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Bridge Capital Holdings (NASDAQ:BBNK)

Q2 2008 Earnings Call

July 18, 2008 9:00 am ET

Executives

Daniel P. Myers - President, Chief Executive Officer, Director

Thomas A. Sa - Chief Financial Officer, Executive Vice President, Chief Administrative Officer

Debra Bradford - Senior Vice President, Accounting & Financial Reporting Officer

Analysts

Jeffrey Rulis - D.A. Davidson & Co.

Donald Worthington - Howe Barnes Hoefer & Arnett, Inc.

Bobby Boland – Keefe, Bruyette & Woods

Aaron Deer - Sandler O’Neill

Operator

Welcome to the Bridge Bank second quarter financial results conference call. (Operator Instructions) I would now like to turn the conference over to Ms. Bradford, Senior Vice President of Bridge Bank.

Debra Bradford

Welcome to Bridge Capital Holdings conference call to discuss the second quarter results. Joining me today from management are President and Chief Executive Officer Dan Myers and Executive Vice President and Chief Financial Officer Tom Sa. We have allotted approximately one hour for today’s call and we plan to conclude the call at 10:00 a.m. Eastern time.

Before we begin I’d like to review our Safe Harbor statement. Certain matters discussed during today’s call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to the Safe Harbors created by that Act. Forward-looking statements describe future plans, strategies and expectations and are based on currently available information, expectations, assumptions, projections and management’s judgment about the bank, the banking industry and general economic conditions. These forward-looking statements are subject to certain risks and uncertainties that could cause the actual results, performance or achievements to differ materially from those expressed, suggested or implied by the forward-looking statements.

These risks and uncertainties include but are not limited to competitive pressures in the banking industry, changes in interest rate environment, general economic conditions nationally, regionally and in operating markets, changes in the regulatory environment, changes in business conditions and inflation, changes in security markets, future credit loss experience, the ability to satisfy requirements related to the Sarbanes-Oxley Act and other regulations on internal control, civil disturbances, or terrorist threats or acts or apprehension about the possible future occurrences of acts of this time and the involvement of the United States in war or other hostilities. A more complete discussion of such risks can be found in Bridge Capital Holdings’ annual report on Forms 10K and quarterly reports on Forms 10Q on file with the Securities and Exchange Commission.

With that I would now like to introduce Dan Myers.

Daniel P. Myers

We issued our earnings press release for the quarter ended June 30, 2008 yesterday afternoon. As you read our earnings, while strongly positive at $1.6 million or $0.23 per diluted share for the period, were less than we had hoped for. This was primarily the result of incurring additional credit costs as a prudent response to specific credit exposures in our loan portfolio, the impact to net interest income of the steep decline in short-term market interest rates, and lower-than-anticipated non-interest income.

It is widely acknowledged that the operating environment for all banks in recent quarters has been challenging to say the least. The severity of this view differs depending on where your bank operates. We operate primarily in the Silicon Valley region. Because of that we believe that we are relatively insulated from the worst challenges of the current economy compared to most banks, but that does not mean that we are immune from some impact particularly in our real estate lending activities.

At this point, while we see some impact developing we do not see significant deterioration in the general economic condition of our core market of Silicon Valley. However, the deterioration in national economic conditions including areas of California outside of the Silicon Valley region are certainly of concern as we experience the same indirect impacts as all banks particularly lower short-term interest rates, disruptions of capital markets, and the rapid downward adjustment of real estate values as the result of fallout from the subprime and credit crises.

Tom Sa, our Chief Financial Officer, will now provide a brief overview of our results for the quarter. Following Tom’s comments I will have some closing remarks and then we will open up the call to your questions. And as a reminder to many of you that have seen and listened to our presentations in the past, our policy is not to issue any specific forward guidance.

Now I’d like to turn the call over to Tom.

Thomas A. Sa

As you saw in the release yesterday the company reported for the quarter net income of $1.6 million or $0.23 per share. This was a slight increase over $1.5 million for the first quarter of 2008 but it was down $1.4 million when compared to the same period last year. For the six months ended net income was $3.1 million or $0.45 per diluted share which was a decrease of $2.3 million compared to the first six months of 2007.

The results for the quarter reflect the impact of an elevated provision for credit losses, greater NIM compression than we had anticipated, and lower fee income contribution from SBA lending operations. I’ll touch on each of these topics but the primary purpose of this call is to provide some color on our credit quality. As a reminder, Bridge Bank’s core franchise is a diversified business banking model. Our commercial and technology industry lines continue to benefit from the relative health within the Silicon Valley economy, which remains among the healthiest economic regions in the State of California.

