Park Sterling Bank's CEO Discusses Q3 2013 Results - Earnings Call Transcript

| About: Park Sterling (PSTB)

Park Sterling Bank’s (NASDAQ:PSTB)

Q3 2013 Earnings Conference Call

October 25, 2013 08:30 AM ET

Executives

Abby Alexander - IR

Jim Cherry - CEO

David Gaines - EVP and CFO

Nancy Foster - EVP and CRO

Analysts

Kevin Fitzsimmons - Sandler O’Neill

William Wallace - Raymond James

Christopher Marinac - FIG Partners

Blair Brantley - BB&T Capital Markets

Operator

Good morning and welcome to the Park Sterling Bank’s 3Q 2013 Earnings conference call. All participants will be in a listen-only mode. (Operator Instructions). After today’s presentation, there will be an opportunity to ask questions. (Operator Instructions). Please note this event is being recorded.

I would now like to turn the conference over to Abby Alexander. Ms Alexander, please go ahead

.

Abby Alexander

Thank you, Operator. During this call, forward-looking statements will be made regarding Park Sterling’s future operational and financial performance. The forward-looking statements should be considered within the meaning of the applicable security laws and regulations regarding the use of such statements. Many factors could cause results to differ materially from those in the forward-looking statements. We encourage participants to carefully read the section on forward-looking statements incorporated in our press release issued this morning and in all documents Park Sterling has filed with the SEC.

I would now like to turn the meeting over to Jim Cherry, Park Sterling’s Chief Executive Officer.

Jim Cherry

Thank you Abby and good morning to our listeners and thank you for joining us today. We’re pleased to have this opportunity to discuss Park Sterling’s third quarter 2013 results, which we announced earlier today. In addition to our earnings release, you can find an investor presentation on our website that gives detailed information about these results and that we will be following during this call. Joining me this morning are David Gaines, our Chief Financial Officer, and Nancy Foster, our Chief Risk Officer.

I’m going to being on Slide 3 with some highlights from the quarter and then I will turn to David and Nancy on greater detail. First of all we are very pleased to be sharing with you our fourth consecutive quarter in a row of record earnings. We increased our earnings to $0.10 per share, and we also enjoyed an increase in our return on average assets, which David will talk more about when he gets into the numbers.

I think one of those pleasing things to our management team is the organic growth that we saw this quarter, especially in our metro markets where I think our listeners know that we’ve been investing. We had a 19% annualized loan growth in our metro markets. That in combination with what I think is a beginning diminishment of runoff in the acquired book that we expected and had shared with you that expectation and some improving production in our community markets resulted in an actual net loan growth for the quarter.

Whether or not, that’s the first time we’ve enjoyed that since the Citizen South acquisition. Whether or not we will -we’re kind of holding the bubble would be the way I would describe that now. And so whether or not we will see that in the next quarter or not, I don’t know. But we are certainly working toward that objective and I think we will soon be over that crossover point if we’d not already done so. We also saw a continued improvement in our asset quality and enjoyed a very strong common equity positions and liquidity as well.

What I wanted to spend just a moment on this morning was to talk about a continuing theme of our investment in our franchise. Continued profitability and cost controls and expense savings allow us to continue to invest in key parts in our franchise. There are two themes that we’ve shared with you in the past, that I would echo again this morning and give you a couple of illustrations.

One of those is what we’ve described is empowerment of our bankers and the other of those was talent acquisition. Now empowerment, I think a lot of people think of that as empowering bankers as decision making. But frankly I think it’s much more than that. It’s not so much about where and how and who are making decisions. It’s really more about the education and training of your bankers, so that they are in a position to deliver your company to the customer. It’s also providing those bankers not only with the skill sets through training and development, but also with tools, both the products and other tools to allow them to be successful in their sales and effort.

In that light I’d highlight a couple of things from the past quarter. One is the Sterling Edge train that we rolled out in retail. We began that rollout in the second quarter. We shared that with you. We now have completed the Sterling Edge training. That’s involved all of our platform bankers in retail. We got a 100 bankers and customer service reps, branch managers that have gone through the first phase of that, which was consultative sales training and then now we have completed a second phase training of all of our branch managers on small business consultative sales training.

This is needs-based selling. And what I would describe that as is positioning our platform personnel to address, understand and ultimately answer customer needs in ways that help them and allow them to achieve their financial aspirations. Another theme that we we’ve continued to talk about has been a theme of being big enough to help our customers achieve their financial aspirations and small enough to still care that they do. The second part of empowerment is continuing to provide them with products and services and capabilities.

So I had also shared with you that we rolled out beginning on September 5th a new mobile banking platform for our consumer base. We have already exceeded what our vendors tells us, where aggressive adaption rates by our consumer base to the new technology, and I think that is indicative frankly of the fact that if you have not seen it, I would encourage you to do so.

It is a very attractive mobile banking application. It is specifically designed for mobile banking. So it’s not just a squeeze down or sequence down version of web based online banking application. It’s designed specifically for the iPad or the iPhone and Android devices. It’s got graphical interfaces that are very distinctive, look different than many of those around the marketplace and if you go with the iPad app, which was a one that is the most robust in terms of its graphics because of the size and the screen, and download the app, even without having signed up for the service yet, if you go simply to the locations portion of the app and click on that, you will be able to see a map and literally drop pins across our footprints. So for those of who are investors who would like to see where Park Sterling is located, and the logic behind what we think is a very attractive and growing footprint, one of the best ways to do that is frankly just to go to our iPad app. You don’t even have to sign up and become a customer to go look at locations and see where we are, very interesting application. I’d invite you to go deeper than that though. So I am now welcoming you to get into touch with us and let us open up banking relationships which is well.

