Sun Bancorp's CEO Discusses Q3 2013 Results - Earnings Call Transcript

Oct.24.13 | About: Sun Bancorp, (SNBC)

Sun Bancorp, Inc. (NASDAQ:SNBC)

Q3 2013 Earnings Conference Call

October 24, 2013 11:00 AM ET

Executives

Thomas X. Geisel – President and Chief Executive Officer

Thomas R. Brugger – Executive Vice President and Chief Financial Officer

Imran Riaz – Senior Vice President and Chief Credit Officer

Analysts

Travis Lan – Keefe Bruyette & Woods Inc.

Matthew Breese – Sterne Agee & Leach Inc.

Operator

Good day and welcome to Sun Bancorp’s Third Quarter Earnings Conference Call. On the line for Sun Bancorp are Tom Geisel, President and CEO; Tom Brugger, Chief Financial Officer; and Imran Riaz, Chief Credit Officer.

At this time, Tom Geisel.

Thomas X. Geisel

Good morning, everyone. This is Tom. As the operator indicated, joining me here today are Tom Brugger, our CFO; and Imran Riaz, our Chief Credit Officer, and other members of my executive team. Imran joined Sun in August after 20 plus years at TD Bank in Boston, where he was last Managing Senior Credit Officer. With exceptional strengths in specialty lending, structured credit and in enhanced portfolio analysis, Imran is an accomplished credit professional, who complements our team and we are delighted to have him join us.

I trust you all have copies of our presentation, and as usual, we won’t go through every point while we will use it as a guide. You have all reviewed our Safe Harbor Statement and non-GAAP disclosures on Pages 2 and 3 of the presentation, so I will not read them. Following my remarks, I’ll turn the call over to Tom and then Imran for additional comments.

As we have discussed on previous calls, 2013 is a year of transition for Sun, where our focus has been laser-like to improve asset quality, reduce risk and remain diligent in building our regulatory infrastructure and reinforce our core businesses. While the short-term effects were negative with regards to earnings, progress in all of these key areas will result in a better foundation for our long-term success.

First, let’s discuss the economic environment. I will primarily focus my comments on the core market of New Jersey, as most of you regularly track the national economy. In September, the national rate of unemployment dropped 0.1% to 7.2%, which is the lowest level since November of 2008. However, U.S. employers added far fewer than expected employees during the month, which suggests that the national economy was loosing momentum even before the partial government shutdown that recently ended.

For September, the unemployment rate for New Jersey is not yet available. However, New Jersey still struggles with one of the highest unemployment rates in the nation. In August, the rate was 8.5%, more than 4 points over the national rate for that month. While that state figure showed incremental progress in August, actually it decreased 0.1% compared to July. New Jersey also saw 12,200 people exit the labor force in the same month. So joblessness remains high and the state economy dormant.

As for progress in hiring and wage growth is essential for sustained increases in consumer spending, which is the largest portion of the economy. Economists believe that fiscal austerity has begun to negatively effect job creation as well as interest rates. We have seen raising rates already significantly affect originations in the mortgage industry. Both refinancing and new mortgage activity is down and as a result, lenders are making adjustments to operations and staff. I will talk more about the impact on this for Sun a little later in my comments.

As reported by others, commercial loan growth has been soft. Companies are still reluctant to borrow due to the economic malaise, the uncertainty of the full impact of healthcare costs and additional concerns about the government budget crisis and potential fiscal cliff. In our markets, traditional C&I is the most effective, which is the direct reflection of our economy. Well commercial real estate has shown some signs of improvement, competition remains high.

Margins continue to be squeezed, lenders are competing fiercely on price and as the pressure increases, the overall loan portfolios bankers memories get shorter, as we continue to see breaches in prudent structures by our competitors. As always, Sun will stay competitive on price, ideas, customer service and experience, but we will not sacrifice safe and sound structures for growth.

Lastly, now that the summer season is over, New Jersey has begun to assess full impact of Superstorm Sandy on the regional economy. According to research conducted by the non-profit U.S. [indiscernible], New Jerseyans will end up paying an estimated $8 billion to $13 billion out of pocket, because the Federal and State Sandy Relief Assistance will only cover a portion of the total costs. For the most part, our customers have been fortunate.

