FCBC - NASDAQ

Greetings and welcome to the First Community Bancshares’ Third Quarter 2012 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It’s now my pleasure to introduce your host, Bob Schumacher, General Counsel for First Community Bancshares. Thank you, Mr. Schumacher, you may begin.

Thank you for joining us this morning for First Community Bancshares’ Third Quarter 2012 Earnings Conference Call. Any statements made today that are not historical are forward-looking. Please review the language at the end of this morning’s earning release regarding forward-looking statements as the information applies to comments made on today’s conference call. With us today is President and Chief Executive Officer, John Mendez; Chief Financial Officer, Dave Brown; and Chief Credit Officer, Gary Mills. At this time, I’d like to turn the conference call over to John Mendez.

Thank you, Bob, and good morning and welcome again to the third quarter 2012 earnings call for First Community Bancshares. We’re very pleased to host the call this morning, as we briefly discuss our third quarter 2012 results and our earnings release from this morning. This is John Mendez, Chief Executive Officer for First Community Bancshares, and I’m joined by Dave and Gary this morning. And following the call, we’ll take questions from registered callers. At the outset, I’d like to first extend our best wishes and prayers to those who have been impacted by Hurricane Sandy and the resulting super storm. We’ve been following the reports and we’re certainly troubled by the devastation in portions of the Mid-Atlantic and North East. We hope that each of you escaped the worst of the storm. Here in Bluefield and throughout much of our legacy markets that we have, we’ve had snowfall up to 2 feet and widespread power outages. Our employees have worked very hard to keep us up and running. And we have been very fortunate that our customers have experienced really no meaningful service interruptions. We also appreciate your indulgence as we move the earnings call back one day, we were hoping that, that would allow a bit more time for those of you in the more severely affected regions to return to your offices and get a bit closer to normal operations to the extent that is possible. With that said, we have some very exciting results to share with you this morning as we began to see the favorable impact of our 2 latest acquisitions and the unfolding of our strategic plan for growth and a material deployment of our excess capital. I’d like to begin the call this morning with some summary comments on the third quarter and our year-to-date results. And then I’ll be followed by Dave and Gary who will provide more detailed analysis. By way of review, we did complete 2 significant acquisitions in the second quarter of this year, Peoples Bank of Virginia on May 31, the Waccamaw Bank acquisition, which followed on June 8. These transactions obviously had very material effect on the balance sheet and the operations of the company. I’m pleased to say that at this early point in the acquisition, operations indicate smooth transitions and very strong contributions by both of these new divisions. This is evident in the earnings release this morning. You can see a material change in the operations for the third quarter, which represents the first full quarterly impact. And most notably, GAAP net income for the third quarter increased by 147% over the linked quarter and 89% over the comparable quarter in 2011. While there are several contributing factors, the principal source of the increase is attributed to the material acquisitions, our resulting balance sheet growth and the significant efficiency dependent to those transactions. I would add that both acquisitions obviously are performing better than planned and well ahead of our modeled results. We continue to have some level of merger related expenses in the income stream; we’ve highlighted that for you this quarter about $645,000 of onetime cost in the third quarter. One other item that I would note is an out-of-period credit adjustment that was reported in the third quarter related to our recently completed technology conversions, and Dave will probably detail this for you a bit further. But in short, our technology conversion highlighted a change in the reporting of charge-off lines under our legacy system, which had the effect of overstating our historical charge-offs. The sum of that net of tax was about $1.5 million and the gross amount of recovery recorded was about $2.4 million, which is treated as a credit to other operating income in the third quarter. Dave again will touch on this in his financial comments. Dave will also discuss a onetime impairment on our one remaining private label RMBS, that impairment in the amount of $940,000. Despite continued performance on this bond, we feel that a reasonable assumption set for future performance indicates that we’re taking a prudently aggressive approach to evaluation of this security. This impairment charge and the onetime merger expenses, as previously mentioned, obviously, mute to a large degree the impact of the favorable out-of-period credit adjustment. So we actually calculate core earnings excluding onetime charges in credits and see that they’re running at about 94% of our reported GAAP net income. So all in, not a huge difference between GAAP and reported. We’re very pleased with our core ROA of 1.35%. Our core return on tangible common of 16.65% for the quarter. Core EPS also increased very dramatically to $0.44 for the quarter, that’s up 57% from the comparable quarter in 2011. And lastly, our GAAP diluted EPS, which is up $0.27 versus the linked quarter to $0.47 in the third quarter for an increase of 135%. These are extremely significant increases as we have now reset our balance sheet and our earnings base. And I’m hoping that Dave will point out as he goes through some of his comments, our non-GAAP schedule of core earnings, which is included in the press release. We hope that this is helpful in sorting out several of these non-recurring charges and credits for the quarter, and giving you some insights in terms of what we see is more indicative of our earnings run rate. Based on our third quarter results, we are also seeing our initial projections of recovery of tangible book value per share from the acquisitions as conservative. At current levels, we expect that recovery will occur in very much shorter timeframe, and certainly at this level, we expect to build capital at a much quicker rate and provide internally generated capital for future opportunities. Lastly, I would call your attention to our credit and our non-performing asset results. Levels of NPAs remain very manageable, still below 1.5%, including covered assets. We actually saw a decrease to 1.28% in our covered assets NPA percentage. We did acquire a level of non-covered land and construction credits in the Peoples transaction in Richmond. However, those are marked at appropriate levels and we’ve actually seen some positive results in some of our early resolutions versus those marked loan levels, and hopeful more on that from Gary Mills later in the call. With that, I’ll turn the call over to Dave Brown for a more detailed look at our financial results for the quarter. David?

