VLY
#Good morning.
Welcome to Valley's second-quarter 2016 earnings conference call.
If you have not read the second-quarter 2016 earnings release that we issued earlier this morning, you may access it from our website at valleynationalbank.com.
Comments made during this call may contain forward-looking statements relating to Valley National Bancorp and the banking industry.
Valley encourages participants to refer to our SEC filings, including those found on Forms 8-K, 10-Q and 10-K for a complete discussion of forward-looking statements.
Now I would like to turn the call over to Valley's Chairman, President and CEO, <UNK> <UNK>.
Thank you, <UNK>.
Good morning and welcome to our second-quarter 2016 earnings conference call.
This morning, we are pleased to review Valley's second-quarter operating results and provide an update on the bank's previously announced strategic initiatives.
For the quarter, Valley generated net income available to common shareholders of $37.2 million, an 8.3% increase when compared to the first quarter of 2016.
Top-line revenue growth provided the foundation for the linked-quarter increase in net income.
Non-interest expense was negatively impacted by a few infrequent items, which <UNK> will discuss in more detail during his prepared remarks.
Exclusive of these items, non-interest expense materially declined from the prior quarter as many of the strategic cost-savings initiatives materialized.
During the fourth quarter of 2015, Valley outlined an aggressive branch consolidation coupled with a bank-wide cost-reduction program which when consummated were expected to reduce annual operating expenses by $18 million.
Nearly $10 million of the total savings were originally anticipated to be recognized in 2016.
Today, I'm pleased to announce that we now anticipate the 2016 savings to equal nearly $15 million and the ultimate annual reduction in operating expense to eclipse $19.5 million, which is nearly 10% greater than originally announced.
The additional savings are largely a function of further consolidation of branch facilities, coupled with technology enhancements for certain back-office operations.
Valley's 2015 branch efficiency program identified 28 locations to be consolidated based on our assessment of customer delivery channel preferences and branch usage patterns.
Based on our continuous evaluation, we have identified an additional three former CNL locations in Florida, which we anticipate closing during the third quarter of 2016.
Further, of the 28 original locations identified, 27 have been consummated and we expect to complete the entire program in early October.
Another component of Valley's cost-reduction program was the increased utilization of technology and process improvements to decrease the bank's reliance on staff expense attributable to transactional activities.
During the second quarter, Valley's full-time equivalent employee level declined by 31 to 2,866.
The current headcount not only compares favorably with the prior quarter-end, but for the same period one year ago when the bank had 2,899 full-time equivalent employees.
Keep in mind, the reduction in staff has been achieved while simultaneously we nearly doubled the bank's Florida presence to 35 offices and added over $2.5 billion in assets.
This expense reduction has been accomplished despite a significant increase in the bank's technology spend to enhance and add new customer-facing delivery channels.
The aforementioned expense reductions are no small accomplishment considering the expanded regulatory expectations, which have led to new risk management positions.
The risk management programs implemented by the bank over the past few years coupled with our strict underwriting criteria have enabled Valley to expand loan originations in categories, which others have either been forced to or elected to scale back.
The bank remains steadfast in its goal of reducing its core efficiency ratio.
Excluding tax credit amortization, we are on track to lower the ratio to approximately 60% by year-end.
During the second quarter, organic loan originations, excluding purchase loan participations, exceeded $900 million, an increase of over 45% from just the prior quarter.
Origination activity was strong across Valley's multiple business lines.
Residential mortgage activity for the quarter was brisk as origination volume was strong across all of Valley's geographies.
This activity resulted in closings equal to $177 million, a significant increase from the prior quarter.
However, in the quarter, Valley sold approximately $120 million of residential loans in an effort to manage the level of interest rate risk on our balance sheet.
As a result, the period-end residential loan balance contracted approximately $46 million from the prior quarter.
Current application volume is robust and as long as the interest rate environment remains accommodative, we anticipate continued strong volume in mortgage banking originations led mainly by refinance activity.