However, sales per stores in the hardest hit short areas were down anywhere from 20% to 40% this past summer, and according to one major realtor, summer rental income was down 67%. As you know, we continue to hold reserves against Sandy and we will monitor closely over the next several quarters. Despite the unpredictability of government, the economy and other factors beyond our control, we have stayed focused on what we can control; execution, client service and capitalizing on opportunities in our marketplace.

So now let’s now turn to third quarter results. Speaking to Page 4 of the presentation. We reported a loss for the quarter of $4.9 million or $0.6 per share. This is compared to net income available to common shareholders of $678,000 or $0.1 per share for the linked quarter and net income available to common shareholders of $1.2 million or $0.1 per share for the third quarter of 2012.

The loss can be attributed to number one, the accelerated investment in consultants and advisors to support our risk reduction and regulatory foundation building efforts, as we discussed last quarter, these expenses will drop throughout the fourth quarter and normalize in 2014. And number 2, our refusal to comprise the risk reward balance for loan growth, which in turn has created margin pressure through higher than optimal cash balances and liquidity. Lastly, we have all recognized the immediate and forceful impact the rising rate environment has had on the mortgage industry and bank earnings. Sun’s mortgage business is a microcosm of these earnings declines.

In the third quarter, our asset quality improvement strategies continued to show progress. Through our efforts, we achieved a 54% reduction in non-performing loans over the last four quarters, and criticized loans declined from the prior quarter to level better than forecast. Our provision for loan losses for the quarter was $724,000 and we are seeing positive trends with three consecutive quarters of net recoveries and $4 million in net recoveries year-to-date. We will remain diligent in valuing our loan portfolio and continue to use all methods available to prudently reduce risk while maximizing asset values. While we may see some fluctuations in asset quality metrics in the short-term, we anticipate over the next several quarters being better aligned with peer banks as measured by NPLs to loans and NPAs to loans.

Turning to Page 5. We continue to balance our efforts to de-risk the balance sheet with opportunities to achieve measured risk appropriate growth across the organization. While commercial lending is challenged in ongoing soft economy and intense competition for a limited business, our commercial loan production in the third quarter was up 158% compared to the second quarter and the pipeline for the balance of 2013 is relatively strong. Of the 208 million in production year-to-date, 62% was from new relationships demonstrating our competitive advantage in the market and ability to source business that values relationships. As we’ve discussed on previous calls, Sun’s residential mortgage division is a strategically important business that has been a driver of our strategy to diversify revenue sources, build non-interest income, and enhance land recognition.

As mentioned, higher interest rates or demand for mortgages has negatively impacted residential mortgage operations at all banks, including Sun. In the quarter, we consolidated mortgage operations and reduced staff to better reflect industry realties. While this process will result in reduced expenses, it also supports our ongoing efforts to increase operational efficiencies.

For the quarter, net mortgage banking revenue totalled $1.6 million with closed production of $188 million down 19% from the prior quarter of $233 million. While closed production has dropped due to an increasing rate environment, year-to-date production of $595 million is 39% higher than the same period a year ago. So while we certainly have been affected by industries trends overall we’re still building this business.

In retail, third quarter reflects our ongoing efforts to profitably grow deposits and bolster non-interest deposits. Average core deposits increased to $31 million or 2% in comparison to the prior quarter, and average checking account balances have increased 8.6% over the comparable prior core. We also decreased our cost of deposits two basis points from the prior quarter to 41 basis points. We believe one of our competitive advantages is that we’re large enough with an experienced team to provide the core products and services of the big bank but delivered them through a relationship focused community bank system.

In keeping with that, we opened a technologically advanced 1500 square foot, de novo branch in Glassboro, New Jersey ideally situated near the Rowan University Campus and a central park of the states largest municipal redevelopment project. We created a new prototype with hi-tech customized features and universal bankers to serve the needs of downtown merchants and the University Community.

This past quarter, Sun also introduced Pogo, a mobile payment processing solution for small businesses. Pogo stands for payments on the go and submits the first New Jersey based bank to provide this mobile payment solution. We also made our mobile banking application powerful with the addition of a mobile deposit feature which enables online banking customers to quickly and securely deposit a check from anyone into a Sun checking account.

Sun’s mobile deposit and Pogo tools are the latest additions to a suite of forward thinking banking solutions, that many large bank competitors still don’t have and had enabled us to give our competitors convenience and choice when banking with us.

