AMCORE Financial, Inc. Q2 2008 Earnings Call Transcript.

Executives

Bill McManaman - CEO

Judy Sutfin - CFO

Don Wilson - COO

Analysts

Mark Lynch - Wellington Management

Mark Mcleod

Peyton Green - FTN Midwest

Kenneth James - Robert W. Baird

Jeff Kurt - Stifel Nicolaus

Ben Crabtree - Stifel Nicolaus

Brian Martin - Howe Barnes

AMCORE Financial Inc. (AMFI) Q2 2008 Earnings Call July 17, 2008 ET

Operator

Good morning ladies and gentlemen and welcome to the AMCORE Financial second quarter earnings results conference call. (Operator Instructions). This conference call is also being webcast and can be accessed at www.amcore.com, and will be archived for an additional four weeks.

Statements made in the course of this conference call stating the company's or management's intentions, hopes, beliefs, expectations or predictions of the future are considered forward-looking statements. It is important to note that the company's actual results could differ materially from those projected in such forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained from time-to-time in the company's SEC filings and within the press release itself.

Conducting the call today will be Mr. Bill McManaman, Chief Executive Officer; and Mr. Don Wilson, Chief Operating Officer; and Ms. Judy Sutfin, Chief Financial Officer.

I will now turn the call over to Mr. McManaman. Mr. McManaman, you may begin.

Bill McManaman

Thank you, and good morning. We appreciate the time you have taken to listen to this conference call and welcome your questions at the end of our comments. We assume that you have seen a copy of our press release issued earlier this morning. So, while we will not review each item in detail, we will discuss operating results for the quarter, identify specific actions we have taken, and provide perspective on the market environment and credit conditions.

As you know, the banking industry continues to face serious challenges. Nationally, uncertainty permeates the credit environment and has been further stirred by earnings warnings for the second quarter.

As we all know too well, bank stock prices have been depressed by unanswered questions surrounding the industry's capital and liquidity needs. Most banks' stocks including the AMCORE are trading low below booked value. We know capital is on everyone's mind. Even with the $100 million provision for loan losses recorded in the first six months of 2008, AMCORE remains well capitalized today at 10.9% on a consolidated level.

Given the current environment, we continue to closely monitor capital and take actions whenever and wherever necessary to assure AMCORE's continued financial strength as we move forward. We also know we have efficiency issues to address, and we are aggressively reviewing the performance in all our markets and will continue our efforts to size our operations to our revenues and future expectations.

Shortly, Judy and Don will detail the various actions we have taken during the quarter. But first, let me give you my perspective on the market conditions and our credit environment.

First, AMCORE has been diligent in recognizing and addressing its credit issues. In fact, we spent much of the first quarter and second quarter determining the extent of our weak credits and imposed stringent metrics as we evaluated our loan portfolio. Tightening credit disciplines is an appropriate and prudent course of action, in the light of current economic conditions, and will help us recognize and resolve issues more swiftly and efficiently.

AMCORE's loan portfolio is concentrated in commercial real estate and a significant portion of our portfolio is loans to developers of residential real estate properties, where they used the proceeds for land acquisition, development and construction. These builders and developers carry housing inventories that have been slow to sell and this has put added pressure on these borrowers.

The challenges for AMCORE and other Midwestern banks are more about decreases in real estate sales volume, rather than declining real estate values. When the real estate market does rebound, unit sales should recover more quickly than real estate values.

According to the last report from the National Association of Realtors, sales of single-family homes, condominiums, town houses and co-ops edged up 2% in May from Aprils' levels. Our residential land development loans represent about $745 million or 24% of our total commercial loans outstanding at about 19% of our total loans. Partially, as a result of AMCORE's concentration in commercial real estate and the mounting pressures in the economy. Our number of non-performing loan balances increased $58 million from the previous quarter.

Given the current market conditions in our quarterly review of the allowance for loan losses, we have discounted the underlining collaterals and recorded a $40 million provision. Let me assure you, company wide efforts are focused on resolving our credit issues and positioning AMCORE to weather today's economic storms, so we can emerge a stronger company tomorrow.

Here's a quick review of key actions AMCORE has taken to resolve these issues and to respond to the requirements of our regulators, initiated stricter credit disciplines that better reflect market realities and are flexible in responding to economic changes and challenges in today's environment; strengthened our customer credit approval process to provide more consistent controls; completed the risk grading of our commercial loan portfolio to reflect current market conditions; strengthened the independence of internal loan review, appraisal review and credit administration and policy groups; hired an experienced independent third party to review our lending practices, which should be completed during the third quarter; added staff and resources including a new Chief Credit Officer and a new manager of Loan and Appraisal Review to strengthen our credit functions, as well as our special assets and loan review groups.

