Integra Bank Q3 2007 Earnings Call Transcript

by: SA Transcripts

Integra Bank Corp. (OTC:IBNK) Q3 2007 Earnings Call October 16, 2007 9:00 AM ET

Executives

Michael Vea - President and CEO

Martin Zorn - EVP and CFO

Ray Beck - EVP and Chief CreditOfficer

Analysts

Ross Demmerle - Hilliard Lyons

Daniel Cardenas - Howe Barnes

Operator

Good day, everyone and welcome tothe Integra Bank Corporation's Third Quarter 2007 Earnings Conference Call.Before we proceed, the company would like to note that statements made in thecourse of this conference call that are not based on historical fact areforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995.

The risk factors and cautionarystatements in the forward-looking statements are detailed in the company's filingswith the Securities and Exchange Commission and in the press release issued onTuesday, October 16, 2007.

The company makes no commitmentsto update any forward-looking statement based on any new information, futureevents or otherwise. Please note that a replay of this call will be availableuntil our next quarterly conference call through our website atwww.integrabank.com and by telephone at 888-203-1112, and put in your passcodeof 9473135.

Today's conference call will bepresented by Mr. Michael Vea, Chairman, President and Chief Executive Officerof Integra Bank Corporation, and other executive officers.

Following the presentation, wewill open this call to questions. And now at this time, I would like to turnthe call over to Mr. Vea. Please go ahead, sir.

Michael Vea

Thank you and good morning, andthank you joining us on Integra Bank Corporation's conference call for thethird quarter of 2007.

I am Mike Vea and with me todayare Martin Zorn, Executive Vice President and Chief Financial Officer; ArchieBrown, Executive Vice President, Commercial and Consumer Banking; and Ray Beck,Executive Vice President and Chief Credit Officer.

Our comments today will refer tothe financial information in our earnings announcements which was issued earliertoday. I will read the highlights from our third quarter results, ask Martin todiscuss the financial drivers in greater detail, ask Ray to provide additionalcolor around credit quality and then we will open the line to question.

The third quarter was anotherbusy quarter for us as we announced the signing of a definitive agreement toacquire Peoples Community Bancorp of Cincinnati, Ohio.

This is our second significantacquisition over the past 12 months to accelerate the transformation of thecompany. The resulting franchise is that of a metropolitan commercial bank witha significant community market funding base.

More importantly, the backgroundof our management team provides a high expectation for success in Cincinnati.Four of our executives already live in the market and have spent their bankingcareers in Cincinnati. In light of the fact that our management team hassignificant loan workout and metropolitan banking experience and marketfamiliarity, we are very excited about our opportunities in the Cincinnatimarket.

When we have met with investors,we have discussed our desire to build franchise value by growing, transformingand improving. This acquisition complements our de novo investments in themarket and will complement our core franchise in Evansville and our communitymarkets.

Additionally, we made goodprogress during the quarter on expanding beyond the niche business that Prairiehad in Chicago, by rolling out high performance checking and recruiting C&Ilenders in the market.

In addition to adding our Chicagobanking theme during the quarter, we were also able to enhance our Evansvillecommercial team by recruiting a senior banker and team leader with 20 years ofexperience in the market. This follows our recruitment of a new Evansville CommercialManager earlier this year, both of which came from the number one and numbertwo market share leaders. These moves are consistence with our strategy torecruit and build successful teams in our key markets.

We are pleased with the thirdquarter results considering the head wins that have profited the markets andthe industry.

Our net income increased 10.5%from the second quarter of 2007 to $9.2 million. Diluted earnings per sharewere $0.45 per share compared to $0.41 for the first and second quarters. Thethird quarter results included increases in net interest income of $1.1 millionand non-interest income of $500,000. Partially offset by increases in non-interestexpense of $400,000, provision for loan losses of $300,000 and an increase intax expense of $100,000.

Positive operating trendsincluded strong commercial loan growth, an improved earning asset mix, strongfees, controlled core expenses, and positive operating leverage. Weaccomplished this while maintaining stable credit quality as evidenced by ourlow level of net charge-offs.

Now, we will have Martin Zornprovide an update on our financial drivers.

