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Sandy Spring Bancorp Inc. (NASDAQ:SASR)

Q3 2013 Results Earnings Call

October 17, 2013 2:00 PM ET

Executives

Dan Schrider - President and CEO

Phil Mantua - Chief Financial Officer

Ron Kuykendall - General Counsel

Analysts

William Wallace - Raymond James

Damon DelMonte - KBW

Mark Hughes - Lafayette Investments

Bryce Rowe - Robert W. Baird

Matt Schultheis - Boenning & Scattergood

Operator

Hello. And welcome to the Sandy Spring Bancorp Inc. Earnings Conference Call and Webcast for the Third Quarter 2013. You will be in listen-only mode during the presentation but there will be an opportunity afterward to ask questions. Instructions will follow at that time (Operator Instructions)

This conference is being recorded. And now I’d like to turn the conference over to Daniel J. Schrider, President and CEO of Sandy Spring Bancorp. Mr. Schrider?

Dan Schrider

Thank you, Keith, and good afternoon, everyone. And welcome again to Sandy Spring Bancorp’s conference call to discuss our performance for the third quarter of 2013. This is Dan Schrider speaking and I’m joined here today by Phil Mantua, our Chief Financial Officer; and Ron Kuykendall, General Counsel for Sandy Spring Bancorp.

As usual, today’s call is open to all investors, analysts and the news media, and there will be a live webcast of today’s call, as well as a replay of the call available at our website beginning later today. We will take your questions after a brief review of some prepared remarks and key highlights, but before we get started, Ron will give the customary Safe Harbor statement.

Ron Kuykendall

Thank you, Dan. Good afternoon, ladies and gentlemen. Sandy Spring Bancorp will make forward-looking statements in this webcast that are subject to risks and uncertainties. These forward-looking statements include statements of goals, intentions, earnings and other expectations, estimates of risk and future costs and benefits, assessments of probable loan and lease losses, assessments of market risk and statements of the ability to achieve financial and other goals.

These forward-looking statements are subject to significant uncertainties because they are based upon or affected by management estimates and projections of future interest rates, market behavior and other economic conditions, future laws and regulations, and a variety of other matters which by their very nature are subject to significant uncertainties.

Because of these uncertainties, Sandy Spring Bancorp’s actual future results may differ materially from those indicated. In addition, the company’s past results of operations do not necessarily indicate its future results.

Dan Schrider

Thank you, Ron. Today as normal, I have some brief prepared remarks and then we will move to your questions. First, it was another solid three months and we continue to be pleased with our consistent and balanced results. Even as a variety of unique factors both internal and external came into play during this past quarter.

From a high level, we have been able to sustain profitability. We continue to produce a steady stream of non-interest income. Despite diminishing revenue on the mortgage banking side, there was respectable commercial loan growth, mostly in the later September and our overall credit quality metrics continue to improve quite favorably.

As I observed during previous calls, our solid performance has been ongoing now for the last couple of years. Despite the fact that the economic environment both across our footprint and internationally continuous to be soft and unpredictable. And with the federal government shutdown behind us for now, at least one area of uncertainty has been removed from the local market.

In response to the recent shutdown, we did develop multiple ways to assist furloughed federal employees during this difficult time and many have taken us up on our offer of assistance and have expressed appreciation for our personal attention to our clients.

As stated in a press release issued earlier today, net income for the third quarter of 2013 was $12.1 million, that’s $0.48 per diluted share, up 10% over a year ago. Third quarter net income was flat when compared to the linked second quarter of 2013.

A major factor effecting this quarter was the positive impact on the net interest margin and also on non-interest income and expense generated from major recoveries of two previously non-performing commercial real estate credits. When considering the financial impact of these recoveries, our analysis would result in a core EPS of $0.38 for the quarter.

These recoveries consist of the combination of interest income, loan fees, substantial legal fees, et cetera. Not to mention the intangible cost associated with all of the time of our internal workout and loan resolution teams that put this effort forth. We appreciate the folks in this team for their hard persistent work over many months.

In addition to the recoveries, there were two specific areas impacting the quarter, the first included lower gains from mortgage banking activity, resulting from the impact of increased rates and the corresponding abrupt decrease in refinancing activity.

The second area was a higher provision expense driven by a very strong quarter in loan growth which was heavily weighted toward the quarter end and giving the timing of this loan growth the benefit of it will kick in during the fourth quarter.

