Good day, and welcome to the Sterling Bancorp First Quarter 2018 Earnings Call. [Operator Instructions] Please note this event is being recorded. .

I would now like to turn the conference over to Allyson Pooley with Financial Profiles. Please go ahead. .

Thank you, Brian, and good afternoon, everyone. Thanks for joining us today to discuss Sterling Bancorp's financial results for the first quarter ended March 31, 2018.

Joining us today from Sterling's management team are Gary Judd, Chairman and CEO; Tom Lopp, President, Chief Operating Officer and Chief Financial Officer; and then Michael Montemayor, who will be participating in the Q&A portion, is also with us. Gary and Tom will discuss the first quarter results, and 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 financial condition of Sterling Bancorp that involve 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 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. .

And with that, I'd like to turn the call over to Gary. .

Thank you, Allyson, and good afternoon, everyone, and again, thank you for joining us today. I'm going to begin with a brief overview of our first quarter, and then Tom will continue the discussion in more detail..

We're very pleased with our strong start to 2018. We delivered excellent revenue growth, combined with well controlled expenses. We generated income of $15.7 million or $0.30 per diluted share, a year-over-year increase of 51% and 30%, respectively..

Despite the first quarter being a seasonally slower period for home buying, we continued to see strong demand for our residential mortgage loans, both our advantage loans and our TIC, or tenant in common loans.

We generated $349 million of residential loan production in the first quarter, which is an increase of 67% over the first quarter of last year. .

Total loan production was $408 million in the quarter, which is an increase of 59% compared to the first quarter of 2017. Given the strong loan production, we increased the volume of loans sold to the secondary market as part of our balance sheet management strategy.

Our loan sale program enables us to [ fully ] capitalize on the demand in our markets and the productivity of the loan production platform we've built without putting excessive pressure on our liquidity or net interest margin. .

We worked hard to build the secondary market for our loans, and we believe there is sufficient market capacity to absorb any sales we might choose to make. We will continue to use loan sales to balance our strong loan origination platform with the growth in deposits. Meeting the borrowing needs of our customers and our markets will remain a priority..

We continue to build deeper customer relationships as most of our borrowers also use our depository products. Our total loan portfolio, including loans held for investment and loans held for sale increased by an annualized rate of 11% on a linked-quarter basis, and importantly, was up 39% from the first quarter of 2017.

Had we not sold any loans during the first quarter of 2018, the annualized growth rate would have been in the neighborhood of 30%, which gives you a better sense of loan trends in the quarter..

Moving to the other side of the balance sheet, the cost of deposits increased with the rising short-term interest rates as reflected in our net interest margin.

We've been more than able to mitigate this pressure and still drive strong earnings growth due to the total revenue we generated from our loan production in terms of both interest income and gain on sale. .

The other key element of our earnings growth is our high level of efficiency. Tight expense control and strong productivity are a daily focus of the company. Our efficiency ratio for the first quarter was 33.6%, lower than our 2017 full year average of 35.8%..

Looking ahead, we remained optimistic about 2018. The housing markets remain healthy in the regions where we operate and there continues to be good demand for our loan products. We entered the second quarter with robust loan pipelines.

We're also moving forward with our plans to expand our franchise through de novo branch and loan production office openings. .

Last week, we expanded our presence in Southern California with a new branch in Chino Hills. We now have 5 branches in the L.A. market, an area that represents tremendous opportunity for Sterling Bank.

We also recently opened our second full-service branch in the New York City market and in the near future, we plan to open a branch in the Seattle market and another in Southern California. These branches should be particularly helpful in generating core deposits that will support our planned loan growth..

In summary, based on our first quarter performance and the positive trends we're seeing in many areas, we believe that 2018 will be another year of successfully executing on our strategy of expanding our franchise, creating high-touch customer relationships that result in strong loan production and a high concentration of core deposits.

This, combined with our strong credit culture and very efficient back-office operations, should continue to drive profitable growth and exceptional returns for our shareholders..

With that as an overview, let me turn the call over to Tom to provide additional details on our financial performance for the first quarter.

Tom?.

Thank you, Gary. As I walk through the income statement and balance sheet, I'm going to focus just on those items where some additional discussion is warranted.

As a general comment on the quarter, we were very pleased at the significant loan revenue we generated, the largest components of which were net interest income and gain on sale income, enable us to offset the impact of rising deposit costs. .

One of the key performance metrics that we track internally is certain components of our total revenue as a percentage of average loans. We believe that this measurement provides a more complete picture of all the revenue sources from our loan portfolio, including loans held for investment and the loans that we sell. .

Since we began selling a portion of our residential mortgage loans back in 2014, we have consistently generated net interest income and noninterest income as a percentage of average loans at 5% or better on an annual basis, although there can be some significant variance in this metric from quarter-to-quarter due to timing of loan sales. .

In the first quarter of 2018, our annualized net interest income and noninterest income represented 5.01% of our average loans. The high-level revenue that we generate is one of the key drivers of our superior returns. .

Now looking at the net interest margin. For the first quarter of 2018, our margin was 3.89%, down 8 basis points from the fourth quarter of 2017. The decline was attributable to a 10 basis point increase in the average cost of our interest-bearing deposits and a 5 basis point decrease in the average yield on earning assets.

