Sun Bancorp Inc. (NASDAQ:SNBC)
Q4 2015 Earnings Conference Call
February 1, 2016 11:00 AM ET
Thomas O’Brien - President and Chief Executive Officer
Tom Brugger – EVP and Chief Financial Officer
Mark Fitzgibbon - Sandler O'Neill
Travis Lan - KBW
Sun Bancorp's Fourth Quarter Earnings Conference Call will now begin. This call is being recorded. On the line for Sun Bancorp are, Thomas M. O’Brien, President and CEO; Tom Brugger, Chief Financial Officer; and other members of Sun's management team.
Good morning, everyone, and welcome to Sun’s fourth quarter and year-end 2015 call. As first order, I’d just like to direct your attention as usual to the forward-looking statement disclosures and suggest you read those at your leisure.
Sun Bancorp reported this morning its fourth quarter and year 2015 results of $0.08 and $0.55 per share respectively. The fourth quarter saw much less noise than in the previous three quarters of the year.
Noteworthy in the financial results are the operating expense level at $16.6 million for the quarter, down almost 50% from the prior runrate which was $33.5 million in year’s past. So, nice decline in a good level of operating expenses for the Bank. This is the first full year profit the company has reported since 2008.
We took a negative provision – loan loss provision of $300,000 in the quarter, counterbalaning that, we booked a $700,000 reserve for a potential recourse claims on some old SBA loans. The SBA introduced some new and very aggressive recourse claim procedures in the fourth quarter last year and we believe based on that, and these new procedures that it was appropriate to have a reserve on the books for these older loans.
Asset quality metrics remained very strong. We remain very credit quality focused and proactive. Liquidity for the company remains high and has been a consistent earnings drag in 2015 as we tried to balance the risk reward equation throughout the year.
We also have exercised appropriate caution given the conflicting economic signals and the demands of what I viewed as, job number one, since I joined Sun, and that was satisfying the many requirements of our regulatory enforcement order.
The announcement we made last week that the OCC has formally removed the order and its restrictions on the Bank was a welcome news. It’s important in my view to note that, many people thought the order was simply satisfied with loan quality improvements and while that was without question, part of the challenge here at Sun, there were many process controls, talent and compliance matters that we had to address.
All of which took non-stop effort and far more than simply just dropping off suggestions in an idea box. We started fixing Sun from below sea level in July of 2015. Those who follow the company over the years have some appreciation and perspective for that undertaking.
The challenges ahead for 2016 are becoming the more traditional business and growth focused ones. We need to remain consistently profitable in each quarter and avoid mistakes. We also need to keep the body armor around the Bank hereafter. No more mistakes for us, so no more regulatory issues.
And with that, I am going to ask Tom Brugger to go through some of the financial results in the quarter and look ahead into 2016 for you. So, Tom?
Thanks, Tom. Good morning everyone. Wanted to talk to you some of the income statement balance sheet trends. Looking at the fourth quarter, the net interest margin was flat quarter-over-quarter at 2.81%, but our earning assets fell $75 million which led to a decline in the net interest income.
Average loans in the quarter fell about $40 million and as a reminder, we’ve had high pay-offs throughout the year, but we had high payoffs late in the third quarter and that rolled into the fourth quarter. But, the originations in the fourth quarter were better and they were focused in the latter half of the fourth quarter. So, if you look at period-end to period end 9/30 to 12/31, our commercial loans grew at an annualized pace of 12%.
Our average cash remained elevated in the quarter at $277 million. So, once we deploy the excess liquidity, our net interest margin will be somewhere in the range of $310 million to $320 million, up from the current rate of about 2.81%.
The provision for loan loss was a negative $300,000. We continue to have very low levels and stable levels of problem loans. The net charge-offs in the quarter were $600,000.
We did a proactive sale of some problem consumer and residential loans in the quarter, which generated a net loss of $700,000. So if you strip that sale out, the net charge-offs were a net recovery of $100,000.
At the end of the quarter, the allowance to total loans was a 116 basis points, but our non-performing loans to total loans were at 20 basis points than our allowance to non-performing loans was at 578%. So, very solid coverage and asset quality trends.
When you look forward, kind of the periods of reserve releases, we believe are close to an end because, we do expect loan growth going forward and we need to add provision expense to fund that growth. Looking at our non-interest income, we had a very clean quarter and it was $3.2 million, no non-recurring items in there.
The other things [Audio Break]. We will start seeing growth from that $3.2 million number on a go-forward basis as we add new relationships.