During the quarter total assets exceeded $800 million for the first time and we achieved solid growth in average earning assets at $28 million on a sequential basis. This growth was funded by growth in average deposits of $29 million. Further, core deposits continue to be the foundation for our growth representing 87% of total deposits at June 30, 2008. In addition non-interest demand deposits represent 32% of total deposits. While we did see growth in our core business the elevated level of NPAs began to weigh on net interest margin this quarter. For the quarter ended June 30 NIM of 6.18% was down from 6.59% in the first quarter. NPA has accounted for approximately 20 basis points of the sequential decline.

In addition as we’ve indicated in the past we expect the natural state of our balance sheet to be asset sensitive and we do have a natural exposure to declining short-term interest rates. When compared to the same quarter last year NIM was down 46 basis points and the average prime rate for the second quarter of 2008 was 5.08% which was down from 8.25% for the same period last year.

Our loan-to-deposit ratio averaged 97.5% during the quarter representing an increase compared to an average of 87.2% for the same quarter of 2007 as loan growth outpaced deposit funding year-over-year. This has been somewhat by design as part of our efforts to offset the impact of lower short-term interest rates and one of our responses has been to increase the leverage that we’re running in the balance sheet. That together with hedging strategies we put in place last year has enabled us to maintain a strong net interest margin through the early stages of the rate cycle.

Of late, in response to the recent news of IndyMac’s failure and the Feds growing concerns regarding inflation, we’ve begun to raise the liquidity profile of the balance sheet. In the second quarter we sold a quarter of our portfolio of agency securities, those were Freddy Mac and Fannie Mae bullets, in part to increase liquidity and to move towards a more asset sensitive posture on the balance sheet. In addition in the near term we expect a slight decline in the loan-to-deposit ratio as a conscious effort to raise the liquidity of the balance sheet and as a result we expect to see further compression in NIM.

Non-interest income has also been impacted by the current state of the secondary markets for SBA loans. The volume of SBA loans sold in the quarter and year-to-date decreased dramatically year-over-year as a result of disruption in secondary markets. Partially offsetting the decline in fees from the sales of SBA loans has been an increase in international fee income. Year-to-date international fee income of $534,000 represents an increase of 84% over 2007. This line of business is highly complementary to our core business banking franchise here in the Valley.

Lastly, before I move into a discussion of the credit quality, even with the lower levels of profitability the company successfully preserved capital and not only remains well capitalized but our total risk-based capital ratio at 11.72% at quarter end represents an increase from 11.56% on the same date last year.

Now the primary topic for the call, asset quality. The most prominent item in our release is the level of non-performing assets. Non-performing assets increased to $23.3 million or 2.87% of total assets at June 30. That’s up from $15.9 million or 2.03% of total assets at March 31. Our view of the NPA number is that it reflects the philosophy of proactive management of credits that come under pressure. As of June 30 our estimate of impairment related to $23 million of NPAs was approximately $1.8 million. We understand the significance of this metric and again want to provide appropriate visibility to the specific issues we’re working through, which we’ll do shortly.

As we explained last quarter non-performing loans are centered in the segment of our portfolio loans secured by raw land for investment or development of five or more residential lots. This is still the case. At June 30 NPAs include three loans from this segment representing $18.5 million or 80% of the total NPAs.

The primary reason for the increase this quarter was one loan of $10 million secured by a first Deed of Trust on land near Palm Springs. The loan is secured by 475 acres of productive farm lands on heavy industrial with a 50,000 square foot produce cooling facility used in the farming operation. The loan was originally made with a loan-to-value of less than 30% on our first Deed of Trust. That was last year. An appraisal received in May of this year yielded a current loan-to-value of 60%. The loan was moved to non-performing status when it did not pay off as planned at maturity.

The second of the three loans is a residential land development loan in Monterey County that we addressed at length last quarter. It represents $6.5 million of NPAs and we still expect it will take some time to resolve. This was a significant driver of our provisions in the first quarter and we continue to believe that the exposure is adequately addressed in reserves. The third significant loan in NPAs is the land development loan in Fresno County. This loan was originally $3.7 million when it was moved to NPA in the fourth quarter of 2007 and remained at that level at March 31 of this year. We received a pay down of $1.7 million in the second quarter and the remaining $2 million continues to move towards resolution.

The balance of NPAs included a loan of $1.1 million on a finished luxury residential lot in Monterey County, $1.8 million secured by three luxury homes in the hills of the East Bay region of our core market, a technology relationship with three loans totaling $500,000 and two SBA loans totaling $400,000.

