Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Sterling Bancshares, Inc. (NASDAQ:SBIB)

Q1 2008 Earnings Call Transcript

April 22, 2008 11:00 am ET

Executives

Graham Painter – EVP of Corporate Communications

Downey Bridgwater – Chairman, President and CEO

Zach Wasson – EVP and CFO

Analysts

Barry McCarver – Stephens, Inc.

Erika Penala – Merrill Lynch

Brett Rabatin – FTN Midwest Research

John Pancari – JPMorgan

Jennifer Demba – SunTrust Robinson

Dave Bishop – Stifel Nicolaus

Jefferson Harralson – KBW

Operator

Good morning ladies and gentlemen. Thank you for standing by. Welcome to the first quarter 2008 Sterling Bancshares earnings release conference call. At this time, all participants are in a listen-only mode. (Operator instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Graham Painter. Please go ahead, sir.

Graham Painter

Thank you operator. Good morning everyone. I'm Graham Painter, Executive Vice President of Corporate Communications for Sterling Bancshares. This morning, Sterling Bancshares released results for the first quarter of 2008. To discuss those results with you today are Downey Bridgwater, Chairman, President and Chief Executive Officer; and Zach Wasson, Executive Vice President and Chief Financial Officer.

Before we begin and I turn the call over to Downey, I would like to remind everyone of the Safe Harbor statement included in today's earnings release. The Private Securities Litigation Reform Act of 1995 provides a Safe Harbor for certain forward-looking statements including statements made during the course of today's conference call. These forward-looking statements are based on the Company's current expectations and beliefs concerning future developments and their potential effects on the company. There can be no assurance that future developments affecting Sterling will be those anticipated by the company. Factors that could cause actual results to vary from those projected in the forward-looking statements are set forth in today's earnings release, which has been posted on the Investor Relations page of our website at banksterling.com.

On today's call, our speakers may reference certain non-GAAP financial measures which we believe provide useful information for investors. If necessary, we will post reconciliations of these non-GAAP numbers to GAAP results on the Investor Relations page of our website. For additional details on these matters and other risks that could affect the company, please refer to the company's most recent annual report on Form 10-K, which has been filed with the Securities and Exchange Commission. Sterling assumes no obligation to update the information presented on this call. I would now like to turn our call over to Downey Bridgwater, CEO. Downey?

Downey Bridgwater

Thanks, Graham, and welcome everyone. We are pleased to report our financial results to you this morning. For the first quarter of 2008, we earned approximately $11.6 million or $0.16 a share, which reflects our company's strong underlying fundamentals. The highlights for Sterling in the quarter include healthy internal loan growth, the successful acquisition and integration of ten banking centers in the Dallas and Fort Worth areas, solid expense control, increased non-interest income, and expansion of our net interest margin. We also experienced temporarily elevated charge-offs and provision, which I will discuss in detail later.

As I am sure you are aware, over the past few months, the U.S. banking industry has experienced rapid deterioration in credit led by continued weakness in the national housing market and overall slower economic activity. Given the national economic backdrop, our first-quarter results were solid.

The economies that we operate in, Houston, Dallas, Fort Worth and San Antonio, all are performing admirably based on the latest economic data. However, we remain aggressive observers regarding the potential impact a slowing national economy might have on Texas. Our markets, especially Houston, are to some extent insulated from many of the issues currently being experienced by other parts of the country, due in part to our relatively stable housing prices, large presence in the energy sector and significant export activity through the port of Houston and other distribution channels across the state. We could still be negatively impacted if the U.S. was to experience a prolonged national recession, but we don't expect that to be a likely scenario at this point in time.

Our earnings were impacted by an increased provision in the first quarter. This increase was due to the acquisition of $54 million in loans from First Horizon, which had no allocated reserve, internal loan growth of approximately $76 million, and an increase in net charge-offs. While net charge-offs were elevated in the first quarter, we still expect charge-offs to be within our stated range of 15 to 25 basis points of average loans for the year. Additionally, our losses were not the result of weakened economic conditions and do not represent a deterioration of any specific industry segment or the overall loan portfolio.

