Q2 2023 Sandy Spring Bancorp Inc Earnings Call
Participants
Aaron Michael Kaslow; Chief Administrative Officer, Executive VP & General Counsel; Sandy Spring Bancorp, Inc.
Daniel J. Schrider; Chairman, President & CEO; Sandy Spring Bancorp, Inc.
Philip J. Mantua; Executive VP & CFO; Sandy Spring Bancorp, Inc.
Casey Cassiday Orr Whitman; MD & Senior Research Analyst; Piper Sandler & Co., Research Division
Catherine Fitzhugh Summerson Mealor; MD & SVP; Keefe, Bruyette, & Woods, Inc., Research Division
Manuel Antonio Navas; VP & Research Analyst; D.A. Davidson & Co., Research Division
Russell Elliott Teasdale Gunther; MD & Analyst; Stephens Inc., Research Division
Presentation
Operator
Hello, and welcome to the Sandy Spring Bancorp, Inc. Second Quarter 2023 Earnings Conference Call and Webcast. My name is Alex. I'll be coordinating the call today. (Operator Instructions)
I'll now hand it over to your host, President and CEO, Daniel Schrider, to begin. Please go ahead.
Daniel J. Schrider
Thank you. Good afternoon, everyone. Thank you for joining our call to discuss Sandy Spring Bancorp's performance for the second quarter of 2023. This is Dan Schrider speaking, and I'm joined here by my colleagues Phil Mantua, our Chief Financial Officer; and Aaron Kaslow, General Counsel and Chief Administrative Officer. Our today's call is open to all investors, analysts and the media and there is a live webcast of the call, and a replay will be available on our website later today.
Before we get started covering highlights from the quarter and taking your questions, I'll ask Aaron to give the customary safe harbor statement.
Aaron Michael Kaslow
Thank you, Dan. Good afternoon, everyone. 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 expected credit 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, 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.
Daniel J. Schrider
Thank you, Aaron. As we noted in our press release, we remain focused on growing core funding and expanding our client base. After experiencing deposit runoff earlier in the quarter, deposits stabilized and we're beginning to see some growth in certain deposit categories predominantly savings and time deposit products. We look forward to capitalizing on the momentum we've achieved to continue to deepen these relationships and onboard these clients to become their primary bank.
We remain confident in our personalized approach, the ease of doing business through our recently introduced digital channel and the value we bring to our clients and community. And we'll continue to aggressively pursue new ways to expand our reach in the Greater Washington region as we have for the past 155 years.
Today, we reported net income of $24.7 million or $0.55 per diluted common share for the quarter ended June 30, compared to net income of $51.3 million or $1.14 per diluted common share for the first quarter of 2023 and $54.8 million or $1.21 per diluted common share for the second quarter of last year.
Current quarter core earnings were $27.1 million or $0.60 per diluted common share compared to $52.3 million or $1.16 per diluted common share for the previous quarter and $44.2 million or $0.98 per diluted common share for the quarter ended June 30, 2022. The decline in net income and core earnings compared to the linked quarter was driven by lower net interest income, coupled with higher provision for credit losses and noninterest expense. To that end, the provision for credit losses for the current quarter was $5.1 million compared to a credit of $21.5 million for the first quarter of 2023 and a provision of $3 million for the second quarter of 2022.
This quarter's provision was primarily the result of an individual reserve established on one large commercial real estate relationship along with several charge-offs of non-accrual consumer loans. The individual reserve is related to multifamily construction loan that is converted to its lease-up phase. And in this case, the units have been slower to achieve targeted occupancy, therefore, creating some cash flow challenges for the borrower who is fully cooperating with the bank as we work through this. Given the slow lease-up phase and competitive market, our assessment is that was prudent to establish an individual reserve at this time while we continue to work with our borrower. But our review of the broader multifamily portfolio does not indicate any similar trends within other relationships.
Taking a look at the balance sheet. Total assets remained stable at $14 billion compared to $14.1 billion at March 31. Total loans also remained stable at $11.4 billion at June 30 compared to March 31. Total commercial real estate and business loans were level quarter-over-quarter, while residential mortgage loans grew 4% due to construction loans moving into the permanent residential portfolio.
