Sterling Bancshares, Inc. F3Q08 (Qtr End 09/30/08) Earnings Call Transcript

Oct.28.08 | About: Sterling Bancshares, (SBIB)

Sterling Bancshares, Inc. (NASDAQ:SBIB)

Q3 2008 Earnings Call

October 28, 2008 11:00 am ET

Executives

Graham Painter - Executive Vice President of Corporate Communications

Downey Bridgwater - Chairman, President and Chief Executive Officer

Zach Wasson - Executive Vice President and Chief Financial Officer

Analysts

John Pancari - J.P. Morgan

Brett Rabatin - Stef Midwest

Terry McEvoy - Oppenheimer

Jon Arfstrom - RBC Capital Markets

Operator

Ladies and gentlemen, thank you for standing by and welcome to Third Quarter Earnings 2008 Sterling Bancshares’ Earnings Release Conference Call. At this time all participants are in a listen-only mode and later we will conduct the question and answer session. [Operator Instructions]. And as a reminder this conference is being recorded.

I’d now like to turn the conference over to Executive Vice President of Corporate Communications, Mr. Graham Painter. Please go ahead.

Graham Painter - Executive Vice President of Corporate Communications

Thank you, operator and we apologize everyone for the technical problems that happened. But, we’re going to start over and we’re going to stick with it. Thanks for your patience. And then, thank you and good morning.

I’m Graham Painter, Executive Vice President of Corporate Communications. This morning, Sterling Bancshares released results for the third quarter of 2008. To discuss these results are Downey Bridgwater, Chairman, President and Chief Executive Officer; and Zach Wasson, Executive Vice President and Chief Financial Officer.

Before we begin, and I’ll turn the call over to Downey, I would like to remind everyone of the Safe Harbor statement including in today’s earnings release. The Private Securities Litigation Reform Act of 1995 provides a Safe Harbor for certain forward-looking statements including statements made during the course of today’s conference call. These forward-looking statements are based on the company’s current expectations and beliefs concerning future developments and their potential effects on the company.

There can be no assurance that future developments affecting Sterling will be those anticipated by the company. Factors that could cause actual results to differ from those projected in the forward-looking statements are set forth in today’s earnings release, which has been posted on the Investor Relations page of our website at banksterling.com. On today’s call, our speakers may reference certain non-GAAP financial measures, which we believe provide useful information for investors.

If necessary, we will post reconciliations of these non-GAAP numbers to GAAP results on the Investor Relations page of our website. For additional details on these matters and other risks that could affect the company, please refer to the company’s most recent annual report on Form 10-K, which has been filed with the Securities and Exchange Commission. Sterling assumes no obligation to update the information presented on this call.

And now, for the second time I would now like to turn the call over to our CEO, Downey Bridgwater.

Downey Bridgwater - Chairman, President and Chief Executive Officer

Thanks Graham and welcome everyone to take two of our conference call this morning. As a nation, we are clearly in uncertain and unprecedented economic times. Based in Houston, we unfortunately got to bear witness to the two hurricanes over the past 60 days one named Hurricane Ike that laid landfall on the Texas Gulf Coast on the September 13, and the other being a financial hurricane that hit financial market globally. Since Hurricane Ike hit right around the same time and really began to unfold our loss rate, let me update everyone on how Sterling was impacted by Ike during the quarter as well as how the recovery process is progressing.

We were extremely fortunate and thankful not to have any employees injured during the storm, some of our facilities were damaged and some of our customers have been negatively impacted. First, let me say I’ve been more proud of a group of professionals in my entire career. Our bankers really responded to the challenge to make sure that all of our customer needs were met. Our disaster recovery plan went into effect a week before the hurricane was to make landfall and because of the hard work of our bankers we open for business at 7:30 am, the first day after the storm.

Currently 28 of Sterling’s 29 Houston banking centers are fully operational with only a few having suffered minimal damage. One banking center that is currently not open for business is located at our reset space at 2550 North Loop West, which also operates as Sterling’s corporate headquarters. This building was significantly damaged during the storm resulting in over 200 employees having to be relocated to other Sterling offices throughout Houston. There was significant roof and water damage to that building and is currently uninhabitable. It is expected that the building will be available to reoccupy in approximately two to three months.

