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Sterling Bancshares, Inc. (NASDAQ:SBIB)

Q4 2008 Earnings Call

January 29, 2009 11:00 am ET

Executives

Graham Painter – Executive Vice President of Corporate Communications

J. Downey Bridgwater – Chairman, President and Chief Executive Officer

Zach L. Wasson – Executive Vice President & Chief Financial Officer

Analyst

Jon Arfstrom – RBC Capital Markets

John Pancari – J.P. Morgan Securities Inc.

Brett Rabatin – FTN Midwest

Terry J. McEvoy – Oppenheimer & Co.

Erika Penala – Bank of America

David J. Bishop – Stifel Nicolaus & Co.

Jefferson Harralson – Keefe Bruyette & Woods Inc.

Brad Milsaps – Sandler O'Neill & Partners L.P.

Rowe W. Bryce – Robert W. Baird & Co., Inc.

Jennifer H. Demba – SunTrust Robinson Humphrey

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Fourth Quarter 2008 Sterling Bancshares Earnings Release. At this time all participants are in a listen-only mode. Later, we will conduct a question and answer session. Instructions will be given at that time. (Operator Instructions). And as a reminder, this conference is being recorded. I’d now like to turn the conference over to our host, Mr. Graham Painter. Please go ahead sir.

Graham Painter

Thank you, and good morning everyone. I’m Graham Painter, Executive Vice President of Corporate Communications. This morning Sterling Bancshares released results for the fourth quarter and year-ended December 31, 2008. To discuss those results with you today are Downey Bridgwater, Chairman, President and Chief Executive Officer; and Zach Wasson, Executive Vice President and Chief Financial Officer.

Before we begin and I turn the call over to Downey, I’d like to remind everyone of the Safe Harbor statement included 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 could be no assurance that the 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 bancsterling.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’ll post reconciliations of these non-GAAP numbers to GAAP results on the Investor Relations page of our website. We also posted on our website this morning and updated investor presentation reflecting Sterling’s fourth quarter results.

For additional detail 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.

I would now like to turn the call over to our CEO, Downey Bridgwater. Downey?

Downey Bridgwater

Thanks Graham, and welcome, everyone. I would like to apologize in advance I’m having some sinus issues this morning. So you’ll have to bear with me, and the quality of my voice.

As noted on our earnings release issued this morning, Sterling earned $0.13 per share for the fourth quarter, and $0.52 per share for the year. Highlights for the fourth quarter include very strong period-end deposit growth, good loan growth, net income of almost $10 million, which includes an increase of our allowance for loan loss during the period, and a level net interest margin as compared to the third quarter of 2008.

Sterling is in a very strong capital position. As of the end of the fourth quarter, Sterling’s total capital to risk-weighted assets ratio was 15% and its tangible common capital to tangible assets ratio was nearly 7%. As we announced earlier this week, our Board of Directors declared a quarterly cash dividend to common stock holders of $0.055 per share unchanged from previous quarters.

This strong capital position will serve us well, as we continue to pursue possible branch deposit acquisition opportunity. But more importantly, it will enable us to take advantage of substantial market share gains that currently exists in our markets due in part to the significant consolidation of some of the larger banks operating in Texas.

Our CFO, Zach Wasson will give you all some more details around our quarter and year-end results later in the call. I’d now like to take the time to reiterate a few things about Sterling, and address a few topics that I believe maybe on the minds of investors in the current environment.

Our strategy at Sterling Bank has not changed. It is simple and straightforward. We focus on providing competitive banking products, and services to all constituencies within the small to medium-sized business segment, more specifically companies with annual revenues of $100 million or less. This includes business owners, their employees, their family members, and people who work and live around our locations. We pride ourselves on building long-term relationships with our customers, knowing their businesses, and helping them to achieve their goals.

Over the years, we’ve expanded into new market such as Dallas, Fort Worth, San Antonio and Texas Hill Country. We’ve taken the same relationship approach and focus on small to medium-sized businesses in each of these new markets. As a testament to this approach, over 85% of our loans are commercial in nature, and 93% of are approximately 16,200 funded loans or less than $5 million in size.

Our average loan balance for our entire portfolio is approximately $234,000. Excluding our energy portfolio, we have a total of 11 loans that are over $10 million in size. Accordingly, we continue to have significant granularity in our loan portfolio. And once in time, Sterling was solely a Houston Bank with the loan portfolio that was primarily secured by Houston real estate. But over the years, we’ve been able to diversify our loan portfolio geographically, and expand our product offering.

One of the areas in which we’ve been able to expand over the last 10 years has been indirect lending to energy company. Being a commercial bank based in Houston and with my background as an energy lender is a natural fit for us to get more involved in energy lending.

We’ve been able to attract extremely experienced and talented in energy lenders, and we’ve been able to build the quality portfolio over the years. As of the end of year, approximately $442 million, or 12% of our outstanding loan portfolio consisted of energy loans.

Because of the corporate nature of the energy business, most of our energy loans are shared national credits and are larger than our typical commercial loans. The only place we have any shared national credits or syndicated credits is within our energy loan portfolio.

