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Sun Bancorp, Inc. (NASDAQ:SNBC)

Q1 2014 Results Earnings Conference Call

April 24, 2014 11:00 AM ET

Executives

Sid Brown - Chairman, Interim President and CEO

Tom O'Brien - Proposed President and CEO

Tom Brugger - Chief Financial Officer

Analysts

Mark Fitzgibbon - Sandler O'Neil

Travis Lan - KBW

Matthew Breese - Sterne Agee

Operator

Sun Banc's First Quarter Earnings Conference Call will now begin. Today's call is being recorded. On the line for Sun Bancorp are Sid Brown, Chairman of the Board and Interim President and CEO; Tom O'Brien, consultant to the Board of Directors and proposed President and CEO; Tom Brugger, Chief Financial Officer; and other members of the management team. At this time, Sid Brown.

Sid Brown

Thank you and good morning. Before we begin, I encourage you to read our first quarter earnings press release on page three where we provide a cautionary note regarding forward-looking statements. We may provide some forward-looking statements on this call and I know you all read this in detail already. So, with that before I introduce Tom O'Brien, who will become our new President and CEO after he receives regulatory approval. I just wanted to make a few short comments. In the first quarter, we really focused on trying to reign in some costs and really focused on limiting or eliminating the use of consultants and really focus on having our management team address the remaining regulatory issues that we need to clean up before, we have our next full exam.

Also we focused on the search for finding a quality executive and we are very happy that Tom has filled the position or will fill the position as CEO subject to regulatory approval. We did focus adding to our bench in the commercial wholesale banking group. That was one of the concerns we had is building the bench, that we could build the pipeline and start seeing some significant increases in the pipeline of loans coming through to the bank.

We continued to maintain a strong capital position at the bank and we believe that we are setting the bank up for future success particularly as Tom takes over the reigns of the bank. So all the things that we said we were going to do in our first quarter, we continued to do. Unfortunately, we still had a loss but we are significantly reducing our expense base and we believe that we are going to be able to position this bank for profitability in a very short period of time.

So at this point I am going to turn the meeting over to Tom O'Brien.

Tom O'Brien

Great. Thank you Sid, good morning. Pleasure for me to be here and as I think you know I am fully in my third week here at the bank and spent most of my time getting to know people process, looking at high level things that I think need attention and opportunities for us. And I can tell you the reception has been very good both from within the bank and outside and we are proceeding on a very quick and focused pace here to develop the business of the bank, sufficient to produce a very strong level of profitability and consistent with running a very good bank and market of New Jersey, which is a robust market. We should do well here. We have got a few things to cover and none of which is going to surprise you when you look through the income statement and the quarterly press release, but as Sid mentioned, we had a $0.02 per share loss in the quarter, the $1.9 million, the challenge for us as I would look at it is really in this comment here, the quarterly revenues were $26 million and the quarterly expenses were $28 million.

So if I could define 75% or 80% of the challenge that we face, it’s going to be in balancing the expense side with the revenues. There is obviously contributions from both ends but I would probably say it’s 70-30, 75-25 on the expense side, not the revenues.

And Tom Brugger will talk a little bit about margins and margin opportunities, but we have to certainly look at both ends of it. Our net interest income $21 million in Q1 gave us a net interest margin of 307, down very, very modestly on a dollar basis from the fourth quarter and then it was improved from the fourth quarter where it was improved from the fourth quarter where it was 2.99, and a year ago it was 3.16.

The big balance sheet items for us, interest bearing cash in the quarter $220 million, down from $342 million in the linked quarter. Investments were very, very stable at the mid $400 million range. Loans at $2.129 billion, down about 50 from the fourth quarter. Deposits $2.7 billion versus $2.9 billion at the fourth quarter and our borrowings were very stable at the 160 level.

Commercial loans, $1.560 billion, down from a $1.621 billion, and mortgage banking revenues under pressure as volumes and rates are down. As Sid mentioned, non-interest expense is down pretty dramatically just on a dollar basis in the quarter driven primarily by professional fees and headcount reductions here at the bank. Notwithstanding the fact we had some occupancy expense increase in the quarter as I think most banks did clearing away all the snow that accumulated at our facilities and that amounted to about almost a $1 million in winter weather related cost in the quarter.