As most that have been following Sterling know, we have done a lot of work over the past several years to improve Sterling's credit culture and overall approach to risk management. It is worth noting that a significant amount of the loans charged off in the quarter were originated by loan officers no longer at Sterling. By transitioning from a decentralized community bank approach to credit, to a more sophisticated, centralized, standardized regional bank approach to credit and risk management, we have been able to significantly reduce credit costs over the last couple of years. Our transition is still underway, but I'm extremely pleased with the progress we have made and the approach we are taking to credit and risk management.

Of the $2.9 million in net charge-offs recorded this quarter, approximately $1 million was related to one loan. This loan, which had an original balance of $1.4 million, was placed on nonaccrual at the end of the fourth quarter, when the borrower filed Chapter 7 bankruptcy at the end of the year. The loan had been current up to that time. There were significant misrepresentations made by the borrower concerning the inventory of the company, which came to light during the creditor's meeting. For the most part, we have liquidated our collateral and are pursuing legal action against the guarantor for the deficiency.

During the quarter, we also took a charge on some older, smaller, non-performing loans, which we sold as part of a cleanup effort to identify some isolated non-performing credits where we no longer had an ongoing relationship with the borrower.

Non-performing loans increased only $1.8 million in the first quarter to 62 basis points of total loans, which is a 3 basis point increase quarter over quarter. As I discussed on our last earnings call, our largest non-performing loan relationship totaled approximately $4 million and is fully secured by real estate. We expect it to be paid off in full near the end of the second quarter or at the beginning of the third quarter of 2008. We do not anticipate taking any losses on this credit.

The increase in non-performing loans this quarter was due in part to an increase in non-performing SBA guaranteed loans. These loans, on average, have a 75% guarantee from the U.S. Small Business Administration. Therefore, we do not expect significant losses on these credits, but will take a few months to work through them.

Over the past 60 days, we have audited and diligently reviewed our remaining SBA portfolio, and related management processes and are encouraged by the results. On the whole, SBA guaranteed loans are a very small portion of our overall portfolio, making up less than 2% of our total loans. Our allowance for loan losses to total loans was 1.01% at the end of the first quarter. Our allowance ratio was flat quarter over quarter, as well as when compared to the first quarter of 2007, even with the considerable loan growth we experienced over these periods.

Based on a thorough review of our loan portfolio and what we are seeing in our markets at this time, we are confident that we are adequately reserved. We generated very healthy loan growth in the first quarter of approximately $130 million, which includes $54 million of loans acquired from First Horizon. Our loan growth was primarily concentrated in C&I and commercial real estate.

While our loan pipeline is healthy across our Texas footprint, we will continue to be prudent in our underwriting, making sure that we fund quality loans that add value to our franchise. As we stated in last quarter's earnings conference call, due to the Fed's decision to rapidly lower short-term interest rates and the need of some of the larger banks and financial institutions to retain liquidity, we made the strategic decision to utilize additional lower-cost borrowings in the first quarter to fund our growth and allow some of our higher cost deposits to run off.

By implementing this approach, we ended up with a managed reduction in time deposits for the quarter of approximately $120 million in average balances. This action, combined with the interest rate hedge we purchased in 2006, helped support our net interest margin, which increased slightly for the quarter to 4.67%.

On February 8 of this year, we successfully completed the acquisition and integration of the ten First Horizon banking centers in the Dallas and Fort Worth area, which we refer to as our North Texas region. With our 17 banking centers and great team of bankers in North Texas, I'm very excited about our future growth opportunities in those markets.

I am also pleased with the progress we continue to show on our expense control initiatives. Excluding acquisitions, our non-interest expense was down by approximately $200,000 as compared to the fourth quarter of 2007. Since the first quarter is typically a little more of a challenge because of salary raises, full payroll tax burden, and increased benefit costs, I am encouraged by our results. We continue to emphasize with our bankers the importance of serving all the financial needs of our customers, not just providing loans and accepting deposits.

