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Park Sterling Bank (NASDAQ:PSTB)

Q4 2013 Earnings Call

January 30, 2014 8:30 am ET

Executives

James Cherry – Chief Executive Officer

Bryan Kennedy – President

David Gaines – Chief Financial Officer

Nancy Foster – Chief Risk Officer

Abby Alexander – Human Resources

Analysts

William Wallace – Raymond James

Christopher Marinac – FIG Partners

Jefferson Harralson – KBW

Blair Brantley – BB&T

Operator

Good morning and welcome to the Park Sterling Corporation Fourth Quarter 2013 Earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today’s presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. To withdraw your question, please press star then two. Please note this event is being recorded.

I would now like to turn the conference over to Abby Alexander. Please go ahead, ma’am.

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.

James Cherry

Thank you, Abby, and good morning to our listeners. We appreciate your joining us and we’re looking forward to this opportunity to discuss Park Sterling’s fourth quarter and year-end 2013 results, which we announced earlier today. In addition to the earnings release, you can also find an investor presentation on our website which gives detailed information about these results and which we’re going to follow during this call.

Joining me this morning are David Gaines, our Chief Financial Officer, and Nancy Foster, our Chief Risk Officer, and Bryan Kennedy, our President. I’ll begin this morning with some highlights of the quarter and then I’ll turn to David Gaines to review the financial results, and then I’ll close with some observations on our franchise and on our full-year results and our positioning for future performance, then we’ll all be available to answer your questions.

So let’s start on Slide No. 3, where you will see that we reported another quarter of very strong operating results, net income that matched the record results of the previous quarter while we also continued to show improvement in asset quality and capital levels from levels that were already positioning us at the very top of our peer group; and in addition to that, yesterday our board of directors approved our third quarterly dividend since we introduced that last year, a cash dividend of $0.02 a share. David’s going to go more into the detail on these financial results, so I’d like to take a few minutes to talk about what we were doing concurrently with producing these matching record earnings, what we were doing concurrently with that, and that is continuing to invest in our key business lines and our infrastructure of the franchise.

On the retail side, we finalized our initial (indiscernible) sales and credit training, which as you’ll remember from previous calls this is a needs and solution-based selling training that we expect to increase deposit gathering, investment referrals, consumer and small business lending out of our retail franchise. At the same time, we introduced the second phase of our new mobile banking platform. That platform now is on par with the best mobile banking platforms offered by any of our competitors, large or small, in the marketplace, and as I suggested on our call last quarter, we are on the verge of introducing a new capability in mobile banking that will clearly differentiate us from the products that are currently offered in our marketplace, and that should be rolling out sometime toward the middle to end of this quarter. So more to come on that – I’m not going to share any more at this point, but we’re really excited about what we think is going to be a distinctive capability in mobile banking.

Another part of what we did in retail banking is we introduced new a workplace retail banking package. One of the most important things for the success of any company is the ability of its lines of business to work effectively together, and workplace banking is one way in which our commercial banking team in both our community markets and metro markets can work effectively with our retail banking team to build customers for the company.

At the same time that we were investing and completing the investment in some of the key areas of retail banking, we also invested more in our infrastructure. We implemented—we prepared for the implementation, which we actually launched the very first of this month for a new human resources information system that will make us much more efficient and effective in the management of our human resources, everything from recruiting through on-boarding and through the information management of our human resources, all of which will position us to be more effective in our merger activities as well.

We also announced new leadership in operations and information technology. We have now rolled all of our operations in technology together under one very strong and capable leader in Mark Ladnier, an announcement that you should have seen some weeks ago. Additionally, we spent the quarter recruiting new leadership and talent both for our wealth and mortgage banking groups, as well as the recruitment of a team, all of which we announced first week of January for Richmond, Virginia and our entry into Richmond, Virginia. I’d like to pause there for a moment and talk about what these mean for our future and how we went about recruiting these individuals and why we’re so excited about the leadership they bring to us.

First, I’d like to talk for a minute about wealth management. Michael Williams, who will be leading wealth management for us – I’ve known him for at least 15 years. Michael was a trust officer at Central Fidelity when Wachovia acquired Central Fidelity, and I was actually leading trust and investment management for the Wachovia Corporation at the time. Michael had begun his career at First Virginia as a retail banker. He’d ultimately come to Central Fidelity, moved into the wealth management space. Ultimately left Wachovia and joined First Market, where he built their wealth management platform in Richmond, and then left First Market to join StellarOne and was managing their platform until we recruited Michael to join us at the first of this year.

Michael brings a holistic approach to wealth management that includes private banking, investment management, trust services, estate planning, and we believe that he’s going to not only help us build and grow a business in Virginia but also throughout our franchise, so we’re very excited to have someone with his talent and experience in building wealth management as a part of our team.

We also brought Steve Farbstein on board to manage our mortgage banking. If you remember, in both the Citizen South and Community Capital partnerships, we brought two mortgage banking groups together. Steve now will be responsible not only for leading those but also for helping us build a mortgage banking franchise in Virginia. Steve is a very experienced and talented mortgage banker. He’s spent a good part of his career in mortgage banking, both at Liberty Mortgage, part of Citi, all the way up through leading mortgage banking for StellarOne.

