Daniel Schrider - CEO, President & Director Ronald Kuykendall - General Counsel, EVP & Secretary Philip Mantua - CFO and EVP.

Casey Whitman - Sandler O'Neill + Partners, L.P. Catherine Mealor - KBW Austin Nicholas - Stephens Inc. Matthew Schultheis - Boenning and Scattergood, Inc..

Welcome to the Sandy Spring Bancorp, Inc. Conference Call and Webcast for Second Quarter 2017 Earnings. [Operator Instructions]. Please note, this event is being recorded. I would like to now turn the conference over to Daniel Schrider, CEO and President. Please go ahead..

Thank you and good afternoon, everyone and welcome to our call to discuss Sandy Spring Bancorp's performance for the second quarter of 2017. This is Dan Schrider speaking and I'm joined here today by the Chief Financial Officer, Phil Mantua; and General Counsel for Sandy Spring Bancorp, Ron Kuykendall.

We really appreciate you taking the time to join us. Today's call is open to all investors, analysts and the news media and there will be a live webcast of today's call as well as a replay of the call available on our website later today. We will take your questions after a brief review of some key highlights.

But before we get started, Ron will give the customary safe harbor statement.

Ron?.

Thank you, Dan and good afternoon, ladies and gentlemen. 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 risk and future cost 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 are 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 very nature are subject to significant uncertainties.

Because of these uncertainties, Sandy Spring Bancorp's actual future results may differ materially from those indicated. In addition, the company's past results of operations do not necessarily indicate its future results..

Thank you, Ron and thanks, everyone, again for joining us. As I mentioned, we'll be happy to take your questions immediately after I share some brief remarks. As our press release issued earlier indicates, we again achieved a very strong performance in this period.

As was the case last quarter, our results continue to be driven by terrific team, strong core operating performance, proactive balance sheet management, strong credit quality and a focus on operating efficiency. Our strong growth and balanced results are generating very consistent performance in this highly competitive Greater Washington market.

Here's just a quick rundown of the main highlights from the release we issued earlier today.

Net income for the second quarter of 2017 was $14.7 million or $0.61 per diluted share compared to net income of $10.6 million which is $0.44 per diluted share for the second quarter of 2016 and net income of $15.1 million or $0.63 per diluted share for the linked first quarter of this year.

On a core basis, pretax pre-provision income for the quarter was $24 million compared to $18.6 million for the second quarter of 2016. That's an increase of 29%. Additionally, pretax pre-provision income was also up 4.5% compared to the linked first quarter of 2017.

Our continued strong core performance was driven by higher net interest income which increased 15% in the second quarter of '17 compared to the second quarter of 2016. As expected, based on first quarter pipelines, loan production in all portfolio segments was solid through the quarter.

Overall loan production for the quarter was up 41% compared to the second quarter of 2016 and 27% compared to the linked first quarter. Loan growth for the quarter was impressive as total loans increased 13% compared to the second quarter of last year and were up 4% compared to the linked first quarter.

Commercial loan segments led the way this quarter and our outlook for 2017 loan growth continues to be consistent with the growth experienced in 2016. The provision for loan and lease losses was a charge of $1.3 million for the second quarter compared to a charge of $2.9 million for the second quarter of 2016.

Provision expense continues to be primarily driven by growth in our loan portfolios. Our credit quality metrics continue to be very solid and the portfolios are all performing very well.

So given the current credit quality and loan growth expectations, we continue to expect the annual provision expense for 2017 to be pretty consistent with what we saw in 2016 and again, driven by growth.

The core net interest margin after adjusting for an interest income recovery this quarter was 3.54% for the second quarter compared to 3.51% for the second quarter of 2016 and 3.51% for the linked first quarter of 2017.

Our margin improvement reflects the impact our team has had by driving loan growth by executing on funding strategies and managing earning asset yields and funding costs. We've had real success on the deposit side, as we continued to grow core deposits from both retail and commercial banking relationships.

At June 30, 2017, combined noninterest-bearing and interest-bearing transaction account balances increased 9% compared to balances a year ago. Our continued ability to further penetrate existing and generate new core retail and commercial transaction relationships are key strengths of our franchise.

Total deposits and other short term borrowings that are a part of overall funding sources derived from clients increased 11% compared to June 30, 2016.

Noninterest income was strong at $13.6 million for the second quarter, up 8% on a core basis compared to the second quarter of 2016, after adjusting for security gains taken in both second quarters of 2016 and 2017.

Noninterest income growth was driven by success in both in our insurance and wealth management businesses, both of which are integrated in our overall sales approach aimed at meeting the needs of clients and enhancing their overall engagement with our company.

