Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Sterling Financial Corporation (NASDAQ:STSA)

Q3 2008 Earnings Call

October 22, 2008 11:00 am ET

Executives

Deborah L. Wardwell – Vice President Investor Relations Director

Harold B. Gilkey – Chairman of the Board, President & Chief Executive Officer

Daniel G. Byrne – Chief Financial Officer, Executive Vice President Finance & Assistant Secretary

Analysts

Jeffery Rulis – D.A. Davidson & Co.

Matthew Clark – Keefe, Bruyette & Woods

Brett Rabatin – FTN Midwest Securities Corp.

Brian Hagler – Kennedy Capital

[Allen Gornhill – Infernus Management]

Unidentified Analyst

Operator

Welcome to the third quarter 2008 earnings conference call. Each of you will be on listen only mode until the question and answer session following today’s presentation. Today’s conference is being recorded for replay. Additionally, the replay will be available at Sterling’s website www.SterlingFinancialCorporation-Spokane.com immediately following the call. I would now like to turn the call over to Mrs. Deborah Wardwell, of Sterling Financial Corporation.

Deborah L. Wardwell

With us today I have Mr. Harold Gilkey, Chairman and Chief Executive Officer and Mr. Dan Byrne, Executive Vice President and Chief Financial Officer who will be discussing Sterling Financial Corporations third quarter 2008 earnings results. Before I turn the call over to Harold I must remind you that during today’s call Sterling’s management will be referencing forward-looking statements that are not historical facts and pertain to our future operating results.

These forward-looking statements include but are not limited to statements about plans, objectives, expectations and intentions and other statements contained in this report that are not historical facts. These forward looking statements are inherently subject to significant business, economic and competitive uncertainties many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change.

Sterling’s actual results may differ materially from the results discussed in these forward-looking statements because of numerous possible risks and uncertainties. These risks include but are not limited to the possibility of adverse economic developments which may among other things increase delinquency risks in Sterling’s loan portfolios, shifts in industries which may result in lower interest rate margins, shifts in demand for Sterling’s loan and other products, increased cost or lower than expected revenues or cost savings in connection with acquisitions, changes in accounting policies, changes in monetary and fiscal policies of the federal government, and changes in laws, regulations and the competitive environment.

In closing, I would like to mention that Sterling Financial’s executive team will be making investor relations calls on the east coast during the third week of November. With that said, I would like to turn the call over to Harold Gilkey, Chairman and Chief Executive of Sterling Financial Corporation.

Harold B. Gilkey

Welcome to our conference call. The volatility in the global financial markets and the efforts of central banks around the world to unclog the financial system and thereby restoring liquidity and stability to the marketplace have been epic. The pacific northwest long insulated from the slowing national economy was indeed impacted. Further, the region’s economy was influenced by Boeing’s machinist strike that started early in September and involves close to 25,000 workers in the Seattle market area.

The upshot of these events and of course other economic factors was a slowing of the sale of housing related product and an adverse effect on the cash flows of Sterling’s customers with housing related credits. Yesterday we announced earnings of $0.10 per share for the third quarter of 2008. Our results included a credit provision of $37 million reflecting a higher level of classified assets predominately in our residential construction portfolio. Importantly, the underlying earnings generation capacity of Sterling’s core banking operation absorbed these credit costs.

Sterling’s balance sheet remains strong. Sterling’s total capital was $1,180,000,000 or up 2% from the prior year. Our capital and liquidity positions improved over the second quarter of 2008. Sterling’s total risk based capital ratio was 11%, a modest increase over the second quarter. Sterling ended the quarter with cash and high grade investment securities of $2.4 billion up from $2.39 billion. Through the Federal Home Loan Bank of Seattle, a Federal Reserve and other sources, Sterling’s additional liquidity capacity is over $3 billion.

We can all agree we’re very deep in to the current crisis which is now more than a year old. Our management team has two priorities, resolve non-performing assets and to improve the bank’s core operations. We are indeed positioning the bank and the bank’s balance sheet for future opportunities that opening up as we work our way through and out of the credit cycle. Our credit administration and portfolio management teams remain diligent in assessing and ranking risks in our loan portfolio and continue to focus on resolving our classified construction assets.

Starting this quarter credit administration will be managed by two dedicated teams. First, the core banking credit administration team and secondly, the portfolio management in construction credit administration team. The segmentation and management of construction classified assets will enable Sterling’s credit team to fix, repair and manage these assets. At the same time our core credit administration team will be able to focus on growing and generating strategic assets, namely core deposits, business banking and consumer loans.

