Beacon Financial Corp (BBT) 2017 Q2 法說會逐字稿

Good day, and welcome to the Berkshire Hills Bancorp second quarter earnings 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 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.

As a reminder, none of today's discussion is intended as proxy solicitation. Our remarks 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'll turn the call over to CEO, Mike Daly. Mike?

Thank you, Ali. Good morning, everyone. Thanks for joining us this morning for our second quarter call. I'll provide an overview of the quarter, and then I'll turn it over to Jamie Moses, our CFO, who'll walk you through some of the specifics in our financials, will discuss our outlook, our guidance, and then I'll wrap it up.

So it was a good quarter for us. We delivered 11% growth in core earnings. We had double-digit annualized loan growth with good operating leverage, and we improved profitability. We also executed a merger agreement to take us over $10 billion. We completed an equity offering and we announced our plans to move our headquarters to Boston. So it's been a busy few months for us, but I really believe that the benefits of a lot of hard work from a cohesive employee base and our previous acquisitions and organic strategies are coming together. We boosted our returns this quarter, driving core ROA to 92 basis points, and we believe this performance ratio will improve even further in the third quarter. Annualized loan growth was 13% quarter-over-quarter, including 10% annualized commercial growth. This was led by significant gains in C&I. As you know, we've been working hard on driving more C&I growth, refocusing our teams and hiring new lenders in several markets, so I'd expect us to continue to see good results here.

On the regional level, we're having success in central New York where there's a fair amount of economic activity, and our relationships continue to grow. We also saw growth in Western Mass, and we're seeing a pickup in ABL activity in Eastern Mass and the Mid-Atlantic this year. Mortgage balances were up for the quarter, including growth in adjustable-rate mortgages as well as our short-term leverage strategy for the new capital, and Jamie will touch on that in just a few minutes. But with a clear path past the $10 billion threshold and additional capital, we do expect to continue to produce solid commercial loan growth for the remainder of the year. Total annualized loan growth is expected to be in the mid- to high single digits for the third quarter.

On the deposit side, we had 4% annualized growth in the second quarter. And we expect seasonal commercial demand deposits to bounce back in the second half of the year, so we expect overall annualized deposit growth to be no less than mid-single digits again in the third quarter. The deposit pricing has so far remained resistant to the move-up in Fed funds. Base rates have seen little to no movement in our markets. And while pricing on CDs has inched up as the deposits roll over, the beta has remained significantly below the rate hikes. Meanwhile we're going to closely monitor our markets for changes in behavior.

Our fee income grew 15% quarter-over-quarter, in line with our expectations. The SBA business contributed $2.5 million to that number, and mortgage banking fees were up 28%. We originated $680 million in held-for-sale mortgages this quarter with new production coming on 75% purchase. That's up from 70% in the first quarter. For the third quarter, we expect to see fee income grow in the mid- to high single digits led by mortgage fee revenue, further growth in loan fee income and stable wealth management, insurance and deposit fees. As we've noted in the past, some of this revenue will be offset by corresponding expenses, but the overall growth is expected to have a positive effect on earnings. Now with that, I'm going to turn it over to Jamie, who'll give you some additional financial detail, and then I'll wrap it up. Jamie?

Thanks, Mike, and good morning, everyone. It was another strong quarter for us. We're demonstrating positive operating leverage, improving our profitability and maintaining a strong credit profile while growing the business. Core EPS was $0.58 for the second quarter, and GAAP EPS came in at $0.53, primarily reflecting acquisition activity.

Average earning assets grew 2.5%. Our net interest margin was 3.36% for the quarter and 3.24% excluding purchased loan accretion. The increase in margin this quarter was primarily due to the positive effects of the recent rate hikes coupled with some outsized prepayment penalties. For the third quarter, we expect the short-term leveraging of the new capital to bring the margin down by about 5 basis points. I'll touch more on that in a minute. Purchased loan accretion for the second quarter came in at $2.6 million, $2 million of that attributable to recoveries. We expect total purchased loan accretion to remain near this level in the third quarter. The provision was $4.9 million in the second quarter, exceeding net charge-offs. We don't expect any significant changes to our overall credit or charge-off levels in the third quarter, and we anticipate our provision will be in the area of $5 million again. We continue to feel that credit is performing strongly, and we are disciplined in managing our credit selection and concentrations.