The net interest margin was 3.88% in the third quarter of 2013, compare to 3.67% for the third quarter of 2012 and 3.51% for the second quarter of 2013. However, excluding the effect of the loan recoveries, I just mentioned, the net interest margin was 3.49% for the quarter. So on a normalized basis, the margin held up quite well when compared to the second quarter of this year.

As expected, the decrease in margin year-over-year was due primarily to a decline in the yield on the higher level of earning assets and is more than offset our lower costs of borrowings and deposits.

As mentioned, loan growth ramped up toward the end of September and was the primary driver of the $1.1 million provision expense. The two major commercial loan growth categories were investment real estate and owner-occupied real estate. And as we look forward, we have a good solid pipeline leading into the fourth quarter.

Unlike commercial loan growth which ramped up late in the quarter, mortgage banking activity were spread more throughout the quarter and began to ramp down throughout the quarter as rates continue to move higher.

But the bright spot in mortgage banking was the linked quarter portfolio growth of 5%. Obviously, all the areas banking companies are experiencing decline in the mortgage-related business especially refinancing.

Also on the fee income side both our wealth management and insurance businesses performed well, with steady and improving results especially in the wealth management area.

On the credit front, we see reserves being maintained at around 1.5% mark, which is consistent with our focus on improve credit metrics, meaning solid reserve coverage, as well as continued ongoing efforts to lower our NPAs. On a related note, there was a charge-off associated with one commercial real estate loan during the quarter.

Our non-performing loans decreased to just over $38 million at September 30, compared to about $59 million a year ago and $46 million at June 30, 2013. And the coverage ratio of the allowance for loan and lease losses to non-performing loans was at 103% September 30, compared to $0.72 a year ago and 84% -- 72% a year ago and 84% last quarter.

On the expense side, we continue to maintain good controls and a solid handle on expense management, expenses were flat notwithstanding those recoveries.

In past quarters we have commented on our analysis of our branch delivery and channel optimization. As we begin to execute on our findings, we are finalizing plans to close several branch locations early in 2014. At September 30, 2013, the company had a total risk-based capital ratio of 15.70%, a Tier 1 risk-based capital ratio of 14.50% and a Tier 1 leverage ratio of 11.30%.

Our capital deployment strategy continues to include focus on organic growth, strategic M&A activity, dividend payouts and share repurchases when prudent to do so, and you may have noticed the approval of the share repurchase plan by Board earlier in the third quarter.

And to wrap up, we are very pleased to be included in the Sandler O'Neill and Partners 2013 Bank and Thrift All Stars. It was great to be recognized for our balanced financial performance and to be among those 31 peer banks from across the country.

That wraps up my comments for today and we will now move to your questions. So, Keith we can have the first question please. We would appreciate it if you would state your name and company affiliation as you come on. So we know with whom we're speaking.

Question-and-Answer Session

Operator

Yes. Thank you. (Operator Instructions) And the first question comes from William Wallace of Raymond James.

William Wallace - Raymond James

Good afternoon, guys. How are you?

Dan Schrider

Hi, Wallace.

Phil Mantua

Hi, Wallace.

William Wallace - Raymond James

My first question, looks, I’d like to maybe dig into the mortgage banking results a little bit. Can I assume that there are some rep and warranty expense or something in there?

Dan Schrider

Well, I know, that’s, there is nothing along those line, the real just of the change quarter-over-quarter relative to the, what we refer to is the gain on mortgage banking activities is really what’s been driven by the lower volumes throughout the quarter and that impact on the evaluation from a fair value standpoint on the commitments that are involved in arriving that number.

So it’s really, the economic impact is really based on the change in interest rate environment and the lesser number of loans that are just going through that pipeline. The accounting for it is what really then drives the number to end up being a slight negative for the period.

William Wallace - Raymond James

Okay. So let’s maybe dig in a little bit then to some of the numbers, what was the production in the quarter and I’d like to get a sense of maybe what the purchase production was and then how much that -- how that compared to the prior quarter.

Dan Schrider

Yeah. In terms of within the quarter, let me just give you a perspective this way. In terms of loans that were held for sale, they eventually make their way through the gain number. At the end of second quarter, the balance there was about $33.9 million and at the end of the fourth quarter, the balance in loans held for sale was a little bit more than $10.4 million in the third quarter.

So I mean, that’s one-third position than what it was in the -- at the end of the prior quarter, which was also a third to the quarter prior to that as well. So I mean, it’s a dramatic drop off for many of the first two quarters of the year.

William Wallace - Raymond James

Okay. And then -- and so if I want to think about moving forward, maybe you could tell me what portion or what was the amount of valuation adjustment on the held-for-sale portfolio that drove the number negative in the third quarter?

