Sun Bancorp, Inc. (NASDAQ:SNBC)
Q1 2013 Earnings Call
April 25, 2013 11:00 AM ET
Tom Geisel - President and CEO
Tom Brugger - CFO
Steve Rooney - Deputy CCO
Fred Cannon - KBW
Sun Bancorp’s First Quarter Earnings Conference Call will now begin. On the line for Sun Bancorp are Tom Geisel, President and CEO; Tom Brugger, Chief Financial Officer and Steve Rooney, Deputy Chief Credit Officer. At this time, Tom Geisel. Please go ahead.
Thank you operator. Good morning everyone. This is Tom. The operator indicated joining here today Tom Brugger and Steve Rooney, our Deputy Chief Credit Officer and other members of my executive team. I trust you all have a copy of our presentation.
While we don’t plan to cover every point in the presentation, we will use it as a guide. You have all reviewed our Safe Harbor statement and non-GAAP disclose on pages two and three of the presentation. So I will not read them. Following my remarks I will turn the call over to Tom and then Steve for additional comments.
So the first quarter 2013 continued our momentum, with productive results as we further shape our approach and refine our tactics in a competitive and unpredictable marketplace. We achieved positive earnings this quarter and in my comments ahead, I will review some details.
First let’s look at the economic environment. Across the country and globally economic recovery remains slow and inconsistent. Economists predict that the modest economic growth seen in the first quarter of this year will slow by half in the second quarter. American households are being affected by higher social security and payroll taxes and higher fuel costs, all of which affect household spending.
Also across the country there has been a decline in the key economic indicators, such as housing permits new orders for manufacturing goods and overall consumer confidence. Here in New Jersey the struggle for recovery continues. The state has been near the bottom in economic for the last few years and remains hampered by high unemployment.
Though the state added thousands of private sector jobs this past quarter, nearly one in 10 Ney Jerseyans are jobless. While the unemployment rate of 9% as of March is the lowest New Jersey had seen since the first quarter of last year, unemployment has not fallen below the 9% mark since May 2009 and it remains well above the national rate of 7.6%.
Additionally, New Jersey is still dealing with the impact of super storm Sandy, which has affected businesses and individuals in our footprint, many of whom are still waiting for federal and state funding assistance.
As noted on our Q4 call at year end, we recorded additional reserves to address the potential loss exposure identified in relation to Sandy in our loan portfolio but to date we have only seen $147,000 in charge-offs. However we do not expect to understand the full impact of super storm Sandy until after the summer season.
In our markets borrowers remain cautious and competition is still fierce among the national and community banks vying for lending opportunities. Margins are being squeezed as larger banks continue to drive pricing down, and try to buy market share. The good news is, is that we don’t see structures weakening between banks at this point as a method to compete.
In the deposit market, we still see consumers opting to stay liquid and competition to date has been rational in this low rate environment, as all banks are focused on keeping funding costs down. Market dynamics being what they are necessitates us to maintain close relationships with our customers and provide superior customer service. But despite the ongoing challenges in the industry and economy, we remain focused on what we can control to strengthen our organization and seize opportunities for growth.
Now let's turn to the first quarter results. Speaking to page 4 of the presentation, we reported a profit for the quarter of $0.03 per share. This as compared to a net loss of $25 million or $0.29 per share for the linked quarter and a net loss of $28 million or $0.33 per share for the same quarter in 2012.
The first quarter was a bit of a transition quarter for some, where we continued to focus our priorities to both de-risk the balance sheet and grow our loan portfolio in fee based businesses. We have also began to position the balance sheet for a rising rate environment, in our retail business, with the enhanced use of technology and changing customer demographics. On a risk reduction side, the bank closed its previously announced of legacy problem loans to a single purchaser and continued to execute on normal course workouts.
In preparation for higher interest rates, we sold longer duration assets in our investment in mortgage portfolios. We also continue to influence efficiency improvements in our branch network and reduced headcount. We are also invested in the boarder franchise by enhancing our risk management in revenue production infrastructure.
The transition manifested itself in our financial statements in the form of higher cash balances from the sale of assets, reduced short revenue growth, elevated levels of asset sale gains and higher legal and consulting costs.
