TrustCo Bank Corp NY (NASDAQ:TRST) Q3 2018 Earnings Conference Call October 23, 2018 9:00 AM ET
Robert J. McCormick – President and Chief Executive Officer
Mike Ozimek – Chief Financial Officer
Scot Salvador – Chief Lending Officer
Alex Twerdahl – Sandler O’Neill
Good morning, and welcome to the TrustCo Bank Corp Third Quarter 2018 Earnings Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]
Before proceeding, we would like to mention that this presentation may contain forward-looking information about TrustCo Bank Corp New York 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 Statements 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 this event is being recorded.
I would now like to turn the conference over to Mr. Robert J. McCormick, President and CEO. Please go ahead.
Robert J. McCormick
Good morning, thank you for joining us today to find out a little more about our Company’s third quarter results. Joining me on the call this morning are Scot Salvador, our Chief Lending Officer; and Mike Ozimek, our Chief Financial Officer. It’s unfortunate to start on a somber note, but we would be remiss if we didn’t talk about Kevin Timmons, who most of you knew at least by name. We lost Kevin this quarter. He was a wonderful person who did a lot for our company and always had the shareholders interest at heart. He was a family man, a good person and a friend, and we certainly miss him very much.
We had a solid quarter at the bank. Our net income for the quarter was about $15.2 million, up significantly over the same quarter last year. We continue to operate 148 full-service branch offices. Our ROA and ROE both showed improvement over the same quarter last year to 1.24% and 12.84%, respectively. Our efficiency ratio was flat quarter-over-quarter and up slightly over the same quarter last year, ending this quarter at 53.4%. We continued to show margin expansion to 3.35%, up quarter-over-quarter and better than the same quarter last year.
Capital ratios and asset quality ratios were all improved this quarter, both over last year and last quarter. Our allowance for loan losses is at 1.17% with a coverage ratio of 1.9 times. Our loan portfolio continues the pattern of solid growth, the only category not up year-over-year as home equity lines of credit. We believe at least part of this runoff is being captured in our residential mortgage loan portfolio.
Our total deposits are up over the same quarter last year but down quarter-over-quarter. As previously discussed, we are doing what we feel we have to with regard to deposit growth, trying to maintain some pricing discipline. We are becoming a little more aggressive in the deposit area with a focus on core growth. We continue to operate a full-service financial services department. Now Mike will detail the numbers. Scot will talk about the loan portfolio. Then we can respond to any questions. Mike?
Thank you, Rob, and good morning, everyone. I will now review TrustCo’s financial results for the third quarter of 2018. As we noted in the press release, the company saw an increase in net income to $15.2 million, up 20.7% compared to $12.6 million for the third quarter of 2017. Net income yielded a return on average assets and average equity of 1.24% and 12.84% compared to 1.02% and 11.06% in the third quarter of 2017. On December 22, 2017, the Tax Cuts and Jobs Act was signed into law, which included a reduction in the federal statutory corporate tax rate from 35% to 21%, effective January 1, 2018. The lower tax rate continues to have a significant beneficial impact on the results going forward.
Now on to changes in the balance sheet. Strong loan growth continued during the quarter – third quarter of 2018. Average loans were up $241.7 million or 6.8% for the third quarter of 2018 compared to the same period in 2017. As expected, the growth continues to be concentrated within our primary lending focus, the residential real estate portfolio. That portfolio increased by $253.8 million or 8.4% in the third quarter over the same period in 2017. This continues the positive shift in the balance sheet from lower-yielding overnight investments to higher-yielding core loan relationships. The loan portfolio expansion was funded by a combination of utilizing a portion of our cash balances and cash flow from our investment portfolios.
Total average investment securities, which included the AFS and HTM portfolios, decreased $70.7 million or 11.2% from the third quarter of 2017. As discussed in prior calls, our focus continues to be on traditional lending and conservative balance sheet management, which has continued to enable us to produce consistent high-quality reoccurring earnings. Our investment portfolio is and has always been a source of liquidity to fund loan growth and provide flexibility for balance sheet management.
Keeping in mind the current environment that has seen four rate hikes in the past 12 months with a likelihood of more to come. As a result, we continue to hold an average of $486.6 million of overnight investments during the third quarter of 2018, a decrease of $135.3 million compared to the same period in 2017, which as noted earlier was used to partially fund loan growth.
