Sun Bancorp, Inc. Q1 2008 Earnings Call Transcript

May.19.08 | About: Sun Bancorp, (SNBC)

Sun Bancorp, Inc. (NASDAQ:SNBC)

Q1 2008 Earnings Call

April 15, 2008 1:30 pm ET

Executives

Dan Chila – Chief Financial Officer

Tom Guysell – Chief Executive Officer

Bruce Dansberry – Chief Operating Officer

Ed Milandro – SVP, Retail Banking

Analysts

Rick White - GI Montgomery Scott

David Darce

Joseph Tinnage

Matt Kelly

Operator

(Operator Instructions) at this time, Dan Chila.

Dan Chila

Good afternoon. This is Dan Chila, and I’m the CFO of Sun Bancorp. Joining me here today is our CEO Tom Guysell, Bruce Dansberry our COO and also our Chief Credit Officer, and Ed Milandro, Sr. Vice President in charge of retail banking. Tom and Bruce will each have some remarks, and then we will take questions. First let me read the customary Safe Harbor statement.

“The following discussions may contain forward-looking statements concerning the financial condition, results of operations, and business of Sun Bancorp. WE caution that such statements are subject to a number of uncertainties and actual results could vary materially and therefore should not place undue reliance on any forward-looking statements we make. We are not under any obligation to and may not publicly release results of any revisions that may be made to any forward-looking statements we make to reflect the occurrence of anticipated or un-anticipated events or circumstances after the date of such statements.” Now I will turn it over to Tom Guysell.

Tom Guysell

Thanks Dan, this is Tom Guysell and I am pleased to be hosting today’s call after my first full quarter at Sun Bancorp. Let me make a few comments about our performance over the last three months, and then I will ask Bruce Dansberry for an update on the lending side of the balance sheet and some commentary on credit quality. I will then come back with a few brief thoughts on some of the principal issues that we are focusing on as we move into 2008. We will then take your questions.

As an overview, our earnings -per -share came in below the street consensus, primarily, as a result of rate- driven margin compression. Gross loans were up 1.6%, over the fourth quarter of 2007, while deposit growth was essentially flat. The net interest margin for the first quarter was 3.35%, compared with 3.47% for the quarter. We experienced a 200 basis point drop in Fed rates in the quarter, and we have made up about 175 basis points of that decrease. We aren’t really in a position to drop our deposit rates any further. We‘ve had to react quickly and be aggressive in dropping our rates. But in order to preserve market share, and given the competitive landscape, we have not had the luxury in being able to lag far behind what the Fed has been doing. However, could not match a point-for-point reduction. So, market dynamics have clearly had an impact on the margin, as we move through the year, we do expect to see the margin benefiting somewhat from downward re-pricing of a significant portfolio of short term CDs assuming there are no further rate reductions from the Fed. Loan Buy-in was a little behind plan for the quarter but we feel this might be due to timing as our pipeline is solid, and composed of good credits. Bruce will have more detail on this in a moment. Operating non-interest income improved during the quarter, and advanced about 5% over the fourth quarter, and about 29% over a year ago as our hedge-direct derivative products, mortgage banking, and SBA loan fees and income received from Boley were all up. There was also a gain from the Visa Public Offering, which we are also reporting as non-operating income. Expenses are elevated and deserve explaining.

