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Executives

Dan Chila – EVP, Cashier & CFO

Tom Geisel – President & CEO

Bruce Dansbury – EVP & COO

Ed Malandro – SVP, Retail Banking

Analysts

Matthew Kelley – Sterne Agee & Leach Inc

Rick Weiss – Janney Montgomery Scott

Sun Bancorp, Inc. (SNBC) Q4 2008 Earnings Call Transcript January 28, 2009 11:30 AM ET

Operator

The Sun Bancorp fourth quarter earnings conference call will now begin. On the line for Sun Bancorp are Tom Geisel, President & CEO; Dan Chila, CFO and Bruce Dansbury, Chief Operating Officer. At the end of the presentation, we will have a question-and-answer session. At this time Dan Chila.

Dan Chila

Good morning. This is Dan Chila, I am the Chief Financial Officer of Sun Bancorp. Joining me here is our CEO, Tom Geisel and Bruce Dansbury, our Chief Operating Officer and Chief Credit Officer. Tom and Bruce will have some brief remarks and then we will take questions. First let me read the Safe Harbor statement. Following discussions may contain forward-looking statements concerning the financial condition, results of operations and business of Sun Bancorp. We caution that such statements are subject to a number of uncertainties and actual results could differ materially and therefore you should not place undue reliance on any forward-looking statements we make today. We are not under any obligation to and may not publicly release results of any revisions that may be made to any forward-looking statements we make to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

Now I will turn it over to Tom Geisel.

Tom Geisel

Thank you Dan. This is Tom Geisel, good morning everyone and thanks for joining us today. I have a few comments about our performance over the past three months and then I will turn it over to Bruce for an update on the lending side of the business and then we will entertain some questions.

As you know yesterday we issued a release which reported a fourth quarter net profit of $4.3 million or $0.19 per share compared to $4.1 million or $0.18 per share for the linked third quarter, and compared to $3.9 million or $0.16 per share for the fourth quarter of 2007. On a consolidated basis, net income for the full year was $14.9 million or $0.65 per share compared to net income of $19.4 million or $0.82 per share for the previous year 2007. As we reported in the release, we realized a pretax one-time gain of $11.5 million during the fourth quarter from the sale of our six Delaware branches. This was a development that had been planned for as part of our overall network optimization strategy to divest our network in an area where we do not have a dominant retail presence.

It was a major first step to focus our retail efforts and resources on New Jersey, which is our predominant market with a great footprint in selective counties. On the other side of the coin, we took a rate down pretax charge of $7.5 million attributable to fair value accounting standards and mark to market for two trust preferred securities held in the investment portfolio. For those of you listening who may not be familiar with what trust preferred securities are, these are very common type of investment grade securities that have declined in value as a result of what is going on in the external marketplace.

The third major factor behind the fourth quarter results is that we substantially increased the level of our loan loss provision for the quarter to $7.6 million. This compares to $3.7 million for the third quarter of 2008 and $5.4 million for the fourth quarter a year ago. I would like to switch gears for a moment and give you some additional color about the economy and how it relates to our markets. Here in New Jersey our markets still have, and I believe will always have, better than average underlying quality, this is because of the benefits of our density, economic diversity, close proximity to major metropolitan MSAs to our north, west and south and the coastal communities to the east.

Our footprint covers a solid, mature marketplace and we are now the second largest independent commercial bank headquartered in the State of New Jersey. That said, it has become increasingly clear over the past six months that as the national downturn is persisting, New Jersey is mirroring [ph] the overall economy. So it has essentially gone from where we were moderately outperforming the overall economy to a declining pace that is in step with what is unfolding across the US and that is about the same story coming from just about all of the stronger metropolitan areas across the country. No area is exempt from the downturn.