In addition, we expect the cash flow from the loan portfolio to generate between $350 million and $450 million over the next 12 months, along with approximately $80 million to $90 million of investment securities cash flow during the same time period, all of which would be able to be invested in higher rates.
This continues to give us significant opportunity and flexibility as we move into the fourth quarter of 2018. During the quarter, we did have $16.7 million of securities that paid down or matured at a yield of approximately 2.25%. This was offset by purchases of $1.1 million of securities at a yield of approximately 3.45%. On the funding side of the balance sheet, total average deposits increased $47.3 million or 1.13% for the third quarter of 2018 over the same period a year earlier.
During the same period, our total cost of interest-bearing deposits increased to 51 basis points from 34 basis points. More importantly, the cost of our core deposits, including demand, remained relatively unchanged also over the same period. The exception being an increase in money market cost to 42 basis points from 35 in the preceding quarter. We continue to be proud of our ability to control the cost of our interest-bearing deposits during a period which saw multiple rate hikes. We feel this continues to reflect our pricing discipline with respect to our CDs and non-maturity deposits.
Over the next 12 months, approximately $927 million in CDs will mature at an average rate of 1.32%. Our net interest margin increased to 3.35% from 3.26% compared to the third quarter of 2017. This increase in net interest margin comes from the asset side of the balance sheet as a result of the continued growth in the loan portfolio and the Fed rate hikes as mentioned before, offset by the increase in funding costs over the past four quarters.
The impacts of the growth in the balance sheet coupled with the changes in net interest margin continued to have a positive impact on the taxable equivalent net interest income. Our taxable equivalent net interest income was $40.5 million for the third quarter of 2018, an increase of $1.3 million compared to the same period in 2017. The provision for loan losses held steady at $300,000 in the third quarter of 2018 compared to the first and second quarter of 2018 and down from $550,000 compared to the same period in 2017. The ratio of loan loss to total loans was 1.17% as of September 30, 2018, compared to 1.23% at the same period in 2017, and reflects continued improvement in asset quality and economic conditions in our lending areas.
Scot will get into the details; however, as in the past, we would expect a level of provision for loan losses in 2018 will continue to reflect the overall growth in our loan portfolio, trends in loan quality and economic conditions in our geographic footprint. Non-interest income came in at $4.5 million for the third quarter of 2018, a slight decrease of $40,000 compared to last quarter. Our Financial Services division continues to be the most significant recurring source of non-interest income. The Financial Services division had approximately $886 million of assets under management as of September 30, 2018.
Now on to non-interest expense. Total non-interest expense net of ORE expense came in at $24 million, up slightly compared to the second quarter of 2018. One item of note, FDIC and other insurance expenses now at its expected level. ORE expense came in at $528,000 for the quarter, which is up $234,000 from the second quarter of 2018. This increase was largely attributable to one commercial ORE property charge-off during the quarter of $170,000. Given the current level of ORE expenses, we’re going to hold the anticipated level of expense in the range of approximately $100,000 to $600,000 per quarter.
All the other categories and non-interest expense are in line with prior quarters and our expectations for the third quarter. As we close our 2018, we would expect the fourth quarter 2018 total reoccurring non-interest expense, net of ORE expenses, stay in the range of $23.9 million to $24.4 million per quarter. The efficiency ratio in the third quarter of 2018 came in at 53.39% compared to 52.79% in the third quarter of 2017. As we have stated in the past, we will continue to focus on what we can control by working to identify opportunities to make the processes within the bank more efficient.
And finally, the capital ratios continued to improve. Consolidated tangible equity to tangible assets ratio was 9.76% at the end of the third quarter, up from 9.33% compared to the same period in 2017. Now Scot will review the loan portfolio and non-performing loans.
Thanks, Mike. As Rob and Mike stated, the bank continue to enjoy strong loan growth for the third quarter of 2018. For the quarter, total loans increased by $85 million in actual numbers or 2.27%. This was up from a 2% increase in the second quarter. Virtually all the growth was in our residential portfolio with commercial loans remaining level. All our regions posted net increases on the quarter with our growth equating to a year-over-year rise of just under 7%. Refinance activity remains at relatively low levels while purchase money business continues to be solid overall.
Mortgage interest rates have climbed by about 0.5% over the last quarter. Currently, we are originating at [indiscernible] for 30 years. Although loan activity typically begins to slow a bit as we enter the fall season, overall originations have been good despite the increasing rates. The loan backlog at quarter-end was about 15% below last year’s, which included a bit more of refinance activity and above that of the prior September.