Lastly, NPAs include two commercial REO properties totaling $983,000 which originated in the SBA portfolio. We have accepted an offer for sale of one of these properties at a level that exceeds the remaining carrying value on our books.

I would now like to put these loans in the context of our overall portfolio for you. As with last quarter we filed some slides last night that we’re going to be walking through. The layout of percentages we’re going to note as we walk through the portfolio. You can pick those slides up off our investor relations web site probably by the end of the day and if they’re not there, just contact me and I’ll get them to you.

Overall our loan portfolio continues to exhibit good diversity with commercial loans comprising approximately 50% of the total. We believe the level of exposure to construction and land development lending in our portfolio is manageable. We continually review these portfolios for progress, for currency of appraisals and developer or borrower liquidity. Based on this review we believe we’ve established appropriate reserves for estimated losses and of course we will continue to review these issues as market conditions change.

We understand that from their representation our NPAs in the land development segment of this portfolio is of greatest interest and therefore I’ll cover those first. As of quarter end we had about $60 million in land investment or development loans. Of this amount $16 million is comprised of 20 loans secured by residential land approved for one to four unit development single-family primarily in the luxury markets in the Bay area. These are the individual scrape and build and infill projects that you’ve heard us talk about in the past.

This portfolio carries an average loan-to-value of 57% with an average of 32% cash in deals. There’s one loan in this category in our NPAs at June 30 and that’s the finished lot in Monterey County. An additional $23 million of land development represents 11 loans for commercial property developments. These projects carry an average loan-to-value of 62% with an average of 19% cash in the project. One NPA, this is the $10 million loan near Palm Springs, is in this segment of the portfolio.

Finally, $21 million represents loans secured by real estate to develop projects of five units or more. Two projects in this segment are holdovers from the last quarter in NPAs, the projects in Monterey and Fresno discussed previously. They comprise approximately $8.5 million or 36% of NPAs at this point. The remaining portion of this segment is comprised of $12.5 million in six projects with an average loan-to-value of 74% when appraised on an as-is basis and an average of 13% cash in those projects. I would note that one of those six loans for $3.7 million has paid off since quarter end.

With regard to the construction portfolio $51 million or 51% of this portfolio is for construction of one to four family residential properties. These projects carry an average loan-to-value of 65% and have an average of 20% cash into the projects. $28 million or 28% of the construction portfolio is for commercial projects. These projects carry an average loan-to-value of 65% and have an average of 22% cash in those projects. The remaining $21 million or 21% of the construction portfolio is related to multi-family projects and these projects carry an average loan-to-value of 65% and have an average of 18% cash in the projects. From a geographic perspective 69% of the construction portfolio is located in the peninsula in the South Bay region primarily in Santa Clara County. 18% of the construction portfolio is located in those markets that are immediately contiguous in the East Bay, Coastal markets, and San Francisco. The remaining 12% of the construction portfolio is located in other portions of the state primarily Northern and Central California.

That sums up my specific comments on the results of the quarter. I’ll now turn it back to Dan for closing comments and then we’ll open up for questions.

Daniel P. Myers

As we did last quarter we have provided quite a bit of detail on our lending activities and non-performing loans. We hope it’s helpful to you in your understanding of the bank and our operating results. We acknowledge and appreciate the challenges that current economic and real estate conditions have thrown our way. We have a team of highly professional experienced and disciplined bankers and through their efforts the company has delivered overall good results since we started seven years ago. The team has a long track record of effectively managing risks and we are now more focused than ever on that task. With the disappointing earnings results for the quarter it is easy to overlook several points of achievement during the quarter that represent continued progress in the growth and stability of our core banking franchise. While Tom covered a few of these in his remarks, I’d like to briefly cover all of these points now.

We continued to see good quality business opportunities for the bank in the marketplace as represented by overall growth of the bank. Total assets of the bank exceeded $800 million for the first time during the quarter. That balance sheet growth was led by continued expansion of our core deposit base. Average top deposits grew $29 million or roughly 5% from the prior quarter and almost all of that deposit growth was realized in core non-interest-bearing DDA balances. The percentage of non-interest DDA balances increased from 29% to 32% of total deposits in the second quarter.

We also saw continued growth in the acquisition of the number of new client business operating disbursement accounts commonly known as DDA. These accounts grew 21% from the year ago quarter and 5% from the prior quarter. We track these accounts as a primary measure of sales effectiveness and that is where DDA balances will accumulate as the accounts are opened and funded particularly in our growing commercial, industrial and technology banking lines of business.

