Satsuma Pharmaceuticals, Inc.
Q1 2013 Earnings Call Transcript

Published: 26 Apr 2013

[Operator:]

Good morning, everyone, and welcome to the Sterling Financial Corporation First Quarter 2013 Earnings Conference Call. (Operator Instructions) This conference call is also being audio webcast and can be accessed on Sterling's website at www.SterlingFinancialCorporation.com. Today's conference is being recorded for replay. Additionally, the replay will be available at Sterling's website following the call. I would now like to turn the call over to Rich Arnold, Vice President of Finance at Sterling Bank. Rich, you may begin.

[Rich Arnold:]

Thank you. Good morning. Joining today's call will be the following members of the Management team at Sterling Financial Corporation – our President and Chief Executive Officer, Greg Seibly; and our Chief Financial Officer, Pat Rusnak. Additionally, we will have some other team members available for the Q&A at the end of the call – President and Chief Operating Officer of Sterling Bank, Ezra Eckhardt; Vice Chairman, David DePillo; and Chief Credit Officer, Steve Hochschild. A supplemental slide deck, which will be referred to during the course of this morning's call, is available on our website at www.SterlingFinancialCorporation.com. I would like to caution participants that during the course of today's conference call, Management may make statements that are not historical facts regarding events or future financial performance of the Company that are forward-looking statements within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act. We caution you that these forward-looking statements may differ materially from actual results due to a number of risks and uncertainties. For a more detailed description of certain factors that may cause the Company's actual results to be materially different, we refer you to the sections entitled Forward-Looking Statements and Risk Factors in our Annual Report on Form 10-K and Quarterly Reports on Form 10-Q, as filed with the Securities and Exchange Commission. We will now begin with remarks from Greg and follow with comments from Pat, and conclude by taking any questions you might have. Greg?

[Greg Seibly:]

Thanks, Rich, and thank everyone for joining us today for Sterling's First Quarter 2013 Earnings Conference Call. For the first quarter of 2013, we reported net income of $22.7 million, or $0.36 a share. This compares to net income of $20.9 million, or $0.33 a share, for the prior quarter and net income of $13.3 million, or $0.21 a share for the first quarter of 2012. I want to point out that our results in 2013 are on a fully taxed basis, compared to the results in the prior year. Despite the headwinds facing the industry during the first quarter, Sterling had solid performance in most key areas. I believe that our first-quarter results reflect a focus on and commitment to our key operating objectives. First, we saw improvement in our deposit cost and mix. Deposit cost fell to below 40 basis points in the first quarter of 2013. This, along with the impact from the balance sheet restructuring last quarter, contributed to the substantial net interest margin expansion during the quarter. Second, derisking and balance sheet management continued to show improvement. Classified assets, NPAs, and average days delinquencies are now in line with our peer group. The progress during the first quarter of 2013 continues to provide clear evidence that our legacy credit issues are behind us. Third, we saw a strong growth in loan balances and originations. During the first quarter, annualized organic loan growth was 8%. Portfolio originations were up over 47% versus the same quarter a year ago. More importantly, we're seeing momentum in each of our four business lines, suggesting that the refinements we've been implementing over the past two years are yielding results. Fourth, we saw a very clear evidence of progress in the area of expenses. Most notably, employee compensation and benefits was down $7 million or 14% from the prior quarter. Overall, noninterest expenses were down $8 million or 9%, compared to the prior quarter, and down $7 million or 8%, compared to the year ago period. Lastly, we continue to actively manage capital. To the last quarter, when this objective was introduced, due to the strength of Sterling's capital position, we will seek ways to leverage capital and options to return excess capital to shareholders. In line with that objective and given the first-quarter results and our performance outlook, I am pleased to announce a 33% increase in our cash dividend to $0.20 a share to be paid in May. Before turning the call over to Pat, I want to briefly comment on two notable items that occurred in the quarter. The first of these was a bargain purchase gain of $7.5 million associated with the acquisition of Borrego Springs Bank. This is clearly beneficial. Along with ongoing performance, we expect from Borrego SBA operations, it provides further validation regarding the merits of the acquisition, which closed at the end of February. The second item relates to our mortgage banking income. During the quarter, and in line with market conditions, the size and carrying value of our mortgage warehouse fell considerably. While this caused a substantial reduction in the overall contribution from our home loan division in the quarter, we do not anticipate similar impacts going forward. I will now turn the call over to Pat, who will walk you through the first quarter results in additional detail.

