Beacon Financial Corp. (BBT) Q2 2015 Earnings Report, Transcript and Summary

Good day and welcome to the Berkshire Hills Bancorp Q2 Earnings Release Conference Call and Web cast. All participants will be in 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. I would now like to turn the conference over to Ally O'Rourke, Investor Relations Officer. Please go ahead.

Good morning and thank you for joining us this discussion of second quarter results. Our news release is available on the Investor Relations sections of our website berkshirebank.com and will be furnished to the SEC. 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 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. 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 Josephine Iannelli, our Chief Financial Officer, she will take you through some of the details in our financials and then I’ll wrap it up. So we were very pleased with the outcome this quarter as we continue to pose better results and maintain ongoing momentum. Core EPS grew by 2% over the first quarter and 16% year-over-year. Second quarter was marked by solid organic loan and deposit growth, improving profitability and in expanding net interest margin. Importantly we achieved these results while managing through the integration of Hampden Bank and putting together an agreement for the acquisition of Firestone Financial. I want to start by pointing out hour proud I am of the team here for executing a seamless integration for Hampden. There are several important components to M&A not the least of which are due diligence, understanding culture and chemistry, getting the marks right and the ability to integrate with little customer disruption. Now I think this last one off and time gets overlooked. Having done a dozen transactions in recent years, integration has become a core competency for the company and that was demonstrated by successfully converting Hampden’s customers and operations about a smoothly as any integration that we have seen. A good execution like that I think makes an enormous difference going forward in our ability to retain and grow the combined business. So I think we are off to a good start. With regards to our organic operations, we grew the loan portfolio at a 5% annualized rate this quarter that was led by strong mortgage origination and solid commercial loan production. The market was favorable to our mortgage business and I am expecting equally good portfolio growth in the third quarter. On the commercial side, we produced a net 8% annualized organic growth well executing on margin strategy. We saw good results across the entire geography with particular strengthen in Eastern Mass and solid contributions from our newer team members in Connecticut and New York. Pricing remains competitive expressly on the C&I side. So I know we’re asking our people to work harder to bring in the right deals meaning solid credit with reasonable rates and frankly they have been successful in doing that. Now the commercial book reflects some timing factors and I expect a few more robust CRE growth in the third quarter while C&I production normalizes, but commercial pipeline remains steady for new production and we continue to target double-digit annualized growth for the third quarter and the year. Now looking at the third quarter total loan growth, we’re expecting double-digit organic annualized growth even while we continue to manage down low margin business in commercial and consumer; I think it’s an important point. Before we return to deposits, I do want to comment on the success we are seeing in ramping up our SBA programs. In the second quarter, we were named the top SBA lender in our central New York region and I’m proud of the focus these guys have put on building that piece of the business. SBA production takes systems, it takes training and discipline to do well and Peter Rice and his team, they have achieved that. We now run every small business application through SBA channels and the targeted growth here in the next couple of years should allow us to package and sell the SBA production turning it into a solid fee generating business, very important point. Now turning to deposits, we posted double-digit organic deposit growth this quarter and importantly again we had double-digit organic DDA growth. Now accounts saw some run-off reflecting a flex between account types and some strategic repositioning efforts that we talked about that began last year. We benefited from both seasonal impacts and some targeted promotions in our newer markets that proved pretty successful. We also rolled out Apple Pay and made enhancements to our debit cards and payroll services for customers and so with that current momentum, we are expecting double-digit annualized deposit growth once again next quarter. Now as you know, we’ve been focused on our branch footprint and optimizing that network. We tagged a total of eight branches in the last two quarters for consolidation or sale which brings us to 26 branches over the last four years and that’s nearly 320% of our current footprint. Now we’ll continue to evaluate our overall branch needs as we’ve been doing and where it makes sense. Let me spend a couple minutes on fee income strategies. We continue to pursue strategic growth absence for our wealth business. In addition to our private banking and wealth advisor staff adds in the first quarter, we further expanded our wealth team in the second quarter with a focus on our New York markets. Our assets under management have grown to over $1.4 billion and we expect to see some of that additional revenue impact in the back half of the year. We also expanded our insurance team this quarter with an emphasis on the benefits business. So we’re continuing to look at other fee revenue drivers including expanding our SBA platform that I mentioned earlier and our goal remains driving fee revenue to 30% of our operations. Now moving on from revenues, I’ll just mention that our asset performance continues to be favorable and improving. We further whittled down our non-performers which have been declining sequentially for many quarters and as you know under accounting rules, the $500 million Hampden loans came over as all performing and with no allowance. Our Hampden credit marks came in right where we expected and I’m pleased with our overall credit profile and our expectations. Before I turn it over to Josephine, I want to take a minute and talk about Firestone acquisition. We’re excited about this addition to our lending portfolio as a specialty finance business, it compliments both our ABL and our SBA platforms and that enables us to further diversify our assets while expanding our client offerings. The company will operate as the subsidiary under its own brand and it continue to be run by the experienced management team that helped it to grow successfully over the last 15 to 20 years. It’s located in market, and it’s an existing customer of our, so we‘re familiar with their loans and their overall organization going in. From a strategic growth perspective, we think there will be opportunities for revenue synergies as we go along including SBA loans and insurance cross sales. Now at a little under $200 million in assets, this acquisition isn’t a game changer, but it is a nice add on that helps to grow our C&I book with higher margin relationship based businesses. For National Business Book provides I think attractive diversification for us and their strong credit track record has demonstrated their expertise in maintaining profitable operations through several economic cycles. With that I’m going to turn it over to Joe, she will walk you through some more of the financials and then she will return it to me to sum it up. Joe?