With the sudden decrease in energy prices, we’ve received several questions from investors about the impact that has had or could have on our energy portfolio in the Texas economy. In order to answer that question, its important to have some perspective on historical prices, as well as basic understanding on how we underwrite our energy credits and about the make-up of our energy portfolio.

I can understand investors have concerns when they see energy prices decreased substantially in such a short period of time. However, its important to understand that reserve based energy loans are not underwritten at current commodity prices with the expectation that prices will continue to be at or above those levels. Because oil and gas production is extremely capital intensive. These reserve-based loans are conservatively underwritten and are based on average historical prices.

From a historical perspective, oil and natural gas prices are still at relatively high level when compared to the average price over the last 15 to 20 years. Strong global demand, weak dollar and speculation on the energy use caused an extreme peak in the energy prices in 2008.

While energy prices saw record highs during 2008, very few decisions in the energy industry and certainly [none] at Sterling Bank were based on those price levels. Certainly, the level of activity, and future energy projects were most likely being reduced and prices continued to be where they’re or go lower. However, at current prices energy companies are still generating positive cash flow.

As of January 30, 2009, the U.S. Energy Information Administration projected the price of West Texas Intermediate crude oil to average about $43 of barrel in 2009, increasing to $55 of barrel in 2010. They also projected to Henry Hub natural gas spot price to average $5.78 per 1000 cubic feet in 2009 increasing to $6.63 per 1000 cubic feet in 2010.

Sterling Banks energy lending portfolio was primarily reserve based. The energy group does not lend drilling contractors, oilfield-service companies or refineries. This means a majority of our energy loans are collateralized by proved oil and natural gas reserves. The maximum amount that can be advanced on these types of loans is governed by a borrowing base and that borrowing base is recalculated at least every six months using a conservative third-party analysis of reserves and related production volumes.

Reserve volumes and production are then risk-adjusted downward to provide a safety caution. Due to projected oil and natural gas prices use the value of the collateral or typically below prevailing market price. These prices are used in conjunction with risk-adjusted reserves to derive reserve value.

The borrowing base is generally 65% or less of this calculated reserve value with the result being that the borrowing base is typically significantly less than the market value of the oil and natural gas collateral. Borrowing bases are also subject to a corporate cash flow analysis to serve sufficient liquidity for general administrative and other corporate expenses.

From a steel commodity price risk, almost all of our borrowers hedged the price of their production helping to offset this risk. Sterling does not participate in any of our borrowers hedging activity. The end result of this conservative underwriting is that for a properly structured reserve based loan portfolio, the loss rate approaches zero. In fact, it’s rare that losses are realized from a reserve base loans.

Based on outstanding balances approximately 80% of the company’s energy portfolio or public companies or subsidiaries of public companies. As of the end of the year, the composition of the collateral of our energy portfolio consists of 63% gas reserve, and 37% oil reserves.

Reserve based loans represent approximately 80% of our energy portfolio. Sterling’s remaining energy portfolio consists of well-secured loans to companies that would be classified as midstream energy company. In simple terms, a midstream energy company is a company that processes and transports crude oil and natural gas.

Part of the height and concerned around our energy portfolio has been caused by the sudden filing of Chapter 11 bankruptcy by one of our energy customers, same group in July of 2008. This filing came in a time when energy prices running all time high, so it came at a surprise to the entire 50 bank lending group.

The bankruptcy was the result of severe cash flow shortage that have been caused by individuals in the company trading outside of their approved risk management and credit agreement. Thereby [improving] large cash margin cost on the commodity trade positions.

The bankruptcy is currently ongoing. In addition to other interested bidders, there has been interest that is expressed by third-party in proposing a reorganization plan to avoid a possible liquidation of the various same group company. However, that plan or any reorganization plans have to be approved by the bankruptcy court. Outside this credit, our energy portfolio is performing exactly has agreed. Another area in which investors have expressed concern is the area of commercial real estate.

Because of the significant decrease in residential home values, but some areas of the country have experienced, it’s natural to worry about the future performance of commercial real estate. However, I’d like to reinsure investors that we have maintained our conservative equity requirement throughout and in fact we become much more sophisticated and standardized in our underwriting approach over the last three years.

Obviously, this is not mean that we won’t experience an increase in non-performing asset due to a slowing economy. As we’ve already seen an increase in NPAs. However, it does mean that because of a high level of equity, the personal guarantees and the cash flow coverage we’ve required. We do not expect to take significant losses on the loans that may end up on non-accrual.

It has been our practice to aggressively recognize non-performing loans, as it’s our belief that if we can identify a problem or issue early it will help reduce future losses. Over our history, we’ve shown that while we vocationally have an increase in NPAs, we’ve mitigated related losses to much lower levels.

Unfortunately, as of 12/31/08, we have approximately $86 million in non-performing loans. As we discussed, our largest non-performer is related to SemGroup in the amount of $29 million. Of the remaining $57 million of non-performing loans, approximately 50 million is secured by real estate with 44 million of that being commercial in nature.

The average loan to value on the non-performing real estate loans is approximately 71% based on the most recent appraisal. Volatility is possible that we could experience losses on some of these individual credits, as a whole, a losses should be minimal. Because of the current environment, it maybe difficult to work through these credits as quickly as we would in a normal environment. Therefore some may end up as other real estate owned for a short period of time.