As we move into quarters three and four, our focus is sharply on execution; improving efficiencies, and resolving credit issues. Make no mistake; we will take thoughtful and prudent action wherever and whenever necessary. Ultimately, the actions we take will establish a strong foundation for 2009 with a solid capital base.

Now, I would like to turn it over to Judy for a discussion of our financials.

Judy Sutfin

Thank you, Bill. As you have just heard, much of our work in the first and second quarter has been to identify and quantify the pockets of our credit portfolio that were weakening. In addition, we put in place an action plans that addressed both our credit and efficiency issues. In just a few minutes Don will address these points. We've recognized some actions we took this quarter had a negative impact on our earnings, but they were necessary steps to put AMCORE in a more solid footing as soon as possible.

As you know this is a difficult time in the banking industry. Our second quarter loss per share was $0.91, which includes the effect of a $6.1 million non-cash charge for the impairment of goodwill. Net of the charge which does not affect our capital levels, the loss would be $0.63 per share. This compares to a loss of $1.25 reported in the previous quarter and earnings of $0.46 in the same quarter a year ago.

The loss through the quarter was primarily driven by a $40 million provision for estimated loan losses, associated with the decline in credit quality. This increased provision net of charge-offs brings our reserves to 3.44% of total loans, compared to 2.48% in the previous quarter and 1.01% in the year-ago period.

We will discuss the credit conditions in a couple of minutes, but let me start by looking at the major components of the income statements. First let's look at the margin or net interest income. Margin income decreased from the previous quarter by $658,000 and was down $4.7 million from the year-ago quarter. There are three primary causes for this reduction:

First, during the quarter we reversed approximately $1 million of interest income from loans moved to non-accrual status. This represents an increase of approximately $200,000 quarter-over-quarter. Second, the cost of funding the increased pool of non-accrual loans placed a drag of approximately $2 million on the margin for the quarter. This represents an increase of approximately $540,000 quarter-over-quarter. Third; pressure on deposits rates especially CDs, continues in all our market.

The margin statistics for the quarter was 3.07%, down 5 basis points from the previous quarter and down 32 basis points from the year-ago quarter. Most of the decline from a year ago was due to the effects of the increase in non-accrual loans, which was 19 basis points. An additional 6 basis points was due to unfavorable funding mixtures and the remainder was due to the prime LIBOR divergence.

As we have indicated for the last several quarters, other than the unfavorable funding mix shift, the structural rate risk position of the balance sheet has been approximately neutral in effect on the margin.

As the non-accrual loans will take time to workout and we do not currently see signs of the deposit pricing pressures waning, we consequently do not expect a meaningful recovery in the margin statistic for several quarters.

Next, let's turn our attention to credit condition. Non-performing loans rose nearly $58 million from the previous quarter. You will note the reduction in the category of loans 90 days past due and still accruing as we placed virtually all loans more than 90 days past due on non-accrual status. As Don will discuss in a few minutes, this is one of several actions we have taken to infuse our credit administration process with more discipline.

We charged off a net $3.3 million during the quarter, which was $10.3 million less than the previous quarter's level and $1.5 million less than was charged off in the year-ago quarter. These charged off loans are primarily residential real estate development loans and commercial investment property. While charge-offs are likely to rise as we work through and resolve the current non-performing loans, we expect our reserve levels to adequately cover such charges.

Construction and land development loans represent about $745 million or 24% of total commercial loans outstanding and 19% of total loans. Approximately 12% of this portfolio is currently on non-accrual status and 40% of this portfolio is rated in our four lowest rating categories which constitute criticized asset. Of the specific allocations we made in our determination of provision levels, 61% are from this portfolio.

Our increased provision net of charge-offs brings our reserve to 3.44% of total loan compared to 2.48% in the previous quarter and 1.01% in the year ago period. This level of provision brings the allowance to 78% of the non-performing loan balance and recognizes both the material deterioration and past few loans during the quarter and the concentration of the concerned and the commercial real estate factor.

