Beacon Financial Corp (BBT) 2014 Q2 法說會逐字稿

Good morning and welcome to the Berkshire Hills Bancorp's second-quarter earnings conference call. All participants will be in a listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions.

(Operator Instructions). Please note this event is being recorded and I would now like to turn the conference over to Ally O'Rourke, investor relations officer. Please go ahead.

Good morning and welcome to America's most exciting bank. Thank you for joining us in this discussion of our second quarter results. Our news release is available on the investor relations section of our website, BerkshireBank.com, and will be furnished to the SEC.

Our discussion will 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. With that, I will turn the call over to Mike Daly, President and CEO. Mike?

Thank you, Ally. Good morning, everyone. Welcome to our second-quarter conference call. With me this morning is Josephine Iannelli, our Chief Financial Officer and, of course, other members of our management team.

We released our earnings last night. I'm happy to report that we grew our core EPS 5%. We produced a clean quarter and we exceeded our earnings guidance. The balance sheet growth was strong. Fee income was up 10%, and we held the line on operating expenses as we said we would.

We reported core EPS of $0.44 and GAAP earnings of $0.46 a share for the second quarter, and the difference here is simply the result of a lower tax rate, which Josephine will comment on in just a few minutes. Our core EPS is now up 10% in the last two quarters and we are able to achieve this while we were observing the runoff of purchased loan accretion. Now, if you back out the accretion, we have moved our core EPS nearly 20% in the last six months.

During the quarter, we increased our core revenues at a 9% annualized rate while keeping core operating expenses flat, thereby producing positive operating leverage. We also completed the integration of our 20 purchased branches, increasing our footprint by more than 20% and we have had a nice run of loan production to utilize those new core deposits. So I think this is good progress and a reflection of a lot of hard work and commitment from a very dedicated employee base, and I want to thank each and every one of them for that right now.

Continuing on the second quarter, total loans increased 5% including a 7% increase in commercial loans. We posted 8% growth in commercial real estate with strong results across the entire footprint after the unusually cold winter. And C&I lending was up over 4% for the quarter, or 18% annualized, continuing our trend of double-digit annualized growth in this category. Looking ahead, the pipeline remains steady in the $140 million to $150 million range for the third quarter, so I would expect commercial loan growth to be near a double-digit annualized rate again.

CRE lending did exceed our expectations this quarter, and it was impacted by some expected runoff that moved into the third quarter and some closings that didn't occur in the first quarter that occurred in the second quarter. So I wouldn't expect to see the growth rate for that category staying at these elevated levels. Central Massachusetts and the Albany region, they showed the strongest growth in commercial loans this quarter, though, as I said, we did have good results across the footprint.

In Massachusetts, growth was led by Jim Curran's team in Westborough, and we once again saw solid results out of Mark Foster's ABL team. Meanwhile, Albany continues to grow organically for us and we are starting to see real progress in the central New York region through our strengthened branch presence. We have also recently added a small business lending team in that market, another example of an established business lending team being drawn to the Company's culture and footprint.

One of the advantages of our footprint is the relationships that we are building a smaller community banks in different regions. We now have the ability to offer services to these banks, including the club deals and other wholesale activities and I like the fact that we can be considered a resource for.

Consumer loans were up 5% quarter over quarter with good growth in just about every category. And, looking at the third quarter, we expect total loan growth to be in the high single digits annualized. Our overall loan growth was funded by a 6% deposit growth this quarter and our loan to deposit ratio dropped to 99%.

We increased our utilization of brokered deposits to diversify our funding and take advantage of the best funding costs, and this did help to bring down our overall cost of funds [9%], up from the first quarter. So kudos to Mike Macey and Rick Thevenet. That is good treasury execution.

We also continue to build on the deposit bases that we acquired with the New York acquisition in the first quarter and that is going very, very well. I would expect that we would continue to grow deposits at a low single-digit rate in the third quarter, while focusing on our demand deposit base, which increased at a 12% annualized rate in the second quarter. These, of course, are the core accounts that establish relationships -- the stickiness. And they also have the greatest impact on our long-term margin.

One of the things that we think is important is the changing needs of depositors. Sean Gray, our retail exec, has put a lot of time and effort and thought into making sure that we enter this new phase of electronic banking prepared. You know that we have reinvented our retail branch model and we are providing just as much energy right now to our online and mobile solutions.