We will continue to work diligently to move these non-performing assets of our balance sheet or in a few cases were its warranted work with the customer to rehabilitate these loans back to a performing status. At the end of the quarter past due loans 30 to 89 days were $32 million basically flat, as compared to the end of the third quarter.

I think everyone is aware of the economic issues nationally ranging from the housing crisis, the unprecedented actions by our government. While the Texas economy has been immune to the slowdown has taken place across the country. Texas has held up comparatively well.

Our statewide unemployment average of 6% and the last 12 months job growth of a 154,000 jobs compared favorably to national averages and results. Texas has benefited from a strong energy sector and state significant exporting activity. Because of the decline in energy prices and relatively strong dollar, Texas will most likely not experience the same levels of growth from those sectors in 2009 as did in ’07 and ’08.

However, even without the benefit of higher energy prices at a weaker dollar, at current energy prices Texas is still poised to outperform the overall U.S. economy. Texas did not experience a significant increase in real estate values over the last five to 10 years as some other states did. And the Texas economy has been continually diversified over the last several years, and its success does not as dependent on energy as it once was 25 years ago.

According to the latest information from the Dallas Federal Reserve, housing inventories, foreclosures and delinquencies continue to look better in Texas than the nation overall. Even so, just like the rest of the country. Home building, residential construction employment in Texas are likely to remain weak for the near-term.

We know that Houston and Texas is an immune to all the challenges to the rest of the country has been facing for some time now, but we believe that we are well positioned for the future growth and increase profitability when the economy begins its recovery.

With that, I’ll gladly turn the call over to Zach Wasson, our Chief Financial Officer to review our financials in more detail. Zach?

Zach L. Wasson

Thanks, Downey. We appreciate everyone taking the time to join us on the call this morning. For the fourth quarter of 2008, net income was $9.6 million, or $0.13 per share, as compared to $13.4 million, or $0.18 per share earned in the fourth quarter of 2007.

The primary difference in the two quarters is a provision for credit losses, which was approximately $6 million higher in the fourth quarter of 2008. Outside of the increase in non-performing loans and the related provision expense, the fundamental operating trends in the fourth quarter of 2008 were encouraging.

We were able to stabilize our net interest margin in the fourth quarter of 2008, which was unchanged from the third quarter at 4.44%. Sterling’s net interest margin benefited from strong core deposit growth and a decrease in our short-term borrowing costs. For the year, the margin was 22 basis points below, but it was in 2007.

We did anticipate further pressure on the net interest margin in 2009 as we feel the full impact of the reduction in the primary, lower reimbursement yields on mortgage-backed securities and the limited ability to lower deposit rates. Speaking of deposits, period-end deposit growth was excellent in the fourth quarter.

Total deposits were up $245 million, or almost 7% quarter-over-quarter, but some of this growth can be attributed to a $40 million increase in brokered CDs, a seasonal increase in public funds of $45 million. We still estimate the growth in core deposits to be approximately $160 million for the fourth quarter, which is very strong.

We are remaining in a core-funded franchise with an attractive deposit base as reported in quarter end, non-interest bearing deposits were approximately 30% of our total deposits. We are expecting to generate and (Inaudible) from 4 to 6% deposit growth in 2009. Of course, we will be looking for more, but we believe that this is the most likely growth rate in the current environment.

For the fourth quarter, period-end loans increased $48.7 million, or 1.3% on a linked-quarter basis. The growth came from mostly that C&I and commercial real estate categories. We anticipate having around 2 to 4% net loan growth for 2009. However, our gross loan production should be much greater as this range assumes that we will be actively looking to reduce loans in certain categories during the year, such as energy, other data, leasing and non-owner occupied commercial real estate.

This loan growth rate assumes that [will] decrease our energy portfolio back to our internal guideline of 10% or less of the overall loan portfolio eliminate our exposure in other data loans currently $20 million, and continue amortization of the small ticket leasing portfolio approximately $7 million. And reduced our ratio of non-owner occupied commercial real estate loans to owner occupied commercial real estate loans.

We plan to step up our lending efforts in C&I excluding energy, owner occupied commercial real estate, as well as consumer lending to move an existing customers. One housekeeping item related to loan calcifications. As you will notice on page nine of our earnings release, the amount of commercial real estate, construction and development loans, as well as residential mortgage loans showed some significant changes from third quarter 2008 to fourth quarter 2008.

Over the last year, we’ve made significant progress towards more precisely reflecting our loan classifications. And as such, during the fourth quarter, we reclassified certain construction and development loans in order to ensure that they were all classified properly based on their most current status.

Based on our review, we ended out reclassifying approximately 200 million from construction and development and to the commercial real estate and residential real estate categories. Obviously, all of these loans were one-time construction and development loans, but after the construction was completed and the loan was changed to a permanent or a mini-permanent in most cases. The coding on our system hadn’t been adjusted to reflect the change.

Non-interest income was down $160 in the fourth quarter versus the third quarter, but the difference primarily being lower fees generating from wealth management. The wealth management fees have of course been negatively impacted by the disruption that is happening in the financial markets.

