your rear expense or fee growth for instance that would back out any revenue or expenses associated with that business.

Philip Flynn

Yes everything history and everything has been moved into discontinued ops so everything that we are talking about is without that in numbers. Okay great thanks

Jack Rice

Thank you very much for attending the call and I think everyone on the line pretty much know this follow up is tom me. Jack Rice, I hope everyone has my number and thank you.

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