[Pat Rusnak:]

Thanks, Greg, and good morning. I'll take a few minutes and go through the financials, then we'll open it up for questions. I'd start with the income statement. The tax equivalent net interest margin for the first quarter was 3.69%, which is up 20 basis points from the prior quarter and up 31 basis points from the same period in 2012. The market expansion was principally due to the partial balance sheet repositioning completed during the last quarter – towards the end of last quarter, which included prepayment of $250 million of structured repurchase agreements with an average cost of 4.26%. On our last earnings call, we indicated this action was expected to have a 17 basis point positive margin impact, so we picked up an additional three basis points from reduced deposit costs. The yield on earning assets for the first quarter of 2013 was 4.32%, unchanged from the prior quarter, and down 10 basis points from the first quarter of 2012. Compared to the prior quarter, the decrease in the average long yield of 15 basis points was partially offset by an 18 basis point increase in the yield of NBS. An improvement in the earning asset mix also had a favorable impact as loans comprised 80% of average earning assets for the first quarter of 2013, up from 76% for the prior quarter. With respect to loans, approximately $642 million of loans repriced down by an average of 20 basis points during the first quarter. This repricing activity was substantially lower than the prior quarter, during which $741 million of loans repriced down by an average of 33 basis points. Also, contributing to the decline in loan yields, was the expected decrease in discount accretion on the First Independent acquired loans. Discount accretion declined by $334,000 from the prior quarter, causing a 2 basis point adverse impact on the loan yield and 2 basis points on the margin as well. Yields on NBS were favorably impacted by the selling of lower yielding securities during the fourth quarter of 2012. The average cost of deposits for the first quarter was 39 basis points, down 7 basis points from the prior quarter and down 28 basis points from a year ago, reflecting an improvement in the mix of deposits. In addition, deposit costs across all interest bearing categories continued to decline. No provision for loan losses was recorded in the first quarter or the prior quarter, while the provision was $4 million in the first quarter of last year. We reduced provisioning. Provisioning reflects lower levels of delinquencies, nonperforming loans, classified loans. On March 31st 2013, the total credit allowance stood at $158 million or 2.43% of loans, compared to 2.60% at December 31st 2012, and 2.85% a year ago. Net charge-offs for the first quarter of 2013 were $5 million or 28 basis points annualized as a percent of loans, compared to a net recovery of $566,000 for the prior quarter and $20 million for the first quarter of last year. Gross from the prior quarter was a function of lower recoveries as the level of gross charge-offs actually fell a bit – $7.2 million, as compared to $7.7 million for the prior quarter. Non-interest income for the first quarter of 2013 was $38 million, compared to $31 million for the prior quarter, $32 million for the first quarter a year ago. As you may recall, non-interest income for the prior quarter included a debt repaid – prepayment charge of $33 million, $11 million in securities gains taken in connection with the balance sheet repositioning, along with an $8 million gain on the divestiture of our Montana operations. As Greg mentioned, during the first quarter, included in non-interest income was a $7.5 million bargain purchase gain related to the Borrego Springs Bank acquisition. For that, I'll direct you to slide three of the supplemental deck. This gain reflects the difference between the fair value of the acquired net assets, $16.3 million, and the transaction consideration, $6.5 million of cash and $2.2 million of debt we paid off. Next, I'd like to direct your attention to slide four of the supplemental deck. The top box shows the change in mortgage banking revenue, which decreased by $16.5 million, or 60%, from the prior quarter. There are three factors that drove this reduction shown in the three stacked boxes on the left-hand side of the slide. First, at the end of 2012, we had $690 million of loans in our warehouse, including closed loans held for sale and fallen and