Overall, we’re budgeting an increase of 3 to 5% in non-interest income for 2009. Non-interest expense totaled approximately 39 million for the fourth quarter of 2008, an increase of just $120,000 over the third quarter of 2008.

However, when factoring out certain expenses related to Hurricane, Ike, overall expense were up approximately $630,000 quarter-over-quarter. Approximately, $485,000 of that increase came in the form of severance and salary costs related to right-sizing our SBA unit and exiting the small ticket leasing business. These decisions were based on decreased opportunities in those areas go-to-market conditions.

Non-interest expense increased $13.9 million year-to-date for 2008, as compared to 2007. The increase is due to three acquisitions completed since March of 2007, resulting an additional non-interest expense of $8.1 million, increased FDI insurance costs of approximately $2.1 million and $800,000 in Hurricane Ike related expenses for 2008, as compared to 2007. Excluding these items, expenses were up 2% year-over-year. We expect expenses to remain relatively constant in 2009.

At the end of the fourth quarter, our securities portfolio totaled approximately $805 million, which equates to 15.9% of total assets, up from $718 million, or 14.5% in the third quarter of 2008. 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 that we have totaled approximately $81 million. These non-agency securities are all senior bonds backed by high quality residential mortgage loans.

Sterling does not own any securities that are backed by sub-prime residential mortgage loans, nor any types of bonds that allow for negative amortization such as pay option arms. We also do not own any Fannie or Freddie preferred stock, CDOs, including any trust preferred securities or any commercial mortgage backed securities in our securities portfolio. Our investment philosophy is in the securities portfolio has always been to view the portfolio floors as a source of liquidity and second as a source of income. This philosophy has served us well.

Our securities portfolio remains sound and we do not anticipate recording any significant future losses in this portfolio. The weighted average life on our securities portfolio, as of December 31, 2008 was approximately 3.6 years with the tax equivalent yield of 4.9%. Sterling’s capital position remain strong, and was bolstered significantly at the end of the quarter, with the additional $125 million in capital invested, as a results of our participation in the U.S. Treasury's Capital Purchase Program.

All our regulatory capital levels are well above minimums to be considered well capitalized. As of December 31, 2008, Tier 1 capital stood at 12.2%, our total risk based capital was 14.9%, and our tangible common ratio was 6.9%.

As another housekeeping item, the provision for federal and state income taxes were $3.8 million for the fourth quarter of 2008, and $17.4 million for the year, resulting an effective tax rates of approximately 28% and 31% respectively. During the fourth quarter of 2008, we reduced income tax expense of $378,000, which resulted in a lower effective tax rate. This reduction was result of expiration of previous tax contingencies. The effective tax rate for 2009 is expected to be approximately 32%. With that I would like to turn the call back over Downey. Before we open the call for questions. Downey.

J. Downey Bridgwater

Thanks Zach. In summary, while a slowing economy creates certain near-term challenges. We are well positioned to navigate through those challenges and ultimately take advantage of growth opportunities ahead. I would also like to thank all of our employees for their deep commitment to providing the type of service excellence that make Sterling to bank that customer’s who want to do business with.

With that, I would like to open the call to question. [Wallis]?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And our first question is from Jon Arfstrom from RBC Capital Markets. Please go ahead.

Jon Arfstrom – RBC Capital Markets

Thanks good morning.

Zach L. Wasson

Good morning.

J. Downey Bridgwater

Hi, Jon.

Jon Arfstrom – RBC Capital Markets

Almost I feel guilty asking Downey a question would you report it, but…

J. Downey Bridgwater

You may.

Jon Arfstrom – RBC Capital Markets

Maybe I will start with that. Zach I appreciate that disclosure on the changing on the construction and development categories.

Zach L. Wasson

Yes.

Jon Arfstrom – RBC Capital Markets

Can you give us an idea of the – what where the growth came from in the quarter, the loan growth was a little bit slower than expected, it’s still not bad, but give us an idea of where that would be coming from and what category?

Zach L. Wasson

Right, if you want to take that schedule, the first thing I would do is, we move 200 million from construction and development. We priced 180 million of that in commercial real estate, and 20 million in residential mortgage. So, during the quarter we have 13 million growth in C&O, and this – that was not in energy, energy was basically flat for the quarter. Our commercial real estate grew 20, construction and development 13, residential mortgage 6, consumer and other went down slightly for net growth of $47 million.

J. Downey Bridgwater

And that’s outside of the transfer.

Zach L. Wasson

Right, that was adjusted for that transfer.

J. Downey Bridgwater

Right, that’s answer your question.

Jon Arfstrom – RBC Capital Markets

Yeah. That’s helpful. And then the comment on reducing non-owner occupied commercial real estate. Could you talk about how – what percentage of your commercial real estate within that category?

J. Downey Bridgwater

Right now our ratio of commercial real estate both owner, we got one-third non-owner occupied and two-thirds owner excuse me – two-thirds non-owner occupied and one-third owner occupied and we would like to get that closer to 50/50 or even flip it overtime. It will take a while for us to move in that right direction, but we want to make sure that we're continuing to focus on our core market [niche of] small to medium-sized businesses and the type of real estate that supports those businesses.

