Sandy Spring Bancorp Inc (SASR) 2014 Q2 法說會逐字稿

Good day, and welcome to the Sandy Spring Bancorp Incorporated second quarter 2014 earnings conference call and webcast. All participants will be in listen-only mode.

(Operator Instructions)

After today's presentation, there will be an opportunity to ask questions.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Daniel J. Schrider. Please go ahead, sir.

Thank you, Chad, and good afternoon, everyone, and welcome to Sandy Spring Bancorp's conference call to discuss our performance for the second quarter of 2014. This is Dan Schrider speaking. And I'm joined here today by Phil Mantua, our Chief Financial Officer and Ron Kuykendall, General Counsel for Sandy Spring Bancorp.

As always, today's call is open to all investors, analysts and the news media, and there will be a live webcast of today's call and a replay of the call available at our website beginning later on today. And we will take your questions after a brief review of some key highlights. But before we get started, Ron Kuykendall will give the customary Safe Harbor statement.

Thank you, Dan. Good afternoon, ladies and gentlemen.

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 risks and future costs and benefits, assessments of probable loan and lease losses, assessments of market risk 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 expectations and projections of future interest rates, market behavior and other economic conditions, future laws and regulations and a variety of the other matters which, by their very 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 in its future results.

Thanks, Ron. Today, as usual, we will look to your questions immediately after some brief remarks.

On a core earnings basis, it was another solid quarter and we continue to be pleased with our consistency and balanced results, as well as the year-over-year performance of our stock price. Unfortunately, the impact of $6.1 million of litigation-related reserve expenses recorded during the quarter, which is an EPS impact of $0.15 per share, was significant, and caused net income for the quarter to come in at $7 million versus $12.2 million for the second quarter of last year and $10.9 million for the linked first quarter of 2014.

As we previously outlined in our press release dated May 16, a jury returned a verdict against the Bank for damages totaling just over $6 million in the case involving the conduct of our former employee of Commerce First Bank in 2011 which is a company we later acquired in 2012. We've continued to aggressively pursue relief through the post-verdict motions process and intend to seek appellate review if necessary.

We are also proceeding with all claims with regard to obtaining insurance coverage for these damages, and we do not expect any long-term impact to earnings beyond the second quarter of 2014. Here's just a quick rundown of the main highlights from the release with a bit of added color where appropriate.

We continued to execute on the priority areas we've indicated previously. Topline revenue growth was 2.7% on a linked quarter basis, and pretax pre-provision earnings were up $700,000, or an increase of about 4.5% on a linked quarter basis. The operating environment continues to be very competitive and remains challenging, but we feel very positive about how we performed in this quarter on a core basis.

As I mentioned earlier, the litigation expense impact of $0.15 per share, but if you add back that back to the $0.28 per share we reported, then you come up to $0.43 per share, beating a Street consensus of $0.41. And from a higher altitude perspective, we're we are also pleased with the growth in the balance sheet.

As expected, we have been able to gradually shift the asset mix from an investment into our loan portfolio, which is a key strategic priority. Loan growth is balanced among all categories and increased 12% compared to the second quarter of 2013 and 3% on a linked quarter basis. Our teams across all lending segments are performing well.

As important, deposits and other customer funding sources increased 4% compared to June 30, 2013, and the combination of non-interest-bearing and interest-bearing checking balances increased 10% compared to June 30, 2013. The result, our non-interest-bearing deposits represent 32% of total deposits at quarter end, June 30, 2014. So, as a result of the balanced loan growth and the strength of our deposit mix, the [industries] margin is holding up well and advanced 1 basis point over the linked quarter to $3.48 from 3.47 at March 31.

Some observations on the mortgage lending front. So far this year, overall volume for residential loans is about half of what it was for the first six months of 2013. While we are not originating as many loans, the mix has also changed.

Last year during the first six months, 60% of loans on the residential side were refinancings. This year it has decreased to 42%. The majority of the real estate loans we are now making are for residential construction. These are loans to individuals for larger homes with mostly seven-figure price points and quality borrowers, as you might expect from our footprint, which has the nation's highest per capita income.

So while the nature of new business activity and mortgage lending has changed, our mortgage division continues to be a significant contributor to core earnings. Our wealth management business lines continue to be a significant contributor to our non-interest income. With assets under management crossing the $2.7 billion threshold at quarter end, wealth management income increased 5% when compared to the prior-year quarter.

There was a slight uptick in NPAs as a result of a couple of specific credits that were already well reserved, although classified and criticized assets continued their downward trend. The provision expense of $200,000, as expected, is being driven by loan growth, and we expect growth to be the main driver of future provisioning. Charge-offs were also at about $200,000 and in line with our expectations.