Both of these lines of business are going to be headquartered in Richmond, Virginia. Part of the reason for that is in line with our desire not only to build our franchise in the State of Virginia, which has been a long-term goal of our management team and part of our strategy, but it also will help us to do one of the things that we try to execute on in all of our markets, and that is to play bigger than our footprint, so we’re delighted to have this kind of senior management in the Richmond market.

At the same time that we recruited this team, we also recruited a team of extraordinary bankers – I would call them franchise builders – in the Richmond market, led by Rob Leitch. Rob Leitch is a 30-year banking veteran primarily with SunTrust in Richmond, Virginia. He is leading a team including Bobby Calgill (ph). Bobby Calgill is a commercial real estate lender. Bobby spent a good part of his career with Regions Bank. Our Bryan Kennedy, who at one time was the North Carolina market president for Regions Bank, actually gave Bobby his first job in banking, so he goes back a long way with Bobby. I go back a considerable way with Rob Leitch. I’ve reminded Rob that when I tried to recruit him three years ago out of SunTrust and he said that he’d been there for 30 years and he’d never leave. Ed Barham did a better job than I did – he ultimately recruited him to StellarOne, but we didn’t give up, and we’re delighted to have Rob leading this team for us. And then finally Tom Zachry, who Rob Leitch describes as one of the finest commercial lenders and C&I lenders that he’s ever worked with in his career.

All three of these are top performers in that market. We received extraordinary press, front page banner headlines on the business section in Richmond when we lifted this team out. We announced it as a loan production office, but we expect to very quickly convert that to a full-service bank and to be adding one or more additional branches or offices to that space in the near future.

This is a good time to also kind of reference this into our strategy. What distinguishes Park Sterling? We believe it’s the exceptionally experienced talent and capabilities that we have and are building as an organization. Our vision continues to be to be large enough to help our customer achieve their financial aspirations and yet small enough to care that they do. I would say that a little bit differently and say it this way, and that is to be large enough to provide our customers with financial solutions they need and small enough to provide them with the service they desire, and that is really the distinguishing characteristic between the large and small banks. If you do surveys, and we’ve recently done some focus group surveys, what you will find is the two most important things to customers of banks, they time and time again say what’s most important to them is solutions and service. But in truth if you force them to decide between the two, it turns out to be solutions, and we know that because if you think about it, the large banks are believed by the general public not to be providing great service, and yet they do have the solutions people want and they are large because that’s where people are voting with their feet in banking. The small banks, everyone says have great service but they don’t have the solutions that people want, and people are not banking there as much.

Our positioning has always been to be between those two to be able to offer solutions to our customers with the kind of in-market service that they desire, and I believe that the way to do that is by continuing to recruit extraordinarily capable, in-market experienced talent who can play bigger than their footprint in the markets that they are in. Park Sterling is literally loaded with talent and it is what I think it’s all about. Talent is the ultimate winner. The winners and losers in this will ultimately be determined by the talent that they bring to the table.

Now you see a balance on this one page between continuing to invest in infrastructure and building our franchise for organic growth and long-term results while at the same time producing what I think will continue to hold us in good stead with our peers in terms of strong quarterly and annual earnings performance. This is reflective of our commitment to our investors of maintaining strong earnings while continuing to invest for the long term growth of our company.

So with that background, I’d like to ask David to go into some more detail on the financials for the quarter. David?

David Gaines

Okay, thank you, Jim, and good morning everyone. I’m on Slide 4. As he mentioned, we’re very pleased to report fourth quarter results that match our record operating levels from the third quarter, with adjusted net income available to common shareholders, which excludes securities gains or losses and also merger-related expenses, of $4.3 million or $0.10 a share. Perhaps more importantly, as he’s discussed, we’re really exceptionally pleased with the financial transformation of the company over the last year, which is a clear reflection of the unique franchise we’re creating. I’m going to cover each of the major income statements on subsequent slides, so if you’ll turn to Slide 5, let’s begin with a breakdown of net interest income.

Average earnings assets decreased slightly during the quarter. There was an $8.6 million reduction in average loans and a roughly $30 million reduction in average other earning assets, and that’s really just the interest-earning bank deposits, were only partially offset by an increase in average securities. We’ll take a little deeper look at this in a moment, but the loan picture is one of continuing strong performance in the metro markets in certain of our central units, builder finance probably being the most notable, being offset by reductions in our covered loan books, the special asset books, and a couple of community markets. One thing that was really great in the fourth quarter, we do have some community markets that are under new leadership producing net loan growth today, and we look forward to that going forward.

Adjusted net interest margin, which excludes that accelerated accretion we pull out for you every quarter, decreased about 5 basis points from 4.04 to 3.99%, and that was really driven by that increase in the cost of interest-bearing liabilities that we told you about last quarter from the expiring acquisition accounting fair market value adjustments, and it was only partially offset by a small increase in the yield on interest-earning assets. The net result was about a $600,000 or 3% decrease in net interest income for the period, and I would share with you on a forward-looking basis, as we’ve consistently stated in the past, we do expect margin pressure to continue in the industry. You can see that from December to December, we experienced about a 13 basis point decrease in adjusted net interest margin. That actually compares favorably to what we told you we thought would happen during the year, where we thought we’d see a 25 to 30 basis point decrease. In general, I think we’re going to manage the company with the expectation that net interest margins could continue to decline by as much as 20 to 25 basis points over the course of 2014, given the realities that like all banks, we have higher priced loans that originated four or five years ago rolling off the books and pricing competition on new loans is going to keep those yields down. The caveat here is that a steep in yield curve could help margins to some degree.

