Good afternoon, and welcome to the Sterling Bancorp Inc. Third Quarter 2019 Earnings Conference Call. My name is Rocco, and I will be your operator today. At this time, all participants are in a listen-only mode.

This call is being recorded and will be available for replay through November 11, 2019, starting this afternoon at approximately one hour after the completion of this call.I would now like to turn the conference over to Mr. Tony Rossi from Financial Profiles. Please go ahead, Mr. Rossi..

Thank you, Rocco, and good afternoon, everyone.

Thanks for joining us today to discuss Sterling Bancorp’s financial results for the third quarter ended September 30, 2019.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 Michael Montemayor, President of Retail and Commercial Banking and Chief Lending Officer, who’ll be participating in the Q&A portion of the call.

Gary and Tom will discuss the third quarter results and then we’ll open up 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 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 Gary Judd.

Gary?.

Thank you, Tony, and good afternoon, everyone, and again, thank you for joining us today. As many of you have seen, I recently announced my retirement, which will be effective November 30. As this will be my last earnings call, I want to take a minute to thank each of you, our covering analysts and also our shareholders for all of your support.

I appreciate your insights, and I’ve enjoyed my interactions with all of you. I wish you great success in your careers and future pursuits.I leave Sterling in the extremely capable hands of Tom Lopp, whom you know very well.

When Tom takes over as CEO and Chairman and joins the Board as a Director on November 30, Steve Huber will be promoted to Chief Financial Officer and Treasurer of Sterling.Tom and Steve are exceptional at what they do and are well deserving of their promotions. I congratulate them for their successes.

Additionally, they have, what in my opinion, is one of the best teams of associates and executives in the community banking sector today. I have been fortunate to work with the entire Sterling team.Now let me begin with a brief overview of our third quarter, and then Tom will continue the discussion in more detail.

Overall, our financial results for the third quarter were in line with our expectations. We continue to generate top quartile returns, as our annualized return on average assets was 1.67% and our annualized return on tangible common equity was 16%.

Our moderately higher EPS for the quarter was driven by higher non-interest income and well managed expenses.Net income for the quarter was $13.9 million, or $0.28 per diluted share, up from $13.4 million, or $0.26 per diluted share in the second quarter.

Our prior quarter results included a $1.2 million valuation allowance taken against our mortgage servicing rights, which impacted our second quarter diluted EPS by approximately $0.02. This quarter, we experienced a much lower valuation allowance at $100,000.

So if you strip out the impact of the MSR, valuation for both quarters, EPS was essentially flat.Our total loans, including both loans held for investment and held for sale declined by $20 million in the second quarter. This was primarily driven by lower production during the third quarter.

Loan production was lower during the quarter, as we maintained our underwriting and pricing discipline in a very competitive lending market.In addition, we are still experiencing some caution among some of our customers with respect to the ongoing trade friction in China and tighter enforcement of currency controls, as well as inventory and general affordability concerns in the housing market, particularly in the Bay Area.Furthermore, our construction and commercial real estate production was relatively flat quarter-over-quarter, as the number of loans are taking longer to close.

That being said, we currently have a strong pipeline of commercial loans and we expect higher overall production in the fourth quarter.In fact, just in October alone, we have either closed or expect to close approximately $45 million in construction and CRE loans.

That number compares to $40 billion of origination of these types of loans in the entire third quarter.On the deposit side, total balances were up $25 million from the prior quarter. The increase for the quarter was primarily attributable to growth in time deposits and noninterest-bearing deposits.

This was partially offset by decreases in money market savings and NOW deposits. Our deposit mix continues to shift as customers rotate out of lower-yielding accounts into CDs.However, we feel that this trend has about run its course and the CDs have reached the tipping point and our CD balances should start to decline.

When our time deposits, retail deposits – within our time deposits, retail deposits increased by $103 million and brokered CDs decreased by $50 million.

The bottom line is that, our core deposits increased during the quarter.During the quarter, net interest margin of 3.7% was negatively impacted by our increased liquidity and lower yields on our loan portfolio, while our cost of interest-bearing liabilities was down slightly.

Tom will get into more detail.As you know, another component of managing our balance sheet liquidity is loan sales. During the quarter, we sold $76 million of residential loans, including agency loans.

Institutional demand in the secondary market for our loans remains healthy, reflecting the high quality of the loans we originate and allowing us to realize continued attractive premiums for the loans we sell.While we continue to opportunistically utilize loans held to diversify our revenue going forward, we may significantly reduce these sales in the fourth quarter and retain the majority of our new loan production on our balance sheet.

