Beacon Financial Corp (BBT) 2007 Q4 法說會逐字稿

Hello and welcome to the Berkshire Hills Bancorp Q4 2007 earnings release conference call. All participants will be in listen-only mode. There will be an opportunity for you to ask questions at the end of today's presentation. (OPERATOR INSTRUCTIONS). Now I would like to turn the conference over to David Gonci, Corporate Finance Officer.

Thank you all for joining this discussion of fourth-quarter and year-end results. Our quarterly news release is available in the investor relations section of our website, BerkshireBank.com, and will be furnished to the SEC.

Our discussion may include forward-looking statements and actual results could differ materially from those statements. For a discussion of related factors, please see our earnings release and our most recent SEC reports on Forms 10-K and 10-Q.

Now I will turn the call ever to Mike Daly, President and CEO.

Thank you, Dave, good morning everyone and welcome to our fourth-quarter conference call. I'm Mike Daly, President and Chief Executive Officer and also with me this morning are Kevin Riley our Chief Financial Officer and other members of our management team.

We released our fourth quarter and year-to-date results yesterday and we also released a preannouncement of certain fourth-quarter developments on January 10. Today, Kevin and I are going to discuss our results and our outlook for the current year and after we conclude our prepared comments, we will be happy to take questions from our callers.

Last quarter, I commented on the Red Sox and the World Series and the pressure to perform here in New England, and of course this quarter we how have the Patriots and the Giants in the Super Bowl, so the pressure to perform continue. All kidding aside, I feel very good about our performance in the past year. Besides the unfortunate credit write-down of one fraud situation we had, the fundamentals in the Company continue to improve. Of course I'm disappointed in the write-down, but with fraud and bankruptcy and the economy the way it is, the collectibility of receivables in this case just became too cloudy and it was the appropriate thing to do. Despite the fact that fraud is tough to defend, anytime something like this happens I think you have to learn from it. I think we have and we've put some better procedures in place to minimize this risk in the future.

Aside from that situation, for the environment we're in, we had a good year. And the fact is that we acted early to the changes in our environment and that helped us fundamentally get ready for 2008. Our preparation for this environment really began as early as 2005 when we stated we would not engage in sub-prime lending activities. We increased the loan loss allowance in 2006 in order to recognize and stay ahead of changes in the credit environment. We started in early '07 tightening some of our lending programs and some of these steps included exiting from the limited amount of asset-based commercial lending that we were doing and we improved the administration of our floor plan lending. We narrowed the scope of our indirect lending program and we have beefed the appraisal requirements on our home equity lending.

We approached commercial construction projects with real scrutiny and we generally slowed down the pace of our loan growth in order to maintain adherence to our credit and maybe most importantly, our pricing objectives. We took advantage of the current environment to find a partner in the attractive southern Vermont market that we have been targeting for several years. We diversified our revenues with non-interest income, now over 30% of our core revenues. We introduced a new brand identity to improve our overall competitive positioning and we restructured our balance sheet and sharpened our pricing discipline to offset the difficult market conditions and to move the net interest margin to the highest level in more than two years.

Now as I said in our last conference call, we have built a better company and we are starting to see the results in our performance. Our fourth quarter ongoing results were in line with the guidance that we provided last quarter and they demonstrate the forward progress we're making. I'm convinced that we are positioned to deliver record earnings per share next year based on this progress. I'm going to get to the 2008 guidance a little later in the call, but I like to review a little 2007 results first.

Our Company produced record earnings of $13.5 million in 2007. This was a 20% increase over the prior-year. Our 2007 earnings per share were $1.44, a 12% increase over the $1.29 in the prior year. These earnings were the result of both our organic growth and our insurance and banking acquisitions. Kevin is going to discuss some of the detail around our noncore charges in a bit, how they are related to the Factory Point acquisition and some other restructuring charges.

Excluding these charges, our core earnings per share were $1.90 in 2007 compared to $2.00 in 2006. I'm going to add that the $2.5 million write-down on the one fraud-related credit that was an unusual situation, it's not indicative of our general loss rate, so we tend to look at our core earnings before this charge as a better indicator of our underlying ongoing earnings run rate in the Company. That number is $2.06 per share, which is in line with our earlier guidance and it's up 3% from the $2.00 we reported in 2006. So that's the run rate we will take into 2008.