In our loan portfolio we have identified approximately $220 million in loans that have collateral located in the areas nearest to the coast, which were the areas more severely affected by Ike. We recognized an additional $2.7 million of loan loss provision in the third quarter related to these particular loans. This additional provision represents our best estimate at this time of possible losses that may occur in these impacted areas. Virtually all of these borrowers have insurance coverage and most have business interruption insurance which would help minimize losses.

During the quarter Sterling also incurred approximately $640,000 in additional expense related to casualty and disaster recovery cost. In additional to the direct financial impact of the storm recognized in the third quarter, the majority of the Greater Houston area was without power throughout the two weeks negatively impacting productivity and businesses and individuals during the last three weeks of the quarter.

Now let me discuss our third quarter financial results in more detail. For the quarter Sterling earned a net income of $7.1 million or $0.10 per share. As I indicated our quarterly results were negatively impacted by approximately $0.03 per share due to the loan loss provision and another expenses related to the hurricane. Additional factors that negatively impacted the third quarter were an additional loan loss provision of $600,000 related to the additional $9.2 million funding of our relationship with SEN group, as well as $3 million in net charge-offs related to a few auto dealer loan relationships that we had identified at the end of the second quarter but were not resolved into the third quarter.

Since as our asset quality results were not what we would have liked for the quarter. Let me give some detail around these results and overall loan portfolio. As I mentioned charge-offs were elevated in the quarter due primarily to a few auto dealer loans that we replaced on non performing status at the end of the second quarter. Unfortunately, we had to take substantial losses on these credits, due to fraudulent activities by these borrowers. In total we charged-off approximately $3 million related to these loans which accounted for approximately half of our $5.8 million in net charge-offs for the quarter.

Over the past few quarters, we’ve been actively trying to reduce our exposure to this type of lending, as it has been an industry that has been struggling with high gas prices combined with change in consumer behavior.

We had approximately $35 million outstanding in auto dealer loans as of September 20, 2008. And while don’t necessarily expect to take any significant losses on the remaining portfolio, we are closely monitoring each auto dealer relationship. The remaining charge offs for the quarter were not concentrated in any one industry or type of collateral. However, most of the charge-offs in the quarter were from loans were originated by loan officers that no longer work externally.

We saw some deterioration in our portfolio during the quarter as non performing loans increased by approximately $21.6 million to a total of $70.5 million. Excluding the $9.2 million increase related to SEN group relationship, non performing loans increased approximately $12.4 million during the quarter. Our largest 15 non-performing relationships totaled about $55 million and make up nearly 80% of our total non performing loans.

As I’ve discussed SEN group is the bulk of that number at $29.2 million and represents approximately 40% of our total non-performing loans. We expect the SEN group bankruptcy to be fully resolved in the second quarter of 2009, and we have approximately $5.1 million reserve for the totals SEN group exposure, $43 million of which is loan loss provision and $800,000 is a discount.

The remaining largest 14 relationships consist of loans in various industries. Let me provide some detail of what makes up these largest 14 non-performing relationships. Five, of the largest non-performing relationships are related to the housing industry, approximately $10 million in total, all secured by real estate. $6 million is related to the medical industry and move to non-performing status due to complications with reimbursements from insurance with the bulk of those loans secured by the Medical facilities.

We have approximately $3 million secured by owner occupied real-estate related to the auto industry. $2 million of loans secured by convenience gas store, convenience store gas station and the remaining is made up of three relationships totaling approximately $5 million and is secured by commercial real estate both office and retail.

We will continue to diligently work through these comp credits and hopefully will begin to see some release in the first part of next year.

Loan growth was strong in the third quarter with the majority of growth coming from the C&I category. Within that category we saw significant line advances in our energy portfolio. With the uncertainty in the national credit markets a portion of our energy customers utilize our existing credit loans out of concerns about liquidity in the market. This has increased our energy loan portfolio to approximately 12% of our total outstanding portfolio. But these loans are to quality companies and are well secured. We internally have a limit of 10% of our total loan portfolio for exposure to any one industry. As such we’ll look to exit or reduce some of these relationships over the next few quarters looking back toward our 10% concentration level.