Our capital, again Sid mentioned this but our capital remains strong. Tier 1 leverage ratio at 9.40, which is up 41 basis points and our risk based capital ratio also increased by 41 basis points to 14.87. Average assets fell $157 million in the quarter and that was really a strategy that was to reduce larger government-related deposits and reduce cash and excess liquidity on the balance sheet due to the lower interest rate environment.

Asset quality in the quarter, large reduction in the fourth quarter of last year and it looks relatively stable in this first quarter. We continue to look at all of the asset quality measures and the underlying assets and both the cost of resolution and the timeframe. And we will look at strategies that ultimately provide the best economic return to the bank at the most expeditious manner. So that may involve looking at some accelerated dispositions and it may involve looking at some more focused collection efforts but probably some combination of both. And we will certainly try to be more proactive, at be active in that sense.

So all said, I’m sure there will be a couple of questions probably mostly direct to done things prospectively here for the bank. I’ll look forward to taking those but before I do, I am going ask Tom Brugger to just go through things in the quarter for you and then we’ll take some questions. Tom?

Tom Brugger

Thanks, Tom. Just wanted to add a little bit of commentary on the drivers of the quarter. Net interest income declined sequentially by about $0.5 million. The margin actually went up and that was due to the $150 million approximately average balance sheet reduction. Again from a margin perspective, we had -- most of that run-off was in interest bearing cash balances at the Fed where we earned 25 basis points and the runoff came in government deposits and CDs. So we took off zero or slightly negative margin, and shrunk the balance sheet.

One another metric is the average interest bearing cash for the quarter was $220 million. So, if we would have deployed about $200 million of that into assets of 3.5%, the margin would have been about 25 basis points wider. As we’ve talked about on the previous calls, once we get to fully deployed with our excess liquidity, the core margin for the bank right now is somewhere in the 330 to 335 range.

On the loan growth side, we continue to see reductions there due to our internal focus on risk reduction and also it continues to be a very competitive environment. We're seeing about a 10% annualized runoff in loans at the moment.

On the deposit side, as we mentioned before, we shrunk the government deposits and CDs, but the rest of the deposit book is very stable. Our total cost of funds of deposits is around 35 basis points, which is down 3 basis points from the prior quarter, and it's now down 10 basis points over the past year. Our non-interest bearing deposits remained right around 20% of total deposits and that's about $560 million.

So, again overall from a net interest income perspective, we continue to have falling earning assets and stable deposits and that's why the net interest income is dropping.

Asset quality, just to add a little bit of detail, in the prior quarter, we did see a 31% reduction in NPLs and a 40% reduction in classified loans. So, this quarter, we saw about $0.5 million reduction in NPLs and the NPL to total loans held stable at 1.8%.

As a reminder, a year ago that ratio was at 3.3%. Net charge-offs for the quarter were $1.8 million. We did have a provision of zero for the quarter and that’s primarily due to the fact that our loan portfolio continues to shrink and over the long term the risk continues to fall in the portfolio. So the provision was that with that zero and reserves to total loans, we have 1.6% and our coverage ratio are AAA and NPL was around 90%. So we are pleased with the progress but obviously we need to continue to work to drive the loan levels down further.

Fee income was basically flat quarter-over-quarter at around $5 million, a year ago we had significantly higher fee income at around $11 million (inaudible) which did not reoccur, but the remainder of the decline that we saw in fee revenue was in the mortgage banking income, net mortgage banking revenue was $26 million for the first quarter which is down from a million in the previous quarter and $3.4 million a year ago.

Just to give you some metrics for loans sold, loans sold settled in the first quarter were only $32 million. Fourth quarter we sold $55 million and a year ago we sold $182 million. We definitely have seen a slowdown due to interest rate environment, but also the weather was really rough quarter which depressed our origination volume there. We do continue to keep an eye on expenses and we have taken out expenses in the mortgage company to match the drop that we have seen in the revenue.

