Sandy Spring Bancorp Inc (SASR) 2022 Q2 法說會逐字稿

Good afternoon. Thank you for attending the Sandy Spring Bancorp Earnings Conference Call and Webcast for the Second Quarter of 2022. My name is Matt, and I will be your moderator for today's call.

(Operator Instructions) I would now like to pass the conference over to host, Dan Schrider, President and CEO of Sandy Springs Bancorp. Dan, please go ahead.

Thank you, Matt, and good afternoon, everyone. Thank you for joining us for our conference call to discuss Sandy Spring Bancorp's performance for the second quarter of 2022. This is Dan Schrider speaking, and I'm joined here by colleagues Phil Mantua, our Chief Financial Officer; and Aaron Kaslow, General Counsel and Chief Administrative Officer.

Today's call is open to all investors, analysts and the media. There is a live webcast of today's call and a replay will be available on our website later today.

Before we get started covering highlights from the quarter and taking your questions, Aaron will give the customary safe harbor statement.

Thank you, Dan. Good afternoon, everyone. 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 expected credit 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 estimates and projections of future interest rates, market behavior, other economic conditions, future laws and regulations and a variety of other matters, including the impact of the COVID-19 pandemic, 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 its future results.

Thank you, Aaron. We are pleased to be on the line with you today to discuss our second quarter performance. This morning, we announced another solid quarter. But as we called out in our press release, our loan growth continues to be a significant success story. Quarter after quarter, our loan growth signifies our reputation in the market as a premier bank for businesses of all sizes. We are reaping the benefits of our prior acquisitions and growing our presence in this highly competitive and desirable market.

Obviously, there's some uncertainty in the marketplace right now, but we remain focused on serving our clients and helping them grow in any environment. And based on our results, our clients continue to be ready to grow, and we are the bank they want to grow with.

Let me quickly touch on some other positive indicators from our results. And while we've grown tremendously, our pipeline at the end of the quarter remains very strong. Obviously, there are economic factors that could impact growth in future quarters. But where we stand right now, we're really pleased with where the pipeline is.

The margin continues to hold up, and we are focused on strategically growing deposits to fund our continued loan growth. During the quarter, we also successfully completed the sale of our insurance business. Through this transaction, we achieved noninterest income gains, and we established a partnership with Hub International to provide enhanced insurance offerings to our client base. We delivered double-digit organic growth in assets, and this will serve us well as we continue to scale up. And finally, our asset quality remains exceptionally strong, but we are continuing to closely monitor asset quality in the current environment.

So these are just a few highlights, but we'll jump right into the details.

Today, we reported net income of $54.8 million or $1.21 per diluted common share for the quarter ended June 30, 2022, compared to net income of $57.3 million or $1.19 per diluted common share for the second quarter of 2021 and $43.9 million or $0.96 per diluted common share for the first quarter of 2022.

Core earnings were $44.2 million compared to $45.1 million for the linked quarter and $58.4 million for the prior year quarter. The decline in core earnings is primarily the result of the provision for credit losses given the substantial growth, the expected decline in mortgage banking income and slightly lower net interest income.

The provision for credit losses was $3 million compared to the prior year's credit of $4.2 million and a charge of $1.6 million for the linked quarter. The $3 million provision reflects our sustained and significant growth in the loan portfolio as well as management's assessment of the probability for a recession.

Given the macroeconomic environment, inflationary pressures and expected interest rate actions by the Fed, management considered several economic surveys and research studies to determine the economists' perception of the near-term risk of recession. These sources included the Bloomberg survey, Wall Street Journal, Federal Reserve research reports and Moody's Analytics Recession Index. So based on these studies, management incorporated a median probability of recession through a qualitative adjustment into its estimate of allowance for credit losses as of June 30.

Shifting to the balance sheet. Total assets were $13.3 billion compared to $13 billion for the linked quarter. Compared to the prior year quarter, assets increased 3% from $12.9 billion. Excluding PPP balances, total assets grew 10% year-over-year. Scale is important. And as I mentioned in my opening remarks, this double-digit growth in assets will help us as we continue to scale out.