Consumer lending results for the quarter varied as direct-to-consumer collateralized personal lines of credit increased over 30% annualized from the prior quarter.
Valley's automobile lending portfolio continues to be negatively impacted by the revised indirect dealer loan level pricing guidelines recommended by the CFPB and adopted by Valley.
For the quarter, Valley originated a little over $70 million of which nearly 7% came from Florida.
Presently, we have signed up over 100 dealers in Florida and expect the contribution from this geography to expand.
Additionally, the bank continues to focus on implementing sustainable initiatives to improve this business line's profitability.
We have recently instituted several technology-based improvements into this area, which we believe will have positive long-term benefits.
That being said, we continually assess the returns of our lines of business and when appropriate will make the necessary decisions to ensure each earns its cost of capital and achieves the bank's desired long-term profitability metrics.
Commercial lending was strong across all categories as both traditional C&I and CRE organic originations each exceeded $300 million respectively for the quarter.
In the aggregate, organic commercial lending activity increased over $200 million from just the prior quarter.
The expanded volume was reflected throughout all of Valley's geographies.
The approved committed commercial pipeline continues to be strong, equaling approximately $600 million at quarter-end.
As a result, we remain optimistic about levels of commercial lending for the balance of the year.
Although origination activity was solid for the quarter, period-end C&I outstandings declined slightly from the prior quarter largely due to a reduction in lines to both Valley's Florida and asset-based customers.
The decline in balances was principally by design as certain developer and warehouse relationships were encouraged to obtain alternative banking relationships as those business lines, although profitable, were inconsistent with the bank's credit profile.
Also, the reduction in some of our asset-based loans was a function of structure and pricing.
This resulted from requests for financing alternatives, omitting personal guarantees and/or LIBOR-based pricing with spreads below our internal floors.
We have previously communicated growth at Valley is a goal, not an obsession.
Maintaining the bank's credit quality and returns remains paramount.
For the quarter, total nonaccrual loans totaled $47.9 million, or 0.29% of total loans.
The ratio of Valley's total past-due loans to total loans, including both non-accrual and accruing past-due loans, was 0.49%, a reduction from 0.61% as of <UNK>h 31.
Valley's underwriting philosophy is unwavering with a focus on requiring borrowers to maintain significant equity in each loan facility.
Our underwriting process stresses borrower capacity to pay and collateral values in multiple interest rate and economic scenarios irrespective of the advanced rates currently prevalent in the marketplace.
During the quarter, our wealth management divisions moved forward on a number of initiatives, which should help to improve our future non-interest fee income.
Under the direction of <UNK> <UNK>, our Florida President, an entirely new unit was built from the ground up.
The division will operate under the umbrella of our trust department and is supported by a very senior and experienced staff of wealth managers and trust personnel.
They will be operating from several of our Florida locations and focusing primarily on clients residing either full or part-time in our Florida markets.
We are also pleased to announce that Hallmark Capital Management and New Century Asset Management, two of our subsidiary wealth management companies, have been combined in an effort to reduce operating overhead.
Just prior to combining the two companies, we were excited to report that Hallmark achieved the distinction of having over $1 billion in assets under management.
Before I turn the podium over to <UNK>, I would like to reiterate our focus on achieving the bank's 2016 performance goals.
Despite the protracted low interest rate environment and challenging competitive landscape, we remain motivated to achieve our targeted revenue stream and expense initiatives.
<UNK> will now provide some more insight into the financial results.
Thank you, Gerry.
For the quarter, total pre-provision revenue expanded 14% on an annualized basis as strong loan growth provided the catalyst for increased net interest income and higher mortgage banking revenue led the growth in non-interest income.
Valley's net interest margin expanded to 3.14% from 3.08% in the prior quarter.
The increase is largely attributable to a reduction in excess liquidity, which resulted in the total interest earning asset yield expanding by a similar 6 basis points.
The loan yield on a linked-quarter basis increased from 4.15% to 4.17% mostly due to additional recovery interest and swap fee income.
