City National's CEO Discusses F2Q12 Results - Earnings Call Transcript

Executives

Cary Walker – Senior Vice President and Manager of Corporate Communications

Russell Goldsmith – Chairman and Chief Executive Officer

Christopher J. Carey – Executive Vice President and Chief Financial Officer

Analysts

Aaron Deer – Sandler O'Neill

Steven Alexopoulos – J.P. Morgan

Paul Miller - FBR

L. Erika Penala – Bank of America Merrill Lynch

Joe Morford – RBC Capital

Brian Klock – Keefe, Bruyette & Woods

John G. Pancari – Evercore Partners

Jennifer Demba – SunTrust

Jonathan Katz - Morgan Stanley

City National (CYN) F2Q12 Earnings Call July 19, 2012 5:00 PM ET

Operator

Good afternoon. I would like to welcome everyone to this discussion of City National Corporation’s second quarter 2012 financial results. [Operator instructions.] This call is being recorded and will be available shortly after it is completed on City National’s website at cnb.com. Now, I will turn this call over to Cary Walker, senior vice president and manager of corporate communications for City National. Please proceed.

Cary Walker

Thank you. Good afternoon. Here to discuss City National’s second quarter 2012 results are Russell Goldsmith, our president and chief executive officer and Chris Carey, our chief financial officer.

This call will include comments and forward-looking statements based on current plans, expectations, events, and financial industry trends that may affect the company’s future operating results and financial position. Such statements involve risks and uncertainties, and future activities and results may differ materially from these expectations.

The speakers on this call claim the protection of the Safe Harbor provisions in the Securities Litigation Reform Act of 1995. For a complete discussion of the risks and uncertainties that may cause actual results to differ materially from expected results, see the company’s annual report on form 10-K for the year ended December 31, 2011.

This afternoon, City National issued a news release outlining its second quarter 2012 financial results. To obtain a copy, please visit our website at cnb.com. After comments by management today, we’ll open up this call to your questions.

And now I'll turn it over to our CEO, Russell Goldsmith.

Russell Goldsmith

Good afternoon. Thank you all for joining us again for this quarterly call. This afternoon, as you know, City National announced a strong and productive second quarter, with net income up 15% from the second quarter of last year to $54.8 million.

Period-end assets grew to nearly $25 billion, up 10% from the second quarter of last year and another new all-time high for us. Loans and deposits increased at double digit rates. Both are at new record levels for City National.

And that total does include the $300 million in loans we were also pleased to add with the acquisition of First American Equipment Finance, which we announced in the quarter, and closed on April 30. The other acquisition in the quarter we were pleased to announce was Rochdale Investment Management, which closed recently, on July 2.

In the second quarter, credit quality remained strong, expenses remained in check, and City National further bolstered its strong capital position with a successful offering of a $150 million subordinated debt offering, which replaced and expanded a piece of our capital structure that we’ve had for many years.

All in all, we’re pleased with City National’s performance halfway through the year, especially in light of today’s economic environment and the continuing extraordinarily low interest rates. Fortunately, City National is well-positioned for the remainder of 2012 and beyond. We are prudently growing a diversified array of assets, adding new clients and colleagues, and investing for the future.

In a few minutes, Chris Carey and I will be happy to take your questions, but first I want to discuss some other highlights from the second quarter. Let me start with loan growth. Following a very strong first quarter of loan originations - in fact our most productive ever - new loan originations in the second quarter actually exceeded the first quarter level, and set a new record of just under $900 million. And that’s without the First American portfolio. And that’s 40% ahead of last year’s pace.

That brings year to date originations to $1.6 billion, also an all-time high for City National. Total net loans - not just originations - are up 16% for the first half of the year, including the First American portfolio.

As you saw, City National recorded a very modest second quarter loan loss provision of just $1 million. That’s primarily a reflection of loan growth and also the fact that we had a net pickup of $2.7 million from loan recoveries. At quarter end, the company remained well-reserved, at 2% of the higher number of total loans.

Deposits also continued to grow, increasing to another new record of $21 billion, up 12% from the same period last year. Non-interest-bearing deposits actually decreased 33%. Our strong deposit base and growth reflects our growing client base, as well as our focused business strategy and value proposition as a premiere private and business bank.

Turning to our wealth management business, second quarter income from trust, investment, mutual fund, and brokerage fees totaled $39 million, up 2% from the first quarter of the year. In this quarter, as I mentioned, City National took a significant step to improve and grow our wealth management business for the future, with the addition of Rochdale Investment Management. That will bring our total client investment assets that our various wealth management companies manage or administer to more than $63 billion.

Rochdale, which is headquartered in Manhattan, manages almost $5 billion in assets for affluent and high net worth clients with their financial advisors in New York, California, and across the nation. Early next year, we will combine Rochdale with one of our key wealth management companies, City National Asset Management, to create a stronger and more diversified national wealth management company, City National Rochdale Investments, under the leadership of Rochdale’s excellent CEO, Garrett D’Alessandro.