Operationally Sterling’s execution remains solid. Our production group is aligned along three priorities, relationship retention, deposit gathering and business lending. In the quarter we grew business and consumer lending and continued to shift our asset mix away from residential construction. Our deposits rose 4% to a record $8,070,000,000. Our fee and service charges income grew as the number of business transactions accounts increased. Residential mortgage origination and their sales at Gulf Savings Bank subsidiary continued to be above the plan in spite of a very difficult market.

We controlled our operating costs. In sum, we are managing through a difficult credit cycle. We believe that government efforts to provide the financial system with a large amount of liquidity in a rapid time frame will help accelerate the economy’s recovery. Some time will be needed however for these efforts to flow through to the economy. During this time our financial team will continue to evaluate the rational to add minimally dilutive capital for opportunistic growth and capital reserves to build a safety and soundness cushion, or what I like to call an umbrella policy.

Our evaluation will include specific provisions of the government’s recent enacted Trouble Asset Relief Program. Given Sterling’s experience with the goodwill breach of contract litigation involving the United States Government I will tell you that our team will cautiously evaluate and vigorously deliberate participation in this program. Given the economic events over the past several weeks, providing explicit earnings guidance is difficult. Our initial outlook for the fourth quarter of 2008 suggests that it will be similar to the third quarter of 2008.

I’ve asked Dan to share our initial expectations in the upcoming quarter. With that, let me turn the call over to Dan Byrne.

Daniel G. Byrne

To supplement the information provided in the press release I’m going to focus on a few key highlights for the quarter and then provided the opportunity for you to ask questions during the Q&A session. Yesterday we announced earnings of $5.0 million or $0.10 per diluted share for the quarter. During the quarter we recognized a credit provision as Harold indicated of $37 million and we also had a reversal of $8.5 million in accrued interest income related to non-performing loans.

Now, excluding this provision and the reversal of non-accrued interest, our pre-tax income would have been $50 million equating in to a diluted earnings per share of $0.69. I’d like to reiterate what Harold noted, our capital position remains strong and our liquidity also remains very solid. I’d also like to point out that we had no impairment charges for investments in Fannie Mae or Freddie Mac equities or charges related to other unusual items. It was a pretty straightforward quarter.

At the end of the third quarter, Sterling’s total assets were $12.6 billion, slightly below the levels at June 30, 2008 but above the levels reported a year ago at September 30, 2007. The reduction in total assets mainly stems from a decrease in our construction loan portfolio, specifically our construction portfolio was reduced by $145 million from the second quarter of 2008. Net interest income in the quarter is lower as is the net interest margin resulting from the reversal of $8.5 million in accrued interest income and loans related to non-performing status.

Net interest income was $90.0 million for the third quarter of 2008, $94.1 million for the linked quarter and $93.7 million for the same period a year ago. The net interest margin on a tax equivalents basis was 3.04% down 19 basis points from the 3.23% for the second quarter of 2008 and down 46 basis points on a year-over-year basis. The reversal of accrued interest income lowered third quarter 2008 net interest income by 29 basis points. There were a few other factors contributing to the net interest margin compression, namely Sterling’s asset sensitivity and its LIBOR based borrowings.

I would like to highlight the 4% year-over-year rise in our deposit base to a record $8.07 billion. On a linked quarter basis you will note that 3% growth in non-interest bearing checking accounts related to C&I lending. This 3% rise is not annualized. On both a year-over-year and linked quarter basis we did experience some mix shift towards CDs particularly from our public entities which shifted from money market demand accounts.

Despite intense rate competition and the shift in deposit composition, we were able to reduce our cost of deposits by nine basis points on a linked quarter basis and on a year-over-year basis deposits costs are down 92 basis points. Total non-interest income was $23 million in the third quarter compared to $25.5 million on a linked quarter and $24.2 million in the year ago quarter. Fees and service charges income was up 2% year-over-year. We continue to be pleased with the increase in analyzed account fees, loan related fees, transaction and fees from Sterling’s balance shield program.

The total number of transaction accounts for the third quarter of 2008 grew 2% over the third quarter of 2007 and was up 2% annualized from the second quarter of 2008. Mortgage banking operating income for the third quarter of 2008 was $6.4 million compared to the $8.2 million in a linked quarter and $7.3 million in the same quarter a year ago. During the quarter we recognized lower brokered loan fee income primarily on commercial real estate. The decline in broker fee income mostly is reflected of the disappearing of the conduit market coupled with the retreat of life insurance companies which has slowed down the funding of their new loans.

Because of the declines in prices for portfolio loan sales, we continue to back away from selling some of our SBA and commercial loans in the current period as it is better to hold the yield than to sell at depressed prices. Our residential mortgage subsidiary, Gulf Savings Bank continues to perform above plan for both mortgage originations and loan sales. Due to the seasonality, Gulf’s contribution this quarter was roughly equivalent to that in the linked quarter.

