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Sterling Bancorp (NYSE:STL)

Q4 2010 Earnings Conference Call

January 27, 2011 11:00 AM ET

Executives

Edward Nebb – IR Advisor

John Millman – President

John Tietjen – EVP and CFO

Analysts

Damon Delmonte – Keefe, Bruyette & Woods

Dave Peppard – Janney

Travis Lan – Stifel Nicolaus & Company, Inc.

Lana Chan – BMO Capital Markets

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Sterling Bancorp 2010 Fourth Quarter Conference Call. (Operator Instructions) And as a reminder, this conference is being recorded.

At this point, I would now like to turn the meeting over to Ed Nebb, Investor Relations Advisor. Please go ahead.

Edward Nebb

Thank you, David, and good morning, everyone. Thanks for joining us.

Our news release announcing Sterling’s Fourth Quarter and Full Year 2010 results was issued today prior to the market open, and we hope you’ve had an opportunity to review it. The release is also posted to the company’s website at www.sterlingbancorp.com.

Before turning to the discussion of financial results, let me remind you that any comments made today about future financial results or other future events are forward-looking statements under the Securities Exchange Act of 1934. Actual results may differ substantially from such forward-looking statements.

The amounts of any dividends in 2011 and beyond will depend on the company’s future results of operations, financial condition, and other relevant factors. A discussion of the factors that could cause actual results to vary is contained in Sterling’s annual and quarterly reports as filed with the SEC.

We will have introductory remarks from Mr. John Millman, President of Sterling Bancorp; and Mr. John Tietjen, Chief Financial Officer. After their remarks, we’ll open up the call to take your questions.

And so without further ado, I’d like to turn the call over to John Millman.

John Millman

Thank you, Ed, and good morning, everyone. Welcome to our conference call for the fourth quarter and year ended December 31st, 2010.

Sterling’s performance for 2010 shows that we have weathered the challenges of the economic downturn extremely well. More importantly, we have transformed those challenges and opportunities for profitable growth and enhanced shareholder value. We are significantly more profitable.

Net income available to common shareholders was $3.5 million for the 2010 fourth quarter, an increase of 76% over the prior year. Our earning per diluted share in the quarter was $0.13. The composition of our earnings is more diverse and broad-based. A greater component of our earnings is coming from non-interest income as we have grown the generating products such as accounts receivable management factoring trade finance and payroll funding.

Credit quality has improved sharply and continues to trend in a positive direction. The level of non-accrual loans is returning to previous session levels. Net charge offs in the fourth quarter were less than half what they were a year ago. And the ratio of allowance to non-accruals is significantly higher than last year.

Our balance sheet is stronger than ever. Shareholder’s equity reached $223 million at yearend, up from $162 million a year earlier, largely due to the successful equity offering in March. Our tangible common equity ratio of 6.81%, up from 4.59%, the strong equity base provides growth capital for the future.

We have strengthened our franchise in the highly attractive New York Metropolitan area marketplace. Throughout the recession, while other financial institutions were distracted or constrained, we maintained our traditional high touch customer service and won a significant number of new relationships as well. The business is on a solid path for growth.

Total loans and portfolio were up nearly 10% from last year. Total deposits increased 10.5% compared to last year, and our 33% ratio of non-interest earning demand deposits to total deposits is one of the highest in the industry. Total assets reached nearly $2.4 billion, an all-time high at the end of 2010.

I would like to focus your attention in particular on the solid improvement in our credit quality. As you know, we made a decision in the 2010 third quarter to accelerate the resolution of certain non-accruals, primarily in the area of lease financing. Given the uncertain pace of economic recovery, we felt it was important to reduce our exposure to credit issues and our potential impact on future earnings. The resulting positive effect on asset quality was immediately evident in our credit trends in the 2010 fourth quarter.

Net charge-offs were $2.9 million in the 2010 fourth quarter, down from $7 million a year ago. The provision for loan losses was $3 million in the 2010 fourth quarter, down from $8 million in the same period of 2009.

Non-accruals ended the year at $6.6 million, a reduction of 63% from $18 million a year ago, essentially marketing a return to pre-recession levels. The ratio of non-accrual loans to total loans improved to 0.49% at December 31st, 2010 from 1.46% a year earlier.

Non-performing assets were $6.8 million or 0.29% of total assets at year end, down from $19.4 million or 0.89% at December 31st, 2009.

The allowance for loan losses as a percent of non-accrual loans increased to 274.5% at December 31st, 2010 from 110.5% a year earlier.

To sum up, we believe that Sterling is very well-positioned for growth and profitability. Our New York Metropolitan marketplace is recovering from the economic downturn and we are seeing solid demand from the existing customers and new relationships.