adjusted interest rate lock commitments valued at a margin of 3.78%, which reflected market conditions present at that time. Significant changes in market conditions during the first quarter resulted in the year-end warehouse loans and locks being ultimately sold at a margin of 2.92%, or 86 basis points below the year-end carrying value. This translates into a revenue reduction of $5.9 million. Although, we do actively hedge both the held for sale loans and locks for exposure to changes in market rates, we did so at a level that was reflective of normal margins and not the best execution market valuations at December 31st 2012. By comparison, the mortgage warehouse loans and locks at March 31st 2013 were valued at 2.49%. Based upon actual sale execution, completed thus far during the month of April, we do not anticipate a recurrence of this factor on the second quarter's mortgage revenue. Second, we had reduced margins on loans locked and originated during the first quarter, compared to the prior quarter. The margin for the new first quarter origination activity was 2.55% or approximately 105 basis points lower than the prior quarter. This resulted in $6.8 million lower revenue on the $650 million of new origination activity. Finally, there was a reduction in total mortgage origination activity for the first quarter of $84 million, or 11%, due to seasonality factors, which equates to a revenue reduction of $3 million. We expect improved mortgage revenue in the second quarter of 2013 due to both the higher margin and increased origination activity. We expect the margin to be in the range of 2.40% to 2.70% and origination activity to be between $800 million and $900 million. Origination buys will be boosted due to both the recent addition of lenders and lending teams and seasonality factors. It should be noted that about 35% of our first quarter originations were for purchased money loans and 12% were HART refis. The $2.1 million favorable variance in loan servicing fees for the first quarter, as compared to prior quarter, was due entirely to NSR valuation adjustments. We have a valuation allowance reversal of $2.8 million in the first quarter of 2013, similar reversals of $754,000 and $2.2 million were recognized in the fourth quarter and first quarter of 2012, respectively. The residential servicing portfolio had a carrying value of 80 basis points at March 31st, and we had approximately $4.7 million of valuation reserves. Total non-interest expense for the first quarter of 2013 was $82 million, down from $90 million for the prior quarter and $89 million in the same period a year ago. Comp –expense was $42 million for the first quarter compared to $50 million for the prior quarter and $47 million for the first quarter of last year. For this discussion, I'll direct you to slide five of the supplemental deck. Bonus and incentive expense shown in the second box is down $5.5 million and was the primary driver of the reduction for the quarter. The $3 million reduction in commission expense was reflective of lower mortgage and multi-family production levels. As expected, we also saw a reduction in bonus expense of about $1 million, compared to the prior quarter, which included some elevated accruals due to our exit from TARP in September 2012. Competition expense for the first quarter of 2013 was also favorably impacted by annual adjustments to the amounts deferred under what was previously known as FAS 91. A majority of the increase in deferred compensation from the prior quarter was related to residential mortgage loans, the offset for which was reflected as a reduction in mortgage banking revenue. Total other non-interest expense for the first quarter was $23 million, compared to $22 million for the prior quarter and $25 million for the same period a year ago. Merger-related expenses for the first quarter of 2013 were $1 million, including $586,000 related to the contingent premium for First Independent and other costs associated with the completed Borrego and pending Boston Private transactions. Also, included in non-interest expense for the first quarter of 2013 was a charge of $1.5 million taken in connection with the tentative settlement of a wage and hour-related class action litigation matter. The prior quarter also included a legal settlement charge in the amount of $2 million. We view both of these settlements as good financial outcomes for Sterling in light of the cost to defend