We think expense controls are satisfactory and working well as non-interest expense for the first six months was $55.6 million versus $55.3 million last year. And on the capital side, the picture is good. At June 30, the Company had total risk-based capital ratio of 15.66%, a tier 1 risk-based capital ratio of 14.48% and a tier 1 leverage ratio of 11.37%.

As we have said previously, our capital deployment strategy continues to include a focus mainly on organic growth, along with strategic M&A activity, dividend payouts, and share repurchases when we feel it's prudent to do so. Moving forward, we are committed to continuing our focus on our core performance, controlling expenses and driving additional revenue from our wealth management insurance business-wise.

That concludes my remarks for today, and we will now move to your questions. Chad, we can take the first question, and if you -- we would appreciate it if you would state your name and Company affiliation as you come on so we know with whom we are speaking.

Sure.

(Operator Instructions)

Jason O'Donnell, Marion Capital.

Nice quarter. My first question relates to the drop in the tax rate in the second quarter. If I did my math right, it looks like it came down to around 28%. Were there any credits in there or unusual items that caused that to decline? And what's a good effective tax rate to assume for the remainder of this year?

Jason, this is Phil. There's nothing unusual that's in there in the current quarter. And from a more normalized perspective, our effective rate is usually in the 32% to 33% range, and I would suspect it will return to that as we move forward.

Okay, fair enough. And then on the -- switching gears, on the margin front, obviously a very favorable outcome this quarter, given certainly what we're seeing of out of some of the other banks in the region. In terms of the loan yield, do you think that you can keep that loan yield stable, around that 4.30% level? I think in the past you had said you felt like the margin could remain relatively stable through the year, we saw that through the first half. Is that something -- how do you look at the loan yield heading into the back half of the year?

Jason, it's Phil again.

A couple elements to that. I think first of all, the stability in the current quarter is, as Dan stated in his opening comments, is as much related to the gradual shift in the mix on the asset side from the investment portfolio to loans, even though the loan yields in general continue to compress to a degree.

The one exception to that that is starting to trend the other direction would be in our mortgage portfolio, where some of the things that are -- some of the individual credits that are being put in a portfolio today are actually yielding higher than the average for the portfolio. And as we go through the rest of the year, that should start to change the general trend of yield in that particular part of the balance sheet.

I think there's still some -- to answer your question more directly, there's still some more compression in the loan yield. But if we continue to have the kind of loan growth we had in the quarter and redeploy of the asset side, that should still allow the margin to stay fairly stable as we go through the rest of the year.

Okay. That's helpful. And then I guess my last question and I'll hop out is just a housekeeping on the expense side of things. Did you have any meaningful non-recurring expenses this quarter tied to branch consolidations, severance expense or other initiatives that we should be aware of?

No, not really. I think, as we communicated in the release, the main drivers of the difference in the core part of the expense during the quarter were related to salaries and then some benefit costs. Nothing out of the ordinary there.

Marketing, which was just over the first quarter, but on a year-over-year basis, very comparable to the expenditures in that area last year this time. And just a couple other miscellaneous things here or there that, normal course of business, so nothing unusual to speak of at all.

Okay. Thanks.

Catherine Mealor, KBW.

You had guided over the past couple of quarters to a mid to high single-digit loan growth, and you've come in at the high end of that range the past couple of quarters. Can you talk a little bit about that guidance and if you feel like this 10% level is sustainable for the back half of the year, and maybe talk about what your pipeline looks like? And do you feel like -- is a lot of this coming from more market share takeaway? Or how much of this do you think is coming from just a better economic environment in your market?

Catherine, this is Dan.

I think our outlook, which has been that mid to high single-digits, is -- continues to be our -- reflect what we think the market -- where the market is. I think the one thing that we're seeing, and we commented on it in our release, is the impact of the mortgage business. And the shift in mix there where moving away from that salable product in this season to growing portfolio balances there has probably been the one area that's kicking that -- has kicked that up a little bit higher than how we've had an outlook in terms of loan growth.

We're also seeing, as you can tell on our balance sheet, starting to see some meaningful growth in the consumer side of the business, which is for us almost exclusively home equity lines through our branch network. There's of those couple of pieces that are more retail oriented, are creating that lift, although we look at the overall economic environment as being stable, but not showing any real momentum at this point.

I think overall, we are still that high single-digit outlook. We could come in better than that if things continued on the mortgage front, but I don't think our outlook has changed much.

Okay, great. Thank you.

And then maybe a follow-up on the provision line. It feels like -- you had mentioned last quarter that the [1:30] reserve to loan ratio felt like the level that you could see, and we saw that this quarter. Do you feel like all else equal, we're at a bottom in the reserve to loan ratio, and from here we should probably see a directional pickup in the provision line, really just to provide for the growth that you're seeing?