We opened four new branches in New York in 2007 and we accelerated the opening towards the first part of the year to get the highest market benefit while we were also in the process of rolling out our new brand. These openings brought us to a total of 10 stores in the important Albany area market and that is comparable to the number of branches that we had in our other regional markets at the start of the year. These openings increased our branch count by 15%.

As we noted in the earnings release, we have expenses of about $0.16 per share for the higher costs of our de novo branch program and our rebranding initiative. We view these as important discretionary investments in our franchise and one that does come out of current period earnings. Without this investment our ongoing core earnings would have been up 11% from last year.

So I feel that the underlying earnings momentum did make progress in 2007 and we feel that momentum was strong through the end of the year. These result give us confidence that we should continue to see earnings improvements in the coming year and I'm going to discuss that in a little more detail shortly.

Acquisitions were definitely a major element of our story in 2007 -- the integration of the insurance agencies which we merged into Berkshire Insurance Group in the fourth quarter of last year, and on the Factory Point acquisition in the third quarter. The insurance agencies added $10 million to our revenues in 2007 and increased our non-interest income to 31% of total revenues. And as I have stated, we remained committed to strategically diversifying our revenue stream to reduce our long-term exposure to narrowing net interest margins.

For the year, we earned $2.2 million, or $0.24 a share in our insurance subsidiary, which is in line with our earlier guidance. Most important, we did not have any significant solution attrition in the first year and we look forward to building this customer base going forward through the energy and commitment of our producers, all of whom stayed with us through the transition. I think that is another important point.

Regarding Factory Point, I will just quickly say that the integration went very well in the fourth quarter. We achieved our 25% cost saves and we continue to expect at least $0.04 annual EPS accretion from this acquisition. Factory Point's asset quality is also very good and we have plans to build on its commercial franchise with our larger lending capability.

Now I would like to take a moment to address our organic loan growth for 2007. As we have stated, we notched on our growth here in 2007 due to some rather uneconomic pricing conditions and changes we made to continue tightening some of our own lending programs. We continue to feel that our markets are growing and that we have opportunity to gain share as larger competitors do deal with credit issues elsewhere in the country. Nonetheless, we believe that throttling back from the double-digit annual organic growth that we have been booking in recent years is going to give us a more sustained margin and better asset quality in this environment.

For deposits, our emphasis as you know has been on core and non-maturity accounts, and we have deemphasized time accounts. We feel that this will continue to lower our cost of deposits and give us more cross-sale opportunities. Our primary focus has been on money market accounts which registered 19% organic growth for the year. Also as you know, we heavily promote checking accounts and we were encouraged by the 8% annualized growth, organic growth, that we achieved here in the most recent quarter. For the year, we opened up new checking accounts equal to more than 12% of our base at the end of the last year.

We have also focused on organic growth of bank fee income. We are certainly pleased with those results this year. Our total bank fee income was up 32%, including fourth quarter Factory Point fee income. Through the first nine months of the year, our bank fee income was up 25% and that was largely due to organic growth before the acquisition. We also reported a 58% increase in wealth management assets in 2007 to $781 million. We posted 12% organic growth here with the balance being business acquired from Factory Point. And that also mentioned that we announced in January that we acquired the Center for Financial Planning in Albany, which will add another $50 million in additional assets under management, and that has gotten us up to about $830 million in assets under management to start 2008.

Let me turn back to asset quality as I said I would. We feel that our loan portfolio is in good shape, and I think that is borne out by our year-end asset quality numbers. Before I get into the numbers, I want to walk through and just point out issues that we don't have. As I stated earlier, we have not operated sub-prime lending programs and we have not purchased sub-prime loans. It's our policy to require mortgage insurance on all residential mortgages over 80% loan to value and it's our policy not to originate home equity loans with higher than 80% combined loan to value. We have not offered all day or other nonconforming loan [doc] programs. We have no shared national credits. We have no sub-prime related securities, no collateralized debt obligations. We have no special investment vehicles, we have no preferred stocks and we have no impaired trust preferred securities.