Jon Arfstrom – RBC Capital Markets

So, in your mind there’s more of a mix shift than it is a reduction on those balances?

J. Downey Bridgwater

Yes, absolutely we are not looking to shrink the portfolio, no we're trying to move the mix around a little bit and then it will take a little while to get that done, but our incentives are designed to do that and our lenders are clearly what they are to pursue.

Jon Arfstrom – RBC Capital Markets

And that commercial real estate pipeline look adequate at this point?

J. Downey Bridgwater

Yeah, I mean we've got a decent pipeline across all the types of loans that we make and our guys are building the emphasis on owner occupied real estate and related commercial loans that we had make to those companies.

Jon Arfstrom – RBC Capital Markets

Okay, and then just one last question you – Downey you mentioned briefly, when you are talking about your capital ratio is about possible acquisitions. And can you give us an update as to what make sense for you if?

J. Downey Bridgwater

Yeah, of course the assisted acquisition opportunities are continuing to increase not so much in Texas, we are seeing a few of those and we've no desire to move out of Texas and make sure everybody is clear about that. Any acquisition or growth that we’re going to undertake will be within the State of Texas. So we'll continue to look for those opportunities. We believe that there will be other players that have made a - an effort to build the presence here, exit that presence, at the same time you’ve seen tremendous industry consolidation with large, large players in our markets. So we think that we are going to have the opportunity to gain that market share and deploy that capital an organic growth as well as just [outlaid] acquisitions of depositors coming to banks like Sterling.

Jon Arfstrom – RBC Capital Markets

Well, something like the First Horizon branchs would be?

J. Downey Bridgwater

Yeah, exactly, exactly.

Jon Arfstrom – RBC Capital Markets

Okay. Great, thanks.

Operator

Thank you. And our next question is from John Pancari from J.P. Morgan. Please go ahead.

John Pancari – J.P. Morgan Securities Inc.

Good morning.

J. Downey Bridgwater

Hi John.

Zach L. Wasson

Hi John.

John Pancari – J.P. Morgan Securities Inc.

Can you give us a bit more detail on the NPL inflows this quarter, specifically the types of credits and the granularity of what moved on to non-performer this quarter?

Zach L. Wasson

Yeah, the bulk of the increase in non-performers could reside in four loans. A $5.5 million, six-store office building in Dallas, the borrower has the ability to pay, this is really more of a dispute and we’ll work through this, so it’s not really a credit issue necessarily. And then a $4 million, [a big] facility in Huston, where you do have Chapter 7 bankruptcy and register liquidation, foreclose and sell the asset move on. $2.5 million retail center and the - again the borrower has ability to repay, but part of this is in Galveston. So, we are working through this with the borrower. And then lastly $1.9 million convenient store and clear like area part of Houston there. They are struggling, and we will see if we can’t get this rehabilitated, but none of these really oppose any loss for us at all. And we think we’ll be able to work down in out of these specifically. Now as to the rest of the non-performing portfolio, as you recall, over third of our NPA’s is just SemGroup, at one credit. And the remaining $57 million is mostly commercial real estate, both owner-occupied and non owner-occupied and the loan to value there is about 71% overall. So, again we don’t expect to have amount to the way of losses if any, as we work down in out of these things. I also mention that we may have to foreclose on some of these, which we typically we’re able to get them work down in and out without having the foreclose but it’s taking a little longer to work through these and if that’s what we have do and (inaudible) not a problem.

John Pancari – J.P. Morgan Securities Inc.

And that 71% is on the new appraisals?

J. Downey Bridgwater

They’re on appraisals.

Zach L. Wasson

Yes, that’s correct.

John Pancari – J.P. Morgan Securities Inc.

Newly appraised?

J. Downey Bridgwater

They’re on the most recent appraisals we have, some number brand new, some number within a few months, but they’re not all brand new appraisals, but they’re on the most recent appraisals we have.

John Pancari – J.P. Morgan Securities Inc.

Okay. All right, and then do you have what the 30 to 89 day delinquencies for the quarter and how they compared from last quarter?

J. Downey Bridgwater

John, its likely flat.

Zach L. Wasson

Likely flat at 32 million.

J. Downey Bridgwater

Yeah.

Zach L. Wasson

So that was flat linked quarter.

John Pancari – J.P. Morgan Securities Inc.

Okay and any differences between the loan buckets for that 30 to 89 day group?

Zach L. Wasson

No.

J. Downey Bridgwater

Not really.

John Pancari – J.P. Morgan Securities Inc.

Okay, that’s all I have. Thanks.

J. Downey Bridgwater

Thanks John.

Operator

Your next question is from Brett Rabatin from FTN Midwest.

Brett Rabatin – FTN Midwest

Good morning guys.

Zach L. Wasson

Good morning Brett.

J. Downey Bridgwater

Hi, Brett, how are you doing?

Brett Rabatin – FTN Midwest

Doing well, thanks. I hope you give the (fog) Downey.

J. Downey Bridgwater

Yeah I'll.