Both of these initiatives continue to reveal cost reduction and revenue-generating opportunities. I think Sean has pioneered new ways for us to build profitable customer engagement channels and we are pretty excited about the possible avenues that continue to develop here.

Let me turn to fee income. Obviously, I am pleased with the growth we produced this quarter. Total fee income was up 10% over the first quarter, realizing healthy gains in most categories. The initiatives we have undertaken to increase and to formalize the cross sell of fee products has been effective and it is starting to pay off.

Swap demand was helped by the decrease in the yield curve and deposit-related fees were also strong. And while insurance and wealth management fees were down quarter over quarter, as expected, due to seasonality, both categories grew year-over-year. Driving the fee income side of the business is key to reaching our long-term goals.

Our fees have improved over the last three quarters as a percentage of our revenues, and I would like to see this number get back to around 30%. And we will continue to look for ways to expand our relationships with customers and take advantage of our overall footprint to do that.

I will quickly note that our credit performance remains strong and, in fact, we do sacrifice some yield as a result of our credit selection, which continues to drive improvement in our internal credit ratings every quarter. We also increased our provision in the second quarter due to our high loan growth, and so we have built our allowance, even though our loss expectations remain modest.

With that, I would like to turn it over to Josephine. She will take you into the weeds of the financials. And then, when she is done, I will sum it up.

Thanks, Mike, and good morning. I am pleased to elaborate on our strong earnings growth for the quarter.

We have touched upon our positive operating leverage from strong revenue growth with flat core expenses. We had 6% growth in core revenue before purchase loan accretion, which was driven by a 6% increase in average earning assets and a 10% increase in fee income over the prior quarter. Mike talked about our loan growth drivers, so I will focus my comments on the margin and our yields.

We had a lot of things going on with the margin in Q1. In Q2, the margin was 3.26%, and this is a good reflection of our current state. We recorded $1 million in purchase loan accretion, which was mostly due to recoveries on the liquidation of impaired loans. At quarter end, the remaining balance of unamortized accretable yield on the impaired purchase loans was $2.4 million.

As you know, we expect this accretion to have less impact as we go along, although it will still be an element of variability. Before accretion, the net interest margin in the second quarter was 3.19%. The loan yield before accretion was 3.86% compared to 3.99% in the prior quarter. We have previously noted that there is some ongoing compression in the markets. Additionally, we saw the flattening of the yield curve in the second quarter contribute to the spread pressures.

Total loans came on in the second quarter with an average coupon in mid-3s. Through our balance sheet strategies, we delivered $1.6 million pickup in securities income. Much of this was the result of the first quarter balance sheet adjustment and the additional higher-yielding securities purchased in the second quarter.

We also continued to reduce our cost of funds in the second quarter, shaving off another 5 basis points, which reflects a full quarter benefit of the branch purchase along with the utilization of more cost-efficient deposits. These deposits are a positive for our interest rate sensitivity for the next couple of years. I would add that our DDA account generation continues to run at a double-digit annualized rate.

Following our branch acquisition, we have been adjusting our costs and account acquisition strategies. In the second half of the year, we expect organic business generation to again be visible in our deposit balances while we continue to closely manage our pricing margins in our DIF fund transition.

Turning to our expectations for spread income in Q3, on an annualized basis, we expect high single-digit loan growth to be funded with a mix of organic deposit growth along with wholesale activities including securities sales, borrowings, and/or broker deposits. We anticipate some additional loan yield compression in the third quarter, including a further decline in purchase loan accretion. We also expect to achieve an additional modest reduction in our funding costs.

Overall, we expect margin compression excluding accretion similar to what we have seen, somewhere in a range from 3 to 6 basis points. The accretion benefit in Q3 is expected to be similar to what we posted in Q2. By limiting our margin compression and maintaining strong loan growth, we expect to see further growth in net interest income.

Turning to noninterest income, Mike discussed the elements of our 10% fee income growth in the second quarter, including strong swap fee income. Looking to the third quarter, we expect that swap fees will ease down, while other fee income will tick up a little despite some seasonal constraints. Overall, we expect a modest decrease in total noninterest income, but a modest increase in total revenue based on loan growth.