If you turn to Slide 6, you can see that adjusted non-interest income, which excludes gain or loss on sale of securities, increased by about 35% to $4.4 million for the quarter. These results include a $1.1 million gain generated from settling at a discount the contingent underwriting fee liability that remained from the bank’s public offering back in August 2010. We pursued this settlement in order to remove the $3 million liability from our balance sheet that was recorded there at the time of the offering, and the resulting gain fortuitously helped to offset some non-recurring expenses we had during the quarter, which I’ll cover in a moment.

A couple of other items to point out on this slide – first, you do see mortgage banking income benefited from a positive swing in SAB 109 this quarter. That’s been a pretty bank-and-forth number for us during the course of the year for those of you have that have followed us. If you look at it throughout the year, it’s probably a little more logical than any given quarter and the swings there. Second, we successfully moved about $288 million of non-discretionary assets out of wealth management. You’ll recall we’re exiting the custody business to focus on what we think is the more profitable and better risk-return profile of our managed book, and you can also see during the course of the year we grew those discretionary assets about $100 million during the year. Finally, you had a little bit of noise in BOLI income where it was down, and that’s just timing of income recognition on a few polices. That will smooth out over time.

When we think about forward guidance in non-interest income, we would expect our expanded retail product capabilities – the training, the things that Jim talked about – as well as the focus on treasury services to result in double-digit service charge growth in 2014. In terms of wealth and mortgage banking, we’re going to give a little bit of leeway to our new leaders there and let them develop their plans before we provide any guidance, other than to say we obviously expect them to grow those businesses. The good news is, as you heard Jim say, both Mike and Steve have done this before and they’ve both commented that Park Sterling has a larger number of attractive markets to offer than they’ve had to work with in the past, so we think that’s going to bode well over the next couple of years.

If you move to non-interest expense on Slide 7, you can see a breakdown which, excluding merger-related items, decreased slightly to about $15.3 million for the quarter. Posted improvements across several categories, which is just that continual work of grinding through merger integration and looking for cost saves here and there. The only material increases occurred in a couple buckets – you’ll see the data processing and service fees increased about 9%. $75,000 of that is one-time processing fees that were related to some work we had to do to exit the custody business, as well as some work we did to install a new data management system to help us with the allowance calculations. It doesn’t change the calculations – literally a data management tool.

The other area that popped up was loss on disposal of fixed assets, which increased by about $432,000. A number of items in there of obsolete acquired fixed assets, but the big driver was a branch that we’ve now shuttered and moved into other real estate owned down in South Carolina.

I’d also note that merger related expenses increased, had a pretty decent pop this quarter, and really that’s driven in large part by just the tail-end of a couple of staff reduction efforts that we had. If you add all those non-recurring items together, you’re going to approach about $700,000 of expense, which is one of the reasons we were happy to have that gain from the underwriting fee settlement.

Looking forward, obviously we’ve invested very heavily in the company just in recent announcements, and we’ve got some pretty aggressive plans and we hope to hire additional bankers and talent and introduce new products, frankly, across the entire franchise, so we would expect to see an increase in our non-interest expenses of anywhere from 7 to 10% on a quarterly basis over the course of the year, given those investments. Now, we can certainly manage that spend over the back half of the year if we don’t see an adequate revenue pipeline developed. We can also utilize our excess capital to do some additional investments to help pay for the increase, which we’ll talk more about in a moment. I would just assure you as you, I think, saw last year, we always keep an eye on balancing that – as Jim said, balancing the current profitability with the long-term growth opportunities of organic efforts.

If you turn to Slide 8, you can see a comparison of our results to peers. Continue to feel very good about our return on average assets, both on a relative and absolute basis, particularly given the amount of unleveraged capital we have on the balance sheet.

If you will turn to Slide 9, you’ve got an overview of the balance sheet. A couple of things to point out here – obviously still have very strong capitalization at TCE to TA of 1179. I would also note here we did acquire about 56,000 shares under our existing stock repurchase authorization during the quarter.

If you move onto the components of the balance sheet and look at Slide 10, you’ve got a summary of our investment trends over the last five quarters, and this is a little more detailed disclosure than we’ve given you in the past. We wanted to do that partly because it’s a bigger part of our balance sheet now that we did have an increase during the quarter, and that increase was driven by a $50 million investment strategy we executed in very late December in part to help offset the expenses associated with that Richmond LPO and some of the other hiring initiatives. The strategy is designed to generate some earnings over the next couple of years, but in a very tightly controlled manner such that the effective duration of the combined long investments, the funding and the hedges that we put on this result in about a one-year duration risk profile, even though the trade term is about seven years. And the performance key here is that out here really depends on reinvestments of the cash flow off of the securities into loan growth. If you get that, it’s a great trade, does exactly what we wanted it to. If you don’t, you’re basically going to end up with a low risk position but probably a low earnings position on that book as well for this amount of money.

