Beacon Financial Corp (BBT) 2016 Q3 法說會逐字稿

Good day and welcome to the Berkshire Hills Bancorp Q3 earnings release conference call. (Operator Instructions). Please note this event is being recorded. I would now like to turn the conference over to Allison O'Rourke. Please go ahead.

Good morning and thank you for joining this discussion of third-quarter results. Our news release is available on the Investor Relations section of our website, berkshirebank.com and will be furnished to the SEC. None of today's discussion is intended as a proxy solicitation. Our discussion will include forward-looking statements and actual results could differ materially from those statements. For detail on related factors, please see our earnings release and most recent SEC reports on Forms 10-K and 10-Q.

In addition, certain non-GAAP financial measures will be discussed on this conference call. References to non-GAAP measures are only provided to assist you in understanding Berkshire's results and performance trends and should not be relied upon as financial measures of actual results or future projections. A comparison and reconciliation to GAAP measures is included in our news release. And with that, I would like to turn the call over to CEO, Mike Daly. Mike.

Thank you, Ali. Good morning, everyone; thanks for joining us this morning for our third-quarter call. I will provide an overview of the quarter; then I will turn it over to Jamie Moses, our Chief Financial Officer, and Jamie has settled right in with his team and he will take you through some of the specifics in our financials and then I will wrap it up.

So it was a solid quarter for us. We delivered $0.57 in core EPS. That's a 6% increase quarter-over-quarter and $0.53 in GAAP EPS. The results reflect the disciplined balance sheet management, significant revenue gains and continued efficiency improvement. Now the team has executed on our fee income strategies; they've made good progress towards our profitability goals; and moved ahead with our preparations for closing the First Choice acquisition later in the quarter.

We had solid loan growth this quarter with commercial lending delivering 6% annualized growth, primarily led by our New York and Connecticut markets. And I would add we are mindful of commercial real estate levels and we've been managing the portfolio to stay below those regulatory thresholds and the pipeline for C&I loans has also picked up, so we expect to see further growth there as we go forward.

Our overall commercial pipeline does remain solid, but we are also committed to remaining selective, especially with underwriting and profitability. Taking that into account, total commercial loan growth is again expected to be in the mid-single digits in the fourth quarter. And I will just note that all of the guidance I'm giving for the fourth quarter is organic guidance and does not include the impact of First Choice. Their shareholder vote is coming up in a few weeks and we will let that process take place before addressing more specifics of our closing plans. And we do expect modest growth in consumer and residential lending in the fourth quarter, as we continue to use sales of these products to balance margin and asset sensitivity goals when market opportunities occur. Overall, fourth-quarter organic loan growth is expected to be in the low to mid-single digits.

Now turning to deposits, we had a very strong quarter for demand deposits, which grew at a 24% annualized pace. I think we are doing a better job of mining commercial relationships, which is helping to drive growth in this category. We expect overall organic deposits to grow in the low to mid-single digits, as well in the fourth quarter, so similar to overall loan growth.

Our net interest margin for the third quarter was 3.25%. The margin before loan accretion was 3.13%. Now this included the impact of the final tranche of forward-starting balance sheet swaps, which are now fully baked in. So we expect the margin, ex-accretion, to hold flat in the fourth quarter.

Now turning to fee income, we are delivering on our strategy here and I am pleased with the results we are seeing from 44 Business Capital, our Philadelphia-based SBA group. Total fee income was up 17% over the second quarter with about $1 million of that attributed to SBA loan sales. We also benefited from strong demand and favorable market pricing in the mortgage market. For the fourth quarter, we expect most of our fee lines to continue at a minimum at these levels, except for, of course, seasonally lower mortgage fees.

Now, before I turn it over to Jamie, I want to touch on some expense initiatives. The team has been doing a good job managing expenses this year and it's the kind of thing we need to stay focused on, especially in light of the $10 billion threshold. Now, as many of you know, I've been reticent to get out ahead of ourselves on costs and plans associated with crossing $10 billion. We wanted to be sure, we needed to be sure of our estimates and our regulator views. Well, we are at that point. So here is the breakdown of what we've absorbed and what we plan to absorb as we thoroughly prepare for that eventuality.