Our efficiency ratio improved again during the quarter as measured by the ratio of non-interest expense to average assets which dropped to 2.24% in the third quarter of 2008 from 2.29% in the linked quarter and 2.54% in the same period a year ago. During the third quarter, total operating expenses were $71.5 million, down from $72.4 million reported in the second quarter of 2008 and up 3% year-over-year. In the quarter full-time equivalent employees decreased by 22 to 2,523.

We continue to pursue operating expense reductions and operating process improvements. I would point out that the quarter-to-quarter reductions have come despite year-to-date increases on FDIC deposit insurance premiums of nearly $3.4 million increase. With respect to income taxes, we did recognize a tax benefit of $440,000. This reflects a tax benefit on certain housing investment projects, the recognition of certain tax credits and a reduction in our reserve for uncertain tax provisions referred as FIN 48 as the statute of limitations expired on some open tax periods.

Now, with respect to asset quality, at June 30, 2008 gross non-performing assets, that is non-performing assets before the specific allocated reserves were $436.7 million which is up from $303.4 million last quarter and $223.1 million at the end of March, 2008. The largest component of non-performers continues to be the residential construction accounting for 73% of all non-performing assets. Residential construction non-performing assets rose 31% over the linked quarter.

The increase is primarily due to one relationship based in Portland which saw the largest increase. Excluding this relationship, residential construction non-performers rose 14%. Non-performers related to other loan categories experienced a slight increase rising to $119.9 million from $62.5 million at the end of the second quarter. The bulk of the incremental increase in non-performing assets in other loan types, particularly the mortgage and commercial as it was related to borrowers primarily connected to the housing industry.

Our loan portfolio in other categories is performing in line with expectations. Classified assets which include all the non-performing assets were $671.5 million which is up from $497.5 million last quarter. The majority of the classified assets continue to fall in the residential construction category and represented 67% of all classifieds this quarter similar to the linked quarter.

The geographic distribution of classified assets is very similar to that of the non-performing assets reflected in our press release with the Portland Oregon market showing the more significant increase from the previous quarter. Regarding Puget Sound which is our largest markets with approximately $1 billion in residential construction commitments, this market continues to hold up relatively well.

Gross non-performing loans increased slightly to $38 million from $31 million last quarter and represent only 4% of outstanding commitments to this region. Residential construction non-performing assets in many of our other previously identified markets such as Bend, Utah and southern California and Vancouver and Boise appear to be stabilizing. As anticipated the Portland market experienced additional softness in the third quarter. Weakness in this market was reflected mainly in one builder as I mentioned before.

We experienced a generalized rise in residential construction non-performing markets throughout some of our smaller markets as well. You will note that in the quarter our construction portfolio was reduced by $145 million. This reduction was accomplished through roughly a $92 million in net maturities and early pay offs. That is pay offs net of any originations as well as partial or total resolution of a number of non-performing construction loans totaling $66.6 million.

Of the $66.6 million, $9.2 million related to non-performing loans being paid off or brought current in the quarter, $8.1 million reflects short sale activity and $49.2 million is due to the transfer of construction loans to REO. The loss content associated with the short sales was approximately 13%. The loss content on construction loans at foreclosure was 31% but note that this is due to a single project in the southern California market which had a loss content of nearly 54%.

Outside of this single relationship our loss content for the quarter was more in the 26% range and our year-to-date experience continues to suggest that our actual loan loss content is in line with our estimate of loan loss allowances. I would just add that during the quarter our total net charge offs were $22 million, specifically $19 million were related to residential construction, $1.6 million was related to consumer loans and $1.3 million was connected to commercial loans.

Getting in to the guidance and looking ahead to the fourth quarter 2008 we’re encouraged by the core performance of Sterling Savings Bank and Gulf Savings Bank. As Harold indicated projecting earnings is very difficult given the continued disruption of the housing market on the counterparty risk that has so dramatically affected the LIBOR markets, commercial paper markets and municipal markets and the federal governments recently enacted TARP legislation, our initial reaction is that the fourth quarter will be similar to the third quarter but there are some wild cards.

Some of these factors which are outside of our control, namely are the Federal Reserve and additional actions it will take with prevailing interest rates and there’s also the relationship for the spread between labor and treasury rates. I will say that the recent declines are encouraging and may be beneficial to our net interest margin. Another uncertainty regarding the economic macro events and their effects on economic growth on the national and regional economies. An additional factor will be the level of our classified non-performing assets over the next quarter.