Turning to the loan loss provision, Mike highlighted our favorable credit trends, which we expect to continue in the third quarter. The increase in the provision was driven by the high loan volume growth of the second quarter. As this growth normalizes in the third quarter, we expect that the provision will come back down in the mid-3s.

Moving now to core noninterest expense, we brought this in flat at $39 million, which was in line with our guidance, and we had no material non-core expenses. Our efficiency ratio came in a little under 63%, now that we have had the opportunity to leverage our branch purchase and build other revenue synergies.

Looking forward to the third quarter, we expect a tick up in expenses related to our ongoing growth while we continue to closely manage our spending. Compared to last year's second quarter, our core expenses are down more than 30 basis points in relation to average assets, even after considering a full quarter of operating costs for the acquired branches. That is huge. This is an 11% improvement as a result of our restructuring work and the team focus that Mike commented on.

Turning to the bottom line, our GAAP EPS was $0.02 more than our core EPS. Our GAAP tax rate is running around 26% as a result of the non-GAAP charges taken in the first quarter, which reduces our year to date GAAP pretax income. Our core income for the year to date is higher than this, and we therefore have a higher core tax rate of 30%.

We should see a similar $0.02 GAAP EPS difference in the next two quarters, but otherwise, we don't expect any other material differences between core and GAAP earnings. Putting it all together for the third quarter, we expect to at least do as well as the $0.44 core EPS that we posted this quarter. And our focus is to move this [book 76] annualized core run rate north from here.

As Mike noted, our run rate is up nearly 20% excluding accretion over the last couple of quarters, while we have also enhanced our overall franchise value and team strength. Our second-quarter results gave us a 4% increase in tangible book value per share to $16.40, and we have more than recouped the dilution recorded on the branch purchase in the first quarter.

Our core return on tangible equity also increased to 11.3% in the second quarter, from 10.8% in Q1.

Tangible equity came in at 6.8% of tangible assets following the high loan growth in Q2. Our internal capital generation is targeted to support our normalized balance sheet growth, and also to move our capital ratios up. As we noted last quarter, we are comfortable at these levels.

We posted an improvement in core and GAAP equity returns in the quarter. Our core return on assets was flat at 71 basis points due to the higher asset growth, and again, we are targeting to see this advance based on more normalized growth.

I mentioned on our last call that we expect actively manage our balance sheet to support our market initiatives and value creation. In the second quarter, this was most evident in our funding diversification while we reduce funding costs and increase the contribution from our investment securities.

I am pleased to report that we enhanced our loan and relationship pricing analytics. I feel we have extensive real-time data and a close partnership with our market leaders to sort through the competitive landscape and make the best loan and deposit pricing decisions. We are determined to show steady progress in driving earnings and profitability towards our long-term goals, and with the same processes, we are rebuilding our equity and improving our asset sensitivity.

We anticipate that our net interest income run rate will increase in the mid-single digits or better with a 200 basis point upward ramp. While we are positioned to take advantage of such a rate increase, we are not depending on that in our strategy for moving towards our long-term financial goals. We made a lot of progress of the second quarter and I believe that this is more readily visible with some of the acquisition noise behind us.

With that, I will turn the call back over to Mike.

Josephine, thank you, and terrific job. Now, as Joe said, we do expect to produce core EPS of at least $0.44 in the third quarter, and we will work as hard as we can to do a little better while we are managing the further runoff of purchased loan accretion, and continuing to adhere to our disciplines in asset selection, both from a credit perspective as well as an asset sensitivity perspective.

And we have announced a couple of significant changes recently and I want to touch on those right now. First, Bill Ryan, former Chairman of TD Bank North, has joined our board as independent chairman. Now, Bill and I share a vision for banking in New England and New York, and the opportunities available for a company like ours. With his relationships, his knowledge of the market, and his banking expertise, I believe there is a lot we can do together to continue growing the value of this franchise. Suffice to say, we're all pretty excited to have him on board.

I also want to take a minute to thank Larry Bossidy, who retired from the board this last month. As many of you know, Larry has been a significant resource to the board of directors, to our executives, and of course to me personally. He joined the board as chairman when I became CEO and he has been both mentor and friend.

I have said before, you don't replace a guy like Larry. The most important thing we can do is take what he has taught us and execute on those things, and that is really all a guy like Larry wants. So I wish him all the best as he settles into yet another phase of retirement, and we look forward to continuing to enjoy his company as an investor and a friend of our organization.

