StellarOne Corp. Q2 2008 Earnings Call Transcript

Aug.25.08 | About: StellarOne Corporation (STEL)

StellarOne Corp. (NASDAQ:STEL)

Q2 2008 Earnings Call Transcript

July 29, 2008 10:00 am ET

Executives

Linda Caldwell – Director of Marketing

Jeffrey Farrar – EVP and CFO

O.R. Barham, Jr. – President and CEO

Analysts

Jennifer Demba – SunTrust

Steve Moss – Janney Montgomery Securities

Michael Rose – Raymond James

Cary Morris – Scott & Stringfellow

Bryce Rowe – Robert W. Baird

Operator

Good day, everyone, and welcome to the StellarOne Corporation's earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Linda Caldwell, Director of Marketing. Ms. Caldwell, please go ahead, ma'am.

Linda Caldwell

Thank you, Rufus. Everyone, we're pleased you could join us today. We have with us O.R. Barham, Jr., President and Chief Executive Officer of StellarOne Corporation, and Jeffrey W. Farrar, Executive Vice President and Chief Financial Officer. Mr. Barham and Mr. Farrar will review results for the second quarter of 2008, and after we hear comments from Ed and Jeff, we will take questions from those listening.

Please note StellarOne Corporation does not offer guidance. However there may be statements made during the course of this call that express management's intentions, beliefs, or expectations. Actual results may differ from those contemplated by these forward-looking statements. Now, may I introduce our Chief Financial Officer, Jeff Farrar, for financial highlights. Jeff?

Jeffrey Farrar

Thank you, Linda. Good morning, everyone.

I'd like to start by focusing on earnings for the quarter. StellarOne reported earnings of $6.1 million or $0.27 a share. I would also like to remind everybody that in terms of comparisons to prior year, as well as the first quar1ter, they're going to be somewhat muted due to the fact that we consummated our merger mid-quarter, first quarter, as – I believe February 28, so we're not going to have a full load, if you will, of both FNB and VFG in the first quarter, and thus, comparisons will be difficult. But we'll – to the extent we can, we will provide indications of trends and so forth that will, hopefully, help.

I really want to focus on three impacts for the quarter, integration expenses, merger-related expenses, being the first. We had about $1.5 million of merger expenses for the second quarter. Most of it was integration related as we worked through the nuances of putting our respective banks together, and that, of course, consummated late May. We did have some merger-related expenses, but they were not near as significant, and we do not expect to see any significant merger expenses moving forward.

The second item I want to focus on is the amortization of purchase accounting adjustments. This was a significant item for the quarter, and this really relates to the notion that under purchase accounting, we would mark the assets and liabilities to market value for the acquiree, which, for accounting purposes, in this case, was FNB. And thus, we had fairly significant amounts of discount premium associated with the loans, CDs, and advances, FHLB advances.

So this quarter saw the first amortization of these discounts and premiums, and that amount – that gross amount was $4.7 million. So we had some pick-up, if you will, from the amortization of these adjustments, which increased net interest income and thus boosted margins for the period, and we'll talk more about that as we get into net interest margin discussion.

For those who care about it, those amortization amounts will decline fairly quickly. The duration of the assets and liabilities, as you might imagine, is relatively short. And for the third quarter, for instance, we're looking at amortization of $2.3 million, and again that's increase in net interest income. And then for the fourth quarter, we're looking at amortization of about $1.6 million. So as you can see, the numbers come down fairly significantly, and by this time next year, it will be a pretty insignificant item for us.

The last item we want to talk about in terms of impacts for the quarter is the loan loss provisioning. Obviously, we did have a significant increase in loan loss provisioning. There are several things that I think we want to touch on. First of all, we did have some deterioration, if you will, from the standpoint of downgrades within the portfolio. We had two credits that we allocated specific reserves of right at $2.4 million on.

Those two relationships in aggregate dollars outstanding approximate $18 million. They were both acquisition and development credits. We feel like we've been pretty conservative in terms of discounting assumptions based on discussions with auctioneers and appraisers, so we feel pretty good about where we've got those two credits from a valuation standpoint.

We continue to see some just overall deterioration relative to the real estate markets, and so some of the soft factors that we embed in our allowance calculation were up, which also necessitated, if you will, an increase in coverage. And we’ve – as you might have noticed, increased our coverage to the total portfolio to 1.25%, compared to 1.17% for the first quarter.