To date we have not seen any significant spill over to other loan types outside of the residential construction. But, given all these uncertainties we do expect to see total assets down modestly at the end of 2008 as we continue to strategically shift our loan portfolio towards commercial and consumer loans and away from construction loans. These and service charge income remains a bright spot. Growth is tied to the level of transaction accounts and we believe the FDIC insurance on business deposit will enable further growth in transaction accounts.

With regard to mortgage banking operating income the volume of loan activity relating to residential mortgage originations could be impacted by the fluctuation of mortgage interest rates as well as seasonal buying trends. But, we think the gain on the sale of residential mortgage loans is likely to be stable or better than expectation. We continue to control our operating expenses and we expect our fourth quarter non-operating expense in line and to be generally in par with the third quarter. However, we do anticipate an increase in the FDIC insurance premiums in to the future.

Reflecting more pronounced effects on tax credits, we expect Sterling’s effective annualized tax rate to be between 14% and 16% below our prior guidance. We anticipate zero tax provision for the fourth quarter of 2008. We expect to remain well capitalized through 2008, we are currently evaluating the TARP capital provisions contained with Emergency Economic Stabilization Act and it seems premature to determine how much capital Sterling would access under the TARP but the minimum capital available is approximately $100 million and the maximum is approximately $300 million.

Our total risk based capital would be enhanced an increased in a range of 12% to 14%. With regard to liquidity, the TARP provisions related to deposit insurance should calm both our retail and commercial customers. At the holding company level, Sterling has cash resources of approximately $12 million and at the bank level we have sufficient collateral to support additional lending from the Federal Home Loan Bank and other sources if we needed to. With that I’ll turn it back to Harold.

Harold B. Gilkey

In these troubled economic times on a whole based on performance of our employees I am satisfied with Sterling’s third quarter performance. In a quarter when there were so many distracting events beyond our control, the entire Sterling team stayed focused on what they can control. Put simply, taking deposits, making the loan, charging the fee and controlling the overhead.

Our employees dedication to client and to community is our unique hometown helpful manner. It mattered more than ever and was a key contributor to the solid performance of our underlying bank. Thanks to safe, sound, secure banking discipline, our capital reserves and liquidity position remains strong. We continue to ship our asset mix towards high quality lending relationships in the business and consumer segments.

We made good and ongoing progress in growing business related fee income and deposit. We are indeed controlling our overhead through systematic process improvement. Our credit team has the skill and the tenacity to resolve problem assets. In conclusion, we are managing through this credit cycle and will continue to do so. As I’ve said before, the resolution process is likely to take longer than any of us would like.

I would however like to end with a reminder of the strengths of Sterling’s franchise. Our capital liquidity position remains solid. Our operating core banking business is solid and performing well. We live in an area of the country where the primary economic drivers are constructive, employment levels, job creation and net migration. We have a strong management team that has experience to address the current market disruption and the asset quality challenges.

Our credit team is capable and seasoned and has the significant experience in loan resolution and work out. We have a diversified loan portfolio, we are continuing to build our commercial banking franchise in Sterling and our residential home loan business at Gulf Savings Bank. With that, I would like to open up the question and answer session.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Jeffery Rulis – D.A. Davidson & Co.

Jeffery Rulis – D.A. Davidson & Co.

Dan, based on the comments you just gave kind of guidance, have you sort of moved past the previous guidance on the loan loss provision in the $100 million to $125 million range?

Daniel G. Byrne

Yes, I think we’re going to be a little bit higher in the fourth quarter and probably more comparable to what we saw in the third quarter.

Jeffery Rulis – D.A. Davidson & Co.

Then the large relationship in Portland is that related to the Renaissance Homes bankruptcy?

Daniel G. Byrne

Yes it is.

Jeffery Rulis – D.A. Davidson & Co.

Then just lastly, of the construction loans percent residential versus commercial?

Daniel G. Byrne

Just on a total portfolio basis?

Jeffery Rulis – D.A. Davidson & Co.

In the construction segment.

Daniel G. Byrne

But just on total or are you looking for –

Jeffery Rulis – D.A. Davidson & Co.

In total, right.

Daniel G. Byrne

Total remains about two thirds in the residential construction and one third in the commercial.

Jeffery Rulis – D.A. Davidson & Co.

Then lastly you expressed your intention to sort of shrink the construction portfolio but the corporate and business banking was down, is that one-time in nature or do you expect that to continue to decline there?

Daniel G. Byrne

We’re actually emphasizing to try to grow those areas but I think there’s been some – people have been impacted a little bit by what’s happening in the market place generally but we would like to see those categories grow.

Jeffery Rulis – D.A. Davidson & Co.

So maybe the business banking a little one-time in Q3?

Daniel G. Byrne

Again, we’d like to grow those areas.

Operator

Our next question comes from Matthew Clark – Keefe, Bruyette & Woods.