As our press release describes, there were several non-core expenses impacting both second quarters of 2016 and 2017, including $1 million in merger-related expenses in this current quarter.

Excluding the non-core expenses in both periods, noninterest expense increased 4% compared to the second quarter of 2016, primarily due to higher levels of incentive-based compensation. The non-GAAP efficiency ratio was 54.10% for the current quarter compared to 59.12% for the second quarter of last year and 54.78% for the first quarter of 2017.

Our success is primarily the result of growth in net interest income coupled with the effects of focused expense management. Our capital position remained very strong, with total risk-based capital at 12%, Tier 1 risk-based capital ratio of 10.96%, Tier 1 leverage ratio of 9.26% and a tangible common equity to tangible asset ratio of 9.10%.

Overall organic growth continues to be strong and we continue to build our revenue-producing teams with newly acquired talent. Our client experience work continues as we build a unique banking company focused on delivering the best possible solutions through a consistently remarkable experience without exception.

And lastly, the integration work is in high gear as we look forward to moving ahead on our definitive agreement to acquire WashingtonFirst Bank. All regulatory applications and filings have been submitted. Teams throughout both organizations are working closely together to plan a smooth and successful transition.

And we continue to look toward the fourth quarter closing and a first quarter of 2018 core systems conversion. That concludes my general comments for today and we'll now move to your questions. So operator, we'll take the first question. If you can just identify your name and company affiliation as you come one, that would be helpful..

[Operator Instructions]. The first question comes from Casey Whitman of Sandler O'Neill..

Nice quarter. First question, just last quarter's margin guidance that you gave was maybe the low or 3.50s. So this quarter, ex the interest recovery, I think the margin was higher than that.

So can you give us an update on your margin guidance going forward and what assumptions you include for rate hikes in the shape of the curve?.

Glad to do that, Casey. This is Phil. I think as far as the margin guidance itself, I would stick to the rest of the year being in that same kind of 3.50% to 3.55% range for the remaining couple of quarters. We, at this point, don't have any additional changes in the short end of the curve due to Fed movements until the end of the year.

We had earlier had some things in September, but those got accelerated by virtue of what the Fed actually has done here in the last couple of quarters. So that's the assumption as it relates to that.

And in addition to that, an overall flattening of the curve, we don't believe that the long end is going to be a whole lot different by the end of the year as to where it is today. In fact, it could even be a little bit -- could be a little bit less.

Our margin guidance is also predicated on us continuing to be fairly aggressive on the deposit gathering side, obviously, based on our liquidity position and continuing to emphasize being top third type payer, especially in the money market area and then also being as competitive as we think we need to be in the time deposit realm.

So I think that, that's kind of why overall, I would continue to suggest that the margin would be in that same range..

All right.

And with respect to just continual increase in your interest-bearing deposit cost, would you say that's been more of a reflection of existing customers' rates going up or higher rate offers for bringing new customers in?.

It's probably a little bit of both. Just because of the way that we've repriced certain tiers within the money market account, that would obviously affect all dollars that were in there in prior periods as well anything new in conjunction with then a higher guarantee rate type situation for new money as well.

So for example, in that area, last quarter when we spoke that, that premier 3-month guarantee was 1% offer rate, today it's about 1.15% rate. At the same time, highest tier in that same product for existing clients was 41 basis points in the end of the last quarter and today, it's sits at about 63. So in that regard, it's a blend.

And then the same thing would just be true on the time deposit sense, although, obviously, probably more of those dollars are coming from outside the organization. And so they're being impacted a little bit differently..

Okay. And it was also nice to see the noninterest-bearing deposits go up quite a bit this quarter.

So can you maybe talk a little bit about how you achieved that result?.

Casey, this is Dan. I think it's simply the continued sales approach, both within our retail banking franchise and those that are focused on small- to mid-sized businesses.

Very robust treasury management practice here at the bank and it's really the result of continued calling effort, focusing on relationships that both have credit needs, but primarily deposit needs. We really didn't see this year -- obviously, the commercial DDA balances do fluctuate pretty significantly inter-month and inter quarter.

But overall, those have been moving in the nice direction. So it's -- short answer is just overall calling effort and winning new relationships..

Yes. I think it's fairly balanced between just core commercial and small business checking accounts. Both of those were 19% and 16%, respectively, average year-over-year balance growth. So it's both ends of the spectrum on the commercial side..

Got it.

And the last question and I'll let someone jump on, that FHLB borrowings that you repaid, at what point of the quarter did you do that and what was the approximate cost?.

We did that over the course of really the entire quarter. And the prepayment penalty that was related to that -- actually, you already know that the cost of the borrowings that we brought back on through the restructuring averaged out to be an effective rate of about $120 million. The ones that we gave up, the average cost was about $250 million.