We have all seen the headlines in recent weeks about one or more of these types of assets that I mentioned. We don't have them and we won't have them. What we do have is loans to borrowers we know and have experience with. All of our lending programs follow conforming lending standards and we took additional steps over the past 18 months to tighten some of those lending programs.

We outplaced asset-based lending balances at par which reduced our C&I loan portfolio by $25 million in the second quarter. We were okay with that. We changed our pricing and product selection in indirect auto, resulting in a $9 million reduction in fourth outstandings. We were okay with that. We slowed our originations of commercial construction mortgages. As projects were completed in the fourth quarter, this portfolio decreased by $22 million. We were okay with that. We made selective changes in our selection and retention of individual credits in the commercial loan portfolio, and I think that was the right thing for us to do.

Now we also took advantage of opportunities to grow the portfolio. We increased commercial mortgages by $40 million, or 7% organically. This is an area where we have good competitive advantage to book good, solid we collateralized strong business in and around our markets. We increased consumer residential construction mortgages by $10 million organically due primarily to our expansion into the Albany market. These are loans to individuals who are working with builders to build owner occupied houses in the expanding Albany area. We offered pricing promotions for good quality conforming home equity lines of credit. That produced an $8 million increase in the fourth quarter.

These early strategies have produced a loan portfolio that is stronger and better positioned for the current economic environment. Improved loan pricing also contributed to the improvement in our net interest margin in the second half of the year and we believe that we are in a position to continue to produce good quality single-digit organic loan growth in 2008 and we feel that's the strategy that's going to serve us well as we head into uncertain economic times.

Of course, we are mindful of the economic environment and we anticipate that there will be continued economic softening in our markets. This softening has increased our delinquencies, but it has not led to any systemic increase in our loan losses. Our chargeoffs were 34 basis points of average loans in 2007, but the majority of our credit charge-offs were for the one fraud-related situation that I already discussed. All other loan charge-offs were a modest 11 basis point of average loans which is lower than the average for the prior four years.

Now at year end, our loan portfolio was not showing signs of higher losses and that was reflected in our loan loss allowance which ended the year at 114 basis points on loans which is the same level that it was at the beginning of the year. Kevin is going to discuss in our guidance, we have budgeted a loan loss provision that would allow for as much as a doubling of our systemic loan losses in 2008 because we feel it's the prudent approach in this economy despite the fact that we have not yet begun to see any patterns develop. We are pleased to see a fourth quarter decline in the metrics for both our delinquencies and our nonperforming loans. These reflected our early increased workout activities along with the write-downs that were recorded. Our loan performance metrics continue to be considerably better than the most recent FDIC average, and we feel that these metrics remain at manageable levels.

I want to focus in for a moment on our nonperformers. At year-end, we had only $2 million in nonperforming assets that were not commercial loans. This is only 20 basis points compared to our residential and consumer loan portfolio. I would add, we only have two properties in OREO, and they're both residential properties. Our commercial loan nonperformers were $9.3 million, or a little over 1% of our total commercial loans. There were only two loans with a balance over $1 million in this total. One loan is a $2.6 million commercial mortgage that we're actively collecting which is covered by real estate collateral and guarantees, and the other is the nonperforming $1.9 million balance associated with the previously mentioned fraud situation. All other commercial nonperformers totaled less than $5 million at year-end and we have a total of $1.2 million in specific reserves set up for these loans, so we don't expect any significant impact on our 2008 earnings from these loans as we go through the collection process in the current year.

I'm going to ask Kevin to provide a little more detail at this point on fourth quarter results and guidance, and then when he's done, I'll sum some things up. Kevin?

Thank you, Mike, and good morning everyone. To start off, I am pleased to report we hit our fourth quarter core earnings target of $0.50 per share before the commercial loan related charge. Let me take a moment to discuss the components of our net income for the fourth quarter and our outlook for 2008.

As you can see, our run rate of revenue and expenses changed significantly this quarter over the prior quarter due to the inclusion of the Factory Point operations, so the third quarter numbers do not provide good basis for comparison. Therefore, most of my comments will refer to the guidance we gave to you at the end of the last quarter which will include these operations.