On past calls, we’ve discussed our company’s collective efforts to make efficiency improvements in our branch network, reduce expenses, enhance risk management and reinforce our revenue production infrastructure. We believe that the actions we have taken in the third quarter following related and equally thoughtful decisions we have made throughout this year complements on this turnaround and that’s our corporate strategy as we close out 2013.

Now, I’ll turn it over to Tom Brugger to talk in more details about the quarter. Tom?

Thomas R. Brugger

Thanks, Tom. Good morning everyone. During this quarter, as Tom mentioned, our year of transition continued as we remain internally focused, centered around reducing problems on the level, remediating regulatory issues, enhancing risk management practices and infrastructure, enhancing our mortgage platform, improving operational efficiency and maintain a low risk profile. This transition has been the lead innings. So we believe that we have made significant progress and doing the heavy lifting required in any turnaround situation.

We’ve posted a $4.9 million net loss for the quarter, which is disappointing, but our operating performance is relatively stable with the only caveat being a recent rise in interest rates, which suppressed our mortgage banking income.

Let’s get into detail and start with asset quality. Our non-performing loans fell $16.3 million during to $55.4 million. A year ago NPLs were $120.8 million. NPLs, the loans held-for-investment fell to 2.55%, which is down from 3.32% in the prior quarter and 5.33% one year ago.

We had net recoveries of 123,000 and are now seeing three quarters in a row with net recoveries. This is continuing evidence that evaluate our problem loans at the right level. Provisions for loan loss totaled $724,000 for the quarter. Our reserves to total loans held-for-investment equaled 2.25% of loans, which is up from 2.22% in the prior quarter and 2.12% one year ago. Our allowance to non-performing loans increased to 88% from 67% in the prior quarter and 41% in the year ago period.

We continue to hold approximately $3.8 million in reserves for risk related to hurricane Sandy. Our last experience from this storm has been very low. So we need more time to assess the impact to our customers in the more severely impacted areas during the important summer season. It is likely that we will have more information to refine our estimates over the next two quarters.

We are taking a very proactive, conservative posture right now with respect to managing our problems. We think this is the right think to do until we’re at comfortable level. As we’ve mentioned on previous calls, we are implementing a new risk rating process. We believe that our new process is more metrics driven, eliminating much of the prior subjectivity. We have kept many of the our qualitative factors in our [indiscernible] a high level entire reserve until we further our risk reduction efforts, give our new credit teams time and new job and finalize the implementation of the new risk rating process. So to sum it up, we believe we have adequate reserves at the time.

Looking at revenue, net interest income drifted higher by $1.2 million to $23 million as the net interest margin increased by 14 basis points to 3.1%. There was $1.2 million interest recovery on a commercial loan during the quarter. So if you adjust to this our net interest income was $21.9 million and our net interest margin was 2.94%. Our cash remains at elevated levels as our average interest bearing cash and short-term treasury totaled approximately $400 million. If $350 million of this excess cash was deployed our normalized margin would have been around 3.25% and we would add $11.4 million of annualized net interest income.

Average loans declined by $61 million from the prior quarter to $2.2 billion, an 11% annualized reduction. Problem asset resolutions plus fierce competition in our C&I business are the primary drivers of the reductions in outstanding. We have been adding some high quality commercial real estate deals to the balance sheet in recent months to deploy some of our excess cash. We will continue to remain disciplined on pricing and structure in the near-term.

Average investments increased by $41 million during the quarter to $414 million. In interest rate growth, we decided to deploy approximately $151 million of cash into mortgage backed securities. Average interest-bearing cash balance improved $42 million to $349 million. These balances are currently invested at the federal reserves and we earned 0.25% on our money. While the recent yield curve steepening is encouraging, but still low level of interest rates combined with tight spreads are used for prudent deployment into investments and fixed rate assets at this time.

Average deposits for the quarter grew $24 million to $2.75 billion and the total cost of deposits fell two basis points. Yearly average non-interest-bearing DDA rose $18 million to $550 million, which is 20% of average deposits. Average now in money markets rose $90 million due to growth in our [indiscernible] accounts where our average CDs fell $14 million.