The short term transition costs on investments, which will generate long term benefits for the bank in the form of more diversification, lower risk or efficient processes, were revenue generation capacity and higher earnings.
During the quarter we saw $9.1 million or 11% reduction in nonperforming loans held for investment. We have now seen a $47 million reduction in nonperforming loans or a 39% over the past two quarters. Our NPL's-to-loans continues to decline and ended the quarter at 3.3%, which is down from 5.2% two quarters ago.
We decreased total classified assets by 20%, as compared to the same quarter last year and we continue to be aggressive in ensuring our loan portfolio is appropriately marked. We expect our asset quality metrics will continue to improve over the year. The company is in a strong equity position in total risk based capital reached 14.2%, well above the regulatory required level.
On page five, we begin to outline our team's efforts to ramp processes; maximize growth opportunities and reduced expenses. As part of our efficiency improvements and to be in line with our strategic shifts taking place in retail banking, we are adapting our retail strategy, reconfiguring our branch model in future to improve site selection and foster the greater use of technology.
For example, late this quarter we will be rolling out mobile check imaging. These changes in more convenient experience for our customers; meets larger deposit branches, generated lower costs per branch and overall provide more growth potential. As a result, we announced three branch closures; this quarter, one each in Cherry Hill, (inaudible) Mystic Islands, which was scheduled for the third quarter and will result in $1.2 million in gross annualized expenses.
In the last five years, the bank has sold, closed or consolidated 26 branches or 34% of the total. Thanks to our strong customer relationships in the marketplace and the ability to integrate mobile and online banking services with these customers, shifting our strategy has produced early positive results.
For example, after closing three branches in April and May of 2012, in Burlington and Cape May County's, we were able to retain 70% of our customer's deposits in those locations, despite not having nearby sister branches, and we are opening a 1500 square foot new model branch in August in downtown Glassboro on barrel on Rowan Boulevard, just off the Rowan University campus..
Continuing on page five, and as mentioned during this transition, we will maintain a balance between strategies to de-risk the balance sheet and strengthen the bank with opportunities for growth. The first quarter of the year is typically a slow time for commercial loan production and as expected we saw a drop from Q4 2012, where our commercial lending team drove an increase in production of 21% compared to the first quarter of 2012. Of the $79 million in total production this quarter, 71% was new relationships, demonstrating our competitive advantage in the market and ability to create new business.
We have contributed 47% of the year-to-date production, B&I (ph) contributed 40% and the reminder was divided amongst ABL and healthcare. The pipeline is building entering a second quarter and we are on pace to meet our 2013 production goals.
Our consumer loan portfolio continues to show growth as a result of our mortgage division. Booked production for the quarter totaled $176 million, a 250% increase as compared to the first quarter of 2012; however, down from the prior quarter due to seasonality and the pull back in our offering a CRE product.
The Sun Home loans division continues to focus on expanding its relationships by performing alliance with builders, realtors and community groups and cross selling retail products into this new client base. Our mix of business for the quarter was 47% new purchase and 53% refi.
Asset quality remain strong and underwriting parameters are conservative to the markets, this is an important business for us as we continue to generate non-interest income in an environment where interest on the assets are more difficult to build.
Additionally, in the retail average core deposits increased by $17.7 or 1.3% in comparison to the prior quarter. Rechecking and account opening are up 9% over the same quarter last year as our average account balances which have increased 12%.
These results reflect our continued efforts cross sell existing and acquire new profitable relationships. In addition, we reduce the cost of interest bearing deposits by four basis points from the prior quarter to 56 basis points.
But being able to balance growth as well as strength our balance sheet and risk management underscores part of our strategy, our customer relationships and our collective focus on execution. Now, I will turn it over to Tom Brugger to talk more detail about the quarter, Tom?
Thanks, Tom. Good morning everyone. As Tom mentioned, the bank reported net income of $2.5 million in the first quarter or $0.03 per share. When compared to the previous quarter, our credit cost normalized as we settled on the bulk sales of problem loans, we continue to reduce problem loans through normal course work out efforts and we have limited loan growth. Our expenses were relatively flat and our fee income group due to asset sale gains in our investment portfolio and mortgage loan portfolio. We do believe that this quarter was transitional and I will now outline these transitions that are occurring in our revenues, expenses and balance sheet.