Thank you, John, and good morning to everyone, and thank you all for joining us. This morning, we reported common net income for the third quarter of 2012 of $10.1 million or $0.47 per diluted share. Core earnings for the quarter were significantly stronger than last quarter and came in at $9.4 million, an increase of over 50%. Core ROA and ROE for the quarter were 1.35% and 11.39% respectively. Net non-core items of $644,000 after-tax were made up of securities impairments through merger costs and a onetime correction of past overstatements of loan charge-offs. Margin for the third quarter was 4.48%, which was largely the result of the addition of Waccamaw and Peoples portfolios. The core balance sheet still remained quite strong with ex-accretion margin for the quarter of about 3.96%, which is up 3 basis points from last quarter. We made a $1.9 million provision for loan losses during the third quarter and other real estate costs and net losses amounted to $490,000. That brought total credit costs to about $2.4 million, were a little higher than the $1.8 million reported last quarter, but still lower than last year. Wealth revenues for the quarter increased $65,000 or 7%, linked-quarter on better advisory service revenues. Linked-quarter, deposit account service charges increased $566,000 or 17%, and up $491,000 or 14% over the same quarter from last year. Those service charges are positively impacted by the addition of the Waccamaw franchise. Other service charges and the fees were up a little over last quarter, but really insurance revenues were one of the big bright spots in there, they were up 21% linked quarter, and 6% over last year. We see growth in the core business continuing to show in line, continues to show, and Greenpoint has shown year-to-date pre-tax income of $1.3 million, which is up over $600,000 compared to last year. Also non-interest income is the effect of some other-than-temporary impairment that we recognized this quarter. It’s due to our one remaining private-label mortgage bank security, credit experienced in that deal has seemed to level off, but we did determine that it will probably stay elevated for longer than we have previously been projecting. That led us to the impairment charge of $942,000 recognized in this quarter. And most notably, other operating income for the quarter includes an adjustment to correct overstatements in loan charge-offs that built up over the course of close to 5 years. The difference was uncovered during the bank’s core system conversion that we did during September. We determined that no prior period’s net income was misstated. So we ran the onetime adjustment of $2.4 million through this quarter. Moving into the area of non-interest expense, the third quarter efficiency ratio got a boost from loan accretion and came in at 52.4%. Ex-accretion efficiency was 57.6% and on par with last quarter. Total salaries and benefits were $10.9 million; it’s an increase of nearly $2 million from last quarter. But about $900,000 of that increase is attributable to Waccamaw and Peoples' salaries and wages, $100,000 is due to over time largely related to our core system conversion, and $390,000 is an additional medical insurance costs over last quarter and about $330,000 is increased in incentive comp accruals. The increased medical accruals are largely due to the new employees we added from Peoples and Waccamaw. But overall, we’re still doing better in that area than we were last year in terms of overall medical costs. The rest of the increase is due to some increases in salaries and staff here at corporate, largely reflective of the additional work associated with the FDIC deal. The other operating expense line was $5.3 million for the quarter. Within that line, there were many individual increases and decreases, but the general increase is attributable to our enlarged branch network and cost associated with the FDIC deal at Waccamaw. So when we look at core earnings for the quarter, I feel we basically reset earnings for the company. Legacy margin has been holding steady. I’d say it would be difficult, but not impossible to maintain this level as we’ll continue to see loans and securities re-price downward. We have some room to push CD cost down further, but also see potential for future benefit by locking some of that funding at a historically low levels for 4 or maybe 5 years. As with many institutions, we’re trying to put as much cash liquidity to use as possible through the asset or liability side, so that can also have a positive effect on margin going forward. So we expect the accretion will tail down over each successive quarter, and actually, we have an overly accurate estimate to give you, but for sure, it will tail down as we progress into the future. On the expense side, we’ll probably see personnel savings of roughly $150,000 annually, since Peoples converted mid-September. We also have a little more juice to squeeze in the Waccamaw transaction as we move through its upcoming system conversion. I expect we’ll see personnel cost savings somewhere between $500,000 and $750,000 annually post that conversion. We’ll also have several branch closure consolidations that will occur in the fourth quarter. So we’ll get to recognize some benefit there. Period-end total assets shrank $15 million or less than 1% since June 30. The CD portfolio in there declined $62 million or 7% since last quarter-end, which has also had a positive effect on net interest margins. I do have one correction from this morning’s press release, for positively could give you all at September 30, tangible book value per share built to actually $11.45, that made pre-preferred conversion TCV come in at 8.6% at September 30. So we’re still very bullish on the 2 recent deals and remain confident that we’ll be able to make our stated earn back goals, and as stated when the deals were done. Bank leverage ratio, we’re estimating to be about 8.8% at September 30, that’s fully in line with where we expected that level to come in whereas once we had the full quarter of assets in the denominator. And with that, I’d like to turn the call over to our Chief Credit Officer, Gary Mills who has got some more detail on loan portfolios.