Commercial loan production in the second quarter totaled $313 million, yielding $160 million in funded production. This compares to commercial loan production of $423 million yielding $156 million in funded production for the first quarter of the year. Over the next couple of quarters, we do not expect funded loan production to exceed around $150 million, essentially matching expected runoff as we continue to focus on both deposit acquisition and retention activities. As we see core deposit growth pick up, we will increase our funded loan activity.
Pages 22 through 24 of our supplemental deck provide more detail on the composition of our loan portfolios, the granularity on our commercial real estate portfolio and specific commercial real estate composition in the urban markets of D.C. and Baltimore. We recently completed an analysis and re-underwriting of our office portfolio, which affirmed the underlying quality and accuracy of risk ratings and overall strength, and performance continues to be strong. We also routinely performed stress tests on portfolio segments and external loan reused to obtain an outside evaluation of our underwriting and risk rating systems. We remain close to our clients in all segments and continually assess the performance of portfolios. A recent stress test confirmed that under several moderate and severe stress scenarios, lost expectations were very reasonable and capital remained strong.
Shifting to deposits. Total deposits decreased $117.1 million or 1% to $11 billion at June 30 compared to $11.1 billion at March 31. During this period, total noninterest-bearing deposits declined $148.8 million or 5%, primarily in commercial checking accounts while the level of interest-bearing deposits remained steady. During the current quarter, savings accounts and time deposits grew 41% and 6%, respectively, while money market accounts declined by 9%.
Quarterly deposit outflow was mostly observed early in the quarter and stabilized during the months of May and June. Core deposits represented 88% of total deposits at the end of the current and previous quarter reflecting the stability of the core deposit base. Brokered deposits represented 11.8% of total deposits, and we expect to continue at this level on a going-forward basis. Total uninsured deposits at June 30 were approximately 30% of total deposits.
We also offer clients reciprocal deposit arrangements, which provide FDIC deposit insurance for accounts that exceed $250,000. During the current quarter, we experienced a net increase of $230 million in reciprocal deposit accounts.
Slide 17 of the supplemental deck provides more color on our commercial deposit portfolio, which represents 59% of our core deposit base, the majority of which is in the combination of noninterest-bearing and money market accounts. With an average length of relationship of 9 years, the portfolio is well diversified with no concentration in a single industry or a single client.
Likewise, on Slide 19 of the supplemental deck, you can see the breakdown of our retail deposit book, which is more diversified in composition among DDAs, money markets and time deposits. With an average length of 12 years, the retail deposit portfolio was also well diversified with no significant concentration. Despite the significant decline in noninterest-bearing deposit accounts year-to-date, the category does still remain strong at 28% of our total deposit base.
At June 30, contingent liquidity, which consists of available FHLB borrowings, available funds from the Federal Reserve Bank's discount window and the bank term funding program as well as unpledged securities and excess cash, totaled $4.4 billion or 132% of uninsured deposits. In addition, the company also had $1 billion in available Fed funds, which provides a total coverage of 163% of uninsured deposits. Non-interest income increased by 8% or $1.2 million compared to the linked quarter and declined by 51% or $18.1 million compared to the prior year quarter.
The quarter-over-quarter increase was mainly driven by higher income from mortgage banking activities, BOLI income and service charges on deposit accounts. The year-over-year decrease in non-interest income was primarily a result of the sale of the company's insurance segment during the second quarter of 2022 and the associated $16.7 million gain. Excluding this onetime gain, non-interest income declined by 7% or $1.4 million year-over-year due to lower insurance commission income as a result of sale and lower bank card fee income due to regulatory restrictions that went into effect in the second half of 2022.
Income from mortgage banking activities increased $600,000 compared to the linked quarter, and total mortgage loans grew $57 million. Future levels of mortgage gain revenue is expected to be in the $1 million to $1.5 million in both the third and fourth quarters. Wealth income stayed relatively unchanged at $9 million and assets under management at quarter end totaled $5.7 billion, representing a 4.8% increase since March 31, 2023.
