Q1 2023 Sterling Bancorp Inc Earnings Call

Participants

Karen Zaborney Knott; Executive VP, CFO & Treasurer; Sterling Bancorp, Inc. (Southfield, MI)

Thomas M. O'Brien; Chairman, President & CEO; Sterling Bancorp, Inc. (Southfield, MI)

Benjamin Tyson Gerlinger; MD; Hovde Group, LLC, Research Division

Ross Haberman; Principal; RLH Investments, LLC

Presentation

Operator

Good morning, everyone, and thank you for joining us today to discuss Sterling Bancorp's Financial Results for the First Quarter Ended March 31, 2023. Joining us today from Sterling's management team are Tom O'Brien, Chairman, CEO and President; and Karen Knott, Chief Financial Officer and Treasurer. Tom will discuss the first 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 future performance and financial condition of Sterling Bancorp that involve risks and uncertainties. Various factors could cause actual results to materially -- 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.
At this time, I'd like to turn the floor over to Tom O'Brien.

Thomas M. O'Brien

Great. Thank you. Good morning, everyone. I am in San Francisco this week, so it's 8 AM here. And I'm in our office on corner of Montgomery in California.
So I guess, first, I'll start off and say what the First Republic Resolution. It's been another momentous weekend for bankers and investors and government agencies. I would say, there is a meaningful cause for concern here, which I think we'd all like to see addressed more proactively by bankers, especially, risk managers, regulatory supervisory teams and I'd also say the fundamental construct of the FDIC. Just these 3 failures basically in the last 4 weeks have caused the deposit insurance fund between 40 and $50 billion.
The way we are going, it looks more like the early 1800s with the first and second bank in the United States. And that concentrates power, resources, basic economic control in very, very few hands. So I'd argue, it's just not good for -- certainly not good for banking in general, and ultimately, not good for consumers. So let's hope that some saner heads prevail here and control both the risk-taking and banks that may look like these 3 and also the regulatory process becomes much more forward-looking instead of backward-looking. So that's my soapbox comment, but I do feel it's fundamentally impacting the future of what has always been the envy of the global banking system, and that is the system in the U.S.
So with that, more specifically at Sterling, kind of go through a few high points. I'm going to ask Karen to give us a little better detail on CECL. But anyhow, so the basically kind of a breakeven quarter again, a little bit of growth in tangible book value mostly from some improvement in the mark-to-market on the held-for-sale securities. Margin had a little bit of compression. A fair part of the margin is occupied by the cost of our sub-debt. And I think at the beginning of the year, I set out basically 3 objectives to do in the order in which I could do them, and they were basically to settle with the DOJ, which we've done.
Once that was done, I was allowed to address the longer term delinquent -- seriously delinquent advantage loans, and we are doing that now. And then the next thing I have to tackle is the sub-debt. It's very expensive, and probably, Karen can correct me, but something like 12 basis points on our margin at current rates. And obviously, rates go up another 25, 1x or 2x, that will continue to impact us.
Expense is still relatively high, not unexpected at the settlement process in the legal space, but the DOJ was time-consuming and expensive. Nonetheless, our goal of protecting book value was -- remains in place. We haven't financed much of this through capital, which was always certainly my goal. Our leverage ratio remains very strong by any calculation. Deposits just under $2 billion. And as we note in the press release, there was at the time of the first 2 collapses, we had a little bit of repositioning accounts mostly in and around the deposit insurance level and we also had some accounts come into the bank. But as of just the other day, I think we're $25-or-so million ahead of where we were the day before the collapse of Silicon Valley.
We keep all of our debt securities in available-for-sale. I've never used held-to-maturity, I don't like it, and the too much camouflage I think from a transparency perspective. And then almost simultaneously with the conclusion of the DOJ settlement, we started looking at the sale process for the non-accrual and seriously delinquent residential loans. So we hired a independent advisor and got several bids and very competitive process, which was nice to see. And I think we should have that sale concluded hopefully late May.
And then, as you all know, of course, we had the DOJ settlement, which is -- it has to go through the court system to get approved and I think that will probably be done in mid July. But the elements are all there and the court has to approve it, which we expect shouldn't present any obstacles. So we've continued to do the job of fixing the bank. And I think we've virtually accomplished 95% of what was the original goal when I started with the bank and we developed all the action plans and remedial plans for the fixing of what at that time was a big issue.
I can also say, one of the biggest concerns I had when I joined the bank was liquidity. Given the loans that were sold previously to outside investors and the risk with that, the reliance on broker deposits and home loan bank advances and things like that were in the hundreds of millions. But I think addressing that the way we did turned out to be good and what turned out to be a liquidity important period right here and now. I can't say I or any of us basically anticipated that, but it does validate the concerns that we and management had at that time in mid-2020 about the illiquid nature and the high loan to deposit ratio in the institution.
So that's kind of my thought on where things are. I think we're going to see more regulation obviously. But as I said earlier, I just hope it's well thought out and that we don't keep coming up with solutions to address yesterday's problems. I mean, they just have to be more forward-looking and understand the market that exists today and the ability of all of us basically to move our money around the click on our phone. And the lines of the 1930s can't be the model for solving bank issues today. I mean, you're always going to have banks to get in trouble like any other business. And whether it's a local economy or bad management, things will happen, but it shouldn't be so unsettled period and really should pass without the kind of crisis we've had since early March.
So I'm going to ask Karen to spend a minute or two on CECL. And of course, during the Q&A, we can -- or she can answer any questions on that. So Karen, if you don't mind?