We are focus on our core strengths and commercial lending products including middle market lending, asset-based financing, factoring, accounts receivable management, trade financing, and payroll financing among other categories. Our earnings stream is increasingly diversified with particular growth in fee-generating products. And we have a high level of shareholder equity giving us the growth capital to further expand our franchise as appropriate opportunities arise.

Going forward, we will continue to focus on building market share by providing customers with a range of financial solutions and superior service. We will pursue a balanced and diversified business model, and we will seek opportunities to deploy our capital in areas that have the potential to drive long-term sustainable growth.

Now, I’ll turn the call over to John Tietjen.

John Tietjen

Thank you, John, and good morning to everyone on the call. I’d like to provide you with some additional detail on our performance for the fourth quarter of 2010.

As noted earlier, net income available to common shareholders for the fourth quarter was $3.5 million with $0.13 per diluted share against $2.0 million or $0.11 per diluted share in the same period in 2009.

Some of the key factors that contributed to our performance were net interest income on a tax equivalent basis was $21.1 million for 2010 fourth quarter, compared to $22.4 million a year ago. This reflected the impact of lower yields on loans and securities, and higher interest-bearing deposit balances; partially offset by the impact of higher average loan and investment security balances and reduce funding cost.

The net interest margin was 3.98% for the 2010 fourth quarter on the tax equivalent basis, compared to 4.49% for the fourth quarter of 2009.

The market trend reflects among other things our plan shift in the loan portfolio mix away from lease financing receivables toward core commercial lending products. [Inaudible] lower yields than leasing, but are preferable from a credit-quality standpoint.

We calculate that the shift in our portfolio mix away from leasing reduced the net interest margin by 20 basis points. We feel the reduction in margin is more than compensated by the expansion of non-interest income and better credit quality profile.

In addition, in order to position the balance sheet with changes and interest rates and to provide the capacity to fund loan growth, we currently have approximately $320 million deployed in short-term assets at a blended rate of 181 basis points. Those assets are funded at an average cost between 25 and 40 basis points.

While holding the assets in this manner is accretive to earnings, the narrow spread contributes to an erosion in the margin. As we continue to fund demand from quality borrowers, we should be able to shift from short-term assets to a greater proportion of loans with a resulting improvement in yield.

Non-interest income was up 12% to $12.1 million for the fourth quarter of 2010. As we have noted, we continued to build our fee-generating products, which represent a unique strength of our business model. Products such as accounts receivable management, factoring, trade finance and mortgage warehouse lending delivered substantial fee income to supplement our net-interest margin.

Non-interest expenses were $24.3 million for the 2010 fourth quarter compared to $21.2 million a year ago. This was primarily due to higher compensation, occupancy and marketing expenses related to the growth of the business and increased business development activities as well as higher professional fees and deposit insurance premiums.

The higher professional fees reflected a reduction of such fees in the fourth quarter of 2009, mostly due to recovery of legal fees in a settlement of litigation. The increased in deposit insurance premiums was caused primarily by the growth of the insurance deposits in 2010.

Turning to the balance sheet, average loans held in portfolio for 2010, net alone and discount were $1.2 billion, up $73 million from a year ago. When comparing these amounts, keep in mind that 2010 figures reflect a continuation of our planned reduction of the leasing portfolio.

Investment securities averaged $768 million for 2010, up from $719 million a year ago. The major increase in – occurred in short-term investment securities reflecting the deployment of proceeds from the March stock offering.

Total deposits for 2010 averaged $1.6 billion compared to $1.4 billion a year ago. The largest shift in interest-bearing deposits occurred in time deposits with the average rose by $183 million. This largely reflects our use of the Cedar’s Program [ph], which authors a flexible, highly cost-effective alternative source of deposits.

We continue to build on our soft, solid core, non-interest-bearing demand deposits, which remain a key factor in our high net interest margin. Average non-interest-bearing demand deposits rose to $489 million for 2010, up nearly 11% from $441 million a year ago. Demand deposits have grown as a result of balances maintained by our lending customers as well as the business activities in our professional banking area. Average borrowings for 2010 decreased approximately $175 million as more cost-effective deposits have comprised a greater proportion of our funding base.

All of our regulatory capital ratios continued to exceed well-capitalized requirements as of December 31st 2010. Our Tier 1 risk-based capital ratio stood at 13.61%, total risk-based capital was 14.68%, and the Tier 1 leverage ratio was 10.15%.

Our liquidity remained strong and will fund further the growth. Ratio with loans held in portfolio to deposits was approximately 75% at December 31st 2010, giving us ample capacity to increase our lending activities.

With that, let me turn the call back over to John Millman.

John Millman

Thanks, John, and we are very excited about Sterling’s prospects for the coming year. We are in a strong position today because of the actions we took during the economic downturn to build our franchise, expand our capital base, and reduce our credit-risk exposure. We are growing our business and delivering a higher level of profitability, which should translate into enhanced shareholder value going forward.