We intend to continue to roll out other features. We began first with location services, balance information, and transfer applications for customers, for consumers. We will follow that with deposit capture, with small business and mobile applications. We have to bill pay and then ultimately we expect sometime next year to be rolling out an application that will be very unique app to the marketplace. I’m not aware of anyone app that is offering this capability, even that the large bank or in the community bank space in our marketplace today, and I will just tweak you with that anticipation of more to come, but we are very excited about the mobile banking rollout.

Finally on the people front, one of the hallmarks of our company from very beginning has been our ability to attract talent to our platform and as I think most of you know, our process has been to recruit that talent for most part without the use of external recruiters as through word of mouth and people we know that we have been able to continue to attract talent. I can’t tell you that we are opposed or wouldn’t use outside recruiters. There will be certain job areas where we probably where we probably will, especially as we’re now getting larger, but we continue to enjoy the ability to recruit talent directly. It allowed us to actually know the right people to hire and in the markets you also know that has been our objective and we’ve been very successful at this, of hiring what I’ve described just the A talent in the marketplace.

These are the people that have spent their banking careers generally in the markets in which they are now operating and we’ve been able to recruit them to our company. Often times they are able to bring books of business with them, but important of that, because they spend most their careers in these markets, they allow us to play bigger than the footprints we may have in those markets.

Some recent examples of that, we’ve just hired Claude Robinson to be the South Carolina Community Market’s President for Park Sterling. Claude will be based in Greenville but his primary center will be out of Greenwood, South Carolina, which is just south of Greenville. Greenwood for those if you who remember, that was the headquarters for Community Capital, which was our first M&A partnership. It is a key market for us. Claude has over 30 years of experience in that market and surrounding markets of upstate and Midland, South Carolina. He was a senior executive with one of our major competitors in that market. So we’re very pleased to have him join us in leading our business development efforts and that important part of our franchise.

Additionally, some of you may have seen the press announcements with respect to Gastonia in Western North Carolina. Gastonia was the headquarter city for Citizen South, which was our second doubling in size and gave us the lead community market, banking market share in the Charlotte Metro market, but Gastonia is one of our obviously key centers of our franchise now and we’ve assigned Dan Boyd who was the former Chief Operating Officer for Citizen South to be the western market executive of North Carolina Regional President for us. He will be responsible for leading our business development efforts in the community markets in Gaston County and surrounding counties, and joining him, another veteran banker of that market as a Senior Commercial Banker, Steve Huffstetler.

In addition to that we have other hires, both in retail banking, new mortgage brokers, in some of our key markets and key support leadership positions that we filled. But I wanted to highlight this specific aspect of our hiring within our markets and the focus we’re getting to growing organically our business. We think that will continue to complement nicely our efforts on the M&A side. M&A discussions are accelerating and increasing and we expect to be active in the M&A as well.

Finally, before turning it over to Dave and Nancy, I just mentioned the capital management. We did complete before redemption on the $20 million in preferred SPLF stock that we had out saying the repayment of that as we anticipate we would during our last earnings call and we declared our second consecutive quarterly dividend, again at $0.02 a share we initiated with last quarter and we’ve announced this morning intentions to pay that again. It does provide a nice return to retail investors and value dividend pay bank stock which we have indicated in the past we believe is a key and important component of our shareholder base, right now based on our stock price, it gives about 120 to 130 dividend yield on our stock.

So with that background for the quarter I’d like to turn it over to Dave to highlight some of the, little more depth on the numbers and then to Nancy on the asset quality. David?

David Gaines

Thank you, Jim, and good morning everyone. I am now on slide four. And as he mentioned we’re very pleased to report our fourth consecutive quarter of record operating results. We had great continued loan growth in our Metro markets, strong performances in both the wealth and the retail banking teams, sound cost controls that Jim mentioned and continued improvement in asset quality, all of which contributed to a 9% increase in adjusted net income available to common shareholders. That adjusted of course we’re kicking out securities gains and merger related expenses which we always do to give you more consistent view but it raised at 9% to $4.3 million or $0.10 a share. That equates to an 87 basis point adjusted return on assets or about 6 basis points higher than we reported last quarter which is also the fourth consecutive quarter of record results.

I am going to cover most of the details in subsequent slides but do want to point out two line items in this table. First, you can see that we posted a $419,000 reversal of provision expense this quarter. That reversal is entirely related to improved asset quality in our PCI loan pools as the cabinet for under the ASC 310-30 the old SOP 03-3. And if you’ll recall we have consistently told you that we feel very, very good about the aggregate fair market value credit marks against those acquired loans. But the vagaries of allocating those marks to individual pools in the past have created the need for us to post some provision expense and create some supplemental allowances. What’s happened this quarter is even those pools that look like they had drifted south really have improving performance and we had to recover that provision expense in accordance with GAAP. So it’s a really all related to that SOP 03-3 volatility that we’ve talked about several quarters in the past.

The second item I would point out is if you look down we had no preferred dividend accrual this quarter, and as previously disclosed and Jim just mentioned, we did repay that $20.5 million in the old SBLF preferred on September 30th. When we were working with treasury on that redemption, we determined or learned that that 152,000 adjustment to preferred dividends we highlighted last quarter which is embedded in that 302 number you see on the sheet under the second quarter, that actually satisfied our required dividend payments for the third quarter which was a pleasant learning and surprise and obviously helpless.