Total operating, non-interest expenses increased 2.4 million, or 11.2% over the first quarter a year ago. And increased 2/1 million, or 9.8% over the fourth quarter of 2007. This quarters’ total expense growth increased over the fourth quarter is partially attributable of expense reduction of $545,000 of reserve for unfunded loan commitments recognized in the fourth quarter of 2007. The expense variances are detailed in the release, but let me give you an overview. The higher operating non-interest expenses over both the prior year and the linked fourth quarter were due to a variety of the same factors, primarily we have increase of about $1.5 million in the first quarter over the prior year in salary and benefit costs, which includes annual base salaries, higher employer payroll taxes and stock-option expense. Actually I would like to point out that our current employee count has remained essentially flat over the past few months, or past year. One item that we noted as an increase is commission expense. As we stated in the release, we changed the structure of our investment products sales-force at the beginning of the year. The sales representatives are now employees of Sun Financial Services, and last year they were employees of our independent third-party broker dealer. As such, their commissions are now paid by the company and no longer netted against our revenue. With salaries and benefits $600,000 on a 1.5 million dollar increase for an apples-to-apples comparison with Q1 and Q4 of 2007. So going forward you will continue to see the separate reporting of gross top-line and related expenses to this business. This area continues to do well and we would expect and hope to see continued increases in commissions, which means that the top-line revenue is growing. There were also higher First Quarter advertising costs compared to prior year and linked quarter. During the current quarter we launched a successful marketing campaign called “Kapow” which was aimed at commerce customers. This was extremely successful and brought in a large number of new accounts and increased our average balances per account. In addition, compared to First Quarter 2007 FDIC expense increased about $400,000. We also have experienced increases in problem loan costs compared to last year in linked quarter, which you would expect in this environment. We also had increases in professional fees and services which mainly relate to the normal first quarter activities related to share holder annual reporting and proxy. The most important point I would like to make here is that we don’t see an increasing expense trend developing. We are intensely focused on expense control and we fully expect to move through the year with that discipline and philosophy. On the credit side total non-performing assets were 30.7 million at March 31st for a 1.2% in total loans and real estate owned compared to 29.6 million Net charge off’s for the quarter were $1.2 Million, and the loan loss provision was $2.1 million or .05% and .08% of average loans outstanding respectively. Comparatively, the charge-offs and the provision respectively were .19% and .22 % for December 31st and .24% and .03% for March 31st a year ago. The allowance for loan losses to total loans is 1.9% compared to 1.08% December 31st and March 31st 2007. Coverage of non-performing loans is 102.60% compared to 95.77% at December 31st, and 177.14% at March 31st of 2007. So that is a quick overview. Most of that was obviously submitted in our press release. I would like to now turn it over to Bruce Dansberry for an update on our pipeline and our credit quality.