We’re continuing to see good loan demand but would be very selective in this environment. On most banks, deposit growth continues to be a challenge. But we are able to generate good quarter-over-quarter average deposit growth, we were down on a period in basis. Historically, deposit growth in the third quarter is seasonally low and with competitors keeping rates high, we expect deposit growth to slow in the near term.

Now, this quarter results are below typical Sterling standards. The overall direction of our franchise is on track and I’m encouraged by what I believe will be significant opportunities over the next month, next few months to further build and strengthen our company. Because of these opportunities, we are strongly considering participation in the US Treasury’s Capital Purchase Program. We have not yet decided whether we will apply for the maximum amount available under the program and the capitals relatively inexpensive, and we wants to make sure that we have the best capital structure possible.

Accordingly it is our intent to pursue acquisition opportunities, due to the current market conditions, we believe that a number of those opportunities will be increasing over the next few quarters. The economies that we operate in, Houston, Dallas, Fort Worth, San Antonio continue to perform relatively well based on the latest economic data. However, we are mindful of the impact of challenging housing sector, the drop in the energy and commodity prices and reduced demand for exports may have on the Texas economy.

Hurricane Ike will likely negatively impact most industries and our markets in the fourth quarter, as well followed by a positive impact from rebuilding efforts in subsequent quarters. Despite the unanticipated increase in non-performing loans brought on this quarter, we are still well positioned to take advantage of significant marketplace opportunities. Major industry disruption should drive market share gains and healthcare, exports and strong energy sector still provide significant support to our local economy. These economic drivers are expected to continue to produce job growth and economic investment in each of our Texas markets. Our team has done a great job managing our capital and we are in an enviable position having able to take market share from the larger banks that are going through major consolidations, retrenching and focused on de-leveraging the balance sheet.

We know that Houston and Texas is in immune to all the challenges that rest of the country has been facing for some time now, but we believe that will exit this difficult environment, better position for future growth and profitability.

With that I would like to turn call over to Zach Wasson, our Chief Financial Officer to review our financials in more detail. Zach?

Zach Wasson - Executive Vice President and Chief Financial Officer

Thanks Downey. We appreciate everyone taking time to join us on the call this morning. Since Downey covered some of the big picture items, I want to focus on primary topics. The net interest margin, the securities portfolio, loan sale for sale, non-interest expenses and our capital position.

The net interest margin for the third quarter of 2008, was a healthy 4.44%, down 22 basis points as compared to the second quarter of 2008. A significant portion of this decrease approximately 7 basis points was attributable to the impacted associated with the increase in non-performing asset and also contributing to the decrease in net interest margin was the second quarter $25 million sub debt issuance and an increase on certain borrowing and deposit costs. The dislocation of LIBOR to prime during the quarter also put pressure on the net interest margin as the majority of our variable rate loan portfolio is priced off a firm for wholesale funding costs in some of our deposit pricing driven by LIBOR. We do expect to see continued pressure on our net interest margin but not at the same pace as in the third quarter of 2008. As we mention previously there were number of unusual events that occurred in the third quarter of 2008 that impacted our net interest margin. Hopefully, in future quarters we will be operating in a more stable financial environment where we can generate a most stable net interest margin.

Our balance sheet continues to be fairly noteworthy challengers in short term interest rate and have other factors such as increasing competition for deposits, continued dislocation of LIBOR to prime rate and further increases in non-performing loans despite additional burden on that margin if they were to occur. At the end of the third quarter our securities portfolio totaled approximately $718 million, which equates to 14.5% of total asset, down slightly from the second quarter of 2008. While we did report small $187,000 loss on securities in the third quarter associated with write-down of some interest-only strips related to SBA product. Our securities portfolio has held up extremely well in what has been a very challenging environment. The majority of our securities portfolio consists primarily of agency-backed, mortgage-backed securities and CMOs as well as municipal bonds. The non-agency CMOs represent total approximately $86 million our investment grade rated and consists of prime loans. We have no subprime related assets in our portfolio.

Our investment philosophy and our portfolio has always been to be in the securities portfolio first as the source of liquidity and second as a source of income. This philosophy has served us well. Our securities portfolio remains very sound and we do not anticipate reporting any significant future losses in this portfolio. The weighted average life on our securities portfolio as of September 30, 2008, was approximately 4.9 years with the tax equivalent yield of 4.9%.