We also had about $1.3 million in charge-offs for the quarter, which obviously would've had some impact on the amount of provisioning recorded. Of that $1.3 million, the largest single charge-off was right at $250,000, so we had a lot of small credits that we charged off for the period. Some of it was conscious on our part. We had a number of small relationships and NPAs that were in bankruptcy status that we were collecting payment on but felt it prudent to go ahead and clear off through a charge-off and then book recoveries as they come in. So, there was about $0.5 million of what I'll call "clean-up" associated with that, and then the other charge-offs, again, less than $250,000.

So looking at those impacts, I look at the provisioning as recurring. I look at the merger expenses and amortization of purchase accounting adjustments as nonrecurring. If you carve out the nonrecurring, we're looking at earnings per share for the quarter of $0.21 on a core basis. We're looking at year-to-date earnings of $8.2 million or $0.44 a share, but on a recurring basis, $9.1 million or $0.48 a share.

If I could then shift gears to net interest income and talk a little bit about the margin, well, we saw a nice increase in margin, but obviously, as I've said, we got a pop from the amortization. As you can see, if you looked at the release, the net interest margins that we enjoyed, if you normalize them and exclude the adjustments related to purchase accounting, you'll see that our net interest margin was in the 3.75 – at the 3.75 level for the quarter, 3.74 for the six-month period, so a very stable margin and certainly one that, given conditions, that we're pleased with.

We do expect the possibility of some modest compression through the remainder of the year. We had the benefit of a significant amount of repricing on cost – on the liability side of the balance sheet this quarter. We see that slowing in the third and fourth quarter. Continue to struggle with loan growth, we were down $20 million in loans for the quarter, or roughly 1%. As long as that continues, obviously, it's going to be difficult to drive asset yields, so modest compression entirely possible as we look to the remainder of the year.

If I could shift gears to the other large component of revenue, and that is non-interest income, obviously, compared to the prior quarter and prior year, significant growth rates, but if you look at them on a normalized basis, retail banking fee income is probably our strongest line item right now. We're seeing a little over 10% growth sequentially on a normalized basis, a direct byproduct of the high profile [ph] direct marketing initiative, direct mail initiative, that's continued to give us some traction. We have rolled it out on the legacy FNB side and are starting to see some benefits associated with that as well.

Mortgage revenue was down 8% sequentially. We're still enjoying some good earnings out of our mortgage area, but we are seeing some contraction, if you will, in the revenue streams and anticipate that continuing through the course of the rest of the year.

From a wealth management perspective, we had roughly 10% decrease in brokerage fees for the quarter, but that was offset, in large part, by roughly a same percentage growth in trust revenues So, we were relatively flat on a comparative basis, again normalizing for the merger.

Other items of note, we did have a loss on sale of OREO of 260,000 for the quarter. That was a $2.2 million piece of OREO that was sold during the quarter. That, along with some payoffs, allowed us to get our NPA levels down somewhat. We'll talk more about that as we get into asset quality.

Other category, we had $400,000 in earnings from Bankers Insurance for the quarter related to our ownership in Bankers Insurance, LLC. We also continued to see some improvement in Boley [ph] Income associated with the legacy FNB ownership of Boley.

If we could switch now to overhead, merger expenses in aggregate, $5.1 million for the year. We had, as I indicated earlier, $1.5 million in merger expenses for the quarter. If we carve out the impact of the merger expenses, efficiency ratio for the quarter was just over 67%, higher than we want it to be. I think the thing that's impacted us most right now is the revenue contraction, but we're certainly very focused on driving that efficiency ratio down and continuing to evaluate our overhead structure.

While we're on that, I want to address FTEs. July of '07, the combined company, if you looked at FNB and VFG together, we had just over 1,000 employees, 1,013 employees. That number as we stand today is 890 FTE, down slightly from the 901 we reported at June 30. So we're making some headway on realizing, if you will, the cost saves that we had contemplated with the MOE. We've got more work, but I think we feel fairly confident that we're going to get the lion's share of our cost saves.

And then lastly, want to focus a little more on asset quality. As I mentioned, level of non-performing assets dipped to $25.9 million or 0.86% of total assets. Charge-offs for the quarter were 22 bps. I think that we'll continue to see an elevated level of charge-offs for the remainder of the year. And as I mentioned, we improved our coverage ratio to 1.25% given market conditions and the downgrade of the two credits that I alluded to earlier.