On the expense side, we did see a nice reduction on our expenses. The average operating expenses last two quarters in Q3 and Q4 of last year was $32.7 million and that came down to $27.9 million in the first quarter, the professional fees $1.5 million. And the couple of quarters before were $5.9 million and $4.9 million. So as Sid and Tom mentioned previously the consultant costs and the professional fees drove that up here most of the work was completed last year, there was a tail that occurred in the first quarter. So when we go into the second quarter you will see an additional reduction in professional fees but as we have talked in the past the normal run rate for us should be around 1 million, 1.25 million, 1.5 million depending on amount of work we have.

Salaries and benefits if you look over the past year and quarterly progression we continue to see reductions there, over $12.9 million in the current quarter, $14.3 million a year ago, our headcount year-over-year is down about 9%. So we have worked on a number of efficiency efforts with consolidation of branches, reductions in the Sun Home Loans our mortgage company we also did some reductions in some of the non-core businesses we’ve had. So there has been a lot of effort to reduce that expense and we are seeing decent progress. The commission expense was down dramatically also year-over-year we had a little less than a million in commission expense in the first quarter and we have 2 million a year ago, most of our commission expense comes from our mortgage operations so was [volume] down, we will see the commission expense come down.

So overall the expenses, we saw a decent progress, with some of the metrics we look at is the non-interest expense to average asset ratio, still it’s high at 3.6% and our efficiency ratio over 100%. So obviously we have more work to do here. On a capital ratios with the reduction in size of the balance sheet that we mentioned previously, we did see the tier 1 leverage ratio jump by 40 basis points and with the excess liquidity we have in the balance sheet had also given us the flexibility to shrink further, if we want to enhance capital.

So capital is trending well and specifically with the reduction in risk over time in the problem loans. At this time we feel that the capital is adequate. So overall we made very good progress on reducing expenses, capital ratios improved and we continue to see progress on reducing the problem loan levels, but this progress was not enough to offset the revenue weakness and we’ve booked a loss. So we are going to focus on enhancing profitability of the bank in the coming quarters, focus on reducing problem loans improving operational efficiency and growing core originations of loans and deposits.

With that let me turn it back to [Tom].

Sid Brown

Okay, thank you. Operator we can now take some questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Move to your first question from Mark Fitzgibbon from Sandler O'Neil.

Mark Fitzgibbon - Sandler O'Neil

Good morning gentlemen.

Sid Brown

Hi Mark. Good morning.

Mark Fitzgibbon - Sandler O'Neil

I was curious first with the pre-tax loss of about $1.5 million. I was wondering why you’d have a tax expense of $359,000, was there something unusual there?

Sid Brown

Great question.

Tom Brugger

Yes. It’s a wonderful tax (inaudible). Some of our goodwill was tax deductible. And because you are -- you kind of have a permanent difference with the deductible goodwill between book and tax. And then we have NOL which are temporary differences there are times when you run through the calculations so you are going to incur a tax expense. So we put language in our 10-K to describe this in more detail and you might want to read through that to get an understanding, but it is an odd thing, but it has to do with the tax deductible goodwill we have.

Mark Fitzgibbon - Sandler O'Neil

Okay. And then secondly should we expect liquidity in capital to continue to build in the next several quarters, as you derisk the balance sheet?

Sid Brown

I would think you would certainly see capital continue to build and liquidity, maybe in this current quarter probably as because what we still have the risk of here is if we're exiting our credit that puts pressure on the loan balances. So liquidity probably stable to and it could certainly increase a little bit in this current quarter and maybe into the third quarter, but longer term liquidity should be deployed.

Mark Fitzgibbon - Sandler O'Neil

Okay. And then Tom, I know you’ve only been there for a short time but you have a sense for how long it might take to sort of rationalize the cost structure of the company?

Tom Brugger

Yes, I’m pretty aggressive on that. So I don’t deal this having a lot of time to over think this, I mean some of the big numbers, just pick out here. And so, I mean we're on a kind of action agenda here to move as quickly as possible. I am certainly planning on going to the Board towards the end of this quarter with some specific ideas. I'd like to get fully engaged on this process as quickly as possible. I'm a shareholder guy, I mean I'm focused on shareholders and the returns they deserve and I don't deal with this having the luxury of a lot of time to do this. So we will move expeditiously without being reckless and so that you can take to mean 2014, but I don't want to be talking about this in 2015.