During the third quarter, we transferred approximately $112 million in loans from held-for-sale into loans held for investment. These performing loans consist of commercial real estate loans and SBA guaranteed loans. Over the last few years we’ve been actively involved in selling commercial real estate and SBA loans in the secondary market to generate additional non interest income for the bank. However, the market conditions were no longer favorable for this type of loan sale activity, therefore, we made the decision to classify all these loans and sale for investment. As part of the transfer of these loans to the loans held for investment category, we marked all the loans to the lower cost to market, which resulted in a charge incurred in the quarter in the amount of $350,000. While we have put this activity on hold for the time being, we will continue to monitor the market and possible resume our loans sales activity when it is appropriate.

Non-interest expenses totaled approximately $39 million for the third quarter of 2008, an increase of $1.3 million over the second quarter of 2008. Third quarter 2008 expenses were elevated due to $640,000 related to expenses incurred from Hurricane Ike and $150,000 in the increase technology expense for new software licensing fees that were one-time in nature.

Salaries and benefit expenses increased by $827,000 in the third quarter mainly due to increased medical costs and other employee benefits. Non-interest expense increased $4 million for the third quarter of 2008 when compared with the third quarter of 2007. Approximately $1.5 million of that increase can be attributed to the additional expense related to the acquisition of the First Horizon branches in 2008. The third quarter of 2008 also included $640,000 in additional expense related to Hurricane Ike as well as $500,000 in increased FDIC insurance cost.

Speaking of FDIC insurance cost, Sterling has chosen to participate in FDIC’s Temporary Liquidity Guarantee Program, which allows funds in non-interest-bearing transaction deposit accounts to be fully FDIC-insured until December 31, 2009. Sterling will incur 10 basis points surcharge to these non interest bearing transaction deposit accounts not otherwise favored by the existing deposit insurance limit of $250,000. Based on our current estimates, we are expecting our overall FDIC insurance cost to increase by approximately $2.5 million next year.

Sterling’s capital position remains strong with all our regulatory capital levels being well above the minimums to be considered well capitalized. As of September 30, 2008 Tier 1 capital stood at 9.2%, our total risk-based capital was 11.8%, and our tangible capital ratio was 6.6%.

As Downey mentioned, we are considering participating in the US Treasury’s Capital Purchase Program, while we already -- are already in a solid capital position, we believe that we have significant opportunities in front of us. We want to be as prepared as possible to take advantage of those future opportunities and do our part in continuing to stimulate growth in our local economies.

With that I would like to turn the call back over to Downey, before we open the call up for questions; Downey.

Downey Bridgwater - Chairman, President and Chief Executive Officer

Thanks Zach. In summary Sterling remains as sound and stable Texas bank with tremendous near-term opportunities.

With that I’d like to open the call to questions. Operator Ruth.

Question-and-Answer Session

Operator

Thank you. [Operator instructions]. And the first question does come from John Pancari with J.P. Morgan. Please go ahead.

John Pancari

Good morning.

Downey Bridgwater

Good morning John.

John Pancari

Can you talk a little bit about the auto dealer loans, and I know you indicated customers fraud at several customers I mean how was -- can you give us some more detail on this fraud and is it something that was part of a certain group -- lending group at the bank that generated these issues and can you give more detail there?