From a balance sheet perspective, we had a lot of moving parts. We did purposely deleverage the company a little bit during the quarter. As you'll note from looking at total assets, we paid off roughly $45 million in advances during the quarter. $22 million of that was a prepayment of former legacy FNB advances that were high-rated advances that obviously, with walking in the market, we had the ability to pay them off without a lot of impact from an earnings standpoint. So we'll enjoy about a 250-basis-point improvement in cost of funds related to that prepayment.

We unwound our commercial paper, which on the legacy FF – VFG side was a commercial suite product. That, in effect, drove deposit levels up because we basically took that commercial paper money and put it back on our balance sheet in the form of retail deposits. So, the $45 million of deposit growth that you'll note is a large byproduct of bringing that commercial paper back on.

I mentioned that we had contraction of the loan portfolio, $20 million. We also sold securities that represented reinvestment of the commercial paper proceeds of roughly $65 million. So, the decrease in security is directly related to the payoff of the commercial paper.

Then, lastly, tax rate. Some of you that are focused on that will note that we had over a 35% tax rate, effective tax rate, for the quarter. A little distortion there related to the deductibility of merger expenses, and to some extent, a catch-up from first quarter. You'll note that the effective rate was 29% in the first quarter, so a little distortion between first and second quarter. I think the thing I'd want you to take from it is, we think our current effective tax rate is 32.5 as we go through the remainder of the year. So, for those that are interested, 32.5, I think, is the normal run rate.

That concludes my remarks for the time being.

Linda Caldwell

Thank you, Jeff. Next, we'll hear from our President and Chief Executive Officer, Ed Barham. Ed?

O.R. Barham, Jr.

Thank you, Linda.

I would just summarize by saying in total where we are at the current time is about where we thought we would be and are pleased with efforts made 2.5 months in from the merger date, which is May 23rd. We are taking an aggressive stance on working our asset quality problems down. I believe capital has two purposes, either help you to grow the company or to help you work through some problem credits, as we all – as bankers are experiencing at this time.

But as Jeff has alluded to earlier, you have heard that our NPA levels have dropped and stand currently at 0.86%. Given any unforeseen issues that, hopefully, aren't out there on the horizon, we think we have a pretty good handle on where our problems are, at least the larger issues that we're facing at this time. We would hope that we can see that NPA level continue to go down over the trend for the rest of the year. But no guarantee, but certainly, hopefully, that's where we're headed with this.

Again, the $64 question is, how long will the economy stay down, and obviously, that will impact us and cause a problem predicting any such exactness as to where we stand asset quality-wise. But all in all, we feel good about the company and where we've been able to put our company together. I think we feel very positive about where we'll be come first quarter 2009, at least on an integration side, from an organizational side, and hopefully, from an asset quality side. We see 2008 as a year where we really are going to put our ship in order as best we can within our own ability to manage issues that are in front of us and hopefully look for a better '09, as I'm sure a lot of bankers are looking forward to a better '09.

I'll just stop with those general comments and let's just open it up for questions. At this time, we'll be happy to answer any questions you might have.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) And for our first question, we go to Jennifer Demba with SunTrust.

Jennifer Demba – SunTrust

Good Morning. You mentioned that in terms of your credit downgrades that were in the acquisition development area, can you give us an idea geographically where those were and if there were any other concentrations in your credit downgrades during the quarter?

O.R. Barham, Jr.

Jennifer, the concentration – let me kind of answer the second question first. The concentration, if we have any at this point, is in and around the Smith Mountain Lake area. There were some fairly significant projects that the old FNB legacy side was involved in. We've been through those thoroughly. We've looked at them pretty closely. We have a good sense of where we are relative to those and have seen some slight improvement on some credits there. So I would say that's the one pocket and the only pocket really we have any concern about as the economy continues to trail down over time. But, again, not overly concerned, but certainly have some concern. The two credits that we ended up adding additional provision for, one was at the Smith Mountain Lake area, and the other was in the Lynchburg market, both A&D transactions.

Jennifer Demba – SunTrust

How much loan exposure do you have in the Smith Mountain Lake market?

O.R. Barham, Jr.

That number would be somewhere around $50 million.

Jennifer Demba – SunTrust

Okay. And, Jeff, you indicated you guys – you think the margin's going to be under some pressure in the second half of the year. Do you anticipate growing the loans in the second half of the year, or do you think that's going to continue to be a struggle?

O.R. Barham, Jr.

Yes, go ahead, Jeff.

Jeffrey Farrar

I just want to say I think, given what I'm seeing in terms of pipelines and discussion or chatter from the loan officers, I think it's going to be a struggle to show any growth in the loan portfolio for the remainder of the year. Some of what's going on here, quite honestly, is allowing some stuff to move out that we think is prudent from a potential quality standpoint.