Loan sales will remain a tool for us going forward to help balance our loan growth with our core deposit gathering and to provide a supplemental source of revenue, enhancing the composition of our earnings stream.Finally, productivity levels remain high, as our non-interest expenses were essentially flat quarter-over-quarter after taking into account the lower FDIC assessments we benefited from in the third quarter.

Focused expense control and strong productivity are always a priority for us. We remain optimistic in our outlook as we end the year.

We are focused on converting our healthy loan pipeline into closed loans, while maintaining solid credit quality and reducing deposit costs.During the fourth quarter, we expect to resume our loan growth and achieve NIM stability, which should translate into continued strong 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 third quarter.

Tom?.

Thank you, Gary. Before I get into the results, I’d like to say a word about Gary. It’s been an honor to work with Gary for the past 11-plus years and to benefit from his extensive banking experience.

He has been a source of great guidance and mentorship, and I want to thank him and wish him well in his retirement.I’m equally honored to be chosen by the Board of Sterling’s next CEO and Chairman and will work hard to build on Gary’s legacy.

I’m excited to take the helm of this great company, and I’m deeply committed to carrying forward our bank’s pattern of growth and expansion, while safeguarding the trust and confidence of our customers and shareholders.In addition, I want to congratulate and welcome Steve Huber in his newly expanded roles.

Steve has been an outstanding CFO for our bank and is the obvious choice to assume the additional roles of CFO and Treasurer for Sterling. We appreciate his contribution since joining Sterling 24 years ago, and we look forward to many more to come.Now turning to the results for the quarter.

As I review our financial results, I will focus just on those items, where some additional discussion is warranted. I’ll start with net interest margin.Our NIM for the third quarter was 3.7%, down 14 basis points from the second quarter.

The decrease was primarily the result of a 15 basis point decline in the average yield on earning assets, partially offset by a 2 basis point decrease in the cost of average interest-bearing liabilities.

The decline in average yield was driven by three main factors.First, our average yield on loans in the second quarter benefited from elevated loan fees, mainly driven by higher prepayment fees.

We did not experience the same magnitude of fees in the third quarter, which had an approximate 4 basis point negative impact on the average loan yields.Second, we were carrying increased liquidity during the quarter, which drove up the percentage of lower yielding other interest earning assets relative to the total average interest earning assets.

This had the effect of reducing our yield on total interest earning assets by approximately 6 basis points.Third, we experienced headwinds on our loan yields, excluding the impact of fees in the amount of 2 basis points.

The recent decline in rates drove lower resets on our prime-based loans and the benefit that we had been experiencing on mainly LIBOR-based mortgage loans.

These loans that repriced at higher rates have decreased given the drop in LIBOR.During the quarter, approximately $132 million of LIBOR-based mortgage loans repriced at an average of 80 basis points higher, whereas that differential was a positive 126 basis points in the second quarter.As of September 30, we have approximately $1.1 billion in LIBOR-based loans that will reprice over the next two years.

LIBOR declined by approximately 15 basis points in the third quarter and 98 basis points for the first nine months of the year.

We expect the prior to payoff, approximately $175 million of LIBOR-based loans will reprice in the fourth quarter at a weighted average rate that is approximately 5 basis points lower.In addition, we have approximately $108 million of prime-based commercial, construction and home equity loans that will reprice if the Fed cuts raised by 25 basis points as expected this week.

This represents approximately 49% of our total prime-based loans, as the remaining 51% are currently at the floor rates.If rates were to drop by an additional 25 basis points then $59 million more in loans would reprice, resulting in 73% of the total prime-based portfolio being subject to floor rates.

Although we continue to see aggressive loan pricing among some competitors, we have been able to keep the pricing on our new production of residential loans relatively stable.That being said, we are putting new loans on the balance sheet at rates that are lower than the current average loan yield, therefore, putting pressure on our average loan yields going forward.

The decrease we saw on average interest earning assets during the third quarter was partially offset by a 2 basis point decrease in our average cost of interest-bearing liabilities, which was a function of both rates and mix.Our deposit costs were flat quarter-over-quarter, as our money market savings and NOW accounts declined by 11 basis points, but the shift in mix to time deposits, combined with a 2 basis point increase in those costs, essentially offset the benefit of lower rates on our non-maturity deposits.However, as Gary mentioned, we feel that our CD balances should start to decline, positively impacting the mix going forward.

Despite declining rates, we are still attracting new retail deposits and we remain mindful of our deposit pricing, as we don’t want to lose momentum on our deposit gathering activities, which will enable us to fund our loan growth when it resumes.We also believe that the absolute level of our cost of funds relative to our competition gives us more flexibility with our deposit pricing going forward.