The environment for deposit gathering remains highly competitive, so we expect that we will continue to see increases in our deposit costs. .

The average yield on our loans was down 7 basis points during the quarter.

This was due to a number of factors, including a lower level of loan recoveries, reversal of interest related to one large loan placed on nonaccrual this quarter, 2 fewer days in the quarter for interest accrual, and we sold some loans with longer resets that had higher yields. .

As I discussed on last quarter's call, approximately 85% of our loans are either tied to one-year LIBOR or the prime [ work ] rate, and we continue to expect that approximately $930 million of the LIBOR-based loans will adjust in 2018.

We are currently seeing between $35 million and $45 million of our LIBOR-based loans repricing on a monthly basis and on average, they are increasing by 30 to 40 basis points. So we expect to see a positive impact on our average loan yields in the upcoming quarters.

In addition, at the beginning of the year, we increased some of our loan offering rates, so that will also contribute to increased loan yields as these new loans close and are funded. However, due to the impact of higher deposit costs, we expect our NIM to slightly decline again during the second quarter. .

Our total noninterest income increased by $3.2 million from the fourth quarter. The increase was driven by a $3.1 million increase and the gain-on-sale of portfolio loans due to the higher amount of residential mortgages we sold in the secondary market during the quarter.

The amount of gain-on-sale income we generate from quarter to quarter will likely vary based on the number of factors, including our loan production levels, our success in gathering deposits and our short-term liquidity needs.

That being said, given our healthy loan pipeline and the higher level of mortgage loans held for sale at the end of the first quarter, we anticipate that gain-on-sale income will increase in the second quarter..

Our total noninterest expense decreased by approximately $400,000 from the prior quarter, as we focus on expense control and the fourth quarter results included $200,000 of expenses related to the initial public offering. We are continuing to add personnel to drive and support our loan, deposit and revenue growth.

We expect that our operating expenses will increase in the coming quarters as we open the new branches and hire additional loan officers and business development professionals. We will also increase our corporate back-office operations team to support our ongoing growth initiatives and deliver on our outstanding service commitments.

However, even with the increase in expenses, we anticipate maintaining our efficiency ratio within our targeted range of the mid to high 30s. But there could be some quarters where it is lower than that depending on our volume of loan sales..

Turning to the balance sheet. Gary already discussed our loan trends, so I will start with our deposits. Our total deposits increased by $46 million from the end of the prior quarter.

We had an increase in retail deposits of approximately $123 million during the quarter, offset in part by a reduction in our balances of brokered CDs of approximately $77 million..

Moving to our asset quality. We continue to experience low delinquencies and generally positive trends in the portfolio.

While our nonperforming assets totaled $8.1 million or 27 basis points of total assets at the end of the quarter, an increase from $3.8 million or 13 basis points of total assets at December 31, the increase was primarily due to one large residential real estate loan in Southern California that became nonperforming while the estate of the deceased borrower is being settled.

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The estate owns multiple properties and is in the process of putting several of them up for sale, including the property supporting the loan it has with us. We received a current appraisal on the property that shows a loan-to-value of approximately 60%, so we believe there is no impairment.

And actually as of today, this account has been brought fully current..

We do not see any meaningful losses in any of our past due loans. We had recoveries and no charge-offs during the quarter. With the lack of charge-offs [ and no ] specific reserve required for the large loan placed on nonaccrual, our provision for loan expense was $641,000 for the quarter.

Our allowance for loan losses was relatively steady at 74 basis points of total loans, up 3 basis points from the end of the prior quarter. This is primarily due to changes in our quarterly model related to past rates and qualitative factors. .

With that, let's open up the call to answer any questions you may have. Operator, we are ready for questions. .

[Operator Instructions] And our first question today comes from Aaron Deer with Sandler O'Neill and Partners. .

Just one question, I guess, prompted by the uptick in the NPLs in the quarter. I believe your average loan size on the residential mortgage is below $500,000 or at least somewhere around there. What -- this obviously is well above that amount.

How many loans do you have on the books? What percentage of loans on the books are -- say, of this size, say, $2 million or larger?.

Aaron, this is Michael Montemayor. While I don't have the exact number, we could follow up with you is a percentage of our overall loans. It's a fairly small number, but obviously, we do [ due ] loans $2 million, $3 million, $4 million. But they are a small percentage of our overall production in terms of the numbers.

We can do a follow-up and get you some specifics. .

Okay.

I mean, obviously, California is pretty a high value real estate market, but I was just curious to know how many are in the larger category?.

And as Tom mentioned, we [ did an occurrent appraisal ] on it and it's listed and appraised for 6.2, the loan balance is 3.7. So about a 60% loan-to-value. So we don't anticipate any loss, and as Tom also mentioned, the account was brought completely current this month.

So we anticipate the estate to continue to maintain the account while they liquidate the asset. .

Okay.

And then relatedly, how much was the interest reversal? And since it's been brought current now before the 10-Q is published, do you expect interest reversal to be reflected in the 10-Q? Or -- and then a recovery in the second quarter? Or how might we expect that to play out?.