Now let me turn to page five, get a little more detail on the rest of the earnings. If you do look at five you can see a breakdown of net interest income. Earning assets actually increased a little bit during the quarter as we deployed that cash into securities which we have been doing for some time, helped offset an average decrease in loans for the period. We did go up at the end of the period but overall we were still fighting that downhill slope in our acquired loan book. But we did also see some margin compression. So the benefit of that higher earning asset level didn't really flow all the way through the net income. We had a little bit of 2% or 350,000 decrease in net interest income.

Now we’ve been saying consistently we think margin pressure is coming for the industry. We are not going to be immune for that. The competition is simply too stiff in new loans for us to hold our margin up. We think without stretching on the risk fronts things we’re just not interested in doing. Now the good news is we’re starting at a better net interest margin base than lot of folks, but we do think it's going to continue to come under pressure.

If you flip to slide six, you can see non-interest income which again we're excluding the gain on sales of securities decreased by about $60,000 -- $100,000 to $3.3 million for the quarter. The primary driver of this change no surprise really came from our mortgage banking income, which declined about $576,000 or 59% as it rolls over just lower activity level, which is the consistent trend I think we’re seeing across the industry.

Now you can attribute about 77%, about $444,000 to that decline. So the way we calculate accrued income associated with our mortgage pipeline under the SAB 109, and that can have the effect of sort of extenuating volatility swings positive and negative in any given quarter’s results and it probably had a little bit of a negative impact swing this time. But ultimately those are real earnings, and so think of them that way. But more importantly, this is why we have consistently said, we really like the mortgage business, we really want to be a strong mortgage player in our footprint but we do not want to grow this in an outsized manner. We're going to continue to add mortgage bankers but we do not want this part of our business to be outsized relative to rest of our revenue stream, because it's just too volatile. It always has been and it always will be. So it’s important for us in our strategy to keep this thing sized properly.

Now more positively, as we mentioned earlier we saw very good results in our wealth management activities. You can see the discretionary assets under management continue to grow for the fourth consecutive quarter, very pleased with the new person that we brought in that business. They really delivered for us. Also very pleased with the momentum building in our retail bank which Jim talked a little bit about. You are not seeing that so much in the numbers, you did see a reversal, a couple of quarters slide in service changes which is great but the excitement level in the branches, the referrals that are coming into wealth and other areas, really shows that that training is paying off well.

Final item I would mention on this slide is that we have decided to exit the custody portion of our wealth management business and we’re in the process of working with those customers to transition them to a new provider. This decision which would be no surprise to you is really driven by the fact; we just don't have sufficient scale to really run this business properly over the long term.

It is expected to have a negative impact on our quarterly revenues of probably around $170,000 once it's fully implemented which we think will be mid next year, however it’s really going to let us redeploy those resources into our core asset management business which we believe will be a better risk return profile for our shareholders over time.

If you turn to slide seven, you see a breakdown of non-interest expenses, which excluding merger related actually decreased 3% to about $15.5 million for the quarter. You can see we posted improvements across virtually every major category, which reflects a couple of things. First we do continue to squeeze out cost savings from merger integration efforts, and we told you those things will kind of come through the course of the year; we're still squeezing those things out.

Second we just got good old fashion expense management discipline in the company, which is something we think is important in this economic environment. The only material increase is the way OREO popped. We went from a small recovery to a small expense this quarter. That was really the only negative item. And I think it's important to remember we have gotten these cost saves in a period where we have made those investments that Jim talked about. And I would say that the cost savings we got out of the two mergers are doing exactly what we hoped they would do. They’re empowering us to invest in higher growth areas of our business but still deliver a good return to our shareholders in the process.

If you turn to Slide 8, you can see the earnings profile versus our peers. ROE/ROA continues to grow and improve over the last five quarters both on a relative and an absolute basis and we continue to see good attractive investment opportunities to deploy that and continue building the franchise.

If you turn to Slide 9 you can see our balance sheet. Just a couple of things I would highlight here, number one you can see we’ve kind of continued that steady deployment of cash into more attractive earning assets during the quarter and in this quarter net loan growth, which we’ll talk about it little bit more in second. And second, you can see what happened when we redeemed that seriously preferred stock. Our TC to TA [ph] remains very, very strong; repaying that capital, simplified our structure. It took out capital. It was frankly getting expensive and certainly would be expensive going forward. But we are still in a very strong capital position to pursue our growth opportunities.

If you turn to Slide 10, you can see our loan mix by product type, not really any significant changes here, a little bit of growth in A, C & D portfolio which is that builder finance group, that’s doing very, very well for us as well as some commercial activities. I think Nancy might mention those. You can see that we’ve still got about 47% of the book designated as acquired in an accounting sense. So it’s carrying a fair market value adjustment.

And then if you turn to Slide 11, you can see that top level top level geographic breakdown, we started sharing last quarter. And those Metro markets which include Charlotte, Raleigh and Wilmington in North Carolina and Greenville and Charleston in South Carolina, you can see that $26.7 million or 19% annualized growth rate they posted in the third quarter, which is great and really importantly we just continue to see good loan growth across every one of those markets. It’s very balanced and we got a good pipeline and good momentum still on every one of those markets heading into the end of the year.

If you flip to Slide 12, this is our traditional breakdown on acquired loan accounting. You can see the fair market value adjustments. We still feel very good about those levels. We’ve highlighted the accretable yield there. You can see it did decline but it’s still declaiming less than the amount of our accretion, which continued evidence that the cash flows in those acquired pools are outperforming our model expectations and I know some folks do this. So if you tax effect that $39.7 million period and accretable yield that’s worth about $0.60 of share of TBD [ph].

