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SBT Sterling Bancorp

Participants
Tom O’Brien Chairman, CEO, and President
Steve Huber EVP, CFO and Treasurer
Ben Gerlinger Hovde Group
Nick Cucharale Piper Sandler
Ross Haberman RLH Investments
Call transcript
Operator

Good morning, everyone. Thank you for joining us today to discuss Sterling Bancorp's Financial Results for the Second Quarter June 30, 2021.

Joining us today from Sterling's management team are Tom O’Brien, Chairman, CEO and President; and Steve Huber, Chief Financial Officer and Treasurer. Tom will discuss the second quarter results, and then we'll open the call to your questions. Please note this event is being recorded.

Before we begin, I’d like to remind you that the conference call contains forward-looking statements with respect to the future performance and financial conditions of Sterling Bancorp that involve risks and uncertainties. Various factors could cause actual results to differ materially from any future results expressed or implied by such forward-looking statements. These two factors are discussed in the company's SEC filings, which are available on the company's Web site. 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 compared GAAP measures. The press release available on the Web site contains the financial and other quantitative information to be 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. Good morning. Thank you for that. The company released its second quarter results today and we're going to spend a little time going through those, and then take your questions. The results were we earned $2.6 million or $0.05 a share. Margin expanded a little bit, certainly off the lows that it had, driven primarily by deposit repricing during the quarter and then late in the quarter, acquisition of some repurchased advantage loans.

So that helped bring the margin up to 2.70%. Expenses continue to run high, a little better than they have been, but still quite elevated. And capital continues to be okay at the bank, although with the company, as I've mentioned in the last couple of calls, we at some point have to address the subordinated debt issue that is upon us. The debt is into the variable stage of the initial 10-year maturity.

So we're in the second five years.

Following the quarter, we completed the sale of the Bellevue, Washington branch and that was done on July 23.

So a good transaction for both buyer and seller, and we're happy about that. And deposits, I think as we've mentioned earlier in the first quarter call, with greater definition to the needs to repurchase the advantage loans, both the timing and the dollar amounts, we had built up liquidity and let that run down in the quarter as we got a little more definition to that. Also that benefits the margin because liquidity is really quite expensive. It's kind of typical with us the second quarter included a lot of moving parts. The bank is going through IT system conversion, and that probably added $600,000 in cost during the quarter. Professional costs were down net predominantly, because we got around $2.5 million back from the insurance company. And there's been some, as we expected, some gradual reduction in other professional and consulting type fees.

I think we're still pretty comfortable that cost will drift down in the third and fourth quarter, not going to be dramatically. It's going to be I think noticeable, primarily because things like the look back that we had to do for AML purposes is nearing its conclusion. The securities class action is nearing its final action. And there's several other things that are at least beginning to finish up from where they were, and the costs that go with it will start to dissipate. We still have not insignificant legal costs until these investigations, at least from the bank's perspective, start to wind down some. The asset quality is modestly better. The allowance was basically unchanged quarter-to-quarter, just about $72 million. We did take a $600,000 benefit there, but that was basically dollar-for-dollar for recoveries we had on loans that were non-performing that paid off in the fall. And those were, I think it was five or six advantage loans in that category. And that has been, I would say, probably the most typical outcome with these advantage loans, as for those that go bad, which statistically is probably not too inconsistent with the general residential portfolios in the banking world. The credit aspects are not as dramatic as the compliance and different activities in the original underwriting that led to the investigations and the problems that the bank faces. That's not to minimize those at all. They've been painful. But they were -- just from the pure credit perspective that gives us $600,000 back in the quarter. Non-performing loans hedged down a little bit at 92.6 million. And as I think -- again, as I've said the last couple of calls, in that total, there's about, say, 50 million of commercial credits and maybe mid 30s or $40 million of advantage loans.

I think as you all know, the ones I'm most concerned about from the credit side are the commercial products.

We have a lot to deal with there. And in terms of the criticized, classified loans and all that hits, it's the ones where we expect to have some difficulty working out of those.