Matthew Clark – Keefe, Bruyette & Woods

As it relates to that non-resi construction NPA category, call it the [inaudible] resi consumer category, just that big other bucket, that was up I guess $57 million second to third, it sounds like you’re relating it to businesses that relate to the housing industry. Have you guys attempted to try to size up what your exposure might be to relationships that touch the home builders sector whether it be subcontractors, other brokers and so forth? And if so, just curious what that might be?

Daniel G. Byrne

I don’t know that we have a total portfolio of other credits that are comparable Matt.

Matthew Clark – Keefe, Bruyette & Woods

So are you suggesting that there’s nothing left out there?

Harold B. Gilkey

Matt, you never know what’s left out there but in general we’ve asked our corporate bankers to look through their portfolios and look at those that are related to construction related products and with that we then have reviewed it for classification. I think our discipline in handling our credit portfolio would follow through. I don’t see a significant portion of our corporate or consumer lending to be directly related to construction portfolio.

Matthew Clark – Keefe, Bruyette & Woods

Then in terms of commitments, resi construction commitments by market, I was wondering if you could help us or at least update us whether it be on a percentage basis or in terms of dollars your commitment in resi construction as it relates to each of those markets that you provide us on that table, Boise, So Cal, Bend, Puget and so forth. I think Puget you mentioned is about $1 billion, I’m going to stay Portland is around $440 to $450 but if you could help us out there I’d appreciate it.

Daniel G. Byrne

You’re pretty close on the Portland, it’s about $444, Boise has declined to $115 million approximately and the total So Cal was $189 million approximately at the end of September.

Matthew Clark – Keefe, Bruyette & Woods

Then Utah $70?

Daniel G. Byrne

A little under that, about $67.

Matthew Clark – Keefe, Bruyette & Woods

Vancouver?

Daniel G. Byrne

Vancouver was approximately $88 million.

Matthew Clark – Keefe, Bruyette & Woods

Then overall would you say what $1.95 billion?

Daniel G. Byrne

Matt, I’m sorry, let me go back I was with the wrong comparison. Vancouver is actually $83 million and for Boise is $100 million. I was looking at June 30 numbers. The Portland market has actually decreased $408 million.

Matthew Clark – Keefe, Bruyette & Woods

Again overall in terms of resi construction commitments dollar was $1.9 something?

Daniel G. Byrne

Commitments on an overall basis are $2.37 billion and that’s down from the June quarter.

Matthew Clark – Keefe, Bruyette & Woods

Lastly, as you evaluate the TARP can you just give us some color as to the types of conversations you might be having with regulators, what you think might be required to be eligible for the TARP capital? Not just maybe for yourself specifically but for the banks in generally.

Harold B. Gilkey

I figured you guys would have a better contact with the regulators and the decision makers on that than I do. I think the relationship more importantly comes from our board of directors. Looking at this transaction the key to our board of directors agreeing forward is one, it is relatively attractive pricing and that is made it reasonable from a standpoint of providing an umbrella insurance policy as well as an opportunity fund.

But, the one question that I think everybody’s revolving themselves around is what do you do when you get the money? Where are you going to allocate it, what are you going to invest it in. My value judgment is that’s the same questions that regulators and the treasury is going to ask. Remember, this is an economic recovery act and the decision has been to try to encourage banks to use this in order to make new loans and get the economy started so it will depend on how we evaluate the marketplace and what the depth of new loan activity is.

In a recession, it’s very difficult to see that pattern but there are certain segments of our ability that we think we can grow that and thereby make use of the capital and help create a better economic situation as well as provide for the payment of the dividends and give our own shareholders a return. But, it’s early in the process, albeit we have to have it completed by the 14th of November I think to get through there.

But, I haven’t found guidance do be provided in great detail with the regulators. I think they’re making it up as they go through and they will define the needs for each individual company both what information they need and what use the companies will make of that fund. A long answer to a very short question Matt, I don’t think either you or I know what they need.

Matthew Clark – Keefe, Bruyette & Woods

I guess just lastly your Puget Sound exposure on the resi construction side, your largest market albeit it’s your strongest market, the non-accruals there what’s gone bad is about only 4%. I guess, what’s your confidence in that moving up materially from here? Have you culled all of your relationships there and if you could just again provide some color on that piece of the business.

Harold B. Gilkey

Matt, I appreciate that question because it really is focusing on what I call the key drivers in the pacific northwest. We are indeed increasing the population base, there is an in migration, there’s new jobs being developed, albeit there are some weaknesses in certain areas. I think that one thing that people overlook is the impact of the Boeing strike. We can clearly identify a number of issues where a problem asset of either a non-classified or classified area has been sold subject to the strike being settled.

