Sun Bancorp, Inc. (NASDAQ:SNBC)
Q2 2016 Earnings Conference Call
July 26, 2016 11:00 AM ET
Thomas O’Brien - President and CEO
Thomas Brugger - EVP and CFO
Mark Fitzgibbon - Sandler O'Neill Partners
Collyn Gilbert - KBW
Please stand by. Sun Bancorp’s Second Quarter 2016 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; Thomas Brugger, Executive Vice President and Chief Financial Officer and other members of Sun’s executive management team.
I will now turn the call over to Mr. Thomas M. O’Brien. Please go ahead sir.
Thank you. Good morning and welcome to Sun’s second quarter earnings conference call. Before I begin, as normal, we will direct your attention to the forward-looking statements and disclosures contained in the press release this morning and encourage you to read them at your leisure.
So the second quarter results for the company we reported this morning, our profitability continues along the path seen in recent quarters. Sun reported net income of $0.16 per share or $3 million. The underlying trends continue to track positively. The quarter included a $1.7 million negative loan loss provision owing to continued strong asset quality, little to no migration in loan risk ratings and flat period end loan balances.
Operating expenses at $17.1 million for the quarter included some one-time expenses and also some one-time revenues. There were also some accruals which are typically intra-year items and will reverse out over the third and fourth quarter.
As I mentioned, asset quality remains very strong in all categories of risk ratings, delinquencies, non-performing loans, virtually any way we measure it here. We added one $2.2 million loan to the non-performing category this quarter. It's a very long term seasoned loan here. It's always performed as agreed but at its recent maturity we elected to restructure the loan with a very aggressive amortization schedule. We reduced the rate and charges-off a few hundred thousand dollars which will be recovered over the next three or so years as the loan pays off. The loan was never delinquent in its history with the bank.
Capital levels and ratios are robust for both the bank and its holding company. Consequently the board was pleased to be able to commence a cash dividend at a modest level of a penny per quarter. Strategically we continue to struggle in the short term with meaningful net revenue growth and balance sheet growth. While new originations are healthy, cash flow from the legacy consumer and commercial book remains high. This presents a very -- this remains a very difficult interest rate environment to carry liquidity. We believe, however, that our disciplined approach in this highly competitive commercial market is the most prudent course of action for Sun. Our business lines are performing well and we are getting and expanding some very nice high quality commercial relationships.
Today banks walk a fine line between conflicting economic scenarios, managing in a highly regulated environment and providing an appropriate return for investors. Everything is of course a trade off and we are making judgments here on protecting our investors’ long term interests. This is an anniversary of sorts here as we began to rebuild Sun in July of 2014. It hasn't always been a picnic in the park but so much has been successfully accomplished and remain on the path -- we remain on the path that was articulated back then. Time has passed quickly but our commitment to all Sun’s stakeholders remains constant.
With that, I'll turn it over to Tom Brugger, our CFO to go through the highlights of the quarter.
Thanks, Tom. Good morning everyone. We reported net income of $3 million or $0.16 a share in the quarter. This is the sixth consecutive quarter of profitability. Overall we're pleased with the results given the difficult external environment and the continuing transition in the loan and deposit portfolios from past strategy to new strategies and I'll get into that in a little bit.
Let’s take a look at the revenue side first. Revenue bounced back by $1 million from the first quarter to $18.6 million. Net interest income grew by $0.4 million sequentially as average loans grew 7% annualized. And deposits and investments were relatively flat. The net interest margin expanded by 7 basis points to 2.98% as we continued to patiently deploy excess liquidity into quality loans.
Average interest earning cash fell by $22 million in the quarter to $126 million. Now as a reminder, our goal is to get that down to about $25 million. You will notice that loan outstanding fell slightly in the quarter when you look at period end March versus June. And also period end cash rose. There are couple of reasons for that. One is we had some late closings in the first quarter in commercial real estate and then in the quarter our payouts and amortization in loans were right around $100 million which is elevated.
Also, the commercial real estate originations were relatively mild versus previous quarters. But our originations will ebb and flow and, for example, in the third quarter our loans are up $30 million and our cash is down about $40 million. So over the longer term we will see average outstandings rise but period end we might see some run off for growth.
We continue to run-off the consumer portfolio and as a reminder we're not doing the originations there. So residential and home equity loans fell by another $13 million. Given the high level of payouts that I mentioned earlier, loan fees and prepayment penalties which flow through net interest income rose by $460,000 to $750,000 in the quarter.
Turning to the deposit side. Average deposits were relatively flat but we are seeing a mild mix shift as we transition relationship customers into our newly revised products and we start going off at that again. The deposit run-off that we experienced in previous periods which were primarily non-relationship and some large deposits that were parked here, has ended and we expect mild growth in future periods.
Our objective has been and continues to be to grow relationships, commercial real estate and C&I loan portfolios and fund that growth with deposits and keep our loan to deposit ratio around 95%. We believe with the current strategies and the current level of interest rates that the fully deployed net interest margin is around 3.1%.