Moving on to expenses. The 6% increase in operating expense quarter-over-quarter was primarily tied to increased loan production, particularly mortgage and SBA. The efficiency ratio improved slightly to 61.7%. Importantly, stripping out the First Choice mortgage business, the bank operated at a 58.7% efficiency in the second quarter. We expect a low to mid-single-digit increase in operating expenses in the third quarter relating to the fee income growth that Mike mentioned earlier. Our core tax rate for the second quarter was 30%, including the benefit of some small tax credit investments. This is slightly higher than we guided to last quarter, as one of the historic tax credit deals we were working on slipped into the third quarter. That particular deal has already closed, and we expect a couple more deals to close this quarter, bringing our core tax rate for Q3 down to the 25% to 27% range with a corresponding charge to noninterest income of approximately $3 million. We still anticipate the 2017 full year core tax rate to be around 27%.

Looking at the big picture, we expect to deliver $0.58 in core EPS in the third quarter with only $0.01 or $0.02 of noncore charges tied to acquisition. Factoring in the additional shares, this would result in a mid- to high single-digit increase in core earnings quarter-over-quarter on the heels of the 11% increase in Q2.

We are pleased with our progress this quarter toward our profitability goals. Core ROA improved to 92 basis points, and we expect to do at least that well over the next couple of quarters. Core return on tangible equity came in at 12%. Due to noncore charges, GAAP return on assets was 84 basis points for the second quarter and return on equity was 7%.

As a result of our recent capital raise, at quarter-end, our tangible equity was 9.2% of tangible assets. We initially used some of the $150 million in proceeds to pay down borrowings and then began the process of leveraging the capital. As discussed on our May conference call, $100 million of the raise will support the Commerce transaction, so we are intensively investing in shorter-duration assets including CMOs. This strategy impacts our NIM in the short run and factors into our Q3 guidance. As Mike mentioned, we also added to our mortgage portfolio, and we will be increasing our BOLI exposure. The rest of the funds will be used to support commercial growth. The net effect of this strategy is to offset some of the share count drag in our EPS while continuing to drive ROA north. We estimate that the diluted share count will average around 40.3 million shares in the third quarter. We are pleased with our performance this quarter and excited about our prospects for delivering solid results for the rest of the year. Our financial condition is good, and we expect to continue to make progress on our strategic goals.

With that, I'll turn it back over to Mike.

Well, thank you, Jamie. So as Jamie said, we're expecting mid- to high single-digit growth in core earnings next quarter, but of course with the increased share count, our core EPS is expected to be flat. Importantly, these results should translate into a core ROA in the mid-90s and stable efficiency.

And for the full year, we continue to anticipate core EPS growth in the 3% to 4% range, which is the equivalent of the high end of our original guidance when you take into account the impact of the recent share issuance. We also expect stronger loan growth and the core ROA to improve into the 90s for the year. Now this guidance doesn't include the impact from Commerce, as the expected timing of close is, of course, still unknown. Our local regions continue to show signs of optimism, and we're looking to capitalize on that while continuing to adhere to our credit disciplines.

The team at Commerce has been terrific to work with, and we look forward to solidifying that partnership in the months ahead. Our strong integration history gives me confidence in our ability to hit the ground running and continue to build on the expanded platforms. We're anticipating a great cultural fit and smooth transition for customers and employees.

I've been spending much of my time in the Boston area lately, meeting with customers and employees as we thoughtfully build out our presence there. I'm pleased with the response we've gotten so far and the relationships we've been able to further develop. We've also been identifying talent in this market, and we're pleased with the reception we're getting in this regard. Now as you know, it's a competitive market but also one where we believe we can be effective.

Now let me touch on our preparations for crossing $10 billion. We're comfortable with the work we've done leading up to the Commerce acquisition, and we've been running internal DFAST-ready stress tests for 2 years now, and we'd anticipate a dry run with regulators next year, ahead of our first official filing in 2019. As I've said in the past, we've got the people and the systems in place to support our growth well past these asset levels.