Over the last three years, we've implemented a full enterprisewide risk management system. We've implemented new compliance systems and software. We've implemented a new asset liability management system and these infrastructure investments, which are a necessity for a bank operating over $10 billion, cost us around $5 million to implement. Now we've also added over 40 people to our compliance and risk departments during this time, accounting for over $3.5 million plus another $0.5 million in ongoing system expense, so over $4 million right now baked into our current run rate.

Also included in this run rate, we spent $750,000 this year on DFAST readiness and we expect to spend an additional $1 million in 2017 as we work through our first dry run with the regulators and then anticipate the ongoing run rate to be about $1.5 million to $2 million a year.

Now Richard is going to be available during Q&A to give more color on this if needed, but, at the end of the day, that accounts for almost 85% of the costs associated with crossing $10 billion already included in our run rate. The only additional compliance expense we anticipate at this time will be people, which will directly correlate with how quickly we scale the business.

Now the strategy remains to find the right combinations that allow us to get to around the $12 billion asset range, absorb the impact of Durbin and continue to improve profitability. Now we've got time to do that, so, in the meantime, it's business as usual.

Now one more comment on expenses. As you know, we've been active in evaluating and adjusting our branch network each year. We completed the sale of two branches in August and at this point, we've identified an additional three branches for consolidation in early 2017. Now that makes 36 branches closed, sold or consolidated over the last five years and we've done that while maintaining our organic growth and expanding our customer services and marketshare.

We also announced the opening of our first full-service branch on Congress Street in downtown Boston. That is scheduled for the first quarter. Now the new branch will use virtual teller technology complemented by full-service MyBankers, private bankers and loan officers. We are excited to enhance our strong lending operations in Boston with a branch presence, especially one that uses the latest technology to provide convenience to customers and of course, cost saves to us. Now, with that, I'm going to turn it over to Jamie. Jamie.

Thanks, Mike and good morning, everyone. This was a good quarter and we feel good about where we are going. We continue to be focused on profitability and we are demonstrating solid growth and disciplined expense management in what remains a challenging environment. As Mike said, core EPS came in at $0.57 and GAAP EPS came in at $0.53 for the third quarter. Our GAAP EPS reflects the impact of non-core charges associated with the recent acquisitions and restructuring.

With good balance sheet management and strong fee income growth, net revenue grew 7% this quarter. Average earning assets grew 2% and are expected to be flat in the fourth quarter taking into account lower securities balances to end Q3. Purchase loan accretion for the third quarter was $2.2 million. We expect recoveries to be bouncy and scheduled accretion to wind down. Total purchased loan accretion, including recoveries, is expected to be lower in the fourth quarter.

Moving now to expenses, where I believe we are demonstrating good discipline. Revenue growth outpaced expense growth creating positive operating leverage. The increase in core non-interest expense was primarily driven by compensation tied to our fee income drivers. We expect organic expenses to come back down in the fourth quarter as some loan production costs roll off.

Our core tax rate for the third quarter was 30%, including the benefit of some small existing tax credit investments. We still anticipate the full-year core tax rate will be in the 27% range, which means that, for the fourth quarter, we see the core tax rate dropping to about 23% with a corresponding offset of about $3.5 million charged to non-interest income.

The additional impact to the bottom line of the lower tax rate in Q4 is negligible due to the structure of the deals. Taken together, we expect to organically deliver $0.57 in core EPS in the fourth quarter. This would result in a 6% increase year-over-year with stronger revenues offsetting a higher tax rate.

Our GAAP earnings will be affected by the acquisition of First Choice. The exact impact of charges on the fourth quarter is to be determined, but we expect to deliver the total deal costs on plan when the merger is completed and integrated. We are pleased with our progress this quarter toward our profitability goals. Core return on assets improved to 88 basis points and core return on tangible equity came in at 13%, moving our metrics in the right direction. Including non-core charges, the ROA was 82 basis points for the third quarter and return on equity was 7.3%.