During the previous 12 months, liquidity from PPP loan forgiveness was used to fund the growth in the loan as well as the investment securities portfolios. Total loans, excluding PPP, increased 17% to $10.8 billion compared to $9.2 billion at June 30, 2021. Excluding PPP, total commercial loans grew by $1.3 billion or 17% during the previous 12 months.

During this period, the company generated $4.4 billion of gross new loan -- commercial loan production, of which $3 billion was funded. And so this production more than offset the $1.6 billion in non-PPP commercial loan runoff. In the second quarter, funded commercial loan production increased 60% to $805 million compared to $503 million for the same quarter of the prior year and $545 million in the linked quarter.

If you look at Page 17 in the supplemental information we released today, you can see our loan composition. We also break down year-over-year and quarterly growth in these respective portfolios. We've commented in prior quarters on our work to increase C&I lending, and it's nice to see our momentum materialize.

The growth in the commercial portfolio, excluding PPP loans, occurred in all commercial portfolios, led by the $1.1 billion growth or 28% growth in the investor-owned commercial portfolio and $230 million or 21% in the C&I portfolio. Year-over-year, the consumer portfolio decreased 7%.

At the end of the quarter, as I mentioned, our pipeline remained robust at $1.5 billion, which is comparable to the pipeline at the end of the linked quarter. So going into the latter half of the year, there will be a continued focus on transactions that meet profitability thresholds and balance the commercial versus commercial real estate transactions.

Looking at PPP. As of the end of the quarter, we had outstanding loans of only $23.5 million compared to $897 million in the prior year quarter. Remaining fees to be earned are just in excess of $600,000. The PPP interest income and fees earned in the second quarter totaled $1.3 million compared to $3.2 million in the linked quarter and $13.2 million in the prior year quarter. Our team has done a great job assisting our clients through the forgiveness process, and we're pleased that PPP is almost completely behind us.

On the deposit side of things, year-over-year deposits increased 1%. This was driven by 3% growth in noninterest-bearing deposits and reflects growth in transaction relationships. Interest-bearing deposits remained relatively unchanged at $6.8 billion. In general, our deposit strategy is to continue to hold the line on core deposit rates until we need greater growth or competitive pressures drive a more aggressive stance in response to the Fed rate movements. To date, we've introduced some targeted rate specials in area of CDs and higher-priced money market products linked to private client relationships.

With the Fed increase next week, we believe it's likely we will start to react more directly to market rate changes in our broader offerings and promotion of additional core deposit products. We continue to model our future funding costs, applying a deposit beta assumption of 40% of market rate changes as they might occur.

Noninterest income increased 34% or $9 million compared to the prior year quarter, and this increase is the direct result of the $16.7 million gain from the sale of an insurance business, which I'll comment on in a little more detail later. Excluding this disposal gain, noninterest income declined 29% compared to the prior year quarter. This anticipated reduction was driven by the rising rate environment and reduced refinance activity within mortgage banking. As a result, income from mortgage banking activities decreased $4.3 million compared to the prior year quarter and $815,000 compared to the linked quarter. Other noninterest income decreased $3.4 million compared to the second quarter of 2021, and these decreases were more than offset by the sale of the insurance business.

It should be noted that total mortgage loans grew $250 million during the quarter, primarily in the conventional 1- to 4-family mortgage loans. We also continue to successfully execute on our strategy to hold a larger percentage of mortgage production on the balance sheet to regrow this asset class. So compared to the linked quarter, mortgage loans held in portfolio grew by 15%.

We expect future levels of mortgage gain revenue to be similar with the levels generated in each of the first 2 quarters of the year. That said, around the $2 million to $2.2 million per quarter mark.

Wealth income is slightly down this quarter compared to the same quarter last year due to market declines. And given the ongoing retraction, we expect wealth income to continue to decrease as we move into next quarter.