Let’s begin with asset quality. We had a net recovery of 1.1 million during the quarter as charge offs moderated and we had large recoveries on two commercial credits. The combination of the large recoveries and limited loan growth resulted in loan provision expense with only 171,000 in the quarter.
The total ALLL increased 1.2 million and now totals 2.1% of loans held per investment. Additional work is ongoing to further improve our asset quality. We may have anomaly in one or two quarters but overall we believe that the asset quality trend will continue to improve over the course of the year.
Net interest income declined by 0.9 million sequentially to 23.1 million as the net interest margin contracted by 14 basis points. The loan yield declined by 5 basis points while the overall cost of deposits felled by 3 basis points.
The average interest bearing cash balance increased by 141 million in the first quarter due to the sale of assets that we’ve been discussing. As this excess cash payment invested in quality earning assets during the quarter at say 3.5%. The margin would have 16 basis points higher and it would have added about 4.6 million of annualized revenue to the company. We will be patient and we will deploy the cash and the quality earning asset in the coming quarters.
Moving to the balance sheet, the transition on the balance sheet continued during the quarter and will continue throughout 2013. Again, during the first quarter where we reduced problem loans, we reduced longer duration investment securities and also the overall investment concentration.
We grew our mortgage lending activities and we prudently added new commercial loans with good spreads. The average commercial loan portfolio declined in the first quarter by 44 million and 105 million over a year ago. This is due to our efforts to reduce problem loans that we have been discussing and we have been remaining very disciplined on pricing and structure for new credits.
We were encouraged that the first quarter saw a growth in ending balances of commercial loans and we do expect mild loan growth for the remainder of the year and this portfolio, so after having a number of quarters of fall in the outstanding, we do expect that to increase going forward.
The average consumer and mortgage loan portfolio increased during the quarter by 2 million by 596 million but was up 169 million versus a year ago. We would like to see the mortgage and consumer mix increase in order to diversify the risk in our loan portfolio. Ideally we would like to grow this in 30% to 40% (inaudible) portfolio overtime versus a 25% mix today. The average total investments declined by 79 million as part of our efforts to reduce this mix down to 10% to 15% of assets in the short term given the very low level of interest rates. As we execute on our strategies to do risk to loan portfolio and diversify the balance sheet, we will see cash at elevated levels which will depress the margin in the near term.
We believe that this is prudent at this time given the low level of interest rates and our focus on reductions and problem loans. We will continue to build our loan production capacity and we believe that we are well positioned to profitably grow our loan portfolio over time. Total noninterest income increased to 10.9 million in the quarter. Our gain on sale revenue was elevated due to the sale of 125 million of investments and 52 million of jumbo fixed rate mortgages. These sales were part of our strategy to reduce interest rate risk.
The bank is currently positioned to benefit from raising rates, so these sales enhance our profile further. Investment sales generated 3.5 million of gain, the sold investments yield in 2.11% and had an average life of 3.3 years.
The bulk mortgage loan sales generated 0.9 million of gains and included 30 year jumbo fixed rate and 50 year jumbo fixed rate loans with a yield of 3.8% and an average life of 7.5 years. These jumbo loans were originated in the past year and these sales will occur on a regular basis going forward. Our mortgage strategy is to originate on product for the portfolio and sell most of our originations have confirming and jumbo fixed rate loans.
Mortgage banking have good decline during the first quarter as compared to the fourth quarter which is normal when activity declined due to cold weather but it is substantially higher as compared to a year ago as Tom mentioned previously.
We are currently seeing a normal seasonal pick up in volumes so you’ll higher core mortgage banking income in the second quarter. The derivative credit valuation adjustment totaled approximately 500,000 in the first quarter relating primarily to one slot termination charge for our problem loan customer. This down from 1.8 million in the previous quarter.