Now, we would be pleased to respond to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Damon Delmonte with KBW.

Damon Delmonte – Keefe, Bruyette & Woods

Hi, good morning, guys, how are you?

John Tietjen

Good.

John Millman

Good morning, Damon.

Damon Delmonte – Keefe, Bruyette & Woods

John, could you talk a little about the margin expectation that you had in the 2011?

John Tietjen

Yes. Again, as we pointed out, Damon, the fourth quarter margin dipped below 4% for the first time in a very, very long time. We pointed out the fact that we shifted the leasing portfolio, and that produced a 20-basis point reduction in the margin, and we talked about the fact that we have this $300 million plus of assets at roughly 181 gross yield.

At this point, I believe that we are relatively comfortable with the level of the leasing portfolio relative to total loans. So, on a go-forward basis that will likely not continue to be a drain. And as we redeploy the funds out of the $300 million of 181 into loans at about a 5% yield, we would expect that, that would have a benefit on the margin.

I mean we do have pretty significant loan growth as we pointed out for 2010, John can comment on the pipeline. It continues to be very strong, so we would look to have good loan growth in the 2011 period.

Damon Delmonte – Keefe, Bruyette & Woods

OK, that’s helpful. Kind of switching over to the income, mortgage banking had a good second half of the year, kind of how are you looking at that for, I believe, this next couple quarters?

John Millman

I would expect that we will not have a repeat of the second half of the year for 2011. Our current plans are for mortgage banking to be down slightly from where it is now. We will look at opportunities there, and the mortgage warehouse lending is providing us with an additional boost. While it’s not reflected in those numbers, it is an area that draws on the expertise of our mortgage banking professionals.

Damon Delmonte – Keefe, Bruyette & Woods

OK, great. And then with respect to TARP and potential repayment, could you kind of help us think whether about the timing of that?

John Tietjen

Yes, Damon, you know, we continually review the option of repaying TARP. And as we look at it against the other capital deployment opportunities that arise in this environment, we will continue to review that option, and we will make a decision that benefits the company and its shareholders at the appropriate time.

Damon Delmonte – Keefe, Bruyette & Woods

OK. Have you had, at least, finished the discussions with the regulators? Is there anything else that would prohibit you from paying it back since you’ve already raised capital?

John Millman

We’re not aware of anything that would prohibit us from paying it back.

Damon Delmonte – Keefe, Bruyette & Woods

OK. Are you aware of the, I think it’s the SBLF fund, the Small Business Lending Fund, where if you participate in small business loans, you can actually have the cost of your TARP reduced to the – is that something you guys still talked about or considered?

John Millman

We are aware that – our current thinking is that, that is not something that we would look to participate in. But again, as John pointed out, we do vis-à-vis from time to time and that thinking could change.

Damon Delmonte – Keefe, Bruyette & Woods

OK, thank you very much.

Operator

And our next question comes from the line of Rick Wise with Janney.

Dave Peppard – Janney

Hi, guys. How are you? This is actually Dave Peppard.

John Tietjen

Hi, Dave. How are you this morning?

Dave Peppard – Janney

Good, thank you. Good, thank you. I was wondering if you could provide a little color on the shelf that you recently filed and what was going on there.

John Millman

Yes. Well, as you correctly noted, it is a shelf offering. We really can’t comment beyond what is contained in the SEC shelf filing on the timing or the use of proceeds of any offering.

I can say that we believe we are in an opportunity-rich environment and the board and management believe that it’s prudent to ensure that we have the financial flexibility to take advantage of any opportunities that may emerge in this environment.

Dave Peppard – Janney

Speaking of opportunities, what’s your take on the likelihood of a bank or a fee-based business deal in the next couple of months and what you’re seeing in general M&A space?

John Millman

We are constantly looking at opportunities and we’re hopeful.

Dave Peppard – Janney

OK. Looking at the long growth this quarter.

John Millman

Yes.

Dave Peppard – Janney

Kind of what do you expect for this quarter coming up? Where was some of the strengths in the growth?

John Millman

Well, a couple of areas. First of all, a great deal of our loan growth comes from new customer relationships. I think we’ve talked to you for the last couple of quarters, we’ve seen unique opportunities and really, and a kind of a window to take advantage of what’s going on in our marketplace. So, the market is emerging from the depths of the downturn. Thus the market is stronger than other markets across the country.

We’re seeing lots of disenfranchised small and midsize business, who don’t have access to the normal credit sources. So, that’s – hey, that’s been a very big source of new business for us.

Also, we told you back in the spring that we envision the warehouse lending product to be successful to produce $100 million in commitments by the end of the year, and we have been very satisfied with the development in that business and it has fully met our expectations.