The increase in each more than mitigated the continued margin compression associated with the low-interest rate environment.
For the period, Valley's new loan volume of $1.2 billion included both organic originations and to a lesser extent purchase loan participations.
The blended new volume rate was approximately 3.5%, which in conjunction with normal principle loan amortization creates approximately 2 basis points of sequential quarter margin compression.
The increase in the taxable investment yield is principally due to the reinvestment of maturing short-term Treasury securities into higher yielding Ginnie Mae securities.
Partly mitigating the increase in yield was additional premium amortization associated with an increase in mortgage-backed security cash flows of approximately 25%.
The total linked-quarter cost of funds remained flat at 0.78% as non-interest-bearing deposits grew approximately $100 million on average.
As of period-end June 30, these accounts equal approximately 31% of Valley's entire deposit base.
In late July, a $75 million long-term borrowing with a cost of 5% matured and was replaced with alternative short-term funds.
The bank's loan-to-deposit ratio equates to approximately 100%, a level at which we are very comfortable operating.
Contributing to the increased loan to deposit ratio is a decline in time deposits as the bank looked to other short-term funding alternatives as opposed to certificates of deposit, which are rate and term-sensitive.
Non-interest income increased approximately $3 million from the first quarter as both current originated and previously held for sale residential mortgage loans sold in the secondary market equaled $128 million, an increase of approximately $75 million from the prior quarter.
Origination volume remains vibrant and we anticipate continued strong residential mortgage gain on sale revenue for the remainder of the year should the mortgage interest rates remain at or near their current levels.
Additionally, included in second-quarter non-interest income was a $709,000 gain on the sale of assets, primarily emanating from the sale of two former branch locations closed in conjunction with Valley's branch efficiency program.
Non-interest expense of the second quarter was $119.8 million, a slight increase from the prior quarter.
Significant linked-quarter increases in professional and legal fees of $1.6 million, coupled with other expenses sparked the increase.
The sequential quarter incremental periodic expense increases overshadowed the noteworthy reductions in salary and employee benefit expense.
Many of the periodic expenses incurred during the quarter reflect at times infrequent items and we do not anticipate incurring similar levels of expense in future periods.
As I previously stated, Valley originated approximately $1.2 billion of loans during the quarter.
Nearly $650 million were commercial real estate loans causing a linked-quarter period-end increase in CRE outstandings of $433 million.
A portion of the growth reflected purchase participations in which Valley underwrites each loan individually applying Valley credit standards, including minimum cap rates on appraised valuations.
Valley's motivation to augment organic originations with participations is largely due to the enhanced ability to manage portfolio duration.
In addition, participating in acquiring loans through bank partners as opposed to purchasing 100% directly through the brokerage community mitigates the potential negative implications of adverse selection for certain loans.
Valley's growth in CRE is a function of the bank's macro credit underwriting and concentration risk management processes.
Valley has a diverse commercial real estate portfolio comprised of multiple property types such as retail, multi-family, industrial, office and others.
Each segment has unique underwriting criteria specific to the inherent risks.
The bank spends tremendous resources monitoring and stress-testing each portfolio.
In part as a result of this diligence coupled with the bank's low historical loss rates and borrower equity requirements, we anticipate continued CRE growth within our balance sheet.
This concludes my prepared remarks and we will now open the conference call to questions.
I think a lot of the paydowns come from refinancing.
People are taking advantage of the low interest rates.
So as long as interest rates remain low, you are going to see a higher volume of refinancing.
That being said, the economy itself is only growing at roughly a 2% rate, so new origination outside of refinancing is going to be tempered to some degree by that.
How long it stays at these levels I think is going to be more dependent upon the Federal Reserve and actions they may take.
People are selling properties also today because of the strong pricing and you are seeing a lot of that taking place.
We are very conservative when it comes to commercial real estate financing, all types of financing, and one of the things we do do is we stress test to our own levels of cap rates irrespective of the cap rate that the appraiser uses.