Martin Zorn

Thank you, Mike. Commercial loanaverage balances increased $76 million, a 21.1% annualized growth rate. The strengthof the loan growth for the quarter is evident from the fact that Septembermonth-end balances were $70.6 million higher than the quarter's averagebalances and $104 million higher than June month-end balances.

Commercial loan growth occurredin all markets, especially in commercial real estate and Cincinnati commercial.Consumer direct loans grew $4.8 million or 12% annualized. Indirect consumerloans and residential mortgage loans declined by $7 million and $26.9 millionrespectively which was in line with our expectations and is in line with ourstrategy to de-emphasize these segments and improve our earning asset mix.

Core deposits excluding CDs andlow cost deposits, which we define as non-interest bearing DDA, now savings andclub accounts were stable quarter-to-quarter. As planned, we were able toreplace higher cost certificates of deposit that matured early in the quarterin Chicago with other sources of funds.

Additionally, we shifted fundingto more interest sensitive liabilities to reduce the assets interestsensitivity that resulted from the Chicago acquisition. The result in theimproved earning asset mix as well as funding shifts resulted in an improvementin our net interest margin of 12 basis points to 3.52%.

Based on the current forwardcurve, which has 50 basis points of cuts built into 2008, we are expecting ournet interest margin to be pretty stable through the remainder of the year. Weexpect to pick up some margin in the first quarter of '08 as a result of $65million of FHLB and brokerage CDs with the rate of 5.3% maturing, offset by thematurity of $65 million of long-term repurchase agreements with the rate of2.84% maturing in the second quarter.

During this quarter, we sold ourClass B MasterCard stock for a pretax gain of $1 million which was offset bylosses on the sale of securities of $800,000. We sold $15.9 million ofsecurities, which had a yield of 3.8% and an average life of 3.5 years. Wepurchased $17.6 million of securities with the yield of 5.45% and an averagelife of 3.1 years.

This was a prudent repositioningof our securities portfolio to reduce our interest rate risk. The repositioningwill add $0.01 to EPS over the next 12 months. Net charge-offs remain low at$712,000 or 13 basis points for the quarter and 17 basis points for theyear-to-date. Our provision for the quarter was $722,000 up $268,000 from lastquarter.

We will have Ray Beck, our ChiefCredit Officer, to provide additional color around credit quality.

Ray Beck

Thank you, Martin. Our loan portfoliocontinues to perform well during the quarter. As Martin mentioned, net loosesfor the quarter were low at 13 basis points with net losses for the year at 17basis points. Year-to-date net losses from our commercial portfolio are nominalat 6 basis points. Our losses from our residential and consumer portfolios arewithin expectations at 16 basis points and 33 basis points respectively.

We have seen an increase inlosses from overdrafts. However, an increase was expected with the growth inour high performance checking accounts over the past quarter. In addition, someof the increase in overdraft losses can be attributed to the transition processas we conform the recently acquired Chicago region to our Integra charge-offpolicies.

For the remainder of the year, weexpect net losses to continue to be moderate at approximately 20 basis points.Our outlook for 2008 is somewhat murkier, due to our expectation of anincreasing level of non-performing loans in our residential builder portfolioas I will discuss.

However, since the increase inNPLs is expected to be centered in secured loans to residential builders, weare not anticipating significant levels of charge-offs and at this point, weexpect approximately 25 basis points of net charge-offs during 2008.

We did experience an increase of$2.3 million in non-performing loans during the quarter, and our ratio ofnon-performing loans to total loans increased from 62 basis points at the endof second quarter to 70 basis points at the end of this quarter. Of the totalnon-performing loans, $10 million is in our commercial portfolio, while thebalance consists of homogeneous one-to four-family residential and consumerloans.

The increase in non-performingloans is tied largely to our residential builder portfolio, located primarilyin the Chicago area, and which consists of loans for the construction ofsingle-family residences and smaller condominium projects. As a result of thedownturn in the residential housing market, many of our builders are experiencinga significant slowdown in sales, and a corresponding increase in inventory.

Most of our builders haveweathered this storm to date. However, a few of our builders have defaulted onsome or all of their obligations. In each case, we are secured by residentialreal estate in the Chicago area, generally at a loan to value of 80% or lessand we do not anticipate any significant losses on those relationships in thenear term.

Despite the increase in totalnon-performing loans, the risk in non-performing loans continues to begranular. Only three non-performing loans exceed $500,000, and only one ofthese is in excess of $1 million, and just under $1.25 million. That loan issecured by residential real estate.