and inherent risk in any litigation. Moving on to the balance sheet, gross portfolio loans, which exclude loans held for sale ended the quarter at $6.5 billion, up $224 million for the quarter. Total portfolio originations for the first quarter were $512 million, which is about the same as the prior quarter and up 47% over the first quarter of 2012. Supplemental deck, slide six, is an updated version of the loan growth slide from last quarter. In the 3/31/13 column, you can see that loans grew by $224 million during the first quarter, of which $103 million is from the Borrego acquisition and $125 million organic. We did not have any bulk purchases or divestitures during the first quarter. The first quarter annualized organic growth of 8% was at the high end of our guidance range indicated on last quarter's call. But we remain comfortable with our near-term outlook for quarterly annualized organic loan growth in the mid single digits range, although there may be some fluctuations from quarter to quarter due to seasonality and payoff flows. The $42 million decrease in total securities during the first quarter was due to principal pay downs with cash flows redirected to fund loans and these higher costing deposits and borrowings. Investment portfolio weighted average life at March 31st 2013 was approximately 3.4 years. The effective duration was about 3%. OREO balances were up during the first quarter, ending the quarter at $29 million, compared to $25 million for the last quarter and $70 million a year ago. The increase is entirely due to properties acquired in the Borrego transaction. As of March 31st 2013, the OREO portfolio was comprised of 55 properties, carried at an average discount of 59% of the loan principal balance. Our single largest OREO was comprised of nearly one half of the total balance at March 31st is under contract and expected to be sold during the second quarter at the current carrying value. On the liability side, we continue to be focused on improving the mix of deposits by growing transaction money market savings accounts, reducing reliance on CDs brokered at public funds. Also, during the first quarter, a $50 million structured repo with a rate of 2.0% maturity. Although we do not have any more scheduled structured repo maturities until 2015, we'll continue to monitor the remaining $500 million, which have an average (technical difficulty) in light of market interest rates and other factors and may elect to prepay some or all at some point in the future. The final two items I'd like to cover this morning are income taxes and capital. We recognized income tax expense of $9.9 million during the first quarter of 2013. It represents an effective rate of 30%. This rate is below the statutory rate due to permanent differences, such as the bargain purchase gain and other tax exempt income items. We expect the effective rate for the balance of 2013 to be similar to the first quarter. With respect to capital, the (inaudible) in equity ratio as of quarter end was 13.0%, up from 12.8% at December 31 and 9.0% a year ago. The large increase over a year ago is principally due to the impact of the DTA valuation allowance release in the second quarter last year. The consolidated leverage to our risk base and tier one common capital ratios as of March 31st 2013 were 12.8%, 9.0%, and 14.1%, respectively. We've indicated over the last few quarters we're continually evaluating available alternatives for managing excess capital consistent with our capital plan, including dividend distributions and acquisition opportunities that make financial and strategic sense. In light of the continued solid internal equity generation capability and elevated capital ratios, a decision was made to increase our quarterly cash dividend one quarter earlier than originally planned, and given a rate of $0.20 per share represents a payout rate of 56% of the first quarter's net income and a yield of approximately 3.8%. We also continue to consider the propriety of special dividends as a means of returning excess capital. We are now only four months away from the third anniversary of our recapitalization, a date which will mark the end of certain restriction on share issuance and repurchase related to the preservation of our significant deferred tax asset near Section 382 of the Internal Revenue Code. At this point, I'd like to turn the call to Greg for some closing comments before we open up for questions.