Bruce Dansberry

Ok, thanks Tom, and good afternoon everyone. As I mentioned in our last call we continue to find ourselves in a very different and difficult economic environment, than what we’ve been accustomed to operating in the past few years. While this presents us with a whole new set of challenges in the lending world, I believe we have identified our challenges, that we are addressing them on a daily basis. We feel that our de-centralized lending process and robust credit culture are serving us well in this current environment. From where we stand the impact of the economic downturn on our credit quality for the most part has been in the areas directly or indirectly related to the residential real estate market. It’s also impacted our small business customers. We have continued to maintain adequate provision levels and solid reserve coverage’s. This is reflected in the increase in our allowance per loan loss coverage to total of loans from 1.08% at the end of the fourth quarter in 2007 to 1.09% at the end of the first quarter of this year. Allowance per loan losses is a percentage to non-performing loans also improved from 95.8% at year end to 102.6% at the end of this quarter. Let me give you an overview of where things are right now with our loan portfolio. As you may recall in the fourth quarter of 2007 we took $4.8 Million in net charge loss. For the first quarter of 2008, our net charge off number was lower at $1.2 Million and was comprised mainly of small business loan and the write down of some commercial loans that we have identified previously at the end of last year. Total charge-offs for the first quarter equated to five basis points on average loans outstanding, which is in line with the twenty basis point projection for 2008 which we recently disclosed in our 10k. Our commercial “”””””portfolio which was at $24 Million at the end of the fourth quarter dropped to$22.9 Million at March 31st when among other things we took an office building in Central New Jersey into our ‘’’’’ portfolio and that loan was for about $1.64 Million. I am happy to report today that although we just took it into our >Oreo< portfolio we already have that property under contract and we expect to close and have a full recovery with some gain some time late in the second quarter or early fourth quarter. Overall our delinquency picture is good, with levels of past due loans in these portfolios at or near their historic acceptable range. While we have seen somewhere upward trend in delinquency pressure in selective portfolios such as home equities, there have seen no real spikes in the past- dues at this time. Now let me take a minute to give you some greater detail on the status of those areas that might be most affected by the current economic climate. As we have noted in the past, total Commercial loans outstanding her at Sun are $2.062 Billion which represents 81% of total loans outstanding. A substantial portion of the commercial loan portfolio or some 74% has a real estate collateral component. These loans are more or less divided evenly between owner-occupied real estate and non-owner occupied real estate. These commercial real estate loans are coming under greater and greater scrutiny by the regulatory community and we have undertaken extensive tracking and monitoring, especially of those loans secured by non-owner occupied real estate. The outstanding balance of our residential construction portfolio is down roughly $5 Million since the end of the year 2007 and has outstandings today of about $65.4 Million, or 3.1% of total commercial loans. This portfolio is spread out over 96 loans to 67 builders and continues to perform well. As we would expect given the state of the new home construction market this portfolio is static with only a limited number of loans being originated and those loans that we have originated are centered around seasoned and existing borrowers of Sun. We feel that our strict underwriting standards, coupled with conservative advance rates have gone a long way to allowing us to avoid any additional problems in this area beyond the one credit relationship that we identified late in 2007. As previously mentioned, we continue to face challenges with our credit score small business loan product, currently there is roughly$22.4 Million of these loans outstanding which represents roughly 1% of the banks total portfolio. The majority of these loans are lines of credit. As these lines mature we are ascertaining in short order the status of the borrowers and the most reasonable way to proceed. We look to obtain tangible collateral and turn these loans out whenever possible. But we do not and will not hesitate to transfer these credits out to our work-out area when necessary. Finally we are keeping close tabs on our home equity portfolio. These portfolios of lines and term loans have grown in outstandings over the past twelve months 11.8% or $37 Million and today we have$348.7 Million in outstandings which represents 13.7% of total loans outstanding. While usage of these facilities has remained pretty constant at around 50% over the past year, the level of delinquency in the portfolio has been creeping up and has moved up from about 70 basis points to about 1.17% today. We think that we are in good shape here considering our conservative underwriting and the modest usage to date and the fact that the residential real estate values have held up better in New Jersey than in some other areas of the country. So that’s my update on where our lending and credit processing at Sun today, we are dealing with these challenges of the current economic landscape while trying to take advantage of opportunities that arise within our market. I will turn it back to you, Tom.

Tom Guysell

Thank you, Bruce. I am going to open it up for questions in a few moments, but before I do that I would like to take a moment or two to provide a little bit of insight into a few of the highest priority focuses that we have as an organization after I have been here for a full quarter. First and foremost is the fact that we need to continue to drive revenue growth. Obviously that’s priority number one. We need to focus on improving the top-line, not just because that will help drive the efficiency ratio lower, but I still believe that there are many unrealized opportunities in the front of the bank today. That said, growth without yields is no good, so we are sticking to our core businesses and only bringing on business that is profitable at that time or immediately after to our relationship banking strategy.

Number two, certainly deposit growth, but again the current economic environment has forced us to make weekly decisions between funding through increased deposits, or funding through lower cost methods. That said, deposits are certainly part of our core funding and relationship banking strategies and are absolutely essential to any banks success.

Number three, we are also continuing to work through our franchise optimization strategy and are putting together a plan to strengthen our branch and lending presence in certain markets by looking at the markets where we know we can grow market share and acquire more customers and then we will re-deploy and add resources to maximize these efforts.

And number four, we are going to continue to strengthen and properly align our management team. We just hired Michelle Estep as our Chief Administrative Officer who came to us from Key Bank and will be focusing on all of our HR related functions, facilities, training, and more. As part of this focus we also recently made some organizational re-alignments that put revenue generating functions, support functions, and operation functions in groupings to enhance efficiency and provide single points of direction and accountability. This will allow for more effective execution, and to drive and support revenue, as well as our customer base. So now it’s time to take a few questions. Please state your name, and let us know which company you are with, and Operator, can we have the first question please? And if I could remind everyone to please state your name and company affiliation as you come on so we know who we are talking with. Operator?