Thank you, David, and good morning, everyone. The FCB loan portfolio measured $1.76 billion at quarter-end and was comprised of loans covered under loss share agreements of $224 million and loans not covered under loss share agreements of $1.539 billion. As previously mentioned, this represents significant growth of 26% and 28% as compared to year-end 2011 and the third quarter of 2011 respectively. During the quarter, the loan portfolio did decline approximately $44 million with covered loans declining $15 million and non-covered loans declining $29 million. I primarily attribute the decline in the covered loan portfolio to work out activity and normal payoff activity. The non-covered portfolio decline was primarily the result of several substantial payoffs received during the quarter, which included a $10 million construction mini-perm facility associated with the multi-family project in the Richmond market, a $5 million loan secured by marketable securities, and the resolution of a $2.5 million 1-to-4 family loan through foreclosure and migration to OREO. Loan application activity within 1-to-4 family and small business loans remains relatively brisk, driven primarily by refinance opportunity. Commercial loan application activity, while remaining generally consistent with prior quarters’ activity continues to be light. Again, a majority of the commercial loan opportunity has been refinanced of existing debt away from other lenders. We have observed some approved credit requests failing to close due to the property not appraising for a sufficient value to provide a conforming LTV. Non-covered, nonaccrual loans remained relatively flat during the quarter, as they were $26.4 million or 1.72% of total non-covered loans at quarter-end as compared to $27.9 million or 1.78% as of June 30. The 5 largest nonaccrual loan relationships account for approximately 39% of total non-covered, nonaccrual loans. The largest of these are $3.3 million relationship in the C&I segment, is in the process of litigation with expected resolution to occur by the second quarter of 2013. And while we believe it’s reasonable to expect a favorable outcome, the Bank has established 100% specific reserve against relationship. The second largest relationship is $2.7 million within the hospitality industry. This relationship has been making timely principal and interest payments since mid-summer and it is anticipated that if this satisfactory payment performance continues through year-end, the credit will be eligible for upgrade to accruing status in the first quarter of 2013. Also included within these larger non-accrual loan relationships is $1.3 million relationship within the commercial real estate segment. Likewise, this borrower has been making timely payments since mid-summer, and it is anticipated that if the satisfactory payment performance continues from this relationship, that it will also be eligible for upgrade to accruing status in the first quarter of 2013. The allowance for loan and lease losses measured $25.835 million or 1.68% of total non-covered loans as compared to $26.171 million or 1.67% of total non-covered loans as of the second quarter. Net charge-offs were $2.25 million or 57 basis points annualized as a percentage of average loans during the quarter as compared to a third quarter provision of $1.916 million. This continues relatively consistent net charge-off performance for the Bank and, as I have mentioned in prior calls, I anticipate this trend to continue with the potential for intermittent lumpy quarters. This concludes my prepared remarks. So at this time, I’ll turn the call back over to John.