While we are hopeful for a rapid recovery, the reality as you would expect is New Jersey and the country will have a very challenging 2009. Looking forward, our net interest margin during the coming year is likely to continue to struggle. The net interest margin for the fourth quarter ended at 3.26% and for the full year at 3.30%. A year ago, the full year margin for 2007 was 3.37%. Now as an asset sensitive institution we have been experiencing margin pressure all year and given the current historic low interest rates and continued low rate forecast for 2009, we will continue to experience margin pressure. Despite that pressure, a focus of ours in 2009 will be to maximize margin even if that means balancing loan growth.

Now I would like to take a few moments and talk a little about credit quality. As I stated in the release, we are going to continue to be proactive during 2009 in reviewing and evaluating the quality of existing loans throughout each segment of our portfolio. Our goal for 2009 remains to sensibly manage our loan portfolio for profitable balanced growth supported by consistent credit quality. We are forecasting that the local operating environment will continue to decline before it rebounds. We will continue to be (inaudible) the assessment of our credits and we will prudently maintain our reserve at an adequate level.

The allowance for loan losses to total loans was 1.36% at December 31, 2008 compared to 1.08% at December 31, 2007 and 1.28% at September 30, 2008. The loan loss provision for the year was $20 million compared to $8.4 million 12 months ago. Internally, we are going to be doing everything we can to manage problem loans throughout the portfolio which means stress testing existing credits, getting frequent updates of appraisals, making sure we have got realistic risk rating procedures in place, assigning adequate manpower to the various functions, informing credit oversight, etc. Right now, we are comfortable with our overall reserve adequacy.

Before we jump to Bruce’s credit report, just a quick word about capital, you all know we sold a little over 89,000 shares of preferred stock under the US Treasury’s TARP Capital Purchase Plan and we received $89.3 million in new capital. Of course we are pleased to have qualified and have been selected to participate in this program. We want the marketplace to know that the additional capital strength will further support our lending activities. Sun Bancorp’s capital ratios continue to remain strong and we are well capitalized by all regulatory standards and definitions. With the Treasury’s investment, the company’s leveraged capital ratio would increase to approximately 12.25% and the total risk-based capital would increase to approximately 14.43%. The company’s tangible capital to asset ratio will improve to 8.45% from 6.10% at December 31, 2008.

With all the discussions about credit quality and capital adequacy, I want to make sure that we don’t overlook something that is very basic and very important and that is our foremost priority for the coming year is to continue to execute on our strategic plan under which our main goal is to produce profitable balanced growth. As we do this on the loan side, we intend to concentrate on rational pricing in order to increase the net interest margin as best we can and we intend to focus on originating high quality new loans without any undue concentration in a particular loan segment.

On the deposit side, our focus remains customer relationship driven not just accounts again revolving around rational pricing. You can’t build a relationship around wholesale funding with brokered CD rates at 1.15 to 1.85 depending on duration, it is certainly a tempting option, we have to be able to balance both. And we will also be continuing to optimize our franchise by better positioning our branches for profitability and more effective coverage in the key areas of our footprint. So we won’t be ignoring our good customers and we intend to generate consistent profitable growth during 2009 even as we address all of the difficulties presented by the economy.

I would like to now turn it over to Bruce and then we will take some questions.

Bruce Dansbury

Okay, thanks Tom and good morning. As Tom said, 2008 proved to be the most volatile market in recent history. We witnessed the decline in revenue generation across our client base regardless of industry late in the third quarter and into the fourth quarter of the year. What we saw initially impacting all aspects of the housing market is now pervasive across both our commercial and consumer portfolios as evidenced by weaker operating results and depressed collateral values.

Overall our portfolio continues to reflect the performance of the economy as a whole. Based on early and ongoing assessment and response to deteriorating market conditions, we have taken an aggressive stance on downgrades, non-accruals and charge-offs and we will continue to do so. We fully anticipate these trends will continue and could very well deepen throughout 2009. However, as a secured lender, we expect a certain level of recoveries through the collection and liquidation efforts of our special asset teams. That said recovery periods are lengthening and recovery efforts could stretch well into 2010.