So they will occupy more of our resources and our time and probably the allowance than anything else. I'm not expecting the advantage loans, again, purely from the credit side, to behave much differently than they have to-date. Other than that, as I said, the look back is nearing its completion. And that was certainly a long time coming. It's been very labor intensive and expensive. And litigations appear to be at the tail end.

I think at this point on the class action, we're looking at September for conclusion there. And then the income tax expense was up in the quarter and in all candor, predominantly because certain person's executive compensation is not deductible for income tax purposes, under 162(m), so that with a lower dollar amount and earnings and a non-deductibility, that drives up the price of the effective tax rate. And as the government has changed or I guess clarified or modified the 162(m) regulations, we have to deal with that. And other than that, things continue. Progress at the bank is, it's moving directionally I think where we anticipate it. It is not something we can speed up or control, because it's really in the hands of government agencies. But time has moved us along. And I think we continue to be optimistic that we're much nearer the end of these things than anything else. And I will say, I did make a trip out to San Francisco in July I think it was, spent some time at our branches out there and got to know the people. That was my first opportunity to make that trip. And there'll be further opportunities to that for me in the near future.

So with that, operator, we can go into the Q&A.

Operator

We will now begin the question-and-answer session. [Operator Instructions].

Our first question will come from Ben Gerlinger with Hovde Group. Please go ahead.

Ben Gerlinger

Hi, guys.

Tom O’Brien

Good morning, Ben.

Steve Huber

Good morning.

Ben Gerlinger

I was wondering if you guys could just take a second to kind of walk through the mechanics of the funding aspect of the balance sheet. I know that the time deposit balances have come down 250 million in the quarter and then also the yield. I know last quarter -- I think it was the last quarter I believe, you guys gave the repricing aspects per quarter.

I think that might have been in a vacuum if you didn't lose any deposits. But I’m wondering if you could just kind of refresh us in terms of what is repricing? And then kind of that new spot rate in terms of time deposit yields?

Tom O’Brien

Yes. Steve, why don't you handle that?

Steve Huber

Yes. The deposits will continue to reprice. Most materially that has occurred in Q1 and Q2, but we expect that to continue into Q3.

We expect another 384 million to reprice, again, mainly our certificates of deposits, mainly in the 12-month category. A lot of those are still at over 1%.

So they will continue to reprice down, certainly to something lower if they continue to remain with the bank.

Our total borrowing spot cost at the end of the quarter is 0.70%.

So we would expect to have continued improvement on the deposit side certainly for Q3, probably less material into Q4 as Q4, the repricing volume is about 152 million.

Ben Gerlinger

Okay, that is helpful. And then if we can move to the expense base. I get that professional fees are a little out of your control. And then based on kind of the guidance that you gave -- excuse me, for the explanation for the 5.7 million this quarter. 2.4 was a reimbursement and then also 600,000 approximately for IT expenses.

So [indiscernible] math, I'm netting around 7.5 million. Previously, you guys had indicated that FY '21 could be about two-thirds of the level of '22. Is that still -- excuse me, FY '21 to be two-thirds over '20. Is that still kind of the guidance, or is there anything more material that you might want to include?

Tom O’Brien

No. The timeline supports that. But as you note, we can't accelerate the government's conclusion on any of these things.

So the longer it takes, just the more it costs and that gets a little bit hard to predict. But on that schedule we're on, it does seem like that's where we're going. And just the look back had its own shelf life, but we're basically at the final drafting stages of the report now and that is, again, not entirely in our control but the end is pretty predictable. And that was -- it went [ph] to cost from start to finish, but it was significant. And the legal costs are wide ranging, but they are heavily centered around the DOJ and the OCC investigatory activities.

So, as they -- at least with respect to the bank or the company, as those come to conclusion, there's the obvious benefit. Again, the timeline would suggest that as we get into the second half of fiscal '21, they will inevitably moderate some and then certainly hopefully more significantly as we move into '22.

Ben Gerlinger

Okay, that's helpful. And then just kind of touching base on the IT expense. I know you guys had the conversion or the upgrade in August, so this month. Is there any sort of dollar amount you can tag to it that might be in the 3Q numbers, or is there anything that’s changing from a go-forward perspective in terms of the expense base?