Yes, Aaron, this is Tom. I believe that is how it will play out. We reversed approximately $100,000 from that loan. It's been on nonaccrual for a little bit. So we'll pick up more than that likely in the second quarter here. .

Okay. And then, I guess, beyond that, just trying to better understand the pressure, if any other on the loan yields in the quarter.

It sounds like as you get the repricings on the existing portfolio and where new yields are coming up, we should expect some material improvement in the loan yields in the quarters ahead, is that right?.

We expect that, Aaron, both on the production yields, which we've already seen an increase in, as well as the LIBOR-based loans in particular that are scheduled to reprice. Obviously, with LIBOR increasing, that helps us. I will add to that, probably even at least as important.

Q1 of '18 for the full year has the lowest number of dollar amount [ of ] LIBOR loans repricing, and it increases dramatically from quarter to quarter, where Q4 is almost 3x what Q1 was, and it's kind of an even step-up ladder, if you will, for the 4 quarters. .

Okay, that's good color. And then on the deposit side, where are kind of incremental deposits coming on the books at this point? I would guess that the remix of greater retail and away from wholesale indicates that you're getting better pricing on the retail side.

I'm just wondering kind of where those incremental dollar or deposit costs are today?.

Well, in the first quarter, we had -- we were raising money with the 12-month CD, that was at [ 1.75% ]. And ballpark on the money market, because we have different clause based on relationship there, it was probably in the [ 1.20%-ish ] range, [ 1.30% ]. So for Q1, somewhere between [ 1.30% ] and [ 1.75% ]. .

Okay.

And is that -- has that already moved higher yet today? Or did you guys kind of front run the market a little bit there so you get a little bit of relief at this point? Or are you still seeing the pressure?.

We're still seeing the pressure. There is definitely more rate competition out there both on money market and CDs. .

[Operator Instructions] Our next question comes from Anthony Polini with American Capital Partners. .

Great quarter. I love when you make me look bad by beating me by a $0.05. You really did it 2 ways. I guess, the provision is the interesting thing. I'm assuming you as well as me would have liked to have been able to throw a little bit more into that reserve, but you just -- credit quality is just too darn good.

Is it likely that the provision remains at a $1 million or less until we have some substantial deterioration in credit quality? Because you had good loan growth and then and that's -- we're looking for that to continue, but I guess I was hoping you could get a little more bump up in that provision level even though the stellar credit quality played out?.

Yes. No, I think the one key point there, Anthony, is the amount of loans that we had designated as held-for-sale at quarter-end, which don't require any provision there. So due to timing of loan sales and classification of loans as held-for-sale, I think you will see some noise there, if you will.

But overall, we are right in the range that we think is appropriate and we're comfortable with. But -- I'm sorry, but if you look at just consistent loan growth quarter to quarter, that type of thing, I would expect a relative percentage to be applied against those loans from what you've been seeing. .

Okay.

And when we take your guidance about gain-on-sale income going up, I assume that gain-on-sale margins are going to be relatively stable, but your production will increase?.

Yes, we expect production to continue to accelerate as we open new branches, add new staff in all the various markets. And then if you just take a look at what we had scheduled in the loans held-for-sale in the end of the fourth quarter versus what we had at the end of the first quarter, you will see an uptick there.

So as Tom mentioned, we expect that to increase. But hopefully, as we increase the other side of the balance sheet, the liabilities, deposit side, we will, as the year goes on, retain more. .

Yes.

I'm assuming like most people, you don't think the Fed is going to move this week, but will likely move in June, is that how you're planning right now?.

Yes. That's correct. .

Okay.

And just for my own information, how much does a new branch in Chino Hills cost?.

I don't have the figures in front of me, but I think compared to some of the other markets we're in, fairly reasonable if you look at New York or Seattle, which we're also expanding in. .

Yes, one thing just to be clear on, Anthony, is in Chino Hills, it's actually going to be a branch with full-service lending, both residential and commercial and backroom process, there's underwriters, that type of thing. The actual portion of the branch is relatively modest, as most if not all of our branches are.

So the actual branch expense is relatively low. And one thing that we do when we open up new branches and new markets is we lead with loans and get a revenue stream created so that the breakeven period is very, very quick. .

Just one more question, little bit of color on the loan growth.

If we had to pick one or 2 markets that were accelerating in growth and one or 2 that perhaps were flattening out or decelerating in growth, what would you say?.

Well, I would say that we -- I don't see any markets that are decelerating, but certainly the higher potential for loan growth for us have been in the L.A. and New York marketplaces. The Seattle marketplace, I think, is a function of getting that branch in more space and accelerating the hiring efforts up there.

But I think it's an excellent market also. And certainly, San Francisco is a more mature market for us. .

At this time, this will conclude the question-and-answer session. So with that, I'd like to turn the conference back over to Gary Judd for any closing remarks. .

Thank you all again, and we do appreciate you joining us today and we'll look forward to speaking with you next quarter. And then we'll follow up, Aaron, with you with the question you had on loan size. Mike will get that back to you, but thanks a lot for participating. .

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