Our non-interest expense was $16.6 million in the quarter, which is the lowest level for the company in more than ten years. We accrued about $1.5 million in savings in the fourth quarter from the third quarter consolidation activity. If you remember, we closed nine branches and sold one branch in the third quarter end.
We extracted $1.5 million of savings in the fourth quarter. We had a handful of non-recurring items in the fourth quarter, but the net effect of those items was only $200,000 negative.
So, our expenses are at a very low level. With the removal of the order, we will accrue additional savings going forward. The FDIC insurance will come down about five basis points. Our D&O insurance costs will decline later in the year.
Our exam fees will decline and legal and consulting fees will decline. So, we will have close to couple million of savings once we get the full effect of the order going away into our numbers. One reminder on our expense is our quarterly expenses. We do have seasonality in our numbers. So, first quarter, we tend to see a little bit of a step-up.
We have snow removal cost and FICA and other compensation-related items. But then by the - later in the year, the expenses come down. So, just a reminder on the seasonality and when you look forward, our operating expenses on average are coming down and we expect less than $70 million of operating expenses.
Couple comments on taxes. In 2016, we expect a similar expense run rate. We have the tax deductible goodwill, so we’ll have a small amount of tax expense. The deferred tax asset which is on the balance sheet for zero currently is a little less of a $129 million.
The fourth quarter of 2015 was the fourth consecutive quarter of profitability and as we’ve said before, once you get the six to eight quarters of consistent profitability then you continue to do your detailed assessments and then you are in a position you can potentially turn the DTA. So that fine line is late this year.
So in closing, the Bank made significant progress in risk reduction and rightsizing the expense structure and remediating a regulatory order. So through this period of high activity, the financials have improved over time.
We will now – as Tom mentioned, previously, we are more focused on growing the revenues of the company and then secondarily, we are going to continue to focus on additional cost efficiencies.
The goal is to improve the quantity and quality of earnings going forward from here and then to eventually achieve pure profitability.
So with that, I’ll turn it back to Tom.
Thanks. Operator, we can now take some questions from those on the phone.
Thank you. [Operator Instructions] And we’ll go first to Mark Fitzgibbon with Sandler O'Neill & Partners.
Hey guys, good morning.
Good morning. Mark.
First question I had is, how long do you think it will take to deploy that excess liquidity and at the same time, kind of lever down the capital to maybe your target, whatever that is, 8% or 8.5% TCE?
That’s been the hardest number to get our hands around I think for a variety of reasons. Part of that, we were cautious with the order in place and kind of the variable economic indicators and moves on interest rates, and then, and loan repayments. So, it’s been hard to calibrate.
But, I think it’s probably, realistically given normal cash flows of the existing portfolios and relatively strong originations, I think probably the better part of the first three quarters of the year.
Realistically, I mean, we are still going to be cautious in terms of volume and activity and it’s hard to make a call on rates now, but we want to necessarily be in that business, but we do want to be cautious. And then on the other hand, I’d say too, we’ve looked at a lot of things and we’ve avoided the big mistakes.
I mean, we didn’t get into taxi medallion lending and some of the other things that have blown up for others. For us, we can’t afford to make those [indiscernible]. So, we are probably more cautious, than most in many cases, it’s paid dividend, but there is an earnings drag to it. We are not unaware of that. We are just trying to be as cautious as a company coming out of the struggles we’ve had can and should be.
Okay. And then, is it likely do you think you’ll do more purchases of pools of loans, commercial real estate or multi-family?
I think it’s more likely we’ll do some participations with some of the institutions that we’ve done. And strictly participations, I mean, we are not inclined to just purchase whole loans given the risk of the adverse selection and just where the general market is. So, the loan participations in the 50%-50% range I think are attractive to us, and you’ll more probably see more of that and our organic originations again have been very strong in both volume and quality through most of the year other than a slowdown that we had in the summer which is typical. And in the third quarter, some delayed closings that brought us into the fourth quarter, but.
And then, I wonder, Tom, if you could share with us your thoughts on stock repurchases and dividends, now that you are out from underneath regulatory order and certainly have excess capital?
We certainly do. I think it’s, we’ll get the first quarter of 2016 behind us and we’ll start looking at that just on the economics, if you look at the stock repurchases from the perspective of recovering the deferred tax asset, it’s an attractive valuation. So we’ll certainly analyze that and put it forward. My guess is, sometime as we get into the end of the second quarter we’ll start talking to the Board about that.