Tom O’Brien

Well, there's two things with the IT conversion. One, it's not optional. And it is a total system conversion. The bank was operating on a homegrown system with a couple of programmers in-house and it just was really problematic from both a regulatory management perspective in terms of getting reports.

So we wouldn't -- I’ll say this, we wouldn't get out of the regulatory handcuffs without a conversion, and frankly we couldn't operate the bank without a conversion to a more contemporary system.

So we were spending next to nothing historically, which is what kept the bank's efficiency ratio pretty low, as low as I've ever seen frankly and over the years past, but it was low to a level that strains your ability to believe, just too low, just not enough resources to put into things like that. And that's where the -- at the end of the game, that's where the class comes.

So I don't expect any efficiencies from the IT conversion.

I think there's probably going to be some net cost to that as we complete the conversion and rollout. That might be over the historical record, it might be $1 million more a year. But as I said, the cost of the regulatory difficulty and all that is significantly greater, and the absence of kind of comprehensive management information is a real roadblock for us.

So it's not one of those things that you would say is optional.

Ben Gerlinger

Got you.

Okay. I appreciate it.

Tom O’Brien

No efficiencies done. Unlike other ones I've done where you get some efficiencies to cost. And I sort of added two actually to sidetrack for a moment on the advantage loan repurchases. We repurchased 90. We were expecting more, but the sellers have called it difficulties so we will be repurchasing the balance of those over the course of this year and then I think two more in 2022. They are coming back, but it's just a different time perspective. And the 90 million I have closed, I don't want to say at the last day of the quarter, but pretty close to the last day of the quarter.

Ben Gerlinger

Okay, that is very helpful. I appreciate the color.

Tom O’Brien

Sure.

Operator

[Operator Instructions].

Our next question will come from Nick Cucharale with Piper Sandler. Please go ahead.

Nick Cucharale

Good morning, everyone. Hope you're doing well.

Tom O’Brien

Yes. Thanks, Nick.

Steve Huber

Good morning.

Nick Cucharale

In the press release, you mentioned the commitment to repurchase another 100 million of advantage loans. Can you provide some color on the timing of those repurchases, or is that yet to be determined?

Tom O’Brien

It's pretty well set based on the call dates that I mentioned.

I think, I don’t know, Steve, March next year was one and July next year as the other big piece?

Steve Huber

Yes, next year basically beginning in March and then throughout the next two quarters.

We have a piece for 59 million and a piece for around 35 million at this point.

Tom O’Brien

All of those loans were into securitizations that have call date features.

Nick Cucharale

Right.

Okay.

Tom O’Brien

Preference over securitize to view it that way.

Nick Cucharale

Okay, that's helpful. And then certainly a fluid situation, but given the changing risk profile of the bank and the substantial build since the beginning of last year, do you sense that the allowance to loans ratio has peaked here?

Tom O’Brien

Yes, I would. That's my own opinion.

We haven't -- last two quarters, that's been steady.

We haven't seen significant migration into the criticized and classified category. We've spent an awful lot of time trying to identify the weaknesses from the credit perspective. And as I said, it's -- credit loss perspective I think is going to be in the commercial portfolio. And identifying the level of classified loans the way we have, I think we've taken a more appropriate look at risk rating and trying to be in front of any potential problems or weaknesses with either the property or the project of the guarantor. And we've had a couple of -- in the last quarter of towards the end of the quarter, we had a couple of loans that were non-accrual that paid off in full. We got a couple more coming where there's some net recoveries to some previous charged off loans. But that's not to say there won't be some realized losses in the period ahead. But that's why I was saying the $50 million of roughly non-accrual commercial loans versus the $40 million of non-accrual advantage loans.

On the credit side, I would say that predominant source of risk is going to be in the 50, not the 40.

Nick Cucharale

Okay. And then just a follow up on funding. Borrowings have remained pretty consistent over the past several quarters. Is there an opportunity to prepay some borrowings over the next several periods, or is that not part of the strategy at this point?