We also saw continued demand for good quality loans. Average funded loans grew by $28 million from the prior quarter and that growth was spread among nearly all of our lines of business. And as Tom mentioned we maintained a net interest margin that is among the best in the industry. Diversification of our loan activity within our loan portfolio remains high. Our loan portfolio is spread among eight primary types with no loan type exceeding 26% of the total portfolio and nearly half of our entire loan portfolio is non-real estate based which continues to place us near the top of our peer group with non-real estate business lending activity. Our reserves for potential loan loss are strong and reflect our proactive approach to early recognition of potential problems, conservative analysis of potential exposures, and aggressive collection practices.

And lastly, our capitalization is strong and nicely above the regulatory guidelines of well capitalized financial institutions.

In spite of our challenges this past quarter we remain confident that we have the right business banking strategic focus, an effective business model, and have built a solid foundation of achievement to succeed going forward. Our strong core banking franchise positions us well to successfully weather the challenges of the current economic cycle. I’d like to thank you for joining us this morning and for your kind attention. We look forward to seeing some of you in person at the various upcoming bank investor conferences over the next few months that we are scheduled to attend. In the meantime please call Tom Sa or myself with any additional questions you may have.

And with that I’ll turn over the call to the Operator for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jeffrey Rulis - D.A. Davidson & Co.

Jeffrey Rulis - D.A. Davidson & Co.

Tom, the LTVs or what are the LTVs for the two loans in Monterey County, the $7.6 million in NPAs?

Thomas A. Sa

We’ve got two loans that you recall. One of those loans is a finished lot. That loan was appraised in April of this year and we didn’t have benefit of this appraisal when we made our original estimate of impairment on both of those loans but the appraisal actually came in much stronger than we expected at $2.6 million on a $1.1 million loan. The loan-to-value on the unfinished lots is, again an April appraisal and that appraisal came in at 98% on a bulk basis.

Jeffrey Rulis - D.A. Davidson & Co.

And you said there’s $3.7 million in NPA payoffs after quarter end?

Thomas A. Sa

That loan was not in NPA but it was in the land development segment. That was a performing loan but it was out of the segment again that we think is under the most pressure in this environment.

Jeffrey Rulis - D.A. Davidson & Co.

On the SBA loan sales, you said that’s drying up a bit. That’s been running about $1 million to $1.5 million each quarter? Has that been the typical range?

Thomas A. Sa

Historically I think that’s been right, Jeff. The last two quarters we’ve not seen that level of activity. And actually $1.5 million is on the high side. I think our annual contribution on the net interest income line was just under $3 million on the SBA front last year.

Jeffrey Rulis - D.A. Davidson & Co.

And that included an anomaly in that we sold a portfolio of the unguaranteed portion of 7A loans?

Thomas A. Sa

Yes. The second quarter of last year we sold a portfolio of $11 million unguaranteed portion of the 7A loans and that contributed $1.1 million in revenue. So generally premiums have been off; it’s not just volumes; our premium levels have been off as well.

Jeffrey Rulis - D.A. Davidson & Co.

Have you had any recent regulatory exams or have you schedule an upcoming one?

Daniel P. Myers

Yes and yes. The regulatory process in the national banking system, we have a national charter, is one where for a good number of years you don’t tend to have just one exam event. They schedule a variety of visits over the course of the year. And I think you’re referring to asset quality exams. The asset quality exams started for us last December and continues coming up here shortly.

Jeffrey Rulis - D.A. Davidson & Co.

And then lastly, I don’t know if you can comment on the delinquent loans either specifically or in general terms, how that trend’s changed in the quarter?

Thomas A. Sa

Yes. Delinquencies have been at low levels and if you look at last quarter’s call report you’ll see that our delinquent 30 to 90 day was in the $1 million range. This quarter it’s approximately $2 million but still at relatively low levels.

Operator

Your next question comes from Donald Worthington - Howe Barnes Hoefer & Arnett, Inc.

Donald Worthington - Howe Barnes Hoefer & Arnett, Inc.

On the other operating expense line, I noticed that was up sequentially this quarter versus last and you may have talked about that but I missed it in terms of what contributed to that increase sequentially?

Thomas A. Sa

Yes, there are a couple of things. One, we had in the prior quarter for Q1 a six-figure recovery of legal fees on a loan workout so that impacted legal fees. Two, We’ve also had in Q2 a slightly heavier legal burden from both loan workouts and a trademark issue we’re working out.

Donald Worthington - Howe Barnes Hoefer & Arnett, Inc.

And then you mentioned a couple of recent appraisals. Just in general, how recent are the appraisals particularly on the non-performers? You mentioned two of them, but on the others.

