David Brukardt - EVP
Greg Seibly - President and CEO
Ezra Eckhardt - COO
Dan Byrne - CFO
Jeff Rulis - D.A. Davidson
Sterling Financial Corporation (STSA) Q4 2009 Earnings Call February 2, 2010 11:00 AM ET
Welcome to the Sterling Financial Corporation’s conference call. All participants have been place on the listen only mode until the question and answer session. (Operator’s instructions). Today’s conference is being recorded if you have any objection please disconnect at this time. I would now like to introduce David Brukardt. Thank you sir, you may begin.
Thank you operator. Good morning. Joining today’s call will be the following members of the management team at Sterling Financial Corporation. Our President and Chief Executive Officer Greg Seibly. Our Chief Operating Officer, Ezra Eckhardt and our Chief Financial Officer Dan Byrne. First, I would like to caution participants that during the course of today’s conference call management may make projections or other statements that are not historical facts regarding events or future financial performance of the company that are forward-looking statements within the meaning of the safe harbor provision of the Private Security Litigation Reform Act of 1995. We caution you that these forward-looking statements may differ materially from actual results due to a number of risks and uncertainties. For a more detail description of certain factors that may cause the company’s actual results to be materially different, we refer you to the sections entitle forward-looking statements and risk factors in our annual reports on Form 10-K and quarterly reports on Form 10-Q as filed with the Securities and Exchange Commission and updated from time-to-time. We will begin with introductory remarks and then open the call to your questions. I will now turn the call over to Greg Seibly.
Thank Dave and thank you everyone for joining us today. By now, we hope you had a chance to review our 2009 results. I will spend a few minutes providing some highlight that align closely with our overall strategy. Since the management change that occurred in October of 2009, our to-do list has been very focused around four key elements. First, to strengthen our capital levels in accordance with our agreements with the FDIC and Washington Department of Financial Institution in the Federal Reserve Bank. Second, to de-risk with deleverage our balance sheet, with both of these efforts being focused around reduction of non-performing loans and adversely rated credits and resolving our real estate and construction loan concentration. Third to maintain and improve bank liquidity and deposits with a particular emphasis on continued improvement in our core deposit mix and finally to continue our transition toward relationship banking and to ensure that we are providing our customers with a superior service they have come to expect from Sterling and its employees. For the fourth quarter of 2009, we reported a loss of $333 million or $6.41 per common share. While these results are disappointing, they reflect the economic situation in the Pacific Northwest and the lingering challenges associated with our residential and commercial construction portfolios. These results included $340 million provision expense that Sterling provided to address both current and future challenges in our loan portfolios. We recognized that this provision expense is sizeable; however, we believe that the actions taken this quarter which were done in close coordination with our regulators should put it in a strong position to maximize the likelihood of a successful recovery or return to well capitalized status and appropriate portfolio concentrations as we moved through 2010. The new management team at Sterling is squarely addressing the challenges that have handed our progress. We will highlight for you the initiates already in place to drive our process going forward. Throughout the fourth quarter of 2009 and continuing till today, we have been actively evaluating our options for requiring additional capital. This is job number one. Yesterday, we took another critical step in this process by announcing a tender offer for the redemption of our trust preferred securities. We are seeking to have these securities tendered for cash contingent upon a successful equity raised and regulatory approval. Overall capital raising effort is a very dynamic process. Over the past 100 days, the new executive team has been working closely with our advisors to evaluate in effect a successful capital raise for Sterling.
Other aspects of our strategy to restructure our capital position may include the sale of equity securities through public or private offerings; the conversion of the U.S. Treasury preferred stock to common; and the sale of certain assets. Our goal is to achieve and maintain Tier 1 leverage capital ratio that exceeds 10%. In line with our earlier public statements, we expect to provide further updates related to our capital strategy later in the quarter.
A second key priority of this management team is to reduce the risk and leverage that was contained in our balance sheet. We are focused on addressing our credit quality and portfolio concentration issues, particularly in the areas of construction lending and investor real estate. We have been at this task for well over a year and we believe that we have demonstrated progress in this area.
