Good afternoon, and welcome to the Sandy Spring Bancorp Earnings Conference for the First Quarter of 2014. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Daniel J. Schrider, President and CEO of Sandy Spring Bancorp. Please go ahead. .

Thank you, Amy, and good afternoon, everyone, and welcome to Sandy Spring Bancorp's conference call so that we can discuss our performance for the first quarter of 2014. Now this is Dan Schrider speaking, and I'm joined here today by Phil Mantua, our Chief Financial Officer; and Senior Corporate Counsel, Don Schuster, for Sandy Spring Bancorp. .

As always, today's call is open to all investors, analysts and the news media and there will be a live webcast of today's call, and a replay of the call available at our website beginning later today. And we will take your questions after a brief review of some key highlights.

But before we get started, Don will give the customary Safe Harbor statement. .

Thanks, Dan. Sandy Spring Bancorp will make forward-looking statements in this webcast that are subject to risks and uncertainties.

These forward-looking statements include statements of goals, intentions, earnings and other expectations, estimates of risks and future costs and benefits, assessments of probable loan and lease losses, assessments of market risk and statements of the ability to achieve financial and other goals.

These forward-looking statements are subject to significant uncertainties because they're based upon or affected by management's estimates and projections of future interest rates, market behavior and other economic conditions, future laws and regulations and a variety of other matters, which by their 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, Don. Today, as usual, I have some prepared remarks and then we will move to your questions.

It was another solid quarter without a lot of major noise or extraordinary items, and we continue to be pleased with our consistency and balanced results, along with the diversity of our revenue sources and also the year-over-year performance of our stock price. .

As stated in our press release issued earlier today, net income for the first quarter of 2014 was $10.9 million, or $0.43 per diluted share.

This compares to net income of $10.6 million, or $0.42 per diluted share, for the first quarter of 2013, and net income of $9.6 million, or $0.38 per diluted share, for the fourth quarter of 2013, a good linked quarter advance. .

Here's just a quick rundown of the main highlights from the release, with a bit of added color where appropriate. You will notice a $1 million credit to our provision expense during the first quarter, resulting from lower historical charge-offs and improved credit metrics over the last 12 months.

The impact of the historical loss factor within our allowance methodology in terms of provision expense credits should diminish in future quarters, with future provision expense being driven by loan growth versus past credit quality issues. .

The net interest margin was 3.47% for the first quarter of 2014 compared to 3.59% for the first quarter of 2013, and 3.53% for the linked fourth quarter of last year. The primary driver of the decrease was a result of declining yields during the period, mainly the result of repricing within the commercial loan portfolio.

The margin for the quarter did behave very much as we had expected in our internal modeling. .

We continue to be pleased with the strength of our core deposit franchise. Overall, customer funding sources, that is deposits and customer repos, increased 2% compared to March 31, 2013. At the same time, year-over-year growth of the combined noninterest-bearing and interest-bearing checking account balances increased 7% compared to March 31, 2013.

We continue our focus on growing new retail and commercial deposit relationships. Our loan book grew 10% compared to the first quarter of 2013, and we are pleased that we have experienced balanced growth in all major categories. On the linked-quarter basis total loans grew 2%.

We do remain disciplined in terms of our underwriting standards within this very competitive environment during this slow economic recovery. .

Non-interest income decreased 9% for the quarter compared to the prior-year quarter, due primarily to the decline in revenue from mortgage banking activity. This was caused by a significant lower -- significantly lower volume of saleable mortgage loan originations. And as you know, this is going on throughout the community banks' spectrum.

At the same time, while salable activity is down, we have experienced consistent growth in the residential construction portfolio, that is loans to individuals who are constructing their own homes. This is a line of business we've been in for many decades and a unique niche where we perform very well. .

During the first quarter, wealth management income increased 10% and insurance agency commissions increased 22%, both compared to the first quarter of 2013. As stated in our release at year end, during the fourth quarter of 2013, we recognized $800,000 in one-time expenses related to the closure of 3 branch offices.

These closures represent the initial phases of our channel or branch rationalization work, that we have previously discussed, and the associated expenses represented approximately a negative $0.02 of EPS for the fourth quarter.

What I must point out is that the actual closures or full shutdowns of these branches did not occur fully until mid-first quarter of this year. So the savings from these branch reductions were not fully realized in this year's first quarter. So as to offset the expense hit we took in the prior quarter.

However, we should see that expense impact normalize from this point forward. .

The channel or branch rationalization effort will be ongoing, but suffice it to say that the driving objective is to most efficiently structure our presence in existing markets where we're already very strong or dominant, while carefully evaluating how to best establish Sandy Spring in profitable new markets, where we do not now have a presence.

And in connection with all of this, we've recently signed a new lease on the Bethesda Maryland Financial Center during the first quarter.

