Sandy Spring Bancorp Inc. (NASDAQ:SASR) Q4 2022 Earnings Conference Call January 26, 2023 2:00 PM ET
Company Participants
Daniel Schrider – Chair, President and Chief Executive Officer
Aaron Kaslow – General Counsel and Chief Administrative Officer
Phil Mantua – Executive Vice President and Chief Financial Officer
Conference Call Participants
Casey Whitman – Piper Sandler
Catherine Mealor – KBW
Manuel Navas – D.A Davidson
Operator
Good afternoon. Thank you for attending the Sandy Spring Bancorp Earnings Conference Call and Webcast for the Fourth 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 our host, Daniel Schrider, President and CEO. Daniel, please go ahead.
Daniel Schrider
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 fourth quarter of 2022. As Matt mentioned, this is Dan Schrider speaking and I’m joined here by my colleagues, Phil Mantua, 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 made available later on our website.
But before we get started, covering highlights from the quarter and then taking your questions, Aaron will give the customary Safe Harbor statement. Aaron?
Aaron Kaslow
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, 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.
Daniel Schrider
Thank you, Aaron. And thank you all again for being on the line today to discuss our fourth quarter and annual performance.
As you read in our press release and I shared last quarter, we’re managing through what continues to be pretty challenging operating environment including high inflation, these rapid increases in interest rates we’ve experienced and a continual threat of recessionary pressures. And while the economic forecasts as well as the probability of recession are driving the provision for credit losses, we are not seeing any trends that indicate that our credit quality is on the edge of deterioration. Now these are complex issues, but we have managed through challenging seasons before. Continuing to balance the long-term view we have of our company and the immediate business needs, our focus is centered on growing client relationships and driving core funding.
So with that, let’s shift to review the details of our financial performance. Today we reported net income of $34 million or $0.76 per diluted common share for the quarter ended December of 31, 2022, compared to net income of $45.4 million or $0.99 per diluted common share for the fourth quarter of 2021 and $33.6 million or $0.75 per diluted common share for the third quarter of 2022.
Core earnings were $35.3 million or $0.79 per diluted common share compared to $46.6 million or $1.2 per diluted common share for the quarter ended December 31, 2021 and then $35.7 million or $0.80 per diluted common share for the quarter ended September 30, 2022. The decline in core earnings is primarily the result of the provision for credit losses and the expected decline in fee income.
Looking at our earnings through another lens, pre-tax, pre-provision income was $56.6 million compared to $64.1 million in the linked quarter and $61.7 million in the prior year quarter.
The provision for credit losses was a charge of $10.8 million compared to a charge of $1.6 million in the fourth quarter of 2021, and a charge of $18.9 million for the third quarter of 2022. The quarterly provision expense contained a provision charge of $2.9 million which was associated with unfunded loan commitments. Excluding the provision for unfunded commitments, the provision reflects the declining economic forecast and the increasing probability of recession. And to clarify, we break out the provisions expense for funded and unfunded loan commitments for accounting purposes, but the primary drivers are the same.
Shifting to the balance sheet, total assets grew 10% to $13.8 billion compared to $12.6 billion in the prior year quarter. When you exclude PPP loans, total assets increased 11% year-over-year.
Total loans, excluding PPP, increased 16% to $11.4 billion at December 31, 2022, compared to $9.8 billion at December 31 of last year. Total commercial loans net of PPP grew by $1.2 billion or 15% during the previous 12 months.
Gross commercial loan production over the past 12 months was $3.9 billion of which $2.5 billion was funded, offsetting the $1.2 billion in non-PPP commercial loan run-off. Funded commercial loan production during the fourth quarter of 2022 was $341.7 million.
Commercial run-off in the fourth quarter was 38% lower than the linked quarter and 45% lower than the prior year quarter. The annualized run-off rate in the fourth quarter was 10% compared to a historical average of anywhere between 12% and 15%. We expect run-off to settle in the 7% to 9% range for the next few quarters.
Commercial real estate, as you know, has been an important business line for the bank representing deep relationships with the region’s best builders, developers, and investors. And while we’ll continue to serve this important client segment, we’re also working hard to diversify our lending concentration by attracting more C&I relationships and focusing all client-facing teams on core funding initiatives.
If you look at Page 17 in the supplemental deck, you can see that this approach is already starting to take effect as our C&I growth has outpaced our CRE growth for the first time in many quarters. As we look forward into 2023, we expect the commercial real estate portfolio to be flat or even slightly down for the quarter. C&I owner-occupied are shaping up to be slower in the first quarter, but expect around 2% to 3% growth per quarter starting in the second quarter of the year.
The mortgage construction portfolio will continue to fall as production is significantly slowed. A construction conversion should drive growth in the permanent portfolio, which again will likely to grow 2% to 3% per quarter. Recognizing that macroeconomic changes could impact our results, at this stage, we expect our overall loan growth for the year to be in the mid single-digits and more weighted in the second through fourth quarter.
At the end of the quarter, our commercial pipeline was at $944 million compared to $1.3 billion for the linked quarter, representing 32% reduction. This indicative of both a change in demand and our shifting focus to do more C&I lending. And shifting over to the deposit portfolio, deposits grew 3% during the proceeding 12 months as interest-bearing deposits grew 6%, offset by a 3% decline in non-interest-bearing deposits.
Additionally, borrowings increased by $928 million during the period. Excluding broker deposits, total deposits decreased 4% in the fourth quarter. The combination of higher interest rates and seasonal runoff drove non-interest-bearing deposits to be lower during the fourth quarter, but we expect to see some recovery in the latter half of this first quarter.
DDA balances are also experiencing pressure due to lower title company deposits, which totaled $437 million in the fourth quarter of 2021, but fell to $227 million at the end of 2022. Core money market in time deposits perform well during the quarter with core money market accounts growing $91 million or 3% and core time deposits growing $199 million or just slightly under 18%. We are clearly relying on more wholesale funding sources while we navigate this challenging rate environment.
As I shared last quarter, we have several near and long-term efforts underway to respond to these challenges. We continue to offer some of the most competitive rates in the market. Every salesperson is being incentivized to drive deposit relationships with both retail and commercial clients. And earlier this week, we launched a more sophisticated online account opening platform that will expand client channels, make the account opening process faster, easier, and more convenient for our clients.
Moving to the margin, the net interest margin was 3.26% compared to 3.51% for the fourth quarter of 2021 and 3.53% for the third quarter of 2022. The decrease in the net interest margin for the current quarter compared to the fourth quarter of the prior year and previous quarter was the result of the increase in the rates paid on interest-bearing liabilities outpacing the increase in the yield on earning assets.
The overall rate and yield increases were driven by multiple Fed rate increases that occurred over the proceeding 12 months. Excluding the impact of the amortization of the fair value marks derived from acquisitions and interest in fees from PPP loans, the net interest margin would have been 3.26%, compared to the net interest margin of 3.31% for the fourth quarter of 2021 and 3.5% for the linked quarter.
On a go forward basis, we anticipate that the margin will further decline in the first quarter into the 3.10 to 3.15 range and then start to rebound under the assumption that the Fed will complete its tightening cycle by the end of the first quarter.
Non-interest income decreased by 37% or $8.2 million compared to the prior year quarter. The reduction as a result of several factors, primarily the impact the economic environment is having on mortgage banking activities and wealth management income. Obviously, the decline in insurance commission has given the fact that we dispose of our insurance business in the second quarter of 2022 and then lower bank card income due to regulatory restrictions on fees since we became subject to the Durbin amendment.
Income from mortgage banking activities decreased $2.8 million compared to the prior year quarter and $800,000 compared to the linked quarter. The decline is a result of the rising interest rate environment, which continues to dampen mortgage origination and refinancing activity. In light of current origination levels, we did execute a reduction in staff in our mortgage division in the fourth quarter and we’ll continue to evaluate that going forward.
However, total mortgage loans grew $377.5 million during the 12 months ended December 31, 2022. We expect near-term mortgage gain revenues to settle into a range between $1 million to $1.5 million per quarter. Due to ongoing market volatility, wealth management income decreased $390,000 compared to the linked quarter and $1.1 million compared to the prior year quarter.
However, assets under management finished strong at $5.26 billion compared to $4.97 billion at the linked quarter. Despite a challenging market, our teams continue to win and drive new relationships. And looking ahead, we see wealth revenue significantly influenced by fluctuations in equities and bonds. But if the market does not take a step back, we anticipate 2% growth per quarter.
Non-interest expense for the current quarter decreased $1.8 million or 3% compared to the prior year quarter, driven primarily by the decreases of $2.1 million in compensation and benefits expense, $1 million in occupancy expense and $0.5 million in other non-interest expense. These decreases were partially offset by increases in various other categories of operating expenses. We look demand as growth in operating expenses in the 5% to 6% range off of fourth quarter levels with an immediate bump in the first quarter of 2023 due to certain compensation related costs that reengage early in the year and increases to the run rate related to some of our technology initiatives.
We then looked to manage quarter-over-quarter growth by targeting a non-GAAP efficiency ratio within the range of 51% to 52% and continuing to evaluate our expense levels commensurate with revenue trends. The non-GAAP efficiency ratio was 5 – I’m sorry, 51.46% compared to 50.17% for the prior year quarter and 48.18% for the third quarter of 2022.
Moving to credit quality. As I noted in my opening remarks, we do not see anything in our metrics that indicates our credit quality will begin to deteriorate. Again, the provision charge is being driven by the economic forecast and not based on any change in current or projected credit based performance in the portfolio. The level of non-performing loans to total loans improved to 35 basis points compared to 40 basis points at the linked quarter and 49 basis points at December 31 of 2021. These levels indicate stable credit quality during a time of significant loan growth and economic uncertainty.
Loans placed on non-accrual amounted to $5.5 million compared to $500,000 for the prior year quarter and $4.2 million for the third quarter of 2022. Within our NPA portfolio, we have no office or multi-family assets. We realized net recoveries of $100,000 for the fourth quarter of 2022 compared to net charge-offs of $400,000 for the fourth quarter of 2021 and $500,000 in recoveries for the linked quarter. The allowance for credit losses was $136.2 million or 1.2% of outstanding loans and 346% of non-performing loans compared to $128.3 million or 1.14% of outstanding loans and 289% of non-performing loans at the end of the previous quarter. Compared to the end of 2021, the allowance for credit losses was $109.1 million or 1.1% of outstanding loans and coverage of 224% of non-performing loans.
The tangible common equity ratio decreased to 8.18% of tangible assets at December 31 compared to 9.21% at December 31 of 2021, a decrease as a result of the $25 million repurchase of common shares during the previous 12 months and the $123 million increase in the accumulated other comprehensive loss in the investment portfolio that resulted from the rising rate environment and the increase in tangible assets during the past year. At December 31, the company had a total risk-based capital ratio of 14.20%, a common equity Tier 1 risk-based capital ratio of 10.23%, a Tier 1 risk based capital ratio of 10.23%, and a Tier 1 leverage ratio of 9.33%.
And before we move to your questions, let’s quickly recap leadership announcement we rolled out this quarter. Our President of Commercial Banking and Executive Vice President, Ken Cook is going to retire from Sandy Spring Bank at the end of February and then thereafter join our Board of Directors. Ken has dedicated his 40 year career to help me clients in the greater Baltimore and Washington regions. I’m really grateful that he will continue to help lead our company as a Director. We are actively interviewing for a new executive to lead Commercial Banking, and we look forward to making announcement here in the near future.
So this concludes our general comments for today. And now Matt, we can move to your questions.
Question-and-Answer Session
Operator
[Operator Instructions] The first question is from the line of Casey Whitman with Piper Sandler. Your line is now open.
Casey Whitman
Hey, good afternoon.
Daniel Schrider
Hi, Casey.
Phil Mantua
Hi, Casey.
Casey Whitman
Maybe we’ll start with the margin and the guide you sort just gave. I guess if the Fed pauses do you have an idea of how much that margin could rebound from the first quarter level, which I think you gave a 3.10% to 3.15% range? And then I guess my follow up would be just sort of against the loan growth guide you gave, what sort of assumption should we make on the deposit side, I guess the core deposits for growth?
Phil Mantua
Okay. Casey, this is Phil. I would suggest to you that beyond that first quarter guide on the margin if in fact the Fed does, at least pause or stop their upward march here that we could probably see the margin come back anywhere from five basis points to 10 basis points a quarter from that point through the rest of the year. Now the caveat on that is that we get the kind of deposit growth that we’re really looking for in terms of the core DDA, and other interest-bearing categories as opposed to the continual need to fund either through wholesale or broker deposits or some form of similar borrowing. Because if that continues to occur, then that expansion in the margin most likely doesn’t happen, just based on the differential in those rates.
Casey Whitman
Okay, got it. And then, sorry if I missed this Phil, but just the other fees what’s in that number and what was the dragging that down this quarter? It looked pretty low compared to…
Phil Mantua
Yes, quarter-over-quarter, it was mostly the absence of swap fee income and prepayment penalties that we were able to generate in the third quarter that did not replicate themselves in the fourth quarter.
Casey Whitman
Okay. And the last question I’d ask, you touched a bit on office just in your prepared remarks. Do you have – do you happen to have your total office exposure?
Daniel Schrider
I do.
Casey Whitman
And maybe with that, can you just talk broadly about some of the larger loans you might have in that book and sort of how you’re positioned suburban versus metro office and just how you’re viewing that asset class?
Daniel Schrider
Yes, right now our total office exposure if you think about our investment real estate probably led by retail and about half of that amount at about a $1.7 billion and office is about $840 million in terms of outstandings. That’s up against the total CRE portfolio of about $4.7 billion. The office for us has always and continues to be kind of suburban office, professional office space as opposed to large four plates. So talking about medical office, office buildings that have smaller units that are easier to turn over the – and then within that context as well are some data center assets that we originated over the past few years that have been very strong performers at origination and these properties have weighted average loan to values in the low-60s and then coverages in the mid-150s.
So, we have never been a big urban player and we’ve never been a large office player. If you kind of think about some of the like Tysons Corner downtown office, large four plates, it just hasn’t been our sweet spot and then very little out of the ground most has been refinance activity from assets that have been under investor ownership for a number of years, which is what’s driven that combination of loan-to-value, and strong cash flow coverages. So, we continue to look hard at that actually every asset class within the CRE portfolio. But office is one that we have not seen significant growth in and just given particularly the last three years given the uncertainty around change of behavior in the post-COVID world.
Casey Whitman
And I think you said this, but you’ve seen no downgrades yet in net portfolio to the office?
Daniel Schrider
Yes, that’s correct. Yes.
Casey Whitman
Okay. Okay, I’ll let some else jump on. Thank you.
Daniel Schrider
Thanks, Casey.
Phil Mantua
Thanks, Casey.
Operator
Thank you for your question. The next question is from the line of Catherine Mealor with KBW. Your line is now open.
Catherine Mealor
Thanks, good afternoon.
Daniel Schrider
Hi Catherine.
Phil Mantua
Hey Catherine.
Catherine Mealor
Just one follow-up on the margin, just back to Casey’s question on the on loan price, I mean, excuse me, deposit pricing, where were deposit costs maybe towards quarter end or were you’re seeing them come as we test look into trying to back into that 3.10% [ph] to 3.15% margins to see deposit costs might be as early as next quarter.
Phil Mantua
Yes. Catherine at the end of December, our overall cost of interest-bearing liabilities was about 2.10 [ph], and overall interest-bearing deposits was in the – was around 1.83 [ph].
Catherine Mealor
Okay. Great. This would fit with your commentary that you think you might get net expansion in the back half of the year, just depending on how deposit balances go. But would it be fair to characterize like – how do you think about kind of over the cycle potential beta for you? Because as I look at where you are, cycle to date you’re at around a 40% cumulatively, and that’s where a lot of companies might be saying that their cumulative cycle betas will be maybe over the next couple of quarters. But is there a case to be made that for you, your cycle beta will still be higher but not significantly higher, and your pace of change should start to moderate as we go to the next couple of quarters? Just especially given your outlook for growth to be flowing in the next…?
Phil Mantua
Yes, Casey [ph], I think that’s a reasonable way to look at it. I mean we’ve really all along said that our model beta and our expectation on beta was around that 40%. So having it kind of average out there is not terribly surprising. It would most likely continue with – but probably a little bit higher. Even with the last 25, I guess, 50 basis points at the Fed, we think has in mind here for the remainder of this quarter. So we were probably averaging this quarter a little higher than that. But I think over time in the past that we’ve been proven capable of having the beta in the other direction move fairly quickly to allow us to take advantage of when rates either stabilize or ultimately drop back in the other direction.
Catherine Mealor
And what’s your view on how active you’ll be in pulling out; I think you’ll be borrowings?
Phil Mantua
It’s really a question of relative pricing between home loan bank borrowings and other forms of brokerage when necessary. We won’t really lock into one form over the other. And I think that’s what’s reflected, in fact, in the fourth quarter here where we really traded out of a couple of hundred million of advances for some – about the same amount, maybe a little bit less in the brokered CD market. So we really kind of look at those things very similarly in terms of how we use them and we really just kind of trade one against the other on relative price and value. And we – I think we said it before; we’ve tried over the course of the cycle to keep all of those relatively short. And so, for example, we have a fair amount of maturity in both of those areas here in the first quarter, and we will replace them according to that same general pricing concept.
Catherine Mealor
And how about on loan pricing? Where are new loan yields coming on and – your loan portfolio is not as highly variable rate, which is partly what’s happening to your margin now, but I kind of view you as – it will be just kind of a slow grind higher over the next couple of years as your longer-term loan portfolio continues to reprice and churn through. So how do you kind of look at maybe the pace of loan yield increases over the next couple of quarters?
Phil Mantua
Yes. Well, I think that’s also embedded in that guidance relative to forward-looking margin is that we’ll continue to get some upward contribution from loan yields throughout that period. Just for pricing within the last quarter, albeit the levels of production in booked loans was slower than customary for us. I mean we in the commercial area alone, we ranged on average from the high 5.80%, 5.90% range up into in some cases over 7%, 7.5% on various categories of new production. And so that should continue to accrue our benefit as we move into the latter part of the year.
Catherine Mealor
Great. All right. Thanks, I’ll pop-out of the queue.
Phil Mantua
Thanks Catherine.
Phil Mantua
Thanks.
Operator
Thank you for your question. There are currently no further questions registered. [Operator Instructions] The next question is from the line of Manuel Navas from D.A Davidson. Your line is now open.
Manuel Navas
Hey good afternoon. The non-interest-bearing deposit, have come down a little bit. How far could that drop over the next couple of quarters?
Daniel Schrider
Well, that’s a really good question. I mean one aspect of what’s happened there is we’re certainly related to title company type of deposits balances, which probably can’t go a whole lot lower than where they are today. And I think, in that respect we’ve probably – we probably have bottomed out. But within the other categories that, are related to small business and just broader commercial type of deposits.
I’m not really sure; I could give you a definitive type of answer. Just not knowing exactly kind of what that pattern is related to other than the stuff that we have normally at year-end. So, I mean, we have – we have it continue to come down and through the first part of this quarter traditionally, and then have it rebound towards the end of the quarter. So, it’ll probably trough during the quarter and you really won’t see it because it will ultimately report on the end of the quarter where it’ll probably bounce back up.
Phil Mantua
Yes, I would agree.
Manuel Navas
Okay. That’s helpful. And so that’s kind of like working capital needs and kind of normal trends and is just a little bit larger the move this quarter than in prior quarters?
Daniel Schrider
Yes, I would say, so this quarter the kind of rundown on demand deposits, on the core demand deposits started earlier in the quarter than normal. And it happened more throughout the quarter than just at the end of the quarter, which is the traditional draw down activity with our commercial client base.
Phil Mantua
And I mean the obvious difference…
Daniel Schrider
I would say the obvious difference this year in that trend is, the availability that this intermediation that would occur within our book of DDA deposits moving into interest-bearing given the availability of actually earning something on your money this year relative to prior periods. So that and hopefully that’s also, a trough that we’ll see end as well and see that DDA balance is start to build back.
Phil Mantua
Yeah. And fact, just a detailed tidbit, but in the premier money market account through the quarter embedded in $123 million increase just in that product line was $109 million of commercial based balance increase. To Dan’s point about the potential of disintermediation.
Manuel Navas
Okay. That’s good. That’s interesting to hear. As you’ve been out of the market in over the last quarter and a half, how have you seen composite competition shift?
Daniel Schrider
I think the last, over that timeframe that you’ve talked about? I think it’s still; this is a highly competitive market. We’ve continued, have been and continue to be near or at the top of the market in our various specials that we’ve offered on both guaranteed rate as well as some select time deposits. So, I wouldn’t say there’s been a material change competitively in that window of time. Still very competitive. And, as we’ve gone through obviously the last week and a half of earning season, it seems like that trend continues of pressure on the funding side and we’re seeing it in pricing.
Phil Mantua
Yes, and I don’t think the, the mix of competitors has changed to any large sticker either. I think it’s still, generally the usual suspects in this market.
Manuel Navas
Thank you for the color.
Daniel Schrider
Sure.
Operator
Thank you for your question. There are no additional questions waiting at this time. So, I’ll pass the conference back to Daniel Schrider for any closing remarks.
Daniel Schrider
Thank you, Matt. And thanks, Catherine, Casey, Manuel for your questions and for everyone else who joined today’s call. With no other questions, our call is now concluded and we hope that you have a wonderful afternoon.
Operator
That concludes the conference call. Thank you for your participation. You may now disconnect your lines.
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