[Greg Seibly:]

Thanks, Pat. We believe that the first-quarter results clearly demonstrate progress and momentum. I want to acknowledge and thank our team members for all of their ongoing focus on our key objectives, their hard work, and dedication. I want to emphasize that our five key operating objectives will continue to dictate our primary areas of focus as we move through 2013. First, continuing to improve the quality and cost of our deposits. Second, resolving the remaining asset quality issues and improving our overall risk management practices. Third, generating high quality relationship based loan growth. Fourth, vigilance around expense control. And finally, active capital management. We believe that these objectives will continue to provide the foundation upon which we can build and sustain a strong earnings base. We look forward to sharing additional developments on each of these fronts next quarter. With that, we're ready to take questions, Operator.

[Operator:]

Thank you. (Operator Instructions) Our first question is from Jeff Rulis of D.A. Davidson. Your line is open.

[Jeff Rulis:]

Thanks. Good morning, guys. I have question on the Boston Private transaction. Do you have an update on timing of when you anticipate close of that? And do you anticipate a bargain purchase gain with that transaction?

[Greg Seibly:]

Yes. I can answer both of those, Jeff. We expect it to close on or about May 10 and no bargain purchase gain is expected.

[Jeff Rulis:]

Okay. And then, trying to triangulate on the mortgage revenue based on your comments on the margins and production, I guess, there's a couple elements there. Are you comfortable with the percentage increase on the mortgage revenue line item, a band of say 30% to 50% increase sequentially, or is that unreasonable based on your guidance?

[Greg Seibly:]

Well, if you look back at – we'll call it the pieces of guidance we have, which are origination activity between $800 million and $900 million and a margin between $240 million and $270 million, so if you took $850 million at $255 million, that's about $21.6 million.

[Jeff Rulis:]

Got you.

[Greg Seibly:]

So, again, we're giving– I don't want to give a specific amount. But we're comfortable with those. You can kind of do the math on both the range of origination activity and the range of margin. We just can't be any more– unfortunately, any more precise than that right now.

[Jeff Rulis:]

No, that's– that's good.

[Greg Seibly:]

This is also only looking out one quarter, Jeff.

[Jeff Rulis, D.A. Davidson and Company:]

Sure.

[Greg Seibly:]

And also lock and chain. So we're not really giving guidance beyond– at this point beyond the second quarter.

[Jeff Rulis, D.A. Davidson and Company:]

That's plenty. I just wanted to confirm that that's kind of what you had said on the– at least for the next quarter. Okay. And then, lastly, just on the expense line item. A good breakout of what occurred – what has occurred so far, but just some – maybe some open thoughts on your expectations for expenses going forward.

[Greg Seibly:]

We have a few more branch closure consolidation sales that are in process that– I'm not saying they're going to be dramatic reductions, but will have positive impacts on the expense– on operating expenses. And I think our next one is probably– Ezra scheduled a closing…

[Ezra Eckhardt:]

The end of May– the three branches of the Bank of the Pacific.

[Jeff Rulis:]

Yes, yes.

[Greg Seibly:]

And Jeff, it's Greg. I think you know we've been talking about this for several quarters now. It's one of probably a few critical objectives for the Company. I think you—but when you look at the quarter and some of the linked quarter declines, that will continue to be an area of focus. And there were some issues in the deck, where you can clearly see some of that is ascribed to personnel expense. But there were also– even in the quarterly number there were, as you know, a number of non-recurring items. So our view will be that we'll continue to be very vigilant around that line item as we move through 2013.

[Jeff Rulis, D.A. Davidson and Company:]

I guess just to follow up on that, Greg, the component of say mortgage banking revenues do pop back, is there a variable effect on the expense line item that may come back relative to that?

[Greg Seibly:]

You'll see– I mean, you'll see some correlation in commission streams from production levels.

[Jeff Rulis:]

Okay. But not necessarily one to one?

[Greg Seibly:]

Not necessarily one to one.

[Jeff Rulis:]

Okay. Thanks.

[Operator:]

Your next question is from Mike Turner of Compass Point. Your line is open.

[Mike Turner:]

Hi. Good morning. Thanks. Just to sort of follow up on the expense question earlier, I assume at this point that obviously the Montana operations are out of there. And then, are most of the First Independent Savings in that first quarter number as well?

[Greg Seibly:]

Yes. The First Independent I would describe as fully phased in. We only had the impact of expenses for Borrego for just one month of the quarter. So, the case there where it’s having Borrego in the mix or just looking at absolute levels of operating expense you'd have an increase for maybe three months of Borrego and there will obviously be some level of expense for bringing on Boston Private as well.

[Mike Turner:]

So, I guess if I think about first quarter, your expenses were $81.9 million. If I back out the one-time charges, I get about $79.4 million. What's– I guess what's the normalized starting point? I don't know if the Borrego just bumps that closer to $80 million. What's sort of a good starting point in the first quarter, if we fully phase in Borrego for operating expenses?