And so we also took the opportunity in that to extend some of the -- some of our shorter term borrowings that we had been utilizing out a little bit on the curve by going a little bit more intermediate-type maturity somewhere between 1.5 years to 3..

The next question comes from Catherine Mealor with KBW..

Casey got most of my questions on the margin. Just one follow-up on the margin.

As we think about WashingtonFirst layering on, how do you think about your pro forma margin with WFBI, particularly in a flattening curve environment, given that they've just got a lot more CRE than you do?.

Catherine, this is Phil again. I think we've talked little bit about this at early points.

But we don't see the overall margin being affected terribly in either direction when we layer them on, at least initially, because even with their higher loan yields in their portfolio, the nature of their funding initially is certainly a lot more blended towards the wholesale type of sources. And so there's a counterbalance related to that.

Plus, as we know, we've got to deal with the fair value accounting implications on the yields once we do that at closing. So when we bake all that in as we sit here today, we don't really see the margin generally moving much from where it is in our right today..

Great. And then one follow-up, too, on the deposit side. Your CDs obviously had higher growth this quarter, as was expected and you've articulated.

Can you give us any color into the incremental -- at what rate your incremental CDs are coming in on about right now and your expectation for that rate to increase once we have the full impact of the June rate next quarter?.

Yes, that's a real good question. I think -- and I'm trying to recollect here in terms of the trade-off, given the nature of what we're doing in terms of the difference in maturity that we're offering.

I think that there's probably on the margin -- in terms of at the margin when we're doing that today, although honestly, we've actually leveled off in terms of some of our CD rates in this quarter or even from the prior quarter. So there's still probably some incremental pickup.

Maybe it's 25 or 30 basis points depending on where we're trading that off from a maturity standpoint when we do that at this particular point. It's probably not as much as it has been in the past, to be honest with you, based on where we came from before. But that's kind of where I -- my recollection is as to where it probably is at the moment.

Was there a second part to that question? I can't remember what the other element you asked was..

No, that's it. Just the impact on the June hike on CD cost.

Do you think it'll move a lot higher?.

Yes, interestingly enough, we had the June hike. And again, as I just suggested, in terms of our CD offerings and looking back, they're really about the same, if not maybe a couple of basis points lower than where we were when we had this call last quarter..

The next question comes from Austin Nicholas with Stephens..

Most of my questions were already answered.

But maybe if you could give some color on the tax rate and how that changes with layering in the acquisition?.

Sure, Austin, this is Phil. First of all, the impact of the tax rate in this quarter is related exclusively to the implementation of FASB that's related to equity compensation. And we had a lot of restricted shares that ended up being vested at tax in the second quarter, because that's when we issue most of our equity-based compensation.

And so that's kind of a onetime-a-year type of event which reduced the tax rate, I think, down to effective rate of 32 as opposed to 33. For the rest of this year, just on a stand-alone basis, we see it about the same. And I don't think we had anticipated it being much different post-acquisition, maybe a little bit higher, maybe 34.

I think we might have modeled it around 34%, 35%..

[Operator Instructions]. The next question comes from Matt Schultheis with Boenning..

Really quickly if you can remind us, what was the amount of the Federal Home Loan Bank borrowings that you repaid and refinanced, if you will?.

It's $110 million, Matt..

Okay.

And then with regard to market conditions, have you seen any benefit from the disruptions that have happened in your market recently? And additionally, but not necessarily related, have you seen any change in risk-adjusted returns on loan pricing over the last 3 months or so?.

Matt, this is Dan. I think the -- probably, what we've seen mostly in the disruption side, given in our market, obviously the Cardinal-United transaction was most significant as it relates to our space which closed, I think, April 20, if I got my dates correctly.

I think most of the opportunity from there that we've seen thus far is simply our ability to recruit and lend some talent from the former Cardinal franchise and we continue to work on that.

I think there will also be -- and I think we saw in the second quarter as loan production was up, some relationships that came our way from that consolidation as well. But to your -- but I think most of that's still on to come in terms of client relationships.

The second part, I would say there hasn't been anything meaningful happening in the marketplace in terms of the risk-adjusted returns within the lending portfolios. I think things are pretty consistent with what we've seen in the last several quarters and how things are getting priced and how things are getting structured, quite frankly.

I think the market is pretty consistent there..

This concludes our question-and-answer session. I would like to turn the conference back over to Daniel Schrider for any closing remarks..

Okay. Thank you and thanks for joining the call. Thank you for your questions and for participating with us this afternoon. We really would love to receive any feedback you have about the effectiveness of our call and how we've done. You can e-mail your comments to us at IR at sandyspring.com. So that concludes our call.

Thank you again and have a great afternoon..

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