With more than $18 billion in assets under management, the merged company will have enhanced capabilities and an expanded team to manage and grow investments for the clients of both firms on a combined basis.

The acquisition of Rochdale is one example of City National continuing to invest in its future. As I mentioned earlier, we were also pleased to acquire First American Equipment Finance, and outstanding and innovative, privately owned, full-service, mid-ticket leasing company based in Rochester, New York.

First American has more than $340 million in assets, and serves organizations across the United States. The firm, led by its outstanding CEO, Bill Verhelle, will also add significant new capabilities in addition to our current equipment leasing unit hear at City National to better meet our clients’ financial needs. The addition of Rochdale and First American illustrates City National’s commitment to supplement its organic growth with acquisitions that meet its criteria for fit, focus, and price.

City National is also investing in technologies like its new state-of-the-art mobile banking service that allows clients to manage their accounts and make deposits 24/7 from their phones. We just launched this, City National Mobile Banking, in the last two months, and have already gotten a terrific reaction from our clients.

In addition to expanding our online presence, over the past few years, since 2008, City National has added 17 banking offices, and today we have a total of 78 offices in five states. In the next 12 months, we plan to open five more branches. Three new offices will be in the San Francisco Bay Area, bringing our total in Northern California to 14.

We also signed two leases in the second quarter to expand our presence in Manhattan by opening next year for the first time, for us, in New York, two ground floor branch offices. One will be at our current headquarters at 400 Park Avenue, and another will be at Sixth and 44th.

This significant expansion will enable us to better serve our clients, both in the Bay Area and in New York, and it will increase our visibility and brand awareness in two dynamic economies. We believe we can grow there significantly in the years ahead on the base we’ve already built in each of these robust regions.

Now let me say just a few words about the economy here in California. Conditions have slowly been improving. The unemployment rate, at 10.8% in May, is still much too high, but it has fallen by a full percentage point in the last year. The technology industries are performing very well, and entertainment is doing fine. The up-front markets for television that just concluded continued to see strongly rising rates for advertising.

Tourism, healthcare, and agriculture are also doing well. International trade continues to grow, and demand for housing is showing particular strength. Home sales have posted year over year gains for 10 consecutive months, and in June they were up 7.5% in California versus today’s national number, which I’m sure you saw went down.

The median price for housing in Southern California was up 5.3% in June versus a year ago, and foreclosures, encouragingly enough, now represent just one in four sales, versus one in three not long ago here in Southern California.

The economic picture in the San Francisco Bay Area, generally speaking, is quite bright, with growth in the tech sector leading the way. Remarkably enough, tourism in San Francisco just hit a new all-time high.

Of course, California’s economic outlook is affected by global economic conditions, national economic conditions, government actions, and uncertainty. When we last talked in April, I think most economic experts were expecting U.S. GDP growth on the order of 2-2.5%. Clearly that’s started to come down with the latest installments of Europe’s debt crisis, slower growth in Asia, and increasing concern about the federal fiscal cliff.

One bright spot for Southern California is the federal transportation bill that was just passed by Congress and signed by the president. It will be particularly helpful here in Los Angeles County to accelerate much-needed transportation infrastructure investment spending over the next couple of years.

However, the growing sense of uncertainty that so many are feeling that is posed by the federal fiscal cliff appears to us likely to slow U.S. economic growth and loan demand over the next six months. As an example, one of our most important clients the other day was telling me that he was poised for a major acquisition and pulled the plug on the deal until he could be sure what the tax rates, the depreciation schedules, fiscal policy, and economic conditions would look like in 2013.

The sort of uncertainty that’s out there today breeds caution by investors and entrepreneurs, as most of you know. However, I am hopeful that once the election is over that, at that time, finally, some decisions will get made in Washington so that entrepreneurs will know what the tax and fiscal policies of the United States will be, and then they can plan and invest appropriately.

The good news is once we have some certainty, and assuming it’s a reasonable and gradual path forward, then the U.S. economy should pick up some steam in 2013. In any event, I’m confident that City National is up to the challenges and opportunities that the next 6-12 months will bring as we’ve demonstrated over the past 3-4 years.

We are enhancing our capabilities and expanding the company’s visibility and reputation, as we add clients and colleagues, not only in the five states where we now have bank offices, but increasingly through our growing national businesses.

Now I’ll turn the call over to CFO, Chris Carey. Chris?

Chris Carey

Thanks Russell, and good afternoon all. I’m going to add some commentary on overall earnings, covered assets, net interest margin, expenses, and capital.