At quarter-end, our tangible equity was 7.7% of tangible assets. Tangible book value grew 2% quarter-over-quarter to $18.78 per share and book value per share grew 1% to $29.97, so there is good movement on the capital front. Also good results on credit, which remains very strong and we intend to remain selective taking advantage of our specialty lending platforms and diverse footprint, emphasizing relationships, margin and profitability. We don't expect any significant changes to our overall credit or charge-off levels in the fourth quarter and we anticipate our provision will be in line with our Q3 level.

We are happy with our performance this quarter and our prospects for delivering solid results in Q4 and beyond. While there are headwinds, we see opportunity for profitable growth and we are making strides on diversifying our income streams. Our financial condition is good and we expect to make further progress towards our fee income and profitability goals. With that, I will turn it back over to Mike.

Thank you, Jamie. That was solid. So, as Jamie said, we expect to deliver another solid quarter in Q4 on an organic basis and that would mean a 6% increase in core EPS in 2016; a double-digit increase in net revenue and steady improvements toward our profitability and fee income goals. So a pretty good year.

Now, in the meantime, I want to touch on some high-level 2017 guidance. Assuming a December close for First Choice, we expect the combined organization to grow loans at mid-single digit pace with deposit growth to match. We are looking at 1, maybe 2 bps of organic margin compression each quarter, assuming a flat rate environment. And I would note we expect to see more pronounced seasonality tied to the mortgage business with stronger quarters of course in the middle of the year.

Now, lastly, an additional comment on taxes. We do continue to pursue the historic tax credit strategy with our local customers. The guidance from the IRS over the summer actually provided some clarity on the value of these deals and that combined with our current pipeline means our annual tax rate will remain in the 25% to 30% range for the next two years.

Now this equates to about a penny a quarter in EPS benefit once you take into account all the offsets. So all in, we are targeting EPS growth in the 5% to 7% range for 2017 with marked improvement toward our goal of a 1% ROA.

Now there continue to be challenges facing the bank industry, but as we look ahead, I am optimistic about our ability to take advantage of the franchise we've built. Our near-term focus will be on closing and integrating the First Choice acquisition and getting to know our new market there. Our strong integration history gives me confidence that we will hit the ground running and continue to build on our expanded platforms. I feel good about the franchise's diverse footprint and expanded customer base, the bank's culture and brand. I feel like we are set up to grow more profitably, that we've been disciplined on pricing and underwriting and that the team had a great vision in spending the time, money and resources to prepare this Company to operate at a new level of regulatory oversight well ahead of schedule.

So our outlook remains positive and we look forward to further delivering on the power of this franchise to all of our constituencies. And with that, I'm going to open it up to any questions.

(Operator Instructions). Casey Haire, Jefferies.

Good morning, guys. Wanted to talk about -- I appreciated the guidance on 2017. Was wondering -- it sounds like you guys have a little bit of work to do on getting ready for the $10 billion asset threshold. If I heard you quickly, it's $1.5 million to $2 million. But on the revenue side, it sounds like you obviously have some momentum there. I'm just wondering does that investment spend, does that take positive operating leverage off the table for 2017?

No, let me just be clear. We spent $750,000 this year on DFAST readiness. There is $1 million baked into our forecast next year and then beyond the $10 billion level, we anticipate somewhere between $1.5 million to $2 million in the run rate.

Oh, okay. All right. So the $1.5 million to $2 million is once you cross $10 billion?

That's correct.

Okay. Got you. All right, great. So switching to the NIM outlook, you guys have done a pretty good job of protecting the NIM by running down that lower-yielding securities book. Sounds like that's going to continue in the fourth quarter here. How much more room do you have with the securities book at 16.5%? How much lower can that go as a percent of earning assets?

I think we are pretty comfortable with where the securities portfolio is at the moment. Obviously, we will always take a look at where we are with regard to interest rate risk and things like that. But I think from a NIM perspective, we expect to be flat in Q4. And then we will also take a look at how our securities portfolio looks in the context of First Choice as well.

Okay, great. And on the First Choice front, so the liquidity profile at First Choice is pretty strong and it will actually, if my math is right, take you guys below 100% loan to deposits. I know the guide is mid-single digits for loans and deposits next year, but I know being above 100% has slowed down other banks in terms of loan growth. Would you guys be a little bit more, I don't know what the word is, maybe aggressive given that you have a stronger liquidity profile below 100%?

