National Penn Bancshares, Inc. Q2 2008 Earnings Call Transcript

| About: National Penn (NPBC)

National Penn Bancshares, Inc. (NASDAQ:NPBC)

Q2 2008 Earnings Call

July 16, 2008 1:00 pm ET


Michelle H. Debkowski – Executive Vice President, Assistant Corporate Secretary & Investor Relations Officer

Glenn E. Moyer - President, Chief Executive Officer & Director

Scott V. Fainor - Chief Operating Officer & Senior Vice President

Michael R. Reinhard - Chief Financial Officer & Group Executive Vice President


Thank you for joining us today on the National Penn Bancshares second quarter earnings webcast. (Operator Instructions) I’ll now turn this conference over to Michelle Debkowski.

Michelle H. Debkowski

Good afternoon and welcome to National Penn Bancshares’ second quarter 2008 earnings webcast. Questions will be accepted after the conclusion of our prepared remarks via email. Please use the email button located on the conference call screen to ask your question. Due to time constraints we may not be able to answer all of your emails. Additionally, as we review questions received we may combine questions that raise similar issues or can otherwise be combined for comment.

As part of our webcast presentation you will see that are slides with financial highlights available for your independent review. The presentation and slides will be available on our website as well as filed on Form 8-K with the Securities and Exchange Commission following our webcast.

This presentation contains forward-looking information that is intended to be covered by the Safe Harbor for forward-looking statement provided by the Private Securities Litigations Reform Act of 1995. Many of these factors are listed on the slide on your screen. I’ll give you a moment to review the slide.

I will now turn today’s presentation over to Glenn Moyer, our President and Chief Executive Officer.

Glenn E. Moyer

Joining me today is Scott Fainor, our Chief Operating Officer and Michael Reinhard, our Chief Financial Officer. I will start the call today by reviewing highlights from our second quarter 2008 earnings release which is available on the Investor Relations section of our website. Earlier today we included the press release in a report on Form 8-K that we filed with the Securities and Exchange Commission. Mike Reinhard will provide an overview of our financials. Scott Fainor will review our loan and deposit growth, asset quality and our merger integrations. I will then wrap up with some concluding comments.

Beginning with financial highlights I would like to note that our financial results for the year-to-date 2008 include Christiana Bank & Trust as of January 4 and KNBT Bancorp as of February 1. The addition of Christiana and KNBT has significantly changed our financial statements. Our second quarter 2008 results under accounting principles generally accepted in the United States referred to as GAAP reflect record quarterly net income of $27.21 million a $10.98 million increase over net income for second quarter 2007. On a per share basis we earned $0.31 per diluted share in second quarter 2008 compared to $0.32 per diluted share for second quarter 07. I made a mistake, let me repeat the per share basis. On a per share basis we earned $0.34 per diluted share in second quarter 2008 compared to $.032 per diluted share for second quarter 2007. Thank you and excuse my mistake.

Growth in second quarter 2008 net interest income as compared to second quarter 2007 contributed to our profit performance as did increases in some key fee income areas. We provided funding in second quarter 2008 for our loan loss reserve of $3.71 million resulting in a loan loss reserve of 1.33% of total loans and leases as of June 30, 2008. We are pleased to present these record results despite the overall negative conditions we are all facing in the economy. While we knew that 2008 would be a challenging year few would have predicted one of the nation’s largest bank failures ever or the need for our government to financially assist Fannie Mae and Freddie Mac. Unfortunately we do not believe that National Penn has been or can remain immune to these developments in the overall marketplace.

Therefore the tone of our message today will be to communicate our good news but to recognize and discuss National Penn’s areas of exposure in the context of the current difficult environment.

I’ll now turn the presentation over to Mike Reinhard who will provide more details about our second quarter and year-to-date 2008 financial results.

Michael R. Reinhard

Let me begin by noting that any references to per share results are to figures that have been restated for the 3% stock dividend paid September 28, 2007. I’d also like to note that this presentation contains a non-GAAP financial measure return on average tangible equity. Due to a number of acquisitions in recent years purchase accounting rules have negatively impacted our GAAP return on equity. The non-GAAP return on tangible equity ratio excludes the impact of acquisition-related goodwill and intangibles and used by National Penn’s management for comparison purposes in its analysis of the company's performance. A reconciliation of our GAAP and non-GAAP return on equity ratios is included in our presentation today for your review.