For the second quarter of 2023, our net interest margin was 2.73% compared to 2.99% for the first quarter of 2023 and 3.49% for the second quarter of 2022. There's no question that our margin has been impacted by the series of rate increases that have occurred over the preceding 12 months. The fierce deposit competition in the market, clients moving funds into interest-bearing accounts and the construct of our balance sheet with significant portion in fixed rate assets.
Compared to the linked quarter, the rate paid on interest-bearing liabilities rose 44 basis points while the yield on interest-bearing assets increased 12 basis points, resulting in the quarterly margin compression of 26 basis points. With our current expectation that the Fed will increase the Fed funds rate by 225 basis point increments between now and the end of the year, we see our margin continue to compress into the low 260s for the next 2 quarters, based on what we believe we will need to do to offer deposit rates in our markets in order to remain competitive.
Noninterest expense for the current quarter increased $2.8 million or 4% compared to the first quarter of 2023 and $4.1 million or 6% compared to the prior year quarter. The current quarter's increase was mainly driven by $1.9 million of severance-related expenses associated with staffing adjustments that were part of our broader cost control initiatives implemented by management during the year. As we shared last quarter, to offset over all profitability pressures, we halted plans to add staff, and we conducted a staffing assessment to ensure we are aligned with business volumes and market demands. With these actions and a continued focus on managing discretionary spending, we look to managed operating expenses in the $64 million per quarter range by the fourth quarter of the year.
I previously mentioned the termination of our previously frozen defined benefit plan. The termination is slated to occur mid-third quarter, and there will be a nonrecurring expense associated with this action. We do plan to disclose this amount once it is determined. The non-GAAP efficiency ratio was 60.68% for the second quarter of 2023 compared to 56.87% for the first quarter of 2023 and 49.79% for the prior year quarter. Both GAAP and non-GAAP have been negatively impacted by the decline in net revenue and growth in non-interest expense as we continue to invest in the future.
Shifting to credit quality. Overall, credit quality remained stable as the level of nonperforming loans to total loans was 44 basis points compared to 41 basis points. These levels of nonperforming loans compared to 40 basis points for the prior year quarter and continue to indicate stable credit quality during this period of economic uncertainty. At June 30, 2023, nonperforming loans totaled $49.5 million compared to $47.2 million at March 31 and $43.5 million at June 30, 2022.
Total net charge-offs for the current quarter amounted to $1.8 million compared to $300,000 in net recoveries for the first quarter of 2023 and insignificant net charge-offs for the second quarter of the prior year. The current quarter's net charge-offs occurred within the consumer loan portfolio due to the elimination of several nonaccrual loans. The allowance for credit losses was $120.3 million or 1.06% of outstanding loans and 243% of nonperforming loans compared to $117.6 million or 1.03% of outstanding loans and the coverage of nonperformers at 249% at the end of the prior quarter.
At June 30, 2023, the company had a total risk-based capital ratio of 14.66%, common equity Tier 1 risk-based capital ratio of 10.69%, Tier 1 risk-based capital ratio also at 10.69% and Tier 1 leverage ratio of 9.42%. All of these ratios remain well in excess of the mandated minimum regulatory requirements.
As I wrap up my comments today, going to reiterate our focus in this current environment. First drive core funding through all lines of business and our digital channels and then converting these new clients to full banking relationships. As we are successful in growing core funding, we create capacity to be more active in loan generation. We'll continue to manage costs while completing important investments in the technology area necessary for our future. And lastly, take advantage of the excellent reputation we built over the decades to grow client relationships, continue to expand assets under management on our wealth businesses and evolve our delivery channels to make it easy to do business with.
This concludes my comments. And operator, now we can move to take questions.
Question and Answer Session
Operator
(Operator Instructions) Our first question for today comes from Catherine Mealor of KBW.