Karen Zaborney Knott

Sure. So as required, we adopted CECL on January 1. There was $0.5 million increase to retained earnings as a result of that adoption, and that was primarily driven by the short-term nature of our construction portfolio. So you reserve for that until maturity. All of our construction portfolio is slated to mature in 2023. And so we were, based on this logic, a little bit over-reserved in that area. Some of that was allocated to our residential and commercial real estate portfolios, which did increase with the adoption due to the longer term nature of those portfolios.
We also established a small reserve for unfunded commitments as required by the guidance. When we move that forward through the first quarter then, we did see our overall allowance decline primarily as a result of the transfer of the residential delinquent and non-accrual loans to held-for-sale. We took that charge-off and reduced the allowance for the residential portfolio. But we did see an increase in commercial real estate, and that's primarily a result of economic forecast around the commercial real estate book and not what you're not seeing in the industry in general, some concerns there. And so we did take more of a provision in that portfolio.

Thomas M. O'Brien

Okay. Thank you. Operator, we can take some questions now.

Question and Answer Session

Operator

(Operator Instructions) Our first question today comes from Ben Gerlinger from Hovde Group.

Benjamin Tyson Gerlinger

I just got somewhat random, so I'll just jump around a little bit. So for the $41 million, it seems like it took a pretty decent haircut on price and the assumption there. I was curious, what is the yield on those?

Thomas M. O'Brien

I'd be guessing a little bit, but I would say, mid-5s. Karen, does that sound fair?

Karen Zaborney Knott

Yeah, I would say that's fair. A lot of that -- those loans are in non-accruals. So we're not booking anything on our income statement for the bulk of that. But 5.5 is about -- is reasonable.

Benjamin Tyson Gerlinger

Assumption based on the likelihood and then also from there.

Thomas M. O'Brien

Yes. The investor yield, I would -- if you do it at kind of a lower mid-80s pricing probably comes up to 11.

Benjamin Tyson Gerlinger

And then from there, had some noise and some back-dated noise within the income statement's expenses like the resolution. I know Tom you said that you should see the court approval in approximately in July. Any thoughts on kind of the 2Q? And then does it fall precipitously post-court or can we see kind of a ramp down, 2Q getting to 3Q? I assume 3Q is probably the most normalized as one could be. And then any thoughts on like when that could see the floor?

Thomas M. O'Brien

Yeah, I think -- I mean, just kind of subtracting these things that we've had to address one by one, the settlement process in this quarter back and forth with DOJ was just time-consuming and expensive. That will drop off to some extent in this quarter because we had a court appearance a couple of weeks ago. And then the next one, as I mentioned, is in mid-July. And after that, there will be a process for us to distribute the funds to the non-insider victim investors. But anyhow, those costs should step down I think in the second quarter.
We did get in -- the current quarter, we got some insurance recovery on expenses that we had previously. Those are hard to predict. I mean, all of the negotiations with the insurance companies are, I'll just say, they're protracted. I mean, there's awful lot of detail that has to go with it, a lot of negotiations. Obviously, they have lawyers. We have lawyers. There are still some claims we have pending, but it's very hard to predict when they're going to be realized. But I would say, you're right on the third quarter, we should start to see some significant benefit on that. And hopefully, in the fourth quarter, we're down to minor fractions of what we've had to experience at least in my tenure here.
To say it's been expensive is probably the biggest understatement in the world these days. But it was -- I think -- I guess, I'd argue, given the seriousness of the issues and the long-running nature of it and obviously the involvement of very senior people in the institution, I'd say, money well spent in a solution that was quite appropriate for the circumstances.

Benjamin Tyson Gerlinger

And then the last one. I think you explained it back there now. But the last one would be just CECL relative to the balance sheet. It seems like you guys are cleaning up more and the balance sheet is getting smaller. Any kind of targeted reserve level or should we expect more recapture?