By taking this holistic approach, we can better serve our customers by providing them the latest products and services that help them make their businesses more efficient, productive and profitable, as well as helping the principals and their employees attain their personal financial goals. As a result of these efforts, the bank benefits by being able to diversify our revenue, and we are making progress toward these goals.

Non-interest income was up approximately $600,000 during the first quarter to $10.7 million representing 18% of net revenue. Acquisition activity has slowed considerably in the banking industry during 2008. We will continue to have dialog and build relationships with potential partners in our Texas markets, but as in the past, we will be very selective with any potential acquisition.

Finally, I note that our capital and reserve levels remain very healthy. We will continue to be vigilant in the management and use of our capital, especially as it relates to acquisitions.

With that, I would like to turn the call over to Zach Wasson, our Chief Financial Officer, to review our financials in more detail. Zach?

Zach Wasson

Thanks, Downey. We appreciate everyone taking the time to join us on the call this morning. Net income for the first quarter of 2008 was $11.6 million or $0.16 per diluted share, down slightly from the first quarter of 2007. We recorded a loan loss provision of $4.2 million in the first quarter of 2008, which somewhat muted an otherwise fundamentally strong quarter. As Downey mentioned, positives for the quarter included healthy loan growth, net interest margin expansion, increased non-interest income, and solid expense control. Excluding the acquisition expenses related to First Horizon, we had positive operating leverage for the quarter.

During the first quarter of 2008, we were able to increase our net interest margin through the active management of funding costs and due to the impact of work we have done over the past two years to position our balance sheet to be more neutral to movements in short-term interest rates. While we expect there to be continued pressure on the margin due to the current interest rate environment and possible future rate cuts, we are pleased with our ability to maintain our net interest margin without compromising the makeup of our balance sheet.

Our margin was up 5 basis points linked quarter and down 23 basis points from a year-ago quarter, despite Fed funds declining by 200 basis points in the first three months of the year and 300 basis points since September of 2007. Our net interest margin benefited this quarter from our strategic decision to use additional lower-cost borrowings and allow some of our higher cost CDs to run off.

Our CD portfolio naturally has a very short duration, which has benefited us in this period of declining rates. As of March 31st, approximately half of our CD portfolio is scheduled to mature in the second quarter of 2008.

In addition to reducing our funding costs, the interest rate hedge that we purchased in 2006 continues to provide interest income as the prime rate has dropped 275 basis points below the strike rate on our interest rate floors. This hedge effectively converts our loan portfolio from a mix of 41% fixed rate and 59% variable rate loans to a mix of 51% fixed rate and 49% variable rate loans.

Our overall average cost of funds on deposits for the first quarter of 2008 was approximately 1.96%, down from 2.39% in the fourth quarter of 2007. We are seeing positive results from our efforts to control the growth in expenses through the establishment of a sustainable cost discipline throughout the organization. For the first quarter of 2008, noninterest expense was down approximately $200,000 linked quarter, excluding expenses related to the acquisition of the First Horizon banking centers.

This decrease is more impressive when you consider that the first quarter of 2008 included an additional $500,000 of expense related to increased FDIC deposit insurance premiums. Going forward, our FDIC insurance premiums should not increase substantially from these new first-quarter levels. However, we expect to be paying at this new level in future quarters. The increase during the quarter in the occupancy expense was related to the acquired banking centers.

Customer service fees were up approximately $400,000 in the first quarter of 2008 as compared to the first quarter of 2007. This increase can be partly attributed to the lower earnings credit rate on our commercial deposit accounts on analysis, which is a direct result of lower short-term interest rates.

Due to the disruption in financial and credit markets this quarter, we did not generate as much non-interest income as we would have liked in the form of gains from the sale of loans. We did manage to sell $7.5 million of performing commercial real estate and SBA loans during the quarter, generating approximately $300,000 in net gains, up $100,000 from the fourth quarter.