This new financial center will include wealth management professionals, commercial bankers, mortgage originators and insurance professionals to serve this important market, and we will also be relocating our existing Bethesda branch into that new space later in the year. .

Retail mobile banking, including mobile deposit capability, is already operational and in the hands of our clients. And we look forward to rolling out business mobile in the next quarter, both of which are an active part of our channel rationalization efforts. .

Switching gears, non-performing loans totaled $38.7 million at March 31, 2014, compared to $49.5 million at March 31, 2013, and $40 million at December 31, 2013. NPLs at quarter end were where we expected.

The allowance for loan and lease losses ended the first quarter at 1.34% and drives our coverage ratio of non-performing loans which was at 98% at March 31, 2014, compared to a coverage ratio of 83% at March 31, 2013, and 97% at December 31, 2013. We are comfortable with both our reserve and coverage levels. .

Non-interest expenses decreased 1% to $27.5 million for the first quarter of 2014 compared to $27.8 million in the first quarter of 2013. This decrease was primarily driven by improved credit quality as legal fees associated with loan workouts declined significantly during this period.

But also note that snow removal expense for the first quarter amounted to $350,000, and that's huge for us in any quarter. The unusual weather was quite unpredictable, but if you take out mother nature's unexpected impact and then normalize our run rate of expenses, you should get a much better and more accurate picture moving ahead. .

The efficiency ratio was up 1% even though expenses were down, and this should be understandable due to the decline in mortgage banking revenue.

Specifically, non-GAAP efficiency ratio was at 61.51% for the first quarter of 2014 compared to 60.8% for the first quarter of 2013, but much better than the 63.6% reported in the linked fourth quarter of 2013. .

At March 31, the company had total risk-based capital ratio of 15.85%, a Tier 1 risk-based capital ratio of 14.64%, and a Tier 1 leverage ratio of 11.43%. And as we have said previously, our capital deployment strategy continues to include a focus on organic growth, strategic M&A activity, dividend payouts and share repurchases when prudent to do so.

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one, achieving balanced loan growth from all client segments; two, increasing the value of our deposit franchise by a continued focus on core deposit growth and relationship expansion; three, enhancing the diversity of revenue sources through growth in our fee-based businesses like wealth management, commercial and personal insurance and mortgage banking; four, executing on our channel rationalization work to deliver to our clients through all of the multiple ways they want to interact with us, while we rationally manage our own cost to do just this; and five, adapting our delivery of products and services based on what we hear from our clients.

We continue to listen to our clients in new ways and use what they say as a means to change how we do business with them. .

That concludes my comments for today. We will now move to your questions. Amy, can we first have the first question please? And we would appreciate it if you would state your name and company affiliation as you come on, so we all know with whom we are speaking. .

[Operator Instructions] And the first question comes from William Wallace at Raymond James. .

I have a few questions, but I'll only ask a couple and I'll hop back in if they don't get asked through the process. But on the margin front, Phil, you were talking last quarter about something in the high 3.40s for 2014.

Do you still think that's the right range?.

I do. Yes, I think that the way we continue to look at it with not really a whole lot having changed in the broader interest rate environment, and what we're doing on the balance sheet. But that is still I think a very reasonable way to consider what the margin will do for the rest of the year, yes. .

So the repricing that you referenced in the commercial loan portfolio in the first quarter, you don't expect that, that pressure will continue as the year progresses? Or are you expecting that you'll have more relief on the funding side as the year progresses?.

I think that the way that, again, that we view how there's some offset to that is that the loan growth that we do expect, the pickup will be between what's running out of the investment portfolio into today's loan yields to offset some of that yield compression within the portfolio of loans itself. .

Okay. So you're expecting then the loan demand will pick back up and you'll be able to deploy earning assets out of securities into... .

That's -- yes, that's the premise for my thoughts as it relates to the margin being relatively maintained in that upper 3.40% range, yes. .

Okay.

And then, are you doing -- are you guys thinking about or making any changes on the funding side of your balance sheet in anticipation of a changing interest rate environment?.

Wally, this is Phil again. We've certainly started to be a little bit more competitive.

Not -- I wouldn't call it aggressive, but a little bit more competitive on some of the rates related to some of our longer-term time deposit products, and just trying to enhance a little bit more stability in that, and therefore lengthening out that part of the funding side.

But beyond that, we really haven't taken any other overt measures at the current time related [ph] to that. We still are most interested in building that core piece of the funding franchise, and I think as we got towards the latter part of the quarter that certainly started to come back a little bit more.

So I don't see a whole lot of change strategically there for the time being. .

Okay. And then, on the expense side, you were talking about operating expenses in that $28 million range, and you came in better already this quarter. And Dan, in your comments, you referenced that there's still more benefit to come from the branch closures.