During the fourth quarter of 2009, Sterling continue to address credit quality by writing down and charging off confirmed losses on problem loans by reducing the exposure to construction lending, increasing our efforts to sell problem loans and insuring that our policies and practices around reserving against writing down and charging off confirmed losses reflect current market conditions and conform with all regulatory expectations and guidance and by continuing to build our allowance in light of ongoing challenges in the economy and with our portfolio.
We believe that with the actions we have taken in the fourth quarter, our allowance position places Sterling very favorably versus our peer group in the Pacific Northwest. Our fourth quarter results reflect a level of conservatism that is appropriate given the current economic climate and our portfolio composition.
We recognized that the magnitude of these actions does not come without consequence, as reflected in the significant size of our fourth quarter provision expense. However, we believe these actions are necessary and important as we move toward resolution of the issues that the weak economy and declining real estate markets have presented.
We have made tremendous progress in deleveraging in 2009 as reflected by the aggregate reduction in our balance sheet from 12.79 billion to 10.88 billion over the past year, a decrease of over $1.9 billion. We continue to see meaningful declines in construction lending. Since the fourth quarter of 2008, total construction loans are down a little more than $1 billion or 40%. Commercial construction loans have declined by 26% to $795 million and residential construction loans have decreased by 50% to $721 million.
We also continue to make meaningful strides in realigning our balance sheet around core deposits in 2009. While our retail deposit totals fell slightly year-over-year, we were able to reduce our overall cost to funding by 94 basis points during 2009 and by almost 21 basis points in the fourth quarter alone.
The dual effect of our deleveraging efforts on the asset side of the balance sheet and our focus on core deposit growth on the liability side of our balance sheet have significantly improved our net loans to deposits ratio, which is at its best level in our history, having improved by almost 11 percentage point during 2009.
Customers on the whole have shown signs of continued confidence, and they have been tremendously supportive of the bank, its employees and our recovery efforts. For that, we are highly appreciative. Our employees across the organization are dedicated to our turnaround efforts. Moral is strong across the company and we are looking ahead to a more positive, more successful year in 2010.
Now Dan Byrne will highlight some of the financial matrix to reflect our strategic progress.
Thank you and good morning. Greg has summarized our strategy for improving Sterling’s capital position and we have been diligently looking at various capital options with the trust preferred securities tender announcement being the most current aspect of that effort.
Since we have provided a significant amount of detail in our press release, I will highlight just a few of the key financial items in the quarter.
In the area of credit quality, we recorded a provision for loan losses of $340 million. The increased provision reflects, in large part, the credit trends we saw in the portfolio as well as our ongoing assessment of market factors.
Our allowance for credit losses as a percentage of outstanding loans is now much higher. At December 31, 2009, the total credit allowance was $355 million or 4.62% of loans. This compares with the year earlier allowance of $230 million or 2.55% of loans. With respect of the adequacy of coverage for loan losses, it is also important to know that Sterling assesses the combined general loan loss reserves and they confirmed write-downs on impaired loans.
As of December 31, 2009, Sterling had gross loans outstanding of $7.6 billion of which 9% or $702 million were being carried net of an impairment write-down of $500 million, representing 42% loss content on this segment of loans.
Let’s now review net charge-offs. For the fourth quarter of the year, our net charge-offs were $272 million, giving us a ratio of net charge-offs to total loans of 12.57% on an annualized basis. A significant level of loss coverage and loss recognition. The lion’s share of the charge-offs remained concentrated in the construction portfolio which account for approximately 75% of total net charge-offs. The increase in charge-offs is related to decrease market values on construction projects as well as disposition of assets.
At year-end, our non-performing assets were $987 million up 62% from last year and up 19% in the linked quarter. Our new release includes of detailed breakdown of our non-performing assets, by loan type and by market. The NPAs continue to be concentrated in the construction portfolio with construction loans making up 69% of our non-performing assets. All through the quarter, we have been reducing the construction balances in our loan portfolio and we continue to monitor and evaluate this portfolio closely. During the quarter, we continue to originate new loans. Our originations were $845 million up 17% over last years’ fourth quarter. This reflected our commitment during a very difficult credit cycle to serve qualified home buyers, consumers, and small businesses, especially those who have failed relationships with Sterling.