So, there’s probably a lot of sales that are standing out there waiting to be closed as the strike settles. So, if you can tell me how long the strike is going to last I have some adverse impact on that. I think it probably will equate, it just takes a little longer than normal. But, the Puget Sound area is holding up extremely well particularly as you’re in downtown Seattle.

Operator

Our next question comes from Brett Rabatin – FTN Midwest Securities Corp.

Brett Rabatin – FTN Midwest Securities Corp.

I wanted to first ask if you mentioned and I missed it I apologize, but I didn’t hear any discussion on the dividend and didn’t know if you guys wanted to discuss your policy going forward just given that profitability is obviously being depressed by the level of provisioning?

Harold B. Gilkey

I think there’s two things to focus on that, one we did provide a dividend for the September quarter payable in October. I don’t remember the exact dates of that but that’s been completed. Our next discussion on dividend will be at our December board meeting and a little will depend on what happens during the quarter either from a capital raise independently or the TARP and obviously what happens in the economy.

But, I think generally speaking the board has looked at that on a case-by-case basis rather than on a long term evaluation.

Brett Rabatin – FTN Midwest Securities Corp.

Then secondly as you evaluate potentially getting in to the TARP, I was curious on two things, one is the pace of the run off on the construction book, is there possibilities for that to be more accelerated in the next few quarters? And, have you considered any bulk sales? The secondly, in the stuff that you were showing us last quarter you were assuming that charge offs for the construction book the range was 4.5% to 5%. I was curious if there was any update or any thoughts on a new range or where you think that might be?

Harold B. Gilkey

First of all I see the run off as being pretty stable in the range that it’s been experienced. I do think you might see a blip up with the Boeing settlement of the strike. But, generally speaking I would say that the run off is pretty stable in a relative angle that we’ve experienced over the last three quarters. We’re not considering any bulk sale, the market place just isn’t right for that kind of transaction. Dan, the loss I don’t remember 5%?

Daniel G. Byrne

I didn’t catch the last part of that question Brett.

Brett Rabatin – FTN Midwest Securities Corp.

I just recall back to the investor day when you were kind of giving a range, you were doing your stress testing and showing some numbers for the stress testing as it relates to the construction book and I was curious if you had updated those numbers or had an updated idea of where those might be today relative to where we were a quarter or two ago?

Daniel G. Byrne

We have not updated that schedule that we had in the analyst day at this point Brett.

Harold B. Gilkey

Brett, I would though like to add that I don’t think anything’s changed from the standpoint of our conversation and the fact that we have identified and we have a very disciplined performance of our credit group to identify the magnitude of the problem accounts. We do indeed have our arms around the issue and resolutions are slower than we want them to because attorneys and accountants get in and bankruptcy steps in place and sure you’ve got to go through some court actions but I don’t believe it’s significantly different than what we’ve said before.

Brett Rabatin – FTN Midwest Securities Corp.

Then I was curious, I’m not quite sure if I understood what you were discussing the LIBOR treasury spread and that it had some impact on you but I wasn’t quite sure if I understood what you were indicating what the magnitude might be from that?

Daniel G. Byrne

Well, as we’ve seen during the third quarter the spread widened dramatically given the disruptions in different credit markets. Just recently I’ve noticed it’s come back down but not all the way back to its normal or historical relationship. That has an impact on our funding primarily LIBOR based borrowings. It also has a positive impact with some respect to LIBOR based lending activities. But, [inaudible] I think it’s going to be in that positive to us if the trend continues where it comes back more in line with its historic relationship.

Brett Rabatin – FTN Midwest Securities Corp.

I guess what I was trying to get at is in the current environment where you are today, how much – I’m trying to get that quantified in terms of how much of an impact would that have on the margin? I can’t recall how much you have on the loan side, that’s the LIBOR tied?

Daniel G. Byrne

I don’t have that quantified in basis points Brett. But, we saw the widest part of that in the latter part of the third quarter and so I do think it’s going to have a positive impact as we go forward. But, obviously there’s other factors beyond that that we try to outline in our guidance.

Brett Rabatin – FTN Midwest Securities Corp.

Then just lastly as it relates to the margin, aside from the $8.5 million of reversal on the interest income, you obviously would have had a little higher margin this quarter. Aside from that on a core basis is it fair to assume the margin will be done a little bit in the fourth quarter just given where you’re seeing funding costs and the repricing of stuff on the asset side of the balance sheet?

Daniel G. Byrne

I think the biggest impact has been the non-accrual interest reversal.

Brett Rabatin – FTN Midwest Securities Corp.

But aside from that piece of it?