Daniel P. Myers

We’ve stepped up the frequency of appraisals on all projects across the board regardless of loan type. The non-performing loans the appraisals are all within 90 days and the bulk of the remainder of the portfolio is concentrated in the current 90 days with almost all the rest in the 90 to 120 days. So we’re making every attempt to get as fresh information as we can to keep abreast of the market as it may move.

Donald Worthington - Howe Barnes Hoefer & Arnett, Inc.

Just one last housekeeping question. Tom, I missed on the $60 million land development portfolio, you mentioned 20 loans in the one to four category. What was the total dollar amount of that? This was on the luxury home piece in the Bay area.

Thomas A. Sa

Yes, it’s $16 million. 20 loans and $16 million.

Operator

Your next question comes from Bobby Boland – Keefe, Bruyette & Woods.

Bobby Boland – Keefe, Bruyette & Woods

Just a few questions on the Coachella Valley loan, the first question is, the relationship for that loan, was that a local person that you followed down there or is that something that you did outside a footprint with somebody else? How does that relate?

Daniel P. Myers

All of our loans including all of our real estate loans are made to individuals local to Silicon Valley. In this case the actual property happened to be located where it is and actually had been owned by the family for approximately four decades.

Bobby Boland – Keefe, Bruyette & Woods

Following up on that, you said the original, it’s a $10 million loan, and this one sits under the construction or land development?

Daniel P. Myers

Actually neither, we made the loan to facilitate estate planning, so we made the loan when it was in escrow to be sold and unfortunately the sale did not materialize due to some of the fallout from the disruption in the credit markets.

Thomas A. Sa

Bobby, when you look at the roll-up, it is rolling up as land development. You could view that category to include what I would call land investment here.

Bobby Boland – Keefe, Bruyette & Woods

It was originally a 20% LTV, $10 million so it would have been a $50 million value?

Daniel P. Myers

It was just under 30% loan-to-value.

Bobby Boland – Keefe, Bruyette & Woods

Okay, I misheard that. And then it’s fallen to a 60%?

Thomas A. Sa

That’s based on an appraisal as of May of this year.

Bobby Bolin - KVW

Is that just based on the underlying land values in that area or is that something specific to that project?

Daniel P. Myers

It’s based on change in values for that particular area. And again, the project or the property is owned industrial but used for farming and does have a rather large active working produce processing cooling facility on it.

Bobby Boland – Keefe, Bruyette & Woods

On the deposit growth, it was a very impressive deposit growth at almost 14% in the non-interest-bearing demand. Is that coming primarily from the commercial relationships?

Daniel P. Myers

Commercial and technology, yes.

Bobby Boland – Keefe, Bruyette & Woods

And that looked like it came pretty early in the quarter, too, because the average is up. Just a significance so it wasn’t all end of quarter growth.

Daniel P. Myers

Yes, it was a good start to the quarter.

Operator

Your next question comes from Aaron Deer - Sandler O’Neill.

Aaron Deer - Sandler O’Neill

How big is the SBA portfolio slit between 7A and 504?

Daniel P. Myers

On a production basis year-to-year it’s changed but its’ -

Aaron Deer - Sandler O’Neill

What I’m looking for is not production but what’s kept in portfolio? How big is what’s kept in portfolio?

Thomas A. Sa

I’ve got that here, Aaron, just one moment. Of the $65 million 504 loans are over $40 million of that so it’s probably about two-thirds 504, one-third 7A. And we do look at that exposure and as I said last year we sold off some of that unguaranteed exposure. I don’t know that that’s available as an avenue for us these days but we do monitor them.

Aaron Deer - Sandler O’Neill

What trends are you seeing amongst those borrowers? Are you seeing anything different from what you’re seeing amongst your larger borrowers?

Daniel P. Myers

Particularly in the SBA portfolio?

Aaron Deer - Sandler O’Neill

Yes.

Daniel P. Myers

We’re not seeing any material deterioration at this point. That’s the type of lending that does carry a slightly higher risk profile. That’s why the SBA guarantee is valuable there. So we’re seeing a similar level of problem loans that we’ve seen in past years but we have historically tended to be on the conservative side in the business that we’ve brought in through the SBA channel.

Operator

There are no further questions.

Daniel P. Myers

Again I’d like to thank everybody for listening in to this conference call. Our goal was to provide additional detail and color on the second quarter 2008 operating results for Bridge Capital Holdings. Again we remain confident in the market in which we operate, our strategy, our business model and the continued disciplined execution of the many fine professional Bridge bankers. We will continue to succeed in the future. I appreciate your time this morning. Thank you.

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