Before I get to the core results, I would like to address the non-core items. These non-core items in the fourth quarter cost us $0.07 a share. About half of the cost was related to Factory Point integration and feel within the guidance range we provided to you. Factory Point was fully integrated by year end, so we do not expect to see any additional costs associated with this acquisition in 2008. The other half consisted of two items -- a settlement charge related to the termination of the Company's Employee Stock Ownership Plan which occurred in 2005, and a settlement related to some old benefit plans for retired executives which are being terminated. For the year, our total non-core charges were $0.43 a share after-tax. Going forward, we're committed to minimizing any non-merger-related non-core charges.

Now I would like to discuss our fourth quarter core income starting with our net interest income of $18.2 million. This was slightly higher than our previous guidance. The net interest margin increased during the quarter to 3.38% which was in line with our projections. As a side note, this 3.3 margin is the highest margin the Company has recorded in 14 quarters. We believe the Company is well positioned to maintain a margin at this level in 2008, absent any major market crisis.

Our interest rate risk profile to date is slightly liability sensitive. This has helped us move down with the market. However in 2008 as rates at historical lows, we plan on shifting to a more neutral to asset-sensitive position.

This quarter's balance sheet growth was a little less than we expected. Total deposits were modestly up, CDs ran off slightly but were more than offset by core deposit growth. Our total loans were also up modestly with most of the increase coming from our commercial mortgage portfolio. Part of this increase was fueled by a decrease in our commercial construction loan book as loans moved to permanent financing.

As Mike has indicated, we believe our markets will grow and that our share in some of these markets will increase, so we're expecting mid-single loan growth in 2008. We also expect our deposit growth to be at about the same level. With projected growth and a stable net interest margin, we expect our total net interest income to exceed $75 million in 2008 which would be more than a 17% increase over 2007.

Moving onto non-interest income, we produced $7.1 million in revenue in the fourth quarter, which was a little better than we had projected. We've had good growth in all of our fee income categories in 2007 and as Mike has mentioned, our non-interest income climbed to 31% of our core revenues in 2007. As you know, we have a seasonal component in our revenue due to the contingent insurance income being recorded in the first half of the year. We expect this seasonality will follow the same pattern as it did in 2007. We anticipate our total non-interest income will exceed $34 million in 2008 which represents a 20% increase over 2007.

Focusing now on our loan loss provision, our provision in the fourth quarter covered our net charge-offs of $3.1 million. This provision exceeded our guidance due to the coverage of the previously mentioned $2.5 million commercial loan charge-off. The other $600,000 in net charge-offs in the fourth quarter fell in line with our expectations. Excluding this one loan, our 2007 net charge-offs were about $2 million, or 11 basis points. This represents a very modest level of charge-offs. For 2008, we expect to record a loan loss provision of between 5 and $6 million. We expect this provision to cover net charge-offs in 2008 and to provide increases in the allowance that cover growth while maintaining the 114 coverage ratio. Absent the one large commercial charge-off, this would enable us to cover more than twice the level of charge-offs in 2007. Currently we do not see any signs of higher charge-offs developing.

Moving now to non-interest expense, in the fourth quarter we reported $17.2 million. This was higher than our earlier estimates of $16.4 million. This difference was due to higher benefits costs than we expected. Our fourth quarter effective tax rate was 20% which was lower than our 32% projected run rate due to lower pretax income. We continue to project a 32% effective tax rate for 2008. For the fourth quarter, our earnings per share also benefited from our stock buyback program, bringing the average diluted shares down from 10.7 million from the earlier estimate of 10.9 million. Our fourth quarter efficiency ratio also improved to 62.5%.

Looking forward to 2008, we anticipate total operating expenses to be about $72 million and we expect to produce an efficiency ratio of 61% or less. As we have previously discussed, we believe this efficiency ratio is reasonable in light of the inclusion of the carrying costs of our de novo branch program and our insurance businesses which have a higher expense ratio. We anticipate that in 2008, five of our 10 de novo branches in New York will become profitable. We also project an average of 10.4 million in average diluted shares outstanding, assuming we continue to purchase shares during the year. We expect the earnings guidance given will produce an earnings per share of $2.16 for 2008. Due to the seasonality of our contingent insurance revenue, we continue to expect the first and second quarter will have the highest EPS. However, the timing of revenues between these quarters can be uncertain.

Our first quarter core EPS is targeted to be -- was $0.56 in 2007 and we're giving guidance that we expect the first quarter EPS to be in the range of $0.58 to $0.59 which would represent an increase in the range of about 4 to 5%.

