TrustCo Bank Corp NY (NASDAQ:TRST) Q2 2016 Earnings Conference Call July 22, 2016 9:00 AM ET
Robert McCormick - President and Chief Executive Officer
Michael Ozimek - SVP and Chief Financial Officer
Scot Salvador - EVP and Chief Banking Officer
Alexander Twerdahl - Sandler O'Neill
Good morning, and welcome to the TrustCo Bank Corp Second Quarter 2016 Earnings Call and Webcast. [Operator Instructions]
Before proceeding, we would like to mention that this presentation may contain forward-looking statements, and forward-looking information about TrustCo Bank Corp NY and that is intended to be covered by the Safe Harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995. Actual results and trends could differ materially from those set forth in such statements due to various risks, uncertainties and other factors.
More detailed information about these and other risk factors can be found in our press release that preceded this call, and in the risk factors and forward-looking statement sections of our Annual Report on Form 10-K and as updated by our Quarterly Reports on Form 10-Q. The statements are valid only as of the date hereof, and the company disclaims any obligation to update this information, except as may be required by applicable law.
Today's presentation contains non-GAAP financial measures. The reconciliations of such measures to the most comparable GAAP figures are included in our earnings press release, which is available under the Investor Relations tab of our website at trustcobank.com. Please also note today’s event is being recorded.
I would now like to turn the conference over to Mr. Robert J. McCormick, President and CEO. Please go ahead, sir.
Thank Rocco. Good morning everyone. As the host said, I'm Rob McCormick, President and CEO of the Bank. As usual I am joined by our CFO, Mike Ozimek; and our Chief Banking Officer, Scott Salvador. Also in the room is Kevin Timmons, who a lot of you deal with regularly.
Our plan is the same as always. I will give a brief summary, Somebodythen turn it over to Mike Ozimek to detail the numbers, and Scot Salvador with the operations, especially our loan portfolio. This will leave time for questions you may have.
Our loan growth has been very good. We ended the quarter at $3.34 billion. That is up about $100 million year-over-year. We have seen some seasonality return to residential mortgage lending. We have built a decent backlog, which Scott will touch on later in the call.
As already stated, our loan growth was impacted by $11 million of [loans] [ph] outstandings in our commercial loan portfolio. As we talked about before, we are seeing some very aggressive lenders in the areas we serve as both rates and standards. We are working with our existing customers and taking a cautious approach to this lending segment.
Our asset quality remained strong. Nonperforming assets fell by 5.7 million year-over-year resulting in a nonperforming asset ratio of 0.68% compared to 0.81% a year ago. Nonperforming loans also showed improvement as did early stage delinquencies and charge-offs.
We continued to grow our deposit base to $4.180 billion. We are encouraged with our core growth and our average deposits per branch continuing to grow and show improvement. We didn't open any branches this quarter. As a matter of fact we closed one of our Union Street branches earlier in the year. The building has been sold and the closing took place in early July. It is just a good opportunity for consolidation.
Our return on average assets was 0.88%. Our return on average equity was 9.88%. Our margin quarter-over-quarter was down a little to 3.09, but that is actually better than 2015. We continue to maintain a strong loan loss allowance with solid coverage ratio, which also showed continued improvement.
Our efficiency ratio was 57.7%, higher than we like, but better than most. Certainly the cost of compliance is a factor. Our tangible equity ratio has shown steady growth growing in this quarter to 8.9%. We are operating under a formal agreement I think most of you know that with the OCC. While not a lot can be discussed, we are moving forward with lot of validations and are optimistic we will emerge a better company.
Say on Pay did not receive enough votes to pass this year’s proxy. Our Board compensation committee has taken this under review. As a matter of fact it was released last night about our clawback policy. Most of you know we maintain a relatively large investment portfolio with a very strong liquidity position. Banking is certainly a challenging environment. We feel our company is well- positioned to deal with whatever is thrown at us.
We are very optimistic about the future of our company. Now I'm going to turn it to Mike to detail the numbers.
Thank you, Rob. I'll now review TrustCo's financial results for the second quarter of 2016. Despite the continued added operating expenses in response to recent regulatory concerns, earnings continued to be solid. Net income was $10.5 million in the second quarter of 2016 compared to $10.4 million for the prior quarter.
For the second quarter our net interest margin was 3.09%, up from 3.07% in the second quarter of 2015, resulting in an increased taxable equivalent net interest income of $36.3 million in the second quarter of 2016 compared to $35.7 million in the same period of 2015. The average loan portfolio increased to $3.3 billion during the second quarter of 2016, an increase of $100.2 million on average or 3.1% over the same period in 2015. The sustained growth continues to be concentrated in the residential real estate portfolio. This also continues a positive shift in the balance sheet from lower yielding investments to higher yielding core loan relationships.