Thanks Mike and good morning everyone. We will go ahead and jump right into the financials. It was another strong quarter for us. We saw good improvement in core earnings including our fee income along with core ROA, core ROE and our efficiency ratio. Core EPS came in at $0.51 for the second quarter compared to $0.44 for the same period in 2014. Our GAAP EPS was $0.35 per share reflecting the non-core charges related to the Hampden acquisition and our restructuring. The results of this quarter reflect a lot of the hard work the team has been putting in. I’ll go ahead and walk through the balance sheet, income statement highlights and outlook and then I’ll provide a financial update on both the Hampden and Firestone acquisitions before returning it back over to Mike. As Mike said, we had solid loan and deposit generation this quarter; we continue to benefit from the efforts to shift the balance sheet mix towards higher yielding commercial loans and away from the lower yielding assets which has resulted in our improved profitability metrics. We do expect to increase our organic loan and deposit growth rates in the third quarter while we also onboard the Firestone loans. Through this balance sheet management and Hampden’s impact our net interest margin expanded one basis point to 316 before purchase loan accretion. Our reported NIM including the impacts of purchase loan accretion rose to 330 from 318 in the first quarter. With the acquisition of Firestone expected to close next month I do expect the net interest margin excluding accretion to expand by at least another five basis points in Q3. Purchase loan accretion came in at an elevated $2.2 million for the second quarter and this was primarily due to the recoveries which will likely be bouncy for the next several quarters as a result of the Hampden acquisition and soon the Firestone acquisition. Scheduled accretion is expected to remain under half million next quarter including Hampden and Firestone. We did have higher expenses to produce these recoveries and I’ll return to that shortly. Turning to fee income, we grew these revenues 14% for the quarter including the Hampden operation. We saw strong growth in loan related fees including interest rate swaps and gains on loan sales. Our mortgage banking fees also remained elevated due to the favorable market conditions. Customer service fees benefited from a seasonal pick up and Hampden’s impact was primarily in that category. We continue to target significant growth in fee income over the next couple of years. For Q3, we expect some pick up in insurance and wealth revenues, but overall loan related income should show some contraction. As a result, our total fee income is expected to decline modestly while still showing solid gains on a year-over-year basis. The provision increased to $4.2 million in the quarter and exceeded net charge offs of $3.3 million as we built the allowance alongside our organic loan growth. We expect the provision to be in the area of $4 million in the third quarter. Core expenses increased by 11% in the second quarter and were generally in line with our guidance. This is mostly due to the integration of Hampden, but we also saw increased cost related to the acquired loan recovery and overall loan fee income. In addition, we had the reinvestment of tax related revenues used to develop fee business lines and support our future growth. We continue to focus on positive operating leverage and I’m pleased to report our efficiency ratio improved to 61.5% for the quarter. Overall organic expenses are targeted to be flat to slightly down next quarter as the cost of loan growth and franchise investments are offset by additional Hampden cost saves, which will further improve our operating leverage. Our core tax rate for the second quarter was 17% in line with our guidance of 15% to 20% that we gave at the last quarter. As with Q1, we got a tax rate of benefit related to the commercial development projects and this is detailed on the table on Page F-9 of our earnings release. We expect to continue to receive this tax benefit throughout 2015 and we anticipate a core tax rate of around 15% in Q3. We are actively working on identifying additional tax advantage strategy for future years and we've already identified potential opportunities. Of note we expect the Q3 GAAP tax rate to be below 10% given the benefit of the non-core charges recorded in the first half of the year. So having said all this for Q3, we expect to deliver the same kind of core EPS as we did this quarter with less expected purchase loan recovery. Non-core charges for the quarter totaled $8.7 million and we are tied to the Hampden acquisition and the branch restructuring we mentioned. Most of the Hampden charges are behind us, but we will see non-core charges in Q3 related to Firestone and the branch restructurings that have not yet been completed. These should be significantly less than what we see in this quarter. Turning to profitability, we saw sequential improvement in both our core return on equity and core return on the assets, core ROE improved to 7.3% for the quarter and core ROA rose to 81 basis points. As you know, ROA has been a critical focus for us, we are committed to a target 1% or better and I do expect to end the year with further improvement towards this goal. Core return on tangible equity also rose to 12.3% and our capital ratios improved modestly. Our tangible equity was 7% of tangible assets at quarter end. Tangible book value per share ended the quarter at 1716 and was impacted by the Hampden dilution as well as the effect of rising interest rates on unrealized security gains in equity. We continue to remain asset sensitive under most of our planning scenarios and we are keeping a close eye in this as we manage the 16% increase in our assets this year and support revenue growth without reaching for duration. As Mike just said the Hampden integration has gone very smoothly, we are on our way to meeting or exceeding the 35% cost saves and I expect a penny or two of EPS accretion before the end of the year. Lastly, I will wrap up by touching on the Firestone deal, we are excited about bringing this company on board in addition to benefiting the margin this deal is expected to be further accretive to capital, ROE and ROA as well as EPS in 2016. There is minimal tangible book value dilution and an earn-back of less than 2.5 years all of which makes this deal a home run. There is shareholder meeting today so there is not much more to add at this point but we will be able to provide more guidance about their contribution on our next call. With that Mike I’ll turn it back over to you.