The second largest non-performingloan is under $625,000, while the third largest non-performing loan is under$525,000. Both of these loans also are secured. No other non-performing loanexceeds $500,000.

We expect to see a continuedmoderate increase in our level of non-performing loans centered in ourresidential builder portfolio, as we are not anticipating an upturn in theresidential market for at least the next 12 months.

For the fourth quarter, we wouldexpect the ratio of NPLs to total loans to be in the range of 75 basis pointsto 85 basis points. In addition, given our outlook for the residentialconstruction market for most of 2008, we would not be surprised to see NPLsgradually climb to a range of 90 basis point to a 110 basis points, excludingany impact from the pending merger with Peoples Community Bank.

The provision for the quarter was$722,000 and the allowance for loan and lease losses totaled $26.4 million or1.15% of total loans at September 30th, compared to $26.4 million or 1.19% oftotal loans at June 30th.

The reserve coverage ofnon-performing loans was 164% at quarter end, compared to a 192% at the end ofthe second quarter. The ratio of the allowance for loan and lease losses tototal loans declined due to the increase in total loans, which Martin mentionedearlier, while the decline in the NPL coverage ratio was due to the $2.3million increase in NPLs during the quarter.

We continue to be comfortablewith the level of our reserve for several reasons. First, as earlier discussed,the increase in NPLs was centered in builder loans secured by residentialproperties in the Chicago region and we believe each of these loans to beadequately secured. Second, the risk in our non-performing loans is granularwith only three non-performing loans in excess of $500,000.

Third, net charge-off levelcontinues to be lower than anticipated. Finally, as we continue to improve themix of our loan portfolio, we are adding new commercial loans which we believeto be of higher quality, while allowing lower quality consumer loans to decline.

For the remainder of the year,and into next year we would anticipate that the allowance will remain in therange of 1.12% to 1.15% of total loans depending upon the amount and type ofloan growth we experienced during the period.

Now, let me turn it back over toMartin.

Martin Zorn

Thanks, Ray. Our operatingleverage was a positive 3%, reflecting good core expense control, as well ascontinued growth in revenue. Non-interest income was $10.4 million whichincluded the $1 million gain on the MasterCard stock, offset by the losses onthe sale of the securities of $0.8 million.

Adjusting for these actions,non-interest income increased $200,000 or 2% from the second quarter. Depositservice charges were flat compared to the second quarter, but were 9% higherthan the previous year.

Debit card and annuity incomecontinue to post solid growth. Non-interest expense was $22.2 million, anincrease of 1.7% from the second quarter. Of particular note, personnelexpenses declined by 400,000. We expect total loans to grow around 3% to 5% inthe fourth quarter reflecting seasonal declines in agriculture andconstruction. We expect our net-interest margin to be stable for the end of theyear and expect positive operating leverage in line with the third quarter. Oureffective tax is expected to be between 24% and 25%.

During the quarter, we did notrepurchase any additional shares under our buyback program. As we look forward,we believe that we have solid growth prospects especially for commercial loans,a good dividend deal with a discounted valuation, stable credit and our stockrepresents a very good value at the current price.

Now, let me turn the call backover to Mike.

Michael Vea

Thanks, Martin. We remaincautious about the impact of the challenges facing our industry as a whole,especially slowing consumer growth and the credit cycle. We will not take onundue risk to stretch for earnings and with the benefit of another quarter weare revising our earnings guidance for the year to $1.72 to $1.74, which lowersthe high end of the range by $0.04.

We will now be happy to answerany questions. So Lisa, if you would please open the phone to questions.

Question-and-Answer Session

Operator

Thank you, sir. (OperatorInstructions). And we have a question from Ross Demmerle with Hilliard Lyons.Please go ahead.

Ross Demmerle - Hilliard Lyons

Hi. Good morning. The stockbuyback, I am wondering assets didn't curtail because of the pendingacquisition right now, and if and when you might be able to start that back upagain?

Michael Vea

Sure. Martin, do you want to takethat.

Martin Zorn

Sure. Good morning, Ross. Ross,you are correct. Since, we were negotiating with Peoples throughout the quarterthat in essence put us in a blackout from the buyback during the past quarters.As we look forward, Ross, what we will be doing is that we will be updating ourmodels, as it relate to our earnings and we expect Peoples going forwardearnings to be. And then what we will be doing is based on our level of capitaland the market conditions, we will buyback stock as both make sense from aneconomic standpoint to do so.