Question-and-Answer Session

Operator

Our first question comes from Rick White, Please go ahead with your question.

Rick White - GI Montgomery Scott

Ok, sure, this is Rick White from GI Montgomery Scott. Hi guys. First question is you talked a little bit about the lending and loan competition?

Bruce Dansberry

Sure, this is Bruce, Rick. How are you doing? I guess the way I would characterize it, is it is still very competitive out there, although our price lines are as Tom indicated earlier are very robust and we are getting a lot of opportunity to look at a lot of different credits across our footprint. We have seen some ability to get some better pricing than what we had been experiencing twelve months ago, but good deals to good companies are still fiercely fought each day in the trenches.

Rick White - GI Montgomery Scott

Has there been any change since Commerce has been acquired? Or is it too early to tell?

Bruce Dansberry

A little too early to tell, although Commerce was not our most aggressive competitor on the commercial lending side of the business. Certainly on the retail side of the business they were very aggressive and very competitive.

Tom Guysell

Rick, it’s Tom. One of the things that I talked about in my comments was the fact that we obviously have to grow the top line, but we need to make sure that we can get some yield and one of the things that we are seeing is surprisingly so, Money Center Banks coming in and pricing what we think are strong credits in areas that we just are not willing to go to. We’re not quite sure how they have the ability to make money, pricing those credits where they are pricing them, and we certainly can’t make money in that area, so we aren’t able for the right credit in the right situation to get the pricing that Bruce talked about, but the market is still pretty eclectic with some of the big players coming in and just buying market share.

Rick White - GI Montgomery Scott

Ok, and Tom can you talk a little bit about the expenses, I guess, or what kind of run rate would you see for your non-interest expense?

Dan Chila

Rick this is Dan. I think we enumerated a lot of the reasons for the increases in the first quarter. We just like to highlight that a number of those expenses, some were one-timers, but more importantly there were timing factors here where some of these expenses were heavier weighted in the first quarter. For the year, if you take our quarterly number here and annualize it you are going to get a run rate you will get a calculation that shows a run rate that is much higher than what we are looking to come in at for the year. Right now, in total for the year, you are looking at about a $93 Million expense for the year. Which would bring us to an efficiency ratio of just under the 70% hurdle rate that we’ve been targeting. So, it’s a little b it higher than we have originally planned, but the efficiency ratio is higher that is, mainly because revenue pieces and that interest income is going to be down. But overall expenses from the run rate are going to be about $93 Million.

Rick White - GI Montgomery Scott

Ok, great and so we use around 30% for a tax rate?

Dan Chila

Yeah, that’s good a tax rate.

Rick White - GI Montgomery Scott

OK, thank you very much.

Operator

Our next question comes from David Darce. Please proceed with your question.

David Darce

Good afternoon. What are the long term benefits of the changes that you have made with the investor services group?

Tom Guysell

David, I’m not sure I know your question. Can you restate it? Like bringing them in-house?

David Darce

Yes. I mean it hurts your efficiency ratio, right? So what are your long-term benefits, and is there a strategy at this time to expand that platform from bringing them in-house?

Tom Guysell

Without a doubt, the fact that we can take what was basically a sales force that we used through a third party broker-dealer and bring them in-house, it really gives us control over our own destiny. It gives us control to be able to hire, and be able to maximize the type of person that fits into the Sun culture. Additionally to that, that’s a scalable business. We look at where our branch distribution is and we look at that retail or consumer client base that gives us an opportunity with Sun Financial Services to give them some simple yet meaningful financial services and wealth planning tools. So it’s basically in addition to acquiring the personnel, it gives us better ability to acquire customers because we have direct control over that personnel.

David Darce

Ok, so you’re saying that previously you didn’t have the ability to hire and manage that staff?