So while the environment for deposit gathering remains competitive, we do expect to see some benefit from lower interest rates in the fourth quarter.

Overall, with respect to our loans and deposits, we will remain diligent in managing the variables that we have control over.All things considered, we would expect NIM to stabilize in the fourth quarter. Our total non-interest income increased $1.1 million from the second quarter to $3.2 million.

The increase was primarily attributable to a lower mortgage servicing rights valuation allowance taking this quarter as compared to the prior quarter, as Gary mentioned.Our gain on loans held was slightly lower due to a different mix of mortgages that were sold.

The amount of gain on sale income we generate from quarter-to-quarter will vary based on a number of factors, including our loan production levels, our success in gathering deposits and our short-term liquidity needs.Our total non-interest expense decreased $0.3 million in the second quarter to $13.4 million, due mainly to lower FDIC assessments, advertising and marketing expenses, data processing and other expenses, partially offset by higher salaries and employee benefits and professional fees, a portion of which were related to increased regulatory compliance initiatives.We’ve added personnel to drive and support our loan, deposit and revenue growth and to increase our corporate back-office operations team to support that growth.

We expect that our operating expenses will increase in the coming quarters, as we hire additional loan officers and business development professionals and corporate back-office support.

In addition, we expect to incur increased regulatory compliance costs, both ongoing and one-time in nature in order to comply with our recent agreement with the OCC.Moving to our asset quality. During the third quarter, we again experienced net recoveries and positive credit metrics in the portfolio.

Non-performing assets were essentially flat quarter-over-quarter and represent 37 basis points of total assets.

We did see an increase in non-performing loans of $3.3 million due to one $3.5 million construction loan that was placed on non-accrual during the quarter.We don’t believe that there is any impairment on this loan, and there is more than sufficient collateral value supporting that.

We do not see any meaningful losses in any of our past due loans or rated credits. We had recoveries of $35,000 and no charge-offs during the quarter and our provision for loan losses was $251,000.

Our allowance for loan losses was relatively steady at 72 basis points of total loans at September 30, up 1 basis point from the end of the second quarter.Finally, we remained active in buying back our shares, both during the third quarter and year-to-date.

During the quarter, we repurchased approximately 0.4 million shares at an average price of $9.89 per share. And year-to-date, we have repurchased 2.7 million shares at an average price of $9.64 per share.If our shares continue to trade at a significant discount to fair value, it is likely that we will remain active on this front.

Our share repurchases demonstrate that we remain confident in the long-term prospects for our business and our commitment to creating shareholder value.With that, let’s open up the call to answer any questions you may have. Operator, we’re ready for questions..

Thank you. We will now begin the question-and-answer session. [Operator Instructions]Today’s first question comes from Aaron Deer of Sandler O’Neill & Partners. Please go ahead..

Hi, good afternoon, everyone..

Hi, Aaron..

First, I want to wish, Gary, congratulations on your pending retirement here. And Tom, congratulations on your new role..

Thank you, Aaron..

Thanks, Aaron..

The – and then I’d like to start on the origination volumes, because it seems like they’ve continued to come down and I know you highlighted the inventory and affordability concerns.

But it’s just – it’s really surprising that I’m seeing a number of other banks that kind of traffic in your same space that seemed to be where their volumes seem to be holding up okay. And so I’m just wondering, you mentioned in the press release that it’s partly related to competition.

If that’s really the driver here, what types of things you see in the competition doing that you guys are unwilling to do, or are there other factors that I’m just not getting?.

Aaron, this is Michael Montemayor. I would say that, some of the competition has offered longer-term fixed rates on some of the products that we hadn’t. We are looking at some of those currently and evaluating whether that’s right for us. But they’ve gone out longer on the maturity and that maybe we weren’t competing with..

Okay. And then I guess, with the decision to start retaining more of your production, I mean, you’re obviously, leaving yourself a lot of flexibility in it in terms of your balance sheet management and I’m sure what the secondary market is offering.

But is – I had at least anticipated the outlook for your earnings, that was a fairly good sized contributor heading into next year, like north of 10% of my EPS number? So just trying to understand, if you are retaining that, obviously, that’s going to weigh on the near-term earnings, but will help build the balance sheet faster.So what is – what are your kind of prospectively looking for in terms of overall balance sheet growth next year? Obviously, it seems like if you’re retaining more, we should do a lot better than what we saw in 2019, or at least year-to-date.

And I mean, can we get back closer to some of the historical growth stories that you had or somewhere in-between, or what are your thoughts on that front?.