At this point, we do not expect loan sale activity to pick up significantly in the next few quarters. If it doesn't, we are more than content to keep these loans on our balance sheet until we can get improved pricing. The loans that we hold for sale consist of SBA guaranteed loans and commercial real estate loans that on average have loan to values below 58% with current net yields around 7%.

Our non-interest income was up during the first quarter by approximately $400,000 over the fourth quarter of 2007. The other non-interest income increase was a result of a pretax benefit of $300,000 we received from the mandatory redemption of some of our shares of Visa related to Visa Inc.'s initial public offering.

From a capital perspective, we are very well positioned. At the end of the first quarter of 2008, Tier 1 capital stood at 8.8%, our total risk-based capital was 10.8% and our tangible capital ratio was 6.8%. Based on our net income less dividends, we anticipate that our capital levels will increase slightly over the near-term due to the capital we should be able to generate internally.

As an update to our share buyback program, we purchased 100,000 shares of our common stock during the first quarter at an average cost of approximately $9.06. The effective tax rate was approximately 32% for the first quarter of 2008. We expect our effective tax rate to be at similar levels for the remainder of the year.

With that, I would like to turn the call back over to Downey before we open the call for questions. Downey?

Downey Bridgwater

Thanks, Zach. In summary, our solid first quarter results reflect the strength of our franchise and our markets. We are well positioned for future for success. We look forward to continuing to execute on our strategy of providing outstanding customer service and competitive banking products to all constituencies within the small and medium-sized business segment in Texas metropolitan market.

With that, I would like to open the call to questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) And the first question comes from the line of Barry McCarver with Stephens, Inc. Please go ahead.

Barry McCarver – Stephens, Inc.

Good morning, guys. A couple of questions, I guess first off, probably for Zach, thinking about a little bit more color on the margin. I could see your point to the liabilities, 67 basis point decline in rate there. Does that leave much left for the second quarter? I'm wondering your thoughts – what margin is going to do moving into 2Q here.

Zach Wasson

Barry, as we said in the comments, we still expect our margin to be under pressure. We do have another $550 million of CDs maturing, but the average rate has moved down to between 3.50% and 4%. So, as we have seen the market correct to these new lower levels, during the first quarter, we were anticipating this, and we have moved our rates down to more appropriate levels. Going forward, we are seeing like every other bank that 2.25% funds rate does not leave much further to go to get to zero. So the margin will be under pressure, but we will do what we can to manage that pressure.

Barry McCarver – Stephens, Inc.

Okay. And then, second question I guess for you, Downey, really kind of in two parts surrounding growth. First off, in the press release, you mentioned your size in Dallas now and in Fort Worth with these new branches and getting some critical mass there. Your thoughts on what else you might desire in terms of numbers in that market. And then just overall, you touched on acquisitions and it certainly sounds like you are still looking. You look over the last two or three years, small deals have been coming in for you guys at a pretty good clip. Is that still something you're going to look to for growth, assuming that the pricing qualities there?

Downey Bridgwater

Yes, I will add to the first part of your question first. We do have a critical presence now in Dallas and we entered Fort Worth with this acquisition. I would love to be able to have eight to ten more branches there over time. But, we are going to add the growth and then the capacity on an organic front. We have always tried to take that approach because it's very expensive and a much more lengthy process to get growth out of a de novo. So, we will continue to look to those fill-in opportunities, but that's still going to be a secondary methodology for our expansion.

And to the second part of your question, most certainly, we are looking for acquisitions that would fit us well. Franchises between the – call it the $150 million to $500 million range in size would fit us very nicely, fold-in acquisitions. But to your point, the price has to be reasonable because it's got to be accretive to earnings or it doesn't really make much sense for us to acquire the bank.

And most importantly, their balance sheet and their funding mix is the most important thing that we look at. They've got to have core deposits that are relationship based. Therein lies the value of those franchises to us. And that's what's important to our growth and the way in which we will underwrite those acquisitions. So, most certainly, we will look for those, but it's been kind of quiet for the last few months.