Tom Guysell

We worked with that group, but we still didn’t have 100% autonomy to really do what we needed to do.

David Darce

Ok, were there any charges associated with firing them?

Tom Guysell

No.

David Darce

Ok, and then you commented on your program the Kapow program. Can you give us an idea of the kind of target products are, and what are the measures of success that you are seeing? Maybe you can quantify, I know you indicated that you had some higher than average balances and new account growth, but it looks like from your deposit figures that the growth has been in higher cost areas and you have had some run-off in the lower cost deposits bases.

Ed Milandro

This is Ed Milandro. What we saw with the Kapow account, we saw a 35% increase in the number of checking accounts we opened in the months of February and March, compared to the same time last year. We also saw our cross-selling increase by about 20%, so we were selling more products and services to the customers we were bringing in. We saw our overall checking balances increase by about $1000. The accounts that we were bringing in had average balances right about what we estimated which was in the $35-40,000 range.

And yes, we did pay off a little bit to get the relationship, but that was part of our strategy.

David Darce

Ok, and then with your charge-offs this quarter, were any of those related to any of those related to any of the three larger credits you referenced last quarter? That became non-performing?

Tom Guysell

Yes, David there was. There was about close to $400,000 related to those prior credits.

David Darce

And assuming that the credit problems remain in the residential and small business area , do you anticipate 30 basis points of provisioning and lower charge-offs this year?

Tom Guysell

I think we are anticipating pretty close to what we had in the 10k. Which was about 20 basis points on average outstanding.

David Darce

For both? Maintaining a relative reserve where it is?

Tom Guysell

Yes. Right in that 109, 108,110 range.

David Darce

Great, thanks a lot.

Operator

The next question comes from the line of Joseph Tinnage. Please proceed with your question.

Joseph Tinnage

Tom, you’ve talked about the top-line focus and some of the things that you are emphasizing there. Have you identified any of the major projects on the expense side, whether it be maybe some things that have been talked about in the past, like a branch rationalization of some kind, or further personnel related reductions, things you have mentioned is the employee count has been kind of steady in the last twelve months? Any big projects you see that you are thinking about in the early stages on the expense side?

Dan Chila

Well, Joe, certainly the franchise optimization is something that we’re looking at, we’re not necessarily focusing on it as an expense reduction, but more as a way to grow top-line and increase efficiency. So, through that you will definitely see some movement, in the future, of our franchise.

Joseph Tinnage

Ok, and then, more of a broader industry-type question, but Bruce referred to the regulatory environment becoming more onerous as it relates to commercial real estate. Is this something you guys have observed first-hand, that the regulators might be asking more questions, digging a little deeper, or expressing greater concern in that area, or is that just sort of a general comment based on things that we have all been reading about in the press in the last few months.

Bruce Dansberry

No, but we have experienced it first hand, Joe, I think it is rightfully placed by the regulatory groups, but we have just come off of our safety and soundness test at the end of the year and we had some very good conversations with the regulators and we are moving forward with some of their suggestions as well as our own thoughts as how to monitor deeper and broader.

Joseph Tinnage

Ok, thanks guys.

Operator

Our next question comes from the line of Matt Kelly. Please proceed with your question.

Matt Kelly

Hi guys, this is just kind of to follow up on that question. It’s a pretty meaningful change in just the tone of capital management from 4Q to 1Q. Just reading though the press release and basically in the fourth quarter you talked about being an active purchaser of your stock, and the buy-back plan, and then the first quarter comes around and capital builds, stock price goes down, and now, not expecting to be as aggressive so clearly building capital and capital preservation has gone way up on the priority list. Is that tied in to the conversation with the regulators as well, on some of the greater scrutiny on some asset classes?

Tom Guysell

Matt, no not at all. That is just the strategic positioning that we chose to do as we looked forward into capitalizing on opportunities such as franchise optimization and some other opportunities that might come out into the marketplace for us.

Matt Kelly

Potential M & A opportunities, is that what you’re….