Brett Rabatin – FTN Midwest

I wondered the first today, thanks for all the color on the energy staff and ask on the constructions well like I know a large part of that is commercial construction. Do you guys have a number for how much of that portfolio is pre-leased type properties versus non pre-leased.

J. Downey Bridgwater

For me to give you that at this moment now I have to go back and look at our files, we have the information, but I would have to go pull all of that info and get it to you. So, let me get that done and I will ship it to you.

Brett Rabatin – FTN Midwest

Okay. And then also on the commercial real estate – you mentioned and I know from regulatory final perspective, you got about 650 in owner-occupied CRE. Can you guys either given on the call or maybe put in the queue, some color from an industry perspective on commercial real estate break it down by office and retail and that sort of thing?

J. Downey Bridgwater

Yeah, we got the ability to do that and we'll make it is as granular by property type in the queue as we okay as we possible we can.

Brett Rabatin – FTN Midwest

Okay and then you mention the likelihood of the margin might continue to be under pressure obviously your asset sensitive and core deposits were fantastic, but they were work less when rates were so low.

J. Downey Bridgwater

Correct.

Brett Rabatin – FTN Midwest

I'm curious about I was really impressed with the management of the CD cost just given the competitive environment at least a quarter or go or so on in Texas. Is that something that you can continue to work down or is the 2.9% is that basically (inaudible) that’s probably going to be in this near-term environment.

J. Downey Bridgwater

We, you know our current rate is below the 2.9. So we would expect that to continue to drift down, but like you say we have to see very conscious competition. And maintain our customer relationships, but I would still say a little drift on the down side on the CD cost.

Zach L. Wasson

The good news is on the competitive front is that; most of the banks in our markets have begun to move downward. There is always a few outliers, but its not a radical drop in pricing, it’s a gradual drop so, we are tracking that as aggressively as we can without exacts point loosing our customer base.

Brett Rabatin – FTN Midwest

Okay and then on the charge-offs, I was curious that number one was obviously nicely lower from the previous quarter. Did any – was there anything in there related to the auto and then what’s you are cleaned up there still?

J. Downey Bridgwater

No.

Brett Rabatin – FTN Midwest

And then on that. Okay…

J. Downey Bridgwater

No.

Brett Rabatin – FTN Midwest

So what the 3.5 can you kind of break that apart closely in terms of industry or was at a few loans or bunch of loans?

J. Downey Bridgwater

If you look at I guess its page 19, you see our charge-offs it was really broken out about 50/50 between real estate and C&I loans and it’s really a bunch of small loans.

Brett Rabatin – FTN Midwest

Okay.

J. Downey Bridgwater

There is no large loss on any particular singular credit that would standout to make the difference there.

Brett Rabatin – FTN Midwest

Okay great. And then just last question, I’m curious on that acquisition stuff is, what I was hoping to get was as if you guys had a number from intangible common equity perspective that you wouldn’t drip below given that you’re – you close to seven now as there are flow or how you are looking. If any goal comes along, we are not going to give below this number?

J. Downey Bridgwater

Well, historically we said 6%, but I think it’s really prudent to hang on to this much tangible capital as possible so. We are going to be very careful and as I have also said in the last quarter conferences and so on is that for us to pay much if any premium for an acquisition at all it’s going to be very difficult to really justify especially, with deposits becoming available through assisted acquisition opportunity. So, we’re – it can be really difficult to step out and paying much of a premium to anybody and haven’t makes sense for us or for the marketplace overall. So I wouldn’t expect our tangible capital to get pressured much during any acquisition.

Brett Rabatin – FTN Midwest

Okay. Well, thanks for the color.

Zach L. Wasson

Thank you.

Operator

Our next question is from the line of Terry McEvoy from Oppenheimer & Company. Please go ahead.

Terry J. McEvoy – Oppenheimer & Co.

Thanks.

J. Downey Bridgwater

Hi, Terry.

Terry J. McEvoy – Oppenheimer & Co.

Just one question for you. A few of the other Texas-based banks with a middle market focus, well like you guys did not apply for TARP capital or the capital purchase program Sterling didn’t has that worked against you at all kind of out there in the trenches as maybe some might view the decision to take TARP capital as implying the bank within sort of a weaker financial position or is that just not an issue out in the markets?

J. Downey Bridgwater

As we understand and it’s not much of an issue, I mean obviously we haven’t had a negative impact on deposits; in fact it’s been the office that we’ve had significant deposit growth and always it’s occurred obviously within the last quarter. So, we view it as a positive, it was a tool that was available to us. We didn’t need the capital of course, but I think now we have a significantly stronger balance sheet and stronger capital position upon which to grow our franchise. There is some work still to do, I think in the community because the media keeps calling it a bailout, and as we all know it’s a loan, it’s preferred to capital. So, we’re having due to spell some of the spin that the median has put on this thing, because it’s a actually a very good thing for the taxpayer as well for our shareholders, so we think it’s a win-win situation and we are glad, we participated in it.

Terry J. McEvoy – Oppenheimer & Co.

Thanks for your help.

Operator

Thank you. Our next question is from Erika Penala from Bank of America. Please go ahead.