O.R. Barham, Jr.

I would agree with that 100%, Jennifer. He's correct. We are actively calling, but some of what we're doing is obviously allowing the portfolio mix to change a little bit, which we want to see some more of that over time.

Jennifer Demba – SunTrust

Thank you.

Operator

We’ll go next to Steve Moss with Janney Montgomery Securities.

Steve Moss – Janney Montgomery Securities

Good morning. Just with regard to the credit downgrades, what were the original LTVs?

Jeffrey Farrar

I can't answer that off the top of my head, but I can assure you that there wasn't anything out of the ordinary on them. It's just merely a matter of economic conditions, and as you would expect, where you have acquisition development in a market such as Smith Mountain, where it is discretionary – home ownership is discretionary because many of those homes are vacation homes, second homes, they're likely to be and so they are. They turn down quicker, and the recovery is slower there than it would be in other areas where job growth really drives market demand on housing.

Steve Moss

And if you could give some color with regard to the housing market in your geographies, Western market and the FNB legacy versus the FGI legacy?

O.R. Barham, Jr.

Yes, well, first of all, we're not Nevada, we're not Florida, and we're not the Rust Belt. Overall, I mean in Virginia, it's not bad. I mean we are holding up, as you would even see on the national news reports, relatively well. Again, I emphasize job growth drives residential demand, and so we still enjoy some of that, not as vigorous as it has been, but feel pretty good other than the pocket around Smith Mountain Lake, which is going to take a little longer for us to work through some of those credits.

Steve Moss

Okay, thank you.

Operator

For our next question, we go to Michael Rose with Raymond James.

Michael Rose – Raymond James

Hi. Good morning. I was wondering if you could discuss trends in your early-stage delinquencies, you know, loans 30 days, 90 days past due, and any trends on your watch list?

O.R. Barham, Jr.

Overall, our past due ratio was just a little over 1.4% at the end of June. Actually, on a trend line, that's an improvement from what we saw a couple of months ago, though having said that, my expectation would be that we'll continue to see that probably inch up, but we're staying on top of it and working it extremely hard. As you would expect, the biggest delinquencies that we're seeing are in the A&D area, which is running a little over 2% overall. On a very small portfolio of about 20 million in indirect paper, which is dealer paper, we've seen quite a bit of past due, a little over 3%, in that category, but again, it's a small part of our portfolio.

But, overall, with the exception of A&D and the aspect of the dealer paper, those are the two biggest bumps in the road as far as past-dues. We are not seeing it in the home equity area. You keep – you know, a lot of discussions floating around about home equities, and we're watching that very closely, but we have not seen that in our home equity, and generally, in our consumer loan portfolio so far, nor have we seen it in the commercial portfolio so far. So the contagion relative to the sub-prime market that we all hear and have heard so much about, we haven't seen that contagion spreading yet, and we'll – that will be something, obviously, that we'll keep a close eye on as we go into third and fourth quarter. But so far as we sit here today, no issues on those fronts.

Jeffrey Farrar

The watch list has trended up some, and that's a direct result of the acquisition and development portfolio.

Michael Rose – Raymond James

Okay. And, secondly, you mentioned that the deposit growth in the quarter was largely the impact of moving the commercial paper suite product back on your balance sheet. Can you net that out and kind of give us a sense for what kind of impact do you have or feel the initiative had on non-interest-bearing deposits this quarter?

Jeffrey Farrar

Well, I can tell you that core deposits, netting out the impact of the commercial paper, in aggregate, was down about $30 million. A large part of that was related to CD repricing. As you may recall, we had a large amount of CDs repricing during the quarter and actually feel pretty good about how much of that we were able to retain because we were repricing a lot of that down as much as 200 basis points.

So I would tell you that we're pretty pleased with the growth in non-interest-bearing deposits and DDA, both in terms of number of accounts and dollars. I don't have the dollars in front of me right now to quote. I can certainly follow up on that, but I think what you'll see is some nice growth in those line items.

Michael Rose – Raymond James

Great. Thank you very much.

Operator

We go next to Cary Morris with Scott & Stringfellow.

Cary Morris – Scott & Stringfellow

Morning, Ed. Good morning, Jeff.

Jeffrey Farrar

Hey, Carrie.

O.R. Barham, Jr.

Morning.