Catherine Fitzhugh Summerson Mealor
I just wanted to start with the margin. I understand the pressure down to the low 260s if we get to more Fed hikes that you mentioned, Dan. Just kind of curious how you're thinking about the component's of that? And maybe just starting on the deposit side, if you could just give us some background or some color around where you're seeing incremental new deposit costs today maybe by product type would kind of be helpful. And then also within that guidance, how you think about the noninterest-bearing mix shift by the end of the year?
Philip J. Mantua
Catherine, this is Phil. So I can talk about the various elements -- yes, I can talk about the various elements of how we're pricing these out looking forward. So if you want to kind of walk down through the product line, one of the biggest things that we've done here of recent time, and Dan alluded to it, was introduced a high-yield savings account. But today, we'll carry about a 4.5% break with that in which we've already generated growth in that category of over $300 million throughout the last quarter, and we would continue to see that piece of the deposit base continue to grow.
In the money market space, where I think we've had some of our greatest challenges in terms of retained balances. We've now gotten even more aggressive on the introductory rates and all of the rates across the varying tiers, the new retail and business premier rate, intra-rate is now at 4.25%, and that has been 3.5% for the majority of the last quarter and into the early part of this quarter as well.
And then on the time deposit area, which we've also had a fair amount of success in terms of overall growth because, in fact, this period, there was no growth in brokered CDs, all of the growth in the time deposits as reported was in the core area. We're out now with a 8-month special at 5.5%, a 14-month special at 5% and a variety of other traditional maturities that are in the 4% to 4.5% range. So we've clearly upped our game in all of those particular areas. As it relates to the DDA element of things, we continue to see runoff out of the core DDA component, much of which we believe has run into the ICS portion of the portfolio, the ICS element of that on average between the checking account offering and the money market account is averaging about 2.8%.
So any further migration there is going to be worth 280 basis points of incremental cost. And then as far as borrowings are concerned, right now, things are fairly stable in terms of our necessity to rely on things in that area. We've been able to reposition some Fed funds and some home loan bank advances here, and we would look for similar stability related to the cost in that area, albeit subject to whatever impact might come from a couple of Fed rate increases.
Catherine Fitzhugh Summerson Mealor
Great. That's all really helpful. And so then -- as we think about the other side of the balance sheet on loan yields, I know your loan betas have been slower just given the fixed rate component of your portfolio. Any -- and I know growth is slow, so it's hard to churn through the portfolio. But is there -- as you look forward over the next couple of quarters, is there a group of loans that you see repricing in a certain quarter where you might see more lift, that just kind of helps either stabilize the margin or just kind of put an end to the bleed down just from the asset side of things.
Philip J. Mantua
Yes. I don't know that there's any real kind of groups or categories that would, from a timing standpoint, kind of change the way that the loan portfolio is repricing. I mean anything that's produced into the commercial portfolio today based on just recent pricing is going to probably have a high 7% to 8% to 8.5% type of rate associated with it, and anything in the mortgage portfolio, which has been growing is probably been topping out in the 7.5% range as well. So anything in that regard would certainly help. But I think it's really kind of more of the same, Catherine, as it relates to any additional contribution towards the beta on the loan side, really being much more than it has been here in recent quarters.
Catherine Fitzhugh Summerson Mealor
Okay. Makes sense. Hopefully, you're going to have a different story for me, but I understand it. And so that's the margin. And so maybe 1 question on just borrowings. It's just -- I noticed that you pulled a little bit of the bank term funding program. Just -- and it looks like you swapped to the FHLB into that. Just kind of curious how you're thinking about the borrowing side and your -- if you think that, that strategy will continue into the back half of the year.
Philip J. Mantua
Yes. The pull down on the Federal Reserve program was purely on the economics and the benefits of the way that it's offered gave us an opportunity to lock that particular rate in over that 12-month period, minimize the pledging implications given the way that those are required on that particular product and then just run down the capacity in Fed funds and in some of the home loan borrowings that had rates that were in excess of what we were able to use the Fed program for not really much else to it than that. We did that actually early in the quarter. So we've still got a fair amount of runway on that aspect of it.