As I mentioned previously, we completed the sale of our insurance business in the second quarter. We made the strategic decision to exit this business simply because it did not meet our profitability requirements. But through this transaction, we've established a referral relationship with Hub International that will benefit our clients and our company.

The net interest margin finished the quarter at 3.49% compared to 3.63% for the second quarter of 2021 and 3.49% for the first quarter of 2022. Excluding the impact of the amortization of fair value marks derived from acquisitions and interest and fees from PPP loans, the net interest margin would have been 3.45% compared to the net interest margin of 3.49% for the second quarter of 2021 and 3.41% for the linked quarter.

On a go-forward basis, we would expect the margin to remain fairly stable, consistent with the margin for the month of June in the mid-3.50 range, with the potential for some slight expansion depending on our success gathering core in-market deposits for our strategy versus utilizing other more wholesale deposits or borrowings needed to fund future growth.

Noninterest expense for the quarter increased $2 million or 3% compared to the prior year quarter, which included $1.1 million in transaction costs associated with the sale of the insurance business. Other noninterest expense increased $1.4 million, driven by various other operating expenses. The non-GAAP efficiency ratio for the second quarter was 49.79% compared to 45.36% for the prior year quarter and 49.34% for the first quarter of 2022.

Shifting for a moment to credit quality. All credit-related metrics continue to remain strong. The level of nonperforming loans was 40 basis points compared to 93 basis points at June 30, 2021, and 46 basis points at March 31, 2022.

Loans placed on nonaccrual during the current quarter amounted to $900,000 compared to $1.5 million for the prior year quarter and another $1.5 million for the first quarter of 2022. The company realized an insignificant amount of net recoveries for the second quarter of 2022 compared to net charge-offs of $2.2 million for the second quarter of 2021 and net charge-offs of only $200,000 for the first quarter of 2022.

The allowance for credit losses ended the quarter at $113.7 million or 1.05% of outstanding loans and 261% of nonperformers compared to $110.6 million or 1.09% of outstanding loans and 239% of nonperformers at the end of the previous quarter. The increase in the allowance was driven by the growth in the loan portfolio during the quarter and the result of management's consideration of the potential impact of recessionary pressures.

The tangible common equity ratio decreased to 8.45% of tangible assets at June 30 compared to 9.28% at June 30 of last year. This decrease is a result of $132.3 million repurchase of common shares during the prior 12 months and the $88.9 million increase in the accumulated other comprehensive loss in the investment portfolio due to the impact of the rising rate environment on the value of securities, coupled with the increase in intangible assets during the past year.

The company had a total risk-based capital ratio of 16.07%, common equity Tier 1 risk-based capital ratio of 11.58%, Tier 1 risk-based capital ratio of again 11.58% and a Tier 1 leverage ratio of 9.53%.

Before we move to take your questions, a few other updates I'd like to briefly share. In the second quarter, Aaron Kaslow was promoted to Chief Administrative Officer. Aaron continues to serve the company as General Counsel, but now has expanded duties that include human resources, our areas of operations and information services. His expertise will continue to help us grow into a larger, more complex organization serving the Greater Washington region.

And lastly, our company continues to earn top industry and workplace recognitions. We are once again certified as a great place to work, named a top workplace by the Washington Post and Forbes ranked Sandy Spring Bank the #1 bank in Maryland for the fourth consecutive year. These recognitions are important to our company, especially in the context of our solid financial performance. It's important that we deliver results while also providing a remarkable client and employee experience.

So that concludes our general comments. And now, Matt, we can move to questions.

(Operator Instructions) The first question is from the line of Catherine Mealor with KBW.

I wanted to start on the loan growth, which was just -- has been so great in the past couple of quarters. Just wonder if you could just give a little bit of color around what's driving it? Is this more line utilization? Is it new projects? And just kind of paint a picture of what's driving the growth? And then also what your outlook is for growth for the back half of the year?