Now looking at expenses. Total noninterest expense came in at 31.3 million which is down slightly from the fourth quarter. We announced in December that we expect 6 million of the expenses savings in 2013 primarily from reductions and problem loan cost and some headcount reductions across the company. The problem loan savings are expected to come later in the year as we continue to reduce our non-performers. The headcount reductions occurred in late February so the full impact of those reductions begin in March.
We had some elevated legal and consulting expenses in the first quarter as evidenced by our 1.2 million increase in professional fees quarter over quarter. These costs are associated with loan sale activities, infrastructure building and regulatory compliance cost. We also continued to build our revenue generation platform with the addition of people and systems in our Sunhome loan business and commercial lending. We're also adding resources in our risk management area to ensure that we have a solid foundation. We are prioritizing our spending and reallocating the dollars where we need it most. Even after making these investments in risk management and revenue production, we expect to see our expenses fall in the second half of the year.
Looking at capital at March 31st, capital ratios remained solid especially when considering the falling risk in the balance sheet. The tier one leverage ratio increased to 9.4%, the tier one risk based capital ratio rose to 12.3% and the total risk based capital ratio increased to 14.2%.
Our current business plan has limited balance sheet growth and the bank currently has approximately 10% of its assets in cash in short term treasuries. With the aforementioned reductions in credit and market risk combined with the solid capital ratios in our liquid balance sheet, we believe that the bank has sufficient capital to support its current strategy in 2013.
So in conclusion we're making significant progress in our efforts to improve the operating performance of the bank. as we look into the second half of the year we see a higher net interest margin as we deploy excess cash in the quality loan growth from our growing commercial and consumer lending platforms. We see a more normalized run rate for credit related costs that includes no loss provision, OREO expense, workout expense, derivative credit valuation adjustments for interest rate swaps.
We see flat to falling operating expenses. We see fee income growth due to steady growth in our Sunhome loan mortgage banking business, so you put all the pieces together again we're methodically improving the operating earnings of the company.
Thank you very much and now let me turn it over to Steve Rooney to discuss asset quality. Steve.
Thanks Tom. Good morning everyone. Overall we continue to see progress in reducing the risk in our loan portfolio. This risk reduction is a result of various ongoing efforts which include conservative underwriting for new credits, intense work out efforts, inductions in specific concentrations where management sees industry weakness, diversification of the loan portfolio in to lower risk segments and elevated monitoring from our risk management team. The combination of all these efforts is the driving force behind the material reductions of the problem loans that we have seen in recent quarters. Based on these initiatives we forecast via peer asset quality levels were better in 2013.
As Tom mentioned we successfully settled on the previously announced held problems loans in the first quarter. Classified loans decreased by 24.5 million since year-end to 143.9 million and have been reduced by 37.3 million or 20% over the past two quarters.
In addition, there were four large payoffs of classified loans during the quarter totaling 9.3 million. We have made significant progress in improving our asset quality, however we will remain vigilant to identify issues early and be proactive in our loss mitigation efforts. These efforts include the normal watch list monitoring portfolio stress test proactive review to performing credit enhanced risk management surveillance and robust loan review process.
Looking at slide 14, total loan non-accrual loans were 73.8 million or 2.4% of loans held for investment as of March 31st. This represents a decrease of 21.8 million from the prior quarter and a 39% reduction from two quarters ago. Included in this (inaudible) was the completion of the sale of 12.7 million of non-accrual loans which were moved or held for sale at year-end.
I’d mentioned in my previous comments the remaining resolution was primarily driven by the payouts from four commercial loans totaling 9.3 million two of which resulted in recoveries of $3 million during the first quarter. The special assets department continues to work through disposition strategies and we are confident in our ability to efficiently reduce our problem loans. Progress is monitored continuously and the forecast is updated in real time.
Slide 15, details our real estate owned portfolio. Balances increased from 7.5 million at year-end to 8.5 million at March 31st. The increase in the foreclosed property portfolio was primarily due to the acquisition of five commercial properties to share of sales brining our foreclosed property total to 24.
As an offset during the first quarter approximately 900,000 of foreclosed properties were disposed of including three commercial and two residential properties. A balance of our real estate owned portfolio is expected to increase next quarter as foreclosure continue to settle. Our strategy remains unchanged dispose the properties within 12 months of acquisition and to keep the balance at an acceptable level.