So maybe you can update us on the expected expense levels?.

Yes, I think it's -- do some of the math from where we are, we've reported about $27.5 million for the quarter. We made mention of a couple to $300,000, $400,000 -- $350,000 worth of this snow removal stuff that hit us because of the weather that obviously doesn't reoccur unless the weather is really a lot crazier than anybody thinks.

So you kind of can discount that out of there. And then, I think that there are some savings obviously from the branch rationalization and the closing of the 3 branches there. Although, we really only got about a half a quarter's worth of value of that here in the first quarter.

But there are also some things that normally don't happen in the first quarter related to compensation and things that will come the other way a little bit. So having said all of that, that $27.5 million is probably a reasonable place to think about where we're going to land quarter-to-quarter going forward. .

Okay.

And last but not least, in the mortgage bank, are you guys profitable in the first quarter?.

Yes, Wally, this is Dan. And when you consider the size of our mortgage portfolio both in what we have on the books in perm, as well as our construction activity, the short answer to your question is yes.

But that's clearly being propped up by the ongoing revenue stream from the fund of mortgage portfolio that we hold on the books, which is, as we've said before, is predominantly 5-1 and some 7- and 10-1 ARMs. .

Are you expecting or anticipating any changes on that side of the business from a personnel standpoint? Or are you expecting that the production volumes will improve now that we get into the stronger seasonal part of the selling season?.

Wally, this is Phil. We've really already done some things on the personnel side in terms of looking at the year-over-year complement in that group. It's down by a little more than 20%, maybe 25% just in that regard. So I think that we're on top of that aspect of it to date. And we will certainly adjust as appropriate.

But I think, as Dan mentioned, even though there's certainly a lot less gain income being had by virtue of what we're able to originate and sell, those portfolios are still growing pretty nicely. And in fact, they were out in front of the other components of the loan portfolio this quarter.

And with the season as it is here coming upon us, that's probably still possible from that perspective. .

Our next question comes from Bryce Rowe at Robert W. Baird. .

Just a follow-up to one of Wally's questions there on loan yields. Phil, understand that the premise around that high 3.40s% margin is a shift into loans from the lower yielding securities, but did want to just try to get a feel for pressure on loan yields. Dan, you mentioned refinancing, repricing in the quarter.

And so just curious if that is ongoing, if that competitive pressure is ongoing?.

I think it has been in the marketplace we're operating in, and we would expect that to continue. So that I don't think that, that the pressure in terms of commercial yields in particular has become more of an issue. I think it's just we expect that to continue.

Just given the slower recovery and the lack of overall demand to feed the competitive landscape. .

Okay. Another question and I certainly understand that the allowance calculation is very much formulaic.

Just curious if there is a -- is there just an underlying floor in terms of the allowance-to-loans ratio? And how kind of you would expect that to trend, all else being equal?.

Yes, good question, Bryce. And it is very methodical. A couple of things I'll comment on. This historical loss factor within our methodology clearly has had an impact as we look back several quarters and some of the lumpiness of provision versus credit as our overall credit metrics have improved.

There's not a whole lot more to give back there in that historical loss area as you might imagine. We used an 8 quarter. Our methodology, not to get too technical, uses an 8-quarter look back and it's weighted. But right now, that historical loss across all portfolios only represents 10%, 11% of our overall reserves.

So it's just -- there's a point to which that's not going to fall.

But your broader question is how do we see the overall provision or the overall allowance relative to loans? And as we -- and again, we follow our methodology, but as we kind of look at our year and what we expect things -- how we expect these things to materialize, that thing could go down in the 1.30% range, and that's not an artificial floor, that's just the way we view it, and the way we think our methodology will work.

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Okay. Okay. And then, last question, Dan. I think we have to ask this every quarter. Just any update on capital deployment, whether it be through M&A, stock repurchases, et cetera? I think you guys have had the opinion that you'd like to get some M&A deals done. So just any commentary around that would be helpful. .

Yes. And I think that strategy and our outlook on that continues to be the same, Bryce. Fair question. And we continue that process of marketing the Sandy Spring story and the potential holding our shares, if we were to use that as a dominant currency in any transaction.

And I know this conversation is to continue, and I still feel optimistic about our ability to make that part of that capital deployment strategy. But I don't have any more to say around that today. .

The next question comes from Damon DelMonte at KBW. .

Just wondering if you could provide a little more color on your loan growth outlook. I know this quarter we saw some increases in residential mortgages and the residential construction.

Can you maybe talk a little bit about the dynamics of what you're seeing there and maybe the thought behind portfolioing more resi mortgages this quarter?.

Yes, Damon, this is Dan. I think the -- part of the equation on the resi mortgage piece, there's 2 things that influence the portfolio there. One, is the origination of residential construction loans.