Our 2008 charge-offs and charge downs have been spread across key portfolios. For the fourth quarter we charged off $3.6 million in commercial loans which totaled 16 basis points of our total commercial loans as of the end of the year. This included $2.8 million related to commercial and small business loans and about $800,000 in SBA loans. In addition we charged off $420,000 of consumer loans of which $249,000 were home equity lines of credit. For the entire year we charged off or charged down a little over $8 million in commercial loans which represents 36 basis points of our year-end balance, small business and SBA loan charge-offs represented $1.4 million and $1.3 million respectively of that total.

Consumer loan charge-offs totaled just shy of $1.5 million of which $1.1 million was from home equity lines of credit portfolio. We continue to assess the collateral values of our impaired loan portfolio and have made appropriate adjustments to maintain accurate collateral positions. Of the $3.6 million in commercial and SBA loan charge-offs for the fourth quarter, $1.8 million or almost about 50% of the quarterly total represented charge downs of existing loans as opposed to newly identified loans. The protracted foreclosure process in New Jersey has prompted periodic charge downs as we are forced to wait for extended periods of time before we can achieve foreclosure liquidate and realize plan or value. In terms of our loan loss reserve, we have and we will continue to provide for increased provision levels in our loan loss reserve in anticipation of the road ahead.

We are enhancing stress testing for various segments of our portfolio and tailoring our assumptions used in that testing for anticipated weakening of our borrowers’ performance over the coming year. As might be expected, levels of loan delinquency have trended up during the course of 2008. The overall delinquency rate for performing commercial loans was in the range of 38 basis points during the first nine months of the year but we saw that level of past dues rise more significantly in the fourth quarter increasing to roughly 87 basis points at the end of the year. While averaging 70 basis points during 2008, the trend in performing small business loan delinquencies mirrors that of the commercial loans with an upward trend in the fourth quarter with 1.05%.

Our home equity portfolio also exhibited a shallow upward trend in performing loan delinquencies during 2008 with significant increases in the fourth quarter. At year end the floating rate portion of our home equity portfolio had a performing delinquency rate of 59 basis points and our fixed rate portfolio was at 1.38%. While delinquency increases were not necessarily dramatic they were indicative of widening slowness especially during the fourth quarter of the year. We fully expect to see delinquency levels increase during the year ahead considering rising levels of unemployment and the overall systemic weakness in the economy.

Over the course of 2008, we did see increases in the level of both commercial and non-commercial, non-accrual loans. Let me highlight some of those increases. As of June 30, 2008 non-accrual commercial loans totaled $26 million and totaled $37.5 million at year end. Non-commercial non-accruals totaled $5.3 million at the end of June and were $4.7 million as of 12/31 this year. Non-accruals in both categories dipped slightly at year end in the fourth quarter as a result of our aggressive charge-off policy.

As a percentage of total loans, total non-performing loans increased from 1.12% at the end of 2007 to its current level of 1.71% at year end 2008. I always like to mention our residential construction lending which we highlighted in past discussions and it does continue to decline as a segment of our portfolio as this sector remains in the doldrums. At year end outstanding residential construction loans totaled $62.4 million or 2.8% of our total commercial loans. This is down from 3.3% at the end of June and 3% at the end of September 2008.

Our residential construction borrowers for the most part appear to be managing the steep downturn as well as it can be expected. At the front end of our process, our pipeline of new deals, deal opportunities is holding up pretty well and we will remain an active lender seeking reasonable opportunities wherever we can. We currently have about $105 million in new approved transactions and another $231 million of deals under consideration. It is worthy to note that despite the turmoil in the lending markets we experienced 2008 loan growth of 9.2% predominantly driven by our increases in commercial loans.

As larger institutions retrenched we were afforded lending opportunities that traditionally eluded us. This is continuing today as evidenced by a strong pipeline in our commercial sector. I do want to be clear that all new opportunities are being underwritten based upon our strict underwriting guidelines while obtaining a healthy margin of net interest income.