Phil Mantua

Yeah. I think what it really is, is a reversal of the accrual related to the commitments from the prior period which was roughly about $1.8 million. And I think that’s the biggest element of what impacted that final loan -- slight loss numbers opposed to the gain.

Now it should -- looking forward, I think to the essence of your question, looking forward unless we have another whipsaw in interest rates like we did during that quarter that aspect of things ought to stabilize itself. And we shouldn’t have that large of a reversal in -- of an accounting accrual to be significant offset against the actual gain in the period. So I would not expect that kind of result to continue as we move forward.

William Wallace - Raymond James

Assuming rates were stable?

Phil Mantua

Right. Right. And at the same time, I would also -- I would also say that the overall level of the reported gain will certainly not approach the levels from prior periods either.

William Wallace - Raymond James

Right.

Phil Mantua

Just because of a lesser amount of activity in the area.

William Wallace - Raymond James

Okay. Thanks. And then if we look at the couple of questions on the two credits that you had recoveries from. One is, what was the dollar amount of the benefit in the non-interest expense?

Phil Mantua

Overall dollar amount, the benefit related to those two credits in non-interest expense was a roughly $500,000. And that was also related to the recovery of the attorney’s fees that had been paid prior to working on those two loans.

William Wallace - Raymond James

Okay. So you had a benefit in other and -- than in the professional fees line. Was it all a professional fee line?

Phil Mantua

I think it’s primarily all in other if I’ve not mistaken.

William Wallace - Raymond James

Your professional fees line was down to $500,000 from about $1.3 million in each of the first two quarters?

Phil Mantua

Correct. I’ll take that back. I think the attorney’s fees are in professional fees. And then there were some very small couple of $100,000 amounts that were in the other expenses.

William Wallace - Raymond James

Okay.

Phil Mantua

Related to those credits.

William Wallace - Raymond James

Okay. That helps. And then last before I let somebody else hop. Well, you mentioned in the prepared remarks that you’ve located several branches that you would consolidate beginning in 2014. Can we talk about roughly how many branches there are and what the expected cost saves would be?

Dan Schrider

Yeah. The -- I don’t know that we’re prepared to quantify the actual cost saves. We do have -- right now, I have identified three branches at this point that we’ve identified that would be in early first quarter events.

William Wallace - Raymond James

Okay. Thanks for your time. Guys, I’ll let somebody else ask the question.

Dan Schrider

Thanks a lot.

Phil Mantua

Thanks a lot.

Operator

Thank you. The next question comes from Damon DelMonte of KBW.

Damon DelMonte - KBW

Hi. Good afternoon guys. How are you?

Dan Schrider

Hi Damon.

Phil Mantua

Hi Damon.

Damon DelMonte - KBW

I guess, just a kind of circle back on the recovery impact. What was the impact to net interest income that caused the margin to go up so much?

Phil Mantua

Yeah. Damon, this is Phil. The impact to the net interest income was roughly $2.9 million.

Damon DelMonte - KBW

Okay. Great. And then the two credits that you had to recovery, could you just tell us what the size of those credits were?

Phil Mantua

It was roughly about $13.5 million.

Damon DelMonte - KBW

Okay. For the two of them?

Phil Mantua

Actually that was -- let's call $13.8 million and two of them to combined.

Damon DelMonte - KBW

Two of them together.

Dan Schrider

Yeah. One was obviously much larger than the other.

Damon DelMonte - KBW

Okay. Okay. And then with regards to the portfolio of mortgages this quarter, could you just talk little bit about that strategy going forward? Is that a category we can see expect to see you continue to grow?

Dan Schrider

In terms of the portfolio mortgages?

Damon DelMonte - KBW

Yeah.

Dan Schrider

Yeah. Our mortgage -- good question, our mortgage businesses has long been kind of two-pronged approach of both providing salable products on the long-term, fixed rate 15-30 year product and then our targeted segments retail wise are the mass affluent, which typically would drive some pretty significant jumbo mortgages which often fall into either a construction product or into 51-71 arm product.

And so would continue to expect that we would originate and grow that portfolio. Interest rate environment, salable market, investors appetite will oftentimes drive know what’s getting to bulk of that production. But we would continue to expect that we would.

Damon DelMonte - KBW

Okay. And then I guess my last question just also in regards to loan growth and the outlook. I think in your past quarters or so you've kind of targeted mid-single digits for 2013. Is that a number you are still comfortable with, or do you expect something a little bit higher?