[Greg Seibly:]

Stay with me one second. I will just...

[Mike Turner:]

Okay.

[Greg Seibly:]

And again, we don't give real specific guidance on the expenses or any aspects of the earnings outlook. So, I can give you just kind of a general—yes, called a general sense.

[Mike Turner:]

Yes, that's not what I'm just trying to get at is sort of what's a good starting point to go off of.

[Greg Seibly:]

With Borrego phased in, and again, Boston Private is going to be something on the order of call it $2 million a quarter of expenses. So, I think we're going to see something that's in the low 80s, say perhaps $82 million, $83 million, $84 million. Again, that's with Borrego in for a full quarter and the impact of Boston Private, again, which will add a couple million dollars a quarter just on its own.

[Mike Turner:]

Okay, that's very helpful. And then, you mentioned earlier on your tax rate at the end of your comments that it should remain at that first quarter level, presumably 30%. Is that a good expectation going out into next year of any discrete items that would make that jump to a more normalized higher 30% level in the future?

[Greg Seibly:]

Yes. There are discrete items. One would be the bargain purchase gain. So– and looking out beyond this year, I would envision a rate. Again, all other things being equal being no things like bargain purchase gains or other unusual items, something more in the 34% range.

[Mike Turner:]

And that's next year, but it should be 30% this year.

[Greg Seibly:]

Yes, around 30% for this year.

[Mike Turner:]

Okay. Thanks. And one last question. Sorry. What was– did your HART percentage– it was 12% this quarter, was it higher in the fourth quarter?

[Greg Seibly:]

I think it was about 16.

[Pat Rusnak:]

Yes. It was annualized 15% for all of 2012. So, it's slightly trending down into the third quarter.

[Mike Turner:]

Okay. Thank you very much.

[Pat Rusnak:]

With our expectations.

[Mike Turner:]

Your expectations? Sorry?

[Pat Rusnak:]

That it would slightly trend up over the remainder of the year given action that we've taken. So, I think just looking at quarterly originations and slowdown in the first quarter, I don't think we're surprised by that number.

[Mike Turner:]

Great. Thank you so much.

[Operator:]

Our next question is from Paul Miller of FBR. Your line is open.

[Paul Miller:]

Hey. Thank you very much. Can you talk a little bit about the– your non-performing assets? They were relatively flat in the quarter. Is that just seasonality? Just add some color to that.

[Greg Seibly:]

Yes. I can give you some specifics, Paul. Some of it was seasonality, but some of it was also what we picked up from Borrego. So, there were some one-time effects that we'll– we can walk you through a little bit.

[Paul Miller:]

$16 million from Borrego, of which a significant portion is government guaranteed. $9 million of the $16 million is government guaranteed.

[Paul Miller:]

Were they FHA loans you had to buy out of the pools?

[Greg Seibly:]

No. This is Borrego. These are SBA in the acquisition.

[Paul Miller:]

V.A. loans – SBA loans, okay. Yes, yes.

[Greg Seibly:]

And U.S. VA loans.

[Paul Miller:]

Okay.

[Pat Rusnak:]

And we noted it in the prepared remarks, Paul. We have a significant item in the OREO that we expect to– will be second quarter that represents nearly half of the entire OREO balance. It's one we've had for a while.

[Paul Miller:]

Okay. And then, the other is M&A. Can you make some comments on M&A? I know a lot of people– expectations of M&A has been not as good as it was in the past because that the asking price is way too high. Are you still looking and do you still see some opportunities up in the Pacific Northwest?