Net income for second quarter 2008 was $27.21 million a 67.64% increase over second quarter 2007. Diluted earnings per share of $0.34 was 6.25% higher than the $0.32 per diluted share earned during the same period a year ago. For the first six months of 2008 National Penn earned $48.81 million of net income compared to $31.72 million for the first half of 2007. Diluted earnings per share for the six month periods are $0.67 for 2008 and $0.63 for 2007, an increase of 6.35%. Our return on average assets for the six months ending June 30, 2008 was 1.16% and return on average equity was 10.48% as compared to 1.16% and 11.76% respectively for the first half of 2007. The decline in return on average equity was as expected due to the increased number of shares and the resulting increased average equity from the Christiana acquisition where the consideration paid included 80% stock and the KNBT acquisition where the consideration paid was 100% stock.

Net income return on average tangible equity was 22.77% in the first half of 2008 compared to 24.43% in the first half of 2007. This non-GAAP financial measure is computed by dividing annualized net income by average equity that is reduced by average acquisition-related goodwill and intangibles. Our net interest margin increased in second quarter 2008 to 3.55% from 3.44% in the first quarter of 2008. The net interest margin was 3.52% for the first six months of 2008 compared to 3.41% for the first six months of 2007. Absent the positive effect of the amortization of the fair value marks for KNBT which we fully described during our first quarter earnings release we had expected the net interest margin for the first six months of 2008 to be 3.26% which was simply the weighted average net interest margin of National Penn, Christiana and KNBT combined without any consideration of interest rate movements or shifts in earnings assets.

The positive effect of the amortization of the fair value marks as 19 basis points during this period. Therefore without the benefit of the fair value marks the net interest margin would have been 3.33%. We attribute this positive seven basis point difference from internal expectations primarily to increased credit spreads on new loans with stable to lower funding costs. However we recognize that we are in a dynamic and competitive market for both loans and deposits where pricing can change quickly. A provision for loan losses of $3.71 million was made in second quarter 2008 as compared to a provision of $1.54 million in the second quarter of 2007. Total net charge offs for second quarter 2008 of $3.70 million compared to $2.30 million of net charge offs in second quarter 2007. The provision for loan losses for the first half of 2008 was $7.12 million versus $2.61 million for the same period in 2007 while net charge offs were $6.26 million and $3.92 million for the first half of 2008 and 2007 respectively.

The larger dollar amount of net charge offs in both the second quarter of 2008 and year-to-date 2008 is the result of a larger amount of loans outstanding. However net charge offs as a percentage of average loans did not change from 2007 to 2008. Net charge offs were six basis points non-annualized of average loans in both the second quarter of 2008 and 2007 and were 11 basis non-annualized in both the first half of 2008 and the first half of 2007. Scott will discuss credit quality in more detail in his remarks. Due primarily to the first quarter 2008 acquisitions of Christiana and KNBT non-interest income of $27.90 million in this year’s second quarter is up $10.01 million or 56.75% as compared to last year’s second quarter. This year’s second quarter non-interest income includes a $1,139,000 pre-tax charge related to NTB Capital Trust II under the fair value option guidelines of FAS 159 and FAS 157 early adopted for this financial instrument compared to a $127,000 pre-tax charge in the second quarter of 2007.

Including the impact of Christiana and KNBT from the dates of their acquisitions this year total non-interest expense for second quarter 2008 was $53.83 million up 58.02% as compared to last year’s second quarter. We are pleased to report that we remain on target to achieve the previously disclosed cost savings from the KNBT acquisition.

Regarding the balance sheet total assets grew 1.46% non-annualized during second quarter 2008 to $9.24 billion. At June 20, 2008 National Penn was in compliance with all applicable regulatory capital requirements. National Penn, National Penn Bank and Christiana Bank & Trust are all considered well capitalized as defined by banking regulators. In fact our total risk base capital to risk weighted assets ratio improved from 10.31% at March 31, 2008 to 10.59% at June 30, 2008. We target our tangible equity to tangible assets ratio to be a minimum of 5%. At June 30, 2008 our ratio stood at 5.32% down slightly from 5.38% at March 31, 2008.

Book value per share and tangible book value per share were at $13.15 and $5.78 respectively at June 30, 2008 compared to $13.17 and $5.77 respectively at March 31, 2008. The relative non-movement of these ratios is attributed to negative fair value marks of the investment portfolios during the second quarter offset by earnings retained after our second quarter cash dividend. We reclassified our CDO investments which include bank and insurance company pools of trust preferred debt and one synthetic CDO from available for sale to hold to maturity during the second quarter. The action exhibits our intent to hold these investments to maturity and will prevent future fair value marks in this portfolio from affecting our capital ratios. Scott will further discuss our CDO portfolio during the asset quality portion of his comments.