And then 2, are the completion of residential construction loans that move from the construction category into our permanent mortgage category, okay? So there is some classification change as those loans, as those projects are completed.

So some of the growth you see in that portfolio, in the perm portfolio is being driven by loans moving out of construction into perm, as well as just flat-out perm production. If given the option, at any point, we would always, from a priority standpoint, move a credit into a salable piece of business that we can move off and generate gain.

Obviously, we can't do that on the construction side. So it's not a strategic decision to necessarily say, "Let's grow the mortgage book on portfolio versus salable." That's just what the market behavior is right now in terms of demand that we're seeing here.

In overall loan growth, we still are looking and have a view towards that mid- to high-single digit overall when we look at '14. Tough to tell, but I do believe some impact -- we lost quite a bit of business days in the first quarter due to the type of weather that we've had on the East Coast.

I can't tell you that, that has had a tremendous impact on loan production, particularly in the commercial side, but I would imagine it had some. So we still have a pretty healthy mid- to high-single digit outlook as we [indiscernible] through the year. .

Okay. And then, just to circle back on the resi construction loans that move into permanent.

What is typical loan like? Is it a 15-year, a 30-year, is it an ARM?.

Great question. So when we're underwriting a res construction loan for the individual to build their own home, we write in on a 5-1 product. And then so the first year of that 5-year commitment is the construction period.

So when they move out of construction into perm, they essentially have a 4-year, 4-year -- 4-1 ARM, so to speak, at that point in time. We also, at the time they come out of construction, we'll look to what salable alternatives there are.

So they have -- the client has the comfort of knowing they've got a 5-1 loan going in and also know that we're going to try to shop them for a salable product as construction wraps up, if that make sense. What's moving into the perm portfolio out of construction would be a 5-1 that's already used up the first year. .

Got you. Okay. And then, just my last question, I think you mentioned about looking for additional branch closures during the year.

Is that like a hard and fast strategy? Or is it just you're kind of implying that you're going to continue to evaluate the branch network and where you see opportunity to maybe consolidate 2 locations into 1, you're going to do something of that nature?.

I think the latter is probably more akin to how we're thinking about it. There are -- our work would -- given the fact that we've been around for so long as a company and some of our branches likewise have been around for so long. Some of those demographics or the traffic patterns or submarkets may have changed quite a bit.

And so in some cases, we may be in a really great market, but in no longer in a really good location, which may provide for some of that consolidation opportunity as we look forward. And also free up -- potentially free up resources so that we can move into the newer markets that -- where we aren't. So that's how we're looking at the overall process. .

Our next question comes from Ross Haberman in Haberman Management Corp. .

Just a quick question, you touched upon the growth of the construction loans. What portion of what you're doing is true spec versus the owner occupied, which you've discussed? And give us a sense of what are you getting on both those owner occupied and spec loans in terms of rates. .

Okay. Ross, when we speak of that res construction piece for the individual, that's all -- there's nothing spec associated with that. It is all individual buying a lot, building a home for their own occupancy upon completion. So there is no spec in that.

We do have on the -- within our commercial portfolio, an acquisition development and construction component where we do finance local and regional builders and developers to either develop lots and/or build homes on those lots. And the spec exposure in those really varies by project.

But I will tell you that we're very conservative as it relates to that. So typically, any spec exposure on home building that is done by a homebuilder is simply enough to get a project started and be able to market from a model or 2 as opposed to getting way out ahead of sales. .

And rates on both those categories today?.

Ross, this is Phil. I would suggest that in the AD&C area, those -- the rates related to those credits were in the kind of 4.25% to 4.5% range, may inch up a little above that on a deal-by-deal basis.

And then on the owner-occupied side, probably up from the 4.5% or so by another 15 or 20 basis points, which is about what experience has been in the last few months. .

And just one final question.

In terms of competition, are you finding more competition in that construction category from other banks or other lines of loans you're seeing more competitive pricing?.

Yes, this is Dan. And actually, in both cases, on the res construction piece through our mortgage group, I mean that's a niche that not everyone plays in, but those that do, it's certainly very competitive but not any more competitive than it's been over the last several quarters.

On the AD&C piece, which we manage to limit the concentration in that book we're, again, we're one of a handful of players that play in that in the market today. Many that did prior to the cycle are no longer participating in that part of the market. .

[Operator Instructions] And at this time, we show no further questions. So I would like to turn the conference back to Mr. Schrider for any closing remarks. .

Thank you, Amy, and thank you, all, for your questions. We do appreciate you taking the time to participate with us this afternoon. And we'd like to remind you that we would like to receive your feedback to help us evaluate how we've done on this call. You can e-mail your comments to ir@sandyspringbank.com. Thank you, again, and have a great afternoon. .

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