Non-performing loan and asset quality measures continue to show improvement despite already being at strong levels. Non-performing loans decreased to $23.8 million on the quarter from $24.1 million in June and $24.6 million a year ago. Non-performing assets were $26.1 million at September 30 versus $26.7 million in June and $27.5 million a year ago. Early-stage delinquencies continue to track at low levels, as do loan charge-offs. For the quarter, net loan charge-offs amounted to only $67,000 in total or 0.01%. The coverage ratio or allowance for loan losses to non-performing loans now stands at 188% versus 179% a year ago. Rob?
Robert J. McCormick
Thanks, Scot. We are happy to answer any questions you have.
We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Alex Twerdahl with Sandler O’Neill. Please go ahead.
Robert J. McCormick
Good morning, Alex.
Good morning, Alex.
First off, I was extremely saddened to hear Kevin’s passing and I’m sorry for your loss.
Robert J. McCormick
Just a couple of questions on the quarter. One, it seems like you did utilize a fair amount of the cash and liquidity in the third quarter to shield the NIM in the wake of these higher funding costs. How should we think about the management of cash and liquidity going forward? Just – is it to manage your margin level? Is it to manage your EPS number, just kind of in the wake of assuming that funding pressures are only just beginning here?
Robert J. McCormick
Yes. I mean a little bit of everything, Alex. We’re doing what we have to do with regard to funding the loan growth. And that’s why we’ve had the cash all the time we have had it. So any margin expansion we can have to support the earnings of the company to provide a good return for our shareholders is what we’re looking to do.
Okay. And then Mike, I just – I missed what you said on the CD pricing over the next quarter or next year, whatever the metric was that you gave?
Sure. So over the next 12 months, approximately $927 million in CDs will mature at an average rate of 132.
Okay. And then can you just talk about in terms of the deposit strategies that you have in place and sort of what we’ve seen over the last couple of quarters, it seems like you’ve been extending out duration a little on CDs and really lagging behind on raising rates in some of the core products. But now as we kind of gone to a point where a lot of your competitors are starting to see betas pick up for the first time, how do you look at some of these different strategies? And how aggressive do you feel like you need to be on deposits today to make sure that this funding liquidity going forward?
You can see the money market is really where a lot of the runoff has come, Alex. And certainly, money market has become very, very competitive across all of our market area. So we’ve been looking at that product and seeing how we can change things. We’ve raised ours a little bit already, so the cost of money markets has risen here, but not near in comparison to what some of our competitors are doing. So we’re trying to walk that fine line between retaining what we have and growing it and not getting crazy.
Do you think we’re at the point now where you need to raise rates to keep that balances basically at least flat or growing? Or is there still enough room given the amount of liquidity you have in the balance sheet, et cetera, to kind of let the balances go down a little bit in order to preserve the lower rates?
Robert J. McCormick
No. You’re certainly seeing rates rise on a slow basis year. There’s no question about it. The world is in a rising rate environment. Thankfully, we’ve been able to raise our mortgage rate, though, and sustain the backlog and the volume that we’ve had. So having the [indiscernible] mortgage rates plus some of the cash investments, the return has increased on the cash investments will hopefully would be able to pay for increasing deposit rates.
Okay, great. And then just a final question. As I look at your capital levels, they’ve kind of been building for 10 years now. You’re now almost pushing 10% TCE to TA. The lower tax rate means you’re accreting capital faster. I mean, is there any – as you kind of look at the capital management, I know you increased the dividend a little bit recently. How should we think about managing to a specific level of capital and weighing things like dividends, buybacks, accelerated growth, leverage, all those different things as we look into 2019?
Robert J. McCormick
We’re certainly looking at all of the above. We did the dividend increase because we thought the – a lot of our shareholders were in it for the dividend, you know that. So we thought with the rates rising, it was a good idea. And we also thought that everybody talked about spending the money that you got from the tax break. But we thought that shareholders should also get a return from the enrichment we got from the tax break. So that was kind of the dividend increase. But we look at all of the other items on a regular basis. And certainly with the increased capital level that we have, all of them are more on the table than they were in the past.
Okay, great. Thanks for taking my questions.
Robert J. McCormick
This concludes our question-and-answer session. I would now like to turn the conference back over to Robert McCormick for any closing remarks.
Robert J. McCormick
Thank you for your interest in our company and have a great day.
The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.