If we could pull down more based on available collateral, it would clearly be more expensive today than what we brought it down at in the $480 million to $490 million range. But I don't know that we're planning to see a whole lot of change in that -- in the borrowing section. At the end of a quarter, we could have a Fed funds position you might see on the balance sheet at a point in time. But otherwise, I don't think it's going to change a whole lot.
Operator
Our next question comes from Casey Whitman of Piper Sandler.
Casey Cassiday Orr Whitman
Maybe just starting with the expenses. So the guide you guys gave for the fourth quarter would imply they're coming down pretty nicely from the second quarter. Is that mostly in the salaries line? Are there other areas we should consider? And sort of where are those all coming from?
Philip J. Mantua
Yes, Casey, this is Phil. Salaries certainly is a part of the equation given that the severance moves that we made during this quarter were pretty much in the middle to the back half of the quarter. So not a lot of realization to that yet, but certainly will be in the third quarter completely as well as we move through the end of the year and the other related costs that were part of that. So that's the first element of it. There's also some costs in this quarter and into the third quarter related to some consulting and professional fees that go hand-in-hand with some of our technology investments that should slow towards the fourth quarter. So that's -- both of those things are significant parts to the guide there as it relates to trying to get it to come through the third quarter into the fourth quarter and land in that $64 million range that we were really referencing to a degree last quarter as well.
Casey Cassiday Orr Whitman
Okay. Great. And maybe just one more back to that margin. I guess can you just dumb down, like do you think -- I think you said the margin hopefully will bottom out in the next couple of quarters in the 260 range. But do you think we could see some lift through 2024 from a Fed pause? Or do we need rates to go down for that. Just bigger picture.
Philip J. Mantua
I think we actually -- yes, yes. I think we need rates to go down in order for us to really get any legitimate lift. I mean it could be 1 basis point or 2 basis points here or there when things kind of level out. But I think for us to get a true lift into the margin, we really need -- we're going to need some rate cuts at some point. And right now, in addition to the prediction of the 2 rate increases in our current forecast, we don't see a rate cut at this point until potentially the second half of next year. Hopefully, we're wrong about that piece and that comes a little sooner, but that's the way we're viewing it for the time being.
Casey Cassiday Orr Whitman
Okay, understood. Last question for me, just thinking about capital here. Are buybacks on the table just given where your stock is and without balance sheet growth expected? Or is that not something really in consideration?
Daniel J. Schrider
It's something that's always on the table, Casey. There are no plans at this point to be active. That could change, but I wouldn't expect it in the next quarter.
Operator
Our next question comes from Russell Gunther of Stephens.
Russell Elliott Teasdale Gunther
I wanted to follow up on the loan growth outlook. I hear you on the $150 million kind of match, so we kind of breakeven there. What's a good bogey for us to think about when -- as to when we could see net positive growth? Is it a loan-to-deposit ratio target or non-IB mix stabilizing in a certain range? Just how are you guys thinking about when you're comfortable demonstrating that growth against?
Daniel J. Schrider
Yes. Russell, this is Dan. I think we've been -- as we went through the kind of all the activity of the first quarter and seeing the pressure on the funding side, really been focused on getting that stable, which, as I've mentioned, we feel like we've hit that stable point. And if we can continue to achieve some momentum as we saw in the back half of the quarter and achieved some growth. And I think we would become more comfortable in getting active. I don't think we are in the short run, looking at moderating our loan-to-deposit ratio. In ideal situation, that would be the case, but I think it's going to be more important for us to be active as soon as we can in lending, keep that -- that might stay about where it is as long as we can get the funding moving in the right direction. There's obviously a relationship between certain lending activity in the C&I space and the accompanying funding that goes along with it. So we want to make sure we get back in that business as soon as we can.
Russell Elliott Teasdale Gunther
Okay. And then just on the ability to retain the talent from a commercial lending perspective given the funding pressure. Are you guys able to hold on to the folks you want? Are you seeing competitors kind of target your guys more than is typical. Just any update you could share?