If you flip to 13, you can see the deposit mix, we did have a decline this quarter in the deposits and what happened is we had really one large deposit relationship that following a corporate action on their part had to move some deposits out of us. Otherwise I would say the deposit trends, we still feel very good about, we still got over 90% of our deposits in core, the way we look at it. The only thing I’d highlight here is well just for your, I think your modeling purposes, we did reach the estimated - the end of estimated life of our acquisition accounting fair markets marks on some deposits. That was worth about $570,000 to us last quarter. Now that’s a declining value over time as you know but we do lose that benefit going forward and want to make sure you all are aware of that.

If you look in Slide 14, you’ve got our capital and liquidity ratio comparisons to peers. You can see we continue to remain comfortably at or above the top quartile. Very important to remember that these ratios are really the ones that give us that financial flexibilities, strategic flexibility that Jim mentioned. It’s this and the asset quality that Nancy will talk about but most banks just don’t have this attractive earnings profile and asset profile, the available capital, good leadership and strong growth markets, an attractive currency and an infrastructure to pursue growth and so we feel very, very good about where we’re positioned at this stage of the economy.

And with that I will turn it over to Nancy.

Nancy Foster

Thank you Dave and good morning everyone. As both Jim and Dave pointed out, asset quality remained strong and continues to improve. So beginning on Slide 15, pass grade loans remain high at over 97% of the portfolio and this reflects just a slight increase in special mention loans as we did have some downgrades primarily in the acquired portfolio which were largely offset by upgrades from classified.

Non-performing loans were down slightly, driven by decrease in TDRs and OREO declined $1.4 million or 9%. We’ve now sold over $20 million in OREO this year, producing over $1.7 million in gains and that does follow aggressive write downs in OREO taking in the fourth quarter of last year. The real estate market continues to perform well in the Southeast and sales activity looks strong for the remainder of this year.

The decline in OREO drove a $1.5 million or 5% decrease in non-performing assets and an improvement in the non-performing assets, a ratio of 1.52 to total assets. Net charge offs of $1.8 million were higher this quarter as we experienced $960,000 in charge offs on TCI loans and $816,000 on the non-acquired portfolio and that consists largely of one loan which was previously impaired and had a specific reserve. Year to date adjusted charge offs remain low at $850,000 or approximately 9 basis points.

Turning to Page 16, the allowance for loan and lease loss is decreased $2.2 million or 20% over last quarter due to a number of adjustments which reflect a continued improvement in the credit environment and loss history. Let me walk you through that, first the quantitative portion decreased $1.3 million or 17% driven by lower quantitative reserves against our A, C and B loans.

The previous method for our loss history reflected the very high losses we took in late 2010 and early 2011 on residential development loans which were largely speculative. This type of lending was discontinued in 2009 and what little exposure we have remaining today is performing very well.

More importantly the A, C and D portfolio today is considered lower risk due to a refocused product mix, which is comprised primarily of single tenant commercial construction loans and the builder finance loans which Dave mentioned earlier, which consists primarily of presold residential properties. In order to more accurately reflect the loss inherent in this type of portfolio mix, we split the previously combined loss histories for A, C and D into three components and applied them accordingly. This decrease in A, C and D reserves were partially offset by a $525,000 or 7% increase in our qualitative reserves. This reflects our caution with respect to a few large, first mortgage loans and acquired portfolio which are substandard but not yet impaired and which in our judgment may not be sufficiently reserved for in the historical loss component of the reserve.

Third and last, the PCI component decreased $1.4 million, driven by the previously mentioned $960,000 in charge offs and improved cash flow projections in the remaining acquired loans. This resulted in the $419,000 reversal provision expense Dave discussed earlier.

Finally as a percent of total loans, the allowance decreased from 0.83% to 0.66%. When adding the $41 million of remaining marks against the acquired portfolio, the adjusted allowance increases to 3.8% of total loans, a number we remain very comfortable with as we continue to work through the acquired loan portfolio.

Turning to slide 17 you'll see our overall asset quality remains strong relative to our peers in each of the measures where we remain well within the top quartile, aside from this quarter's accounting anomaly, which produced the 57 basis points of loss on an annualized basis.

As you recall this was due to PPO loan charge offs and as we said before the accounting produces a timing difference, which we believe will return these losses to accretable yields over the next several quarters. Our credit outlook remains positive for the remainder of this year and going into next year.

And with that I'll turn it over to Jim.

Jim Cherry

All right, Nancy, thank you very much. Just as closing comments before we turn to questions. We continue to exhibit very strong financial performance and improving performance, both in terms of our earnings, in terms of cost controls, as well as in terms of asset quality and capital strength. All of these things position us, as Dave mentioned with greater flexibility and optionality where we will place our emphasis, will continue to be on two core areas. One is organic growth in the key markets that we've identified by continuing to recruit and build out our teams in those markets and by continuing to leverage the talent that we have through training and development and new product introduction.

Second we continue to pursue appropriate and disciplined M&A strategy, primarily again focused on the key markets that we’ve identified from before, but markets that we are in today as well as potentially markets that we’ve identified as key expansion markets, those M&A activities are likely to be more as we mentioned last quarter and we are more likely to do smaller transactions to fill out and to build presence in markets. So don't necessarily expect continued doubling in size though that certainly could be a possibility.

So with that background of where we are, I think we're very well positioned to pursue both of those objectives and we will open it up for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question and answer session. (Operator instructions). And the first question comes from Kevin Fitzsimmons from Sandler O’Neill.