Over the next several quarters, however, we're going to be entirely focused on growing our organic business, closing and integrating our acquisition of Commerce Bank and opening our new headquarters in Boston. We expect to deliver strong results over this period, and that momentum should benefit all of our constituents. And with that, I'm going to open it up to any questions.

(Operator Instructions) Our first question comes from Mark Fitzgibbon of Sandler O'Neill.

Mike, just to clarify, I thought you had said you expected earnings in the third quarter to be $0.57 but then later you said they would be flat. Did I hear incorrectly? Because flat would imply $0.58, correct?

Yes, that's the correct number. I don't know if I said it or you heard it somewhere else, but the $0.58 is the correct number.

Okay, great. And then how much in tax credit investments do you plan to make in the third quarter and also maybe some sense for fourth quarter expectation?

Mark, it's Jamie. We expect that we're going to do a little bit of that in Q3 and Q4. That's going to bring down the Q3 and Q4 tax rate in the 25% to 27% range or so. And we expect then the full year core tax rate to be about 27%, which is right in the middle of the guidance that we had talked about at the start of the year.

Okay, great. And then, Jamie, is it possible you could give us maybe a little more detail on the mortgage banking income line, maybe the approximate gain on sale margins and what the mix of originations look like?

Yes. So the originations came on at, I think as Mike said in the script, 75% in the purchased category. And I guess kind of the way to think about it, Mark, we don't have this accounting segment broken out here. But I think the way that we're thinking about for you guys is probably in the 30 to 35 basis points range in terms of profitability dropping to the bottom line.

Okay. And then do you have handy by chance the size of your commercial loan pipeline?

Sure, Mark. Sean here. It remained strong, approaching the $150 million mark. I think we've got a good spread amongst all geographies with C&I remaining the focus but a little bit more balanced growth of C&I and CRE on a go-forward.

Okay. And Sean, I know it's early, but the Boston office on Congress Street there, can you share with us any, sort of, early data on loans and deposit side at that location?

Yes, going well. Organically, that Boston office in and of itself has driven about $15 million in deposits. We look at this post the Commerce acquisition. We will have 4 branches in Boston, which will be a great platform. Within those 4 branches, we'll have about $350 million in collective deposits and the bank in Boston will have close to $2 billion in overall assets. So we feel, post-Commerce, it's a great entry and a great platform to really increase our production in that Boston market.

Our next question comes from Laurie Hunsicker of Compass Point.

Just to follow up on Boston. I guess the marketing expense jumped that we saw, linked quarter, from $2 million to $3.2 million. Is that somewhat related to Boston? Or how should we think about that as you continue to push toward Boston?

Laurie, Sean here. That had nothing to do with Boston. What that is, is additional marketing related to the additional production we saw in mortgage this quarter. It was within our expectation and within our budget.

Okay. And so how should we be thinking about that line going forward?

Laurie, I think you should think about it in terms of seasonal -- seasonality tied to the mortgage production, so maybe about the same or a little bit higher in Q3 and then dropping down into Q4.

Okay. Okay. And then as we look at pro forma Boston, and pro forma right now, just overlaying Commerce, you are $265 million in deposits, the way that I guess I'm screening it per us now. How do we think about that if we fast forward a year or 2 years? How -- where do you want to see your Boston footprint with respect to your overall franchise value?

We see that as the area of -- most ripe for growth. But one of the things that we see as advantage to us from a opportunistic perspective is the geographic diversity we have. We're very particular from a profitability and a credit discipline perspective. So we'll remain opportunistic rather than pigeonhole ourselves to growth in a particular area. But we do see the contribution from that marketplace to continue to be a major factor on a go-forward.

Okay. All right, and then the merger charges of $2.9 million, that was all related to Commerce? First Choice is completely done, is that correct?

No, no, it was about 2/3 related to Commerce and 1/3 related to First Choice. There would be a small tail in Q3 related to First Choice but not more than $0.01 or $0.02 in terms of noncore charges in Q3.

Okay. I thought you guys had mentioned last quarter that First Choice was all done in merger charges? Was there something else that came up or did I mishear that?

