Beacon Financial Corp. (BBT) Q3 2015 Earnings Report, Transcript and Summary

Good morning and welcome to the Berkshire Hills Bancorp Third Quarter Earnings Release Conference Call. 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 Allison O'Rourke of Investor Relations. 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 sections of our website, berkshirebank.com and will be furnished to the SEC. Our discussion will include forward-looking statements and actual results could differ materially from those statements. For a discussion of related factors, please see our earnings release and our most recent SEC reports on Forms 10-K and 10-Q. With that, I’ll turn the call over to CEO, Mike Daly. Mike?

Thank you, Ally. Good morning everyone. Thanks for joining us this morning for our third 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. It was a good quarter for us. We grew core EPS by 6% quarter over quarter and 17% over the third quarter of last year. The teams worked hard to post solid positive operating leverage and maintain good momentum. As you know, we were expecting a $0.52 quarter, but the bottom line benefited from some extra purchase loan recoveries in the last week of the quarter, bringing us up to $0.54 in Core EPS. Loan and deposit growth remained strong. Margins have been expanding, benefitting from both the addition of Firestone this quarter and our ongoing efforts to achieve the right mix on our balance sheet. Expenses are benefiting from the Hampden integration and internal strategies. Excluding the Firestone acquisition, we grew total loans at a 14% annualized rate this quarter. This included strong portfolio growth in residential real estate and 9% annualized growth in our commercial loan book. I’d expect continue to see double digits annualized growth in mortgage, although not at the elevated levels we experienced this summer as rate volatility has put some pressure on that market and we typically see a seasonal slowdown heading into the end of the year as well. On the commercial side, we’re experiencing above average originations from our Albany and Central Massachusetts markets. And while our teams continue to be selective as we execute on our margin strategy, the commercial pipeline remains solid for new production. Joe will provide some comments on the Firestone and Hampton progress, but I think it’s important to note that both acquisitions are performing well for us. Firestone’s diverse portfolio benefits the NIM and the teams are already taking advantage of our SPA preferred lender status to bring in some good SPA opportunities. Our business banking commitment to developing a strong, small business platform are paying off and we walked away with top SBA awards this year in the state of Vermont, Western Massachusetts and the Central New York market. With respect to deposits, we posted $185 million in growth this quarter, primarily in time deposits in our accounts and money markets, but we do expect the pace to normalize in the fourth quarter to a mid-single digit annualized growth rate. We’re on target to complete the sale of our Tennessee branch during the fourth quarter, which will leave us with 93 branches in our footprint at the end of the year. We continue to evaluate the overall branch network to ensure we’re meeting customer demand at the appropriate level. I think Sean Gray and Tami Gunsch, our new EVP of Retail, have done a very effective job at managing this process and ensuring the appropriate resource deployment with little customer disruption. I also wanted to mention an initiative that has been a personally important to me and some of my colleagues. We launched a new program this week targeted at veterans and active military and their families. The program provides tailored products and services and it’s been kicked off with volunteer projects and foundation grants in November, all aimed at helping veterans in our communities. This is only the beginning of what I think we can do to say thank you to our men and women in uniform and you can expect to see us play an even bigger role going forward. Now with that, I’m going to turn it over to Josephine and she will walk you through some of the more detailed financials. Josephine.