Barry McCarver – Stephens, Inc.

Okay. And then just a quick housekeeping, I noticed staff expense was down a couple of hundred thousand over 4Q in the quarter despite the additional branches. Am I missing something driving that?

Downey Bridgwater

No. We are now paying competitive salaries and competitive incentives. So, we are now finally at the place where we have needed to be for quite some time and the relative overall compensation and benefits are at competitive levels. Our HR group and particularly Wanda Dalton, our Chief Human Resources Officer, has done a magnificent job at competitively bidding various different services that we provide our employees and benefits that we provide our employees, and reducing costs in those arenas, everything from insurance to health care and other things like that. So we've done a very good job at managing those expenses downward.

Barry McCarver – Stephens, Inc.

That's great. Thanks a lot, guys.

Operator

And the next question comes from the line of Erika Penala of Merrill Lynch. Please go ahead.

Erika Penala – Merrill Lynch

Good morning. Downey, I was just wondering, the regulators have been speaking out publicly about bank reserve levels. But, are you actually receiving any ground-level encouragement from the regulators to re-examine your allowance ratios?

Downey Bridgwater

No.

Erika Penala – Merrill Lynch

Okay. What are the – you said that you are an active observer of what's going on in your marketplace. Is there any particular loan category that you are watching, and what are early stage delinquencies looking like across the portfolio?

Downey Bridgwater

Sure. We watch all of our loan categories very carefully. There are some categories that we don't necessarily bank, such as smaller home loans, mortgage loans – we don't have any of those in our portfolio. We don't have a mortgage company. The loans to homes under $250,000 in pretty much all of our markets has become quite soft. That extends all the way to land acquisition, lot development, as well as home construction and relative sales. Above $250,000, it's a little more firm. We've seen some softness in the $500,000 to $1 million home range. But certainly above that level, the demand is still very strong.

Now, we also are noticing some pullback in some projects. There are some projects that have been planned, whether they are shopping centers or other retail construction projects, and we have noticed that they've started to slow up somewhat, so that's a very healthy thing. And frankly, that's a good sign that the bankers are paying attention to demand overall as well. So, we are not seeing in our portfolio any significant deterioration or any systemic issue that's broad across any particular industry sector that we are overly concerned about.

Our borrowers are being really smart. We at the same time are encouraging them to make sure that they keep their inventory levels in check and they don't take unnecessary risks to expand their business at a time when there may be some challenges. I think we are all just pretty nervous and we're watching this. The challenges that we all went through about 20 years ago are still pretty much fresh in our memory. So, we are not going to do anything stupid to create problems for ourselves or for our customers.

Erika Penala – Merrill Lynch

I know your construction concentration is mostly commercial, but do you have any exposure to residential projects that have homes or that do fall under that $250,000 sales price range?

Downey Bridgwater

That I know of, we only have one small one and it's actually not performing the way that we want. So it's a very small, less than $2 million relationship, but we are watching that very, very closely. As you can see from our numbers, our residential construction is just under 6% of our total loan portfolio and we don't really have a big exposure to that at all. Most of our residential construction is to business owners and wealthy individuals.

Erika Penala – Merrill Lynch

And one last question. Zach, is this $37.5 million expense run rate a little bit high going forward, or what should we – what's a number that we should assume?

Zach Wasson

No, $37.5 million with the increased FDIC is probably a little high, but only by the amount of the one-time charges for the acquisition.

Downey Bridgwater

Which is a little over $0.5 million.

Zach Wasson

Right.

Erika Penala – Merrill Lynch

Thank you for your time.

Operator

And the next question comes from the line of Brett Rabatin with FTN Midwest. Please go ahead.

Brett Rabatin – FTN Midwest Research

Hi, good morning. Wanted to ask you, you mentioned in the commentary that you had some portion of loans charged off in the quarter from loan officers that were no longer with Sterling. Can you give us a little better estimate of what the percentage might be other than obviously you had the $1 million charge-off for the Chapter 7 issue, but any more color around how much that might be relative to the total?