Daniel G. Byrne

Again, it’s a little hard to gauge. I would say it’s probably going to be down a couple of basis points but there’s some items that could actually be positives, as I just mentioned the spreads on LIBOR could have a positive impact. Generally I’d say that you’re going to see a slight increase going in to the fourth quarter.

Harold B. Gilkey

Brett, I think you’ve hit on what we’ve been trying to say is our core banking business is doing very well. When you separate out the credit costs including reversal entries of interest, the core bank is doing extremely well and that’s because we aren’t chasing dollars. We’ve had some depository relief in that our competitors are not out with wild rates because of the demise of other institutions. So, I think I want to commend our employees for the fine job that they’re doing in managing the core business.

On the other side of that, we are indeed managing the problem assets so I think you’ve struck the point is once you’re through the credit cycle the core business of Sterling and Sterling Financial seems to be well intact.

Brett Rabatin – FTN Midwest Securities Corp.

One last question, I apologize for all the questions, on the TARP I’m curious, I know there are four or five banks in the Washington state that are not well capitalized. Could you potentially have a basis of taking the higher end of the range with the premonition that you might be able to pick up some deposits of a bank or two in the state in the next year or so?

Harold B. Gilkey

I think as I tried to explain we will look to what do we do with the money and first I think the umbrella coverage will help a comfort zone while we’ve indicated that we don’t need capital to solve the credit problems, I think an umbrella policy might benefit others. Secondly, I think that we would open up a real opportunity to increase our penetration in the marketplace through specific targeted loans and specific targeted customers.

In the long term I don’t think it bodes anyone well to have institutions come under the control over the government in the form of liquidation so I don’t know and I have not looked at undercapitalized institutions so I think it’s too early to look at that. As I’ve indicated on several calls that I do believe that the M&A activity will pick up after the credit issues are solved. I think it’s a little premature to have that discussion. Let’s have it in March.

Operator

Our next question comes from Brian Hagler – Kennedy Capital.

Brian Hagler – Kennedy Capital

Harold, you just alluded to a minute ago the demise of some institutions in your market and I’m assuming the upheaval on the retail banking side in your market in general is probably among the highest it’s ever been. Can you just kind of talk about any benefits you guys are seeing from that? Any programs that maybe you’re putting together to try to attract additional customers now that I believe you’re the largest independent bank in the state of Washington.

Harold B. Gilkey

Well let’s go back to our basis strategy Brian. We’ve always positioned ourselves to be what we call hometown helpful. Hometown meaning that we are a relationship bank and that gives us a competitive advantage against the big boxes. Then on the helpful side we provide all the products that any customer would need which gives us a competitive advantage against the boutique banks. So I do believe that our growth has come more at the expense of the big boxes than of the boutique banks.

With the disruption in the marketplace I do believe we have an opportunity to succeed in taking9 market share from big boxes.

Brian Hagler – Kennedy Capital

I guess is there anyway – I know it’s fairly early on but can you cite anything specific as to are you seeing more customers move in to your bank? Are you seeing opportunities for employees? Anything like that?

Harold B. Gilkey

In just a general sense if you look at the overall cause of what I could classify as a crisis, greed overcame fear and people took their money and invested in wild and wonderful derivative marketplace. During the last year and specifically during the last quarter fear has overcome greed and there’s a rush to safety. So we’ve seen some migration from institutions to ours because of the safety issues.

Cleary, the FDIC has stepped up in this program by increasing the insurance of accounts that’s helped [belay] that issue. Obviously, we have spent a lot of time with our employees to provide the helpful side of hometown helpful along with the hometown function and training them how to deal with customers, explaining to them the safety issues and providing guidance to people in the long term that will pay great dividends for us. I’m pleased with our employees performance.

Brian Hagler – Kennedy Capital

One last question, I know in the distant past have acquired some failed institution, your goodwill lawsuit but I guess it sounds like you guys would be interested in that opportunity and would be I guess deemed eligible to look at those types of institutions?

Harold B. Gilkey

You’ve touched on a couple of areas that the discussion at the board level was, “I’m from the government I’m here to help you.” That brought back a lot of the 19809s memory and while we took on institutions with the support of the government it was later to our great demise and once burned twice shy is the word that came out of our board room fairly comfortably.

We have an absolute good functioning group that clearly good enter acquisitions. But, as I indicated to Brett that it’s premature to talk about that. We’re focusing on increasing our market share, solving the problems and maintaining a good quality balance sheet and providing the safety for our customers. Focus on today’s problems will give us opportunities in the future and I indicated M&A will pick up next year. I think the conversations will start probably in March or April.

Operator

Our next question comes from [Allen Gornhill – Infernus Management].