The foreclosed real estate balance increased $6.5 million from the previous quarter. This represents the amount we expect to realize a promised sale of the property. A positive indicator in all of this is the fact that delinquencies which include loans more than 30 days past due, are down 12% quarter-over-quarter. While there is no doubt that the last quarters delinquencies contributed to this quarter the increase in non-performing loans. The delinquencies that migrated to non-performing loans were not replaced at the same pace, as the previous quarter, and delinquencies has declined for the first time in over a year.

The next category to discuss is non-interest income. This quarter's non-interest income was essentially flat compared to the second quarter of 2007, and increased 9% or $1.6 million compared to the first quarter of 2008, primarily due to increases in deposit services and bank card income as other income line item, resuming to a more normalized level.

Moving on to our non-interest or operating expenses. Overall our second quarter expenses are higher than last year by 7.8 million, primarily due to three significant items. First, we had a non-cash goodwill impairment of 6.1 million. The goodwill impairment charge is not tax deductible, does not impact our tangible equity or regulatory capital ratios and does not adversely affect our overall liquidity position. Because our stock price is trading below book value, accounting rules require this goodwill impairment.

Second, we had $1.5 million in charges related to property, consolidation. Third, FDIC premium, increased by $1.1 million. On the positive side, our efficiencies continue to be a major focus, with salaries and wages running 8% below last years level.

From a balance sheet perspective, average loans were down 32.6 million from the previous quarter and down 109.5 million from the same quarter a year ago. Inside this total however, it is important to note that we are beginning to gain some traction on shifting our mix of business to be more focused on non-real estate business loans. The declines have come in the real estate loan categories and the commercial loan sector was higher than the previous quarter on both a quarter average and in ending basis. While we obviously have been quite busy with the improvements for the credit process, we are pleased with the beginning signs of growth in the C&I portfolio.

Average bank issued deposits fell 79.4 million during the quarter, most of which was the result of a couple of commercial clients, seasonal deposit changes. The average balance of the investment portfolio increased approximately 19.1 million during the quarter. We do not expect the size of the portfolio to materially change in the current market environment, although it may fluctuate a bit quarter-to-quarter, primarily due to timing of settlements.

The increasing risk from the economy and financial markets make the retention of capital a key consideration that we take very seriously. Our current capital ratios remained strong and above the well capitalized levels as our total risk based capital ratio is 10.9% on a consolidated basis.

Don Wilson

Thank you Judy and good morning everyone. On our previous quarter's earnings calls, I described 10 specific actions we had taken to improve the organization. We'll like to update that list and to provide a status report on ongoing projects.

Specifically, first the required review of our commercial credit portfolio by an independent third party is well under way. We hired a Big Four public accounting firm to develop the sampling methodology and the framework for the review. Then we hired a western based consulting firm, staffed with former banking regulators, to complete that review. Well not yet final, this process is now a little better than 50% complete has not identified any material concerns.

Second, we have not only moved all residential development loan relationship into a specialty unit focused on such issues which we mentioned last quarter, but also all remaining construction loans on any commercial real estate project will be managed by this group.

Third, we've continued to add staff and resources to the special assets or workout unit to assure that we are relentlessly pursuing successful resolution of non-performing credits.

Fourth, we are in negotiation off to sell approximately an $80 million portfolio of non-performing and underperforming loans to a third party. We expect to close on this transaction by the end of this month. The sale price was approximately our current holding value including allocated reserves. This transaction will remove further exposure from these assets, add incremental liquidity to the bank and be neutral to the capital position. Fifth, we hired a new Chief Credit Officer with extensive experience and strong leadership and portfolio management skills. In addition, we have hired a senior staff and we have hired other senior staff to manage the credit administration, loan review and appraisal review functions.

Sixth, we continue to review opportunities for efficiencies including the identification of four underutilized facilities that could be consolidated with other nearby locations. Two office buildings; one is a small older branch in our historical markets and one of the least suburban location with minimal retail activity and mostly offices for commercial lenders. These consolidations are expected to save us about $1 million a year on a run-rate basis.

Seven, we have nearly tripled the number of ATMs in our markets that our customers can now access surcharge free and offer similar access to nearly 13,000 ATMs across the country. This opportunity is in part of restructuring of our ATM network contract which will allow us to offer this increase convenient to our customers while still reducing expenses to the bank.

Eight, we have a continued focus on commercial-industrial lending, which is helping to improve the diversification of our portfolio as will the loan sale previously discussed. Finally, managing the balance sheet to assure a secure capital position and deep liquidity reserves are always key responsibilities of any banking organization.