Downey Bridgwater

Ex the $1 million, it's a little more than half.

Brett Rabatin – FTN Midwest Research

A little more than half, okay. And you also talked about a cleanup effort. Any color around what that resulted in as far as charges for the quarter?

Downey Bridgwater

The ultimate charge from some of those loans was just about a third of the charge-offs, just under a third, call it $800,000.

Brett Rabatin – FTN Midwest Research

Okay. And then wanted to go to the margin, from what I understand, it sounds like you are going to be able to lower your cost of CDs going forward. But I didn't quite understand if we might also see some mix change going forward. And so I was curious to hear some color on if you might continue to utilize the borrowing market more in the next few quarters and just kind of some thoughts on liquidity and whether – where you see the securities portfolio from here.

Downey Bridgwater

Well, let me first quantify – what we did in the first quarter was kind of a – I would almost call it a onetime opportunity. Because we saw the Fed drop rates so quickly, we let some rate shoppers that are not necessarily relationship driven CD customers, if they want to go to other places that they can get higher rates, fine, and we wanted to take advantage of that and we saw that coming. So we kind of took advantage of this one quarter. We don't expect our CD costs to drop dramatically. I mean, it's still pretty competitive out there and I think that things are going to begin to level off somewhat to Zach's earlier point.

Zach Wasson

Right, and on the investment portfolio, there was an opportunity this quarter with some of the spreads widening out for us to acquire some securities. And we still have a very nominal exposure to a falling 100 basis point move in rates. And that would be around 1% of our net interest income. And by buying some fixed-rate investment securities, we are able to manage that situation better. Plus, they give – those securities had over a 5% yield, which versus a 2% or 2.25% Fed funds rate, adds value to Sterling.

Downey Bridgwater

And we actually had a yield curve. It's been a while.

Brett Rabatin – FTN Midwest Research

And then just lastly, Downey, I wanted to ask you on – I noticed the yields on the loan portfolio versus the last quarter. And I was curious to hear your thoughts on whether you were being better able to price risk in with an abatement of some of these competitors being out of the market and CRE and maybe C&I, and just where you see opportunities relative to where people have maybe pulled their horns in (inaudible).

Downey Bridgwater

Well, we are beginning to see a little of that, and that is a good thing. And so therefore, we can be a little more selective. As to price, it's still a big factor and we are having those discussions. We encourage our bankers to be as fair, but certainly as supportive of the overall interest of the bank as they possibly can be relative to pricing their loans. More importantly is pricing their deposits as smart as they possibly can. And of course, you dial in the hedge that we mentioned, that we bought back in 2006, that's helped out a ton.

Brett Rabatin – FTN Midwest Research

Okay, great. Thanks for all the color.

Operator

And the next question is from the line of John Pancari with JPMorgan. Please go ahead.

John Pancari – JPMorgan

Good morning. Just trying to get a little bit additional color on your outlook for your loan loss reserve, if we do see some incremental upside pressure on nonperformers and if you could provide some clarity on your expectations there, but if we do see some upside pressure there, do you expect that the relative reserve size, particularly relative to loans will likely trend higher from where it stands right now?

Downey Bridgwater

I'm going to give you two answers to that. One, I don't expect our nonperformers to increase materially. But if it did, of course, we would follow the formula that we utilize for setting aside reserves. The challenge we are having right now of course is the fact that more of our overall reserve is growing in the unallocated portion. So we are very careful about that, but given the uncertainty in the market and other issues like that, we are going to be as prudent and mindful of keeping reserves as much as we can and still stay within the guidelines provided by all the regulators.

John Pancari – JPMorgan

Okay. And then separately, on the bankers, the recent banker departures, can you just remind us of the total number of bankers that you have lost in, I guess, in the past six months? And then, how many of them – I think you indicated before that you had a small number that were actually regrettable departures. But just if you can give us some additional color on how many people have left.