Thanks Joe. You did a great job. So as Joe said, we think $0.51 is a good number for next quarter and we will work to do little better than that if we can. I am pleased to welcome our new shareholders from Hampden and I look forward to being able soon welcome new shareholders from Firestone. Now we have issued more than a $150 million in new equity for those transactions and we certainly appreciate this investment in our company which is further contributed to our growing profile and of course the liquidity of the stock. Our core strategies continue to produce a lift in earnings and profitability; we are posting solid organic loan and deposit growth while expanding our margins and improving our overall returns. Capital is being generated at rate that supports our growth and we remain focused on further enhancing our return on assets and capital as we deliver on our franchise investments. Now as Josephine noted we continue to invest in team recruitment and other revenue generating sources to support the market share opportunities we see, while we’re growing our business we’re also deepening our infrastructure and our control. Importantly we’re maintaining our disciplines in these competitive markets and I think that is clear from our trends in margin and our credit metrics. So our outlook remains positive and we certainly look forward to further delivering on the power of this franchise to all of our constituents. With that I am going to open it up to any questions.

We would now like to turn the call over for questions. [Operator Instructions] Our first question comes from Mark Fitzgibbon with Sandler O'Neill.

Good morning.

Hey, Mark, how are you?

Terrific, Mike. Josephine, just clarify one quick question on the tax rate, I think did you say that the effective rate would be 15% normally, but there will be some adjustments in the third quarter that will get it to around 10%?

The core tax rate for Q3 is 15%; the effective GAAP tax rate will be just below 10%, Mark. I mean certainly, if you just look at the non-core charges that came through in the first half of the year, with significant lead last expected in Q3 and Q4, it’s the same amount we saw year, you are going to have less GAAP income than core income.

Okay. Great. And then secondly, I wondered if you share with us what the annual approximate expenses are for Firestone? What their cost structure looks like?

Yes. I mean, one second. I want to say $1 million, $1.5 million Mark.

Okay. Great. And then, lastly, I wondered if you could - I’m sorry.

Just a quick clarify. I would say $1.5 million per quarter.

Okay. Great.

Big difference.

Yes. And then I wondered if you could also share with us the size of the commercial and the mortgage pipelines today.

George, do you want take the commercial?

George and Sean one of you guys go first.

Hi, this is George. The commercial pipeline is pretty steady and solid as compared to last several quarters. It’s in excess of $150 million which is a pretty solid number, this early into the quarter.

The mortgage pipeline continues to grow; we’re looking at about $125 million to $150 million, Mark.

Great. Thank you.

Thank you, Mark.

Our next question comes from David Bishop with Drexel Hamilton.

Yes, good morning, guys.

Hi, David.

Hey, my question, sort of one back to the SBA efforts there and the whole targeted 30% the income range, I’m just curious in terms of as you build the critical math there securitize sale, how big that component of the income thinks is against actually get to?

As big as we can get it, but to be - to give I guess some type of a frame work around that, Sean where would you see that?

Could repeat the question.

What he is asking is, let’s say you start doing, we start to be able to really get SBA production going and we’re selling that and it becomes a percentage of our total fee income. Where do you think that can end up as far as…

Sure. We’d look to do it really on a quarterly basis to really kind of flatten the expectation and the portfolio bumpiness. You are getting 10% premiums in the market today, you could see that go to $0.5 million to $1 million on a quarterly basis once we get to scale, I do think we’re probably another six months from scale.

Sure.

Does that help, David.

Absolutely. That’s six months to scale, okay, that’s helpful. And then, Josephine, maybe you can give us an update maybe in terms of the [indiscernible] positioning, there been a change quarter-to-quarter in terms of asset sensitivity related to raising interest rates.

Yes, David, there hasn’t been much change in most cases we see ourselves as being asset sensitive, years one, two, and three. Certainly, in the middle of year two, while 2016, in the middle of 2016 are forward starting slap start to kick-in and our asset sensitivity goes up from there and we see ourselves much asset sensitive, beginning year three.

Got it, and I heard you at the beginning of the call, you were expecting a five additional basis points of margin expenses in the next quarter.

Yes. We would expect five or better.

Is that a just a function on some of the new loan categories coming on, that loan yield from the new assets.

Yes. Certainly we are going to be on-boarding the Firestone loans, we continue to implement the margin strategy that you’ve seen here in the last couple of quarters, and we’ve had solid growth and success in doing that.

And just to be clear that’s on the core basis for our margin.

Correct. The margin excluding attrition. Correct.

Got it, thanks.

Our next question comes from Laurie Hunsicker with Compass Point. You may now go ahead with your question.

Yes hi good morning.

Hi. Laura how are you?

Good, thanks. Just a follow-up on the margin here, so Joe I want to make sure I’m thinking about this is the right way, your core margin in June was 316, you reported was 330 and that included $2.2 million of accretion income and you stated that accretion income in the third quarter were likely dropped to $500,000.

The scheduled accretion, Laurie so again there is two pieces of that. The scheduled accretion would likely drop to less than a $0.5 million. The recoveries are lumpy and those are harder to predict and again the core margin is really what we guided to.

Let me add to that Laurie, we pay attention to and somebody did asked me last night about the accretion is derived from, we have some loans, we mark them pretty well when we do deals and then there is lumpiness. So this quarter, we pick up $2.2 million let’s say in earnings accretion from getting rid of some loans and again that is probably a $1.06 million or so higher than what we would normally get, but there is what $800,000 or $900,000 worth of additional loan cost that track to that and so there was when you look at the reserve, the amount we put in the reserve to support the C&I growth, you know it’s a few hundred thousand bucks, but it’s important to note that because that doesn’t drive a quarter for us, when you look at it in totality, it’s really important I think that people look at that in totality and that is the reason that we concentrate so often on the core margin not the gross margin.

Right. That makes sense. And I guess to that point five basis points of your core margin growth and obviously this lot of factors 316 to 321 that your reported margin just by the drop in accretion income if we assume and I realize that is something that we assume it is round number 500, the reported margin is going from 330 down to 324, am I thinking about that the right way?

You are thinking about it the right way, but again that is one of the reasons that the core margin is the…

Is so important.

Right. That makes sense and can you share with us, what your accretion looks like potentially for 2016?

It’s going to be early because we just finished putting together the Hampden deal and we will have Firestone mark. So I think it is pretty early to start making those kinds of projections. Joe I mean if you disagree go ahead.

Yes I mean, certainly there is going to be a bump up in the scheduled accretion just as component of the Hampden acquisition, we will have something there related to Firestone. At the end of the second quarter, our scheduled accretion is up about $6.5 million, up from the $3.5 million where we were at the end of the first quarter.

Yes then that would be the scheduled accretion.

Right.

Okay. Okay and then on Firestone and I apologize if you hit this Mark, [indiscernible] for just a minute. Loan loss provisioning can you share with us if obviously you got it is $4 million in September but can you share with us a little bit if in theory you had Firestone for the whole quarter, how you would be thinking about loan loss provision there. Thanks.

Yes Laurie its Richard Marotta, again because of purchase accounting in the first quarter that we bring them in the actual provisioning is going to be minimal. So we will mark the portfolio after our due diligence and we bring that over with minimal up provision through the third quarter and as time goes on that will start to build as we see the performance of the portfolio.

It wouldn’t be any different in any of the bank acquisition portfolios Laurie, so again we marked these as we bring them over and no provision follows.

We’re not going to do that let’s talk about that number.

Yes I guess Laurie the way I guess we should all look at this, it is a couple of hundred million dollar portfolio and their credit metrics they are underwriting their knowledge of their markets is very, very good. So there is no true material difference between the process, we provision now with our normal book versus Firestone, it is not going to be materially different than a normal $200 million portfolio.

And Richard just to add on to that, most of their years if you look at their historical experience their charge offs have been under 1%.

Yes where do the 2% come from that’s the question asked.

Laurie this is Ally, the 2% was in 2009, so that was at the height of the crisis that was at best it got.

And again Laurie if you remember looking at banks back in the height of the crisis 2% is not materially away from the norm and I would probably argue that it is better than many banks posted.

Okay. Thanks that is helpful.

Our next question comes from Matthew Kelly with Piper Jaffray. Please go ahead with your question.

Yes hi guys. I was wondering if you could just talk about longer term kind of expense management plans and what you see in terms of opportunities to maybe reduce the branch count further as we go through 2016 and just taking cost out of the platform more broadly in longer term talk about that.

So Matt you weren’t impressed with my 30% reduction in the overall branch network, 26 branches are pretty good number but Sean do you want to respond to that.

We look at every branch individually and we stack it to a profitability threshold of which we expect. So you got to look at some of our world branches a little bit differently than our metropolitan branches in what we do. I do think we will continue to identify, I do think we have gotten through the bulk of it not depending on any other changes factors obviously as we brought on Hampden there were opportunity in that, we will be opportunistic in those respects. So there should be a little more but nothing hugely material at this point.

Okay. You guys have done a good job there, just wondered about the longer term view and have you seen any changes in the dynamics of branch based transactions that would cause you to slow down the pace of branch closures I think that the follow on question for that I mean the secular trends seem to be firmly in place here pointing towards the need to kind of reduce more broadly across the industry and I assume you’re in that camp still?

Yes and Matt it is interesting, I think it is a combination of two things, I think the some of the environmental changes that occur would lead us to continue to take a look at the process and have the process to similar to the one that we have been using but also think the better we get at using sources outside of the branches that My Banker program that Sean runs said those kind of things those become more powerful then I think that could also have an impact on our ability to look at branch closings and when you look at opportunities to have more profitable branches in different areas, the more profitable the higher portion of our branches are the more opportunity there is we will take a look at some of the branches that aren’t as profitable and I guess two people raising their hands. So Joe you go first.

So Matt just to kind of put it in perspective for you, from a Q3 perspective we do expect those core expenses to be flat to slightly down, we have already touched around the branches, but obviously concentrated effort around the efficiency ratio and you are going to continue to see additional cost sales with Hampden.

That’s true.

Okay. Good.

And Matt, too agree, the leading indicator of transactions will drive profitability, so we do look at that and as we use as we migrate to other channels as Mike talked about some of those metrics could change and we could see some pick up in it.

And to everyone should grant no longer have a branching Tennessee is that true Sean?

That’s correct. Visiting Tennessee, I don’t need to do that.

Got it.

No, Tennessee is outside of the franchise.

No more rocky top. And then I apologize, I did hop on a little bit late here, but when you’re talking about the loan pipeline at the end of the quarter how would it break down towards kind of the by market place. In terms of how the pipelines are setting up for the back half of the year, strength, weakness by region.

And George, if you have specific, but it’s been generally the same all along, right? You get good growth out of New York, you get really good growth out of Eastern Mas, and you are starting to see traction in Northern Connecticut is that fair.

Right. As I said, Matt, earlier the pipeline is strong for really the beginning of the quarter and as I looked by region we’re really seeing good growth coming out of New York, coming out of Hartford, coming out of Eastern Mas, Berkshire County, so really we’re seeing really contributions from all the areas. So I really feel like we’re making the most out of our franchise in our wide geography.

And when you also say that I mean, [indiscernible] Pioneer Valley has got that heaten up there, and I like what he is doing, I like the opportunities that I think we are going to see some real change and some significant growth there as well wouldn’t you.

Pioneer valley is, they are really to be one of our best performers it’s an interesting region, we’ve really doubled the size of our commercial book there, we have some really strong relationships there and all indications early on are that really going to take advantage of the new folks.

It looks better than its looked in a long term, I would like to look at Pioneer Valley right now.

Definitely yes.

Then, just a last question across each of your geographies, where are seeing the most pressure on deposit pricing and the most promotional activity.

Sean that should be a soft ball for you.

Sure. I think the Connecticut market as we move towards New York, I think you are seeing some robust loan growth out of that market; we don’t have a huge franchise down there so I’d say that market is driving the highest deposit cost to fund some of that loan growth that we do see down there. Anytime you have large box - banks, they created disciplining your markets so those markets typically will have a more discipline approach to a raising rates.

Ok, all right. Thank you.

Thank you, Matt.

Our next question comes from Collyn Gilbert with KBW. Please go ahead with your question.

Thanks. Good morning, everyone.

Hi, Collyn.

Mike, can you just talk a little bit about how you guys are thinking about cyber security, I mean I think you are a bit out of the game and the way you are thinking about your branch network and I just would like to get your thoughts on that issue.

Yes. It’s a great question. It’s probably the one thing that I worry about more than anything else and think we are a bit ahead of the curve on net as well, because I’m sort of afraid of it. I look out and I see the smartest people in our country allowing for hackers to get in. So we double up our efforts in this regard would probably small enough and nimble enough to continue to have our hands around it, I believe that cyber security - the best thing you can do for cyber security is put in all of the infrastructure bells and whistles that you tend to protect and be ready for and prepared our opportunities that do occur. So we’ve taken kind of a two-fold effort here. One is to utilize every bit of potential hardware and software that we can from a cyber security standpoint use the best consultants in the country and that we can find but in addition also be prepared to handle any cyber attack so that a small cyber attack doesn’t become a large cyber attack and I think that’s piece that if there is a weakness in the industry, it’s that one, because people spend all their time trying to figure out how to prevent it and I think you have to spend as much time figuring out how to reach to it. If you can’t prevent it.

Okay. Have you sort of fragmented or tied cost to this specific initiative?

Expensive, but it is worth every penny and I am not prepared to get into the specific dollar spend but we spend an enormous amount of money on cyber security, because the ramifications are so huge.

Okay. Okay. That was it. Thanks.

Thank you Collyn. End of Q&A

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

Okay. Thank you very much everyone for joining us today. We appreciate it and we certainly look forward to speaking with you all again in October to discuss our third quarter results.

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