Tom Guysell

Whatever that might be, investing dollars back into the business, whether it be M&A opportunities, whatever the case may be, we feel that capital is important to have on hand, it was not a regulation driven change in philosophy at all.

Matt Kelly

Next question, on your CD portfolio, $1.1 Billion, with an average cost of $456, what’ s the average maturity of that portfolio?

Bruce Dansberry

Less than a year.

Matt Kelly

And what is the promotional product that you are pushing right now?

Bruce Dansberry

Well right now we are not really pushing a promotional type product, as Tom alluded to, we’re pricing to make them profitable, and that’s our strategy with them right now, so there is no promo with the CD portfolio. The promo that we came out with was a checking promo.

Matt Kelly

Ok, so we should expect the CD balances to be coming down, and then funding that, and then going forward, sounds like wholesale opportunities and FHLB advanced in the low threes are just more advantageous?

Bruce Dansberry

WE intend to hopefully hold the portfolio flat, so I really don’t see it coming down. We’re managing it on a daily basis, we’re just not up-pricing for artificial growth at this point.

Matt Kelly

Ok. Question for Dan, could you give a little more detail on what the one-time items or the timing factors were during the first quarter on the expense side that we should be thinking about in the light of the $93 Million dollar kind of targeted expense relative to a $96 Million dollar annualized rate this quarter?

Dan Chila

Matt, we had a number of > on the salary area, and a heavy quarter with payroll taxes and employer related payroll taxes in the first quarter, that was about $400,000. Obviously that’s a first and second quarter heavy hit, and it smoothes out over the balance of the year. As we enumerated in the release in the non-operating expense we had the impact of a lease-buyout of a branch that we closed in the fourth quarter and relocated, about $70,000. We had a bonus that we talked about in the area of fees and services, probably had in the range of $200,000 at least in terms of services that were either first quarter related and will not be recurring, or heavy expense in the first quarter related to legal type fees for annual report proxy, shareholder activities, and they were basically the items that counted for the heavy first quarter hit versus our plan for the year which had some of these more level loaded.

Tom Guysell

It’s Tom again. You asked a question earlier about the CD and CD is one of the promotional products, and a run-off of that, and we had a question earlier about bringing Sun Financial Services in-house and the scalability and the importance of that business. Well, this is a time and place where that business becomes important to us because CD’s roll off and there may not be real high rate product for CD;s to roll into for every single one of our consumer customers, we have our Sun Financial Services products that we can offer as a wealth management tool for that, so while we won’t be building the CD portfolio balances, we will be bringing that in to income through fee income. So the fact that we wanted to bring SFS in-house is to be able to offer more products and services to our customer base when we have these kinds of economic hedges in the environment.

Matt Kelly

Any sense of what percentage of CD maturities you are actually able to transition into financial services products?

Tom Guysell

We do not have an answer for that for you.

Matt Kelly

I mean I guess what I am getting at is, presumably this is a pretty decent benefit, and the market rates for CD’s are well below 4.50. I was looking for the potential funding benefit if that portfolio kind of goes through the maturity process.

Tom Guysell

Correct.

Matt Kelly

So your pricing, would that be middle of the road, is that the way you are approaching it?

Tom Guysell

Our pricing is middle of the road, right now. We are not on the high end, we are not on the low end, and you are right, you are going to see a benefit because they are coming off from the 4.50 range and we are not replacing them at 4.50.

Dan Chila

But we want to stay competitive. And in that we watch it daily, and if we need to make an adjustment to that CD rate we can afford to do that given the alternatives, so we are watching it very carefully.

Matt Kelly

Ok, it looks like a couple of the thrifts in your neighborhood are operating at about 3% type of rate on 6 month to 13 month type offerings.

Tom Guysell

And that’s the kind of rate we are in right now. We are seeing that retention being very good at this point.

Matt Kelly

Ok, thank you.

Operator

At this time we have no further questions in queue.

Dan Chila

Well on behalf of our management team and the board I would like to thank you for joining us, and we will speak with you next quarter. Thank you and have a good day.

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