Tom O’Brien

It’s not part of the strategy. It's pretty expensive. And to -- we probably look at it a little bit later. But I think at the moment, we're really just looking at letting the runoff to maturity, because they're basically yield maintenance payoffs. And I don't know if that helps or anything in the long run.

Nick Cucharale

Okay. Thank you for taking my questions.

Operator

Our next question will come from Ross Haberman with RLH Investments. Please go ahead.

Ross Haberman

Good morning, Tom.

Just a follow-up question on some of the deposits. Is there much more room to keep on lowering deposit rates on your CDs, money markets, or basically have we hit sort of the floor here? Thanks.

Tom O’Brien

I think we've hit the floor, Ross. Sterling funded predominantly in the manner of a -- more of old line [ph] threat, so not a big demand deposit base, not a big transaction base. It was basically money market savings and CDs.

So, I think -- and we've been careful lowering rates because of that propensity of the savers that we did have to rates.

So we didn't shock it. We kind of gradually drifted down closer to pocket. But unless there's some change in the market in general for interest rates, I'd say we're probably pretty close to best we can do.

Ross Haberman

And just one last question on the litigation. What was the -- could you go over the non-government litigation? I guess you’re being brought in on I guess what the -- the ex employees litigation, where does that stand? And when is there going to be some sort of resolution there?

Tom O’Brien

Well, we have -- there have been criminal complaints and plea deals with a couple of former employees. Again, that's -- other than supplying information that might be requested by the Justice Department, we don't really have a role in that other than being cooperative. That's ongoing. And I -- usually when I refer to trying to get things done, I try to be careful to say with respect to the bank or the company, because that's about the only thing I can really care about at this point in time. Individual issues are what they are and they're not our concern. And then the securities actions with the class action and then the reported derivative, and they're hopefully kind of at the tail end.

Ross Haberman

And you’re hypothetically reserved for all of that?

Tom O’Brien

That's hard to say.

Ross Haberman

Okay.

Tom O’Brien

We are reserved at a level that is our very best approximation of the likelihood of the bank not getting -- as the Justice Department said in their own press release, the bank's been the victim. That's not to say, there's not some accounting from the bank, especially in the BSA space.

So based on nothing other than our best estimate, we have set aside a reserve for potential fines and penalties. But I don't -- I can negotiate those, but I can't step in.

Ross Haberman

Got you. I just want to know if you could be dragged in on some of the other non-governmental suits, they can drag you in. And you might have some liability, which you really didn't anticipate, because for whatever it is, they're going to go for the deep pockets. And they're going to make life -- your life hell until, I don’t know, you need to throw them a bone possibly, I don't know or not.

You get involved with lawyers, they're going to drag in any and everybody.

Tom O’Brien

Yes, I know. I've seen that movie a couple of times.

Ross Haberman

Yes, you have.

Tom O’Brien

You can't control what happens in these kinds of messy situations. The foundations for the problems were laid over many years. And the consequences and the number of people involved is significant. And time and cost involved in kind of unwinding these Gordian knots are just, it's painful.

Ross Haberman

Right.

Tom O’Brien

That hurts.

Ross Haberman

I know you can't control, but what do you think is the timing on settle of these things sort of wrapping up? Is it going to be next quarter or two, or it's going to go into '22?

Tom O’Brien

Well, this is purely aspirational on my part for a comment. I'm hoping that, only again as respect to the bank or the company, we have our reconciliation with the agencies by year end.

I think that's right and I think that's fair. And it's very hard to run the bank strategically, until these things are resolved as it respects us.

Ross Haberman

I got it.

Okay. Best of luck. I do appreciate the time.

Tom O’Brien

Anytime, yes.

Ross Haberman

Thank you.

Tom O’Brien

Sure.

Operator

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

Tom O’Brien

I hope everybody's enjoying a nice summer and through the conclusion on Labor Day. We'll look forward to our third quarter call. And again, thank you for your interest and participation today.

Operator

The conference has now concluded. Thank you for attending today's presentation.

You may now disconnect.