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Sandy Spring Bancorp (NASDAQ:SASR)

Q1 2008 Earnings Call

April 22, 2008 2:00 pm ET

Executives

Hunter Hollar - Chief Executive Officer

Phil Mantua - Chief Financial Officer

Dan Schrider - Chief Credit Officer, President

Ron Kuykendall - General Counsel

Analysts

Matt Schultheis - Ferris, Baker Watts

Jennifer Demba – Suntrust Robinson Humphrey

Steve Moss

Bryce Rowe – Robert W. Baird

Kyle Cavanaugh - Palisade Capital

Alan Bach

Operator

Hello and welcome to the Sandy Spring Bancorp first quarter earnings release conference call. (Operator Instructions) I would like to turn the conference over to Hunter Hollar. Mr. Hollar, the floor is yours, sir.

Hunter Hollar

Thank you. Good afternoon and welcome everyone to Sandy Spring Bancorp’s conference call to discuss our performance for the first quarter of 2008. Joining me here today is Phil Mantua, our Chief Financial Officer; Dan Schrider, our Chief Credit Officer and the new President of our company; and Ron Kuykendall, General Counsel for Sandy Spring Bancorp.

As always, this call today is open to all investors, analysts and the news media. There will be a live webcast of today’s call and there will be a replay of the call available at Sandy Spring’s website beginning later today. We can take your questions after a brief review of the key highlights.

Before we make our remarks and then take your questions, Ron will give the Safe Harbor statement.

Ron Kuykendall

Thank you, Hunter, good afternoon. Sandy Spring Bancorp will make forward-looking statements in this webcast that are subject to risks and uncertainties. These forward-looking statements include statements of goals, intentions, earnings and other expectations; estimates of risk and future costs and benefits; assessments of probable loan and lease losses; assessments of market risks and statements of the ability to achieve financial and other goals.

These forward-looking statements are subject to significant uncertainties because they are based upon or affected by management’s estimates and projections of future interest rates, market behavior, and other economic conditions; future laws and regulations, and a variety of other matters which by their nature are subject to significant uncertainties.

Because of these uncertainties, Sandy Spring Bancorp’s actual future results may differ materially from those indicated. In addition, the company’s past results of operations do not necessarily indicate its future results.

Hunter Hollar

Thank you, Ron. I will recap just a few of the key financial performance highlights and then we’ll move on to a brief discussion of where we are with project LIFT, Looking Inward For Tomorrow. Then Dan Schrider has a quick update on credit quality and after that we’ll take your questions.

First, net income for the first quarter of 2008 was $8.2 million or $0.50 per share compared to $7.5 million or $0.49 a share for the first quarter of 2007 and $8.4 million or $0.51 per share for the linked fourth quarter of 2007. So there was year-over-year growth for the first quarter, but we were down slightly compared to the linked quarter.

On a linked quarter basis however loans and deposits increased 4% and 3% respectively for the first quarter compared to December 31, 2007. In this environment where the focus is so intense on booking only the highest quality loans and where competition for deposits is as tough as we’ve ever seen that’s decent progress; not great, but we hope to build an improving trend in both areas over the course of the year.

As we noted in our press release, some of the other key first quarter numbers were as follows: First the net interest margin declined to 3.99% for the first quarter compared to 4.07% for the prior year quarter and 4.19% for the linked fourth quarter of 2007. This shouldn’t be a surprise as the Fed cut rates 200 basis points.

Second, the provision for loan and lease losses totaled $2.7 million for the quarter compared to $800,000 for the first quarter of 2007 and $1.7 million for the linked fourth quarter of 2007. We increased the provision as a result of two factors: growth in the overall loan portfolio from new originations and also in response to a higher level of non-performing loans.

Third, there was the continuing favorable impact of expense management initiatives as part of the company’s overall strategic business improvement program, project LIFT. We contained the growth of non-interest expenses to 5% compared to the prior year and notably a decrease of 2% compared to the linked fourth quarter of 2007.

This reduction in non-interest expenses, together with a 16% increase in non-interest income in the quarter, produced an improved efficiency ratio of 59.2% compared to 63% for the prior year quarter and 60.2% for the linked fourth quarter. Obviously, driving our efficiency ratio lower is a major objective of the overall LIFT effort.

Just to expand a bit on what has been happening with project LIFT, which was in the implementation phase for the first full quarter over these past three months, salary expense decreased by $500,000 or 5% inclusive of planned severance-related costs. Expenses related to corporate benefit plans and discretionary spending decreased by $800,000 or 20%. There were significant decreases in pension expense and consulting or professional fees of 72% and 54% respectively.

Overall discretionary spending decreased by 37% from the linked fourth quarter 2007, and this was the major driver of the $1 million or 20% decline in the other expense category.