I think that's one of the things that has put us in good stead with our portfolio in the past and will in the future.
It's really a combination of those things.
At times, we want a balance.
The residential mortgage portfolio tends to be heavily when they refinance in the 30-year bucket.
We don't want to hold 30-year paper, which will extend far beyond what it has been in the past when people are refinancing in the low 3%s, mid-3%s for a 30-year mortgage.
On the other hand, the participations we buy into are generally a much shorter duration and they have a remaining life usually in that three to seven-year range so that we are actually in a much better position from a duration standpoint.
And again, as <UNK> correctly pointed out, we underwrite every single loan to Valley's credit standards.
We don't buy everything that's presented to us by a long shot.
Yes.
Yes, I would say so, <UNK>.
That's what you should expect.
Sure.
The one thing to keep in mind is the CFPB has their disparate impact measures that they use.
I attended a meeting about a year ago in which Director Cordray spoke.
He did not direct his comments at Valley, but he did speak about indirect auto lending and how the CFPB is concerned about disparate impact.
And he gave some what he called his Safe Harbors, areas that he felt were appropriate for a bank because it's very difficult to measure disparate impact when you are buying paper from a dealer and there's no indication as to whether it's a male, female or what the ethnic background of the borrower is.
But he did give some Safe Harbors and we went to those.
We adopted his recommendation as to a Safe Harbor.
It did have an immediate impact, negative on our volume, although it is to some degree clawing back.
We've put in some enhancements to the dealer so they can better understand what they are going to be earning on the loan.
As a result, it has come back to some degree.
We've also entered into some other arrangements to build auto volume in the future.
We have an auto lease finance program that we've gotten into, which is very attractive.
We have a strong guarantor who is behind the residuals, so that was an inducement for us to get into the program.
Not only that, they also guarantee the performance of the loans.
So the volume of automobile paper should build back up again to a level that meets our expectations.
(multiple speakers).
Obviously, that is down today.
It's not what it was at one point in time.
We do measure it all in.
But that being said, it's still at this point another line of business that gives us an outlet in the lending arena rather than just doing for example so much of CRE.
We like the cash flows and we are hopeful that over time we will be able to come up with some efficiencies to increase the returns on that portfolio.
<UNK>, one other point to that.
There are corollary benefits that we get out of the automobile financing such as automobile dealer floor planning, which we have about $100 million of lines available in that area.
We've been in that business since the 1950s with a very, very strong track record.
It also brings in an opportunity to do some dealership financing as far as their buildings are concerned.
So there are some corollary benefits to the automobile business that don't always show up when you simply look at the car volume.
Yes, it will be lower than where it is.
I think, <UNK>, we were pretty comfortable with the number we gave everybody at the early part of the year.
I think we gave an overall rate of about $455 million annually.
Unfortunately, there are quarters in which that number can go up or down depending on events taking place, which we had some of those during this particular quarter.
But we are continuing, as Gerry pointed out, to work hard to bring down those expenses, so we expect to get close to a 60% efficiency ratio by the end of the year.
Just as an example though, we talk about infrequent items.
I'd give you a small taste of the fact that we had a loan that was an FDIC loan that paid off three years ago.
We ended up having to take a hit this quarter for something that we thought was long gone and it cost us a fair amount of money this quarter that we don't expect to happen again.
It was a very unusual item, but unfortunately it happened and we had to record the loss.
So things like that occur.
It drives our numbers up and down a little bit from quarter to quarter, but that's ---+ unfortunately, that's the way things go quarterly.
Yes, I would tend to agree with that and I think you have to assume there's going to be at this level that quarterly margin compression just as a basis of rates we are lending at.
There's just not much you can do to offset that.
Well, we had that $75 million that went away this month, just a couple of days ago, so that obviously is a help.
We still have more out there that matures in 2018.
We have some going out to 2021 and 2022.
So we still have some high cost borrowing out there.
We constantly look at it, look for alternatives and when and if it makes sense, we will maybe do something about that.