There's just a small tail that's left in Q3. We thought it was all going to be finished up in Q2. Some things came in towards the end.

Laurie, on our last call, this is Ali, we said that we thought there was about $2 million worth less than we thought it would be in Q2. We're going to come in total less than that even though there's just a little bit left.

Okay, okay. And then with respect to Commerce, can you update us on their $103 million taxi portfolio?

We really can't get into a lot of detail on Commerce right now. The S-4 would be out probably in the next several days, Laurie, and so we're kind of precluded to get into any information on Commerce at this point.

Okay, okay. And then just lastly, on Firestone, can you give us where you are in loan balance, new originations and nonperformers?

Yes, Laurie, this is Richard. Ended the quarter at $226 million, which is about 2% growth quarter-over-quarter. Originations were about $30 million for the quarter. NPLs came in about $1.9 million versus $1.8 million at the end of the first, and charge-offs for the quarter were 25 bps, about $140,000 versus the $700,000 in the first quarter.

Our next question comes from Collyn Gilbert of KBW.

Just to go back to follow up on some of the questions. Can you, Jamie, just talk a little bit more about sort of this seasonality that we should be expecting in the mortgage banking business? And I guess, part of my question there is that your mid- to high single-digit core fee income growth linked quarter seems strong, really strong especially relative to what you put up this quarter. So just trying to frame that as we kind of look out for the rest of the year, how we should be thinking about the volatility there?

Yes. Collyn, thanks. That's -- I think that's a good number for Q3. There is going to be seasonality in that mortgage business. Q3 is going to be the highest in terms of expenses, and then we think we should come back down to around the same levels of Q2, in between Q2 and Q1 in terms of expenses in Q4. And that would generally be the pattern of the seasonality in the mortgage business and, of course, that can be affected, obviously, by things that happen in the macro markets in terms of interest rates. But I think that's about the right way to think about it.

From the fee income -- the fee income guide, Collyn, also include some seasonality in the SBA business, so that business too has a higher Q2, Q3 and then tailing off a little bit.

Okay, okay. That's helpful. And then just back to the marketing number. I mean, it's a big number. Is -- was there something -- I know you said it was tied to loan production, but is there also something else that goes on in the second quarter within First Choice's mortgage business that, that marketing number is going to be elevated? I'm just -- just a big number to try to reconcile.

No, Laurie -- nothing, no, Collyn, nothing else coming through. Essentially, it's going to be a derivative of volumes as a percentage and continue on this path.

Okay, okay. Okay. And then just on the commercial pipeline, Sean, you -- the mention -- you kind of mentioned the composition, but how about the yields? Where are you guys seeing kind of origination yields relative to portfolio yields?

We're actually seeing a slightly stronger roll-on then roll-off by low to mid-single digits in that perspective.

Okay. And then on the deposit side, the pricing side too, Mike, I know you said in your opening comments that despite the Fed move, we're not -- you're not seeing much deposit pricing pressure on the core products. Can you just talk a little bit about the competitive environment as it relates to deposit pricing? And maybe, Sean, how you guys are positioning yourselves kind of going forward as you think about deposit pricing competition?

Yes, of course, that's the benefit of the regionality of the franchise in the rural markets, but, Sean, you may want to give some color on that?

Yes, we -- obviously, the New Jersey market, Boston market, from a macro perspective are more competitive. You do see higher deposit rates. We set our thresholds based on profitability and mix and then mine our entire geography, and we're bullish that we will be able to continue to do that and maintain the appropriate cost of deposits that fund the franchise.

And Collyn, I'd just add one thing to that is that in terms of our base rates across our geography, we're not seeing much of a change to those, if any. The sort of changes in rates that we see are tied to time deposits, which I suppose you would expect in -- when rates rise. And so -- but we're not seeing betas that are anything approaching historical averages. They're much lower than that.

The larger bank market leaders have remained disciplined to this point, which has helped all of this as well.

Okay, okay. That's helpful. And then just one final question, you've mentioned the press release. What's the -- and if you guys talked about it last quarter, I apologize. What's the relationship with Costco? And I'm assuming that acronym was First Choice? Or whatever the acronym was in the press release?