I’d also note we did have about $24 million in CLOs on our books today, about $5 million of which has been already amended to ensure compliance with the new Volcker rule. Frankly, we like these securities. They have a low credit risk profile, they have great diversification benefits for the underlying collateral to our balance sheet. We like their floating rate nature; however, if the remaining bonds are not made Volcker-compliant, we’re going to need to sell them. And our expectation is most if not all of them will be, but if they don’t we’re going to have to sell them; and they had about a $274,000 negative market year-end, and if we’ve got to sell on that, we’ll move into OTTI at some point this year.

Loan mix – if you turn to Slide 11, you can see various breakdowns of the loan portfolio. As mentioned, continued to see good growth in the metro markets during the year as well as in builder finance. If you’ve been on our calls before, you know that’s a very consistent storyline for us this year, very proud of the efforts of those bankers. Also consistent has been the fact that the covered loans special assets have been shrinking throughout the year, so the real swing factor – and I think we’ve talked about this before – the real swing factor in terms of net loan growth for us really lies somewhat in our community markets. The positive here is that, as I mentioned before, we do have a couple of community markets now that are showing net loan growth, and that wasn’t true a year ago. We think it’s in no small part due to the new leadership that’s taken over these markets. As Jim said, this is all about talent. This is not a mystery. We have a couple that are declining, but we’ve got more recent new leadership in those markets and we’re working very hard with them to reverse those trends.

What I can tell you confidently is that our loan production pipeline has never looked better. In some cases, these opportunities may take a couple of weeks to close; in others, they can take several months, so I’m not going to give you guidance of what I think is going to happen this quarter. But I will tell you very confidently that we fully expect to post double-digit net loan growth in 2014.

If you move on to Slide 12, you’ve got some detail on our deposits and borrowings. Just quickly point out to you that these new Promontory IND borrowings that we have, which are a brokered money market product – it’s a broker-dealer suite product that comes through promontory – you can see those on the balance sheet. We tried to pull those out so you can see those. We will count those as brokered, but they’re probably a little bit better deposits. It’s really a seven-year commitment we have from Ray-Jay through Promontory to fund those things. You can see some hedges in there, including some hedges we put against the home loan borrowings. We’re just trying to be cautious against potential rate increases – nothing radical, but just trying to round the edges to make sure we’re ready for an increasing rate environment.

If you turn to Slide 13, you can see the capital and liquidity comparisons to our peers – you know, generally remain comfortably in or above the top quartile. Turn to Slide 14, you can see an overview of asset quality measures. We’ve kind of kicked Nancy off the call because look at loan grades, NPLs, NPAs, charge-offs – it just all continues to tell a very positive story about the company. We did take, in our judgment, a pretty prudent stance on one legacy Park Sterling loan during the quarter that resulted in almost $1 million in combined charge-offs and incremental provision expense, which is another reason we were happy to have the gain from the underwriting settlement.

If you turn to Slide 15, you can see that we had a slight uptick in allowance to total loans. Several interrelated drivers here, but I think it’s probably simplest to say that we’ve been, in our judgment, prudent over the last couple of years in extending the look-back periods on our loss history to ensure we adequately capture inherent loss in the portfolio and keep that allowance up at a decent level. You can also see that we continue to have roughly $38 million in remaining fair market value adjustments against the acquired loan book, and also you can see that accretable yield remained fairly flat at roughly $39 million sitting out there on the balance sheet. Continue to sort of see cash flows in the acquired pools outperform the model expectations, which is why that number hangs up; and if you take that number and tax-adjust it, you’ve got about $0.60 in additional tangible book value per share.

In closing, feel very good about the quarter, perhaps even more so about our full-year results. As we’ve shared in previous calls, just feel very good about the markets we’re playing in, the bankers we have, the product lines we’re building, the earnings profile we’ve been able to keep up during that investment period and hope to do so, expect to do so going forward. The asset quality – still have the excess capital to deploy. You know, we really feel good about where the company is, and with that, I’m going to turn it over to Jim.

James Cherry

All right, thank you David. We are now on Slide 17, so it was a quick tour. I’d like to speak for a moment about what we look like today, how we performed for the year, and how we are positioned for the future, and then we’ll welcome your questions.

So first on Slide 17, you see a picture of Park Sterling today. We clearly have a covetable franchise in the greater Charlotte Metro MSA with the largest branch network and deposit base, as well as an exceptional banking team. I think if you look at the bottom of that and you see that little chart, you’ll see that almost 55% of our deposits are actually based in the Charlotte MSA, which is obviously a high growth market with 8.15 projected growth for the 2012 – 2017 time frame relative to the national average projected growth of about 3.47, so obviously that helps us considerably. In addition to that of course, if you look at our entire franchise and take the MSA portion of that, our weighted average population growth is almost two times the national average. Obviously, being in growth markets helps when you are trying to drive growth.

We’re also growing our originating capabilities in other attractive growth markets, of course – Raleigh and Wilmington in North Carolina, Charleston and Greenville in South Carolina, and Richmond, Virginia, as we mentioned earlier this morning. We think this is a very—we have a very logical footprint with a strong core deposit franchise that extends from Charlotte through upstate South Carolina and into north Georgia, and that is complemented with accelerated growth that we can get out of these higher growth metro markets. We also have broad product capabilities, certainly relative to the smaller community banks and that are comparable to the large banks, at least for the market segments that we are focused on serving, and of course these include wealth management, mortgage banking, treasury services, asset-based lending, builder finance, and others.