That completes my discussion and now I turn the teleconference over back to Mike.

Thank you, Kevin, nice job. As Kevin indicated, our guidance is for $2.16 in 2008. This is in line with our earlier expectation for the year and is about a 5% increase over the $2.06 that we view as our ongoing run rate for 2007. We get there with a pretty substantial $5 million plus loan loss provision built into our projections. Of course the $2.16 EPS guidance is nearly a 14% increase over the $1.90 core earnings that we've reported for 2007, which is net of the loan charge that we discussed. We do expect to move the ball forward in 2008 in a difficult year and we want to be back at double-digit EPS growth after 2008. But realistically, this will depend a lot on what happens in the economy. We're seeing some pretty significant changes in federal, fiscal and monetary policy right now to ward off a recession, but I don't think we really know what direction economic growth will take. We understand that growth in 2009 and is going to depend in some measure on these events. We have steadily maintained that our markets and our franchise are a sound investment for growth and value. Through the end of 2007, our stock outperformed the bank and thrift stock indices that we follow, but we've certainly seen a major market correction here. We see real value in our stock and hope to see a rebound in our stock and in the financials generally. We feel the environment will continue to provide some M&A opportunities in 2008 to fill in and expand our franchise. As always, a deal has to fit strategically and it has to provide attractive, long-term return on investment. We also evaluate impact on both EPS and tangible book value per share carefully.

We'll also evaluate capital sources throughout the year as they may be available to us through our shelf registration or through other debt and equity sources, or through the M&A process itself. Our objective is to find ways to accrete both earnings per share and tangible book value per share over the long-term while we continue to create an outstanding franchise here in the Northeast.

Regarding our organic growth, while we continue to set down new branches or expect to primarily to fill in our current footprint, we do not have specific commitments at this time for new locations in 2008. We're also evaluating other means of widening our distribution channel, including possible banking capabilities where we have our insurance offices. We have a high priority to keep our electronic banking capabilities at the head of the pack, for both retail and commercial markets.

As we discussed in 2007, our team has lots of energy, they have lots of experience and they can channel that energy and experience not only into growth, but also into other means of franchise enrichment. So in 2007, they dove into expense save projects and we really got a lot of benefit from this team effort. In 2008 in addition to keeping up with cost save initiatives, we do expect to double down on our service standards and our relationship building in all of our existing markets.

We have high expectations for this Company and I really hope that you do as well. And with that, I'm going to conclude my prepared remarks and certainly now invite questions from any of our listeners.

(OPERATOR INSTRUCTIONS) Mark Fitzgibbon, Sandler O'Neill.

Thanks for providing all of that detail, it's very helpful. I just wanted to first clarify two points. Did you say, Kevin, 10.4 million average diluted shares for the full-year '08 as your target?

Yes.

Okay. And then, Mike, you mentioned that you did not have any branches yet on the drawing board. Do your estimates incorporate any new branches in '08?

We are looking, continue to look for different sites all the time, Mark, in the areas that would help fill in gaps. But for '08, we're not planning on any new branches.

And then I noticed you had pretty decent growth this quarter on the securities portfolio. Could you maybe share with us what you're buying in hat -- what kinds of yields or what kinds of structures you're putting on?

Sure. Most of them are MBS type securities, with shorter lives. Plus, I think some of the growth also came from Factory Point.

Okay. And then with respect to Factory Point, you have had a couple of months to kind of get in and really dig into the Factory Point franchise. Have you found any surprises either positive or negative?

We found some surprises, Mark, but frankly they have all been positive. We got what we expected to get, which was a really nice core franchise in southern Vermont. What we did not expect was to get the quality of leadership that we ended up getting. We have actually now taken their senior lending officer, [Dan Stannard], and we have given him the charge of regional leadership in that area. And [Guy Border] who was the prior President and CEO, has joined our company to be our executive in charge of retail banking for the whole company. They ran a very good bank and credit quality was excellent and they brought more to the table I think than we originally expected. The cost saves are in the bag at this point and I think that getting through the integration as efficiently as we did will give us an opportunity to make some headway in that market as we get into '08.