Yes. Catherine, this is Dan. Thanks for the question. I think with regard to -- I'd probably say the primary driver of our successful loan growth is having moved through PPP and having our larger broader team that came as a result of our acquisition of Revere, fully engaged with hitting the Street and driving new business.

The growth is not driven by increase in line utilization. We're not seeing that move yet. And also impacted by some local disruption or lack of activity from some local players in the market while they might be focused on dealing with some other issues. So we're just seeing a great number of opportunities that continue to come our way based on our ability to serve clients and the reputation that we've generated.

As I mentioned in my comments, in the last couple of quarters, we've kind of had great production, but at the end of the quarter, we continue to maintain a really solid pipeline going into the future quarter. And that has held true here at the end of the second quarter into the third. And that's probably about as far out as you can kind of see on the horizon. But there's nothing that indicates apart from the impact that rates might have on demand, and then ultimately, if there's any type of recessionary activity that drives demand. There's no signals of that yet. But -- so I would say third quarter continues to look really solid in terms of opportunity.

Are we going to maintain this level of quarter-over-quarter production? I think we went into the year, kind of our outlook was in that 8% to 10% growth, and even doing that would be healthy. But in the current environment, where we are competitively, probably doesn't hold up at the same level. And quite frankly, it will be driven by our ability to drive funding behind it as well.

I don't know if that answers your question, but that's what's driving. And if activity is -- activity, I want to reiterate the comment I made in my comments, our success on the C&I side, we still want to see that start outpacing growth in the CRE book as we move forward. And our pipeline going into the third quarter is really well balanced with C&I opportunities versus CRE. And that's important for us as well.

And your comment kind of probably to my second question is on funding. It was great to see the deposit growth this quarter too. How do you think about deposit growth? And what -- I mean, I imagine your beta will pick up significantly last quarter or next quarter as it probably will for a lot of your peers. And certainly, we've seen some high deposit rates for some of your competitors in your market. So how are you thinking about deposit growth and then also deposit costs as we move into the back half of the year?

Yes, Catherine, this is Phil. I think as it relates to growth, we would want -- just tied back to your prior question, as Dan alluded to as well, we need to be in a position from this point forward to really match deposit growth with expected loan growth. And so we're -- as I think we mentioned in the opening comments, going to most likely get more aggressive in that regard in terms of pricing to the market or establishing what we want in that regard so that we could be as effective as possible with core in-market deposits as opposed to any other form of wholesale, although that may be required as well. But that will then drive the way we'll price and therefore, the way that the betas will come out. I mean as we mentioned, again, we continue to model as if the 40% beta still applies, but there may be situations and specific points where that beta will get higher. And I think you're right. I think that's going to be the case with competitors as well once the Fed makes their next move in the coming week.

Do you have what your deposit costs were as of June? Or is it -- have you started to see that move yet? Or is that really more of a third quarter?

We have. Yes, I do. And I can tell you what that is. We have seen it move. Because one of the things that we did mention that we have been doing to kind of protect the full book but also deal with the request of certain clients is to do a bit of -- a fair bit of exception-based pricing, so that we can continue to hold certain levels of deposits within particular relationships and yet not be out there repricing everything else that's behind it.

Our total interest-bearing deposit cost in June was about 29 basis points. And so that's not -- still not terribly high, but that has certainly moved from where it was earlier in the year.

Yes. Yes, but certainly not as high as I would have imagined. That's great. Okay.

I would say not in comparison to others, yes.

Yes, for sure. Yes, for sure. Okay. And so then -- and you gave the guidance just for the bottom line margin to be relatively flat, so that makes sense. And so how about -- let me move to expenses. Any view on expense growth in the back half of the year to some light inflationary pressures?

The biggest thing is -- and I think we touched upon this last quarter as we talked about expenses. The biggest thing that will, will be 2 things that will drive any difference in the expense levels. And we've been continuing to forecast this and plan is for us to have greater success in attracting new employees into the company. We're running at a fairly high vacancy rate for our normal experience here. And as we are more successful in replenishing and/or adding to our employee base, that would be one of the things that would potentially drive some additional salary benefit costs, which we would welcome because we're looking to add those folks to the roster here.