I think the answer to that question is yes. I think it's going to be a growth-driven provision expense, although it's tough to -- methodology could drive that reserve to loans a little bit lower for a season, but it's still going to be driven by portfolio growth. I don't necessarily see 1:30 as the absolute bottom, but I think that's pretty darn close.

Very helpful. Thank you.

Bryce Rowe, Robert W. Baird.

Dan and Phil, just wanted to talk about some of the recent activity from an M&A perspective up in your market, and more notably, the Virginia Heritage deal. I know you can't comment specifically, but just wanted to get a feel for how you felt about pricing there, given that we know that you have been looking for acquisitions. And so, just wanted to get a feel for what pricing you might have paid for something like that or the level of discipline that you would have shown in terms of pricing there.

Bryce, this is Dan.

Obviously, meaningful transaction in the market, and certainly could set expectations as we look around with other banking franchises. I think our appetite with regard to price, as we've indicated before, is driven by the level of accretion on the EPS front and the internal rate of return, and then balancing that tangible earn back period.

And some of that's driven by how that pricing gets structured, obviously and how you're paying and what type of cost saves. I don't think there's any one formula. Can't really specifically comment on that transaction, but that's what's going to drive us and that's going to be the discipline we employ, is really take into consideration the strategic aspect of the transaction plus those key financial attributes. And then how aggressive or not you might get in a transaction would be driven by how meaningful all those things are to us for our future.

Okay, that's helpful, and maybe a follow-up.

With your capital at arguably very healthy levels, 10.5% type TCE, what is your appetite for maybe some more active buyback activity, especially in light of where your stock is from a currency perspective and relative to recent pricing on some of these M&A transactions?

I don't -- I can't say that our approach has -- that we view it as being a whole lot different. What's difficult in terms of commenting on that is it's -- what we'd like to see as a priority to that would be to deploy our capital in other ways. And so that's always going to be part of the equation. We certainly will be active if we believe we're -- it's in a position of weakness, it's in our best interest to do so. But I can't say that our attitude about repurchases have changed much.

You could argue, one of the metrics I mentioned on the M&A front is that [tangible] payback period, and obviously, you throw in the towel on that when you start looking at the repurchases. It's clearly a short-term gain on that front. We'd like to -- we're going to consider all the options for deploying capital. That's one of them. But we haven't really changed our attitude toward that at this point.

Thank you.

William Wallace, Raymond James.

I wanted to dig in maybe a little bit more on loan growth first, following up on Catherine's questions. In the quarter, do you think that this quarter benefited any from some pent-up demand, given the weather impact in the first quarter?

Wally, that's a tough question to be certain about. We can certainly say that the weather in the first quarter we feel did have an impact on overall business activity in the region. How much of that was created of pent-up aspect, really tough to tell.

The mortgage activity in the quarter on the construction side certainly was very strong in that. There's always a seasonal aspect to that anyway in the spring. Whether that was a little stronger by virtue of the weather, tough to tell. Although as we look forward through the remainder of the year, we feel like the pipelines and activity look pretty good.

I don't know if you have these numbers in front of you or not, but can you give us a sense of how the loan production progressed on a monthly basis through the quarter?

Give us a second on that.

Wally, this in is Phil.

It's actually pretty balanced through the first couple months of the quarter, and then we certainly had a fair amount more, especially in the commercial side, in the month of June. Interesting enough that the month of April and May were not really terribly different than what it looks like January and February were. And so, I don't know that there's a discernible pattern in there, to be honest with you. I'm trying to get at that.

Okay, and so except for, it sounds like basically except for June, the production has been relatively stable month-to-month?

I would say so, yes, yes. And June was a really good month, and there were a couple of larger deals that happened to close during the month of June. And so on the commercial side, that's always something that's going to swing the pendulum from a total production standpoint.

Okay. And as we think about your margin and your ability to fund growth out of your securities portfolio, I think in the past you've mentioned what you view as an ideal mix relative to your securities versus loans and your earning asset base. I just couldn't find it in my notes. Could you remind me of what you think is an ideal level of securities versus loans in your earning --?

We would target that in that 10% to 15% of assets range, so we've got a -- there's a significant amount of capacity within the investment book to fund that shift.

Okay. That's all the questions I had. I appreciate your time.

Thanks, Wally.

(Operator Instructions)

Robert Longnecker of [Jovetree].

This is Rob Longnecker, Jovetree Capital.

Wonder if you could provide a little more information on your decision to remain retain more of the mortgage originations? And maybe in the context of that, also talk about what spreads are like in the margin right now and you don't retain them?

Sure, Rob, this is Dan Schrider. The -- I think first of all, it's probably important to understand what it is that we're putting on the balance sheet within the mortgage business and what we are not. We did not put any long-term fixed rate paper in the book.