Downey Bridgwater

Well, the regrettable – we had a couple of bankers that I wish – that's two, that I wish could have stayed. But they are – one was over in our de novo operations group and another was a small business lender. So in terms of the overall impact of the franchise, it's not huge, but they are good people and we would love for them to stay.

The remainder of those individuals have chosen to seek opportunities elsewhere. We look forward to competing with them fairly. And the exact number of bankers is around a dozen, including those two.

John Pancari – JPMorgan

Okay. All right. And then lastly, on the expense side, can you just give us some additional color on where you think you could be getting any incremental expense saves, or where you can be pulling out some additional improvement to your operating efficiency ratio here as we move through '08?

Downey Bridgwater

Sure. There's the vendor management. We're doing more and more consolidation. As we talked about before, we are consolidating several of our operations around the Houston area into one location. And in fact, the first group just moved in this past weekend, so the relative efficiency and productivity that is going to be gained out of that consolidation is going to benefit us for many years to come. It's something, frankly, I wish we could have done several years ago. But having sold our mortgage operation, it put a big cramp in our earnings and we had to earn our way back to the ability to become more driven to achieve greater efficiency.

Zach Wasson

And John, this is as much about an attitude as anything. And our bankers are really coming around to being thrifty, to spending money where we need to spend it, but not to, of course, waste any. In the vendor management area, we have a task force that's identifying a number of the expense categories, identifying the top-10 vendors in those categories, and we are going through a process to either get those vendors to reduce expenses or get the vendors to teach us how to use their products more effectively and efficiently. So we've made a lot of progress, but we plan on making this a part of Sterling.

Downey Bridgwater

And of course, the largest expense category is salary and benefits and having gone through the various iterations of our incentive programs, both short-term and long-term, modifying our benefits to be competitive and ultimately paying competitive salaries is making the biggest difference of all.

John Pancari – JPMorgan

Okay. And then more specifically on the efficiency ratio, do you have any expectation about where that could trend? I know on a cash basis, it's generally hover between 61%, 62%. Any color about where that could go as a result of these efforts for the year?

Downey Bridgwater

We have talked in the past. Our goal is around 60%, and we feel very comfortable that we will get in that 60%, 61% range. It's dropped the last couple of years in a row and we expect it to continue that trend.

John Pancari – JPMorgan

Okay. And the 60% to 61% is a target by the end of this year or –?

Downey Bridgwater

Right.

John Pancari – JPMorgan

Okay. All right, thank you.

Downey Bridgwater

Thanks, John.

Operator

And the next question comes from the line of Jennifer Demba with SunTrust Robinson. Please go ahead.

Jennifer Demba – SunTrust Robinson

Hi.

Downey Bridgwater

Hi, Jennifer.

Jennifer Demba – SunTrust Robinson

Could you quantify for me, Zach, how much of your net charge-offs in the fourth quarter and the first quarter were related to the departed – the former lenders? How much you expect in future quarters?

Downey Bridgwater

We think we have cleaned all that up. We don't really have much left. There may be a few isolated loans here and there, but there's not a large amount remaining. And I would certainly in the first quarter, as I mentioned earlier, we quantified that as around about 50% of our charge-offs, ex $1 million broad [ph] deal. In the fourth quarter, I'm going to guess it's about a similar number. I don't have that off the top of my head. I would have to go back and look at it. We'll gladly get that for you.

Jennifer Demba – SunTrust Robinson

Okay, thanks a lot.

Downey Bridgwater

Thanks, Jennifer.

Operator

(Operator instructions) The next question comes from the line of Dave Bishop with Stifel Nicolaus. Please go ahead.

Dave Bishop – Stifel Nicolaus

Hey, good morning gentlemen.

Downey Bridgwater

Hi, Dave.

Zach Wasson

Good morning.

Dave Bishop – Stifel Nicolaus

Quick question. In terms of the allocation to the First Horizon loans there, in terms of the provision this quarter, do you have a number for that?

Downey Bridgwater

Call it 1%.