And then the other thing is the continuation of spend on a current basis that goes along with our strategic initiatives in the digital and data world. But even having said that, I don't know that you're going to see a significant amount of quarter-over-quarter growth. I think I said before, we might year-over-year look at -- look by the end of the year between 4% and 5% of overall expense growth. It's probably not going to be quite that now because we just haven't had to spend in the first couple of quarters. But I think if we're successful bringing the types of folks on that we wanted to, then that will pick back up.

The next question is from the line of Russell Gunther with D.A. Davidson.

Could I just switch back to the deposit beta conversation for a second, just try to better understand that 40% number you guys are talking about. So is that a near-term expectation? Are you thinking about that as more through the cycle as we get the remaining Fed hikes and those are fully digested?

Yes, it's probably -- I'd probably look at it as both. I think the thing that could change that from just essentially looking at every time the Fed moves, we're going to move in that kind of an incremental move ourselves would be that if we have to -- in terms of other competitive pressure, try to catch up on rate that we've been able so far to not have to price to relative to where general market rates might be at that time, because we've been able to lag as you know here from the result, not really even having any significant beta to the first, what, 100-some-odd basis points of Fed move through the first half of the year.

So the question will be, as rates from here move forward, is there any element of that -- those rate changes that have already occurred that we might have to catch up with. And that would ultimately make the actual beta greater than the way we're looking at it at 40%.

Okay. No, that's very helpful. And then just sticking with the margin on the securities portfolio, just an update in terms of what the sort of monthly cash flows are, where you're reinvesting? What type of yields you're getting?

Yes. In that regard, trying to think about what we have in terms of the monthly cash flows. We have added to the portfolio here throughout the last quarter. So it's predominantly been in cash flowing type of product, again, mostly kind of mortgage-backed type of securities. We finally are starting to see some acquisitions into the portfolio with rehandles on them as opposed to the sub 2 and 2.5 in the past. So that's really kind of where we are in terms of what's been added to the portfolio. We're not, again, really looking to grow it relative to everything else. Just kind of replenishing the cash flows as they come forward and move ahead.

Okay. Very helpful. And then just a follow-up on the loan growth expectations. I hear you on the near term. So this is a little more bigger picture. But do you guys feel like the market that you're in, the people that you have, this high single-digit type of results, that 8% to 10% in commercial is sustainable even with some of the macro headwinds that are out there that may materialize more in 2023?

Russell, this is Dan. A short answer would be yes. I think that what we've built here in terms of the quality and depth of the team coupled with the market we're in and our position in that market, we've got scale, we've got capacity to work with clients from small business to middle market. And we've found that we've become the go-to local bank for business, that those growth rates and outlooks are sustainable.

Okay. That's very helpful. Last one for me. And given that commentary on the organic growth outlook, you mentioned the funding challenge to keep pace. So just your thoughts in terms of utilizing M&A to help you fund that? Is that a near-term objective? Or given, again, some of the macro headwinds, is that on pause until there's better visibility? Just your thoughts there would be great. And then that's it for me.

Yes. Good question, Russell. I think that we've always -- well, we've been very organically focused, and we'll always continue to be coupled with that is being an opportunistic acquirer in the banking space and also with the disposal of the insurance business also on the fee side. So not taking a pause from our activity of building relationships. And we do -- when we look at targets and build those relationships, solid core deposit bases are really important in that discussion. So we would not hesitate to move forward if the right opportunity came along.

Russell, real quick follow-up to a little more detail on your question about the investment portfolio. We've probably got about $100 million of cash flows left throughout the remaining course of 2022. And then we've got a couple of hundred million dollars a year over the course of the next couple of years of projected cash flows in the portfolio and a little bit of -- as I mentioned before, a little more confirmation. Yes, the buys that we had in the last month, overall kind of average yield for the things that we picked up during that period was around somewhere between 3.10% to 3.20% with roll-off rates in the 1.90% range.