Downey Bridgwater

Sure. The auto dealer loans that Sterling had -- and we start with second part of your question came from acquisition that Sterling had made over the years lot of community banks for some reason are attracted to making floor plan lines and dealer direct lines and no financing lines for used car dealerships, and frankly, it’s fairly high risky lending and in fact, it’s probably the most risky lending that we have in the bank. And at a period of time, we were up to almost $90 million of these and we worked them down to -- as I mentioned down to around 30 in fact, we got some pay offs just recently so we are closer to the $24 million range right now today. So, we’ve been working to get these things out of the bank as fast as possible. These types of borrowers generally have to be watched quite closely their -- that the industry itself is typically fraught with fraud. And, we actually don’t like this kind of lending we’ve been working our way down and out of this for the last few years. And we are kind of down to the last few pieces now. We consolidated it from all the branches that we had and all the banks that we had acquired into one particular group and we are now watching that very closely and as I said working it down and out. These charge-offs came from two different key relationships in Dallas, with one small and another one in San Antonio actually. So, we’ve -- and there were different types of fraud frankly related in all three of these one of which is the dealer just sold all the automobiles and didn’t pay down the line, so we had to work that down and out and that was a significant loss and then others had a very similar situation where frankly the cars were sold out of trust and proceeds never came to the bank and we could not find the automobiles. We only found a few. So, that’s part of the risk of this kind of lending and we don’t like it at all, and as I said we are working right down and out of this and we have various different opportunities to move these out of the bank just as I mentioned this morning and we hope to be down to the $10 million to $12 million range by the end of this year and then we will work the rest of this out of here hopefully in the next few quarters. But, it’s our intent to get out of this business completely as quickly as we can and minimize future losses. So, that’s kind of the story.

John Pancari

And you indicated that you expect in limited loss content on remaining portfolio how do you get that comfort just given that the prevalence so far?

Downey Bridgwater

Well, identifying really the automobiles having not only third-party but our lenders reviewing the inventory on the various different floor plans, doing not only spot checks but continuous spot checks to make sure that we track every single vehicle that happens to be on the lot or out on sale, or whatever. So it’s tracking the inventory. And frankly, I think it’s small enough now that we’ve got our hands around it we know exactly what we can have in terms of inventory.

John Pancari

Okay. And then one last question it’s a last quick question. I know you had previously discussed the $4 million construction credit on the last quarter conference call that is in the process of resolution, you expect it pay down I believe last quarter, did you see that percent in the third quarter?

Downey Bridgwater

It was not a construction loan, it was a retirement home. But yes, it was real estate-related, and we did get that thing moved out of here. Yes, we did.

John Pancari

Okay, all right, thank you.

Downey Bridgwater

Thanks, John.

Operator

The question will come from Brett Rabatin with FTN Midwest, please go ahead.

Brett Rabatin

Hi guys good morning.

Downey Bridgwater

Good morning.

Brett Rabatin

One of the first outstanding on the top issue are you gays already seeing some opportunities or books? And can you give us a little more color on what you might be interested in and where you’re looking to potential acquire?

Downey Bridgwater

Sure, as you are alluding the primary utilization of the funds on the capital program would be acquisitions. We have conversations ongoing and we believe we will have some opportunities in our markets, in Houston, Dallas, San Antonio, Fort Worth and so on that will add to our franchise in the new term. So, we feel very comfortable that we’ll have those opportunities and be able to utilize that capital in that manner. Of course, we’ll support our ongoing branch building programs and our internal loan growth programs that we already have under way, but I believe the fastest and most expedient utilization of those funds will be for acquisition in Texas markets.

Brett Rabatin

And then secondly, did want to talk about credit for a minute. And first, just going back to the auto dealers, how much of the $90 million -- or both the $90 million and then currently -- how much of those were for floor plans?

Downey Bridgwater

About 65% of floor plans and the others were what they call, they’re note financing lines they call tote-the-note lines.

Brett Rabatin

Yeah.

Downey Bridgwater

Where the bank is effectively financing notes that have been created by the dealer, between the dealer and the customer. We’ve got rid of all of those, all the note financing lines have gone 100% of them. And we’re down to this $24 million now in floor plan lines that we are working our way out of. Like I said we got some pending solutions for these that we hope to be down to the $10 million to $12 million by the end of the year and we are going to exit this completely in 2009, early as possible.

Brett Rabatin

Okay. And then, I was hoping to get some more color on -- you identified 220 million of loans that were put inside the evacuation zone, where there’d been some impact from Hurricane Ike, and had set aside a $2.7 million provision. Can you give a little more color on those loans, and why that specific reserve?