The provision for loan loss was negative $1.7 million in the quarter. We continue to see limited downward migration in the commercial portfolio. We continue to see high quality in our new originations. And we also continue to see sustained recoveries and limited charge offs, so given that sustained asset quality success over time, the reserve levels are now moving lower to match the risk profile of our loan portfolio. We do not expect the reserves to loans to go much lower from here. But it really depends on the portfolio risk trends and the changes in economic conditions in our marketplace.
Couple of other pieces to note with the reserves for the quarter. We did move a portfolio of consumer loan into held for sale and took a charge-off of $0.5 million. This is a continuation of the proactive strategy for early identification of problem loans and try to restructure or sell them. We also had the one commercial TDR which Tom mentioned and that generated a charge-offs of $200,000.
Turning to fees. Fees rose by $600,000 sequentially. We had security gains of $426,000. Most of that was from the sale of FISA class P shares which the company received when Visa did their IPO, we sold those shares to another bank in the quarter. We also did a small restructuring of the investment portfolio where we sold $22.5 million of CLOs and $8 million of residential agency mortgage backed, and we reinvested the proceeds, plus a little bit into government backed multifamily CMOs.
The CLOs were not in compliance with the broker rule. So we had wanted to eliminate any exposure one year prior to the deadline for compliance, which is now 100% complete. We also saw a nice bounce back in our investment products. Fees in our Prosperis division which rose $160,000 from the first quarter. Overall the core non-interest income is trending around $3.3 million per quarter with branch and deposit related fees making up about 80% of that total.
Expenses totaled $17.1 million in the quarter. We continue to see good underlying expense trends. And one reminder that -- at our expenses, we do have seasonality, we tend to have higher expenses in the first and second quarter and then we see lower expenses in the third and fourth quarter.
A couple of items of note for expenses in the quarter. We did increase our recourse reserve for SBA loans that were sold in the past by $250,000. We also booked our PTO accrual which was about $350,000 in the second quarter, that were reversed itself in the fourth quarter as a reminder.
We had about $230,000 of severance related expenses and another $150,000 of other kind of one-time items. So if you add all those up, it’s about $1 million of expenses that are nonrecurring. We do expect some savings in the second half of the year with FDIC insurance premiums coming down, our OCC exam fees will come down. We also have some insurance savings for our D&O policies. We have a lease that's expiring. And we continue to see good progress on the headcount reductions over time.
So you put it all together, in summary, we are pleased with the progress given the challenging environment both from an interest rate and economic perspective. And we also had this headwind that I talked about with the transition runoff of old portfolio versus new.
Overall our revenues are stable and we're seeing sustained asset quality strength, solid expense management trends and we also have plentiful capital.
So with that, we turn it back over to Tom.
Okay. And operator we can take questions now.
[Operator Instructions] Our first question comes from Mark Fitzgibbon with Sandler O'Neill Partners.
Just – first, two clarification questions on expenses. Should we assume, I think, $17.1 million was the expense this quarter. I thought you said there was $1 million of nonrecurring expenses isn't there. When will that go away and so should we assume a good run rate for expenses it’s sort of 16 million-ish?
I think we take a longer term view, the average expenses – if you strip out seasonality, the average expense is around $16.5 million. We just kind of ticked off the items in the quarter that -- one of those items, the $350,000, the PTO accrual is – that’s a intra-year issue. Some of the other ones are kind of non recurring which would be the SBA items and the severance related expenses, that sort of thing. But on average we're trending around $16.5.
Okay, and then just to clarify the Visa gain of $387,000, that is included in the gain on sale of securities line or is that somewhere else?
No, it isn't – cannot tell.
And then given your announcement on the dividend, I guess, I'm curious you're still fairly heavily capitalized, would a buyback be a possibility at some point in time?
Yes, Mark, it’s Tom. It certainly could be – it’s not the most of financially attractive right now. And so we've looked at it. And I think it's probably one of those things that we've put on the agenda for the next capital discussion. But it's probably a couple of quarters out before we do that.
And then lastly, given that you've sort of jumped over most of the hurdles for DTA recapture, what's left, and when do you think you might be able to recapture that DTA in its entirety?
I think we’ve said pretty consistently at six to eight quarters and kind of a back end 2016 discussion. So I think we're still there. I mean, given the longer history here on the size of the DTA we're probably a little bit of an outlier in terms of the standard process. But I think we're pretty comfortable that it's basically under your discussion and evaluation.
Our next question comes from Collyn Gilbert with KBW.
Just wanted to circle back on your comment. I know this has been a target of you guys for a little while that 3.10% NIM on the fully deployed liquidity. Can you offer kind of what you think the mix of the balance sheet will look like when you get to that level? Or what you need the balance sheet to look like to get to that level?
I mean, basically if you look at our second quarter numbers, if you add -- if you replace the cash with loans and we kind of see the same mix would be around 3.10%. And we have kind of the normal level for prepayment penalties that flow through margin. And then on a go-forward basis, then we want to grow it and kind of keep it around 3.10%. And as you know yield curve is very flat, absolute level rates are very low. So that’s kind of with the mix that we have right now that that's where the margin will migrate to. But mix would be basically add loans into second quarter numbers we will get around 3.10%.