Thank you to both Dave and Gary for those observations and that does conclude our prepared remarks. At this time, we’d like to turn the call back over to our conference operator and we would like to queue up some questions. Operator?

[Operator Instructions] Our first question comes from William Wallace of Raymond James.

My main question is just trying to figure out how to think about the accretion related to Peoples and probably more so Waccamaw. So you cite $3.32 million in accretion in the third quarter, my first question would be, is any of that accretion accelerated due to resolutions or payoffs or refinances away?

It is not, Wally.

Okay. So the expectation then would be a gradual decline from that level moving forward outside of any refinancing or payoff or resolutions?

That’s right and I would expect, it’s not going to surprise me to see that number come in for fourth quarter maybe in the area of $1 million less than where it was for third quarter.

Okay. And then so may be the question is, what’s your expectation of the life of the acquired portfolio? So that’s a pretty quick deceleration.

I think the way we’ve got it, the bulk of it is dollars, Wally, come from some of the marks put on the Waccamaw portfolio, and I believe the weighted life that we look at those was going to be in the neighborhood of 3 years or so. So it’s going to burn down, it is very front-end loaded and we expect that base level of accretion to burn down pretty quickly.

Okay, okay, very good. And then on the loan growth side, it sounded like you were citing actual payoffs or resolution of credits driving that 1.8% decline rather than working out maybe some of the, I guess, you’re breaking out -- the entire Waccamaw portfolio has covered, is that correct?

Most of it, I think there’s some $8 million or $10 million that were non-covered.

So excluding that and looking at the non-covered portfolio, was the commentary meant to suggest that you could perhaps actually see that loan growth pick back up in the fourth quarter?

I think over the coming quarters we still see it as a challenging loan environment. I don’t think level to slightly increasing balances would be unrealistic to expect. But with the primary opportunities that we are seeing are refinance opportunities. That makes it extremely competitive and generally what’s going to drive the success rate there is going to be an interest rate and what we’re willing to price those credit there. So from that point of view, I think it’s still very competitive environment. We’re seeing very few credit requests that are driven by expansion of inventory, expansion of equipment or expansion of receivables. So I think for the next few quarters, at least for the larger commercial loan side, I think it’s going to be still challenging.