Erika Penala – Bank of America

Good afternoon - good morning.

Zach L. Wasson

Good morning Erica.

Erika Penala – Bank of America

Just a quick follow up question. Could you also breakdown your commercial construction portfolio by future asset class or is that something we can also look forward to in the K?

J. Downey Bridgwater

It would have to be in the K, for me to try to give you that off the company would be a little tough to do, but we will put certainly put that in the K.

Erika Penala – Bank of America

Okay. All of my questions are answered. Get better soon Downey.

J. Downey Bridgwater

We will do. Thanks Erica.

Zach L. Wasson

Thank you.

Operator

The next question is from David Bishop from Stifel Nicolaus. Please go ahead.

David J. Bishop – Stifel Nicolaus & Co.

Hi.

J. Downey Bridgwater

Hi, David.

David J. Bishop – Stifel Nicolaus & Co.

Good morning gentlemen. How are you doing Downey? See just a little commentary, I know you give some color in terms of that and the period deposit flows but on the core deposit front, any sort of marketing initiative you’re seeing driving that or you more community awareness or is that just a matter of (call) or client volume increasing from some of the other distressed banks within your market there?

J. Downey Bridgwater

It’s a combination of several things. Have a little deposit promotion, with all the noise that’s coming around the bigger banks, some of its year-end, some of it is Zach mentioned is public born some of it’s broker CDs but, vast majority is just across the board, good healthy deposit growth. So, we’ve been the beneficiary of that as I think you’ve seen in other Texas banks we’ve all pretty much had a pretty healthy growth in deposits across the entire franchise.

Zach L. Wasson

And we participated in the FDRC guarantee programs on the DDA account, and when your T-bill is - as low as it is and this guarantee is for any account that pays 50 basis points or less as far as DDA and so, it picked up a number of accounts, we did a lot of work internally talking with our customers during the (inaudible) the financial Hurricane, which was probably earlier in the fourth quarter and really timed our customer base sound what’s able to use these tools to help grow deposits.

J. Downey Bridgwater

So there was a benefit to have in Hurricane Ike, it was fact that we really had the contact just about everyone of our customers. So, is that opportune time to reassure them that’s everything is every fine and really a hold your hand through not only in the weather

related Hurricane but the financial Hurricane as well.

David J. Bishop – Stifel Nicolaus & Co.

Driving the guidance for deposit growth next year, in terms of the energy portfolio there. What’s the deposit exposure of those customers?

Zach L. Wasson

Very little.

J. Downey Bridgwater

Very little yeah, since their shared national credits we don’t have a lot of deposit relationships with them. We have some, but it’s a very small percentage.

David J. Bishop – Stifel Nicolaus & Co.

Gotcha and I think Zach in your preamble commentary, so there could be some get back on the margin here I assumed here the late quarter fed rate cuts there any order of magnitude, you can – give us there.

Zach L. Wasson

Not at this time, I mean we continue to – it’s interesting if you look to the stimulation model when you anchor it, zero.

David J. Bishop – Stifel Nicolaus & Co.

Okay.

Zach L. Wasson

So when you say rates down a 100 basis points, what’s you are really talking about this is a curve flattening about 100. Because so many rights can drop 100 basis points, but we say a lot of we have some quarterly based prime based loans that are drop at the first year, but it’s this continuous pressure that we've talked about for the last couple of years of competition. The deposit mix what the smarter consumer and as far as the deposit side, the loan side prime is probably stable, where it is. And we are aggressively trying to grow the CNR relationship type lending and our owner occupied commercial real estates. So hopefully with that type of loan growth it will continue to help our deposit mix stays so rich that we have right now.

J. Downey Bridgwater

We are also asking our lenders to put floors on our loans because – just because prime is now 3.25 it doesn’t mean that we need to offer prime as a rate to a customer. We have to maintain a certain spreads. So we’re utilizing guideline such as really a prime plus one with a floor five across the Board. So, that’s a way in which to make sure that we are watching the loan yield as well. So that pricing on that side of the mix is going to be important exercise for us this year.

David J. Bishop – Stifel Nicolaus & Co.

Can you give a estimate of what percent of portfolio is that floors and when eventually obviously we’ll see that the fed reverse itself who knows when. Any sort of directional or number the last rate cycle there were the Fed had to move on a 100 to 125 basis points, we actually saw those loans move out their floor?

J. Downey Bridgwater

Right and if you take into consideration, the hedging that we’ve have already done. We’ve effectively moved our portfolio to basically 50% fix and 50% floating anyway.

David J. Bishop – Stifel Nicolaus & Co.

Okay.

J. Downey Bridgwater

So we are looking to move that, but not beyond two to three year period of being fixed, because we don’t want to be on the short-end of this, when rights turnaround. On the other side of this environment. So we’re being very mindful, very careful about this, but we’re making sure that we try to drive our fixed ratio as high as we can on a relatively short-term basis.

David J. Bishop – Stifel Nicolaus & Co.

Thanks guys.

Operator

Our next question is from the line of Jefferson Harralson from KBW. Please go ahead.

Jefferson Harralson – Keefe Bruyette & Woods Inc.