When we write -- when I speak to the mortgage production being largely driven by our residential construction activity, those are typically written on anywhere from a 5 to a 6 to a 7.1 ARM type of product where the first 12 months of that commitment is the construction period, then it rolls into an ARM product. That's a been a customary product for the construction side.

And then as construction -- as that construction period comes to a close, if there's an appetite in the borrower for a salable fixed rate loan, then we might choose to do that. Otherwise, we'll move into the portfolio.

Said another way, we're not taking a bunch of duration risk on that mortgage portfolio piece. And given the nature of it today, it's pretty attractive to put into our portfolio.

I'll let -- Phil's going to comment on the spread a little bit, but the other aspect of our mortgage book on the perm portfolio is that nearly 40% of that book has already moved through its initial ARM term. It's in that annual repricing mode, which is one reason why the yields in that portfolio have the potential of turning up over time, but also a pretty short portfolio in terms of duration.

Yes. Robert, as it relates to the spread in that mortgage book here of late, from the perspective of how we view it internally as we funds transfer price with the portfolio or the production in the portfolio, it's averaging roughly about 150 basis points of net spread, including any fee generation or amortization that's included in that yield.

Got you, okay. And that's an improvement over the last couple quarters?

Yes. I would say that is on a balance basis. I would say that, yes, that's probably a little bit better than what it had been.

Got you, okay. And then in terms -- thank you. And in terms of the litigation expense, obviously that was a pretty big number relative to the size of the M&A deal. Have you been rethinking your M&A approach or how you're thinking about yields as a result of this?

Rob, back to Dan. Short answer would be no. Just is a extremely unusual outcome, and obviously one of the reasons why we're pursuing all efforts to remedy that and overcome that through the legal process. But it does not drive a different approach to M&A or appetite for it.

Okay. Thank you.

Mark Hughes, Lafayette Investments.

Just a technical question here, if I could. Within the wealth management business, what percentage of those revenues are driven by a percentage of assets fee? For example, typically a mutual fund or investment advisors, 1% or whatever. Is most of your business that way, or is there just set fees? And the reason I'm asking is, I'm trying to figure out why that business, the revenues were up 5% and the stock market was up over 20% over that period. Obviously, everything's not in stocks, but I would have thought it would have been a little bit stronger.

Mark, this is Dan. The three legs of our stool, so to speak, are split among our trust division, the RA that we own in the claim and our investment services group, which delivers products through our retail delivery model. Of the $2.7 billion in assets under management, approximately $0.5 billion of that, $400 million to $500 million of that would be just classified in that transactional piece that you're talking about and the balance being fee for assets under management on the repetitive side of it. And that's a number that over time has continued to shift less transactional and more fee for investment management.

I'm still confused at why the number wasn't -- if the bulk of it is asset under management fee versus transactional, is it skewed heavily towards bonds? Or why isn't the number larger given how strong the stock market is or was over the June to June period?

Right. Well the -- let me clarify something, Mark. The -- if you're talking stock market comparison June to June, the 5% increase in the wealth area is, I believe more quarter-over-quarter than it is year-over-year. Our trust department fees, which is where the significant amount of the assets under management reside, was up over 14% on a year-over-year basis.

And the incomes related to those that are -- those assets being managed through our RIA at West were also up somewhere between 12% and 13% year-over-year. So, they're a little more comparable to the market per se than the quarter-to-quarter -- linked quarter-to-quarter growth, which was not.

Okay. I thought I was comparing June to June.

When you add in the -- it may also be that on a June to June basis, when you add in the implications of the investment services piece that Dan referred to, that may average out that way, because that portion of the revenue stream did decline by about 25% on a year-over-year basis.

Okay. Just while we're talking, I did check my number, yes, I was comparing June to June.

Yes, and I think that that's where the bulk of the transaction-based income is derived, and so I think that's how it balances out that way. But where the bulk of the assets under management are being driven on a more annuitized basis per se than -- I think that's closer, but not quite comparable to your 20% in the market.

Okay. Thank you.

Sure.

Jason O'Donnell, Merion Capital.

Just a quick follow-up on the credit quality front. It looks like there was a linked quarter increase in owner-occupied CRE non-accruals by about $3.5 million. I'm wondering, how granular is the mix of loans that are driving that increase? Was it just a couple of loans or where there are a number of relationships under underlying that trend?

Yes, there are two main loans that the bulk of that balance. Those were -- and those were loans that had been within our watch category for a seasonal time and also reserved against. And so it wasn't a broad swath of the portfolio.

Great. Thank you.

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

Thank you, Chad, and thank you, everyone, for your questions and taking the time this afternoon to participate with us. We'd love to receive your feedback to evaluate the effectiveness of our call. You can e-mail your comments to IR@sandyspringbank.com. We again thank you for participating, and have a great afternoon.

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