Overall, our deposit base is very stable and our objective is to methodically reprice, retain and grow our relationships overtime. We believe that we are well positioned to rising rates with a low mix of CDs and an attractive mix of non-interest-bearing DDAs.

Total non-interest income fell on a linked quarter basis by $4.4 million to $5.8 million. Recent increases in interest rates negatively impacted our Sun Home Loans mortgage results. While we have a retail platform with relatively high purchase mix verus rebuy, we did see a fall in production in the quarter. Some of the production metrics were loans sold excluding both loan sales fell from $162 million in the second quarter to $127 million in the third quarter. The locked sale pipeline fell from $84 million to $27 million. Loans held-for-sale excluding both sales fell $24 million to $19 million, whereas we could see all of our metrics; saw a decline with the rate rise.

In prior quarters, we had also sold some jumbo loans – jumbo mortgage loans out of the loan portfolio in an effort to reduce interest rate risks. In the third quarter, we only sold a small amount of jumbo [indiscernible]. We put it altogether and our net mortgage banking income fell from $5.6 million to $1.6 million. We do expect lower volumes in coming quarters due to the interest rate environment. We are seeing a high purchase mix in our pipeline right now, which is what we have been focusing on for the past couple of years.

Late in the quarter in reaction to the changing environment, we reduced our fixed expenses through the reduction of 19 people, which will save about $1.3 million annually. We remain committed to building this business in the future. These reductions are part of the normal process of aligning expenses and revenues in a retail mortgage banking platform. All of the fees were [indiscernible] in the quarter.

Moving to expenses, total non-interest expense came in at $33 million, which is down from $33.2 million in the previous quarter and up from $31.3 million two quarters ago. We decided to accelerate regulatory remediation and spent on home loans platform enhancement efforts in the quarter. Total professional fees were $5.9 million which is up from $4.8 million in the prior quarter and $0.7 million in the year ago period. In a more normal environment these expenses should be about $1 million per quarter.

Salaries and benefits declined by $0.3 million in the quarter to $12.7 million and declined $1 million relative to one year ago. Operational efficiency efforts plus adjustments in some accruals were the main drivers in these expense reductions. We had $439,000 in one-time cost related to the closure of three branches which occurred during the quarter.

Going forward, we expect it to be $1.2 million of annual expense savings as a result of these closures. Overall, we continue to manage our expenses tightly. Our high-level of spending solvency [ph] safer in the second half of Q4 and then normalize in the Q1, Q2 2014 timeframe.

With our net loss for the quarter our capital ratios fell slightly. Total risk based capital ratio at the Bank ended at 14% and 14.7% at the Bancorp. The Tier 1 leverage ratio ended at 9.1% for the Bank and the Bancorp. While considering the following risks in our balance sheet, considering our recent worked out progress, considering a large amount of excess liquidity and considering the absolute number of capital issues, we believe that we had adequate capital at this time.

In conclusion, we are making significant progress in our efforts to improve the operating performance of the Bank. As we look ahead, reduce the higher net interest margin as we deploy excess cash and probably loan growth form our lending platforms and opportunistically purchase investments. We see a normalized run rate for credit related cost. We see following operating expense as we see a tapering of consulting expense. And we will see a fee income pressure when you look at year-over-year comparison due to the rise of interest rate as our fee income fall from a Sun Home Loans mortgage banking business.

With that, thank you and let me turn it over to Imran Riaz to discuss asset quality.

Imran Riaz

Thanks Tom. Good morning everybody. As you have heard from Tom and Tom our overall strategy is to focus on smart growth without going out on the red curve. We are achieving this by good underwriting processes and careful plan selection. During this past quarter we have also added some key positions in our credit administration area to enhance our portfolio management capability. These enhancements coupled with aggressive work out strategies and proactive tuning of non-core loans, is helping us improve the risk profile of our loan portfolio

During this quarter, we also introduced a comprehensive update and revision to our credit policy. This update operation lies some key portfolio monitoring and control policies that will help us in early identification and management of softening credit. On the last call we informed you about the new risk rating system. In the late third quarter, we began the project to rewrite our loans in accordance with the new rating system. This process is expected to be completed during the fourth quarter. Based upon the early testing, we have not seen any major deviations in the rating, however, the final impact if any, of this project is unknown at this time.