FCLS.

Okay. What's the specific question is...

I just didn't know what that relationship was with just -- like what that even was about, like what is that?

Okay, so we are the endorsed lender for the Costco relationship from a mortgage perspective, so we do affiliate branding and marketing, and we're very happy with it because it really drives our brand on a national level.

That's right, that's right, okay. And that was something that First Choice had had before you guys entered into the agreement with them, right? Or that's a new relationship?

Nope, something that First Choice has had for a long time, a good long-standing relationship.

Our next question comes from Matthew Breese of Piper Jaffray.

Just a follow-up on that Costco question. I know when the deal was first announced that they had -- they were with Costco and then Costco drove a lot of refi business, but now the composition's switched where it's more purchase versus refi. Now I was just curious if Costco has moved in kind. Have they move more towards purchase?

Yes. The Costco team, our Costco team based out of California, it's a fantastic team. They have been able to move in kind and mine that purchase activity more. I think that's a derivative of the strength of Costco's membership and the brand loyalty they have that translates over as market conditions translate. And it's also a testament to the leadership of the overall FCLS team that they've built the team with purchase-oriented LOs, and we'll continue to be able to keep that strong pace.

And of the overall mortgage banking activity, how much is -- stems from Costco?

Costco still remains under 1/3 of the overall activity. So we haven't seen -- no additional jumps in Costco. The blend has remained consistent from the early FCLS days.

Okay. And then I just wanted to get a firm handle on the margin this quarter and the outlook for next quarter. So the 3.36% headline, you had the accretable yield to the core is 3.24%. How much of the 9 basis point increase was due to prepayment? And how much was due to the leverage strategy?

So thanks, Matt, for the question. So 9 -- there's a 9 basis point increase as you highlighted. A lot of that is due to prepayments. A lot of it is due to just the rate hike activity that we saw heading into Q2. And then there was a little bit of -- we paid down some borrowings towards the end of the quarter based on the leverage strategy that we had. And I guess, I would say from a go-forward standpoint, as we highlighted in the script, we're going to see about a 5 basis point decrease in the NIM, and that's primary going to be based on the leverage strategy that we have over the back half of the year.

Okay, and -- but that's all-inclusive, like you're not backing out the prepayment and then applying the other 5 basis point decrease?

Yes. No, that's all-inclusive. That -- our guidance of 5 basis points is where we think we'll be.

And then do you have any idea of where the blended NIM will shake out once Commerce is completed?

We don't have that broken out exactly yet, Matt, but we expect it's going to be -- we expect to be pretty flat in terms of NIM.

And then the one thing in the press release I noticed was the alliance with Princeton Advisory Group. Can you just talk about what that is? What the benefits are, the cost, the expenses, just more color?

Sure, Matt. Sean here. It's a strategic partnership so there's no cost to us. But what we provide is private banking and deposit services for their customers. So what that did was open up another wealth management book for us to provide our banking and deposit services to, helps them insulate themselves from some larger institutions that may pirate those customers. What we get is they supplement our wealth banking offering. They have a professional athlete offering. They have a multitude of different offerings that allows us to build our scale in wealth management in a very practical sense down in New Jersey over time. So a great partnership from both ends that really has no cost with strategic upside.

Good. Can you quantify the upside? Or is it more or less gravy if it works out well?

I think it will be gravy as it works out to this point, but I think it then opens up additional partnerships with other organizations over time.

Understood, okay. My last question, Mike, you noted in your commentary that activity in upstate New York was a little bit better. And I was just curious, was that a quarterly phenomenon or are you just seeing in general better activity in those markets?

Well, we've said for some time that the chip manufacturing that's going on there would begin to show signs of real economic activity. And at this point, this is just a continuance of what we've seen over the last few quarters, so there's nothing major that's occurring other than there's the maturity of a market that we've been expecting for some time, and the economic activity in that market is positive and it's solid, so we're taking advantage of it.

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

Okay, well, I appreciate everybody joining us today. We look forward to speaking with you again in October. At that point, we'll discuss our third quarter results.

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