Dave Peppard – Janney

Right. And are you guys still opportunistically hiring loan officers? Are we starting to see the impact of that in the numbers?

John Millman

We are constantly interviewing, and in fact, hiring business development officers. And yes, we are seeing productive results from that effort.

Dave Peppard – Janney

OK, thanks, guys.

John Millman

Thank you.

Operator

Thank you. And we’ll move on to the line of Collyn Gilbert with Stifel Nicolaus.

Travis Lan – Stifel Nicolaus & Company, Inc.

Thanks. This is actually Travis Lan, in for Collyn this morning. How are you?

John Tietjen

Good morning.

John Millman

Good morning, Travis.

Travis Lan – Stifel Nicolaus & Company, Inc.

I was wondering if you could refresh us on the specific dynamics of the asset-based and factoring segments, and kind of how those generate such substantial fees.

John Tietjen

Well, I mean the asset-based lending goes back to the core of our business here.

Travis Lan – Stifel Nicolaus & Company, Inc.

Right.

John Tietjen

And when you go through in asset-based lending, which would include factoring and which would include resource funding, those are commissioned products. Most of the revenue from those portfolios are in the non-interest income area. We do get interest income when our clients borrow, but the lion share of the income is in non-interest income.

In addition, there are many covenants that come into play in asset-based lending. And if a client were to meet one of those covenants, there are fees associated with that. That get charged at that time depending upon the relationship in the account officers evaluation of why the covenant was met.

Travis Lan – Stifel Nicolaus & Company, Inc.

OK, that’s perfect. Thank you. That’s all I have.

Operator

Thank you. And we now have a question from line of Lana Chan with BMO Capital.

Lana Chan – BMO Capital Markets

Hi, good morning.

John Tietjen

Hi.

John Millman

Hi, Lana.

Lana Chan – BMO Capital Markets

Two questions. One, just curious on the Cedar [ph] that you’re putting on, what’s the average rate of those? And why do you need those with your loan to deposit ratio is already relatively low compared to the industry, and you’ve got pretty – simply, you’ve got plenty of liquidity.

John Millman

The Cedar’s [ph] program, Lana, we have found is the most cost-effective way upon [ph] a relative to other sources of borrowings. We’re getting funding between 25 and let’s call it, 50 basis points out to a year, and we’re not finding those opportunities on the borrowing side, hence the use of the Cedar’s [ph] program.

Lana Chan – BMO Capital Markets

OK. And then on the commercial loans that you’re putting on in terms of the shift in the loan mix, has it change your interest rate sensitivity and can you just remind us how you position for rates right now?

John Tietjen

Yes, we continue to remain asset-sensitive. Most of the new business is booked on a floating rate basis. So, we should benefit in a rising rate environment.

John Millman

And just to finish up on that, Lana. The leasing business was fixed-rate business.

John Tietjen

Yes.

John Millman

So, yes, we are more asset-sensitive as a result of the mix. However, we feel very, very positively about the improvement in the credit quality.

Lana Chan – BMO Capital Markets

OK. And then just one question, John, on the tax rate, I might have missed it on the call. But why was the tax rate lower this quarter?

John Millman

Because two things, mostly the proportion of municipal income to total income that has increased as our investments in munis have increased. And I can hear a question following up, so let me just –

Lana Chan – BMO Capital Markets

You know me so well.

John Millman

Let me just touch on that. The munis that we are buying are at purchase full A rated underlying or better. We have a cap of $2 million per issuer. So, while the portfolio has grown, the relative risk has not because we’re capped at the $2 million. And we do get notifications of changes in ratings and we follow-up on those changes in ratings, and if warranted we will get out of that security or that issue of security at that time. But, again, I think the protection there is that it’s a $2 million limit of per issuer.

Lana Chan – BMO Capital Markets

And any guidance in terms of what we should use our tax rate for 2011?

John Millman

Yes, I would go up to about a 30% rate. We’re expecting improvement in taxable income, which the proportion of muni income to the increase taxable income will not be as great as it was for 2010.

Lana Chan – BMO Capital Markets

OK, thank you.

Operator

Thank you. (Operator Instructions). And presenters, we have no additional questions in queue.

John Millman

All right. Thank you, operator. We thank you for your interest in Sterling and we look forward to speaking with you in the future. Thank you.

Operator

Ladies and gentlemen, this conference will be made available for replay after 12 noon today through February 10th at midnight. You may access the AT&T Teleconference Replay System by dialing 1-800-475-6701 and entering the access code

189902. International participants may dial 320-365-3844. Those numbers again are 1-800-475-6701 and internationally, 320-365-3844 with the access code 189902.

That does conclude our conference for today. We do appreciate your participation, and you may now disconnect.

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