We have a dynamic liquidity model that has been lengthening the liability side of this balance sheet for more than a year. Management actions over the last 18 months from the reduction of the securities portfolio, the loan sale mentioned above to the previous issuances of trust preferred securities and supporting the debt securities, all provide important capital support during these times.

In closing, our AMCORE management remains fully committed to resolving current credit related challenges. We are also moving our organization forward addressing and addressing our future needs and those of our customers.

Operator, you may open the line for questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. (Operator Instructions). Our first question comes from Mark Lynch from Wellington Management. Please go ahead.

Mark Lynch - Wellington Management

Good morning. I was wondering to what extent the non-performing loans included loans that had not actually delinquent, but that you just put them on non-approving loans because you thought they were going to become delinquent? How much is discretionary, in other words?

Don Wilson

The non-performing are mostly with the delinquency. The issue really is where you handle the provision process. So the ratings of the loans that we've reflect weaknesses that may or may not be causes of delinquency that gets incorporated in our provision calculation going forward.

Mark Lynch - Wellington Management

Okay. Thank you.

Operator

Our next question comes from [Mark Mcleod]. Please go ahead.

Mark Mcleod

I really have two questions. My first is that as an investor and watching what happens, it looks as though the institutional community is usually surprised by results, and I would like to know what type of interaction process you have with the institutional community and particularly how you guide them. Secondly, I have been associated with AMFORE as an investor for about 15 years now, and if I were to characterize that I would say that there has been a large phase of reactive performance. I am just wondering if there is discussions and thoughtful analysis that whether or not strategic alignments or mergers of the organization without the organizations is on the radar screen for members of the board?

Don Wilson

The answer to the first question is, the rules with regard to what you can say to analysts and investors and for a period are quite stringent, and so we are quite cautious about this. There are some firms and any industry that choose to provide interquarter guidance on a public basis and essentially it is just a question of when you time, when you make your statements. We've chosen to provide variable guidance with regard to that, the quarterly conference calls, the time when we are as transparent as we can about the current situation. With regard to broader industry issues that you brought up, we understand and our board understands the fiduciary responsibilities that they have. As you know there is a lot of things going on in this industry right now and we maintain understanding and respect for the fiduciary responsibilities that we've at all times.

Bill McManaman

I think Don, the only thing that I would add to that is a comment that I made at the shareholders meeting back in May and that is well, there is very little activity going on in the banking world today from that perspective but at the same time there is lot of discussions going on. Do we participate, and have we participated in the past, and will we participate in the future with regard; for those discussions, the answer is absolutely yes.

Mark Mcleod

Thank you.

Operator

(Operator Instructions). Our next question comes from Peyton Green from FTN Midwest Securities. Please go ahead.

Peyton Green - FTN Midwest

Yes. My question was on, to what degree do you expect maturities of your loan portfolio to provide cash flow in the second half of the year versus the first half?

Bill McManaman

I do not have it on my finger tips a hard number for you, there we will not might be able to get back to you on that. I think the answer is buried in our discussion in the text about the mix shift that you see going on and clearly there is not a whole lot of real estate activities we had even if you wanted to. So, since we've such a large initial portfolio as you both work out problem credits and as normal maturities happen on good credits and commercial real estate, there is not anywhere near equal volume to be put on in the commercial real estate sector and therefore only results in the C & I sectors is going to wind up consuming that from a liquidity source and therefore the remainder, the net of those two differences will wind up flowing into liquidity, availability of the company.

Peyton Green - FTN Midwest

Okay, and then in terms of the changes that going on in terms of the credit process. When would you expect to have them fully implemented? Do you think there is another shoe to drop in terms of credit grade responses or provision?

Bill McManaman

The reason why we mentioned to you the status of the third party review, have done with the process and no material issues that has been identified at this point. Clearly it indicate that it is not just our view that every quarter we do our best to recognize everything that we can and so with regard to the grading process its not just what management is telling you now also giving you a preliminary look as we can in terms of the results of the third party review. As soon as that process is complete, there is a strong likelihood that we will make some form of announcement at that time as well.

Peyton Green - FTN Midwest

Okay and again so exactly it is fair to say that you all have been clamping down in terms of refining and reworking the credit process such that you are a lot close the way you want to be.

Bill McManaman

Yes right. I can assure you that we spent a considerable amount of the second going through all material, commercial loans one by one utilizing the new disciplines in the higher bars that have been establish and I feel very confident that we did an excellent job and a thorough and complete job as we completed that process.