We will probably finish up the First Choice deal at maybe a little below 100%, but maybe right around 100% and I think we are going to remain comfortable in that 100% to 105% range if that answers the question, Casey?

Yes, it does. Thank you. And just last one on the First Choice. The national mortgage origination platform that they have is going to be a very nice addition to your fee income stream. It's also going to be pretty volatile. If I'm looking at the historicals correctly, it's been as high as [24] as low as [10], is there any clear line of sight in terms of what kind of fee contribution we can expect with First Choice onboard next year?

You are right on with your mix. We modeled it at the lower level, so we feel comfortable that the deal worked at the lower levels with higher seasonality obviously in the mid-quarters, Q2 and Q3.

Okay, great. Thank you.

Mark Fitzgibbon, Sandler O'Neill & Partners.

Good morning. Jamie, just wanted to clarify one question you had on the tax rate. I think you said you expected it to be a 23% rate in the fourth quarter. How much is the offset in other income? What do you expect that to be?

Yes. It's $3.5 million, Mark.

$3.5 million? Okay.

Yes.

And then, secondly, I notice you had I think $717,000 of restructuring expenses in the second quarter. What exactly was that for?

That's tied to executive severance.

Okay. Lastly, I wondered if you could share with us what the commercial pipelines look like right now and the complexity.

Sure, Mark. Sean here. Pipelines remain strong; approximately $150 million and we are encouraged that we are seeing a mix of about 50% C&I in that pipeline.

Okay, great. Thank you.

David Bishop, FIG Partners.

Good morning, gentlemen. In terms of the outlook next year as you budget it out, you noted the Congress Street branch opening, are you gearing up, are you budgeting much in terms of loan growth next year, do you think it's going to take several quarters to ramp up? I'm just curious if you are already laying the seeds there to jumpstart some of the growth upon the opening of that branch.

Are you talking about loan growth across the enterprise, Dave?

More just from that Boston market.

Dave, we feel really good. We feel the branch is a natural progression because we've already committed to some substantial loan growth in that market. As you know, we have a middle-market team in the Boston area. We have an ABL team that sits in that Boston area and obviously from a mortgage perspective, we are doing a good job of originating residential mortgages in that area. So the hope of the branch is more so to leverage those relationships, gather deposits and enhance the overall depth of wallet in the Boston area.

Got it. And then as it relates to 44 Business Capital, just curious in terms of how you view that shaping up coming into the fourth quarter as well?

Sure. They are doing great. There's a tremendous amount of synergy within our other divisions, so we believe we can continue at that $1 million pace and really look to $1 million to $1.5 million on a go-forward with 44 Business Capital, from an SBA fee-generation perspective.

Okay, great. And then one final question. Loan growth a little bit muted from last quarter. Just curious what impact payoffs or maybe some seasonality played in restraining some of the end-of-period loan growth?

There was some, but I don't think it was material. We were where we expected to be.

Got it.

That's right, David. There was some seasonality in our specialty lending groups and so there's also some seasoned loan sales that we had in there as well. So that's why you are seeing the number you see.

Any sense or magnitude in terms of the loan sales, dollar amount?

So forward, Dave, or --?

I'm sorry?

Are you talking about going forward or this past quarter?

This past quarter in terms of the impact.

From a seasoned loan perspective, we sold approximately $100 million in residential mortgages.

Great. Thank you.

Collyn Gilbert, KBW.

Thanks. Good morning, everyone. Just to start with the NIM discussion, it sounds like the 1 to 2 basis points on a quarterly basis of compression you guys are looking for is a little bit better perhaps I think maybe than you were suggesting coming out of the second quarter. Just trying to understand what's driving that?

Well, remember, the third quarter, we had the final tranche of the forward rate swaps in there. So that had the biggest impact on the margin coming into the third quarter. So now we are talking about basically just pure margin compression based on yields.

Okay.

That's right, Collyn. In Q3, we also did some portfolio remix that helped support the margin a little bit in Q3. We expect that to be supportive in Q4 as well. We expect a flat margin in Q4, but we also are getting closer and closer to the roll on, roll off being closer in line together.