Frank, it's <UNK> <UNK>.
I think that within our footprint in in-strategy, we are not discouraged about any of the markets.
Having said that, we have our target institutions that we stay close to and we are asked to participate in most processes if someone engages in a process.
But I wouldn't say that there's a market that's discouraged.
It's an annualized run rate.
I was hoping you weren't going to say it was a quarterly number.
I got a little nervous there, Matt.
Not quarterly.
Well, the borrowing that just matured is going to help us beginning next quarter.
It only matured at the end of this month, so we will get two months of benefit out of that $75 million, which matured at 5%.
So we are going to pick up something there, but that being said, we still expect to see some core margin compression every single quarter until something changes.
I think we revised that a little bit at the end of last quarter and said we didn't really expect that.
And I think we said we were much more at the lower end.
And that being said, that would have been 318, so this quarter came in at 314.
It's better than where we were last quarter by 6 basis points, but you are still going to have the core compression.
Also, if you remember, we reported in the first quarter the PCI, we had an adjustment on some PCI loans, which impacted our interest income on PCI loans going forward.
So that impacted the original number we gave you of 318 to 325, so 318 to 325 is not a number that I think you are going to see.
No, our New York City Medallion portfolio, which comprises the vast bulk of our taxi medallion loans, are all performing at this point.
I don't know.
It all depends upon what the City of New York does as far as Uber is concerned.
We have always scrutinized our commercial real estate portfolio on our own.
Over the past several years, we have artificially imposed cap rates that were somewhat higher than the appraisers were sending in valuations at.
But we felt that making loans using crazy cap rates would only get banks in trouble just like making subprime residential mortgages did.
So for some time now, we have been setting our own floor, coming up with appraisals that give us a level of comfort.
As long as we get product that meets our criteria, we are happy to move forward and we haven't had any pressure regarding our levels of commercial real estate as long as they fall into those categories that we've been following.
If you start to do apartment houses using a 2.5% or a 3% cap rate, you are going to have problems.
If you are doing them at 5.5% cap rates, chances are you won't have problems, particularly if you maintain your loan to value using those cap rates.
So ---+.
It stays pretty much with the originating bank.
I was having a dialogue with our Chief Credit Officer just yesterday about it and other colleagues and it's interesting because I think it's getting a little tougher on the lending front largely because we are we think common sense lenders and conservative lenders and we are finding profiles of clients that are looking for non-recourse structures that in our judgment don't deserve non-recourse structures.
From a pricing perspective, I think that we have best-of-breed pricing and we use it appropriately to the risk involved.
I think from an advanced rate perspective, if we are dealing with real estate purpose lending, we tend to be conservative.
There are lenders, without a doubt, that have much higher, very aggressive advanced rate structures.
And then from a cash flow underwriting perspective, I think we are common sense and conservative.
And, yes, we are finding more lenders that will accept skinnier debt service coverage ratios and so on.
So it is that part of the cycle it seems where banks are I won't say desperate for lending, but aggressive about lending and are relaxing standards below that which we will accept.
And so we pick our spots and our transactions.
I think we are all in it together from a lender perspective, a credit perspective, our risk management team in general.
And so I think sticking to our guns means that we will sustain ourselves through any next downturn.
But Florida is becoming frothier from a structuring and pricing perspective.
For the most part, I would say the answer is yes.
We've just sold, for example, as I pointed out, a couple of branches this past quarter that we had on our books and we had a gain on those.
I know there's ---+ as we move into the next quarter, I think there was another one that got sold that also was going to have a gain.
So for the most part, I would say that's correct.
There's always going to be a potential anomaly where that won't really be the case, but we also have an awful lot of leased branches as well and so we are trying to exit those that we've closed down.
A lot of those are trying to make deals with the landlord and figuring out a way to pay them something up front so we get out of the lease if it extends longer than we'd like.
Thank you for joining us on our second-quarter conference call.
Enjoy the rest of your summer.