Mark Fitzgibbon - Sandler O'Neil

Great. Thank you.

Operator

(Operator Instructions). We'll move next to Travis Lan from KBW.

Travis Lan - KBW

Thanks, good morning guys.

Sid Brown

Hi Trav.

Tom Brugger

Hi Trav

Travis Lan - KBW

So I think last quarter, you mentioned that you thought you would reached the point where you could start to focus on growth a little bit more. And I just wondered, Tom, with the 10% annualized runoff that you mentioned, what the time line could be to kind of stabilize that and really begin to grow the loan portfolio?

Tom Brugger

I think it’s probably a quarter or two Travis. I mean, I would just say from my perspective speaking individually and only here a couple of weeks. But at this point, I'm going to focus more on profitability than I'm on growth. And that is from both an efficiency perspective on the expense side and a yield of revenue perspective on the income side. But…

Travis Lan - KBW

Okay.

Tom Brugger

Growth will come at time, but I just don’t think it’s our immediate challenge here.

Travis Lan - KBW

So in the short term and I guess should have been more specific but in the short term, even if the balance sheet doesn’t grow, are there opportunities to kind of begin to deploy the liquidity onto the loan book, and is that kind of that same one to two quarter timeline?

Tom O'Brien

Yes, I think there are that I guess to qualify or put on that is what I mentioned earlier is if we have loans that we exit out, it may be a challenge to see net growth. I mean we could certainly see some good originations but [mandate] being a push if we have long payoff. So I’m just not in a position to give you a lot comfort on growth there other than over time that’s where we’ll see it.

Travis Lan - KBW

Got you. Okay. That makes sense. Tom Brugger, just back on expense real quick. So, just to start with $27.9 million and adjust it for the snow removal, you think over next couple of quarters, you can take it even lower than kind of $26.9 million starting point that you would get?

Tom Brugger

Yes. Part of it is, Tom has mentioned previously, we are going to look at all of our business plans. And Tom is going to have some suggestions to adjust what we’re doing. So I do, the snow is not going to repeat and consultant expense will come down little bit. And as you know over the long term, at one point Sun had seven big branches, now we have 51. So, we have been consolidating here and there the branches and so those efforts will continue.

Travis Lan - KBW

Got you, okay. And then just two more from me. First, how do you feel about credit here and I guess with the charge-offs in the quarter, was that fairly widespread or was there kind of a single loan that drove that and then how you feel about the kind of future provisioning?

Sid Brown

Little over half of the charge-offs came from the consumer books, there was a lot of smaller charge-offs and then in the commercial book, it was handful of credits but it wasn’t just one large charge-off.

Travis Lan - KBW

Okay. And then in terms I guess - and I guess it’s last one for, go ahead.

Sid Brown

What was second part of your question, I am not sure we answered that.

Travis Lan - KBW

Yes, just provisioning going forward. But I think you kind of discussed it in your opening remarks, so I think I am okay with that. And I guess the last one from would just be if there is any update or change to the regulatory situation over the last quarter?

Tom O'Brien

How about if I do that, we continue to make progress, we had a what I call kind of an update exam, short exam to look at the progress that the regulators saw and what we are doing. We did close out a couple of continued MRAs that we had and we continue to make progress on the balance. There were no new findings which is always a positive when regulators come in and do a interim exam. We are really looking forward to our full blown exam come to fall because we are going to be very anxious to put a lot of the remaining issues away in terms of completing our processes and procedures and look forward as soon as we can to move the bank away from being a troubled condition bank.

Travis Lan - KBW

That, great. Thank you guys very much.

Operator

(Operator Instructions). We move next to Matthew Breese from Sterne Agee.

Matthew Breese - Sterne Agee

Good morning guys.

Sid Brown

Good morning.

Matthew Breese - Sterne Agee

Without explicit capital raise, you had mentioned showing up capital, presumably by shrinking the balance sheet. To what extent do you think you would have to shrink the balance sheet?

Tom O'Brien

Let’s not get into the specifics here, but just there is a couple of different levers in terms of capital, one is the size of the balance sheet, one is the -- another is the asset quality. And then don’t forget, we’ve got deferred tax asset is basically a capital raise, it’s just on balance sheet at some point that would, as we start not only to recognize it for accounting purposes but when you start to recognize it from a regulatory capital perspective, it will basically flow through into our regulatory capital at $100 million plus. So I mean it’s obviously in and of itself a relatively significant capital accretion item over time.