Thanks Mike. Good morning. As you heard, this was another strong quarter for us. We demonstrated positive operating leverage and we did what we set out to do. We drove revenues higher. We kept expenses in check. This led to improvements in core earning, our net interest margin and our targeted profitability metrics. Core EPS came in at $054 for the third quarter compared to $0.46 for the same period in 2014. Our GAAP EPS was $0.49, reflecting non-core charges related primarily to the recent acquisitions. The results reflected are continuation of the progress we’ve been making. We had solid loan and deposit generation this quarter. Our effort to shift the balance sheet mix towards higher yielding commercial loans and away from lower yielding assets continues to benefit our margin and profitability metrics. Our net interest margin before loan accretion improved six basis points to 322, which reflects the balance sheet management strategy and benefit of Firestone. Our reported NIM, which includes the impacts of purchase loan accretion expanded seven basis points to 337 in the third quarter. Given more of the same current rate environment, I would expect to see one or two basis points of compression on the NIM before accretion next quarter. The benefit of a full quarter of Firestone will help to offset most of that organic margin pressure. Purchase loan accretion totaled $2.7 million for the third quarter. Most of the accretion was recoveries, some of which came in during the last week of September, contributing to the extra $0.02 of EPS we posted. I expect the recoveries to continue to be bouncy in future quarters as we work through the Hampden and Firestone acquisitions. Scheduled accretion came in under a half a million as expected. Now, that should remain at the same level or slightly below for next quarter. Net interest income for the fourth quarter is expected to be slightly up with the benefit of Firestone and organic loan growth offsetting less expected purchase loan accretion. For fee income, we saw contraction in this category quarter over quarter related to the slowdown in mortgage banking volume and commercial loan swap activity. The comparables are tough as both categories are sensitive to long term interest rates and benefitted from the dip in rates earlier in the year. Deposit related fees and insurance both posted slight gains quarter over quarter. Now I’d expect fee income to grow at a mid-single digit annualized rate in the fourth quarter, which should partially offset some timing factors contributing to less other non-interest income. Overall, we expect core revenue to be up a little in Q4, taking into account the tick-up in net interest income. The provision remained unchanged at $4.2 million in the third quarter and exceeded net charge-offs. We expect the provision to remain steady for the fourth quarter as well. Looking at expenses now, I’m pleased with the progress we continue to make here. Core non-interest expenses were up 1.5% quarter over quarter, but this included the impact of Firestone. Excluding Firestone, core expenses were down overall. The benefits from the Hampden acquisition and the lower mortgage volume, offset the cost of our business expansion. We continued to make additional investments in developing our business lines this quarter. This included the expansion of our auto lending and our wealth management teams, as well as dedicating further resources to developing revenue synergies with Firestone. With these strategies, we continue to focus on positive operating leverage and I’m pleased to report our efficiency ratio improved in this quarter. Overall core expenses are targeted to be 1% to 2% higher next quarter as we absorb the full impact of Firestone. Our core tax rate for the third quarter was 17%, in line with our guidance. We anticipate a similar core tax rate in Q4. Our GAAP tax rate was 8% in the third quarter, which reflects the tax benefit related to the non-core charges for Hampden and Firestone and we do expect this to repeat in Q4. As we look to the fourth quarter, we expect to deliver a more normalized $0.53 in core EPS. This would result in a 10% increase year over year. Our profitability measures are similarly expected to show good improvement year over year, given the benefit of our operating and acquisition strategy. Our full year core EPS projection is 208, which represent a 16% increase over prior year results. Non-core charges for the third quarter totaled $3.3 million and were primarily tied to the recent acquisitions. Most of these charges are now behind us, but we do expect to see a small amount show up in Q4. We continue to make strides towards our profitability goals and posted sequential improvements in both our core return on equity and core return on assets. Core return on tangible equity rose to 12.8% and our capital ratios improved through internal capital generation and the benefit of Firestone. At quarter end, our tangible equity was 7.3% of tangible assets, up from 7% in the prior quarter. Tangible book value per share ended the quarter at 17.61, a 3% improvement quarter over quarter despite the addition of Firestone. Now, turning to Hampden and Firestone, the Hampden integration is running ahead of schedule and we attribute one penny of EPS this quarter to the cost saves we’ve achieved so far. The Firestone integration is also going very well. This one’s a little different, since we’re operating it as a subsidiary. We closed on that deal August 7 and brought on $190 million in loans. As a reminder, we do not model any cost saves into this deal and the expenses tied to the operation for Firestone will be north of $2 million on an ongoing basis. We did issue 1.4 million shares for this deal and the tangible book value dilution was minimal. And as we’ve stated previously, we anticipate a payback period of approximately two and a half years. With that, I’d like to turn it back over to Mike.

Thanks Josephine. Really well done. As Joe said, we think $0.53 is a good number for next quarter. We remain focused on developing the revenue channels we see in front of us and closely monitoring our expenses. I believe this discipline will give us the long term positive operating leverage we need to continue to improve our profitability and deliver results for our shareholders. I’d like to take this opportunity to comment on some of the promotions and reorganization of responsibilities you saw us announce a couple of weeks ago. These moves were a natural extension of the strong growth we’ve delivered and I think they position as well for future growth and expansion. Richard Marotta and Sean Gray have been essential to the growth of this company and their promotions to President and Chief Operating Officer of the bank, certainly reflect that fact. Equally important is the great group of execs below them, who all demonstrate strong integrity and high energy and have great new ideas to drive performance higher. It was time to give them more of a voice by broadening their responsibilities, deepening their accountability and letting them drive results. This new structure will help to accelerate our progress toward our goals while allowing us to operate more effectively as a larger bank. I don’t think there’s a better way to unleash the potential of a company than to engage smart and accomplished people and give them the opportunity to add value and be held accountable for their contributions. I’m excited about our future opportunities, having empowered this kind of talent and energy and I have no doubt this leadership team will drive us to the next level. With that, I’ll open it up to any questions.

[Operator Instructions] And our first question will come from Mark Fitzgibbon of Sandler O’Neill.

Hey guys, good morning. Mike, I wondered on, as it relates to Firestone, with a much bigger balance sheet for them to utilize, is it likely that their loan production is going to ramp up a lot in coming quarters?

