Sterling Bancorp, Inc. (Southfield, MI) (SBT) CEO Tom O'Brien on Q3 2021 Results - Earnings Call Transcript

Sterling Bancorp, Inc. (Southfield, MI) (NASDAQ:SBT) Q3 2021 Earnings Conference Call November 1, 2021 11:00 AM ET

Company Participants

Tom O'Brien - Chairman, CEO and President

Karen Knott - Executive Vice President and CFO

Conference Call Participants

Ben Gerlinger - Hovde Group

Nick Cucharale - Piper Sandler

Ross Haberman - RLH Investments

Operator

Good morning everyone. Thank you for joining us today to discuss Sterling Bancorp's Financial Results for the Third Quarter September 30, 2021. Joining us today from Sterling's management team are Tom O'Brien, Chairman, CEO, and President; and Karen Knott, Chief Financial Officer and Treasurer.

Tom will discuss the third quarter results and then we'll open the call to your questions. Before we begin, I'd like to remind you that this conference call contains forward-looking statements with respect to the future performance and financial condition of Sterling Bancorp that involve risks and uncertainties. Various factors could cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. These factors are discussed in the company's SEC filings, which are available on the company's website. The company disclaims any obligation to update any forward-looking statements made during the call.

Additionally, management may refer to non-GAAP measures which are intended to supplement but not substitute for the most directly comparable GAAP measures. The press release available on the website contains the financial and other quantitative information to be just discussed today, as well as the reconciliation of the GAAP to non-GAAP measures. At this time, I'd like to turn the call over to Tom O'Brien. Tom?

Tom O'Brien

Great, thank you. Good morning, everyone and welcome to our third quarter earnings call. I’m joined this morning by our newly appointed CFO, Karen Knott, Karen brings a long experience with Sterling to us and I look forward to working together.

So today we reported earnings per share of $0.19, which was comprised largely of a $6.5 million credit that we received under the CARES Act for employee retention. Sterling is eligible for this credit because we've maintained our employee base without furloughs or layoffs and met the criteria for eligibility, which was revenue is down year-over-year by 20% and fewer than 500 employees. So, we expect also to be eligible for a similar credit in the fourth quarter, which we think will amount to about $2.2 million.

These are employee tax credits and not income tax credits or refunds. So, but more importantly, we had some improvement in NIM in the quarter, reached 283. We had a decline in operating expenses, excluding the employee retention credit to about $17.6 million. We had been hoping to see some modest decline in OpEx as certain of our remedial projects neared conclusion.

Notably, the look back required by the OCC under the formal agreement is now just about complete and that represented about a $10 million effort over several quarters. We're also near finality on the securities litigation matters, and that also helps to bring some expenses down.

So while the risk of volatile expenses remains elevated, we're working tirelessly to move things along as best we can. The various investigations and supervisory issues confronting Sterling continued to be significant and we continue to cooperate fully and address those issues under our control as quickly and comprehensively as we can.

I believe we have made substantial progress on the matters found in our formal agreement. The system conversion was a huge step in that direction since multiple remedial steps required that successful transition. On the DOJ side, we have less insight into criminal investigations of various individuals.

Again, we continue to fully cooperate and be as transparent as we can, whenever requested. I continue to believe we'll have some greater insight into these matters as year-end approaches, but resolution from the bank's perspective will not be forthcoming, at least in my opinion until well into 2022.

The credit story in the bank remains I'd say pretty much unchanged. We continue to work the commercial criticized and classified list aggressively. NPAs are pretty much unchanged from prior-quarter. But as you can see from the tables in our release, the split between the residential and commercial is roughly $40 million each.

We have not experienced significant credit losses to date on the residential side, notwithstanding obviously the horrendous costs that we've incurred to remediate the origination fraud that occurred in the past. Also included in the residential NPAs are several loans that are paying but have yet to return to accrual status. As I've noted over the last several quarters, my concern from the credit loss perspective remains centered in the commercial portfolio.

We have not seen much in the way of migration into classified territory. And I think, we at this point now we've properly risk rated the vast majority of the commercial portfolio. So, again that's where I think we retained some element of risk in the credit loss side, but we're looking at various alternatives.

We've had some success in moving loans out of the bank without incident. We probably look at some individual or bulk loan sales in the quarter ahead and beyond. And our goal is to get the number down as efficiently and as quickly as we can, with a minimal loss. But as I've said, over -- probably since I've been at the bank, the exposure to loss really in my view continues to be heavily centered in that commercial portfolio.