Suffice it to say that all of the extensive project LIFT planning that we did during the fourth quarter of last year is producing the desired effects and the expense reductions that I’ve just reviewed are very consistent with our expectations from LIFT.

Before I call in Dan Schrider for a credit update, I just wanted to say how very pleased I am that we were able to announce Dan as our organization’s new President and that he will also be transitioning into the role of Chief Executive Officer over the next several months in advance of the point where I will be retiring.

I really am looking forward to working with Dan to pass the leadership baton and I know I speak for every member of our board of directors and the company’s employees as well. Many of you may not know that Dan Schrider has actually been with Sandy Spring longer than I have. Over the course of his career, he has not only held responsibility for numerous management functions but his outstanding people skills have really won the hearts and minds of everyone across the company. We are quite fortunate to have the depth of talent that enables us to promote top leadership from within the company and also to be able to surround Dan with a core group of very well qualified senior managers from which to build this team.

One of the hallmarks of Sandy Spring is that our performance and the nature of our culture have both been very consistent and we feel that having an internally focused management succession process will ensure that this consistency is ongoing.

Now I ask Dan for his commentary from a credit perspective.

Dan Schrider

Thank you, Hunter. I am very honored and excited to have been named Hunter’s successor and very enthusiastic about our future. Our company has a benefit of a very strong balance sheet with a terrific reputation and a history of high performance and a wonderful market; top it off with the best employees and I believe we have a great future.

I will comment briefly and more specifically on our company’s credit quality. Hunter commented on the increase in our provision for loan and lease losses, and both loan growth and a higher level of non-performing loans. Non-performing assets totaled $46.9 million at March 31, 2008 compared to $7 million a year earlier. On a linked quarter basis, non-performers were at $34.9 million at December 31, 2007. The increase from December to March was due primarily to two commercial construction loans totaling $11.3 million that we believe are adequately reserved.

The large year-over-year increase in non-performing loans is primarily driven by the housing sector and includes one loan totaling $13.4 million that was placed on non-accrual in the second quarter of 2007.

As we have reported previously, we continue to work with our borrowers to make full payments on these credits a reality. It’s also important to note that our entire acquisition, development and construction portfolio -- in other words our builder business -- represents less than 10% of our entire loan portfolio. Additionally, the builder business is well diversified in terms of product type and geography.

Our non-performing loans also include approximately $6.5 million of loans from our residential mortgage portfolio. These loans represent a rather small group of borrowers that are suffering the effects of a slower economy such as job loss or a reduction in household earnings. We continue to work with these retail borrowers and believe that we are well secured or adequately reserved.

Our consumer portfolio, a majority of which is made up of home equity loans and lines, is performing well. We continue to underwrite conservatively and adjust underwriting standards appropriately. Our provision during the first quarter of $2.7 million resulted in an allowance for loan and lease losses of 1.18% of outstanding loans. When you consider our relatively low level of net charge-offs historically, we are comfortable with this ratio.

Generally we believe the asset quality remains very strong even though some of our metrics are higher than traditional Sandy Spring standards. Given the turmoil in the economy and its impact regionally, we remain confident that our portfolio quality remains solid.

Hunter Hollar

Okay, so that’s our comments for today which we are happy to expand on as we take your questions.

Question-and-Answer Session

Operator

The first question we have comes from Matt Schultheis - Ferris, Baker Watts.

Matt Schultheis - Ferris, Baker Watts

Hi, good afternoon gentlemen. What were the severance costs associated with LIFT in this quarter?

Philip Mantua

So far to-date the severance costs in the first quarter are roughly around $100,000.

Matt Schultheis - Ferris, Baker Watts

And you will probably have more in the future I am assuming?

Philip Mantua

It’s possible that we could as we continue to roll out the other elements of the initiative.

Matt Schultheis - Ferris, Baker Watts

As I looked at your breakdown of non-interest income and I normalized it for security gains, there is a large jump in the insurance commissions and I was wondering if those are contingent commissions coming in the first quarter?

Philip Mantua

Yes they are, about $600,000 more than slightly down from the first quarter of last year, but nevertheless $600,000 that won’t recur in any of the other quarters for the rest of the year.

Matt Schultheis - Ferris, Baker Watts

So, you were up roughly say $200,000 over the fourth quarter adjusting for that?

Philip Mantua

Well, yes that’s correct although there is one another one-time item that is running through non-interest income that’s also related to the Visa settlement. $175,000 of a reversal, although it’s running through non-interest income of an accrual we made for potential litigation back in the fourth quarter that you may recall. So that $175,000 won’t reoccur in the non-interest category either. It’s in a miscellaneous category.

Matt Schultheis - Ferris, Baker Watts

As far as your non-performers, what was the impact on your net interest margin of those this quarter?

Philip Mantua

Let’s see. It’s probably worth roughly 10 or 15 basis points.