So I think from where we stand today with my limited experience here but as I’ve seen things, I mean I think our sense is that capital is fine for what we need at this point in time the opportunity in the future as we kind of get more on a growth strategy. Longer-term, capital appears to be there. And as I mentioned earlier, the size of the balance sheet is at least my perspective, not the big driver here, it’s really profitability and shareholder returns.

Matthew Breese - Sterne Agee

And as we think about the expense side of the equation where you said most of your focus would be, what are some of the likely courses of action you’ll take and the plan you will take to the board, what would that entail, what are some of the actions?

Tom O'Brien

Well I don’t exactly what the actions will be, but if you look, if you take our bank and compare it to those, you might consider our peers, where we make money and where we spend it, we have to look the way our bank, our size and our business model, the way it should look. And so we’ve got multiple business lines here, we need to look at each and every one of them. On some, there will be pricing and revenue opportunities, on others there will be questions as to sustainability.

We need to look at each one of those and say number one is that business that represents a core competency for us and appropriate focus, is it something we can do well, is it something we have sufficient customer demand for and that we can manage the risk. And if the answers to those questions are yes, then that’s where we will spend time and energy. And philosophically, I’ll love to be a more focused lender and probably not as broad based as we are.

My view as banks like us, we can do two or three things really well, and that’s we should identify those two or three things and focus like a laser on those and that’s where our profitability will come from. And extraneous activities and initiatives and products tend to create risk and complexity for us that goes either unrewarded or worse gets punished.

And so I think we’ll look at any line that creates that sort of a risk profile for the bank very, very selectively.

Matthew Breese - Sterne Agee

Will we no more -- about the specifics of this plan from you over the coming quarters, will something be outlined for shareholders?

Tom O'Brien

Absolutely. First it’s going to go to the board and I’m going talk to our regulators and we’ll talk within management, but-- and it will be a plan, if it is not a plan today, but it will be a plan and it is my -- I'm going to call it my first quarter understanding, it's the company's second quarter. But my goal is to go to the Board towards the end of this quarter with specific recommendations and concepts to discuss, fully mapped out.

And as I said earlier, the goal is to address profitability issues here at the bank expeditiously and comprehensively and not, we don't want to be talking about this and later parts of 2014 and in the 2015, it's not in our interest, it's not in our shareholders’ interest, not in our regulators interest, not in our Board's interest and certainly not in management's interest.

So, we'll make the tough decisions we have to make and direct the bank’s efforts towards that goal of providing a good investment opportunity and a reasonable level of profitability for our shareholders.

Matthew Breese - Sterne Agee

Okay. And then last one is, at what point do you expect to receive the non-objection? Presumably in the next week or next couple weeks or months.

Sid Brown

So, we had some conversations with the regulators. We're hoping, but hope is not a strategy, but we are hoping to sometime in a next 30 days to 60 days to have the non-objection. But there is a process that the regulatory bodies go through. You have three of them, you have the FDIC, the Fed and the OCC and Tom has got to clear through all three of them.

We're not worried Tom clearing, it's just that there is a process that you have to go through and that’s what we are doing at this point in time. It’s a rather extensive application you file. And if you have not done or not seen it, you’ll learn more about yourself and you knew going into it.

Matthew Breese - Sterne Agee

Very good, I appreciate that help guys. Thank you.

Sid Brown

Yes, sure. Thank you.

Operator

And at this time, we have no further questions. I would like to turn the conference back to your host for any concluding remarks.

Sid Brown

This is Sid again. I’d just like to say that as a large shareholder in the bank and as chairman of the board, we are very excited to have Tom O'Brien as our pending CEO. And the management team here has worked very hard with me, and I am probably like to acknowledge the help that they gave me and helping oversee the institution in the first quarter. And I would expect that those continue to help Tom steer the bank in a direction that will provide real shareholder value over the next couple of years.

So at this point in time, I think that’s it. So, thank you very much.

Operator

Again that does conclude today’s teleconference. We thank you all for your participation.

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