So, that's kind of the story with the bank for the quarter. We made a lot of progress, probably some of it below the waterline that you don't see or appreciate as much as those of us who are on the inside cannot see every day. But fixing the supervisory issues that are found in the formal agreement are really our [Technical Difficulty] through infinity. We're focused really on nothing else other than clearing those things away as quickly as we can and trying to bring some finality to the supervisory efforts of the difficulties that the bank has. So with that, operator, I'm through with anything I wanted to say. And maybe Karen and I can take some questions from those on the phone.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Ben Gerlinger with Hovde Group. You may go ahead.

Ben Gerlinger

Hey, good morning.

Tom O'Brien

Good morning, Ben.

Ben Gerlinger

How's everyone doing?

Tom O'Brien

We're doing fine. You're getting any sleep?

Ben Gerlinger

Yes, hasn't had any sleep at all. Two little ones and Halloween candy make for not much sleep for anybody, but appreciate it. Actually I think, let me just start with Karen, if you look at the deposit, and the cost of deposits, there is a pretty good reduction linked quarter, both in time balances and the yield. I was curious if you had any insight over what could be coming up for renewal? And then what is the new rate that is coming on over the next quarter or two?

Karen Knott

Sure. So, in the next quarter, we have about $150 million CDs maturing. The rate on those is about 1%. Our highest offering rate, base right now is about 65 basis points. So, we do expect to see some more reduction in our cost of funds in the next quarter.

Ben Gerlinger

Okay, good to hear. And then Tom, just thinking big picture, I know that you can't answer it with a [indiscernible], but if you look at the professional and legal fees reduction in the linked quarter, and so there's a lot of heavy lifting being done behind the scenes, which I think we can all agree that is important. But there's not a lot of clarity in terms of total costs going forward. So, if you had any thoughts to what professional fees might be for the fourth quarter or even the first quarter, and then kind of juxtapose against that, like what would theoretically a core run rate be for that line item?

Tom O'Brien

Well, let me I guess, start at the back end of the question. So, I think Karen can fine tune this one-off, but I think our core runaway rate would be something around the $12 million range. Does that sound right Karen?

Karen Knott

Yes, I would say with the current level of services that we are using third party for.

Tom O'Brien

Yes, the excess over that in this case for the quarter, so we kind of adjusted it to $17.6 million, that's down from $19 million, $20 million, $21 million in prior quarters over the last year or so. So, I guess what we call the extraordinary cost with predominantly legal and professional or advisory type work, we would run anywhere from almost a double of our regular OpEx, $10 million or $11 million a quarter.

As I've said before, I think they'll drift down a little more as we get into the fourth quarter, and as we get into the first quarter. The risk of volatility though remains high if something comes out of one of these investigations, and it requires us to do another deep dive into something. I'm not aware of it at the moment. That’s been going on or a year predating my arrival, so two plus years. So, I think the trend that we've talked about, which is slowly declining rates with the risk of some volatility is intact, but it's really, really hard to put a number on it, because month-to-month it can vary at a level beyond what we might expect or something gets delayed, an expense that we might have incurred gets pushed off to the next quarter.

The secret really is just to get these things past us and resolve all of the issues in a formal agreement quickly, and then as best as we can push for resolution of the bank's exposure with the regulatory and the Justice Department side and with the SEC, it's like an alphabet soup sometimes of agencies. But I just - I feel uncomfortable trying to give you a hard and fast quarter-to-quarter estimate, because a lot of it's out of our control. But as we kick off things like the securities litigation, then they no longer contribute to the risk of higher expenses.

Ben Gerlinger

Got it. Okay, that's fair. I mean, just thinking just from an OpEx perspective, there's no like looming lump sum that could cause it to increase outside of an unforeseen investigation. Right. It trends lower. It's just the pace is unknown.

Tom O'Brien

Yes. Okay. The trend continues to be better, just as I said, we're not going to have any more expenses probably as we get into 2022 with litigation, because it's over. We're not going to have any more expenses with a look back, because it's over. So, it’s fewer kids eating at the table.

Ben Gerlinger

Fair enough. Okay. Well, I appreciate it. That was good to see the tangible book value growth.

Tom O'Brien

Yes, that's a nice benefit.

Ben Gerlinger

Thanks.

Operator

Our next question comes from Nick Cucharale with Piper Sandler. You may go ahead.

Nick Cucharale

Good morning everyone. How are you?

Tom O'Brien

Fine, Nick. How are you?

Nick Cucharale

I'm doing very well. Thank you. So I wanted to start on the loan balances. While the residential portfolio continues to run off, you had strong commercial real estate growth this quarter. Do you anticipate this becoming a trend and just some color there on the sequential increase will be great?