We are committed to this marketplace and have the capital to support clients that will navigate this economic storm successfully. We are ready, willing and able to lend money to qualified borrowers. Overall 2009 should be a time of extraordinary challenges for us in our credit culture but we are going into these challenging times with our eyes wide open and prepared to adjust our approach when necessary in order to maintain our credit quality. Tom?

Tom Geisel

Thanks Bruce. Before we go to the first question, I would just like to reiterate a few things. The first one is that there certainly was no doubt that 2008 presented financial challenges in the way of continued economic downturn in margin pressure and increased portfolio stress. With that in mind, my (inaudible) and I agreed to forego any cash bonuses that we might have received for 2008.

That said, 2008 was also a year we feel we had some successes. We strengthened our core foundation, we created better alignment within our organization, we hired some top talent, we created the company’s first ever three-year strategic plan and entered into lines of business we feel will position us better competitively. So we are confident that we are well positioned structurally to emerge stronger from the downturn.

So, now it is time to take a few questions. Please state your name and let us know which company you are with. Operator, can we have the first question.

Question-and-Answer Session

Operator

At this time the lines are open for questions. (Operator instructions) Our first question comes from the line of Matthew Kelley, please proceed with your question.

Matthew Kelley – Sterne Agee & Leach Inc

Yes on the expense front, what are you folks anticipating for the expense growth off of the $93 million for the full year in 2008?

Dan Chila

Mat, this is Dan, we are projecting a nominal expense growth in a range of no more than 2% to 3% if that is on the base.

Matthew Kelley – Sterne Agee & Leach Inc

Okay. And what are the FDIC premiums, how much are those going to go up in ’08, ‘09?

Dan Chila

We have built in – that includes projected FDIC premium increase which year to year has an impact of over $2 million for us based on our budget.

Matthew Kelley – Sterne Agee & Leach Inc

Okay, alright. A question for Bruce, I was wondering if you could give us a little bit of insight into what you see in cap rates and customers’ ability to re-buy [ph] properties as they come due and they are just going to – all the new underwriting standards for commercial real estate when things are refined and the owners of those properties have to come to the close, what are they seeing in terms of cap rates and new structures and ability to roll into new financing.

Tom Geisel

Certainly it is a little bit more challenging today than it was a year ago to refinance. You have got a couple of things working, collateral values are down, real estate is down, we are pricing cap rates in the 8% to 9% range. So it is really a function of how stabilized the property is and how it is holding up with respect to (inaudible) and things of that nature. But I would say that it is more difficult for the borrower depending on the property and the nature of the property.

Matthew Kelley – Sterne Agee & Leach Inc

In the 8% to 9% cap rates where was that 18 months ago and what types of properties that offers retail and –

Tom Geisel

I don’t – a year ago?

Matthew Kelley – Sterne Agee & Leach Inc

Yes.

Tom Geisel

I don’t remember, more in the 7% to 8%.

Dan Chila

7.5%.

Tom Geisel

Yes, 7.5% to 8% probably and it is office, it is apartments, it is kind of across the board.

Matthew Kelley – Sterne Agee & Leach Inc

Okay, got you. And Dan, can you just give a simplified explanation on what is going on in the BOLI plan?

Dan Chila

I guess in terms of our BOLI (inaudible) I am not sure what directly is the question you have?

Matthew Kelley – Sterne Agee & Leach Inc

I know you switched some from general to separate and what is going on there?

Dan Chila

We have a total BOLI portfolio of about $75 million in late 2007 we did a major restructuring of that BOLI portfolio and moved about $53 million into a separate account BOLI and the remaining balance remained in the general account because there were on contracts, employees who were no longer at the company and were not eligible the converted portfolio is invested in separate account (inaudible) we have a wrap [ph] agreement on that portfolio and the market value to surrender value is well above the trigger point in that wrap agreement so we have no impact or write down on our investment.

Matthew Kelley – Sterne Agee & Leach Inc

Okay.

Dan Chila

Is that generally what you were – okay.