The allowance increased modestly from 45.9 million at year-end to 47.1 million at March 31st. There were net recoveries for the quarter of 1.1 million primarily due the 3 million received and the two commercial loan payoffs. We continue to have solid coverage ratios as reserves to loans held for investment were 2.1% at the end of the first quarter which is up from 2% at yearend.
Provisions for the quarter was only 173,000 due to the continued risk reductions, limited loan growth and net recoveries reported in the quarter. In conclusion we are encouraged by the progressive and demonstrated improvement trends we are experiencing quarter-over-quarter and fully expect them to continue as the year progresses.
Now I will turn it back to Tom Geisel
Thank you Steve. Our first quarter result signaled progress, and we remained focus to take meaningful steps each quarter to create sustainable improvements, increase our loan production, balance the risk and most important, serve our customers and enhance our value. Thank you everyone and operator, now we will take questions. Again please state your name and company affiliation.
(Operator Instructions) And we will go first to Fred Cannon with KBW
Fred Cannon - KBW
First of all it’s nice to see the credit improvement and maybe Tom you could just address, do you think we are really on a sustainable path here at this point in time?
We are on a sustainable path as of this time. We expect that as we get to the end of this year, we'll see significant improvements in where we are from a credit perspective. As you know we have had in the past, what I will call chunkiness in our portfolio. So when you look at some of our nonperformers we have, several peak credits within those numbers, so you may see some chunkiness on the ups and downs but you know (inaudible) fully expect that by year end, our asset quality metrics will be at peer levels.
Fred Cannon - KBW
Right and then, regarding that where are we on the differed tax asset, and kind of what strategies about potentially getting some recovery in that.
The differed tax asset is about a 113 million as of the end of the quarter and again the metric we are going to look at is really four to six to eight quarters of profitability. We think around six quarters of sustained profitability and then we could start turning that back into earnings. That’s why it’s so critical we talk a lot about profitability improvements and you know obviously that’s important goal for us.
Fred Cannon - KBW
Do you think this will be like quarter one of that or do you think we'd have to see more elevated profitability than these levels to kind of begin counting?
Yes, again it’s a judgment there is no, break line, but we will make that conclusion as we look forward.
Fred Cannon - KBW
Okay and then just another quick question on the professional fees were elevate in terms of the expense line; I think they were double from last quarter around 2.6 million. Is there something going on in that line; is this the level that we should expect that? Or is that something that could come down?
Yes, it is definitely going to come down in the second half of the year. Again, some of that is; we're growing our central loans business. We brought in some people to help us with that. If you remember that at business approved starting in Q2 Q3 of last year and so it is just some additional resources to get that growth going.
And then as we have said, we have the loan sale activity; so we have a lot of kind of these short term costs that we're booking to help our grow our platform; also just a little bit elevated costs with regulatory compliance, that sort of thing, but we do see that coming down in the second half of the year.
Fred Cannon - KBW
Great and then finally, maybe just some color on loan pricing and especially kind of the duration of loans that you have to be out there with in terms of clients these days?
Unidentified Company Representative
Fred this is Brad; Head of Commercial Credit. Regarding pricing, we saw as you watch the numbers, we saw a lot of pressure on pricing through most of last year. We have seen that settle in last quarter, fourth quarter last year and the first quarter this year. I mean we are maintaining spread on the new business being put on north of 3% spread. And we are keeping our duration on the commercial side, on the shorter side, more floating rate and five years less and not taking a lot of long term fixed rate risks on the commercial balance sheet.
And I see that maintaining at least at this point, through most of the year.
Fred Cannon - KBW
Okay so even on floating rate you get 3% plus and as you go up to five years, you'd be somewhat north of that; is that fair?
From a spread standpoint.
Fred Cannon - KBW
Spread standpoint okay. Thanks so much for the color and nice to see a profitable quarter.
(Operator Instructions) And it appears we have no further questions.
Thank you all for joining us this morning. Have a great day and we will talk to you at the end of Q2. Thank you.
And that does conclude today’s conference call, thank you everyone for your participation.
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