So you will take that cash position pretty much all the way to getting close to nothing, I presume.
Right, and if you remember back in time as we went through the restructuring that number was around $500 million. So it just keeps getting chipped away every time, and down to $125 million and we have about another $100 million to go.
And just around the loan growth too. Do you have the split as to what the originations were versus what the pay-downs were in the quarter?
Amortization and pay-offs were right around $100 million. So you can see the change in the balances for the quarter and the difference would be the originations.
Okay, so $100 million. And that $100 million, how does that compare the past few quarters? Is that number decelerating I presume?
Well, it was very high last year and then it decelerated somewhat. And now I think it kind of accelerated again. So it was running when the portfolio was bigger, that number was obviously higher, at $175 million, the last few quarters have jumped up a little bit.
And your expectation I think from what -- I think what you guys said is that you are thinking loan balances will -- the actual net growth will start to reappear in the third quarter.
Again I think with the strategy, you're doing a lot of a little bit bigger credit here now focused at commercial real estate and C&I. So you're not doing little granular loans every week, you tend to have a $15 million, $20 million credit close, that’s like two or three of those that will close and sometimes it will be over quarter end, sometimes it will be before quarter end. So you might see a little lumpiness when you look at period end, but the average outstandings will drift up over time.
The issue, Collyn, that we talked a little bit about the transition in the portfolio because we have the consumer portfolio that’s running off. We have some of the old portfolios that have been running off for the last two years. And then we have the new strategies and the origination levels for the new strategies are pretty good but you're dealing with that runoff and we’re getting closer to the end of that. But the growth will get better in the future as the run-up flows from a legacy stuff.
And then just what do you anticipate the impact to be? I mean just following your comments that you're kind of now moving a little bit more to an offensive strategy on the deposit side. Any impact we should see on the funding costs fair or I sounded like the objective is to get to me commercial relationships to bring over deposits so does that mean that we see kind of maybe more the non-interest bearing grow more, how should we think about what might be happening on the deposit initiative side?
I think Collyn, you'll see a couple things there. First of all, it's designed to, as you said, build the commercial deposit balances and the relationships with Sun. Also some of the accounts that either we were able to increase or move out of the bank had operating costs associated with them. So you'll see some operating expense savings in areas like technology. But I think the 4 basis points you saw in the quarter is probably representative of what the strategies expense impact us.
And then just two things. Tom, also just circling back your comment on the buyback, you just said not financially attractive right now to do that. What kind of goes into your thought process on how you evaluate the buyback versus the dividend when it comes to allocating capital?
Frankly, the dividend was easier to do given some of the longer term history here at Sun. And the biggest issue with the buyback really is the earn-back period.
And you're looking at that – I am sorry, go ahead.
No, no, and there's two ways to look at it. Obviously the stated tangible book value today and then the fully phased in deferred tax asset recapture book value. And that's kind of the dilemma.
You're looking at it more on a stated basis than –
One level it’s attractive, or doable and – but at the stated tangible book value today it's pretty expensive.
So if we – so then is it safe to assume that perhaps assuming capital continues to build, you get to the DTA recapture that, then buyback maybe would come to a little bit more of a forefront in terms of capital pool?
Yeah absolutely. I think that's consistent with what we do.
And then just final question, how much tax rate should we use for the third quarter or for the rest of the year do you think?
Well the only tax that we’ll have will be the tax side and we mentioned in the past, we don't have any normal income tax with an effective rate should run $100,000 a quarter or so. Around $100,000 a quarter.
[Operator Instructions] And our next question comes from [Ross Hatterman with Hatterman Management Corp].
Good morning gentlemen. Just two quick questions. With all the local consolidation, Tom, could you give us a sense of how you view that or you’re seeing change in pricing either on loan or the deposit side? And a quick update, how big in dollars was the DTA allowance as of the end of June 2?
I think the deferred tax asset at the quarter end was 126 or 127 million.
Yes. And we've actually -- we picked up a few good commercial accounts as a consequence of some disruption in the market, and let's say the Philadelphia area and Camden County and Burlington and also up in North Jersey. We’ve also had -- some of the banks with really high commercial real estate concentrations have had to scale back due to some regulatory pressures and there's some opportunity for us in that. But competition still remains really really tight. I mean it's very competitive on both financial terms and covenants and valuations. So as I said in the opening comments, we're trying to be -- we're trying to walk that fine line between doing this the right way and still getting our share of deals.
I think with the turmoil with some of the consolidation and I'd say more so in kind of the Philadelphia and New Jersey border counties to that market. There's probably some greater opportunity forthcoming and some of the other ones, Ross, they tend to be more single family mortgage originators and I don't expect to see much out of that.
End of Q&A
And there are no questions in the queue at this time. [Operator Instructions] And with no further questions in the queue, I'd like to turn the conference back over to Mr. O’Brien for any additional or closing remarks.
Okay, thank you. And as always we appreciate your interest in the Sun Bancorp and your participation in these calls. Enjoy the balance of the summer and we'll talk to you at the third quarter call. Thanks operator.
And that does conclude today’s call. Thank you for your participation. You may now disconnect.
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