Total average investment securities increased during the second quarter of 2016 by $58.9 million or 9.1% on average from the first quarter of 2016. This was the result of investment purchases of approximately $115 million in a mix of agency and mortgage-backed securities, prominently during the first half of the quarter. We also had $20 million of agency securities called during the latter half of the quarter. And finally when rates dropped as sharp as they did at the end of the quarter, we took the opportunity to sell approximately $45 million of mortgage-backed securities for a gain of $668,000.
On the deposit side, we continue to be successful in increasing balances throughout our branch franchise. Total average deposits for the second quarter were $4.2 billion, and our cost of interest bearing deposits decreased to 38 basis points from the quarter, which continues to reflect our pricing discipline with respect to CDs and non-maturity deposits while average core deposits increased $47 million, when compared to second quarter of 2015.
Our average balance of overnight investments was [$668 million] [ph] for the second quarter of this year, down $7.2 million from the average balance in the first quarter of 2016. In addition to the liquidity that is on our balance sheet in the current rate environment, we continue to expect that we will have between $300 million and $500 million of loan payments coming in over the next 12 months, along with approximately $200 million of investment securities cash flow during the same time period. This continues to give us opportunity and flexibility during the remainder of 2016.
Our provision for loan losses has remained level at $800,000 in the first and second quarter of 2016 compared to $1.3 million in the fourth quarter of 2015, and is in line with the first three quarters of 2015.
Asset quality and loan loss reserve measures improved over the first quarter of 2016 and the second quarter of 2015. Nonperforming loans to total loans was 0.84% at June 30, 2016 compared to 1% at June 30, 2015. The continued reduction in nonperforming loans is the result of a combination of continued efforts to collect or dispose of them [Indiscernible] at the end of the second quarter of 2016. As a result, we expect the level of the provision for loan losses in 2016 will continue to reflect the improving credit quality of the portfolio and economic conditions in our geographic footprint and the ongoing efforts to resolve our existing problem loans.
Non-interest income net of securities gains came in at $4.5 million for the second quarter, virtually unchanged compared to the $4.6 million in the first quarter of 2016 and $4.5 million in the same period last year. The most significant recurring source of non-interest income is derived from our financial services division. Our financial services division had approximately $851 million of assets under management as of June 30, 2016.
Now onto non-interest expense. Total non-interest expense came in at $24 million, up $535,000 from the first quarter of 2016. During the second quarter of 2016, salaries and benefits expense was $8.9 million, up $770,000 compared to the same period of 2015, and down slightly compared to the first quarter of 2016. Something we have discussed in prior calls, we have now seen an increase in the salary and benefits expense line as new hires begin the process of replacing the consultants. We would expect to see this trend continue during 2016 and into 2017.
Other expenses returned to the expected level of $2.8 million, up from $1.9 million in the first quarter of 2016 and flat compared to the $2.8 million in the same period of 2015.
We continue to expect the estimated total annualized cost of implementing the recommendations in the agreement will be approximately $5 million annually. These added costs reflect the company's continued investment in additional personnel and systems within the retail loan, deposit and regulatory compliance areas. We will continue to experience increased professional services expense during 2016 and into the beginning of 2017. The good news these costs have leveled off as we complete the implementation of the requirements of the formal agreement.
ORE expense came in at $423,000 for the quarter, which is down from last quarter and has stayed consistently within our expectations for the last five quarters. We continue to expect ORE expense to stay in the range of approximately $500,000 to $1 million per quarter going forward. All the other categories of non-interest expense are in line with prior quarters and our expectations. Going forward, we would continue to expect that total reoccurring non-interest expense net of ORE expense to be in the area of $23 million to $23.5 million per quarter.
Our efficiency ratio continues to be strong, despite the increased cost discussed earlier. As always we will focus on what we can control by working to identify opportunities to make the processes within the bank more efficient. Second quarter of 2016 came in at 57.7%, up from the first quarter’s 56.22%.
As noted in prior calls, second quarter numbers continue to be negatively affected by our decision to retain a large amount of overnight investments and the increased costs associated with implementing the recommendations of the agreement. I would expect the efficiency ratio to end 2016 in this range.
And finally, the capital ratios continued to improve. Consolidated tangible equity to tangible assets ratio increased to 8.9% at the end of the second quarter, up from 8.48% compared to the same period in 2015.
Now, Scot will review the loan portfolio and non-performing loans.
Okay, Mike, thanks. Total loans for the first quarter increased $42 million or 1.3%. Year-over-year the portfolio was up $100 million or 3.1%. Growth in the quarter included $45 million of residential loan growth, with commercial loans down approximately $3 million. The growth in the quarter was centered in our 30-year and fixed rate products with the home-equity lines of credit down approximately $4 million.
Our upstate New York region strengthened on the quarter and accounted for approximately $22 million of the net growth. We were pleased at the increased mortgage activity we noted at the end of last quarter carried over and translated into net growth of almost 1.5% for the residential portfolio in the second quarter.
Our current backlog remains solid, ahead of 3/31 and the same point last year. Although activity typically slows a bit in the summer months and interest rates remain a question, we would expect to post continued net growth on the quarter.