[Allen Gornhill – Infernus Management]

Can you quantify for us in the residential construction portfolio how much is represented in numbers of units, how many are completed units that are awaiting buyers and how many units are under construction.

Harold B. Gilkey

[Allen] I don’t think we have those specific numbers but I would equate it this way for you and the numbers are, as Dan would tell you, accuracy is not important to me and he has an accuracy issue. I would tell you that about a third of our portfolio is in vertical construction, maybe a little more than that.

Daniel G. Byrne

I think you’ve got almost 60% at the end of September.

Harold B. Gilkey

But I was pointing out about a third of that would be completed units and about a third of it would be a vertical that is in a stage of construction and then a third of it would be in some stage of either land, land development or lots. Is that about right, Dan?

Daniel G. Byrne

Well, I think it’s higher Harold. I think if you look at the total vertical it’s running just under 60% and you’ve got probably – I don’t know what the number is what’s completed versus what’s in process, the raw land component of our total residential construction remains relatively low at about 10% of the portfolio and then the lots represent about 6% of the total portfolio and then the difference would be in A&D for the balance.

[Allen Gornhill – Infernus Management]

Vertical means?

Daniel G. Byrne

Vertical would mean you’re in the process of constructing the house or maybe it’s completed houses or maybe nearly completed houses. I just don’t have a breakdown as to how much was actually 100% complete versus some level of completion.

[Allen Gornhill – Infernus Management]

So you say about 60% is under construction.

Daniel G. Byrne

Correct.

[Allen Gornhill – Infernus Management]

Raw land plus developed lots is those two amounts you mentioned?

Daniel G. Byrne

Right.

Operator

Our next question comes from Unidentified Analyst.

Unidentified Analyst

You mentioned earlier that at this point you’re really not interested in any bulk sales at this point just given the pricing dynamic. But I’m assuming you probably at least explored the opportunity in the past to see what’s out there. Can you talk a little bit about the types of discounts maybe you’re seeing across some of your markets in terms of potential bulk sales and if the bids are really much different than kind of the loss content you outlined earlier in the call on what you’re seeing with some of your foreclosed properties.

Harold B. Gilkey

I’d just point out there’s always bottom fisherman but I’ll turn it over to Dan to give you specifics.

Daniel G. Byrne

I was going to say I don’t think we have done a whole lot. We’ve talked to a number of folks and when they kind of indicate the ranges we kind of indicate that sounds like bottom fishing and we’re just not interested in that. Our special assets group has done a marvelous job of creating relationships and alternative buyers at much more supportable levels so that’s why we’re not considering any bulk sales at this point.

Unidentified Analyst

What would you consider kind of bottom fishing levels in the pacific northwest markets? We hear a lot about what’s going on in California and I guess it seems like a little bit less activity in the northwest.

Harold B. Gilkey

Bottom fisherman like to use Southern California, Texas, Florida as it translates to the pacific northwest and it’s just not applicable.

Unidentified Analyst

Another question, you mentioned I think on the call earlier potentially still considering an independent capital raise and also thinking about the TARP and kind compare and contrast your appetite for those two different alternatives?

Harold B. Gilkey

I think we’re doing a lot of analysis on the TARP. As you know if you are able to provide Tier-1 capital after taking down the TARP you can reduce your warrant provision. So there’s a lot of number crunch that has to take place. As you know the investment banking industry has a need to make an income stream so we’re getting several different unique opportunities.

Unidentified Analyst

The last question was on the Renaissance Homes credit, can you talk a little bit about the kind of expected path to resolution to that.

Daniel G. Byrne

Typically we don’t get in to individual credits in terms of those discussions so we’ll have to pass on that.

Operator

Our next question comes from Matthew Clark – Keefe, Bruyette & Woods.

Matthew Clark – Keefe, Bruyette & Woods

I was just going to ask about that Renaissance credit, it seemed to be about $42 million and just obviously stacked up towards the higher end of your classified exposures and I was just curious if you had set aside a reserve yet on it or not and what your expectations might be for loss.

Daniel G. Byrne

Matt, I think we’ve answered that question in that past. That was on our analyst day scheduled of classified assets broken down geographically and was the largest item in the Portland market place so we had the loss associated with that.

Deborah L. Wardwell

This will conclude our conference call.

Harold B. Gilkey

Thank you everyone. I would like to express our appreciation for your participation on this conference call. We look forward to talking to you again after our fourth quarter 2008. Our earnings release is currently scheduled for Tuesday, January 27th which will be followed by a conference call at 8 am Pacific time the following day. Thank you and this concludes our conference.

Operator

A replay for the call will be available in one hour. You may access the replay by dialing 203-369-4009. This concludes today’s conference call.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Sterling Financial Corporation Q3 2008 Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts