Beacon Financial Corp. (BBT) Q3 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to the Berkshire Hills Bancorp Third Quarter Earnings Release Conference Call and Webcast. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to David Gonci, Investor Relations Officer. Please go ahead.

Good morning. Welcome to America’s Most Exciting Bank, and thank you all for joining this discussion of third quarter results. Our news release is available in 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. Now, I’ll turn the call over to Mike Daly, President and CEO.

Thank you, Dave. Good morning, everyone. And welcome to our third quarter conference call. With me this morning are Kevin Riley, our Chief Financial Officer, and other members of the management team. We released our third quarter earnings last night. We produced $0.52 in core EPS, which was frankly a little better than we expected, and it was up 11% from the prior quarter. Our results for the quarter also showed the benefit of our growth and diversification, which I’ll talk more about in just a few minutes. We also reported that the annualized amount of our tangible equity generation increased $2.31 a share, and I see this as an important measure of the value we’re creating in our operations. Our core return on assets rose to 100 basis points during the quarter, and our core return on equity is closing at 98%. While these are improving metrics for us, I can assure you we plan to continue with steady march towards our goals of a double-digit ROE and an ROA north of 1%. I’d also add that with our acquisition of Beacon Federal, we expect to take a closer step towards those objectives. And I’m going to return to the subject of Beacon in just a few minutes as well. Our core return on tangible equity reached 15% in the third quarter. This is one of our strategic goals and allows us to share our earnings-driven capital accretion with our investors, while also retaining internally a generated capital to continue to grow our franchise organically. Hence, we are increasing our quarterly dividend by 6%, $0.18 a share, which follows the $0.01 increase that we announced last June. Our dividend continues to yield more than 3%, and we’ll manage the company to support the price appreciation potential that we see for the stock. So our team was active during the quarter as we continue to work on the successful integration of our recent CBT and Greenpark Mortgage acquisitions. We’re very proud to announce that Sheryl McQuade is joining us as our original leader in the Hartford and Springfield market. Sheryl was an important and seasoned senior manager at Bank of America. And this hire is consistent with our approach in other regional markets, which is recruit a strong and prominent leader who can leverage our strengths to develop a sound commercial banking portfolio. Now in September, we completed our core systems conversion. Many of you know that these conversions are major undertakings, and our team delivered cleanly and they delivered on schedule. Our new platform positions us over the long term for growth and development that I think will keep us competitive with the largest banks in our product and service capabilities while also providing ongoing opportunities’ proficiencies. This conversion was managed by our project management office, and I’m happy to say they can now turn their attention back to a schedule of 6 Sigma projects in line with our continuing process of re-engineering. And this new platform will allow us and provide us with a much more granular data, and we will use those analytics to guide us towards the best and most profitable products and service positions. So, we do anticipate that we’re going to be harvesting the benefits of this conversion for many years as we take advantage of its depth and we take advantage of its scalability. Of course, our most recent news was the completion of our merger with Beacon Federal just last Friday. We’re very pleased with the attitude and the customer orientation of the Beacon team, which we’re combining with our existing branches in our Central New York region. We now have 10 branches and we have approximately 800 million in deposits, servicing a combined population of close to 1 million potential customers in the Syracuse, Rome and Utica area. With this acquisition, we’ll also have our first full service branch in Eastern Massachusetts in the town of Chelmsford. In August, we also announced that we purchased a property in Westborough for a regional financial center that, I think, we’re going open early next year. These branches will further extend our capabilities in Eastern Massachusetts as we serve the many customers that we handle through our 10 commercial and mortgage lending offices in that market. Of note, we also have 2 branches scheduled to open in the Albany area in the fourth quarter, bringing our total branch count in that market to 17 offices. So, we maintained our ongoing focus on organic business growth as we increased our depth and our momentum in our footprint. That focus on organic growth produced annualized loan growth of 6% and annualized deposit growth of 5% in the third quarter. We’ve had 11% organic growth on an annualized basis since the beginning of the year, and that includes a nearly 40% increase in our C&I book. And with that strong growth, we’ve continued to manage down our commercial real estate concentration. And also, we had -- we’ve been able to continue to meet our targets for commercial lending spreads over the first 9 months of the year as well. On the deposit side, we were certainly pleased with a nearly 20% annualized demand deposit growth in the third quarter, and these were primarily personal accounts and personal balances. Our new mortgage team has recently operated with record volume, and our loan-related fee income was up 16% over the prior quarter. The recruitment of this team, it’s worked out very well for us, particularly as we increased our Eastern Massachusetts presence. With our organic balance sheet growth, our net interest income did continue to climb in the third quarter, rising at a 2% annualized rate. And of course, it’s up 13% in the last 2 quarters when you include the CBT impact. Now as we anticipated, there was some compression of our net interest margin due to the low rate environment. We estimate that the core margin compression was 5 basis points during the quarter, and we reduced our cost of funds by 2 basis points. As we discussed in our release, we also recorded a margin reduction due to the 6 basis point credit we received the last quarter on a commercial loan prepayment. We also had an additional 9 basis points reduction, which was mostly due to the non-cash write-downs and purchase accounting adjustments resulting from the higher mortgage refinancing value. On this regard, our Greenpark acquisition has really provided a perfect hedge to this impact since our mortgage business volume picks up with refinancings and our revenue gain more than offsets the revenue loss due to the temporary non-cash accounting adjustments in the margin. Now I’m not thrilled with the volatility in the margin as a result of the impact of pre-payments on these non-cash accounting adjustments. In fact, I’m not thrilled with the 5 basis point reduction in our core margin. However, with the overall revenue and earnings we’re producing, I do feel we can delay pulling additional interest cost leverage at this time while we capitalize on our market share opportunities. But I think if we’re patient and we take a pragmatic approach, this is going to produce the highest long-run revenue and earnings contribution for the company as we move into 2013 and beyond. Now, meanwhile, I’d also note that the core margin excluding those accounting fluctuations is not that far south of the 3.60% we came in for the year with, which was also part of our guidance range for the quarter. And I assure you that we are laser focused on margin management as part of our overall profitability execution. On the credit front, our asset quality metrics continue to be at favorable levels. Our risk management team, as evidenced by prior deals, continues to assess Beacon’s portfolio. And once again, I think that we are confident in saying we’re quite comfortable with the credit margins that we’ve budgeted in putting together the merger agreement. Now let me pause for a few minutes, I’ll ask Kevin to provide some more color on the third quarter and fourth quarter guidance, and then I’ll return with some closing comments. Kevin?

Thank you, Mike, and good morning, everyone. For the third quarter, we reported $0.52 in core earnings per share. This represented 11% increase over the prior quarter results of $0.47, and it exceeded our third quarter guidance of $0.49. We had nice organic growth in our loans and deposits. This, coupled with strong volumes in our mortgage production, helped us fuel our earnings growth. This quarter, we reported $0.06 in non-core charges. These charges were mostly associated with our core system conversion for the year. And for the year, our total non-core charges are going to be about $10.5 million, which is what we estimated for you at the beginning of the year before we announced our Beacon acquisition. At this time, our costs for the [indiscernible] conversion are mostly behind us. Turning to the balance sheet, we reported a 6% annualized loan growth and a 5% annualized deposit growth. With our loan growth, we continued to focus on growing our C&I loan portfolio while we managed down our CRE book. Our New York and Eastern Mass market continue to provide us with high growth opportunities as we take market share. On the deposit side, our mix improved, with checking account balances increased at an annualized rate of 19%. And looking forward, we continue to expect our loan and deposit growth to remain in the mid-single digits. In the fourth quarter, we also will be adding the benefits of the acquisition of Beacon, which closed last week. Our previous guidance on this acquisition projected that it would be completed close to the end of the year, and we are pleased that we’re able to complete this deal on an earlier timeline. I will comment later in my remarks on our expectations on the earnings impact this acquisition will have. Moving to the income statement. Net interest income grew at an annualized rate of 2% during the quarter. Now, as Mike had mentioned, our organic growth in interest income was partially dampened by the write-off of deferred origination cost and purchase cost associated with the elevated mortgage refinancing activity which occurred during the quarter. At this time, we are expecting that refinancing will remain elevated during the fourth quarter, so we are expecting our organic net interest income to growth to remain around the 2% annualized rate. And in the fourth quarter, we expect our core margin to remain around 3.50%, and we have the expectation that the margin will rebound when current refinancing activities dissipate. Currently, we are still analyzing the Beacon acquisition marks and the impact they will have on the margin. We continue to reduce our funding cost through our pricing disciplines, and we believe we do have some additional room to manage more cost out over the next several quarters as needed. This will help us offset the asset yield pressure in this current environment. We continue to remain dedicated to maintaining an asset sensitivity interest rate risk profile. At some point, we do believe we’re going to see rates rise and we want to be able to protect our earnings stream. I now move to our core non-interest income, which showed nice growth in the third quarter, with mortgage refinancing in all-time high and our recent expansion -- expanded mortgage team positioned us quite well to capture a share in this lucrative business. We’re not expecting to see this activity slow in the fourth quarter, so we are expecting similar results to that of the third. I’d also like to add that in the quarter, we also saw a tick up in income from the sale of interest rate swaps as our customers took advantage of locking up interest rates in this low rate environment. Our insurance and wealth management revenue was consistent with that of the second quarter, and we continue to evaluate growth opportunities in these 2 areas. So for the fourth quarter, we expect non-interest income to be around $14 million to $15 million. Sensitivity around mortgage-related revenues could impact our results. For the third quarter, our loan loss provision was $2.5 million, and this was in the range of our previous guidance. Our loan performance continues to remain favorable. As in the prior quarter, our provision exceeded our net charges [ph] as we built the allowance to cover loan growth and acquired portfolios. I’d like to note that our loan growth has been focused in lower-risk segments as we continued to reduce our CRE exposure. And for the fourth quarter, we are expecting provisions to be flat to that of the third quarter. Due to purchase accounting, the Beacon acquisition should have no impact on the fourth quarter provision. With the third quarter -- for the third quarter, our non-core interest expense decreased slightly compared to the prior quarter, and this is in line with our expectations. For the fourth quarter, we’re expecting this line to remain flat to that of the third quarter. By holding the line on expenses, we were able to push the efficiency ratio down to 57% in the third quarter. This continues to show our efforts to improve our operating leverage and is in line with our strategic goal to improve our efficiency as we scale up our enterprise. Our third quarter tax rate came in at 33%, which was a little higher than the 32% that we expected. This was due to the pre-tax income coming in higher. We expect our tax rate for the fourth quarter to be in this range. In summary, we expect, before adding Beacon, our core expenses to be flat and we expect modest growth in revenue which will be sensitized to mortgage activity. So, we are expecting about $0.01 in quarterly core earnings per share growth from these factors. Now for Beacon. Our original projection after purchase accounting and cost save was that it would add approximately $0.05 per quarter in quarterly earnings per share. For the fourth quarter, we are estimating about $0.02 due to the timing of the closing. The majority of the transition integration is really planned for the first quarter of next year. Our CBT conversion is planned for November, as we held off that conversion until we completed our own core conversion. As Mike mentioned, we also upsized our subordinated debt offering and this additional interest cost reduced projected earnings by about $0.01. So, our current expectation for the fourth quarter is for Beacon to add approximately $0.01 in core earnings per share net of financing costs. As Mike mentioned earlier, the economic environ makes it particular hard to predict and we have a lot of moving pieces and parts, but we intend to keep focused on moving the earnings per share needle solidly to the north. So, we’re projecting our fourth quarter core earnings per share to come in at around $0.54. We feel confident in achieving Beacon’s earnings accretion next year and our performance metrics to improve when we integrate their operation and achieve the full benefit of the Beacon acquisition in the first part of next year. Our projection was that Beacon’s non-core deal cost would be about $9 million to $10 million after tax. Most of this will be recorded in the fourth quarter. Initial pro forma treated these expenses as adjusted to equity and acquisition date. And as you know, under purchase accounting, they are recorded in the current period expenses. I anticipate that we might do a little bit better than our original projection. Another item I’d like to note is our plan to divest to 2 Tennessee branches of Beacon, which consists of about $50 million in deposits and $100 million in loans. At this time, we are well on our way to negotiating the sale of these branches and we expect to consummate a deal in the up-and-coming weeks. At this point, we are pleased about achieving our ambitious plans for growing our core earnings per share and that we surpassed our goal before we added the benefits of our accretive Beacon transaction. We continued to manage at cost while investing in future growth with recruitment of teams and adding of new branches and the building of a stronger infrastructure. We believe we are creating a strong institution for the future. We feel the environmental challenges today require us to be nimble, and we feel we have the employees that give us the competitive advantage to respond to these challenges. This, we believe, will allow us to further take market share and deliver the financial benefits to our investors. With that, I’ll turn the call back over to Mike.

Okay, thanks, Kevin. How is this microphone working? I’m told I sound like I’m a little underwater, so if everybody bears with me a minute, I’ll move to a different microphone. I will try this one. I apologize for the interruption. So anyway, Kevin, nice job. As Kevin reported, our guidance for the fourth quarter, core EPS is $0.54, which is a 23% increase over the $0.44 in last year’s fourth quarter. Now, this brings our guidance to $1.97 in core EPS for the year. That’s a 26% increase over last year’s result of $1.56. Now, this also exceeds our guidance at the start of the year when we provided a range of $1.90 to $1.95. A core EPS accretion has been a major focus for us in delivering shareholder value. And this accretion has improved our profitability metrics, which we see as fundamental to the ongoing strength of our stock. Now while we’re confident that the earnings momentum is solid, as standard, we’ll be developing further guidance for next year during this quarter. But keep this in mind; our fourth quarter guidance equates to an annualized core EPS run rate of $2.16, and that we expect to end the year with a run rate nearly 10% higher than our full year core EPS. We expect to build on that run rate through additional Beacon-related accretion, as well as accretion from organic growth in 2013. A few weeks ago, we announced that we had placed $75 million in 15 years subordinated debt with an institutional investor at a 6.875% rate fixed for 10 years. Now, this new Tier 2 capital allowed us to right-size the mix of our regulatory capital and to improve the overall cost of capital to the benefit of our common stockholders. We’re pleased to be able to obtain the competitive fixed rate capital funding at this low point in the interest rate cycle. And we did upsize the offering from our original expectation of $50 million, because in our judgment, the strong investor demand along with the interest rate environment provided the right opportunity to increase this capital funding source. And while the near-term impact of this upsizing is an additional $0.01 per quarter in interest expense, we are confident that the long-run benefit to common stockholders of this leverage will be significant. An ongoing focus has been to diversify our revenues. Now, we’ve diversified geographically, as you can see from our current map. We have diversified our market segments. This includes the benefit of our asset-based lending group, which positions us to serve important new business segments. It includes the development of our small business banking program. And it includes our core system enhancements, which allow us to better target larger commercial relationships. And finally, we diversified our product lines, including our mortgage banking effort along with our ongoing initiatives in wealth management and insurance. Now when we set our plans and provide guidance, we try to take into consideration the many moving pieces we have in this environment, the increased uncertainties in the interest rate environment; the economic outlook; regulatory expectations; and of course, the political environment. But despite these uncertainties, we do remain optimistic about the strength of our earnings as we now have multiple levers that we can work to maintain top line and bottom line growth while we adjust to the changes in the environment. With the Beacon acquisition, we now have about 25 million common shares outstanding and our market cap exceeds $550 million. Now, this should provide additional visibility and liquidity for our stock. And as we announced yesterday, we do plan to transfer our stock listing to New York Stock Exchange and we’ll retain our BHLB stock symbol. We do feel that we’ve delivered the benefits of increased scale to our markets and to our investors. And of course, we’re pleased to join with other successful companies that have traded there. We do plan to ring the opening bell on the morning of November 29 in celebration of our recent achievements. But I assure you, we will continue to pursue the high-performing metrics that create distinction and investor value. Now just bear with me, I want to quickly recap the key things we delivered in the third quarter that matter most to the value of the franchise. We ended the quarter with annualized core EPS north of $2 per share, which was above our guidance. We put together 100 basis point ROA and an ROE approaching 8%. We improved our efficiency ratio to 57%. We continued to drive strong organic revenue growth, and we posted growth in both interest income and non-interest income. We reduced our core operating expenses, resulting in further operating leverage of our revenue growth. And we’re pleased to deliver a dividend increase to enhance the return and attractiveness of our stock. And finally, we did convene our America’s Most Exciting Bank University to this fall for our transferring students and for our continuing students. Our theme was work hard, play hard, rest hard, and it was warmly received by our employees. And I want to extend my thanks to all of our team members who put in the hard work to successfully execute on the several growth initiatives in recent years. And I’m confident that with their help and with their work ethic, we’re going to maintain our focus as we continue to build an exceptional franchise and an exceptional investment opportunity at our enterprise. Now this completes my prepared remarks. And I want to invite the operator to open the lines to questions.

[Operator Instructions] The first question comes from Mark Fitzgibbon of Sandler O’Neill.

The first question I have for you is could you breakout for us what your loan pipeline looks like, maybe the size of it and the mix?

Pat, you can -- you or Richard want to give us that information?

Pipeline has been very strong in the commercial side, Mark. C&I continues to increase. And you saw, in the third quarter, we had a lot of good bookings. We’re really not afraid of competing against the bigger banks in this environment, and we’re taking market share on the C&I side. On the real estate side, we’ve been very, very selective on property class. And we’re inclined to run off some of our assets in our existing portfolio or pass on things in the marketplace, because we’re just not going to aggressively pursue fixed rate financing for property classes that we just don’t feel fit in the long run. And we’d rather put all our efforts into hiring more relationship managers and to grow the C&I business, so that’s why our pipeline is probably at an all-time high as we move into the fourth quarter.

That pipeline, Pat, that is majority C&I at this point.

Mostly C&I.

Mostly C&I. And geographically, we’re probably talking about Central, Eastern Massachusetts, some now Northern Connecticut. And of course, the Albany area.

And our asset base group has a very strong pipeline...

Yes.

Across our whole footprint.

I hope that helps, Mark.

It does. In rough dollars, how big would you say it is?

Well, we’re probably always looking at a pipeline well in excess of $100 million. And then, we handicap it based upon probability of close.

Okay. And then, secondly, on Greenpark, I wonder if you had a sense for the gain on sale margins look like in the third quarter?

Yes, the net was about 100 basis points.

Okay. And then, lastly, with Beacon looking like it’s going to be closing shortly, I wonder if, Mike, maybe you could give us some commentary on the M&A outlook and where you see opportunities and whether you think it’s likely that Berkshire Hills will be doing some additional transaction soon?

Sure. The Beacon already closed. So, that, we’re able to accomplish. I think that last Friday, we closed on that. And then, with respect to other M&A, Mark, we’re pretty focused right now on the infrastructure of the company. We feel real good about our ability to generate earnings in the footprint that we have. So I’m not really concentrating on a lot of M&A at the moment. I’m really concentrating on driving earnings in the company, adding to those fundamentals that drive the value of the currency. Obviously, when deals are available, we’ll look at them. But I’m really focused at the moment -- I know our whole team is focused on the moment in really squeezing the orange and getting everything we can out of everything we’ve done. And so, I think over the next few several months, you’re going to see us putting the numbers on the board that help improve the value of the currency.

The next question comes from Damon DelMonte of KBW.

My first question probably goes to Kevin, regarding the outlook for the margin. I think you had said that the core margin of 3.50%, you feel comfortable with that for the fourth quarter?

Yes, we’re talking for the fourth quarter, correct.

Okay, and are you able to quantify any potential impact for the additional mortgage refinancing activity, and maybe how much is at risk to the margin from additional activity during the quarter?

Well, we believe quite frankly that the volume that we took in the third quarter is not going to be anything different than we’re going to see in the fourth quarter. So, the actual impact of those hits are -- which should be consistent in the fourth quarter. As we try to say, we have some purchase accounting that ran off at a little quicker pace, but we don’t anticipate that pace to quicken any more than we saw in third quarter. And actually, we are hoping and we think we’re starting to see that that might be dissipating a little bit going into the fourth quarter.

Okay.

From the standpoint of their budgeting purposes right now, we’re anticipating about at the same as we were this quarter.

That’s correct.

Okay. So all [indiscernible] counts of the margin would grow from 3.50% to 3.40% then, or 3.41%?

No, no.

Did you have 9 -- you have 9 basis points?

No. That’s not correct. We’re anticipating the margins to be around 3.50% net.

Inclusive of potential refinancing impact?

That’s correct. That’s true.

Okay. Okay, all right. That’s helpful. And I guess my other question, just regarding the C&I growth that you guys saw this quarter, could you just describe a little bit about what asset classes it was? Was it more asset-based lending or -- I don’t know, maybe it’s for Rich or for Pat.

Damon, Pat here. If I look at the -- it was straight across middle market and we’re on the less risky side, obviously a bank ABL. So, these were straight-type companies, service-type companies, distributors, light manufacturing, spread really I think the 3 primary areas that had the most growth or asset base, obviously Central Massachusetts, Central and Eastern Massachusetts, and in Albany. So, good, good, basic middle market-type credits.

The next question comes from Aaron Brann of Stifel, Nicolaus.

Just following up on the margin question, the impact of the accelerated write-down -- or the write-down from the accelerated mortgage refinancing activity, is there any offset, because that’s talking about deferred cost? Are there any deferred fees that are also flowing through your income statement?

Well, as you saw in the third quarter, our margin was elevated a little bit higher than the normal core rate, and then we guided it down because we had some discounts that were brought in on loans that were paid off earlier. But most of the mortgages that we acquired in these banks are acquired at a premium. We do have some credit discounts that we put on loans that we plan on exiting. And if we do better in exiting those credit impaired loans, then we do get a little bit of a positive impact with regards to the margin. But mostly, the premiums are on mortgage-type products.

Okay. And changing to the mortgage banking -- or the loan fee income that was up sharply quarter-over-quarter, I suspect a lot of that had to do with Greenpark, can you break out what was the dollar contribution from Greenpark this quarter?

Well, we probably did an additional $0.02 more than we expected based on the kind of volume we got last quarter. So, we’re doing about $125 million to $150 million a month in mortgage origination right now. And so, yes, Kevin, you can correct me, but I think over and above what we thought, there’s probably $0.02, maybe a little bit more in additional earnings that we just weren’t expecting with respect to the refi boom.

That’s correct, Mike.

Oh, I’m sorry. I was talking about the dollar value through the income statement, the loan fee income line item.

Yes. Aaron, Dave Gonci here. We noted in the release that the mortgage production net revenue, which is part of our loan fees, increased by $1.5 million to $4.3 million during the quarter, and that obviously includes the Greenpark operations.

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

Thank you very much. This does conclude the call. I want to thank everyone for joining us. And of course, we look forward to speaking with you all again in January to discuss the final results for the year.

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