Hi, Aaron, I think it’s probably somewhere in-between, I think, it is really driven by our ability to grow our originations. But obviously, we look at amount of liquidity we’re currently holding, the mix in terms of maturity that we’re holding when we come up to these decisions.

So we thought it would just be prudent, given our current liquidity, our origination volumes, but we’re doing a lot of different things to return to a higher growth rate than we’ve seen in the past quarter or two..

Okay. And then on the margin, I guess, with – that three months ago when we spoke, I think you had guided towards moderate margin pressure for the third quarter, it seems like maybe it was a little more – a little worse than that. But now, you’re talking about stabilization here in the fourth quarter.

Can you give us some more color behind what’s supporting your expectation of stabilization? Have you really started to see your deposit rates come down in a material way, that’s going to give you some relief on that front?.

Absolutely. Aaron, this is Tom. In the third quarter, we’ve decreased our CD rates five times and our money market rates, or at least a portion of our money market rates three times. I can share with you that our September NIM was higher than the two, three average. So we’re very encouraged by that.

And we honestly think that if the rates cut or the Fed cuts rates here, we will likely cut deposit rates again and make some further progress..

Okay, that’s encouraging. Okay, I’ve got a few other questions. Well, I’ll get back in queue. Thank you..

Our next question today comes from Matthew Clark of Piper Jaffray. Please go ahead..

Hey, good afternoon and congrats to you Gary, Tom and Steve..

Thanks, Matt..

Thanks, Matt..

Do you happen to have the spot rate on interest-bearing deposit costs at the end of September, or maybe even in the month of September either one?.

We cannot dig that up for you here as we’re going through..

Okay..

Any other questions, Matt?.

Sure. Yes.

And then just on the new production this quarter, if you can give us a sense for the weighted average rate on those new loans?.

For the third quarter – Matt, this is Michael. They were down 15 basis points from the second quarter down 15 basis points..

Down 15 basis – sorry, it’s hard to hear you, down 15?.

That’s right. Yes, they were down to 498 in Q3, that was down to 7 basis points from Q2 of 513..

Okay, great. Thank you..

And Matt, to your earlier question, we have a spot rate of 1.76 interest-bearing deposits..

Was that at the end of September, or was that at the month of September?.

That’s the end of September..

Okay. Thank you.

And then just on the excess liquidity that you’ve accumulated this quarter, I guess, what are your thoughts in terms of redeploying those proceeds in terms of the timing and as we now go into more of this the balance sheet growth – retaining more loans?.

Yes. I think with further rate cuts on the deposit side, that’s one thing we’re going to do with the excess liquidity, as well as different thought on loan sales as we alluded to, that is a factor. We also – and that kind of goes to Aaron’s question as well. We have a pretty significant number of CDs coming up for maturity in November.

So we have the opportunity to let some of that higher cost funding move on and right-size of the cash..

Okay. And then just on the buyback a little slower this quarter.

Just thoughts behind that and whether or not you might be able to finish the authorization by the end of the year?.

Yes. I don’t think we’ll finish by the end of the year, Matt. I think we’re just over halfway of what we’ve been authorized. And as you acknowledge it, it’s slowdown. I don’t think we’ll get through there by the end of the year..

Okay. Thank you..

And our next question today comes from Anthony Polini of American Capital Partners. Please go ahead..

Hey guys, congratulations..

Thank you..

I just had a couple of questions.

As far as the balance sheet growth and perhaps lower gains going forward, is this something that is kind of definitive like don’t model any gains for next quarter, or is this something that you expect to – it’s a process that you’re starting now? And we’ll see outlook for next year lower gains, more growth – more balance sheet growth, but it doesn’t mean zero gains?.

I think the latter, Anthony. We’re in the middle of looking at what to do here in Q4. There’s a lean towards not selling much, maybe not selling any that’s not definitive yet. And that’s really the thought for Q4 to be revisited for 2020, again, with the bigger picture thought of, as we’ve always guided, slightly weaning off over time.

So we’ll revisit it for Q1 2020 with potentially a completely different look and try to communicate as accurately as we can what our plan and thought process is..

Okay. And I realized 2020 is way out there. But if we look at what’s happening to the margin so far this quarter, and let’s say, we get two more 25 basis point cuts on the Fed and the yield curve steepens a little bit over the next few weeks.

How does that bode for the margin in 2020?.

Yes. I think that we’re neutrally positioned pretty well. I think with what you’re describing, we probably fair pretty well. I’d be optimistic that we can make some headway on the margin with where we’re at on our deposit pricing, in particular, relative to competition.