In addition to the board changes, we also made a change to our charter, converting from a thrift to a commercial bank under Massachusetts statutes. Now, this has no immediate impact on us or our customers, but it does give us greater flexibility with respect to the future commercial lending since the bank will no longer be required to comply with the qualified thrift lender test.

Together with this charter change, we also ended our membership in the Depositors Insurance Fund. Our customers will, however, continue to be covered by the FDIC insurance and we don't expect any significant impact from this change.

We have done a lot in the last year to retool our business. We right-sized our expense structure and we brought in new executive management. We upgraded our commercial and finance teams, and we have improved materially our analytics for day to day decision-making. And we did this while retaining all of our key personnel. In fact, we saw increased commitment and increased energy from our people.

One of the reasons Bill Ryan agreed to join us is the strength of our culture. And I think these past several quarters show just why culture is so important. So I am pleased with the progress we have made in the last year as we build on our franchise investment. But, believe me, we understand this is a start, not finish.

Our focus continues to be on our performance goals, improving our efficiency, and our returns for shareholders. I think we have built a unique franchise in New England and New York with a footprint in a culture, frankly, that are difficult to match. We are comfortable with our capital levels and our double-digit internal capital generation, which is consistent with our long-term goals for balance sheet growth and positive operating leverage.

And, as we move into the back half of the year, I am confident about the opportunities in front of us. And we are committed to delivering strong results to those who have invested and those who will invest in this enterprise. That is our obligation. That is our promise. And we are fully committed to it.

And, with that, I will open it up to any questions.

(Operator Instructions) Mark Fitzgibbon, Sandler O'Neill.

I wondered if you could sort of comment on your long-term outlook for expense growth, excluding acquisitions, how you are thinking about expenses and perhaps your goals for the efficiency ratio long term.

Well, as you know, we know we have to get our efficiency ratio down under 60%. And, frankly, we all believe that the mid to high 50s is an area where we can operate and operate effectively. So, on a long-term basis, Mark, that is it.

Now, positive operating leverage is going to be the key to us getting to that efficiency ratio, and so there will continue to be a disproportionate increase in expenses to income. So I see that as the road to that efficiency ratio, rather than taking a lot of expense out from this point on.

Okay. And then, secondly, I wondered if you could share with us the duration and the cost of those broker deposits that you added in the second quarter.

Sure. Jo?

Sure. Mark, we added about $288 million and most of those are 1 to 12 months, average nine-month period. And we paid about 55 basis points for them.

Okay. Super. And then, Mike, I was curious if you could sort of share with us some macro M&A thoughts, what you are seeing out there.

Well, sure, Mark, and I am not sure that I am seeing anything other than what anybody else is seeing, which is not a ton. There is activity, I think. I think people are having conversations, and we may see towards the end of the year and next year some potential consolidations and some partnering. Frankly, our priority right now is to improve the performance of the Company, so I may not be as in the know as I've been in the past.

Matthew Kelley, Sterne, Agee.

Just a couple of questions here. What was the C&I utilization rate? Any improvement versus the first quarter or year-over-year?

George?

It has been very steady, still around low 60% -- 60%, 61%. Utilization for ABL is even lighter in the high 50s.

Okay. Got you. And then, the home equity growth, what were the yields on that balance growth? And is that a promotional program that is ongoing? And what should we expect there?

Sean?

From a yield perspective, that new business is coming on approximately at prime; no promotional increases. I think it is just based on the expanded footprint as well as the expansion of net new customers to the organization.

Okay. And then, the securities book was up a little bit, but it sounds like you might take that back down to fund some of the loan growth and have a little bit of a remix. Is that an accurate assessment?

Yes. Exactly, Mark. As you see, it is up about $50 million for the quarter, but it did contribute $1.6 million of income to the quarter.

Okay. And from that $1.2 billion base directionally, is it flat or down over the next year?

From the $1.2 billion, is it flat or go down over the next year?

It will go down.

Got it. I missed the -- what you were going through the guidance there. Could you repeat again what you said on the loan loss provision?

Yes. It was elevated in Q2, given the surge of loan growth. And we expect that to kind of come back down to the mid-3s in Q3.

Okay. Got it. And then, the core margin, which you talked about having 3 to 6 basis points of additional compression in 3Q, if we just stay in this current rate environment, where would you anticipate the core margin troughing out?