(Operator Instructions) The next question is from the line of Mark Hughes with Lafayette Investments.

Question for you. With nonperformers now back basically to pre-COVID levels and adjusting for the loan growth, it actually looks to me like it's a better situation. Could you just talk a little bit about how you managed to get those nonperformers down from the levels they were 1 year, 1.5 years ago to the current levels?

Yes, I think the -- we had throughout the course of that time, Mark, I think it's a combination of not having significant additions while also resolving a handful of more sizable relationships that had been in the nonperforming category throughout the pandemic. So nothing -- I think -- and the only thing that might have been a little bit unique during the pandemic, we did dispose of -- or through the sale of a couple of notes related to the hospitality industry in that process, which I say unique is not unique for banking, but a little bit unique for us. Everything else we've done has just been kind of a normal workout of relationships. But I think from a broader big picture, we clearly spend a great deal of time in the area of portfolio reviews, stress testing, reunderwriting, adjusting cap rates, stressing interest rates on a good bit of our portfolio, particularly in the income-producing real estate area. And things continue to look really, really strong as we are all anticipating what this inflationary rate environment and potential recession activity might drive. But so far, good and we'll continue to work the portfolio really hard as we have been.

Well, nicely done. There's been a couple of questions sort of around this point. But with the Fed raising rates, so and bigger increments than it has done in the recent past, how do you all deal with your -- what you're paying on deposits? It just seems like in recent years, the growth in interest rates has been incremental. Now we're jumping 50, 75, maybe even 100 basis points. Do you get pushback from your depositors on -- most of your people know they can get 3% on the treasury bill today. What are you hearing from them about how are they putting the pressure on you to raise your rates even more quickly than you have been doing?

Mark, this is Phil. I think our experience so far is we've probably heard from some cross-section of clients in that regard. And we've chosen, and I'd say, successfully served to deal with them on a kind of one-by-one basis what we referred to as exception price, those individual relationships as they come forward. But to your core question, it is clearly harder in my view to deal with the Fed changes when they come in such large chunks as they have now and will continue to as we anticipate what's going to happen next week and maybe even to a large degree in the following month or the next Fed meeting. Because then I think it drives such greater expectations for what we would need to do to kind of keep pace. So it does make it harder. And it certainly has us think about it in a little bit different way.

Now having said all that, to date, most of our competitors have done, I think, as we have without other circumstance, which is to try to lag this as long as possible because I think we're all starting from a different point from an overall liquidity standpoint than maybe most of us were in other rate cycles.

Well, I wish you luck. It can't be easy to hold the line as well as you have done so far.

The next question is a follow-up from Russell Gunther.

Just a modeling question, if you could. Any clarity around how we should think about the fee and expense impact from the sale of insurance going forward? Is there 0 revenue attached with that going forward? And then any associated expenses that may come out of the P&L that were not reflected in this quarter? Just kind of thinking about the run rate.

Yes. Russell, this is Phil. So if we look back at '21 as an indication of what the insurance agency provided to us, it was about -- top line revenue was around $7 million. Expenses related to it were a little under $6 million. And so on an after-tax basis, the bottom line contribution was less than $1 million. And so you could probably take those to what would be left into the last 2 quarters of the year and remove them from your model. There will be, as expected, with the relationship with Hub, some preferred revenue, but I wouldn't take a lot of time to try to factor that in. I would run it like you're suggesting just to eliminate those 2 line items or eliminate those amounts out of those line items and move forward.

Thank you for your question. There are no additional questions waiting at this time. So I will pass the conference back to Dan Schrider for any closing remarks.

Thank you. Thanks, Catherine, Mark and Russell for your engagement this afternoon, and thanks, everyone else, for joining the call. That concludes our call, and we hope you have a great afternoon.

That concludes the Sandy Spring Bancorp earnings conference call and webcast for the second quarter of 2022. Thank you for your participation. You may now disconnect your lines.