If you look on Slide 18, just a brief recap of the year results, you will see here that we produced record net income that was triple the net income produced for the previous year; that we improved our asset quality significantly when it was already very strong relative to peer performance: and we grew capital while repaying at the same time 20 million in preferred stock, which was the SBLF that we acquired from Citizen South which previously converted that from (indiscernible), and we did that while also initiating a quarterly dividend in the third quarter of 2013.

So we’re obviously very proud of these results, and the fact that they were accomplished, as we mentioned, in balance while also positioning ourselves for long-term performance and growth and building the coveted footprint that we described earlier, and of course that includes the retail banking that we expect to benefit from the investments we’ve been making in training and product capabilities from wealth management and mortgage banking, that we clearly expect to benefit from the new leadership that we’ve brought in, and additional product capabilities that we expect in those lines of business. The new metro markets, including obviously the entry into Richmond, Virginia, and the new leadership that last quarter we announced in our community markets, all of this together with the infrastructure improvements that we’ve made, I think will continue to differentiate Park Sterling.

What makes us attractive to bankers and to customers will continue to make us attractive to banks who are looking for strategic partners, who are looking for banks that can demonstrate performance and that have the talent to continue to perform at exceptionally high levels. So we will continue to be active in M&A in 2014 and I would certainly expect to see some results on that front as well.

So with those comments, we’ll stop now; and Operator Denise, if you could open the lines up for any questions.

Question and Answer Session

Operator

We will now begin the question and answer session. [Operator instructions]

We have a question from William Wallace from Raymond James. Please go ahead.

William Wallace – Raymond James

Hey, how are you guys doing?

James Cherry

Fine, thank you.

William Wallace – Raymond James

Good. So correct me if I’m wrong, but it looks like you guys underwent a fairly complex securities transaction with the intent of having the earnings generation from that trade offset the expenses related to the entry into the Richmond market. Is that correct?

David Gaines

Yeah. I’d say partially offset, first; and it’s really not all that complicated. The only thing you wanted to do is kind of put it in a box so hopefully it would be more transparent and easier for you all and everybody to understand, but basically very simple pass-through and sequential CMO, all-agency mortgage-backed securities. You funded it through these new MMPA deposits through your institution, but just to make sure the risk didn’t get out of line in the back years given potential for interest rate increases and net interest rate risk, we put hedges on it. So it’s designed to produce income for a couple of years and then to generate cash flow to redeploy into the loan book and just not take a lot of risk in the process.

James Cherry

The only thing I might add, Wally, is that we looked at this the same way we would look at an M&A transaction where the decision to go into Richmond and lift this team out and to build a franchise there a little bit under the theme, if you can’t buy it, build it; if you can’t build it, buy it. They both went through the same financial analysis of what we thought the returns would be and how successful we thought we could be at doing that, so it’s a little bit different and unlike an M&A where you have a large upfront expense and then, at least in today’s world, you typically have immediate earnings accretion. Here, you don’t have the large upfront expense but you do have some earnings drag, so the intention of this financing vehicle was to offset that in the early years while we build the revenue.

William Wallace – Raymond James

Okay, so that I can understand then, the securities, did you put those all in the out to maturity bucket? Is that what drove that balance increase?

David Gaines

No, there are some that did go in there, but we have generally been putting any kind of long duration assets in, and that’s increased pretty steadily over the last couple of quarters. If we bought longer duration assets, we tended to put them in held to maturity.

William Wallace – Raymond James

And then the hedges—go ahead?

David Gaines

So there were part of these securities that did go into that bucket, but really the hedges were designed—if we took this thing straight through, Wally, the duration on these bonds just kind of sitting there in and of themselves would have been four, five or six-year duration bonds, depending on which one you look at. We didn’t want to take all that risk, right, and you didn’t need to generate the earnings for a couple of years. So you put the hedges on, you basically drop that duration profile back to about a year.

William Wallace – Raymond James

Okay, yeah, so it looks like you hedged out seven years, right?

David Gaines

Yeah, yeah. You give up earnings in the process, obviously, but that’s the trade-off always, right? It’s always a risk-return decision, and for us, to Jim’s point, we do want to cover part of that expense those first couple of years. We fully expect those guys and others to generate the loan growth to redeploy the cash off the investment book, because these things should cash flow, so we wanted to take the interest rate risk off the back end.

William Wallace – Raymond James

Okay, so optically then we should see a boost to net interest income to more or less offset some of the expense pressures that we’ll see in 2014 from the salaries and office expenses. Is that a fair way of thinking about it?

David Gaines

Yeah, yeah, and it probably won’t do it fully, Wally. They’re going to have to carry their own weight, too.

William Wallace – Raymond James

Right. And help me quantify, then, on the expense side what we’re going to see from the investments that you’re making in the Richmond market.

David Gaines

I think if you look at a quarterly run rate, take where we were for the fourth quarter, I think it’s going to pop up anywhere from 7 to 10% in any given quarter. Now, that will ramp during the course of the year. We will have a chance to revisit decisions as you get into the course of the year, and when I say that, Wally, we’re looking at our budget and forecast and where we hope to add talent in various markets. This is not just what has happened today, right? It’s looking at that full reinvestment.