Hi, thanks. Zach, I want to ask you question on the funky LIBOR rate this quarter did it help the margin this quarter and it does the normalization of that – of the LIBOR hurt you next quarter on the margin.

Zach L. Wasson

No its - I think it was a help this quarter, but in the third quarter its definitely hurt but now it's more closer to where it should be so it's more of a recurring item here not one of where you will see just based of the LIBOR rate any decrease in the margins. But it did hurt the third quarter and have more normalized in the fourth quarter as the way to say.

Jefferson Harralson – Keefe Bruyette & Woods Inc.

And a longer-term question and maybe it’s too long-term, but what's the planning of the likely repayment of TARP. Would that be done with another preferred comment or if you just wait long enough to write a check for it less than…

J. Downey Bridgwater

Under the rules we have to raise capital to pay it back we can ride a check for and it being redeemed, so we have to raise capital to replace it that is I understand so it is our goal to replace that what I've said many, many times this is not my objective to ever dilute shareholders unless we bring in new earnings, so we need to either grow leverage that capital or elaborate my growing internally. And or through strategic acquisitions and then utilize those opportunities to replace as much if not all the TARP as quickly as possible. Certainly, if we get it done before 2009, we reduce the amount of outstanding warrants, and that would be our number one objective, but at the same time we don’t want to dilute shareholders just for the exercise.

Jefferson Harralson – Keefe Bruyette & Woods Inc.

All right, thanks a lot guys.

Zach L. Wasson

Thank you.

Operator

Our next question is from Brad Milsaps from Sandler O'Neill. Please go ahead.

Brad Milsaps – Sandler O'Neill & Partners L.P.

Hi, good morning.

Zach L. Wasson

Good morning Brad.

J. Downey Bridgwater

Hi, Brad.

Brad Milsaps – Sandler O'Neill & Partners L.P.

Hi, Downey last quarter you identified I think about 220 million loans or so that. You thought could potentially be affected by Hurricane Ike and I think you set up small reserve around 2.7 million. Just I want to see if there is any update on those, have you been able to you kind of move through that that book of loans you’ve identified or kind of where are you with that?

L. Downey Bridgwater

So far, we’ve identified about $400,000 worth of potential losses that may come out of the Hurricane Ike loans, but that’s about it and so far. We should be able to get that result either this quarter or first part of next quarter. And we would be able to do something with that relative provision, but as a fans right now we’re not seeing significant deterioration, through any of the loans or loans in the regions that we identified right after the Hurricane. So we’ve not had any others pop-up. So that’s the good news out of this, that whole exercise.

Brad Milsaps – Sandler O'Neill & Partners L.P.

Great, great. Okay. Thank you very much.

Operator

Thank you. And our next question is from Bryce Rowe from Robert W. Baird. Please go ahead.

Rowe W. Bryce – Robert W. Baird & Co., Inc.

Thanks, good morning.

Zach L. Wasson

Good morning Bryce.

Rowe W. Bryce – Robert W. Baird & Co., Inc.

Hi Zach, can you just I missed it. Can you restate what the severance number was in the fourth quarter?

Zach L. Wasson

It was 485,000.

Rowe W. Bryce – Robert W. Baird & Co., Inc.

Okay, anything in that occupancy line, on the operating expenses. Anything have normal there?

Zach L. Wasson

That we did have some real estate taxes we paid. We had a new branch office that we began a land leased on and, so it’s up a little this quarter. Like I said earlier the next year, we plan on keeping expenses fairly plan.

Rowe W. Bryce – Robert W. Baird & Co., Inc.

Okay thanks guys.

Zach L. Wasson

Thank you.

Operator

And our next question is from Jennifer Demba from Suntrust. Please go ahead.

Jennifer H. Demba – SunTrust Robinson Humphrey

Good morning.

Unidentified Company Representative

Good morning Jennifer.

Jennifer H. Demba – SunTrust Robinson Humphrey

If I’m missed this forum sorry. What are you projected FDIC premiums in ‘09 versus ’08?

Zach L. Wasson

‘09 they will go up another 1.5 - $2 million maybe based on our deposits in such. But once again our total operating expenses would plan on maintaining down constant.

Jennifer H. Demba – SunTrust Robinson Humphrey

Okay, so you have the Ike costs this year?

Zach L. Wasson

Right.

J. Downey Bridgwater

Right.

Jennifer H. Demba – SunTrust Robinson Humphrey

That would somewhat offset that.

Zach L. Wasson

Correct.

Jennifer H. Demba – SunTrust Robinson Humphrey

Were else would the offset be?

Zach L. Wasson

And just managing our expenses and seeing what we do with occupancy. What we do with some of the discretionary spending, managing our people and such as that. So it's across the board.

Jennifer H. Demba – SunTrust Robinson Humphrey

Okay. Thanks.

Operator

(Operator Instructions) And gentlemen, at this time there are no further questions in queue.

J. Downey Bridgwater

Okay thanks for joining us today. And we appreciate your interest in Sterling and look forward to speaking to you next quarter. Good bye.

Operator

Thank you. Ladies and gentlemen that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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Source: Sterling Bancshares, Inc. Q4 2008 Earnings Call Transcript
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