I’d now like to introduce Scott Fainor, our Chief Operating Officer.

Scott V. Fainor

I would like to take a few moments to comment on our loan and deposit growth and our overall asset quality and then I will address the KNBT and Christiana integration processes. With respect to our loan portfolio at June 30, 2008 total loans and leases outstanding are $6.13 billion. All regions across our company remain fully engaged in increasing customer relationships while maintaining quality loan growth. Organic loan growth was 2.01% non-annualized on a quarter-linked basis during the second quarter 2007 and was reflected most notably in the areas of commercial business and commercial real estate lending. We continue to monitor all our credit pipelines which currently remain in a strong position. We are focused on maintaining this momentum through relationship cross-selling of commercial and consumer loans in addition to our cross-selling of our expanded array of insurance, wealth management and deposit products and services throughout our new footprint.

Total deposits were $6.08 billion at June 30, 2008 a slight decline from $6.10 billion at March 31, 2008. The primary reason for this decline is a $121 million seasonal reduction in school district deposits which historically returned during the third quarter of the year plus the maturity of $18 million of brokered CDs which we did not replace. For deposits overall we are currently in the midst of a delicate balancing act of reducing interest rates paid on deposits commensurate with the reduced rate environment triggered by the Federal Reserve’s interest rate cut while at the same time maintaining our overall liquidity and core deposit positions. Our over-arching goal is to generate reasonably priced deposits commensurate with loan growth.

National Penn also has varied sources of wholesale funding which we chose to use to a greater extent this quarter as an alternative to paying higher rates to generate greater deposit growth. We feel that at the current time we have ample sources of funding to cover our anticipated asset growth. Within this balancing act of deposit growth versus cost of deposits National Penn is focused on relationship profitability management. Non-performing assets plus loans over 90 days delinquent for our combined company totaled $22.63 million at June 30, 2008 down from $24.15 million at March 31, 2008. We believe that our ratio of non-performing assets to total loans of 0.37% is better than industry averages. This compares to a ratio of 0.40% as of March 31, 2008 and 0.39% as of December 31, 2007.

We also believe we remain appropriately positioned in our overall loan and lease loss reserve as $8.164 million or 1.33% of total loans and leases as of June 30th, 2008 after second quarter net charge offs of $3.70 million. Based on the current reserve our coverage ratio of non-performing assets is 360.8%. This compares to a coverage ratio of 338.1% at March 31, 2008. Based on the strength of this coverage our review of overall credit quality indicators and our ongoing loan monitoring processes we feel we have adequately provided for loan and lease losses during second quarter 2008. This is a dynamic process and we will continue to evaluate the appropriate level of provision on a quarterly basis.

As in the second quarter we feel that in the current environment we may need a larger provision expense in the near term than in the recent past in order to maintain our loan loss reserve at an appropriate level. We continue to monitor the slow sales pace of both and existing homes and the resultant economic drag that impacts business owners and residential developers. It is important to note that National Penn’s increase in non-performing assets in charge offs is not a consumer loan or residential mortgage issue nor does it reflect any repercussions from subprime exposure. The increases are consistent with the trends in our slowing economy. For National Penn the increases in net charge offs have been driven by credit in the commercial and residential development segments of our portfolio. All of our banking teams are aware of the impact of the current economic slowdown and changes in our credit cycle and we will continue to monitor our portfolio’s risk and concentration exposure diligently.

With respect to our investment portfolio, I’d like to speak specifically about our CDO investments as these types of investments have come under scrutiny lately. Our CDO investments are primarily pools of bank and insurance company trust preferred debt with a costs basis of approximately $160 million representing 23 different pools plus 1 synthetic CDO in the amount of $20 million. None of our CDO investments are directly invested in subprime loans. The ratings on the trust preferred pools are mostly triple-B with a few rated A or A minus. The synthetic CDO is rated double-A minus and is referenced off a portfolio of 100 investment grade corporations. As of June 30, 2008 99 of the 100 corporations in the synthetic CDO remain rated investment grade. Despite our original intent to hold these investments on a long term basis we have been concerned about the fair value marks of these investments for most of this year with this concern culminating in our decision to reclassify these investments as held to maturity.