Cary Morris – Scott & Stringfellow

Could you guys help us just understand. Obviously, Jeff, you're talking about the loans and what your portfolio's doing, but you've recently just lost someone in the Fredericksburg market, and just kind of tell us what you're going to do there to replace that particular asset or human resource, so to speak, and how you look to proceed further.

O.R. Barham, Jr.

I assume you're talking about the loss of Ron Davis?

Cary Morris – Scott & Stringfellow

Yes, sir.

O.R. Barham, Jr.

Okay. All right. You want to take that?

Jeffrey Farrar

Yes, sure. Well, I'll speak to Fredericksburg first. We're really excited about the addition of a commercial lender in that market, but I don't think we're quite ready to announce who at this point. So I can't give you a name, but we've added a lot of bench strength there in Fredericksburg in the commercial arena and continue to have a nucleus of folks there that we feel good about. I think that we're well positioned, if you will, for the Fredericksburg market to continue and grow that market.

We'll open another branch there on Plank Road by the end of the year, a former Wachovia branch that is a great site for us, and we're real excited about, which will give us real good coverage along that Route 3 corridor as you head back toward Culpeper. So that market, I think we feel real good about and more to come in terms of who that individual is, but he is a household figure in that market with a large bank in that market.

O.R. Barham, Jr.

Yes, someone we've been trying to recruit for several years and finally were able to bring him on board. And he is onboard at this point, so more to come on that. But back on the loss of the person that we had there, that individual really didn't carry much of a portfolio, so what we've really done here is picked up somebody that has a huge following in the Fredericksburg market, and in particular, I might add, in the medical community, which is an area that we really want to focus and penetrate more over time.

And I will add we were fortunate enough to bring on board on our trust business Ken Whitescarver, who's a native of Fredericksburg, who started in the trust department there for National Bank of Fredericksburg years ago. And he is in that market, working in that market as we speak, as well. So we feel that this particular individual that we just added on the loan side and Ken Whitescarver 's presence really has added some strength in that market and should do good things for us over time.

Cary Morris – Scott & Stringfellow

Great. Thanks a lot.

O.R. Barham, Jr.

You're welcome.

Operator

(Operator instructions) We go next to Bryce Rowe with Robert W. Baird.

Bryce Rowe – Robert W. Baird

Thanks. Good morning, guys.

O.R. Barham, Jr.

Morning.

Bryce Rowe – Robert W. Baird

Ed and Jeff, could you guys speak to the auction process experience, assuming you've had one with some of the OREO?

O.R. Barham, Jr.

We really haven't had much auction experience at this point. I will tell you that we have some auctions teed up in the latter part of August, and we feel pretty good about what we are hearing. In fact, we've – one party, they were very anxious to get to us first, and we worked out a situation with the auctioneer to go ahead and sell some property, parts of a development off to some individuals who wanted to pick up several lots in this particular development. So anyhow, we haven't had the experience yet, Bryce, so we'll talk to you about it in September and let you know how it goes.

Bryce Rowe – Robert W. Baird

Okay. And one more question for you, Jeff. It's more related to the merger cost. In the first quarter, you talked about specifically where those merger-related costs fell on the income statement. Could you do the same for the second quarter?

Jeffrey Farrar

Yes. The difference in second quarter versus first quarter is that we really had, what I'll call direct merger integration expenses, and so they're all encaptured, if you will, in the other category.

Bryce Rowe – Robert W. Baird

Okay. Okay, that's great. Thanks, guys.

Jeffrey Farrar

You're welcome.

Operator

(Operator instructions) And with a follow-up, we return to Jennifer Demba with SunTrust.

Jennifer Demba – SunTrust

Thank you. Jeff, I was just wondering if you could update us as to all your capital ratios at the end of June.

Jeffrey Farrar

Still kind of refining the calculations, Jennifer, so I don't have the ratios for you today. I think you'll see that given the contraction in the balance sheet and the fact that we did have net earnings net of dividends growth in equity, that they'll be slightly increased from first quarter.

Jennifer Demba – SunTrust

Thanks.

Operator

And with that, ladies and gentlemen, we have no further questions on our roster. Therefore, Ms. Caldwell, I'll turn the conference back over to you for any closing remarks.

Linda Caldwell

Thank you, Rufus. Everyone, thank you for joining us and for your questions today. We truly appreciate your participation. And there are no further remarks from our two gentlemen here, this concludes our conference call.

Operator

And again, ladies and gentlemen, this does conclude the StellarOne Corporation's earnings conference call. We do appreciate your participation, and you may disconnect at this time.

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