Dan Schrider

Yeah. As we look forward, part of our outlook has always been tempered by the effect of both the economic environment but also our resolution of NPAs. And so with our NPAs down to a pretty healthy level of $139 million, $138 million, we would expect that that mid-to upper single-digit is an area that we are targeting for ’14.

Damon DelMonte - KBW

Okay. That’s all I had. Thank you very much.

Dan Schrider

Thanks, David.

Operator

Thank you. And the next question comes from Mark Hughes, Lafayette Investments.

Mark Hughes - Lafayette Investments

Good afternoon.

Dan Schrider

Good afternoon.

Phil Mantua

Hi, Mark.

Mark Hughes - Lafayette Investments

Hi. Couple of questions, the lien down of loans placed on nonaccrual kind of have been running in the $5million or $5.25 million range for a number of quarters and then this quarter, it jumped up to about $11.5 million. Anything one item significant there, there is a lot of little things, what’s going on there?

Dan Schrider

Yeah. Mark, this is Dan. We did have one commercial real estate credit move into non-performing status this past quarter in the $9 million to $10 million range, which is driving those -- that number was a little bit higher than prior quarters, so not multiple credits. Just one that we have been watching for several quarters and there was some distress within the borrower world and many other projects that kind of pushed it in that direction.

Mark Hughes - Lafayette Investments

Got you. And one question on the branch closing. Kind of unusual for you all I think, haven’t had too many for the years. Do you expect to charge-off related to that or is it kind of no P&L impact?

Dan Schrider

Yeah. There will be some upfront costs associated with unwinding those three branches as we progress towards ’14.

Mark Hughes - Lafayette Investments

Okay. Terrific. Thank you, guys.

Dan Schrider

Thank you.

Operator

Thank you. And the next question comes from Bryce Rowe with Robert W. Baird.

Bryce Rowe - Robert W. Baird

Hi. Thanks. Good afternoon.

Dan Schrider

Hi, Bryce.

Phil Mantua

How you doing, Bryce?

Bryce Rowe - Robert W. Baird

Doing well. Thank you. Couple of my questions have been answered. Just wanted to dig a little more on the recovery of interest and the impact on the loan yields? You had quite a spike up in the loan yields in 8 commercial AD&C and then the commercial investor real estate buckets. Just wondering, what kind of dollar impact or even basis points impact those recoveries had on those loan yields?

Phil Mantua

Yeah, Bryce. This is Phil. I will give you exactly what those yields by category would've been. Commercial AD&C, the average yield for the quarter would have been 527 which was only 1 basis point different than the prior quarter. Commercial investor real estate would have been 499, which would've been down a bit and owner-occupied -- actually those are the two major categories where it was -- where the two loans were. And then the overall yield on loans would have been 447.

Bryce Rowe - Robert W. Baird

Okay. And then, I guess I jump into the next question, just trying to get a feel for the competitive dynamic. We heard MNC this morning talk about the mid-Atlantic region being their most competitive from a loan pricing and structure perspective. I just wanted to get your take on that dynamic as well?

Dan Schrider

Yeah, Bryce. This is Dan. It clearly has been really the dominant scene going back probably eight quarters if not more, as we’ve kind of emerged from this cycle. With still tepid real live organic growth in the market, it’s still predominantly a taking share type of market which is driving the pricing. And it’s a considerable issue to both the large guys that we compete against as well as the smaller institutions. So for us the challenge is to make sure we are picking our spots along the yield curve that we think create the best value for us and as well as full banking related .

Dan Schrider

And on the yield side, Bryce, you might have an expectation because of what was going on with the long end of the yield curve that commercial deals will be able to get priced up a little bit. But because of those competitive pressures in this market, nobody really step forward in that and so that the actual yield depth were earned kind of held the line and really didn’t move very much.

Bryce Rowe - Robert W. Baird

Okay. And I guess last -- last topic, Dan, we have obviously heard you talk about having built up the capital base on the look out for acquisitions. We have gone through without hearing about any -- just wanted to get a feel for, why you think and maybe some sellers haven’t accepted the offers or what’s the disconnect between getting a deal done?

Dan Schrider

Yeah. That’s a good question and probably only the population of sellers could give you the most accurate answer. But I will give you my shot at that, Bryce. I think in a lot of cases, there is some of the pricing from stronger currencies from outside of the market, have perhaps caused some folks to have a greater perception of value. You have seen a few of the deals that have happened and I think in a lot of cases you have very, very patient -- very patient capital waiting perhaps for a better day.