Moving on to deposits, at the end of the quarter, total deposits were $7.78 billion and the ratio of net loans to deposits was 94% compared to the prior year’s ratio of 105% reflecting Sterling’s improved levels of liquidity and a notable shift toward a balance portfolio model. At the close of the quarter, Sterling had over $2.4 billion in total sources of liquidity. This includes un-priced cash in securities and available borrowing capacity. We have funding and liquidity management plans in place to ensure that we have access to adequate liquidity. Additionally, Sterling’s investor portfolio comprised mostly of high-quality, government-backed securities and is managed to provide liquidity and capital preservation. In keeping with our past practice, we are not providing any guidance on our arrange for 2010 and with that I will now turn the call over to Ezra Eckhardt our Chief Operating Officer for a review of the results of operations.
Thank you. As you heard from Greg and Dan, Sterling has been highly focused on rebuilding and strengthening our organization so that we can move forward as expeditiously as possible. We appreciate the tremendous level of customer allegiance and loyalty that we obtained over the past 12 months. The relative stability of deposits and our focused deposit gathering strategy have helped us maintain a solid core funding base. The net number of transaction accounts grew by 3% and the total transaction account balances grew 10% in 2009. These increases are direct testament of the capability of our organization to organically fund the future lending needs and drive long term profitability. We are continuingly energized by what we’ve seen here first hand from our retail and commercial banking offices across the northwest. The messages are very positive. Our 2700 hardworking and dedicated employees are encouraged everyday by the confidence and support of our customers, friends in the community, our regulators, and the general public. Our combined teams are focused on strategic shift to relationship banking that we initiated in June of 2008. Our customer facing value proposition centers on knowledgeable bankers delivering reliable convenient and good products, all at fare price. Our ongoing business model is build around relationship based deposit gathering driving stable loan origination and supported by value driven fees, all conducted in a sustainable, responsible cost structure. For these fundamental activities, our mission Critical to some extent, they are over shadowed by the cost and energy devoted to resolving the challenges of the downturn in the economy and our credit resolution issues. For example, although net interest income declined in this quarter, this is primarily result of the effective Sterling’s higher level of non-performing assets including non-accrual loans and other real estate loans. Similarly, the year-to-date net interest margin decline was due to several factors including the reversal of non-performing loans, the fact that we are holding higher cash balances consistent with the priority to improve our on-balance sheet liquidity. Excluding interest reversals and carrying cost of cash, our net interest margin grew by more than 380 basis points demonstrating a long term earning power of our entire organization. Our non-interest income has been driven by fees on transaction accounts and mortgage banking income. In the fourth quarter of 2009, non-interest income was $28.1 million representing an annual increase of 28% compare to the fourth quarter of 2008 and up slightly in the linked quarter as well due to higher mortgage banking operations. Additionally, our gain on sale is holding up favorably compared to prior quarters. Overall, non-interest expense rose 6% to $94.5 million in the fourth quarter of 2009. This increase is primarily due to FDIC insurance premiums and the higher cost of credit resolution, the carrying cost of other real estate owned. The critical elements of our business model are already in place. Our return-to-relationship banking is demonstrated in our deposit in funding performance. We are addressing our capital plan and credit quality directly. Our team is aligned to take the most aggressive approach possible around asset resolution, continue to focus our top talent around our most important objective. Additionally, we have detailed plan in place to aggressively manage expenses. All of this underscores the efforts we haven’t place in our customer facing value proposition of knowledgeable bankers delivering good products and service in an easy convenient fashion for a fair price. I can assure you that everyone on the Sterling team is supremely focused on our efforts to stabilize performance, quickly return to profitability, deliver best in class customer experience and restore the pride and luster of our strong hallmark brand. I will now turn the call back over to Greg Seibly.