I think the loan production will ramp up, but one of the things that you know you’ve heard as say Mark is that in order to make sure that we continue to manage the margin, in many cases we will not rebid on a loan that’s not economical, so there’s a tradeoff. So while I believe that their production will continue to improve, the net increase in loans may be buffeted a little because we’re trading off loans that have rates that you just can’t make money on for loans that we can.

Okay, and then secondly on the margin. Josephine you had said that the -- I believe the core margin will go down 1 to 2 basis points in the fourth quarter and it sounded like purchase accounting adjustments will be a touch lower than they were. The reported margin it sounds like down a few basis points in 4Q. Am I reading the tea leaves correctly?

Yeah, that’s about right, Mark. I think you’ll see some further margin compression. We should be well positioned and insulate much of that, but you could see one or two bps.

Okay and then I know the guide you gave guidance on the fourth quarter tax rate. Is 17% a reasonable bogie as you sit here today, looking at the effect of tax rate for 2016?

Mark, what I’d tell you is we’re not really giving guidance for 2016. However, you know the tax strategies that we employed this year. I do expect some of that to repeat next year. Exactly how much gets reloaded and the impact for 2016 we’ll share on the next call, but I would expect it to be another favorable rate.

Okay and then lastly I just wondered if maybe I can get your perspective on what you see the big banks in your market doing. Are they getting more competitive, less competitive or staying the same?

I think it’s probably -- the answer is probably C, it’s staying the same. The engagement probably hasn’t improved terribly, but on loans, when I talk about loans that are not economical for us from time to time, it’s because in some instances the big banks either to save a loan or they get hypersensitive about a specific credit, they’ll drive the rate down to a point where I just don’t think it makes sense for us to put the loan on, or to renew the loan and that’s why you see us with this strategy that we’ve had of making sure that our growth comes from a balanced growth, a balanced net growth. My view is that it’s status quo and to change behaviors in communities where the largest banks don’t really have a major executive presence or interest is like turning the Queen Mary around. I suspect it’s going to be some time before we see major change in behavior from most of the large banks in the New England and Central New York area. Anybody disagree with that comment? Everybody is shaking their heads. It must have been a brilliant comment.

Thank you.

The next question will come from Collyn Gilbert of KBW. Q – Collyn Gilbert: Thanks. Good morning everybody. Mike, just to try to follow up a little bit more on your loan growth comment or loan outlook comment. When Mark first asked about expectations from Firestone, were you talking about the growth out of Firestone or out of the whole portfolio? I’m just trying to follow where you think this trajectory – so you’re saying that growth will be less, but yet the quality of that growth is going to be better?

I think that that is a fair statement and the reason I say that is, one of the things that Firestone has been really willing and able to do is to cross sell and to look at loans that for the most part don’t reflect exactly what they had been doing in the past in some sectors. SBA lending is a big piece of what we’re seeing Firestone push for us. If you were to look at a specific point in time and you look at a specific type of portfolio, you might see growth that is more diverse and runs across the spectrum of our whole loan portfolio. This was really the value of these entrepreneurial type of managers that we picked up. They’re interested in developing loan portfolio growth for us across the board, not just specific to things that they had done in the past and we’re seeing that already as they continue to put strong SBA focus on for us. That could show up in an SBA bucket, not necessarily in a bucket that you would pinpoint for Firestone alone. Q – Collyn Gilbert: Got it. Okay, that makes sense. It makes sense. Yes, thank you. Then just, can you just give a little -- and if you said this, I missed the beginning of the call, I apologize, but a little bit more color around the auto lending initiatives that you guys are kicking off or adding to I should say.

Sean?

Sure. Really we’ve just acquired some talent to lead that division. Our division was very centric to New York, based on the old beacon franchise. So there is an opportunity to leverage the infrastructure we already had in place that served New York to serve really all of New England and get better economies of scale and also that leadership helps provide direction as we look at fair lending and other regulatory impacts to that business as well. So that’s the initiative essentially Q – Collyn Gilbert: Okay. This is maybe a dumb question, but when you say auto, are you talking indirect or floorplan or both?

I’m talking all indirect. Q – Collyn Gilbert: Okay. And then just one final question Mike. Could you just give us an update on how you’re thinking about M&A at this point, given what you’re seeing in the market, given where the opportunities are within your organic business and just update us? That would be great, thanks.

I don’t think there’s been material changes in overall M&A opportunities. And for us Collyn as you know, the entire organization is pretty focused on performance ratios and where we can go in order to improve the performance of the company organically. That doesn’t mean that there won’t be opportunities to look to do variety of different acquisitions, whether it be on the insurance side or the wealth management side, our other niche type businesses or even whole bank acquisitions, but they’re really going to come on an opportunistic basis. So our focus really is on driving the company for what we have. I don’t again see material changes in the hunger for extensive consolidation. Not like we've talked about in the past. I think what I’ve heard and what you’ve heard is we are going to get to a point where there’s going to be this wave of consolidation. I don’t know that I see that. I see opportunities for banks to combine forces when it’s appropriate for both of them to do so and really nothing more than that. Q – Collyn Gilbert: Okay, that’s helpful. I may have said that was my last question, but just you triggered, your comment on performance, obviously that’s where the initiatives have been for you guys. Can you give us any sort of update on when you think you might be able to achieve that 1% ROI target?