[Greg Seibly:]

Yes, it's Greg. Just a couple things. I mean, I think we've been real clear in the past around where key areas of emphasis would be the Pacific Northwest, Portland, and the Bay area. Well, Seattle, Portland, and the Bay area. And then, frankly, we have screens out on a lot of companies; we watch those regularly going around expectations and valuations is spot on. Our sense is that there are a number of conversations across the industry taking place. But at this point I think the bid-ask between what sellers are willing to pay and what buyers expect to receive still remain in many instances quite wide. And I think specifically with respect to the Pacific Northwest, Paul, I mean, if you just look at the numbers, there's about 80 community banks in the states of Washington and Oregon and there's a lot of capital up here. So, I think the– what we would expect for Pacific Northwest transactions is that those deals would be relatively hotly contested. And then, in one market where we've obviously got the operating franchise in Northern California, California has about 250 community banks. So, I think it's clearly got more in terms of numbers of potential sellers. But we're active across our footprint at this point. And as you know, it's an opportunistic issue. We will look to continue to put capital to work there. And if opportunities arise, we'll do so.

[Paul Miller:]

Okay, thank you very much, gentlemen.

[Operator:]

Our next question is from Jacque Chimera of Keefe, Bruyette and Woods. Your line is open.

[Jacque Chimera:]

Hi. Good morning, everyone. I just had an accounting question actually as to how the Borrego– the non-performing assets, I was under the impression that once those were marked they weren't included, and they were included in classified, but not in NPAs. Was there a change to how to think about that?

[Greg Seibly:]

I'm not aware of any regulatory reporting requirement that would indicate that an acquired loan is– like that is not non-performing. It may not be reported as a TDR, but it would still be reported as a delinquent or non-performing loan.

[Jacque Chimera:]

Okay.

[Greg Seibly:]

And the other thing is on the reporting, you have to report both under SEC rules and kind of call report rules items on a gross basis. You can separately note the portions that are government guaranteed, but the reporting needs to be done gross of any guarantees.

[Jacque Chimera:]

Okay. And then, was there anything– I know the BPO had an effect on the tax rate. But I had in my notes from last quarter to expect something in the 37% range, and then you had guided to 34% in 2014. Did anything happen that changed that?

[Greg Seibly:]

We have I think just trued up our analysis on some of the other call it permanent items with things like bank life insurance and municipal income, and I think we've just refined our effective tax rate analysis and have a– I think probably a more accurate read on it now than when we did our call last time.

[Jacque Chimera:]

Okay. And then, lastly, if you could just go maybe a little bit more color on the fair value mark and hedging. And I know that what happened in the current quarter was kind of a perfect storm versus a great 4Q result. What happened between 4Q and 1Q that that I mean – we know what happened. But what makes you think that there– it's unlikely for that to happen again in future quarters?

[Greg Seibly:]

Well, one is– I guess the short answer is– and we had this in the prepared remarks – our valuation of the warehouse, that's the held for sale loans and the locks, at March 31st is in line with kind of historic profit margins for that business at about 2.5%. You go back and look at how we've reported this for several years now. You can go back and see that we've been at those levels. The margins creeping up into the threes– middle threes and higher as we move to the– through the third and fourth quarter of last year was an aberration. So, I think our view is that we don't see a case, where margins for this business would go from – say, from the mid-twos down below 2% or to 1%. That just doesn't– we don't see that being in the cards. There were unique conditions and what would be described as best execution for certain types of loans and mortgage backed security pools that were present at the end of the year that with just a few changes in the market those went away. And as we again described in the remarks, we only hedged at essentially the normal historical profit margin level. We did not cover that additional profit. So, in short, just looking at where we have things valued– the warehouse valued at the end of March, we see limited risk to the downside for something reoccurring like what happened in the first quarter.

[Jacque Chimera:]

Okay. So, as I understand it then, when you look at your hedging activities, you hedge to that roughly 2.5% rate because it's consistently where these margins are. So, because of what– the unique experiences in the fourth quarter, that's what caused the decline and the increment was loss from it. And since margins have returned to a more rational level, it's unlikely to occur in the future.

[Greg Seibly:]

Right. So, our view is that on that slide in the supplemental deck, that we don't really see a case of that top box of the stack of three being an issue at least in the near term.