Not dissimilar from what we did in 2013, I think what we told you all in 2013 is we thought the cost saves coming off the merger integrations would help cover that up. It did, right? That’s what you saw. So what we’re doing now is basically saying, we think we’re going to use some investment strategies but well risk controlled to help offset that. And again, it all goes back to that we want to be balanced. We’re not trying to maximize earnings in the next 12 months. We’re not trying to maximize growth in the next 12 months. We’re trying to get a solid earnings performance for the shareholders today, manage the capital intelligently today, whether it’s deploying, stock repurchase, dividends, but make sure we’re investing for the long run for this unique franchise because that opportunity is very much still there, and the success that we’re seeing in this metro market tells us we know how to get there. So it’s a balancing act for us.

William Wallace – Raymond James

Okay, I understand. So when you say 7 to 10% increase in any given quarter, are you suggesting that if I look at your four-quarter run rate of about $14.9 million after the fixed asset expenses, et cetera, over the course of the year we could see that run rate increase to, call it 16, $16.5 million?

David Gaines

Yeah, but I think I’d start with a 15.3. I think I’d start there, Wally. I think any given quarter, you could see it from that 15.3 up 7 to 10%.

William Wallace – Raymond James

Great. And then how do you guys model—what’s your expectation of time to breakeven for the investment in the market?

David Gaines

Okay, so we look at the LPO differently than we would look at the other—you know, the business line investments. So the LPO, to Jim’s point, it’s the same analysis we would do on a merger, and so we would expect that based on the forecasted expenses and the forecasted revenues, both of which could improve, we would expect to break even kind of first quarter-ish of next year, and you probably have payback sometime later next year that you’ve covered the cost of your full investment.

William Wallace – Raymond James

Okay. Great. And switch gears a little bit – I was wondering if we could talk about two other markets that you entered, Charleston and Raleigh. Raleigh looks like there has been some momentum there, and all I really can see is the deposit data. Charleston looks like maybe it’s still struggling. I know there was a restart in that market. Maybe if we could address Charleston first – is that a market that Park Sterling is fully committed to, and are you making any changes or are things improving better than we can see just looking at the deposit data?

David Gaines

Yeah, Charleston had a great year, Wally. They really did.

James Cherry

We thought it was Wilmington.

David Gaines

Yeah, they’ve done well, and our only issue in Charleston is we’d love to get more quality bankers on the ground because that’s a market that’s very attractive. The Boeing effect is very real. We’ll see if the port has the effect that I think the state and region hope, but Boeing is very real. There’s probably more activity in Charleston than they’ve had in 50 years. The branch—we’ve got one branch there. We’ve got it fully staffed. It’s doing well, but I think it’s a market we can do much better in, but feel very good about their performance last year.

William Wallace – Raymond James

All right, so are you profitable there now?

David Gaines

I don’t think we ever tell you whether we’re profitable or not in any given market, but I would tell you we’re very pleased with where they are, very comfortable with where they are, if that’s enough code for you.

William Wallace – Raymond James

Yeah, I appreciate it. And then what about Raleigh?

David Gaines

Yeah, I would say Raleigh is one that is a great market, and I’m not sure we have fully taken advantage of that market, frankly. So it’s the same story – we very much would love to get some more bankers on the ground in that area. A lot of good competition there, just as there is in every market we’re in, so we’re not saying it’s a lay-up by any stretch but I think we can do better in Raleigh. We had a couple of bankers that had very good years. We could use several more bankers to have the kind of years they had, and we’d feel much better about Raleigh.

William Wallace – Raymond James

Okay, I’ve taken a lot of your time. I’ll let somebody else hop on. Thank you.

James Cherry

Okay, Wally. Thank you.

Operator

Again just as a reminder, if you’d like to ask a question, please press star then one on your touchtone phone. We have a question from Christopher Marinac from FIG Partners. Please go ahead, sir.

Christopher Marinac – FIG Partners

Thanks, good morning. How are you guys?

James Cherry

We’re well. Thank you for covering us, starting your coverage this last quarter, too.

Christopher Marinac – FIG Partners

No worries. I wanted to ask about the adjusted margin that you laid out in the text of the press release. Does that exclude the deposit change that you talked about, or is that deposit liability change in the quarter included in that adjusted margin?

David Gaines

It’s included. The only thing we adjust out is that accelerated accretion that comes in off the acquired performing loan book, and the only reason we do that is because it’s not a lost of noise every quarter, Chris, but there have been quarters where—you know, go back to, I think five quarters ago, it was a million dollars that came in, so we didn’t want people looking at that and thinking that was the new run rate. But everything else is in that margin. That’s the only thing that pulls out.

Christopher Marinac – FIG Partners

Okay, but for practical purposes we could adjust that in our minds, because it is still related to the covered portfolio—or the acquired portfolio, rather.

David Gaines

It’s the acquired portfolio. It’s really the acquired performing book that creates that acceleration.

Christopher Marinac – FIG Partners

Got you, okay. But otherwise, your cost of funding, you still have opportunities to see that slightly revise down or move down?

David Gaines

Yeah, and it has been; but it’s basis point by basis point, deposit by deposit is how you’ve got to attack that thing. But we continue to do that, and I think there is a little bit of opportunity there. Obviously we had a little uptick in the earning asset yield. I think it’s the same thing – it’s every banker, every security, you’re attacking, trying to get a basis point here or there because it makes a difference.