Matthew Kelley – Sterne Agee & Leach Inc

Yes, that I think gets to it. And then the last question on deposit pricing, what are you folks seeing more recently over the last 30 to 60 days in terms of deposit competition and pricing in your markets?

Ed Malandro

Matt, this is Ed Malandro. What we are seeing is a lot of our competitors are offering rates for new in the range of still 2.75% to 3% and that is the mechanism they are using to attract new customers. On the CD side, you are still on the 2.75% to 3% range and everyone is as Bill is saying fairly short 12 months or less.

Matthew Kelley – Sterne Agee & Leach Inc

Okay, got you. And where are you folks in this regard?

Ed Malandro

Right now, we are in 3% on a nine-month CD, so we are right with the competition, we are not above them, we are right in there.

Matthew Kelley – Sterne Agee & Leach Inc

And experiencing some growth in that product.

Ed Malandro

A little bit, not a lot but again to Tom’s comments, we are trying to maximize margins.

Matthew Kelley – Sterne Agee & Leach Inc

Yes, okay. Thank you very much.

Operator

Our next question comes from the line of Rick Weiss with Janney Montgomery Scott. Please proceed with your question.

Rick Weiss – Janney Montgomery Scott

Hi guys.

Tom Geisel

Hi Rick.

Rick Weiss – Janney Montgomery Scott

Let me start out, I was just talking about asset quality, have you reached the number of people working on loan workouts?

Tom Geisel

Yes, we have Rick. As a matter of fact, we just recently brought onboard a very seasoned professional to add to the group. We have also added to our collection process and we have even shifted some time of our aligned people to spend a little bit more time on some of the stressed [ph] assets.

Rick Weiss – Janney Montgomery Scott

So I guess that also would restart to drive up your other operating expenses as well then from doing that but in terms of the non-performers actually sequentially, it looks pretty good and although the charge-offs certainly went up a decent amount this quarter, is that due to the one or two large loans or just kind of more systemic?

Tom Geisel

There were a couple of large loans in the quarter itself, there were a couple of loans that we had in there that we did some updated appraisals and reevaluations of our collateral positions mostly on the real estate side so we did write them down more but I would say predominantly our charge-offs were in the commercial and small business area but we did see some uptick in the home equities and the consumer loans as well.

Rick Weiss – Janney Montgomery Scott

And are these charges, they are coming from longer time customers that you have known for a while and they are just getting stressed or are they more new borrowers and looking back there are loans that you probably should not have made.

Tom Geisel

I don’t. I look back at them all the time and I don’t think they were loans that we should not have made, I think that they were – some of them were just simply victims of the economic times depending on the industry that they are in. So I would say that it is a mix, some of them are longer term customers and some of them are relatively short and relatively short for us is anything that does not make it past five years is a short time for me.

Rick Weiss – Janney Montgomery Scott

And that is really the scary part of this cycle.

Tom Geisel

Yes.

Rick Weiss – Janney Montgomery Scott

Talking about the part, actually right now it seems like it is pretty hard to deploy those funds profitably, it will take a while to lend it out, certainly the short term rates are not going to be helping so it looks like it is going to be diluted if I can calculate this right about $0.04 [ph] a quarter, does that sound good to you Dan?

Dan Chila

Rick, I guess that would assume that we had no investment –

Rick Weiss – Janney Montgomery Scott

Yes, exactly.

Dan Chila

And that is assuming no investment in part you are pretty much on.

Rick Weiss – Janney Montgomery Scott

Okay and what kind of tax rate would be good going forward?

Dan Chila

Rick, right now we are looking at about 25% effective rate for ’09.

Rick Weiss – Janney Montgomery Scott

Okay. I guess that is it for now. Thank you very much.

Dan Chila

Thanks Rick.

Operator

(Operator instructions) We have no further questions at this time.

Tom Geisel

Thank you all for participating and we will speak with you next quarter.

Operator

That concludes the conference for today. You may now disconnect.

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Source: Sun Bancorp, Inc. Q4 2008 Earnings Call Transcript
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