And the cash dividend, I think also makes sense for us. We start admittedly at a relatively modest level until we are further along on earnings and the consistency of our earnings, but there is a whole new universe of potential investors for the Bank who only look at dividend paying stock.
So, it would certainly be appropriate for us and I think the right sign that we’ve come out of a pretty difficult period in a condition where we can payout a cash dividend. So, yes, we’ll be analyzing all of those as we get into 2016.
And then just one point of clarification, Tom Brugger, you had – I think said that, you expect operating expense to be around $70 million for the year. Does that include the savings that you expect from the lower regulatory cost, FDIC insurance, et cetera?
Yes, I mean, we’ll be at $70 million or below, but the expense runrate as you go through the year, as we extract the savings will improve somewhat. So we are just below $70 million right now and we’ll come down a little bit.
Just keep in mind the seasonality that Tom mentioned earlier because social security and things in the first quarter and I am not sure what the snow removal cost will be, but then – and several years past, they were at modest in my first year here and last year, they were extraordinarily high.
So, so far we’ve had a mild winter and just one storm and – but it’s one of those things that’s out of our control. We do have fewer branches that should be a savings, but those are two things. Just to keep in mind, the seasonality, especially in 1Q.
Great, thank you.
Sure. Thanks, Mark
[Operator Instructions] We’ll go next to Travis Lan with KBW.
Yes, thanks. Your commentary on the timing of the excess liquidity deployment was helpful. But, can you just remind us how you think about kind of the quantity of excess liquidity and what a more normal cash balance would look like?
That’s probably going to be a joint question, but I’d say, from where we stand today, the excess is 150 plus.
Yes, I mean, ideally we want it to be around $25 million of excess cash and we were at $277 million in the fourth quarter.
And the other thing too when you look at liquidity, it is – there is cash on the balance sheet and then access to cash and so as you look at all these different stress scenarios for liquidity planning, we have significant access to cash from a variety of primary, secondary and tertiary sources. So, running with $25 million on the balance sheet, I think we’re all be pretty comfortable with that.
Got it. Okay, that’s helpful. And I know the timing of kind of loan payoffs is weighed on the loan growth, but the securities portfolio has also fallen over the last eight quarters. Is there any thoughts to investing or re-bolstering the securities portfolio as you go forward?
That’s probably every quarter throughout 2015 and to be honest, it’s hard for me sit here and say it, there was or wasn’t a mistake. But we’ve been, again, cautious given the regulatory order that had been in place and our concern about the absolute low level of market yields that prevail through most of the year although there was some volatility in rates and probably a few better entry points that we didn’t realized.
So, if we end up buying securities, it will probably driven by either high payoffs of lack of – loan growth didn’t materialize that we anticipate.
Okay, all right. That’s helpful. And then, given the timing of the loan growth that happened in the quarter, do you have a sense for what the margin would have been at the end of the quarter? If you kind of had a full benefit of all the loans that you put on late in the fourth quarter?
Yes, I mean, you could probably run that number just taking the period-end loan balances versus the average loan balances for the quarter and then pull down the cash a little bit. But, it’s like 10 basis points if you do the math.
Okay, all right. That’s helpful. And then just the last one is, if you could just talk a little bit about some of the deposit strategies that you guys are thinking about as you head into 2016 and kind of that will drive the deposit growth for the year?
Yes, what we are trying to do is build a more relationship-based deposit strategy and get away from what had been a more single product focused strategy here. We had a lot of CD type accounts that had – nominally had checking accounts associated with them, but there was no activity in the checking accounts.
So what we are trying to do is, build both a commercial and retail consumer deposit strategy that brings more activity, more balances and probably a lesser number of actual accounts, because as I said, we had an awful lot of checking accounts with virtually insignificant dollars in them and they were expensive to maintain.
So, it really a deeper relationship strategy that we are trying to rollout and make it a better value proposition for customers on both the commercial and retail side to do more business with us and discourage those from just doing nominal business with us.
Okay, all right. Thank you all very much.
[Operator Instructions] And it appears there are no further questions at this time. Mr. O’Brien, I’d like to turn the conference back to you for any additional or closing remarks.
Okay. That’s it for the fourth quarter and for 2015. As always, we appreciate your interest in the company and in our progress and look forward to being with you at the first quarter call in April. So, thank you and enjoy the rest of your day.
This does conclude today’s conference. We thank you for your participation.
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