Christopher Marinac – FIG Partners

Great. And then the next question, I guess this goes back to Richmond, given the timing of how the expenses hit and how revenues built, plus the securities transaction that you outlined this morning, does that market—could it get to breakeven in calendar or at some point later this year, or do we think of that kind of turning profitable in general in 2015?

David Gaines

It could. It’s an exceptional banking team. There were down having dinner with our board the other night and they are all very pumped, and if they can do what they say they can do, it could break even this year. But we’re not going to hold their feet to that. If they get to the budget, we’ll be happy; if they beat it, we’ll be happier.

Christopher Marinac – FIG Partners

Got you, okay. Then last question is just sort of a minor one. I noticed that there was a difference of, I think, $0.03 a share of tangible book from what you reported in September for what’s reported now. I didn’t know if there was a reason for that. It seems that the share has changed.

David Gaines

Yeah, and thank you for bringing that up, Chris, because one of the things I should have pointed out, and I totally apologize – we basically figured we were including some shares in that diluted that we shouldn’t have been including. It’s just that simple, and so we went back and fixed that, and thank you for saying that. I apologize for not adding it.

Christopher Marinac – FIG Partners

No problem. That’s great. Thanks guys. Appreciate your time.

Operator

Our next question is from Jefferson Harralson from KBW. Please go ahead.

Jefferson Harralson – KBW

Hey, thanks guys. I wanted to talk about the loan growth opportunities that you highlighted there, and I think Dave, you talked about double-digit loan growth in ’14. Are we talking about the originated loans or net basis? Can you just talk about if it’s the new markets that’s driving it? I just wanted to make sure I understood what you were saying correctly.

James Cherry

Yeah, Jefferson, and one, I think it’s net loan growth and we think we will see that for the year, meaning by the end of the year you will be able to see at least double-digit growth—well, it won’t be more than double-digit, let’s put it that way. But you’ll see double-digit growth in that category unless there’s a huge acquisition that does something different. It’s really going to be coming from both. I mean, if you go look at the challenge we’ve had, and it’s been there for quite some while, we have for quite a while now had really good strong loan growth out of our metro markets, and in fact they all met their production goals for this last year. So the general metro markets, producing has been really good.

Where our biggest challenge has been has been acquired and covered portfolios, the planned and expected run-off in that, and then quite frankly deleveraging economy that you’ve had to deal with, and then unquestionably there’s been some competitive pressure and we’ve had some things that we weren’t willing to do that we’ve seen some business has gone off the books that we’d like to have to have kept but just didn’t make sense. Some of that, too, had a long-term 10-year fixed rate kind of thing, so especially being an example of that.

So what we’re saying is now when we look at the production that we’ve got going and the budgets that we have for that and the expectation that we’ll continue to do that, we think you’re going to see the community markets now beginning to hold more and more of their own – David mentioned that. We’ve got several of them already that are beginning to be net producers on the loan side. You add that into the metro markets and what they’re doing in those higher growth markets, and that’s what’s going to drive double-digit loan production for next year.

David Gaines

But even if you look at the retail bank, Jefferson – I mean, a year and a half ago, they just weren’t lending money. Part of that training and part of the new leadership and part of the—you know, in places where you had a branch manager maybe say, I don’t think I’m a lender and how we replaced those folks, it’s just a different outlook there. And they alone would not drive you to double-digit growth, but if you can get production out of those folks, all those little things matter. The community markets that are—and we’ve always had a couple of really strong bankers in a couple of community markets that have done great. While we’ve got more of that happening now, we’ve got to get the rest of them there and then it’s going to be a very different equation for us.

Jefferson Harralson – KBW

Right, so just to clarify, do you think year-over-year you’ll be 10%, or are you saying you’ll get to that 10% growth rate by the end of the year?

David Gaines

No, we’ll be double-digit year-over-year.

Jefferson Harralson – KBW

Okay, awesome. Thanks. And on the securities transaction that you and Wally walked through, should I expect that to come on maybe at a 1.5% spread or a 1%?

David Gaines

Yeah, I’d think that zip code. We can make more money, Jefferson; you’re just going to take risks we don’t think make sense in the process, and so it’s—

Jefferson Harralson – KBW

Yeah, okay. And then last one for me is the accretable yield in total stayed flat, although you had some accretion there. I guess we had some non-accretable move to accretable? Can you just comment on the moving parts there?

David Gaines

Yeah, I mean to the extent I can, because it’s always a little bit of a black box, right? I would say the primary driver there is obviously the loans continue to perform better than the model expectations, so what happens is in any given quarter we take a snapshot, model tells us what it expects, model tells us what the losses are going to be and what the earnings going to be, and you’ve got that difference sitting there. During the course of the quarter, we obviously—and in theory if everything worked exactly like the model says, whatever we’re showing as accretion should just come right off of that number, right, and you should just track straight down. The fact that it keeps holding up is telling you the loans performed better than we thought in aggregate. I mean, any given pool obviously can be wherever it is, but in aggregate; and that’s just been a consistent story. It’s partly I think Nancy’s team did a great job with due diligence with these things, making sure we mark these things right to begin with. I think partly the economy has helped us and I think partly it’s the diligence of the workout teams. It’s kind of everything working well.

