Sterling Bancorp, Inc.

Good morning, everyone. Thank you for joining us today to discuss Sterling Bancorp's financial results for the second quarter and the June 30th, 2022. 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, 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 conditions of Sterling Bancorp that involves 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 two 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 gap 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 gap to non-gap measures. At this time, I'd like to turn the call over to Tom O'Brien. Tom? Thank you.

Good morning, everyone, and welcome to our second quarter earnings call. We have reported this morning a net loss of $0.04 a share or $2.2 million, you know, predominantly, as I noted in the press release, related around some extraordinary items and, you know, what we'd call noisy entries we made. And I guess the problem with these noisy quarters is it tends to mask some of the important progress that we make. But nonetheless, let's kind of go through them quickly here, and then we'll get to the more critical stuff at the end of my comments. But first, the expenses are still stubbornly high, $19.5 million, and an awfully large part of that excess is due to the legal and related costs of dealing with the various investigations and the the process that that takes. It's a lot of time and energy and obviously money. Also in the quarter, we had some significant noise related to the surrender of a pretty large split dollar life policy and some smaller, older, bully policies that were former executives and the split dollar policy being for a controlling shareholder. So there was, you know, tax implications for that and reversal of some accrued liabilities. And Karen can probably go through any of that that you might have a particular interest in. More importantly, we did move to an outsourced platform, the Promontory Mortgage Path program for the origination prospectively of our residential home lending in our markets. MortgagePath will basically handle kind of like a turnkey basis all of the origination work including quality control compliance and originating subject to our final review and approval all of the mortgage loan products that we might offer at any given time. It's an innovative program and we were all pretty impressed with it. We spent a fair amount of time in due diligence and I think from our perspective it appeared to be a simpler program which has some variable origination costs but very limited fixed costs as opposed to the previous platform we had in-house. We anticipate you know, fixed cost savings of around $3 million a year. And I guess equally critical for the decision was that many of the burdens in residential lending reside in the compliance space and the disclosure world. And that is all assumed by MortgagePath. Again, we would certainly have our oversight and audit of that process, but you know, the critical parts of it are in this outsourced program. And I think gets us away from a lot of the inherent risks in residential mortgage lending. And frankly, given the radical downturn in the residential business in the last couple of months with a slowing economy and significantly higher rates, for us, the timing could not have been better. With the adoption of that program, we did have some severance costs in the quarter, and again, that was about, I think, $400,000 of more noise. The margin, I don't know if I can be a little bit creative with numbers here, actually improved about 13 basis points on a basis that doesn't consider the $1.5 million we had in recovered income last quarter. So we reported a margin of 295 versus 303 last quarter, and the 303 was favorably impacted by about 21 basis points in the first quarter, so with a one-time recovery. So, you know, I guess One of the ways to look at it, I guess, most favorable is, you know, we went from a 282 basis point margin to a 295. And if you want to look at it, then the reported numbers, we went from 303 down to 295, a decline of eight basis points. But directionally, I think, you know, I feel pretty confident in terms of where we go with margin. Deposit costs, you know, will, you know, begin to go up. they already have in some instances. And, you know, depending on what happens with the Federal Reserve and inflation, I think our expectations are that there will be several more increases certainly in the current year and probably going into 2023. The magnitude of those increases, I think the Fed's already put a stake in the ground with two 75 basis points increases. Perhaps they might be a little more moderate the next time around, depending on what the inflation numbers look like. But at the current rate of 9%, 8.5%, however you want to look at it, it is an enormous cost for most people in the country to bear. And certainly my expectation is the Fed will adhere to its mandate and address inflation. inflation as aggressively as it need be to break that cycle. So I guess the more important thing for most of us to talk about here is where we stand with these investigations. The work involved, I think you probably all appreciate the fact that it's It's been a fact-breaking for all of us, and certainly the patience of our shareholders is, I hope you realize, always acknowledged and appreciated. It's just been a very big undertaking, and dealing with two separate investigations takes a lot of time and energy and obviously cost, but I think it's safe to say here that the formal agreement, which has been outstanding since 2019, You know, all of the requirements in the formal agreement are, of course, public, but I think it's safe to say that the requirements were pretty extensive. As I noted in my remarks in the press release, I think we're now in a position where we have satisfied 100 percent of these findings and the requirements in the formal agreement, and our expectation is that it will be lifted with the formal conclusion of our exam. It's an achievement that's hard for me to underestimate how critically important it was, but it's really a testament to the hard work and the expertise of Sterling's board and management and staff. From the start of our efforts, I think it's been about 18 months since we've been able to fully attack the formal agreement with the management group and, you know, the direction we've followed in terms of satisfying it. But it's, you know, it's been a, if you've dealt with formal agreements before or different enforcement actions from the bank regulators, I think it's usually safe to say it's a, you know, generally at best a two-year process and more typically a three-year process. But it's important to understand that the satisfaction of the formal agreement requirements is really critical to closing out the OCC enforcement. I guess I'd say I have a reasonable level of confidence that both the DOJ and the OCC investigation will conclude this year. And again, we expect to be in a position to have much more clarity in the third quarter report. These investigations are independent of each other, so it can be a laborious process, which means time and expense. Again, we are complying with all of the requests and pushing as expeditiously as possible for finality, again, only with respect to Sterling and not individuals. But the process is, I think, well underway. Again, as I said, I think we expect finality by the end of the year, but the timeline with respect to getting all the I's dotted and T's crossed and coming up with what ultimately the fines and penalties are going to be takes some time. We don't have any insight at this point into the fines and penalties are going to be or even proposed to be. So that remains to be discovered as we at least get initial proposals from the agencies in the weeks and months ahead. As I said, I think by the end of the third quarter, we will have a pretty good sense of where these are going and hopefully have everything documented and completed by the end of the fourth quarter. There's, you know, good business and legal reasons to meet that timeline, and I think that's the sense we've been given. Probably worthwhile, Karen, if you just want to go through the noise with the insurance policy, policy surrenders, how it impacted taxes and operating expenses.

Sure, I'd be happy to. So, as Tom mentioned, we surrendered about $25 million worth of policies. With regard to that, the largest was the split dollar policy, which had a cash surrender value around $19 million. So for that policy, we had two liabilities on the books recorded, one for the cost of the insurance, which is just an accounting way to account for the portion of those proceeds that would have gone to the beneficiaries that were not the bank, and then another smaller piece to cover taxes for the increase in the value. So those two totaled about $4.5 million, and those were reversed through the salary and benefit line on the the expense side of the balance sheet. So additionally to that, we had to book taxes on the life-to-date gain on those policies. These were modified endowment contracts. And if we would have not surrendered them and waited to receive a death benefit, that would have been 100% tax-free. But because we surrendered them, we had to pay tax on the gain. So the gain was about $13.1 million, and so that equated to about $3.6 million additional income tax expense below the line. And then lastly, just like if you cash in something of your own early, since we cashed in the policies early, there was a modified endowment contract additional tax of 10%, and that is in the other expense line on the income statement. So all in all, it netted to about a half a million dollars of expense. It just happened to hit three different line items on the income statement.