The biggest unknown factor would be the one year LIBOR and the repricing impact on our loans..

Okay. Now when I look at overall expense growth this year, it’s going to be something like 7%, 7.5%, obviously, much lower than previous years when balance sheet growth was much greater. You have a little bit of regulatory issues here that you’re working through.

What expansion plans do you have for 2020? And is that 7% growth rate at this stage a good ballpark for next year?.

I believe it is. I think that’s fair. And if you’ve nailed nailed the two issues, the growth has slowed somewhat, the expenses do reflect that, as well as some incremental costs for regulatory compliance. But I think 7.5% is a fair estimate. And every quarter, we will try to guide best we can at least a quarter out..

Okay, great. Thank you, guys..

Thank you..

[Operator Instructions] Today’s next question comes from Andrew Tucker of Jennison Associates. Please go ahead..

Yes. Good afternoon, guys. Thanks for taking the question. I guess, just two questions. First, just quickly, if you give us more granularity on the one apartment loan just in terms of whatever metrics you can disclose about LTV or guarantor just give you the comfort that there’s no los content.

They’re just given the overall size of it?And then secondly, if you could talk about in the same vein as some of the other questions on balance sheet growth and sales and like, your – if you could talk about your efforts to diversify your origination platform, I know, you have a – and obviously, the – you have a great franchise in the Chinese American and Chinese national borrower, but we don’t know how long that’s going to take to resolve the issues today.

And I know you’ve been building other platforms and you have other – even have other web portals and other languages. So if you could just talk about your efforts to diversify on the origination side as well? Thank you..

This is Michael Montemayor. Thanks for the question. I would start with the one problem loan, it’s actually a single-family residence in San Francisco. We’ve had it recently appraised, so we’ve looked at it consistently over time.

We’ve decided to move on from the relationship due to the time that has taken this developer to move the asset through its progression to completion.

We feel very confident that based on a number of different factors, including, like I said, the appraisal that there’s a significant amount of equity in the project.And while things can be delayed, we do anticipate potential resolution with that in the coming months, potentially by quarter-end.

But there are various things that could happen that could delay that, so I don’t want to get ahead of myself with it. But we believe that there’s opportunities for this developer to move the relationship out of the bank and for him to continue with this project elsewhere.

So that’s what gives us the confidence that we don’t have any pending loss on that large project in the very high-end area, San Francisco.As for loan diversification and product diversification, we’ve been working very diligently on onboarding new staff over the course of the year for our commercial originations, multi-family development loans and C&I.

We’ve been able to really expand our pipeline for originations in that regard. The pipeline currently is as high as we’ve ever seen it. We do have a new hire that was on Board just this quarter, that’s going to continue to expand our staff.

And that allows us to upload that side of the balance sheet – part of the balance sheet.On the residential side, we’ve expanded our origination staff to include some ethnic Spanish Indian and Korean speaking to target different market segments.

As you mentioned, we even have a website, a landing page that’s dedicated to Spanish-speaking individuals.So we’re hopeful that, that expansion within some of the products and the expansion of some of our TIC lending down to the LA market starting to get – gather some momentum over the last quarter or so to increase our volumes and pipelines in those regard.

So it’s a continued effort on all of those fronts. And we’re starting – we’re beginning to see some progress on several of those fronts..

Great. Okay, guys. Thanks..

Thank you..

And our next question is a follow-up from Aaron Deer with Sandler O’Neill & Partners. Please go ahead..

Hi, thanks, guys. Actually to Andrew’s question. I kind of wonder one of the areas that I was curious about, in particular, the TIC, so thank you for addressing that. And then one other just kind of cleanup thing, the FDIC credit in the third quarter, I’m guessing, it was right around $200,000.

But can you give us the exact dollar amount on that, so we can just for modeling purposes?.

$240,000..

Okay.

And the remaining credit on that, I’m guessing, it’s probably going to last, at least at some point into the – to the New Year?.

Yes, we believe two more..

Okay. Good stuff. Thanks, guys..

On our Q4 and Q1 of 2020..

Terrific. Thank you..

And ladies and gentlemen, this concludes your question-and-answer session. I’d like to turn the conference back over to the management team for any final remarks..

Thank you very much, everyone, again for joining us today. We do appreciate the time and appreciate the opportunity to talk with you. And again, from my personal standpoint, a sincere thank you for all of your support and guidance and insights that I’ve experienced over the last several years. So thank you, and that will finish the call..

Thank you, sir. Today’s conference has now concluded, and we thank you all for attending today’s presentation. You may now disconnect your lines, and have a wonderful day..