Kevin Fitzsimmons - Sandler O’Neill

You mentioned expenses and that was definitely a positive this quarter. Just curious, how you would characterize that? Would you view this level we’re at now as more of a run rate because I heard you mentioned continuing to look and realize synergies from Citizen South but also investing. So should we look at it going forward more as a stable run rate or could it actually decline from here? Thanks

David Gaines

Yes Kevin, this is David. I think I would say the same thing we said a couple of quarters ago, which is, I think it could bounce $0.5 million dollars either way in any given quarter depending on the timing and savings versus investments. But I think this kind of $15.5 million - $16 million range sort of feels very achievable to us and certainly that’s where we have been running for some time now.

Kevin Fitzsimmons - Sandler O’Neill

Okay. And just a follow-up, just curious how you are thinking these days, is about buybacks. I know you put that authorization in place a while ago, and also M&A. It sounds like, Jim you’re very interested in M&A and doing disciplined M&A, but curious what’s the interest level out there of sellers. Are you getting a sense that there is more interest/less interest; is it just going to be a very patient process? Thanks.

Jim Cherry

May be I will try respond to both of them and let Dave jump in as well, but first on the buyback program, that is still in place. We did put in place a program for doing that. At the time we put that in place, we were trading below tangible book value. So it was obviously more attractive than it is when you’re trading above tangible book value in terms of buyback. But we still have that program in place. We’ve not shared the refinements we’ve made to that. But it is still active and we could see the right opportunities that we’d identified to continue that. But our primary emphasis and use of capital, we expect is going to be to support our organic growth and the M&A activity.

And on that second front, I think we shared this with you in the last earnings call as well, but there is absolutely an increase in activity and discussions, kind of across of the spectrum and it’s still a matter of getting, I think -- it’s not just the bid ask, I think that’s been a challenge, but as certainly as the market has improved across the board, even though the relative relationship between acquirers and buyers of stocks have remained pretty much the same, I think this it’s just a sense that I’m getting more just because the price is higher, even if the relationship is really the same. So I think that’s probably been part of it.

But there still seems to be some disjoint between where boards and management teams may be in the process and it works both ways. We have some management teams that I think are beginning to recognize they can’t get home and can’t deliver the results to shareholders that they believe that they should and they realize that the best way to do that and the solution to virtually every challenge they face is scale and the partnership is the best way to do that. Some of their boards are not there yet and we have the vice-versa. We have some boards who are there and the management teams who are saying, gosh, I am not ready for a change yet and I keep thinking maybe the world will change.

One dynamic that I think is really beginning to come home especially, probably will now, as we approach year end and people are doing their budgets, and that is what’s happened to net interest margins. There is a 20 year steady decline in net interest margin and I think there are some that think that, and there is now a 5 year steady flatness if you will to loan growth in the market. So I think there is a dawning recognition that while asset quality maybe diminishing as an issue, the net interest margin isn’t going to bail some of these financial institutions out.

Even if rates increase, I would not expect a significant expansion of net interest margin. I think the environment is way too competitive for that. You may even see a continued narrowing which is the now historical trend for net interest margin and I think that as people begin to put together their 2014 and beyond budgets, they’re going to have to recognize that fact and I believe it will continue to encourage dialogue around strategic partnerships, which is really what we’re pursuing. We have not been presuming the FDIC. Now I don’t know if that fully answered your question Kevin or if you want some?

Kevin Fitzsimmons - Sandler O’Neill

No, that’s great Jim and one additional thing on that topic, you’ve talked about disciplined M&A. If you could just give us a little color on what that means to you, it seems like every transaction announced is an accretive acquisition. I think the key thing the investors hone in on is how long does it take to earn back that tangible book dilution. So if you can give us little color on how you view disciplined M&A? Thanks.

Jim Cherry

I think the key metrics that we have been using all alone have been EPS accretion, IRR, and how long it takes for us to get back any dilution if we take it and most important of those probably is the EPS accretion, which we expect to be very strong immediately. There is some who would argue for the IRR, but I think our view on that has been, it depends on how you go about producing that and be a lot of things in there that the EPS accretion can discipline you around. Dave, I don’t know if you

David Gaines

I would say, it’s almost -- so according to us you don’t think it can but a lot of it going to be how does it fit your strategy, right. I mean fundamentally there is sense deploying capital in the market or in a business line that is not part of what we think is still out there for us in the Carolinas and Virginia.

Jim Cherry

We have gotten continued -- actually probably the best board there. We’ve continued to get calls and see opportunities in markets that we are not in or not what we think are attracted growth markets and we see no sense in continuing to invest in unattractive growth markets and that doesn’t mean they’re not attractive markets, you’d have to live in, but if they don’t have growth dynamics to them, when there is so much opportunity in markets that do, we think we’d be foolish to be pursuing those opportunities as a focus point.

David Gaines

It’s kind of the curse and the blessing of our footprint. If you think about it Kevin, I mean there are not many community banks that have such large portion of their business in growth markets. So there is virtually no partner we look at that doesn’t distort our demographic profile. And that doesn’t mean you don’t do the deal, don’t get me wrong, but you’ve just got to understand what not don’t look at the year 1, 2, you’ve got think through, what’s year 3, 4, 5 look like, if I can’t somehow magically either flatten or turned that growth profile and its demographics are on your favor, very tough to turn that growth profile in the small market.

Jim Cherry

Awfully hard to carry those other markets which ultimately you would have to do. So the discipline is as much around where we want to go and being willing to weight and pursue the right opportunity in there as it is around financial metrics that make that an attractive proportion for us.