Downey Bridgwater

Sure. We went through a process where we utilized the four evacuation zones that were prescribed by the various different counties here in South Texas, Southeast Texas. And we identified every property within those zones. We had every loan officer go out and review and take a look at each one of those properties, talk with the customers to the degree that they could. There were some customers that, of course, you couldn’t get in touch with them. Power was out, no phone, etcetera, etcetera. So, it took quite some time to try to get to this level. And in doing so, we identified those that we believed had physical damage or those that were just shut down temporarily because of power loss. And at the same time, we reviewed our loan portfolio in the note department and checked every single loan for the presence of active insurance. And, every loan that we looked at had insurance but one, and it was a small $100,000 loan. And, it actually had expired in between the time in which we could -- we can’t force-place insurance within a 45-day period. And it’s one of those really challenging times -- challenging rules for us that had we force-placed insurance, we wouldn’t have lost that $100,000. But anyway, that’s just one loan. We had another that their billing was wiped out. And they’re going to rebuild, they have insurance. I think the biggest impact for this is the time in which it takes to actually get the proceeds either from business interruption insurance, if it’s applicable, or the actual proceeds from repairs. Filing the claim was not a difficult for -- I don’t think, for most of our customers to do. But the receipt of funds has created some cash flow issues for some of our borrowers. Accordingly, we have put some of these on payment deferral, some on interest-only. Some are very strong, and they’re paying for everything out of their pocket with no deferral at all. But there are a few that we have identified that may have some issue so we have placed this reserve against them accordingly. Now as you know under hurricane accounting, if we don’t utilize these fund for those specific reserves then we have to then take them back out of reserve and into earnings. We hope to not have to use any of it, and we hope to be able to take it all back to earnings but we would like to see what happens over the next few months.

Brett Rabatin

Okay. And then I wasn’t clear on what -- you had made some comments about the fourth quarter in terms of expenses and non-recurring stuff. I wasn’t quite clear on the net of that from an expense perspective?

Downey Bridgwater

We had a handful of things -- the hurricane expense, and the coofs. And Zach you want to

Zach Wasson

When you look at the, say, fee income, we had almost $500,000 in other than temporary impairment. And the lower cost-to-market markdown on the loans we moved from held-for-sale to held-for-investment. We could not specifically identify any impact as far as fees, customer service fees, due to Hurricane Ike. But in the last three weeks of the quarter, there was significant dislocation in the market. When we look at non-interest expense -- during the quarter, we had $640,000 from Hurricane Ike, we had $150,000 of licensing fees that we expensed during the quarter, and we had some slight uptick in some employee benefit costs, which -- all of that will probably not be recurring in future quarters. So, I would estimate our non-interest expense was overstated by $1 million.

Brett Rabatin

No. I’m sorry, I meant what -- you were talking a little bit about the fourth quarter you were talking a little bit about the fourth quarter, and that’s what I was asking -- what you were looking -- what you were expecting to happen in 4Q? Just from an expense perspective. I mean, not fee income.

Downey Bridgwater

He just kind of went through an exercise that said we expect that it was overstated by about $1 million. So you’d have a run rate that’s $1 million less on the fourth quarter.

Brett Rabatin

Okay. So, you don’t expect anything meaningfully non-recurring in the fourth quarter, then?

Downey Bridgwater

No, and if we did have anything it would be over -- loan loss side relative to the hurricane possibly. But, we think we have provided for that accurately. So, we don’t expect anything outside.

Brett Rabatin

Okay, great. Thanks for the color.

Downey Bridgwater

Okay.

Operator

And the next question comes from Terry McEvoy with Oppenheimer. Please go ahead.

Terry McEvoy

Thanks good morning.

Downey Bridgwater

Good morning.

Terry McEvoy

Just looking at your period and deposit they were down about a $120 million. Half was CDs, the other half more core in nature. Was that reflective of the competitive landscape that you addressed earlier? Or was some of it maybe based on higher balances above FDIC insurance leaving the Bank?

Downey Bridgwater

It was mostly the competition rates, although we did have a few customers that moved some of the above insurance deposits they had into either sweeps or some treasuries that we handled for them. But for the most part, it’s driven by competition. It’s very different, I believe, in this market in Texas, as opposed to the rest of the U.S. It’s extremely competitive in terms of deposit pricing. So, we’ll certainly stay in the mix and get our fair share. But we haven’t seen just wholesale exodus of customers because of a scare of deposits, or anything like that.