We are no equally concerned about the overall quality of the bank trust preferred pools as a more significant number of banks have elected to defer interest payments on their trust preferred debt. While we still foresee the ultimate collectibility of our principal we cannot rule out the potential for some of these investments degrading into a non-accrual of interest status. Accordingly we have been monitoring these investments closely and have developed a methodology to determine if any of these investments have other than temporary impairment. Our analysis is performed for each individual investment and shows that the credit quality of the individual bonds range from good to deteriorating. Based on this analysis we did not have other than temporary impairment at June 30, 2008 but we cannot rule out a potential charge on individual issues in the future.

Ultimately the quality of these CDO investments will depend on the financial strength of the individual banks and insurance companies who issue debt into these pools coupled with the protections afforded to the rated class holders within the structure of the CDO. Obviously we will continue to monitor this situation very closely and communicate material developments as warranted.

On a positive note we’ve received questions in the past few weeks concerning our bank owned life insurance investments as well as concerns about whether we own any Fannie Mae or Freddie Mac Perpetual Preferred Stock. We are pleased to note that our ongoing evaluation of our BOLI investments show them to be of high quality with no concern about an impairment charge. In answer to the second question National Penn has never owned any Fannie Mae or Freddie Mac Perpetual Preferred Stock. Further we on 1,780 shares of Fannie Mae common stock and no shares of Freddie Mac common stock both immaterial amounts.

Regarding the status of the integration of our recent acquisitions during last quarter’s earnings webcast we reported that the core banking system conversion of KNBT was imminent. We can now report that we successfully completed the KNBT conversion with minimal disruption to our customers. Initial reports of customer retention are very strong which is consistent with our past conversion experiences. With that major milestone behind us we can focus even more energy on customer retention and expansion, our cross-selling efforts and attainment of the remaining KNBT cost save opportunities.

Work is also well under way on the Christiana core banking system conversion with an early fourth quarter target date. Our partnership with Christiana Bank & Trust which began on January 4 of this year has been promising as expected. The main benefit of Christiana is the diversified earnings power from their unique business model. The currently uncapped potential is the introduction of core National Penn customers to what we’re calling The Delaware Advantage. We are hard at work on that opportunity.

I’ll now turn the presentation back to Glenn Moyer.

Glenn E. Moyer

While we are pleased to report record earnings we clearly recognize that we and most others in our industry are operating in troubling times. Scott reported on our outlook for loan quality and potential future charge off levels and also discussed our concerns about the CDO portfolio. We have devoted significant energies to these areas and believe that they are manageable. Nonetheless we are carefully reviewing our capital levels and our re-evaluating our capital targets in the context of a more difficult operating environment. Given the current environment and the emphasis on sufficient capital levels we have discontinued our opportunistic repurchases of blocks of National Penn stock as they become available from time to time and we have discontinued our daily de minimus stock repurchases. These actions have helped to preserve our capital ratios. Furthermore we believe that quality organizations like National Penn can raise capital in this market if we determine the need.

Notwithstanding the foregoing thought process our current stance emphasizing higher capital levels does not negate the fact that we have an approved stock repurchase plan in place for capital management purposes if we deem appropriate at any given time. Based on our earnings to date and our capital levels we anticipate the ability to continue to pay cash dividends at the current level. The declaration of a cash dividend is a matter entrusted to our Board of Directors. The Board considers this quarterly based on our earnings, capital position and other relevant facts and circumstances at the time.

We would also like to acknowledge the volatility in the market value of our stock over the past few months. While we wish the movement in our stock price was more positive, realistically National Penn has been affected like the rest of the financial services industry. As disclosed in our most recent proxy we monitor a peer group of similarly sized publicly traded financial institutions. On a year-to-date basis our stock performance compared to this peer group is in the top 30%. While this may be small consolation we trust that our continuing strong performance will eventually provide some stability and support in this area.

This ends our planned remarks and we will now address questions that have been received to this point. Questions that may be received after this point will be addressed as possible in the public filing of the transcript of our question-and-answer segment.

Question-and-Answer Session

Michelle H. Debkowski

We’ve had several questions presented during the webcast. Mike, I’m going to begin with you. Mike, we’ve received a few questions on our investment portfolio specifically the linked-quarter increase in held to maturity securities. Also what is the difference between the amortized cost and the fair value of the CDOs held in the securities portfolio?