Ross Demmerle - Hilliard Lyons

Okay. So, you are not blackoutanymore? Okay.

Martin Zorn

We have the normal earningsblackout, but going forward what will happen is that we will have somerestrictions around our buyback once we begin the solicitation process for theshareholder/Board.

Ross Demmerle - Hilliard Lyons

Okay.

Martin Zorn

But outside of normal SECblackout, there is no restriction on our buyback.

Ross Demmerle - Hilliard Lyons

All right. Were there anynonrecurring expenses this quarter related to mergers?

Martin Zorn

No. There were not. All theexpenses that are reported are core and there weren't any nonrecurring onesrelated to the MNA activity.

Ross Demmerle - Hilliard Lyons

Okay. And then finally, yourrecent hires, are they under any kind of non-competes or are they going to beable to start production right away?

Michael Vea

Well, Ross this is Mike Vea. Wereally need to break that into markets. As you look at Chicago, we really don'thave non-compete or non-solicit situations up there. In Evansville andCincinnati primarily we've had non-solicit arrangements with those vendors. So,if you go back to 2003 when we hired the commercial real estate team they wereunder those, and the Cincinnati commercial team little over year ago they wereunder those and they are off now. So, there are non-solicit restrictions and wedo live by those but it's not any different than what we have experienced inthe other teams we've hired over the last three or four years.

Ross Demmerle - Hilliard Lyons

All right. Thanks for comment.

Michael Vea

Thank you.

Operator

(Operator Instructions). And wewill take our next questions from Daniel Cardenas with Howe Barnes.

Daniel Cardenas - Howe Barnes

Good morning. Martin, I guess mycoffee didn't kick in yet, but could you go through your prepared comments onyour net interest margin and what you expect to happen in the first and secondquarter?

Michael Vea

Sure. Dan, what we expect tohappen is really two things. In the first quarter, what we have is some higherrate relative to the current market rates of maturities in primarily FHLB debtand brokered CDs. Those currently have a rate of 5.3%. So, those will mature inthe first quarter and the result of those maturities and the ability to replacethose looking at forward curve, we will add a couple of debts in the firstquarter to the net interest margin.

In the second quarter, we have$65 million of long-term repurchase agreements. If you remember when we did thebalance sheet restructure, basically, we went in and put on four trenches offinancing that each had bullet maturities and this is the last of those thatwill mature that we put on four years ago, and that has a coupon rate of 2.84%.So, again, based on the forward curve, the repricing of those will basicallyoffset the gain that we had in the first quarter.

So, as we look out over the nextcouple of quarters, what we expect is basically a neutral net interest margin.We've got those refinancings and then what we have is a slight assetsensitivity in the balance sheet coming out of the Chicago merger, offset bythe forward yield curve. So, right now we're pretty comfortable with a prettystable interest rate margin over the next two to three quarters.

Daniel Cardenas - Howe Barnes

Just regarding your constructionportfolio, how recent are the appraisals on that portfolio in general?

Ray Beck

Dan, this is Ray Beck. Thatobviously is going to depend upon the particular transaction. But, by and largewithin the last few years, when we have had properties repriced in Chicago,we've not seen any significant decrease in value in those appraisals. We haveseen some decrease in the value of condominium projects, primarily due to thediscount factor used. But the core value or the underlying value of the assetsto-date, we've not seen much deterioration.

Daniel Cardenas - Howe Barnes

Great. Thank you.

Operator

And I would like to turn theconference back over to Mr. Vea for any additional or closing remarks.

Michael Vea

Sure. Thank you, Lisa. So, inconclusion, we believe we're well positioned to continue to execute and deliveron our promises for 2007 to our customers, employees and shareholders. We werepleased with our double-digit earnings increase, and solid loan growth, andcontinued growth in the number of customers.

We hope we answered yourquestions regarding credit quality and we believe we are well positionedheading into the fourth quarter. So, we appreciate your continued interest inIntegra Bank Corporation. Thank you for joining us today. Have a great day.

Operator

And that concludes today'steleconference. Thank you for your participation and you may now disconnect.

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