Terry McEvoy

And just one last question -- the MBM Advisors -- could you just remind me again how those -- where those fees come from? Is it fee-only relationships? Is it based on the underlying value of equities? Just to give me a better feel for what that revenue stream could look like going forward?

Zach Wasson

Right. And during the quarter, as you would expect, we had a little weakness in MBM. They were down just slightly linked-quarter. That fee income shows up in wealth management. And it’s driven a lot by both the value of assets that they’re managing for people and the relative fee levels. So, it was slow in the third quarter. And it would be what you would expect in the market that we have in the third quarter.

Terry McEvoy

Thank you, appreciate it.

Operator

[Operator Instructions]. The next question comes from Erika Penala with Merrill Lynch. Please go ahead.

Analyst

Hi.

Zach Wasson

Good morning Erika.

Analyst

Hi, this is actually Elena Karen [ph], not Erika.

Zach Wasson

Oh sorry.

Analyst

It is alright. I guess I had a question, I know that you guys provided a breakdown of your non-performing loans earlier in the phone call. But with regards just to the quarter-over-quarter increase, could you give a little more color on the type of properties that were backing these credit like, specifically what sort of asset clause that was?

Zach Wasson

Sure. As I described on the call, we have got $10 million of the increase.

Analyst

Right.

Zach Wasson

One was a medical facilities, we talked about, it was -- they had some complications due to reimbursements from insurance and those are secured by the medical facilities. There are the surgicare centers if you will, and we believe that’s been since been resolved and we hope to get that one either on performing or out of here within the next quarter or so. Then we got $3 million as I mentioned debt secured by auto dealer, not auto dealer but auto industry, they are related to that. They are the actual mechanic shops, if you will. Then we have a single family residents on -- like Travis, it is a very large single family home, got a couple of attorneys behind that. So we are working with them. We may end up having to foreclose on that property. So, it might move to non-performer, I mean move to ORE and then we will sell it after that. And then, the last piece that has an immaterial amount is a custom home builder in the Clear Lake area, had some liquidity issues and these loans consist of three different construction loans and residential lots, so we will work with him to try to get that down and out. They got some buyers for these homes at this time, so that at least reduce that amount, we believe during the fourth quarter. But that is what added to that $12.4 million worth of net increase for those types of credit.

Analyst

Ok Zach, thank you. And also a quick question just on your earlier fee delinquencies what it was, what it is like, are there any trends that you are seeing, whether the -- a specific type of commercial real estate product?

Zach Wasson

I didn’t understand your question completely. Are you asking about past dues or?

Analyst

Like thirty to eighty nine or ninety –

Zach Wasson

Yes. Some of that increased in the quarter because of the hurricane. We didn’t get any mail for two to three weeks so that, it actually impacted our ability to get some of these checks in for payments on loans so it increased about $10 million I think from link quarter to link quarter, I mean quarter to quarter $21 million to $31 million I think so that was a big part of it. We have since seen our typical working program for past dues during the fourth quarter. The mails are beginning to flow a lot more quickly now but there was a period of time where we were not getting any mail. So that impacted that we think negatively, so directly related to hurricane.

Analyst

And then I have got somewhat -- have a better understanding about your margin at this quarter and I was wondering if you could tell us how much of a interest reversed? How much was your margin impacted due to interest reversal?

Zach Wasson

That’s – I have got part of the seven basis to one which mentions in the comp why is the interest reversal, when the 90 days passed over. We reversed that interest and the otherwise the earnings we lost when the loans were in a non-performing status. I don’t have the exact write-down in front of me but it is the combination of those two advance. We estimate that was seven basis points of the decrease in the net interest margin.

Analyst

And then, I also know that you guys mentioned that deposit competition is heightened and with rates being high and also just kind of what has been going this quarter, can you tell me what has been going on, just for the first month of fourth quarter has been, started to lighten up freshly with the FDIC introducing the liquidity guarantee program?

Downey Bridgwater

Not at all, They haven’t let up. In fact they have been intensified.

Analyst

Okay.

Downey Bridgwater

And some of that we believe is because of the consolidation that is going on and the efforts of the larger banks to try to hang onto customers that might come to banks like us during this time of disruption. So they’re advertising. So, for some customers, they’ll hang onto them. But those that really want to have service and deal with a Texas bank will pick those up.