Operator

Thank you. And the next question comes from the William Wallace with Raymond James.

William Wallace - Raymond James

Couple of questions. It was good to see to loan growth in the quarter. I was wondering if we could maybe dissect that little bit. The first question is, if you just kind of look at the production during the quarter, would that accelerate and has that acerbated every quarter this year?

Jim Cherry

I can’t remember whether it’s accelerated every quarter or not quite frankly, but it is absolutely up and wasn’t in the quarter and our pipeline is up now. We have had very strong production, especially out of the metro markets which is where we expected and invested for that production. But I think maybe more equally pleasing is that we’re beginning to see that I as mentioned in the community markets, which we had not seen before and I think part of that is that for the most part many of these community markets don’t have this higher growth dynamics, but I think the other factor there is that some of these community markets, there has been a transition period as you adopted to new cultures, to new ways of doing business and that empowerment through training and development has now taken hold and we’re be getting to see that turn as well.

David Gaines

Now anecdotally, you clearly had the value of the builder finance group building during the course of the year and those pipelines clearly have been going up from that activity and he’s done very, very well. We clearly have the benefit of the new leadership we brought into Charlotte late last year which is same thing . You’ve clearly seen momentum building every quarter in those markets. And so my guess is while it’s probably close to quarterly build every -- and I apologize, I just don’t have that in front of me to absolutely swear to it for you.

Jim Cherry

And I think Dave may have mentioned this before but I think he mentioned it, every single one of those Metro markets are up, probably two. So it’s not saying well this market versus that. They’re all showing that kind of growth.

William Wallace - Raymond James

Yes. But it sounds like you’re also saying you’re seeing stabilization and perhaps even growth in the more rural markets as well.

Jim Cherry

Yes.

David Gaines

Kind of stabilization, not sure net growth. There are some markets that do grow. While there are some guys that have done a great job in some markets out there but overall it’s just a demographic problem. It’s not that you don’t have good bankers working hard because we do.

Jim Cherry

Well, it’s a combination, there is the demographic problem but here is the kind of the combination. In many of those smaller community markets that we are in, we have a significant market share. And because of that, it makes it difficult to grow faster than the market does or in fact if the market is climbing, it makes them very difficult to grow. If you look at our market share, in some of the larger Metro markets that we are in, it is small. In those it is much easier to grow, even faster than the market grows because of the small market share that we enjoy. So it’s funny for people to say you enjoy a small market share but at this stage in our development, it actually is a benefit in terms of our growth.

William Wallace - Raymond James

Right, and then it looks like the lion’s share of the growth was coming in your acquisition construction development line? Can we talk a little bit about the nature of the credits that you’re putting on the balance sheet?

Nancy Foster

Sure, this is Nancy. There is really kind of two areas of focus. The first really now all the year, probably over a year, we’ve been very successful in the commercial construction arena, where we’re doing a lot of single tenant construction which great product, it does turn over. It goes to the permanent market and we’ve seen that happen but good fee generation, good spreads and I think we’ve mentioned some of the clients to you in the past, people like Trader Joe’s, Dick’s Sporting Goods. So that’s been a really good business for us and continues. Actually that is the largest component of the three that I’ve mentioned when I spoke about the allowance.

The second really is what Dave mentioned, the builder finance and that we’ve had Steve on board now since the beginning of the year and he got up to speed very quickly but he really didn’t see the outstandings really move the numbers until about the third quarter. So those will continue to build in the fourth quarter. The fee income has been tremendous. And so that leaves the third which is land and loss and that’s the portion that continues to shrink, quite frankly.

William Wallace - Raymond James

Okay, and then switching gears a little bit, I want to talk little bit about the mortgage bank. Are you taking any actions on the cost side given the slowdown in production volumes?

David Gaines

I’d say yes and no. The leadership down there is certainly looking around and trying to make sure that we’re not overstaffed in any area. But we still have not filled out our network. We don’t have mortgage banking in some of our markets, certainly in some of the metro markets. And so I think there is a little bit, we have an opportunity to grow in the infrastructure that’s there already Wally. To the extent we can’t find that growth, either in bankers or productivity, we’re not afraid to go look at the cost side of the business obviously. But right now that’s probably not the smart thing to do for us because of the opportunity to get into some new markets.

William Wallace - Raymond James

Okay, so you mentioned in the prepared commentary David about the timing difference impacting the quarter. So we’ll get a little bit of relief in the fourth quarter and then whatever happens for the bottom line will be driven by what happens to production volume compared to the third quarter. Is that correct?

David Gaines

Yes, I think that’s right. And it’s kind of -- and don’t get me wrong. I’m not going to try to ever hide behind the accounting. But I would say you can sort of look at PCI, you can sort of look at the SOP 03-3 accounting, you can look at the SAB 109 accounting. Both of them ultimately, those results would happen. It’s just over what time frame would they have happened and they tend to distort what we might think of as a given quarter’s economic activity, might now show through because the way the GAAP works. And in this quarter you probably did have a little more down draft than you would have thought of economically in that business. But everybody is in that same camp, right? It's comparable to what you are seeing from other banks. So we're not in any way alone on that front in either of those accounting considerations.

William Wallace - Raymond James

Okay. And then my last question, I wanted to ask about the exiting of your custody business. Are there going to be any charges associated with that?

David Gaines

No there is really not. It's just the winding down of the business. It was running through the same platform that we run our normal asset management business through. So it's not that we’re getting rid of that platform.