I’ll bring your attention to Slide 13 as I talk about the classified loans. Our classified loans increased by approximately $22.6 million to $174 million

.

Approximately $13 million of this increase was in the surgical central portfolio. This portfolio includes loans to startup surgical centers which have been slower in their ramp up to the originally projected revenue targets. Due to the change in healthcare industry and additional risk associated with startup financing, we have stopped originating these loans since the beginning of 2013.

In addition a real estate office building loan approximately $7 million lost a major tenant and the re-leasing of the space has taken a little longer than originally anticipated which resulting in the downwind. The newly enhanced monitoring and control process is recognizing the softness in the credit and addressing the risk grading and developing a strategy before it is too late to resuscitate.

An important point to highlight is that as of September 30, 68% of our classified loans are current in the payment and are accruing, with this at year-end 2012, approximately 66% where on non-accruals, which is a complete flip-flop. If there is such a thing as a better quality classified loan, we have these, which should minimize future downgrade migration or charge-off that is the legacy risk in the portfolio is methodically being eliminated.

On Slide 14, non-accrual loan metrics as of quarter end September 30, total non-accrual loans were $55.4 million, a $16.3 million reduction from prior quarter. This highlights the positive trend in our continued reduction of problem loans. During this quarter, we also realized the net recovery for the third straight quarter and as a positive trend. On slide 15, real estate owned, our real estate owned portfolio continues to shrink as more properties are being sold without any significant new additions to the OREO balance.

Slide 16, ALLL, the allowance increased modestly from $48 million as of June 30 to $48.9 million at September 30, a net increase of $725,000. This included new charge-offs of $1.7 million in recoveries of $1.8 million or a small net recovery of $123,000.

As Tom had previously mentioned, our reserve to loan helper investments improved to 2.25% from 2.22% at the end of the second quarter. Our total reserve to NPL ratio has also improved to 88.2% up from approximately 67% at the end of pervious quarter. The improving asset quality may result in a reduction through the amount of reserves that we hold. However, just like the reserve for super storm Sandy, we will take a cautious approach and assess the need and adequacy of reserve levels and we’ll find the amount at the appropriate time.

In conclusion, we are building a scalable and sustainable credit risk management model at Sun that will allow us to grow in scale while adhering to sound underwriting and robust credit administration. These practices will poise us nicely for continued improvement in asset quality and smart portfolio growth in 2014 and beyond.

I thank you. And turn it over back to you Tom.

Thomas X. Geisel

Thanks, Imran. For the closure, the third quarter has brought has closer to creating an organization that has a strong sheet and acceptable risk profile in a business model that will allow to a predictable and sustainable earnings growth moving forward. [Indiscernible] we are confident in our progress and optimistic about the opportunities ahead.

Thank you. And operator, I would like to now open it up for questions.

Question-and-Answer Session

Operator

Thank you, sir. Ladies and gentlemen we will begin the question-and-answer-session. (Operator Instructions) And our first question comes from the line of Travis Lan with KBW. Go ahead sir.

Travis Lan – Keefe Bruyette & Woods Inc.

Yes thanks. How do you just think internally about the timeline to normalizing the liquidity position?

Thomas X. Geisel

Yes, Travis we’re currently in our planning process for next year and we kind of have a baseline estimate and then we are looking at some new opportunities. So setting on whether we want to move into some different asset classes that are more global by multi-family, et cetera. We’ll determine how quickly we deploy that. But as we’ve been saying, the primary objective right now is on solidifying the platform, we are meeting the regulatory issues and then that we’ll look forward.

Thomas R. Brugger

Travis this is Tom. I think we have more opportunities in front of us, we really do and we take a look at the economic environment, C&I has absolutely been affected probably more than any upper loan asset class with the exception of maybe mortgage lending appear just recently. And we have also through this process of strengthening our infrastructure we’ve also spent some time and taking some time away from our loan officers and asked them to focus a little bit more internally also.

So I think if we know we didn’t, as we begin 2014 and we start to point our loan officers and our credit officers and those that make up our origination team more outwardly down to the marketplace, I think the team that we have will just inherently continue to grow our core business because most of them much more other time will be focused on that. If you look at the statistics that I pointed to a little bit earlier, over 60% of our, new loan that we are originating are from new customers.