Analyst

Great, thank you very much.

Operator

And the next question comes from Jon Arfstrom with RBC. Please go ahead.

Jon Arfstrom

Good morning, guys.

Downey Bridgwater

Good morning, Jon.

Jon Arfstrom

You know, its Jon Arfstrom.

Downey Bridgwater

That was an interesting pronunciation.

Jon Arfstrom

Couple questions for you -- can you just touch on the loan pipeline, and how that looks in general? I know you said you’re maybe a bit more cautious than you have been in the past. But I’m just curious what the demand is from clients in some of your key markets?

Downey Bridgwater

Our demand from key clients is still very healthy. In fact, I have luncheons with existing customers in all of our markets at least once a month. And they still have healthy backlogs. They have projects they’re working on. They’re still having difficulty finding qualified people to work on these projects. So, they’re still seeing a pretty healthy environment, at least in Houston, Dallas, San Antonio.

We have seen a lot of loan requests coming from regional and larger banks that are of commercial real estate in nature. And we’re telling our guys, unless they’re really relationship that bring deposits with them, and it’s something that we could bank, that makes sense long term, we’ll just pass on those. But it’s an inordinate amount, a very large, large amount, of real estate credits that are getting pushed to us. We’ve heard from different people we’re interviewing, frankly, from some of these other banks, that they’re being incented directly to move them off the balance sheet. So, we’re being very, very selective in any real estate loans -- commercial real estate loans in particular -- that we might do.

Jon Arfstrom

Okay. That was just -- the second question I had was just behavior of the larger competitors that -- you touched on that, on the deposit side. And you touched a bit on the commercial real estate. But, what are they doing in C&I? It’s still as competitive as ever?

Downey Bridgwater

Yes, it’s still pretty competitive. And of course, that’s where the deposits are, and they’re doing everything they can to hang onto those customers. Pricing is getting better on those types of loans. In fact, all types of relationships, we’re getting the opportunity to price our credits a little better. I think that they’re being very careful about what types of loans they’re putting on their books. And we’re right there with them. So still good demand here.

Jon Arfstrom

Okay. And then, in terms of the held-for-sale change to held-for-investment, what kind of appetite, on-balance -- on-balance sheet appetite do on-balance -- on-balance sheet appetite do you have for those loans?

Downey Bridgwater

Well, they’re very typical of the types of loans that we make anyway. But in terms of originating, co-originating loans, we’re not going to continue to pursue bringing those on. Because there’s no secondary market to sell those into. I mean, the model that we had for that program has changed. So, right now, we have on balance sheet the loans we’ve originated, and we’ll manage through those, as we do the rest of our portfolio. And then, we’ll be generating loans out of our markets on a consistent basis, but not in that program. If for some reason the secondary market comes back, and there’s an appetite for buying some of those loans, we might be able to put those in pools and sell them. But we don’t see that coming back anytime soon.

Jon Arfstrom

Okay, all right, thanks guys.

Operator

The next question comes from Brett Rabatin with Stef Midwest. Please go ahead.

Brett Rabatin

Just wanted to follow up on, Zach, the -- you mentioned LIBOR was a function in the margin decline. How much of the funding base is LIBOR-tied?

Zach Wasson

In a virtually, all of our borrowing -- we use Federal Home Loan Bank of Dallas for a good portion of our wholesale funding. A lot of the times, their funding is driven by LIBOR. And during part of the quarter, their funding costs evidently went up. And we had to pay some higher rates for some of that borrowing. So, the rest, we use Fed funds some, and we use repo. But the biggest piece is Federal Home Loan Bank.

Brett Rabatin

But there’s -- you don’t have a base of institutional money market funding that’s LIBOR-driven?

Downey Bridgwater

No

Brett Rabatin

Okay, great, thank you.

Operator

And, there are no further questions in queue. Please continue.

Downey Bridgwater

Okay. Well, thanks, everyone, for joining our call this quarter. And we appreciate your interest in Sterling and look forward to speaking to you again next quarter. Goodbye.

Operator

This concludes your call for today. Thank you for your participation and for using AT&T Executive Teleconference and you may now disconnect.

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