Our current 30-year fixed rate is 3.49%, down slightly from preceding weeks with the recent drop in interest rates. Nonperforming loans stood at $28.2 million at quarter-end, down from $30.3 million at 3/31 and $32.5 million as of June 2015. Included in these totals is a loan sale of approximately $1.2 million on the quarter.
Nonperforming assets decreased from $36 million to $32.8 million on the quarter. Almost all asset quality indicators showed continued improvement on the quarter, although we expect the pace of improvement to slow as problem loans reach increasingly lower levels.
Early-stage delinquencies are very strong in all regions. The coverage ratio of allowance for loan losses to nonperforming loans now stands at 156% versus 146% in March and 140% in June 2015. Net charge-offs of 1.1 million in the quarter were lower than any of the preceding four quarters. Rob?
Thanks, Scot. We will be happy to answer any questions you might have.
Thank you. [Operator Instructions] Our first question today comes from Alex Twerdahl of Sandler O'Neill. Please go ahead.
Good morning guys.
Good morning Alex.
Good morning Alex.
First of Scot, I missed your commentary on the pipeline at 6/30 versus the previous quarter as well as the year-over-year.
Yes, Alex, we are ahead of the previous quarter and year-over-year. Year-over-year we are up a little more than 10%. Quarter-over-quarter we are actually up more than that. But that is a little deceiving I think because last quarter just really ramped up right at the end of the quarter itself. So that might be a little deceiving. But year-over-year we are up a little more than 10%.
And is that – I mean do you correlate that to the drop in interest rates at the very end of the quarter or is it kind of been throughout the quarter the pipeline has been building?
It was a good quarter throughout. If you remember last quarter we mentioned that towards the tail end of the first quarter things started to pick up, and it basically carried through the quarter. We had a pretty steady solid quarter Alex.
Okay, great. And what is the rate on new production today?
3.49% for 30-years.
3.49% and so is that – I mean, is there a floor on the yields that you guys will offer given what has gone on with the 10-year treasury, it is certainly at where we hope to be low but if it goes – suppose a tenure went down to 1%, does the rate on the yield on the loans go down with it or is there a floor at some point?
Well, I mean, obviously we’re competitively driven and market-driven and we're in the mortgage business, but on the flipside Alex I think a very positive note as we have proven I think for a very long time now that we don't have to be the lowest rate in town to get business. So, we are going to watch our margins, we are going to watch the competition and do what we need to do, but again we don't have to be the lowest rate around to get business.
Okay, and then how do you guys think about – when you think about the sort of the characteristics of your loans historically I think you said your 30-year mortgages roll off in something like eight years on average. But given this historically low rate environment, do those projections and assumptions change in your model in terms of your interest rate risk outlook?
We haven’t seen a big change in that number Alex. It is about 7.5 years – 7.5 to 9 years depending on the month. There has been some extension, but nothing that is significant or really even worth mentioning at this point. So, it is a $3.3 billion behemoth that moves like a dinosaur and it takes a lot of origination to move that either way. And consumer habits, I think we have talked about on the call before, consumer habits certainly haven't changed and we haven't seen people sticking with the mortgages because of that. They still want the – they still want the new bathrooms, and they get divorced and all of those things. And you also have to remember our average loan balance is probably a little lower than our peer group too.
Okay, that is good. And then, the loan sale that you mentioned at the end of the second quarter, is that a non-performing loan sale?
And what happens is you get – yes, you want to answer? What happens is a lot of times impaired loans you have to keep them nonperforming for a very long period of time. So if there is an opportunity for the life of the loan. If there is an opportunity to unload them at a decent price Alex, we take advantage of it. We are not burdened with it. We have done it several times in the past.
And then just finally, with respect to deploying your excess cash and obviously the rate environment doesn't make that any easier, but has anything changed in the strategy or the pace in which you will deploy or put money to work to either shield the margin or shield the NII et cetera?
I think we are spending more time on our deposit pricing, and looking for opportunities in our CD portfolio, and as far as the investment portfolio goes we are trying to stay as short as we possibly can, and not getting crazy on that. If you have held the trigger for as long as we have, we certainly don't want to blow it at the end of what appears to be the end of a cycle.
When we look at it, the reality is the loan portfolio is still – we have said it before, but the loan portfolio is still the best place to put the money. When you look at last quarter, we did deploy north of $100 million into the investment portfolio. So, we are in the market, but just what Rob said, we are not looking to go too far in right now, which is probably the model.
Your question about floor earlier, Alex, was perfect, because if Cushing and my father were here they probably would have said 7%. It shows that the world has changed.
The world has changed. Thanks for taking my questions guys.
[Operator Instructions] Showing no further questions, I like to turn the conference back over to Mr. McCormick for any closing remarks.
Thank you for your interest in our company and have a great day.
Thank you. Today’s conference has now concluded and we thank you all for attending today's presentation, and you may disconnect your lines and have a wonderful day.
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