Jefferson Harralson – KBW

All right, thanks a lot guys.

James Cherry

Okay Jefferson. Thank you.

Operator

Our next question is from Blair Brantley from BB&T. Please go ahead.

Blair Brantley – BB&T

Good morning everyone. Just had a question about capital and what your thoughts are between buybacks versus M&A, and kind of what you’re hearing out there right now.

David Gaines

Well, obviously from just a pure capital standpoint, we have more than we think we need for the risk profile and the business strategy of the company, so that’s why we say we have excess capital. Would you be comfortable at 9.5%, 9%? Yeah, you would be with the risk profile we’ve got today, so that would give you some magnitude of what we’ve got there.

I think in terms of M&A, I’ll let Jim comment on sort of what’s—

James Cherry

I mean, that’s the primary means by which we’ll leverage that and the organic growth that we anticipate, and we didn’t have a question on the M&A part but we continue to have very meaningful dialogues. I expect that you’ll continue to see us with future announcements in that area, but we are taking the long view of the race in everything we do. We are being deliberate and careful both in the growth side and the M&A front as well, but we’ve got leverageable capital to do that with and that’s the primary purpose for which that capital was raised, and that we expect to be its primary use though buybacks and dividends are other ways of deploying especially the capital that we are creating through future earnings.

Blair Brantley – BB&T

Okay. Have you seen a change in attitudes or pace of conversations or anything like that for your target market?

James Cherry

Yeah, there are a lot more conversations, and I think this was said before – when all the banks stocks went up, it just felt better for banks who might be on the selling side to be able to talk when they have prospects of selling at or above tangible book, where previously it was below that and they just didn’t feel good about it. Second is we clearly have people that are becoming more and more shop-worn, those who thought that they would have won when they finished the asset quality crisis, then discovered the NIM crisis, and I think that is creating additional fatigue. Management teams are finding they can’t attract talent. This really is an exceptional franchise if you go look at the kind of talent that we are attracting at all levels, and this is not normal for community banks to be able to do, so they are finding themselves in greater and greater difficulty from the ability to attract talent.

So yes, absolutely – more and more conversations that are going on. Still a challenge, though, to get everybody to the same reconciliation of where values and transactions can occur. So more than was last year – yes. I wouldn’t be surprised if there’s more activity this year than last, but I don’t think it’s going to be what’s called robust, just all of a sudden there’s a floodgate of this happening. I don’t see that.

Blair Brantley – BB&T

Okay. And then one last question – has your thought process changed regarding buying some companies with a little bit of a hair on them versus paying more of a premium-type deal?

James Cherry

No, I don’t think it has. If you mean are we more interested in or willing to do a distressed bank, I think we’ve never looked at it thinking we would really do FDIC loss share. So unless there was an opportunity that was in a market that we are focused on already that just became particularly attractive, we’ve not thought that would be something we would do, even though we have clearly the capability of doing it and we have some covered assets from the Citizen South acquisitions in north Georgia. So it’s not a lack of capability, it’s just that we don’t want to build our franchise around where that opportunity has to be. We want to decide where the franchise is going to be, and if that came along, we would.

If you mean the next level of distressed where maybe banks that are under written agreement, we have the full gamut now. Community Capital was under a written agreement and that was our first partnership. Citizen South was clearly an FDIC-bid eligible institution, a much stronger franchise similar to us in terms of their strength, and so—and that was our second transaction.

Blair Brantley – BB&T

Okay, I was thinking about some of the transactions within North Carolina that have come out recently and some pretty hefty prices out there. Does that change or alter your thought process there within—

David Gaines

No, I think that—well, I think the criteria for looking at M&A have not changed, which is you’re going to consider the EPS accretion, you’re going to consider the TBV payback, you’re going to consider the IRR. I think if anything’s changed, and certainly in the last two years it’s been the market’s tolerance for the TBV payback – in other words, there was a period of time where folks said, hey, I want immediate EPS accretion and I want immediate TBV, and you sort of went, well, there’s only one way to do that and that is those, to your point, kind of very distressed deals. It’s hard to put the franchise together that way, to Jim’s point.

Our sense now is the market is, frankly I think, being more reasonable about that. If you go back in time—go back 15 years ago, Blair. We did M&A. If we were EPS accretive in two years, we thought it was a good deal, right? That’s how we put all these big banks together. So I think if you can get EPS accretion immediate, I still think you need that. I think if you can get TBV payback in a time period that makes sense for how you’re changing your company, right? I mean, if you take some transactions that have been truly transformational for those institutions, they’ve had four or five years, might have made sense for them. A deal that’s not going to transform you like that probably doesn’t make that sense to take that much TBV dilution, right? And then IRR is always the truth serum – that’s the cash-on-cash. If you don’t have a decent return on that, all the other stuff is just GAAP funny numbers. And I think you’ve got to have all three of those levers out there all the time to stay disciplined.

James Cherry

That’s what I meant to say, Blair!

Blair Brantley – BB&T

All right, thank you very much, guys.

James Cherry

Thank you.

Operator

Ladies and gentlemen, this concludes our question and answer session. I would like to turn the conference back over to management for any closing remarks.

James Cherry

All right, well thank you all very much for being with us again. We continue to appreciate your interest and support, and we’ll look forward to future earnings calls. That concludes our call. Thank you.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.

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