Thomas M. O'Brien

With CECL, a little hard to say. As Karen said, it's really focused on the maturity date. And obviously, most of what we do with the portfolio that remains on the books is getting shorter and shorter. So we're basically around just under 2.5% now. By any standard, I know that's -- I mean, I can't talk about releases, but I would say that's very robust. So I'm not overly concerned about the coverage with this loan sale -- well, I should say, in the quarter, once again, we had -- on the commercial side, we had zero delinquencies, zero past due maturity.
I mean, it's -- I would say, that's the last -- I think, 5 or 6 months, it has been as good as any I've ever seen. And the residential was always hung up by that group that we marked down this quarter, but I couldn't sell them until we resolved with the DOJ. So that takes care of virtually everything we have at March 31 and there will certainly be migration at sometimes in the future. And to delinquency in non-accrual, there's a certain inevitability to that. But at that point, it becomes kind of one by one, not a big bucket.
So a long way of saying, I'm certainly comfortable with the level of the reserve. I think it validates the approach that we took back in, I guess, November, December of 2020, looking at the risk profile at that time. And I don't -- I guess, I can say, I don't envision any more additions unless and until we got into significant originations, which is hard to forecast that right now.

Benjamin Tyson Gerlinger

And then lastly, now that we're done with -- or maybe you have to wait till July, but it seems like we're done with everything from a legal perspective. Is there any appetite for doing something on the capital base, whether it be share repurchases or addressing the sub-debt or anything to that end?

Thomas M. O'Brien

Well, as I mentioned, the next and last issue I have from a financial statement perspective is a sub-debt. It's -- I mean, it sticks out obviously by cost and there's a little, if any, value to it. On a capital perspective, we have plenty of liquidity. So -- that is the third of 3 items that I wanted to address this year. I think all of us in management and the board and all of our investors kind of understand the drag that that provides. So that does lead you, Ben, to the idea that we can get that done, the next coupon date is in mid-July. So the calls are on coupon dates, so to be July 15, October 15, et cetera. So the sooner we can get that done, the less expense we'll have to deal with, that's a holding company expense obviously and the -- again, the cleaner the balance sheet.

Benjamin Tyson Gerlinger

We don't have to throw out the needle with like what happens within the courts. Like, we could theoretically do it in the next call date, right?

Thomas M. O'Brien

We have the liquidity. There's some regulatory process we have to go through and all of that. So yeah, but in theory, sure.

Operator

(Operator Instructions) And we do have an additional question from Ross Haberman from RLH Investments.

Ross Haberman

Did we bottomed out with the margin here or if they raise rates another this week and maybe one time over the summer that will continue to put pressure on the margin like [they're doing] for most banks?

Thomas M. O'Brien

Well, it's a little hard to predict because -- I mean, you probably look at the same banks I do when the each quarter end. So I mean, you saw margin compression almost everywhere. Some was relatively minor like ours and then you had some that were 80 and 90 basis points. It's hard to predict. But I think when you -- if we take in the conversation we had on the sub-debt and we look at the asset repricing and the liquidity that we have, I think we have a reasonably good amount of protection on higher rates and there's always a little bit of margin between the rate that we pay our customers and the rate we're earning. So I'd be hard-pressed to predict a bottom, but I think we're okay within a handful of basis points one way or the other.

Ross Haberman

And with that -- with the sub-debt, I guess, there's no active secondary market with that stuff, as you said, it's just on each coupon date. You have the option of buying it back or how does that...

Thomas M. O'Brien

Yes, it's callable.

Ross Haberman

It's callable. Okay. And you can call 100% of it or just a portion of it?

Thomas M. O'Brien

My understanding is we can call some or all of it.

Ross Haberman

At par?

Thomas M. O'Brien

Yes.

Ross Haberman

Okay. Let's see how amenable the holders are, I guess.

Thomas M. O'Brien

Well, if we thought if they don't a choice of course, but the...

Ross Haberman

You're right. You're right.

Thomas M. O'Brien

There was a -- it certainly does not trade much, but I'm aware of one trade several months ago that if it wasn't par, it was like 99, 98, I mean.

Ross Haberman

And you're saying that clearly would be a help to the margin?

Thomas M. O'Brien

Yeah. If the current coupon is over 11%, that would be a great help.

Operator

And ladies and gentlemen, with that and showing no additional questions, I'd like to turn the floor back over to the management team for any closing comments.

Thomas M. O'Brien

Okay. Thank you. I appreciate all of you being on the call today. It's always certainly good for us to have the opportunity to explain things to those who have an interest in our stock and watch the progress as we go along. As many times as I've done this in my career, it's always a challenge looking forward. But there does get to be a time in the process where you can look back and take a lot of comfort and satisfaction from the team you've assembled and the successes we've had as a group in dealing with what was a very nasty situation and I think successfully. So we enjoy it. We enjoy the opportunity to talk about it. And we will all look forward to the second quarter call in July. So thanks very much.

Operator

And ladies and gentlemen, with that, we'll conclude today's conference call and presentation. We thank you for joining. You may now disconnect your lines.