[Jacque Chimera:]

Okay.

[Pat Rusnak:]

Yes. The only other comment – the only other comment I'd make on that, Jacque, is the bottom left box is really attributable to some seasonality as well, because you come through the third and fourth quarter at elevated carrying levels. The first quarter production, at least for us given where we are, is typically lower. So, the overall warehouse size fell as well. And to the extent we expect higher production levels in the second, third, and fourth quarter levels than we had in the first quarter, that effect should also not recur at least with respect to the second quarter. But that's a seasonal variant that typically would occur on a linked quarter basis between Q4 and Q1.

[Jacque Chimera:]

Okay. Yes, I know, that's what I understood. And thank you very much for the chart. It was incredibly helpful. And that's all I had. Thank you for taking my questions.

[Greg Seibly:]

Thanks, Jacque.

[Operator:]

(Operator Instructions) Our next question is from Dan Mazur of Harvest Capital. Your line is open.

[Dan Mazur:]

Good morning. Thanks for taking my question. I wanted to follow up quickly on slide five. You referenced it briefly, but I didn't quite catch it on the deferred direct origination expenses. Just what is that? And it's– I guess I'm surprised that has gone up if originations are down. So, I wanted to see if you changed your– the way you compensate originators or what's going on there.

[Greg Seibly:]

Yes. That is– under Generally Accepted Accounting Principles. We need to defer direct origination costs on loans we evaluated once a year. So, we have a case, where we have – a look at (patient) or aspect and also some other costs as well that are not as significant and show up in other parts of the income statement. In this case, we increased the standard cost by about $800 a loan. And so that– essentially what we have here is a case, where the net profit to the bottom line is the same, a case where we decreased compensation expense and it also decreases the margin or revenue side by an equal amount. So, it's simply a matter of geography on the income statement. And we defer– the total deferral– average deferral on a loan is about $3,500 roughly.

[Dan Mazur:]

Okay. Great. And thanks. And the– there's been a lot of speculation about additional guarantee fee increases at the GSEs. And I figured it just– your view of that impacted the increase in the fourth quarter– if that impacted margins from third quarter to first quarter, and if we get another 10 basis points or 20 basis points this year, your ability to pass through or potentially impact any of the margins or volumes.

[Greg Seibly:]

Really can't offer a comment on that.

[Dan Mazur:]

Was there an impact from the fourth quarter to first quarter with the increase in G fees?

[Greg Seibly:]

I can't– I don't have an answer to that.

[Dan Mazur:]

Okay. Great. I'll follow up later.

[Operator:]

Our next question is from Nathan Race of Sterne Agee. Your line is open.

[Nathan Race:]

Yes. Hi, guys. I was wondering if you could provide an update on your outlook for other loan sales, one in particular, SBA, and multi-family.

[Greg Seibly:]

Sure. We did not complete any multi-family sales in the first quarter. We do have an expectation that looking out over the longer horizon we will be able to generate more multi-family loans than we can have room for on the balance sheet given concentration limitations and also concentration limitations at the borrower level. So, I would expect that between the second quarter and end of the year we will have additional sales of multi-family loans. As you may recall, we did a few sales last year with gains that were in the 2.5% to 3% neighborhood. I can't say that the gains will still be at those levels. I should think they're probably down a little bit, but we will expect to have that. We also will have an increase in sales on SBA as a result of Borrego. We've done a little bit of that from time to time. I think we had a few hundred dollars of SBA gains in the first quarter. Most of what Borrego produces are 7A loans, for which the best economics are to sell the guaranteed portions. The gains on that are pretty significant in the 10% neighborhood. So, that's– I think we will see an increase in the sale activity and the related non-interest income by virtue of the Borrego transaction being integrated.

[Dan Mazur:]

Okay. Great. Thanks, guys.

[Operator:]

At this time, I am showing no further questions.

[Greg Seibly:]

All right. Thank you. Thanks, everybody, for joining us for the first quarter. And we'll look forward to speaking to you next quarter. Have a great day.