Dave Bishop – Stifel Nicolaus

About 1%?

Downey Bridgwater

Because it didn't have any allocation to it at all, so – (inaudible).

Dave Bishop – Stifel Nicolaus

(inaudible) overall?

Downey Bridgwater

Yes, exactly.

Dave Bishop – Stifel Nicolaus

How about – what does the deposit mix look like there at the end of the quarter? Were you successful in sort of revamping that a little bit? Or is that still sort of in a workout phase there in terms of getting that more in line with the rest of the Sterling franchise?

Downey Bridgwater

We're working to get it closer to our mix. They had some checking accounts and some money market accounts, but a big chunk of that was CDs. So we have been working some of those high-priced CDs out of there. In terms of what we actually took, it was down to about $88 million overall, so – and about half of that was CDs. So we've been working to move those either into a money market account that might pay a little bit higher yield, but still much lower than what they were paying on the CD side. So we're starting that transition and we are very pleased with what's going on.

Bruce Bradford, our Regional CEO and Greg Martin, our Regional Manager there, has done a great job at getting that integrated. I can't tell you how pleased we are with the level of sophistication and the attitude of the folks that were at First Horizon and their ability to step in and make our acquisition work very well and their attitude about helping to build Sterling now along the lines that we've talked about strategically. So great fit and it was a very smooth, clear, clean transition.

Dave Bishop – Stifel Nicolaus

And Zach, in terms of the interest rate hedges there, I don't know if you can quantify the net interest income benefit that that provided this quarter.

Zach Wasson

Not off the top of my head, but they have 8%. For orders [ph] in the strike price, it's a total of $363 million. So, whatever that calculates into is our benefit.

Dave Bishop – Stifel Nicolaus

Thanks.

Operator

And the next question comes from the line of Jefferson Harralson with KBW. Please go ahead.

Jefferson Harralson – KBW

Thanks, guy. Zach, I want to ask you an accounting question. It was my understanding that when you bring over loans from a purchased brands acquisition, that the loans just come over with a kind of mark on them, and not have to have a provision set aside against it, a specific reserve set aside against it. Is that a – was I just wrong there? Or how does the accounting work on bringing over –?

Downey Bridgwater

Jefferson, this is not a specific allocation. This is a general allocation of 1%.

Jefferson Harralson – KBW

Okay.

Downey Bridgwater

Does that make sense?

Jefferson Harralson – KBW

It does.

Downey Bridgwater

It's combined in with the total of the whole loan portfolio.

Jefferson Harralson – KBW

All right.

Downey Bridgwater

In fact, there were no loans that we acquired from First Horizon that required any specific loan reserve allocation.

Jefferson Harralson – KBW

All right. Can you comment on the kind of your energy lending business this quarter and sort of the trends that we should expect for the year in that business?

Downey Bridgwater

Yes, the energy business, energy lending group has done a very good job at being able to pick up additional credits from larger banks who have looked to shed some assets. Obviously, there's tremendous opportunity, and we have a certain appetite, certain tolerance for exposure to that in our overall loan portfolio. We've talked about it many times, keeping it at or below 10% of our overall loan portfolio and that's where we are.

So we want to be careful with that and not stretch out and do things that are going to hurt us on a lot of fronts. In particular, our overall loan yield and relative net interest margin. (inaudible) to us at all.

Jefferson Harralson – KBW

Thanks a lot.

Operator

Mr. Painter, there are no additional questions at this time. Please continue.

Graham Painter

Thanks for joining us today. We appreciate your interest in Sterling and look forward to speaking to you next quarter. Good bye.

Operator

Ladies and gentlemen, this conference will be available for replay after 12 PM today through April 29, 2008 at 11:59 PM. You may access the AT&T Teleconference Replay System at any time by dialing 1-800-475-6701 and entering the access code 917677. International participants dial 320-365-3844. Those numbers again are 1-800-475-6701 and 320-365-3844; access code is 917677. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Sterling Bancshares, Inc. Q1 2008 Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts