Sterling Bancorp, Inc. (Southfield, MI) (NASDAQ:SBT) Q2 2022 Earnings Conference Call August 15, 2022 11:00 AM ET
Company Participants
Thomas O’Brien – Chairman, President & CEO
Karen Knott – EVP & CFO
Conference Call Participants
Ben Gerlinger – Hovde Group
Nick Cucharale – Piper Sandler
Ross Haberman – RLH
Operator
Good morning, everyone. Thank you for joining us today to discuss Sterling Bancorp’s financial results for the Second Quarter Ended June 30, 2022. Joining us today from Sterling’s management team are Tom O’Brien, Chairman, CEO and President; and Karen Knott, Chief Financial Officer and Treasurer. Tom will discuss the first (ph) quarter results, then we’ll open the call to your questions.
Before we begin, I’d like to remind you that this conference call contains forward-looking statements with respect to the future performance and final — financial condition of Sterling Bancorp that involves risks and uncertainties. Various factors could cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. These two factors are discussed in the company’s SEC filings, which are available on the company’s website. The company disclaims any obligation to update any forward-looking statements made during the call.
Additionally, management may refer to non-GAAP measures, which are intended to supplement, but not substitute for the most directly comparable GAAP measures. The press release available on the website contains the financial and other quantitative information to be 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?
Thomas O’Brien
Thank you. Good morning, everyone, and welcome to our second quarter earnings call. We have reported this morning a net loss of $0.04 a share or $2.2 million, predominantly, as I noted in the press release, related around some extraordinary items and what we’ve got called noisy entries we made. But — and I guess the problem with these noisy quarters is it tends to mask some of the important progress that we make. But nonetheless, let’s kind of go through them quickly here, and then we’ll get to the more critical stuff at the end of my comments.
But first, the expenses are still stubbornly high $19.5 million and an awfully large part of that excess is due to the legal and related costs of dealing with the various investigations and the process that, that takes a lot of time and energy and obviously, money. Also in the quarter, we had some significant noise related to the surrender of a pretty large split dollar life policy and some smaller, older BOLI policies that were former executives and the split dollar policy being for a controlling shareholder. So there was tax implications for that and reversal of some accrued liabilities, and Karen can probably go through any of that, that you might have a particular interest in.
More importantly, we did move to an outsourced platform, the Promontory MortgagePath program for the origination prospectively of our residential home lending in our markets. MortgagePath will basically handle kind of like a turnkey basis all of the origination work, including quality control, compliance and originating subject to our final review and approval, all of the mortgage loan products that we might offer at a given time. It’s an innovative program, and we were all pretty impressed with it. We spent a fair amount of time in due diligence.
And I think from our perspective, it appeared to be a simpler program, which has some variable origination costs, but very limited fixed costs as opposed to the previous platform we had in-house. We anticipate fixed cost savings of around $3 million a year. And I guess, equally critical for the decision was that many of the burdens in residential lending reside in the compliance space and the disclosure world. And that is all assumed by MortgagePath. Again, we would certainly have our oversight and audit of that process, but the critical parts of it are in this outsourced program and I think gets us away from a lot of the inherent risks in residential mortgage lending. And frankly, given the radical downturn in the residential business in the last couple of months with a slowing economy and significantly higher rates, for us, the timing could not have been better.
With the adoption of that program, that we did have some severance costs in the quarter. And again, that was about, I think, $400,000 of more noise. The margin, I don’t know if I can be a little bit creative with numbers here, actually improved about 13 basis points on a basis that doesn’t consider the $1.5 million we had in recovered income last quarter. So we reported a margin of 2.95% versus 3.03% last quarter, and the 3.03% was favorably impacted by about 21 basis points in the first quarter so — but with a one-time recovery. So I guess one of the ways to look at it, I guess, most favorable is we went from a 282 basis point margin to a 2.95%.
And if you want to look at it, then the reported numbers, we went from 3.03% down to 2.95%, a decline of 8 basis points. But directionally, I think I feel pretty confident in terms of where we go with margin. Deposit costs will begin to go up. They already have in some instances. And depending on what happens with the Federal Reserve and inflation, I think our expectations are that there will be several more increases certainly in the current year and probably going into 2023.
The magnitude of those increases, I think the Fed’s already put a stake in the ground with 275 basis points increases, perhaps they might be a little more moderate the next time around depending on what the inflation numbers look like. But at the current rate 9%, 8.5%, however you want to look at it, it is an enormous cost for most people in the country to bear. And certainly, my expectation is the Fed will adhere to its mandate and address inflation as aggressively as it need be to break that cycle.
So I guess the more important thing for most of us to talk about here is where we stand with these investigations, the work involved. I think you probably all appreciate the fact that it’s been backbreaking for all of us. And then certainly, the patience of our shareholders is — I hope you realize always acknowledged and appreciated. It’s just been a very big undertaking. And dealing with two separate investigations is — takes a lot of time and energy and obviously, cost.
But I think it’s safe to say here that the formal agreement, which has been outstanding since 2019, all of the requirements in the formal agreement are, of course, public. But I think it’s safe to say that the requirements were pretty extensive. As I noted in my remarks in the press release, I think we’re now in a position where we have satisfied 100% of these findings and the requirements in the formal agreement. And our expectation is that it will be lifted with the formal conclusion of our exam. It’s an achievement that’s hard for me to underestimate how critically important it was, but it’s really a testament to the hard work and the expertise of Sterling’s Board, management and staff.
From the start of our efforts, I think it’s been about 18 months since we’ve been able to fully attack the formal agreement with the new management group and the direction we’ve followed in terms of satisfying it. But it’s been an — if you’ve dealt with formal agreements before or different enforcement actions from the bank regulators, I think it’s usually safe to say it’s generally at best a two year process and more typically a three year process. But it’s important to understand that the satisfaction of the formal agreement requirements is really critical to closing out the OCC enforcement.
I would guess I’d say I have a reasonable level of confidence that both the DOJ and the OCC investigation will conclude this year. And again, we expect to be in a position to have much more clarity in the third quarter report. These investigations are independent of each other. So it can be a laborious process, which means time and expense. Again, we are complying with all of the requests and pushing as expeditiously as possible for finality, again, only with respect to Sterling and not individuals. But the process is, I think, well underway.
Again, as I said, I think we expect finality by the end of the year. But the timeline with respect to getting all the Is dotted and Ts crossed and coming up with what ultimately the fines and penalties are going to be takes some time. We don’t have any insight at this point into what the fines and penalties are going to be or even proposed to be. So that is — remains to be discovered as we at least get initial proposals from the agencies in the weeks and months ahead.
As I said, I think by the end of the third quarter, we will have a pretty good sense of where these are going and hopefully have everything documented and completed by the end of the fourth quarter. There’s good business and legal reasons to meet that timeline. And I think that’s the sense we’ve been given.
So with that, I — probably worthwhile, Karen, if you just want to go through the noise with the insurance policy surrenders, how it impacted taxes and operating expenses.
Karen Knott
Sure, I’d be happy to. So as Tom mentioned, we surrendered about $25 million worth of policies. With regard to that, the largest was the split dollar policy, which had a cash surrender value around $19 million. So for that policy, we had two liabilities on the books recorded: one for the cost of the insurance, which is just an accounting way to account for the portion of those proceeds that would have gone to the beneficiaries that were not the bank; and then another smaller piece to cover taxes for the increase in the value. So those two totaled about $4.5 million. And those were reversed through the salary and benefit line on the expense side of the balance sheet.
So additionally to that, we had to book taxes on the life-to-date gain on those policies. These were modified endowment contracts. And if we would have not surrendered them and waited to receive a death benefit, that would have been 100% tax free. But because we surrendered them, we had to pay tax on the gain. So the gain was about $13.1 million. And so that equated to about $3.6 million additional income tax expense in the — in below the line. And then lastly, just like if you cash in something of your own early since we cashed in the policies early, there was a modified endowment contract, additional tax of 10%. And that is in the other expense line on the income statement. So all in all, it netted to about $0.5 million of expense. It just happened to hit three different line items on the income statement.
Thomas O’Brien
Thank you. And that’s why I said it was — it created some noise on several different lines in the income statement. But the net result is the policies were surrendered, and we booked them accordingly.
So with all of that, I’m happy to take questions on any of the topics I covered.
Question-and-Answer Session
Operator
We will now begin the question-and-answer session. [Operator Instructions] And our first question will come from Ben Gerlinger with Hovde Group. Please go ahead.
Benjamin Gerlinger
Hi. Good morning, guys.
Thomas O’Brien
Good morning, Ben.
Benjamin Gerlinger
Just kind of just thinking big picture here about the expense base. I get that there’s a lot of moving parts, especially given the — all the noise in the quarter. With the kind of the new process on MortgagePath and that new endeavor and kind of thinking with the BOLI and all the tax thing stripped out of 2Q, when you think about 3Q, is there just like kind of a core run rate you guys have been guiding to, excluding professional fees? I know that can always be a bit of a wild card for any 1 quarter. Like I’m just trying to think when you think holistically, the new expense base is X. Is there something you would guide to for a core?
Thomas O’Brien
I’ll give that to Karen.
Karen Knott
Yeah. I mean, so obviously, salaries and benefits need to be higher than it was. So if you’re excluding the professional fees — got to do a little math here, I would say, around $15 million or so excluding professional fees.
Benjamin Gerlinger
Got you. And then if you were to strip out all the DOJ and OCC type kind of actions you guys are doing behind the scenes, like does professional fees account for anything else? Like is there something else that’s also baked into that? Obviously, it would be minimal, but can professional fees go to zero or is that still something in there?
Karen Knott
No. There’s definitely still expenses in there, just the expenses of being a public company, general, legal fees from doing business but by far, extremely bolstered by these investigations.
Benjamin Gerlinger
Got you. Yes. Okay. That’s what I was thinking, too. And then when you — anything — just kind of bigger picture here, obviously, I think everyone is well versed that the balance sheet is shrinking. With rates higher on mortgage properties and just in general, do you think the melting of the ice cube as Tom would put it here, do you think that, that slows at all? Or are we still kind of on the same path that we’ve seen over the past couple of quarters?
Thomas O’Brien
Well, I’d say, Ben, with higher rates and liquidity on the balance sheet, we’re getting some benefit in the margin, and that certainly is helpful to us. But it’s still a concern as you get into second half of 2023 depending on your forecast for rates and volumes. I mean, we’ve been pretty patient with even investing the bank’s money when rates were quite so low. We invested a little bit as rates went up, and even that was too soon from a yield perspective, but we’re fairly short-term invested.
So I think we can manage through the process. If the rates had stayed down basically at zero, I think the ice cube theory was more of a current concern. I think we buy a little time with higher rates. But we still have to, obviously, to address some significant strategic issues once we get through the sign-offs on the various investigations. And it’s a little tough because not having a clue where the fines and penalties may come out, you just don’t know what you’re dealing with.
Benjamin Gerlinger
Got you. Yeah. No, I appreciate that. [Technical Difficulty] for the color. Thanks guys.
Thomas O’Brien
Good. Thank you.
Operator
[Operator Instructions] Our next question will come from Nick Cucharale with Piper Sandler. Please go ahead.
Nicholas Cucharale
Good morning, Tom and Karen. How are you?
Thomas O’Brien
Hi, Nick.
Nicholas Cucharale
Good. Thank you. So I just wanted to follow up on the professional fees. So making the assumption that the DOJ and OCC investigations are concluded by year-end, do you have an estimate for a normalized level of professional fees?
Thomas O’Brien
I don’t. Karen, what do you…
Karen Knott
One thing that I’m not sure will be resolved or not, maybe Tom can provide some color as the legal expenses we’re incurring for third parties. So if that was all resolved, both the company and the third party, you’re looking at minimal amounts, right? Like $300,000 to $500,000 a quarter in a normal situation.
Nicholas Cucharale
Okay. That’s helpful.
Thomas O’Brien
Yeah. Nick, with — the indemnified parties, I mean, there are obviously people in the bank who might be in a position to provide some information to either or both of the agencies. They are reaching Title II, the advancement of legal fees under certain conditions. And that’s another thing that starts to get a little easier once we get to sign off on the final terms and conditions of the various investigations.
Nicholas Cucharale
Super helpful.
Karen Knott
Yeah, Nick. I want to change there a little bit because I was looking primarily at legal and professional. And I wasn’t considering some regular audit expenses and stuff that we have. So that’s probably going to be closer to $750,000 on a normalized quarter.
Nicholas Cucharale
Okay. Thank you for the clarification. You’ve made considerable progress in derisking the balance sheet and bringing down higher-risk credits. From an asset quality perspective, what are your remaining concerns at this point?
Thomas O’Brien
That’s funny. I didn’t — in my remarks here, I didn’t get in too much into the credit picture because I — as I noted in my quote last year at this time, I think I expressed a fairly high degree of concern with the aggressiveness in the commercial portfolio. We’ve got some really good credit people now who’ve taken apart the loans we were most concerned about. We got accurate risk ratings on them. And in some cases, we worked with borrowers. Other cases, we exited out of the relationships.
And a more significant case, we sold a large pool of those single-room occupancy hotels. So that brought the risk down a little. I think as I noted in the press release, we’ll probably look at one more commercial sale in the next quarter or two of loans that perform but are always going to be substandard and the risk that they start to perform erratically. And then with respect to the residential loans, our experience with those continues to be quite good.
In terms of ultimate loss exposure, I think of the group that we reported as nonaccrual, 18 or so million was paying under some delayed terms or modified terms but not really ready for prime time accrual status. And the rest are loans that either are about to hit foreclosure or in foreclosure. And we might look — once we get cleared of the investigations, then we might look at a significant sale of the nonperforming or under foreclosure advantage loans and to clean it up that way.
Not too different if you followed at all what we did at Sun National Bank when I was there, a couple of big transactions and all of a sudden, the risk profile was extremely modest. And that’s our goal here. You don’t want to make high-risk loans in an economy that’s slowing down. And the challenge for us will be to balance that against the net interest margin. But first and foremost is the credit. I think we’re adequately reserved in the case of potential losses.
And as I mentioned to date, we’ve lost exposure on the advantage loans that went into foreclosure or otherwise off the balance sheet, pretty insignificant. One — we had one that was a fire in the house, and I think we lost some money on that. But for the most part, they go to foreclosure. We tend to — at the foreclosure sale, we tend to be outbid because the loan to values at origination were fairly low. And — but more importantly, prices have also improved in most of those markets. So there’s plenty of equity in those. But it is — the advantage loans are the major part of our non-accruals.
Nicholas Cucharale
That’s great color. Just one final one for me. Can you remind us how much remains in the mortgage repurchase liability allowance and where you stand with respect to further repurchases of advantage loans?
Thomas O’Brien
I can’t, but Karen can.
Karen Knott
Sure. There’s just under $2 million left in that repurchase reserve. There’s about just under $90 million worth of total advantage loans that have been sold to third-party investors. We were expecting to get a pull back, hopefully, in the third quarter, might be pushed to the fourth quarter of about probably $35 million by the time we get there, maybe a little less. And then there’s another — a couple of others, one under agreement, one not. But those seem a little less likely at this point, given where the market is.
Nicholas Cucharale
Great. Thank you so much for taking my questions.
Thomas O’Brien
And I guess I’d add, Nick, just to put it in perspective, when I joined the bank, the loans sold to others, which were all advantage loans was, I think if memory serves correctly, around $850 million. So we’re down to pretty much the tag ends of our exposure to the loans sold to others, and I think most of them, the performance levels we look at in terms of the loans sold to others that we service remains quite good. So my guess is they’ll just hang on to them.
Nicholas Cucharale
Yeah. Really big difference. Great, job. Thank you very much.
Thomas O’Brien
Sure. Thank you.
Operator
Our next question will come from Ross Haberman with RLH. Please go ahead.
Ross Haberman
Good morning, Tom. How are you?
Thomas O’Brien
I’m fine. You?
Ross Haberman
I just wanted to go back one more further — some further questions on the nonaccrual and nonperformers. Generally, would you say — I don’t know, would it be too aggressive to say you can knock that number in half by the end of the calendar year?
Thomas O’Brien
No. If you take the — well, it depends on when we satisfy the — sign off on formal agreement and the DOJ investigation. But let’s just for argument’s sake say that’s 12/31, then we could look at selling the portfolio of advantage loans that are 90 days or more delinquent and under foreclosure. And that’s more than half of the total. So yes, in theory, that would all work. The timing, I can’t quite pin it down to a quarter, but there’s a market for those. And it just requires us to get through the DOJ investigation.
Ross Haberman
Could you remind us, did — have you adopted CECL yet? And if not, are you running parallel programs and you’re hopefully not going to shock us in March with a multimillion dollar addition? You’d seem pretty well reserved.
Thomas O’Brien
Well, I’ll say what I think, and then Karen can add color to it. But we’ve had a CECL team and progress. We’ve had — we have outside experts guiding us on the issues in and around CECL. And we’ve hired another firm to validate everything we’ve done. So I think we’re in very good position to be providing a little more information directionally in the third quarter and even more in the fourth quarter. And then we should be fine with adoption in first quarter ’23. I would say, in my opinion, you won’t see any shocks, but hear from the CFO, too.
Karen Knott
Yeah. I would agree with that. We’ve been running the models parallel without adding the qualitative factors. So we’re really just working on finalizing those and seeing what makes sense, given the models are more robust since they already bake in the economic forecast and such. But I think we’re pretty well reserved, and I would be surprised to have any shocking news come at the end of the year when we report that number.
Ross Haberman
And just one follow-up regarding the investment securities. The held-for-sale portion of that, what was the average yield or average duration of that?
Thomas O’Brien
I don’t think we have any investment securities in held for sale, do we, Karen?
Karen Knott
Well, the whole portfolio itself.
Ross Haberman
You have [indiscernible] adjustment, so I figured [Multiple Speakers]
Karen Knott
Whole portfolio is held for sale. I don’t have the data in front of me, but the duration is relatively short. When we buy things, we’re always looking at two to three years. So it’s pretty short.
Ross Haberman
Okay. All right. Thanks. Best of luck. Hopefully, you can wrap up — can wrap everything up by the Christmas. Thank you.
Thomas O’Brien
That would be a nice holiday, yes. And I was thinking of a trading portfolio, not held for sale. Okay. Anything else?
Operator
Our next question is a follow-up from Ben Gerlinger with Hovde Group. Please go ahead.
Benjamin Gerlinger
Sorry for the double question. You kind of answered half of it, but I was just thinking it’s a negative AOCI in the quarter. With rates up pretty notably over the past 180 days or so, I know you guys have a different liquidity strategy relative to most banks. Is it safe to say we’ve probably seen most of our loans here in the AOCI and actually starting back to even? Or do you think we’re going to have another negative? I’m just thinking because of the curve is all over the place, so the 10 year is lower, but the two years higher kind of thing from that perspective of the balance sheet?
Thomas O’Brien
Yes. From the — with the yield curve the way that it is, I mean, as Karen mentioned, we tend to invest three years and in. So we’re probably a little more exposed to higher rates there from an AOCI perspective. But the — in a sense, my view is generally the rates will go where they go, and the marks will be where they are. There’s no credit risk in anything that we buy. So it’s hard to predict valuations other than even if those two year kind of rates and shorter stay inverted, it will impact the value of the securities.
But at the end of the day, we get our money back. And I don’t lose a lot of sleep over it. I’d be more concerned, obviously, if we have longer-term investments with greater exposure because that just can drop like a stone probably back where we were when I first started in this business.
Benjamin Gerlinger
All right. Yes. No, I agree. I was just double checking. And it seems like from a liquidity perspective, you are not going to have to sell for a loss. So like you said, marks are where they are, you won’t get it back in three years or less.
Thomas O’Brien
Yeah. No matter how you look at these things, they’re either — they either come back to you, they’re yield adjustments, they’re — but the timing is always difficult for any institution buying securities whether it’s equities or bonds or you try to buy smart, you don’t always do it.
Benjamin Gerlinger
Right. Got you. Appreciate the color. Thanks.
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.
Thomas O’Brien
No, just hope everybody enjoys the balance of the summer. And year is going incredibly quickly, but we will be talking to you again at the conclusion of the third quarter. So that will be in October. And I think we’ll have more to say at that point and I think, obviously, as I mentioned earlier, more clarity. But as always, we appreciate your time and your interest, and wish you the good rest of the day. Thank you.
Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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