I think the reality, as we move into yet another year ahead of us where interest rate environment is not anticipated to change here for the next 24 months or so. It is going to be an earnings challenge for all of us as well as the smaller community banks. So, I am still optimistic that there will be opportunities but it obviously hasn’t been heavily populated rest of deals that have been announced and we continue to work it. We continue to think that we have a long-term view and will allow community banks that continue to want to have an identity locally that were great option and a good currency and a good liquidity for them. The other thing we don’t necessarily offer by strategy is the double debt and some may look for that.

Bryce Rowe - Robert W. Baird

Okay. Just the last question on the CRE loan that moved into non-accruals, can you just tell me if you already did, it might have missed and what the charge-offs associated with that was?

Dan Schrider

Yeah. That charge-off this quarter on that particular credit was about $4 million to $4.5 million.

Bryce Rowe - Robert W. Baird

Okay. Thank you, guys. Appreciate it.

Dan Schrider

Sure. Thank you, Bryce.

Operator

Thank you. Next question comes from Matt Schultheis with Boenning & Scattergood.

Matt Schultheis - Boenning & Scattergood

Good afternoon, gentlemen.

Dan Schrider

Hi, Matt.

Matt Schultheis - Boenning & Scattergood

A quick question on the recovery. I think you mentioned something about an increase to non-interest income or benefit to non-interest income, can you quantify that?

Dan Schrider

Sure, can. That was related to the recovery of some late fees that had not been collected before and that was roughly about $235,000.

Matt Schultheis - Boenning & Scattergood

Okay. And I suppose I have one more question but I am not sure, not frankly I am not sure if you’re going to answer but with regard to your buyback, you had one. You didn’t really use it aggressively to say the least and was wondering if your view on using the authorization has changed at all with current market conditions?

Dan Schrider

Matt, this is Dan. I would say that it has not materially changed and with the current market conditions. With that said, another way that could be deployed at some point you see other companies do it. So it is on the back end of a transaction and -- but our overall view has not materially changed.

Matt Schultheis - Boenning & Scattergood

Okay. Thank you very much.

Dan Schrider

Thank you, Matt.

Operator

Thank you. And we have a follow-up question from William Wallace from Raymond James.

William Wallace - Raymond James

Hey guys. Hi. I just wanted to ask couple of questions on the mortgage bank that line item, are you reporting that net of the associated variable compensation expense?

Dan Schrider

Yes.

William Wallace - Raymond James

Okay. Are there any -- are you making any changes to the business given the slowdown to the refinance side, are you cutting cost at all?

Dan Schrider

Yeah, Will, this is Dan. We have -- we began to do that in the quarter and continue to evaluate that as we move forward. But yes, it’s a scalable business and we’ll continue to evaluate that as we go forward.

William Wallace - Raymond James

We will see some relief in the fourth quarter related to changes at the end of the third.

Dan Schrider

Yes, within that unit, yes.

William Wallace - Raymond James

Okay. And then one follow-up on the two CRE credit. So I am 100% clear, so if these loans, did they pay off or did they just -- did they start accruing again.

Dan Schrider

Yeah. Great question. Both of these transactions paid off and one was through the outright sale of real estate. It never follow-through OREO. It was sold without taking title to it, which allowed us to have a significant recovery as we described. And the other was a longer term workout of an A, B and C credit which one point was much larger and then we work that out through the sale of the underlying residential lots which have all sold and paid that off and also allowed us to post some recovery.

William Wallace - Raymond James

Okay. And…

Dan Schrider

Those assets are off the books.

William Wallace - Raymond James

Okay. And so that -- in that -- that was, they were carried at $13.8 million to the question that so answered earlier, but that was the full value of the recovery?

Dan Schrider

They were carried at the $13.8 million.

William Wallace - Raymond James

Okay. And so you had -- so some of the recovery was related to charge-offs of collateral and some of it was related to interest that had not been accrued?

Dan Schrider

That’s correct.

Phil Mantua

Correct.

William Wallace - Raymond James

Okay. Great. That helps for me. Thanks a million guys. I appreciate it.

Dan Schrider

Thank you, Will.

Phil Mantua

Sure.

Operator

Thank you. And there are no more questions at the present time. I would like to turn the conference back over to Mr. Schrider for any closing remarks.

Dan Schrider

Well, first of all, we like to thank you for taking the time to participate with us this afternoon. And secondly I’d like to remind you that we’d appreciate receiving your feedback to help us evaluate the effectiveness of our call. You can e-mail your comments to ir@sandyspringbank.com. So thank you again and have a great afternoon.

Operator

Thank you. That concludes this teleconference. Thank you for participating and have a nice day. You may now disconnect.

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