Peyton Green - FTN Midwest

Okay and then when would you hope to get back to breakeven results from a bottom line perspective?

Bill McManaman

We've taken the position I may go back to the previous questioner's comments here as well. That we are doing our best in each of these quarters to show you with as much clarity as we can, what our current position is and what our current actions are and we've stayed fairly far away from making too much forward-looking statements. We know that some of our peers have done that over the last quarter or two and we think they may ultimately regret doing that. So we want to provide you as much clarity as to where we are and what we are doing and giving you that understanding and then unfortunately you have to make conclusions about where that is going to go if those are going to be effective. So I do not have a hard answer for you and that a lot of that answer would also be dependent upon an economic forecast which as you all know is a hard thing to make these days anyways.

Peyton Green - FTN Midwest

Sure and then I guess the last question in terms of the loan portfolio cash flow to what degree do you still have unfunded real estate commitments that will be funded in the back part of the year?

Bill McManaman

It is a relatively small and shrinking number I do not have a hard number for you but it's not a material concern for us right now.

Peyton Green - FTN Midwest

Okay great. Okay, thank you very much.

Bill McManaman

Thank you.

Operator

Our next question comes from Kenneth James from Robert W. Baird. Please go ahead.

Kenneth James - Robert W. Baird

Hi, good morning.

Bill McManaman

Morning.

Kenneth James - Robert W. Baird

Don I apologize I missed most of the prepared remarks I jumped on right towards the end of yours and I heard you mentioned something about subordinated data. Did you announce the issuance of some kind of a regulatory capital or just your ability to or your room to raise some?

Don Wilson

No sir, I did not announce that we've done it in the quarter. What I was trying to do is give a perspective that we've been managing this balance sheet from both the liquidity and a capital position over the course of last 18 months in order to make sure that we've basically a solid base underneath us in both those areas. So we've issued over the course of last 18 months, [sub-debt] trust preferred etcetera. We've gone down inside his investment portfolio. We spend some of that on share buybacks in the past that obviously is up. However, you also by the reduction of both the loan portfolio and the investment portfolio now, we believe that 10.91 on the consolidated total capital ratio, we remain in a strong capital position despite all these provisions that we've had in the last few quarters.

Kenneth James - Robert W. Baird

Okay. Thank you.

Don Wilson

Thanks.

Operator

Our next question comes from Ken Mannino from Stifel Nicolaus. Please go ahead.

Don Wilson

Good morning Ken.

Jeff Kurt - Stifel Nicolaus

Actually its Jeff [Kurt], hold on.

Don Wilson

Hi Jeff.

Jeff Kurt - Stifel Nicolaus

Hi, how are you?

Don Wilson

Alright.

Jeff Kurt - Stifel Nicolaus

There has been a lot of fear in the investment community in the last week and IndyMac, Freddie Mac and Fannie Mae. I just really wanted to know from an investor and a depositor standpoint what you are doing to kill those fears. Are you going to be taking any action specifically and could you just maybe articulate that?

Don Wilson

We are taking several steps that in our local markets will become more visible very shortly Ken in particular and you will see a variety of different methods to that. We've also looked for this just an industry issue. One of those things that we as an industry all have to be careful about making sure that we are as clear with folks as we can be about our stability as an individual organization as well as an industry. I know others are doing the same as we are. We are just working on essentially a framework for those conversations and working with media and other sources to communicate as clearly as we can our strength and stability as an organization.

Bill McManaman

The comments that I would add to Dons'; the industry especially from the media's perspective obviously has been in a crisis for last several weeks. The differentiating points between us and IndyMac are obviously very strong. Obviously we've not been involved in sub-prime activities in any way whatsoever. So I mean do we obviously have some areas especially with our loans to developers that have hurt us and will hurt us in the future, of course we do and that is why we wanted to make sure that we got to the first step which is self awareness and I think I feel comfortable with where we are.

The other thing is that we've got a balance sheet as Don has point out, even after the significant write-offs that we've taken during the past six months, stands to serve us well going forward. Third is the communication efforts that we've across the board, not just the Wall Street but primarily to our customers and employees that we are changing to the marketplace, each one individually because AMCORE has been a bank that has grown over it is 98 year history, not only in Rockford, and the community banks which we hold, but also to the Chicagoland marketplace. So we are changing those communications to meet the needs of our customers and employees.

Operator

Our next question comes from Ben Crabtree from Stifel Nicolas. Please go ahead.