Tom O'Brien

We did actually originate a loan or two on the commercial side in the context of new credit to the bank, and then some of the loan growth in the commercial side as we've had matured construction loans that moved into, I guess the sales period you'd call it, and we put those down as bridge loans just to more properly identify what's really construction risk and what's now, I guess marketing your sales – time and sales risk.

So, that's the bulk of it, nothing dramatic, but I would say that would not be something I'd be uncomfortable with to the extent we can find some good commercial product in and around our various markets and with people that we've known before that I have no problem. The residential side is, it's in my view, as you probably know, it's for community banks, it gets tougher and tougher to be a residential lender of any substance, it's a high risk from the compliance side, it's very, very costly.

The risk of doing something wrong on the compliance side is always high. And when I say that, I don't mean the things that Sterling went through, but I'm just -- good faith mistakes. And the market multiples aren't so great for revenues from gain on sale and residential loan business in general. So, it's not one of my favorites.

Nick Cucharale

In your prepared remarks, you referred to some bulk loan sales. Is that solely on the commercial side?

Tom O'Brien

At this point, it's on the commercial side, the residential honestly, up for that. We did move that group of loans that I referenced in the press release to held for sale. But we can't do much until the justice department investigation is over. We're kind of stymied on that, but once - as it pertains to the bank. Once that's over, then I'd be more inclined to sell those as quickly as I could. And we had some good interest in those, but there's just this issue with the DOJ part of it that we've got to retain those until they finish with the bank. So, another reason to encourage them to move along.

Nick Cucharale

Yes, completely understandable. We've discussed this on past calls, but can you update us on your scheduled loan repurchases over the course of future periods?

Tom O'Brien

Yes, we're pretty much through everything there's about. So, when I joined the bank, there was about $800 million worth of loans at risk of repurchase, $750 million maybe. And that's now down to about $160 million. And they do continue to pay off pretty quickly as you saw. But the scheduled committed repurchases I think we have, and Karen correct me again, but I think we have one in March '22, and one in July '22, and that is it and that amounts to about I think $75 million, $80 million, $90 million in the aggregate, and then we'll have what is today, almost half of that $160 million. And then the rest of the investors who bought those didn't take our offer. So, I assume they remain outstanding. We've had no interest from them and putting them back.

Nick Cucharale

Okay, and then the other part of that is just the excess liquidity that you're holding a huge part for the potential purchasers. When do you anticipate more normalized levels of liquidity?

Tom O'Brien

I think we got down some in the quarter. I would go back and say, I feel a little better when we reach some finality with the governmental investigations, because you just always have to be cautious with issues that could surround that and potential publicity or something like that, that causes a problem. So we're more cautious on the various needs for liquidity, but the big need at the point in time when I joined the bank for long repurchases is pretty well extinguished.

Nick Cucharale

Okay. And then lastly, as you pointed out in the press release a lower tax rate relative to the prior quarter is just what's your expectation for the go-forward tax rate?

Tom O'Brien

That's why we have a new CFO on the call.

Karen Knott

Yes, I mean, I think typically we're around the 30% range, maybe slightly less. And I anticipate that score will be for the whole year at the end of the year.

Nick Cucharale

Thank you for taking my questions.

Tom O'Brien

And this is - I'll say also, Nick, the tax rate from a guy who spent his life working in New Jersey in New York banks, the tax rate in the state of Michigan consolidated is substantially more attractive than it is in New York or New Jersey or most of the Northeast states that I've worked in.

Nick Cucharale

I can confirm that as well.

Tom O'Brien

Go Michigan.

Nick Cucharale

Thanks again.

Tom O'Brien

Or go Michigan State. I should say that was.

Operator

[Operator Instructions]. Our next question comes from Ross Haberman with RLH Investments. You may go ahead.

Ross Haberman

Good morning, Tom. Tom, how are you?

Tom O'Brien

Yes, I'm fine. How are you, Ross?

Ross Haberman

Good. I just wanted to focus in a little bit on the non-performers both the residential and the commercial. I think the commercial was down a little bit, residential was up. Could you give us a sense of what's in there and how comfortable you are with your carrying values? And what you're doing to readily get rid of them, work them down? And could we see any significant drop off in the fourth quarter? Thanks.

Tom O'Brien

Sure. So let me start with the residential side. And that's actually why we broke them out in the tables for this quarter. So the residential, as I said, I think I said in my remarks that there's a number of those that are, I guess you'd call them either a radically performing, where they may catch up payments with some regularity. And there's also some that were substantially delinquent and [indiscernible].

And so that and Karen may know the exact breakdown or rough breakdown of those two differentials on the residential side. We've not experienced losses either in short sales or liquidations or anything like that on the residential side. Notwithstanding the compliance remedial costs we've incurred, but the credit side of it has been fairly benign reason, I have to think that that won't continue. That group of about $22 million or so that we mark to held for sale at year-end as paid down to around $11 million at this point.