So I do think we have a competitive advantage, as Tom said I think we could do some more in the multi-family marketplace. We all believe here at this company that we could do more in small business. We’ve got a good network of branches, we are falling in the central and certainly the southern part of the state, we do to small business lending, we are very good at growing deposits in small business and merchant services and small business, but I think there is more that we can do there.

So as Tom said we’ve got some plans, we’re planning right now overall, it’s more focused on growing the portfolio, more external than internal. But at the same not forgetting about kind of where we were and making to conservative and how we underwrite not sacrifice that as we grow.

Travis Lan – Keefe Bruyette & Woods Inc.

Okay, that’s very helpful. And just in the mortgage side how does the pipeline respond kind of the pullback in rates late in the quarter and your early part of this quarter?

Thomas X. Geisel

We have saw – sharp reduction in our refi volume and then also the purchase volumes declined. So was – I went to you some of the metrics before and the locks for example $84 million down to a very low level. So we definitely saw a movement there. Rates compared to back the other way, we saw shock up when they are coming down. Fourth quarter and first quarters tend the seasonality tends to be negative. So as we look forward we do expect to see a little bit of rebound in this frame. But to your question, late in the quarter we did a pretty sharp reduction.

Now we’ve been very closely monitoring our pricing and we’ve adjusted our margins to make sure we get a fair share. The whole industry did the same thing where you saw rates back up everybody kind of pulled their margins in a little bit most of the expense side and try to manage your profitability of your platform to the right level. So again we are pretty well positioned for the lower volumes environment, but we do see a rebounding into spring timeframe.

Thomas R. Brugger

Actually it’s Tom again. I also think it’s important to think about the mortgage business on strategically here at Sun and when we take a look at our mortgage business, I know we talked about this before and the year-over-year close production certainly indicates this. We are in early stages of building this business and so as we said, we are investing still in infrastructure to it, but as you look into next year certainly with where the mortgage industry is probably everyone will be down or flat at best, I think you can includes us in that grouping, but we have a unique opportunity because this is relatively new business for us.

We came through just some tweaking of our model, we can actually it increase our margin. So it for example, we don’t sell direct right now. We do best efforts, we don’t do mandatories. We don’t have a huge investor base. So as we move into 2014, in the retail platform is build. Those are some other initiatives that we are working on that should allow us to increase our margin and while we continue tot build the business. So we think we should be able to take more market share at a better margin in 2014.

Travis Lan – Keefe Bruyette & Woods Inc.

That’s really helpful. And then just finally, what give a sense or what percentage of the portfolio has been reviewed under the new rating system?

Imran Riaz

On a dollar amount basis, this is Imran. On a dollar amount basis, we have about 54%, 55% complete.

Travis Lan – Keefe Bruyette & Woods Inc.

Perfect. All right thank you guys. Very much.

Thomas X. Geisel

Thank you.

Operator

And your next question comes from the line of Matthew Breese with Sterne Agee. Go ahead please.

Matthew Breese – Sterne Agee & Leach Inc.

Good morning, guys.

Thomas X. Geisel

Hi, Matthew.

Matthew Breese – Sterne Agee & Leach Inc.

A few questions, you mentioned in our commentary that it sounds like by May 2014 you expect to get the some sort of normalized expense run rate or more normalized I should say? Can you give us an idea of what that in fact is where you expect – expense to settle out?

Thomas R. Brugger

I think we get more normalized in the first quarter – late first quarter and the second quarter. But, that the biggest – there is two big categories one is the consulting expense, which the professional fees gives at our income statement, in a normal environment around $1 million per quarter. Last quarters were around $6 million. So if you did a math on that you’ll recover the past few quarters, so that consulting expense will do – go away. The other is our problem loan costs, throughout year we seen notes drop as our problems loan costs further. As we go into next year, you’ll see those expenses far away.

The couple of expense initiatives I mentioned to is we continued to consolidate our branches; the three we consolidated will shave off some expenses. We also reduced some headcount earlier this year, as just normal operational efficiency type efforts, so if you look at our expense it will take [indiscernible] our problem loan cost will fall back. We’ve done operational efficiency and then we’ve made some investment. We’ve used some of that we are still going to net-net see stated amount of money, but we made some investments in our risk management infrastructure.

Matthew Breese – Sterne Agee & Leach Inc.

Okay. But nothing specific as far as targeted quarter expense run rate?