Thanks Ezra. The last 100 days have given a new management team and opportunity to affirm a comprehensive strategic initiative and to review and explore every options for potential paths forward. Despite the current challenges within the economy and our portfolio, we are hyper-focused on four key priorities I mentioned at the offset. First, completing the capital rate in a timely fashion. Second, addressing our troubled credit issues. Third, maintaining and improving bank liquidity and finally refocusing our business on relationships in a way from transactions. Across our 4.5 state footprints, our teams are hard at work on these efforts. We appreciate the energy and result they demonstrate in supporting customers and communities throughout our franchise. We also continue to appreciate the boat of confidence our customers have placed in us and look forward to earning that support each day as we moved to 2010. Operator, we are now ready to take question.
Question and Answer Session
(Operator’s instructions). Our first question today from Jeff Rulis with D.A. Davidson. Your line is now open
Jeff Rulis - D.A. Davidson
Good morning, Jeff.
Jeff Rulis - D.A. Davidson
Your stated goal of Tier 1 ratio of 10%, you know, based on the latest numbers, what would be the capital shortfall currently or what would pull you up to 10%? What would you need?
Jeff, let me address that question. First of all, we are not here to announce what the amount of our capital ratio would be, but generally Ezra will tell you. We now that the regulators require minimum of $300 million and we have capacity on ourselves to go up to about $600 million that combined with restructuring the trust preferreds which will generate some taxable income as well as continue downsizing of the balance sheet, we think that is within our capacities.
Jeff, I would tell you that we think the number approaches the top into that range, about $600 million.
Jeff Rulis - D.A. Davidson
Okay, that helps. And are you still restricted on the common share count authorization of up to 750 million shares?
Yes, we are.
Jeff Rulis - D.A. Davidson
Okay. And I guess what would you hope to net if fully successful on restructuring the trust preferreds? What would that piece be worth?
Well as you saw from the (inaudible) announcement yesterday, we are offering $0.20 on the dollar for 100% of the trust preferred securities. Obviously that decision will be in the holders hands, so it is hard for us to identify exactly how much will be tendered. We hope for whole thing.
Jeff Rulis - D.A. Davidson
Okay. And I guess, you know, kind of switching gears, you'd sort of alluded to some potential asset sales. I guess if – what would be the logical pieces of the business to part with if you're comfortable sort of going through maybe some of the (multiple speakers) pieces?
Jeff, this is Greg. I will just say that we are looking at all options as is appropriate at this point in the capital review. We are not prepared at this point to talk about what assets we may be willing to part with and that’s part of our ongoing evaluation process and will come back with appropriate comment when and if we have more report.
Jeff Rulis - D.A. Davidson
And then in terms of the, I think you sort of alluded to a regulatory exam recently. Was anything changed on their front in terms of the capital deadline that had been set in mid-December? It's just sort of still pending; is that how that sits with regulators right now?
Yeah a couple of things that we comment on there. One we obviously cannot really talk about regulatory exams. The issue I would tell you relative to the 300 million and Tier 1 requirement by December 15, as is typical with any consent agreement or letter agreement that we would have with regulators generally they would never move that deadline. There approach historically has been to allow firms to operate and forbearance which is a situation that we currently have and so we are in ongoing contact with our regulators about where we are in the process and they are fully up-to-date with respect to all our activities and actions around the attempt to raise new capital for the company.
Jeff Rulis - D.A. Davidson
Okay and then lastly any update on Chief Credit Officer hire?
We are, that was obviously announced in connection with Steve Page’s departure from the company about a week ago. We are in the process of looking at interim solutions around support for our activities in that area. There are number of firms that provide that capability to us and we yesterday engaged a company on a national search for new Chief Credit Officer on a permanent basis and we expect that that process will take some period of time and potentially could happen before capital raise, but likely would happen either in connection with the capital raise or after a capital raise on a permanent basis, but we think the window is somewhere between 45 and 100 days in terms of new Chief Credit Officer.
(Operator’s instructions). I am currently showing no further questions.
I have one item, I want to go back and correct a number that I made combining the general loan loss allowance with recorded a confirm losses on impaired loans, I indicated that was 11%, it should have been 10.3% as my staff has just corrected me.
I am showing no questions.
Thank you everybody for joining today and we look forward to updating you soon. Have a great day.
Thank you. This does conclude today’s conference call. Thank you for participating. You may disconnect at this time.
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