Okay. And lastly, John, you obviously closed a pretty big acquisition in the second quarter, have you stepped back from looking for new opportunities or have you remained active in conversations?

We remain interested in what we considered to be the best opportunities. So I would say that it’s business, as usual. We’ve done we think a very good job of absorbing 2 deals very quickly, on top of that we went through a major technology conversion. The good news to report there is things have gone well, very smoothly. Assimilation has worked well. So we think that in reasonable timeframe, we will be in a position to consider other opportunities, again, we’ll be disciplined and looking for those that we feel best support our strategic plan for growth. But we do think that we’ll be positioning quickly if those opportunities do arise. We continue to look at the market, scan for opportunities, particularly those that provide greater efficiency and fill in to our existing footprints. So I think the short answer to your question, Wally, is we remain very interested.

Okay. So you’re interested have you -- has there been any change in the past couple of quarters in how those conversations with potential sellers have gone or do you feel like there is, you’re getting closer to seeing any increase in deal activity or do you still think we’re kind of far away from a bid ask perspective?

Yes, it runs the gamut, Wally. There are range of companies out there who are considering strategic alternatives. And much of what we see is, they’re challenging deals, so while we continue to look at those and assess those, we hope to see some eventual, some additional opportunities in the assisted arena, but we continue to listen and talk to those who are otherwise considering strategic alternatives.

Our next question comes from Carter Bundy of Stifel, Nicolaus.

Jumping back in on the purchase accounting questions. Dave, it sounds like it’s going to drop down pretty materially in the fourth quarter. Do you have any sort of idea what that may look like sort of from a run rate as that sort of decelerates going into early 2013?

I would, as I kind of do a poor job of forecasting on the accretion, because it is kind of difficult to do. So I would expect it will probably tail down by $1 million or so for fourth quarter ‘12, and I will fully expect to see another $0.5 million on top of that come off in the first quarter of ‘13. So I think that you see the rate of decline decelerating pretty, it’s pretty big today, I think it’s going to burn down to a more reasonable level pretty quickly.

Okay. So just doing annualizing that math, the ‘14 benefit is going to be very, very minimal?

Minimal, maybe a little much, but I think you’re going to see it significantly less than a rate of $14 million a year.

And Carter, this is an interest method type computation, so it’s highly sensitive to expected lines and changes in cash flow, that’s something that we’re just going to have to continually reassess. I mean, we’ve got contractual maturities and then we’ve got the practical side of that with renewals and prepayment and a lot of factors come into play there. So I think it’s -- we’re going to have to take a look at that every quarter and reassess that assumption.

Yes, I think it will be -- lumpy maybe a good term for it. I think that base level of accretion, which was what we had this quarter, I think, that burns down pretty quickly because it’s the bulk of kind of what I’m going to call in rough terms the FAS 91 or unallocated part of the Waccamaw mark, which was give or take $22 million. So it’s not -- it will go away over the course of, say 3years or so.

Okay, that’s helpful. And was there any adjustment on the indem [ph] asset on projected outlook for cash flows this quarter, or was this simply just nothing specific in terms of collecting more cash flows or adjustments there?

No, we really made no adjustments to our cash flow expectations for either Waccamaw or Peoples this quarter.

Okay. And then secondarily in terms of expected or potential expectations for run off at Waccamaw, what does your sort of crystal ball tell you in terms of what additional run off you may see there, I guess, the question for pretty much any one there?

Well, I’ll start and say, I think we were down give or take $10 million. On recorded investment of Waccamaw, I think, that one continues to burn down relatively quickly just through pay downs and resolutions. I don’t know if Gary has any different thoughts or...

Are you looking at the asset side of the balance sheet, Carter, or...