Thomas R. Brugger

Yes. We haven’t put any public target to that place. But again the biggest one is the professional fees. You could save – look at the Q3 pick off $5 million.

Matthew Breese – Sterne Agee & Leach Inc.

Okay. And then in regards to professional fees and the regulatory remediation efforts there were – the cost are expedited this quarter. Can you update us on the MOU and where that stands? And how the expedited taking those got any closer to a resolution?

Thomas X. Geisel

Sure. It’s Tom, Mathew. First to say, it’s a formal agreement with the OCC. But as you know it’s very difficult for us and we are actually prohibited from commenting on that but where we see the business moving forward from a regulatory and an infrastructure perspective is, putting the right foundations in place. So I’ll give you an example, all right, so vendor management, right. I mean you hear a lot about that in the press, so what’s our vendor management look like? Can we enhance it? Can we put something on line? What’s critical vendors? What do they cost us? And really going through it and really proactive and methodical on how we build the governance across the organization. And so we have like policies and procedures, not just on who we are today but really who we want to be tomorrow.

So what we decided to do as an organization was really accelerate these versus just nickel and dimming ourselves for $1 million or $2 million a quarter. Let’s get some additional bodies in here and just get some expertise in here that can help us build some of these processes and this infrastructure and at the same time back fill with very experienced professionals so that we can sustain all of those systems that we’ve put in place. So while I can’t comment directly on where we are, I can tell you that we certainly believe that we are making progress. We’ve got the energy behind it. We are spending the dollars and we are doing everything we can to accelerate it.

Matthew Breese – Sterne Agee & Leach Inc.

I’m sorry I called it MOU, it’s the formal agreement.

Thomas X. Geisel

No, that’s okay.

Matthew Breese – Sterne Agee & Leach Inc.

In terms of capital in that formal agreement that’s part of it. At what point do we reach the breaking point where you guys in fact do need more capital to satisfy the agreement?

Thomas X. Geisel

Well, let’s just be very direct. We don’t need more capital to satisfy our IMCRs as they are outlined in the formal agreement. And we are significantly above those, but I’ll let Tom talk about capital more.

Thomas R. Brugger

So I mean the one thing we consider with capital is you look at the current risk profile of the company, we could do is reduce our problem loans. We have a lot on liquidity and we are enhancing the management, the risk management infrastructure. So the whole company is at a much lower risk profile than two or three years to go. So if you look at our capital issues where the absolute level is relatively high. The other thing which we talked about on previous call is, if we go forward with our deferred tax assets out there, if we get to a sustained level of profitability that’s an additional profit to capital that comes back on the balance sheet.

So we have adequate liquidity to deploy into loan growth about growing the balance sheet, we have capital cushions there; we’re seeing significant risk reduction progress. So at this time the conclusion is capital is adequate. So that’s where we are. And again we believe we have enough capital to handle the risk on the balance sheet today and then as we look forward into next year, we have that pocket of growth capital that if we execute we’ll be able to tap.

Matthew Breese – Sterne Agee & Leach Inc.

In regards to the DTA with this quarter’s loss and considering the look-back period, where do you think we stand in terms of the ultimate recovery or at least a partial recovery?

Thomas X. Geisel

Yeah I think the way to answer that and I’m going to be like a broken record on this one. Its [indiscernible] the number of quarters of profitability, the absolute level of profitability and our future outlook for profits. So if you looked at say last quarter, we had a number of quarters of profitability. And I think with the loss this quarter we had said that A, in the mid next year we could take a look at it. I think that pushes it out to the end of the year. So that’s how we’re going to look at that is we need to string our number of quarters of profitability together and continue to grow the absolute level of profitability.

Operator

Excuse me this is the operator something happened to Matthew’s line and he is suddenly disconnected.

Thomas R. Brugger

Okay.

Thomas X. Geisel

Okay thank you. I’m sure he – he knows how to get hold us and we can answer his question offline. But everyone heard Tom’s answer.

Operator

And there are no further questions at this time sir.

Thomas X. Geisel

Okay. Well thank you all very much. We appreciate your time and attention. And we will look forward to speaking with you at the end of the year. Thank you, have a good day.

Operator

Ladies and gentlemen this does conclude your call for today. Thank you for your participation and you may now disconnect.

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