And then also, have you been able to bring sort of the pricing structures of the two companies together, or have you migrated to the Berkshire model, or is the goal over time to leave the pricing structures separate and distinct?

Pricing structures with regards to loans and deposits, Mark?

Yes.

Interestingly, the pricing structure for the southern Vermont market and the pricing structure for the Berkshire County market are quite similar. One of the things that I have always suggested is in markets like both of those, there still seems to be a little loyalty factor. I don't know if it's 10 basis points or 15 basis points. But the margins in both Berkshire County and southern Vermont seem to be a little higher than some of the other areas that are a little more competitive, meaning Albany and the Pioneer Valley. So we have not had any issues with putting the pricing together. We are not really at this point doing any regional pricing to speak of an any of the regions.

Jared Shaw, KBW.

On the home equity loan growth, was most of due to new customers or new loans, or is that due to an increase in the utilization rate?

That was actually new loan production, and much of that is because the Albany area, which I think we are still trying to keep a bit of a secret, is exploding. So it's a lot of new people that are moving into the Albany area. We are able to capture some of that business. I would say pretty much all of that is from new business.

Do you think that those growth trends are able to be sustainable for a little while?

I think, at least in the Albany area where when you look at the projected growth in that area, we are likely to be in the very early stages of it. So yes, I think there's a good chance we can continue to see good growth in our consumer products in the Albany area.

In terms of the margin guidance saying that you think that's going to be able to be flat, is that flat on an average basis for the year, or is that basically flat as you look out through the next four quarters?

Flat on an average basis.

And do you think that the significant Fed cuts right away will put a little pressure on the margin in the first quarter?

No, I think the first quarter margins might be stronger and I'm more concerned in the later part of the yet.

So is it more, you have a lot of deposits coming up for repricing in the first quarter?

Yes.

Yes. Let me also state that, with rates coming down, we don't know where the bottom is on this. If things were static today, it would be a lot easier to make that bet. But the lower rates go, I think the more difficult it is to continue to keep the spread where it is. So a lot of this will depend on what the Fed does in the future.

Finally, on the acquisition front, you have made a couple of good acquisitions now. It's certainly a time when some banks are feeling some weakness. What are your thoughts on doing -- or continuing to do deals looking out into '08 and into '09?

That hasn't changed much, Jared. I think we're going to continue to be opportunistic. I think that there may very well be opportunities for us to partner with some other institutions to help either fill in our gaps or to help fill in the circumference that we've delineated. So I think there is opportunity and I think we're going to be ready, as long as there's a good return on investment and there's a good strategic fit.

Mike Shafir, Stern Agee & Leach.

I have a question on the non-interest expense in terms of the compensation line this quarter. Obviously that includes a full quarter of the Factory Point acquisition. So working from there, are we going to see I guess some of that usual seasonality in the compensation increase in the first quarter as we do relative to the insurance income coming in?

Yes. But it's also, you start the [FICO] tax over again too, so you get a little bit cost there then you don't have in the later quarters.

Mark Fitzgibbon, Sandler O'Neill.

One quick follow-up. You mentioned before that the net interest margin you think will be flat on an average basis for the year, so I think the average margin for '07 was like 324. So that would imply that if the margin is up a bit in the first quarter that it would have to go down a ton in the back half of the year. Am I understanding that correctly?

I don't know that I agree with that math, Mark. I think if we floated up a hair in the first quarter and we started to see some pressure in the latter part of the year, a 338 average margin is probably realistic. And Kevin, you can correct me if I'm wrong on that.

No, I think the first quarter is going to come in slightly stronger than what we reported in the fourth quarter, so I believe that it's going to come out strong. I think as Mike has mentioned, that we don't know how far rates are going to go down and you start getting a floor on some of your deposit pricing. So our anticipation is that margin could come on it as a little pressure later in the year than earlier in the year.

Okay, but just to get the margin down to an average of about 324 for the year -- (MULTIPLE SPEAKERS).

Mark, it's 338 for the year.

I'm sorry, I apologize. I'm looking at the wrong number.

At this time, there are no further questions. I would now like to ask the Company to make any closing remarks.

This concludes the call. We thank you all for joining us and we look forward to speaking with you again next quarter.

Thank you. That does conclude the conference. Thank you for attending. You may now disconnect.