Matt Schultheis - Ferris, Baker Watts

Is some of that reversal as well as just simply carrying them on the balance sheet?

Philip Mantua

No I would say that’s primarily just a carry effect.

Operator

Your next question comes from Jennifer Demba – Suntrust Robinson Humphrey.

Jennifer Demba – Suntrust Robinson Humphrey

You mentioned that the non-performer increase was primarily related to commercial construction credits. To date we haven’t heard many banks talk about deterioration in their commercial portfolio. Can you give us some color there about what you are seeing in those two credits specifically and then what you are seeing in the rest of your portfolio as well?

Dan Schrider

Actually Jennifer, great question. For clarification these projects I referred to were in our commercial portfolios but they were actually residential projects.

Hunter Hollar

Jennifer, just to add to that our typical language we use is as Dan just said is if it’s a builder who is building commercially for resale that gets put in our commercial loans. So we use that commercial real estate very loosely but in this case these are residential builders.

Jennifer Demba – Suntrust Robinson Humphrey

You said before the builder portfolio is about 10% of the total book?

Dan Schrider

Yes, it’s less than 10% of the total book, yes.

Operator

Your next question comes from Steve Moss.

Steve Moss

Good afternoon guys. Just wondering with regard to the commercial construction price what is the average loan to value ratio?

Dan Schrider

We have guidelines that really are based upon the nature of the projects so for instance if this is a project that is lots to be developed for residential builders, we generally stick with the standard that’s 65% or under. That’s the majority of what we have in our non-performer category now, at origination obviously.

Steve Moss

What is the average size for your commercial construction portfolio?

Hunter Hollar

I would say Steve that is probably in the $5 million to $10 million range is the typical project for us on deal size. That obviously ranges based on product type but that’s our sweet spot.

Steve Moss

Just for clarification with the LIFT project gong forward, should we expect further declines in expenses for Q2?

Dan Schrider

I think in certain elements of our overall expense categories there should continue to be some decline in future expenses, especially as it relates to a continuation in some of these discretionary areas which are primarily in the other expense category on the income statement. At some point later as we move closer towards working on elements of property management and things like that we should see some changes in our level of occupancy expenses. But that is clearly towards the latter part, end of the year, into 2009.

Operator

Your next question comes from Bryce Rowe – Robert W. Baird.

Bryce Rowe – Robert W. Baird

Phil, do you have the FTE count or the headcount at the end of the quarter?

Philip Mantua

Yes I do. The FTE count as of March 31 is 699. That compares, for what it is worth, to 712 as of the end of the year, FTE again.

Bryce Rowe – Robert W. Baird

The two builder loans that were added here in non-accrual can you guys tell us where they are, what counties they are located in?

Hunter Hollar

Yes we have a project in Washington County, Maryland, and Frederick County, Maryland.

Bryce Rowe – Robert W. Baird

Are those predominantly in development or are those homes in different stages of completion or are they finished?

Hunter Hollar

No, these are projects that were finished last year with two homebuilders that have backed off.

Bryce Rowe – Robert W. Baird

So the same situation as the one in Delaware?

Hunter Hollar

Similar, yes.

Operator

Your next question comes from Kyle Cavanaugh - Palisade Capital.

Kyle Cavanaugh - Palisade Capital

The NPA portfolio is about $24 million for the three homebuilder credits, is that correct?

Dan Schrider

Yes.

Kyle Cavanaugh - Palisade Capital

Could you go over what the remaining portion of it is?

Dan Schrider

The portfolio as a whole?

Kyle Cavanaugh - Palisade Capital

If there’s any other larger credits within the NPA?

Dan Schrider

Yes, our non-performers, the builder relationship is primarily driven by a handful of builder relationships that are struggling as a result of what’s going on in the housing sector. As I mentioned we do have a relatively small $6.5 million portion from our residential portfolio as well. The only other signs of weakness that are included in the NPAs are sample of credit from our SBA guaranteed commercial portfolio which are included in that as well.

Kyle Cavanaugh - Palisade Capital

You had recoveries this quarter. Could you connect that to where the recoveries came from?

Dan Schrider

Absolutely. The recovery that was received for a previously charged off loan from one of the banks we acquired, County National Bank.

Operator

The next question we have comes from Alan Bach.

Alan Bach

Could you give a little bit of extra color on the security gains in the quarter?

Dan Schrider

The predominant piece of that is the gain related to the redemption of Visa stock that we were granted in that ownership situation. About $425,000 to $430,000 of that gain was related to that. The rest of it was gains that were taken as certain securities that we mark to market in the acquisitions matured.

Operator

I’m showing no further questions again. Would you like me to give the instructions again?

Hunter Hollar

I think we’ve allowed enough time to give folks the opportunity to ask questions so I’ll assume we have no more questions and that wraps it up. I certainly do want to thank everyone for participating on our call today.

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