William Wallace - Raymond James

So you will see -- I think you said it was $170,000 roughly per quarter that would go away?

David Gaines

And I think it will just kind of drift out. We think it will sort of all be gone by mid next year.

William Wallace - Raymond James

Changing staff?

David Gaines

No we'll probably use that staff and redeploy them. Honestly, what happens right now is quite frankly custody is a tough business. It's not the best risk return business in the wealth management space, at least not in our assessment of it. It chews up a lot of our people's time to do it properly and I think we can use those people to support other customers that are probably a better risk return profile, much better. It's a real redeployment issue Wally, more than anything.

Jim Cherry

Yes Wally, the way I would describe it is, that's a business that it should be low margin, low touch and high volume. We were low margin, high touch and low volume. That simply doesn't work. And if we take those same resources we have and commit those to our asset wealth management business, which can give much better returns, it shouldn't take us long at all to overcome that, and where that cross over point will be in terms of seeing that business run off over the next six to nine months, and bringing in new business that overcomes it. I am not sure what you're going to see of that frankly, because I think the crossover point will come fairly early in that cycle.

Operator

Thank you. Next question comes from Christopher Marinac with FIG Partners.

Christopher Marinac - FIG Partners

Just a quick one on the last question. So the wealth management assets just adjust temporarily lower and then you build it back up, is that right?

David Gaines

It's really going to be that non-discretionary bucket that you see shrinking down. The discretionary is the core business. So I hope that is growing.

Christopher Marinac - FIG Partners

So the margin of the business really won't be stronger over time? There will obviously be a transition period as you mentioned?

David Gaines

Exactly.

Christopher Marinac - FIG Partners

Jim, I have a question, it has to do with staffing. The training and other part you mentioned at the early part of the call, what are the opportunities for you to further build staff with some of the changes at the big banks, perhaps at the mortgage arena, but this as a kind of global question, do you see this staffing and the producing team kind of getting larger the next year or you think you can stick with what you have and just mine their production levels?

Jim Cherry

I am not sure Chris whether you are asking that from the standpoint of our attractiveness or you are asking that from the availability in the market?

Christopher Marinac - FIG Partners

I guess it's more of availability of the market and so the likelihood of you executing on additional hires.

Jim Cherry

We continue to be unusually, to have a distinctive capability to bring in new talent. And I think they are attracted to the vision and strategy that we are pursuing. I think they are also attractive to the people that are already here. We said this before, talent begets talent, and talented people like to work with talented people, and the more of that you can build I think, the more it attracts others to your vision and strategy.

I think the fact that we are pursuing a long term vision and strategy is also attractive, both to potential M&A partners and also to potential people who join our company. And so yes, I think you will see us continue to do team lift out in key strategic markets that we have already identified, some of which we maybe in already. So it may not be a new one but it’s literally lifting out potentially either teams and/or individuals in those markets as well as potentially doing that in new markets that we are not in today but have previously expressed the aspiration to be in.

And frankly so far and I missed this earlier, we’re doing this through people we know or people that we know who know people. It is as important to be able to know who not to hire perhaps, if it is who to hire and most of the people that we have been hiring are not people that have been looking for jobs. Most of them were not out in the marketplace, they are not approaching us looking for jobs from the fact that they don’t have one, but we all have people approach us who are with other companies and seeing what we’re doing the same, or would like to be part of that.

David Gaines

The one thing I would add, that would sound a little bit hokey, the consistent thing we hear from people after they have joined us for a week or two or three months is they are having fun. And there is not many bankers you talk to today that they are having fun and I think it’s because we do have a good platform, we’ve got a good solid financial position, we’ve got a good management team, but part being a good management team is you hire good people and let them run their business. And I think they’re just having fun particularly if they’re coming out of a big bank universe where it’s more difficult to do that today.

Christopher Marinac - FIG Partners

And I guess sort of follow up question, with the progress that you are making now in the last three quarters on sort of the adjusted core ROA, almost pushing 90 basis points, does that become a little bit of a litmus test for some of the acquisitions that you may be looking at that has to sort of be accretive if you will of that ROA?

David Gaines

I haven’t thought about it that way Chris. To Jim’s point we are sort of running the more traditional EPS, TVV [ph], IRRs. So I guess indirectly it could. Certainly, I mean if you didn’t think you could do something with that earning of that asset base you’re acquiring, it’s going to show up in one of those three measures. But I don’t look at it on a ROA basis per say, because frankly you probably think you’re going to do something different with their company.

Operator

And the next question comes from Blair Brantley from BB&T Capital Markets.

Blair Brantley - BB&T Capital Markets

I had a couple of questions on the margin. Can you give us sense as to what you’re seeing in loan pricing, I guess how it compares for new production from last quarter to this quarter?

David Gaines

I’m not sure there is much change from last quarter to this quarter. The big change I would say we saw was when the 10 year spiked in May, for the most part you saw people get out of that 10 and 15 year fixed rate lending business. I think we’ve seen one occasion this last quarter which sort of surprised us but that’s pretty much gone. I don’t know.

Nancy Foster

I would call it stabilized, I don’t see pricing pressure increasing per say. I know Steve is getting a little bit of pressure on the builder finance side but we’re holding. But I think we’re holding pricing even on some of the launch.

Jim Cherry

Probably the narrowing is coming more from maturing lends that are being re-priced at the more stabilized, than it is that they is continuing pricing pressure, if that helps you Blair.

David Gaines

6% loans rolling off and they are coming in at 4.50% or 4.70% or wherever they are coming in. So, that’s…

Nancy Foster

And the improvement in credit quality also has an impact. So, you’ve got special assets, lower quality rolling off.

David Gaines

Yes, it’s really, I would say if we’ve a change in this quarter, it’s really been people starting to get a little loser in their structures. People taking folks that probably should be an asset based loan, turning it into a cash flow loan and people giving up guarantors where they really, that’s just never great idea in the type of customer we deal with as a community bank, it’s probably been more edgy around that than it’s been pure pricing.

Jim Cherry

We knew the bankers memories were short term, that we would ultimately be destined to repeat the past but we didn’t think it would happen within only three to four years.

Blair Brantley - BB&T Capital Markets

So the drop in yield, the loans from this quarter, is that something that’s going to….

David Gaines

Yes, we do have that same re-pricing phenomena going on. So if majority of our loans re-pricing are coming down, yes 75 to 100 basis points. Any given quarter you’re going to have unevenness from the accretion coming off the acquired loan books but I would say the key driver, where we say the long term margin pressure is coming, it’s really that re-pricing of the assets and even if rates go up, our expectation is banks are so hungry for loans, they are not going to go up with rates. If rates go up 100, they are not going to raise the prices 100. It’s just not going to happen, despite what everybody tells their ALL model. That’s not going to happen.

Blair Brantley - BB&T Capital Markets

And then from a purchase accounting benefit this quarter, is that just going to keep on trending down? I think it was down 1 basis point from last quarter. Was that fair?

David Gaines

You’re talking about from the provision reversal or which part of it?

Blair Brantley - BB&T Capital Markets

Just I thought I saw in the press release that if you look at the reported margin versus kind of core, it looks like that.

David Gaines

Oh, yes, what we do, that's very unpredictable and it's why we pull out that accelerated accretion for you guys, because that acceleration happens when a loan gets restructured or pays off and all of a sudden we got to accelerate that mark in and these are not the PCI loans, these are the acquired performing loans. And so we’ve always pulled that number out to get back to what we think is a more core net interest margin level.

Blair Brantley - BB&T Capital Markets

That accretion, is that one time or is that just being built in over time?

David Gaines

We have had some every single quarter, virtually every single quarter, but we can’t predict it. So it's basically a little bit of manna that comes in but it's really just accelerating. Its income you would have had over a longer period of time, it happens the accounting drives you could take it now. That's why we kind of want to segregate it for you all so you don't get fooled, take our margins on a trend that it's not.

Blair Brantley - BB&T Capital Markets

Fair enough. And then on the deposit side, are you saying that costs are going to go up by $500 plus $1000 next quarter from the loss of accretion?

David Gaines

You've got a lot of things that are driving; you have the accretion from the mark on those deposits that was a benefit and that has now burned, it’s through its estimated life. So that benefit is gone. If nothing else happened and all the deposits stayed flat and all the pricing stayed flat, the mixes, yes, you could just take that amount. Now that's not what really happens and in fact the core deposit rates have been improving throughout the year and so we'll keep working on that but again, I just don't, we never want to leave you all but there's something unusual happening in our financials. Good or bad, we're going to try to point it out to you so you don't get confused and that is when we will have to.

Jim Cherry

Or maybe you stay as confused as we are.

David Gaines

That is one that's detrimental to us to be sure, but you knew it was coming. It's not like that's a surprise. Those are things you set up and you know that's going to burn off over time.

Blair Brantley - BB&T Capital Markets

So I mean is it fair to assume that deposit costs are going to jump next quarter?

David Gaines

If everything else stayed flat, yes.

Blair Brantley - BB&T Capital Markets

Okay, because that’s like 17 basis point or so.

David Gaines

If everything stayed perfectly flat, you'd see that kind of increase but I don’t think you'll see that full impact come through.

Blair Brantley - BB&T Capital Markets

And then last question. Actually I have two more questions, I'm sorry. The fee income totals have come, that $3.3 million this quarter for a run rate, is that a more near term kind of run rate or is it more closer to like the first quarter? I know that second quarter was $4 million. Just kind of some thoughts there as to what to expect obviously, with the mortgage being impacted and….

David Gaines

I'm going to bail out on that one just because we never given, we're not big on forward guidance for that particular line item. I would say, mortgage banking is obviously the big volatility driver here and so I think watching mortgage naps generally and seeing what's happening there is probably going to be as good an indicator as you can get or we can get on what's going to happen to those markets, but I'm going to bail on giving you more specific guidance than that and I apologize.

Blair Brantley - BB&T Capital Markets

Okay, fair enough. And then regarding credit costs, just any kind of color, what you're seeing? Obviously you've changed your methodologies and you obviously have the different, a nice impact for this quarter but obviously in the last few quarters, one loss provision has been pretty much nominal. Just any thoughts there with what you're seeing in reserve levels and I know there's a lot of moving parts in there, but just any kind of color would be helpful.

Nancy Foster

Well, I think one area I can address is the OREO. We did take fairly significant write downs in the fourth quarter of 2012 and we've enjoyed some recoveries this year as a result of that. So next year I think those recoveries are going to burn off if you will. Otherwise you know the portfolio is very clean. We've got a lot of mark left on the acquired side. So I can't say that I see credit costs increasing but I also don't think they can get any lower.

Operator

And there are no more questions at the present time. So I would like to turn the call back over to management for any closing remarks.

Jim Cherry

Great, thank you. Well as always, we appreciate your interest in Park Sterling. We're committed to continuing to provide strong financial performance and returns and we look forward to being with you again next quarter to share our results. With that we'll end our call. Thank you.

Operator

Thank you, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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