And that's just from loan satisfactions and repayments, prepayments, and things like that without any credit loss, and so that. Whether or not that continues hard to see, but it's certainly not indicative of loans with the -- residential loans with the big losses embedded in them. So, I'm not at all uncomfortable with where we are in the residential side. And Karen, do you know the breakdown between the kind of rough awkwardly performing, non-perform?

Karen Knott

Yes, so I would say just slightly less than half of the non-performing residential loans are not even 90 days delinquent. They're either current or maybe 30 days, but like you said, they just really haven't established a regular repayment patterns and they went on to non-accrual. And so, if they achieve those goals, then according to our policy, we can flip them back or just monitoring them.

Tom O'Brien

So that's a residential -- the commercial is I think I've said every call I've been on, it's the one that troubles me the most from the credit risk perspective. It's a combination of what gets banks into trouble all the time is too aggressive on commercial originations, and I'd say probably the last lack of expertise or talent in certain areas that creates credit exposures that get difficult to manage.

So, we've got these SRO loans, single room occupancy loans predominantly in the city of San Francisco. I think we're overlent on several of those. And we've had some success at encouraging the owners to refinance elsewhere has the loans came due. We've had some where we could improve the credit by restructuring it, improving the amortization schedule, getting additional collateral things like that. And we've got a couple others that are just stinkers that, we're going to lose money on.

And then in the construction side, again, my experience at a lot of different banks has always been banks going into construction lending, because they get seduced by the terms and the rates and things like that. But that's a whole different game, and the expertise to manage the sophisticated construction portfolios. It is hard to come back, and we did not have it.

So we had, again, we've had some success with those loans that are completed. And we're looking at marketing periods. And we've had one or two of those paid down significantly or pay off as the property got sold. And there's a couple others that are ill conceived and problematic, and I think, we'll end up experiencing some losses on those. But we talk about them every day, almost, or at least those that are on the agenda for that day. We look to reduce the risk to the bank in the most efficient way we can, and efficiencies measured in both dollars, but also in time on the books.

So, that's why I said earlier, I wouldn't hesitate to look at a handful of book sales in the period ahead. I'm just and in all candour, I've got to manage the -- I've got to manage carefully here the things that I put into the bank for us to do. So the project management is important, and I just can't. We've got a lot of priorities. I can't overload the system here. So we had a lot to do with those IT conversion. We had a regulatory exam in August and September. So I kind of have to look out in the calendar and do these things in a way that this is best for the [Technical Difficulty] the institution and the staff's ability to handle all the moving parts.

Ross Haberman

No, no, I was just curious. I got to -- I was looking at the allowance, you put in about $400,000 for the quarter. I've got to assume at least from what you know today, after you've gone through all your summaries that I guess you're fairly comfortable, I guess with what you're carrying all that the commercial. Let's just talk about the commercial. What you're carrying at now. Otherwise, I guess we would have seen a much bigger provision in the September quarter. Is that -- will that be a good summary.

Tom O'Brien

I think you know me well enough by now. If I weren't comfortable, it would reflect the number that, I think it should be.

Ross Haberman

Okay.

Tom O'Brien

That's why it went up in 2020.

Ross Haberman

And last question. I know you sold the Washington office. Any other offices you see, I shouldn't say superfluous, but extraneous or not fitting in well, which if you got a bid you would sell it? Thank you. That's my last question. Thanks a lot.

Tom O'Brien

Sure. Sure. Well, I could probably say yes to that in particular location. If somebody were that interested in it. But it's a general rule, I think we have to look at the markets that are -- let's call them non-core.

Ross Haberman

Right.

Tom O'Brien

And evaluate those and we are doing that. I mean, we look at every location. And even in a core markets, we're looking at individual branches to see if it makes more sense to either consolidate or if we've been there for a while, and a branch hasn't really achieved what we thought it should. Is there a reason to stay? So, again, I got to be careful with what I load into the system here because we're all working a lot. But branch locations are high on the priority list.

Ross Haberman

Okay, all right. So best of luck. Thanks a lot. Bye-bye.

Tom O'Brien

Sure. I hope you too. Thanks.

Operator

This concludes our question-and-answer session. I'd like to turn the conference back over to Tom O'Brien for any closing remarks.

A - Tom O'Brien

Okay, well, thank you, again. Appreciate the questions and your interest in the bank. And while it's hard to believe the next call will be into 2022. So times moving along quickly here. I hope you all enjoy a delightful fall. And we'll look forward to talking to you in January with our year-end commentary. Thanks so much.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.