Michael R. Reinhard

Before I start talking about CDOs, I would like to correct a misstatement during our prepared comments. We mistakenly said that the rating of the synthetic CDO was AA minus. In actuality the rating is double AA.

I’d also like to reiterate in answers to the questions received the fact that during the second quarter we moved the CDOs to held to maturity. As stated that action mitigates the risk to capital of future negative fair value marks. Concerning the entire held to maturity portfolio, at March 31, 08 the book value was $271.4 million, the fair value was $269.4 million and the difference therefore was $2 million. At June 30, 08 the book value of the entire held to maturity portfolio was $406.7 million, the fair value was $371.8 million and therefore the difference at that time was $34.9 million.

Michelle H. Debkowski

Scott, can you provide some details on the construction portfolio and any weakness you are seeing? Also have business conditions particularly in construction lending changed since the end of the second quarter?

Scott V. Fainor

Our residential construction portfolio consists of $242 million in commitments and $158 million in outstandings. The portfolio today is performing satisfactorily; however, we continue to monitor this portfolio very closely as home sales pace is down across our market. The investment commercial construction portfolio is $176 million in commitments with $113 million in outstandings and is performing well. Economic growth in the areas that National Penn Bank operates remain slow but steady while the housing market continued to suffer from weaker macro economic trends. Housing in the entire region is still holding better than national averages. Employment growth and economic growth is slower but still stronger than those national trends. We continue to keep monitoring all of this data and other trends very closely within this economy.

Michelle H. Debkowski

How does National Penn compare in the industry in regard to commercial loans?

Scott V. Fainor

Commercial loans represent approximately two-thirds of our total loan portfolio or $4.07 billion. The portfolio is performing well with a delinquency rate of 23 basis points at 6/30/2008. The portfolio has a non-accrual rate of just 36 basis points so our portfolio performance is at or better than our peers’ performance.

Michelle H. Debkowski

Mike, the 24% tax rate was a bit below expectations. What should we assume for an effective tax rate in the second half?

Michael R. Reinhard

We believe that our effective tax rate for the second half of the year should be similar to the first half of the year.

Michelle H. Debkowski

Scott, what’s the latest on deposit pricing trends in your markets and the aggressiveness of [Dinovo] Banks?

Scott V. Fainor

As we commented in the presentation pricing continues to vary and it is a very competitive marketplace around deposit pricing and in liquidity needs. We continue at National Penn to focus on relationship banking and core deposit profitability. Our multiple products and the cross-selling to our customers is what we’re focusing on as a top priority.

Michelle H. Debkowski

Scott, is the watch list still around 3% of loans?

Scott V. Fainor

Yes, at 6/30/2008 it was 3.04% of outstandings.

Michelle H. Debkowski

Are there any credit problems emerging at Christiana or KNBT?

Scott V. Fainor

Like all of our portfolio some problem assets are emerging, but nothing extraordinary or unusual. The one or two situations at Christiana Bank & Trust do not involve material dollars at the holding company level.

Michelle H. Debkowski

With regard to the Christiana and KNBT integrations, of the $30 million in targeted cost saves, how much has been achieved to date and how are those integrations progressing?

Scott V. Fainor

As we stated in our presentation we are on track towards achieving our $26.2 million of merger related cost savings of which as stated back when we announced the merger in September 7th of 2007, 75% would be achieved in the first 12 months and the remaining 25% in the second 12 months and we are on track to achieve those cost savings.

Michelle H. Debkowski

Mike, have you analyzed potential outcomes of possible OTTI charges and what is the likelihood that additional capital will need to be raised?

Michael R. Reinhard

Our analysis includes a capital stress test. Based on what we know today we believe that we have sufficient capital on hand to absorb potential other than temporary impairment charges. Keep in mind that if the credit quality of our CDO investments reduce to the point where an OTTI charge would be necessary, that would occur on a bond-by-bond basis and therefore the charges, if necessary, would be spread over time, they would not necessarily occur all at once.

Michelle H. Debkowski

Mike, turning to net interest margin, how much of the net interest margin expansion was associated with the acquisitions? For NIM going forward, how much re-pricing do you expect on the deposit side? Also please discus the impact that the purchase accounting has had on the net interest margin.

Michael R. Reinhard

In our prepared comments we reported that the impact to NIM from our fair value accounting was 19 basis points and going forward, absent the impact of the KNBT fair value marks, we would expect that NIM will remain relatively steady for the remainder of the year.

Michelle H. Debkowski

This concludes our presentation.

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