First, overall earnings. As we noted in the highlight section of our press release, we had three different, unusual items in this quarter that added about $9.5 million pre-tax, or $6 million after tax, $0.11 a share. So very roughly speaking, we look at core earnings as about $0.90 a share. I would note that in the second quarter of last year, we had a gain from an FDIC bank transaction that contributed $0.09 a share, so adjusting for both years, we’d still be up 14%.

Now looking at covered assets, we recorded a $3.9 million net gain to reflect updated cash flow projections, and it was coupled with $3.4 million in net other income related to covered assets. The net impact of these two items was income of $7.3 million, $6.4 million higher than the $0.9 million in the first quarter of 2012.

As many of you know, this does not include the more stable interest income from the covered loans that had a base yield of 6.3% in the quarter. We provide much more detail on the covered asset information on page 14 of the financial tables that accompany our news release.

Now let’s move to net interest margin. I’m sure initially you were surprised that our margin was up 17 basis points from the first quarter. This increase reflects covered loan prepayments that were $15 million higher than the first quarter of 2012, and also $2.3 million in interest income from the recovery of a previously charged off loan.

Excluding the recovery and the higher covered loan prepayments, which tend to fluctuate from one quarter to another, the margin would have been around 366. We expect deposit growth, loan rates, and the steady run of covered loans to place continuing pressure on the margin through the end of this year.

Non-interest income was down from the second quarter of 2011, but essentially flat with the first quarter, although trust and investment fees, brokerage and mutual fees, international and cash management fees, and gains on the [transfer] of covered loans to [REO] were all higher in the second quarter than they were in the first quarter.

Unfortunately, higher FDIC loss-sharing expenses offset these gains, and while our wealth business is up this quarter, which we are pleased about, it was down versus the prior year, principally due to the divestiture of some of our institutional assets by one of our affiliates, which we mentioned last quarter, as well as a decline in the Asian markets, which impacted our revenues from that piece.

Finally, looking at expenses, total noninterest expense was down 8% from the second quarter of last year. That decline reflects lower FDIC covered REO costs and FDIC assessments. Legal and professional fees also were down to the reimbursement of legal expenses related to the loan recovery mentioned earlier - that was $3.6 million - partially offset by $2.8 million in transaction costs related to the two acquisitions. The linked quarter decline in expenses stems from lower FICA taxes and REO costs.

Through the first half of the year, expenses were down 3%. We’ll continue to keep a tight rein on spending while investing in selected growth opportunities.

Now regarding capital, we were very happy to take advantage of the favorable rate environment and raise some very cost-effective sub debt. We continue to look for the right kind of acquisitions and long term flexibility that the new capital provides to move quickly in an opportunistic manner.

Regarding the proposed Basel III rules, while we, and many others, believe there are some very significant flaws, when we take a worst case view on a pro forma basis, our capital levels are still well in excess of the proposed guidelines.

So, in conclusion, as the economy improves, and interest rates return to more normal levels - at some point - the investments we are making today will make a bigger impact on the bottom line. In the meantime, we are generating steady amounts of net interest income by adding clients and growing loans and deposits. Credit quality is solid, and our balance sheet is strong. All of these advantages give us tremendous flexibility to invest in the future and build value for our investors.

Now, Russell and I will be happy to take your questions.

Question-and-Answer Session

Operator

[Operator instructions.] Your final question comes from Aaron Deer from Sandler O’Neill .

Aaron Deer – Sandler O'Neill

Russell, had a question on the expansion in New York. I saw the location on Park Avenue, one of the two new leases that you signed. It looks like a terrific space. Big space. And I’m just wondering, is this any change in your kind of push into the Manhattan private banking market, being that you’re going to have a much more visible presence there?

Russell Goldsmith

I’m glad that you like the space. We’re very enthused about both locations. Our bank in New York, which, as you know, next year will celebrate its 10th year in Manhattan, continues to grow and we need more space for our private bank, wealth management, entertainment, and other capabilities. And so that continues to be the focus of what we’re doing in New York.

We thought that we had a strong enough base and a strong enough opportunity in New York that the time was right to make City National Bank in New York look more like City National Bank looks elsewhere in the country. We need to enhance our visibility and our accessibility, and so we’re going to open these two branch offices.

But we’re not getting into the retail wars of Manhattan. You’re not going to see a whole bunch of branches spring up from us in Manhattan. Our branch system, today, has a set of capabilities we’re very enthused about, and think will work well in New York, that we’ve developed over the last five or six years, that we didn’t have when we first came into New York. We have what we call preferred banking, which is for a very high end retail client, kind of an access to private banking, ultimately. We also have very strong capabilities in small business, and as I touched on in my remarks, an increasing array of technology, with mobile banking platforms and so forth.

So we think the time is right, and our products and capabilities are such that strategically locating some branches in Manhattan will be good, both in and of themselves and as a way of bringing more visibility and recognition to our private bank and our commercial bank and our wealth management businesses.

Operator

Your next question comes from Steven Alexopoulos from JP Morgan.