Daniel J. Schrider
Yes. Probably not seeing targeting any more than what we typically would. We've got a great reputation and some really good talent. Part of some of the staffing adjustments we did last quarter that I referred to was trying to rightsize certain aspects of our front line around the lending business that would be in line with what our appetite was going to be as well as the nature of what we want to book in the portfolio. So I think at this point, our teams have done a great job taking care of clients, managing production at a level we think is reasonable with funding and also shifting a lot of their efforts and emphasis toward deposit gathering. And we've adapted our incentive opportunities around that to try to preserve the opportunity to earn in a reasonable comparison to what had been predominantly loan-oriented incentive type of program. So I think we're in pretty good shape in terms of the retention of talent.
Russell Elliott Teasdale Gunther
Dan, I appreciate the color. And then just last one, switching gears a bit. I think I heard you say you took a look at the office portfolio again intra-quarter, we underwrote that. Any kind of color you could provide on the details of that exercise, whether it's observed declines in value or just any incremental details?
Daniel J. Schrider
Yes. It's say, all in all, things have held up both from a cash flow standpoint, a valuation. It was a focus of our most recent stress test, which in company the office portfolio, which also held up really well under a variety of different stress scenarios. We're not seeing leading indicators on office that would create concern. And as I've indicated, historically, our kind of office exposure tends to be smaller unit professional properties as opposed to the large floor plates that were 1 or 2 tenants leave, creates a significant amount of stress. So far, it's performed well. Right now, average current debt service coverage ratio on the portfolio is 154% weighted average loan to value on the portfolio is in the low 50s. So it's -- I think we're in pretty good shape. We'll continue to watch it as we will every asset class in the [accrual book].
Operator
(Operator Instructions) Our next question comes from Manuel Navas from D.A. Davidson.
Manuel Antonio Navas
If we hit a point where NIM is rebuilding, I guess, we're in an environment where we've had a couple of cuts. Can the pace still be 5 to 10 basis points per quarter improvement?
Philip J. Mantua
Yes, I don't know that -- Manuel, this is Phil. I don't know that we are thinking about that any differently than we have before. And I know that the 5 to 10 basis points is, I believe, the number we've used in prior conversations along this point. So yes. I don't see it -- I don't know that I see it any differently today than what we've said in the past. I think what's just different is our starting point, obviously, for where we have come to land here recently more so than anything else.
Manuel Antonio Navas
Got it. And on that -- on the large CRE net charge-offs or the provision for the large CRE loan, what's roughly the size of that loan?
Daniel J. Schrider
It's in the low $20 million range.
Manuel Antonio Navas
Got it. And it seems that if we get some of the deposit growth here, it seems like you're a little bit more interested in some loan growth, what's kind of changed there? You just kind of realized you might be in a higher rate environment for longer and it's hard to keep loan growth turned off? Or did anything else really change? Or just you're happy with -- you're seeing some stabilization deposit trends?
Daniel J. Schrider
Yes. I think it's related to stabilization on the deposit front. I mean, I think the -- last time we were talking, it was on the back end of some bank failures and obviously, concern across the industry as to what the funding situation would be. And so while we're paying heavily for the deposit growth we're getting, we don't -- we still want to be active in the market. And as you can tell from the conversation today, a ton of levers we have until we see the Fed move in a direction that would be helpful to us. So one of those levers would be to be active in the lending business when funding allows us to do so.
Manuel Antonio Navas
And I mean as you get closer to 60%, that's almost the marginal rate of new assets, it makes more sense to grow at that point, right?
Daniel J. Schrider
I'm not sure I'm tracking with that, Manuel. Can you repeat that?
Manuel Antonio Navas
If your yields are -- new loan yields around 7.5%, 8%, it seems like most of your...
Daniel J. Schrider
Yes, I would agree with your statement. I think I didn't pick up the whole sentence at first.
Operator
(Operator Instructions) Okay. At this time, we currently have no further questions. So I'll hand back to Mr. Schrider for any further remarks.
Daniel J. Schrider
Okay. Thank you all for joining today's call and for your questions. If you have, obviously, additional questions that we weren't able to address today, please reach out to either Phil or myself. And thank you for your time. Have a great afternoon.
Operator
Thank you for joining today's call. You may now disconnect your lines.