Okay. That's helpful. And that feeds into my next question. Sean, as you talked about 50% of the pipeline being in the C&I side, where are you seeing that demand, the C&I demand and how are you seeing the pricing on some of the loans moving through the pipeline?

Sure, sure. The good news is the demand is diverse across the franchise. Most recently the Albany market has done a tremendous job and I think that's one of the advantages of having such a wide geography. From a pricing perspective, we are seeing the roll-on coming in the mid-3 and we think we can continue at that pace and of course, we are looking for full relationship cash management fees and the full bundle with those clients.

Okay. Okay, that's helpful. And then just recognizing that there's going to be volatility here on some of the fee lines commission-driven, how are you guys structuring, or how should we think about the incentive comp part of the puzzle as we look out and model for some of this incremental growth that's coming on?

Yes. I think you are going to see some seasonal uptick in expenses, but those are definitely tied to income that we are getting from those expenses. So you'll see some things tick up, but it's all tied to good stuff that we are doing.

Okay, so the incentive costs will come in in conjunction with the increased volumes? It's not like it's an accrual situation, which you will change throughout the year? It will come when the volumes come?

You got it.

Okay, okay. That's helpful.

And Collyn, I mentioned it prior, the mortgage company, the top-five executives are based on a net income compensation structure, so that should remove any additional volatility that could come from just loan production.

Okay. Okay, that's helpful. And then, finally, Mike, you had mentioned maybe a December close for First Choice. I know I am slicing hairs a little bit here, but are you thinking the beginning of December, end of December? I know it's hard to tell when you are in the hands of the regulators, but just trying to figure out what the better way to model this is.

Well, I would love to see it closed in the first part of December, but I think as you eloquently put, that's really not up to us. So our hope is is that the earliest in December as we can would be our hope and we will see if we can get it done.

Okay, okay. All right. I will leave it there. Thanks, guys. Oh, wait, one final question, sorry. Just on the tax guidance that you gave for next year, what should we assume the offset to be? Does it go back to the $1.5 million a quarter, or will it --?

No, that goes to $3 million a quarter at those levels.

So, in 2017, $3 million a quarter?

Yes.

Got it. Okay. Thanks very much.

Matthew Breese, Piper Jaffray.

Good morning, everybody. Just on the tax rate, you guys provided some pretty good guidance. I'm just curious about the nuts and bolts of that and behind the scenes on your end, what are the drivers of the volatility and how does it work?

Well, the drivers of the volatility are basically when the deals close. So what we are looking at for next year and for 2018 as well is you can expect a 25% to 30% tax rate for a full-year guidance. There will be some lumpiness depending on when those deals close, Matt. And that's tied to the offset. At those levels, again, it's $3 million a quarter in offset, but again big picture, this is about a penny a quarter for the tax stuff.

Just to add to that, if a deal didn't close in one quarter, so there was more lumpiness like you saw this quarter, 30% -- we are guiding to 23% next quarter -- the impact to the bottom line is very minimal.

Got it. And then how comfortable do you feel with the pipeline of future deals that you can invest in?

We feel really good. We've spent a lot of time making sure that that pipeline is there, cultivating those relationships and, again, as Mike said, these are relationships with our customers that we have that we feel good about, helping out in the communities as well. So we feel pretty good about that guidance, Matt.

Okay. Can you talk about how much swap fee income there was this quarter and the outlook for that line of business in fourth quarter and 2017?

Sure, Matt. So $1.5 million was swap income here in Q3 and we feel pretty good in that $1 million to $1.5 million range going forward.

Okay. Can you remind us, if there is a Fed funds hike in December, what kind of impact would that have on the margin?

So it's going to have a positive impact. It's not a huge amount. Again, we are slightly asset-sensitive at this point; maybe a couple hundred thousand dollars or something like that. It's not a big number, Matt.

Got it. That's all I had. Thank you.

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

Okay. Well, thank you, everybody, for joining us. We certainly look forward to speaking with you again in January to discuss our year-end results and so off and running. Thank you very much.

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