What do you think, Rick?

Somewhere north of [3.10].

Yes. I would agree.

Okay. So, not a lot of compression on the core left. Got you. I think that was it. And then, what is your expectation for mortgage banking -- the gain on sale line item there as we head into 3Q? And what are the pipelines like, and what have you seen just over the last couple of weeks here?

What are you seeing, Sean?

I think Q3 will look a lot like Q2, Mike. Obviously, we are originating in New England. We are moving out of a really tough winter, so I think that helped us this quarter. So, from a modeling perspective and from our expectation, we think it will look a lot alike.

The pipelines are healthy. We are looking at over $100 million from a pipeline perspective. So I hope that helps.

Collyn Gilbert, KBW.

I was wondering if you could just give a little bit more color as to sort of the structure or types of loans that you guys are putting on this quarter on the C&I side and CRE side. And, Mike, I just want to clarify your comments that the CRE -- some dynamics will cause CRE not to be as strong in the third quarter, but does that mean balances fall because of these paydowns? Or you just don't see as much of growth?

No, it won't fall. George, you can.

This is George. I think we continued our emphasis in our momentum that we had in the first quarter. As Mike mentioned, there were a few items that sell into the second quarter, a couple of payoffs that we anticipated in the second quarter that got pushed into their quarter. Our pipelines are continuing strong.

I think what's different here is that we are seeing activity -- strong growth in all of our markets, so our geography is really helping us. When I look at some of our larger new relationships that we have in the second quarter, we had a larger one in Boston. We had large in Albany; Hartford contributed, Syracuse contributed, another Boston-based ABL loan. So we are really starting to see activity from all the regions, which really bodes well for the future.

Do you think we will see mid-single-digits commercial real estate next quarter? (multiple speakers)

I do. Yes.

Does that help, Collyn?

Yes. That helps. Thank you on that. And then, just on the broker deposit side, Josephine, what is your appetite there? How big could you take that portfolio? Or are you targeting a certain percentage of overall deposits to stay in the brokered?

Yes. As I said, it was part of our strategy. We spoke in Q1 about our active balance sheet management and what we saw in the brokered market was an attractive alternative to a borrowings rate. I think from an internal perspective, we are probably about 6% of total assets right now. We don't see that growing above 10% and that is really the limit that we are measuring to.

Okay. So, 6% total assets not going higher than 10%.

Correct.

Okay. That's helpful. And I just wanted to confirm, if you could, the dollar amount of swap income that you saw this quarter. I know you said it was elevated, but just wondering if you had an actual dollar amount there.

I don't have that detail on hand, but I can follow up with you.

Okay. I also wanted to just clarify your comments about the tax rate. So we should assume that rate for the back half of the year?

It is still the 30%.

The 30%, okay. Okay. And then, Mike, one just final question on capital. You had indicated that you feel very comfortable with your capital levels. Could you just expand on that a little bit more?

I mean, what is it -- what is the ratio that you are looking most closely at? I'm just kind of curious, is this growth here -- it sounds like you guys have a path now for some really -- some meaningful growth, so just trying to think a little bit more -- a little deeper on that capital question.

You know, I -- and, Jo, you can add to this, but one of the things that we have dug in pretty deeply on is how much of our internally generated capital will that support from the standpoint of earning asset growth. And, based on the earning asset growth that we have in our long-term planning, exclusive of everything else, through positive operating leverage, our internally generated fund supports that. And it keeps us at capital levels that we are at or higher. And those are fine.

Okay. So it is more of a maintenance of where you are now versus the build, but sufficient enough to support the growth.

Well, I think it will actually grow. I mean, it is not going to grow with this batch, but we will definitely grow capital through internally generated funds, because there is enough in that internally generated route to fund the earning asset growth and add the capital.

Okay. That's helpful. And are you thinking mostly on a tier 1 basis or a tangible common equity basis?

Both.

Collyn, real quick, I just wanted to follow up on your question regarding swap income. It was $1.2 million.

Great, okay. Thank you.

This concludes our question and answer session. I would like to turn the conference back over to Mr. Daly for any closing remarks.

Terrific. Well, thank you, everyone, for joining us. We certainly look forward to speaking with you again in October when we have a chance to talk about our third quarter results.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.