Yes, yes. John, sorry about that, just the one side of the loan. And then I guess fair enough on the deposit side. I know you all had a lot of deleverage in 2Q, but wanted to get your thoughts, I guess, on the liability side also.

Well, from a loan perspective, obviously, we’ve got some work to do, to work out some loans in the portfolio down there. I will say there is, at the commercial level, the commercial lending staff has been substantially completely retooled. I think our regional president has been very diligent in trying to retool its staff. I think we’ll start to see some benefits from the newly hired lending staff over the coming quarters. I think any time you bring someone on, there is a ramp up period. They came in probably late third quarter, we’re already starting to see some request flowing in as result of their efforts. So I think that will help. But with the assets that we have to resolve and how we’re working through there, I think it’s going to be challenging. But I think the new lending staff and the credit culture that we have installed in that unit gives us reason to be optimistic over the next year or so.

And, Gary, that was a whole team that you brought over to effectively replace, would that be fair to say, replace a lot of personnel at Waccamaw?

It’s true it’s a team, but they didn’t come as a team. They were recruited individually and then you compile them together and they’re now a team. Placed all over that market in North Carolina and...

Brunswick County, Columbus County, even took one out of there and relocated them to Mecklenburg.

Yes. We did not recruit a team that came as a team, but Milton aggressively went out and located multiple individuals to build his team back.

That’s right.

And I’d say on the liability side, Carter, the bulk of deleverage did occur, obviously, second quarter pretty quickly before June 30 hit and then a little bit more as we progressed into third quarter. I think those, the deposit base, we have been very surprised at how well that deposit base has reacted. And when you look at any of the core demand deposits, the core savings and money market type accounts, those have held relatively steady over the course of from June to now. And really the only thing that we’ve seen go off of the quick rate CDs plus any kind of hot money.

Our focus obviously has been on the core deposits; we’ve done most of the deleverage in the quick rate and the wholesale funding. We put in, at the outset we put in a program for tracking and retention of core deposits, and gave the employees some interesting incentives for retention. And it’s really some of the best results that I have seen in one of these through about the first 4 months. Our core deposit retention, including transaction savings, money market accounts, were at about 98% retention level after close to 4 months.

That’s great. From the CD side, do you all have additional hot money that you could run off or stuff that’s maturing that doesn’t make sense to keep on the balance sheet?

I think there is. It’s a little bit, the effect of that is, is somewhat muted because they’d come on the balance sheet a fair value. But I think you’re right, Carter, there will be continued delevering out of the Waccamaw and Peoples books, the single-service, no relationship kind of households and accounts get weeded out.

Okay. That’s really helpful. And then jumping back in on a particular line item, you said that systems conversion is scheduled sort of mid-quarter -- this quarter for Peoples, and you anticipate roughly $500,000 of annualized expense savings?

Well, Peoples was done mid-September. It’s done, it’s folded in. And we’ll probably post that conversion see on the order of about $150,000 pre-tax in cost saves coming out of the final conversion there. Waccamaw’s conversion is actually slated for next weekend, and I would expect somewhere in the neighborhood of $0.5 million to $0.75 million annually in cost saves, pre-tax cost saves that come out because of that conversion.

And that’s predominantly in personnel?

Exactly. That’s all that estimate is.

It seems there are no further questions at this time. I would like to turn the floor back over for closing comments.

Once again, we would like to thank each of you for your interest in First Community. Thank you for joining the call this morning. And we invite you to continue to follow our company as we grow our presence and impact in the regional financial services industry. I would like to inform you of upcoming investor relation events for the company. On November 15, we will be presenting at the Sandler O’Neill East Coast Financial Services Conference in Aventura, Florida. Hopefully, we will see some of you there, if not, we certainly invite you to join the presentations through the sponsored webcast or available archived replays. Again, thank you very much. We are very pleased with our results for the quarter. We look forward to reporting to you again in January. Thank you. Have a great day.