I've been pretty candid about this. I'm not going to give some guidance on when we might hit a performance ratio. If you’re at 95 or 105 or if you’re at 93, those numbers, I think as long as we incrementally improve our performance ratios on a quarter by quarter basis, people will be able to watch the environment and watch the math and come to their own conclusions. I don’t think it’s going to be forever. I have been specific about the fact that we know what short, medium and long range means and I think we know what the timeline is that people would like to see us achieve a 1% ROI. So I think we will leave it at that. But one thing I do want to make sure Collyn is that when you asked the question about the Firestone growth, that I didn’t give the wrong impression on that. I know Josephine had her hand up and I was kind of giving her well, let’s use the George Costanzo method, which is when you say something, everybody agrees to leave the room. But Josephine, do you want to add to that to make sure that I didn’t say something that you were not in agreement with?

Sure. Collyn, just from a more holistic perspective, total loan growth, we are targeting a high single digit for the fourth quarter. Q – Collyn Gilbert: Okay, got it. Okay, that’s very good color. I’ll leave it there. Thanks guys.

The next question is from Matthew Kelly of Piper Jaffrey.

Hi. I was wondering maybe talk a little bit -- How are you? Maybe talk a little bit about your plans for the year ahead on additional potential cost cutting and branch reductions. And maybe just talk about your experience over the last couple of years, what you’ve learned and why would you not accelerate that process? It seems like banks are able to take cost down and retain deposits. What have you learned and what should we expect?

I would agree. The banks that have been able to cut branches out of their network have shown a good propensity to cut deposits. Our own experience has been when we've consolidated branches, we've actually retained about 98% of deposits. I know we've spoken to it. I'm looking at some of my peers in the room. We’ve probably consolidated and closed this at its greater pace as anyone. We’ve totaled over the last three years close to 26, 27 branches. I think in the last call we mentioned that there is still more to come. It’s just on a slightly slower pace. The economics in some of our more rural markets allow for branches to be profitable at lower levels and still serve that community base. So completely agree with you. In this environment, with technology where it is and some of the programs we are doing, like our private banking initiatives, our online initiatives, we are able to retain a good base and keep the most minimal infrastructure cost as possible. We’ll continue to do that. You could see a handful over the next year or two, but we like our network where we are at today and how it serves our communities.

Sean, I think that’s an important point too and I just want to echo that. There have been many a days where somebody will look at the amount of a deposit that you have in a branch and they make a broad brush common, well that’s a $30 million branch or a $25 million branch. And so it’d be easy to just get rid of that branch because it can’t possibly have been making money. I think it’s important to note that in some of our rural areas, we do make money on a branch like that and those deposits are stickier than in some case a $60 million or a $70 million branch in more of a metropolitan area. So it’s important to keep those branches from a liquidity standpoint. It services the community that doesn’t have a lot of other options and we make money. Your profitability analysis I think is a good one and it’s based on the profitability of a single branch. It’s not based on taking a look and just picking branches that have low deposit levels or lower deposit levels. Is that appropriate?

That’s correct.

Got it, okay. And then just looking at the residential mortgage growth during the quarter, obviously pretty big. You suggest that’s going to slow down a little bit. But remind us again what was added to the portfolio on the residential book during the quarter, what kind of yields and structure there.

Do we have the exact breakdown?

Mostly jumbo mortgages or?

Predominantly jumbo. We were looking to get you the exact breakdown. Predominantly more in the 30 year fixed bucket. Obviously there was volatility in the secondary markets. I can say this; we typically look when the economics are appropriate to do some season loans with the rates not ticking up recently. We've got a very strong demand in regards to other banks looking to acquire larger jumbo portfolios from us. We've done that from time to time and I think that opportunity has presented itself again. We are just looking for the exact breakdown.

Yeah, there wasn’t much change from last quarter, Sean. They’re primarily 30 year fixed rate I think you said and in terms of the average work I know it was about 360.

Okay, got it. Okay and then just taking a look at the margin one more time, if we don’t see any change in the interest rate environment over the course of the next 12 months, just directionally what would you anticipate for the margin in ’16 from the 320 base, kind of guided to here for 4Q?

I’d expect it to be about flat, Matt.

Okay, all right. Good. Thank you very much.

The next question comes from Laurie Hunsicker of Compass Point.

Good morning. Just to stay on margin, can you quantify for us what accretion income is going to look like in 2016?

Laurie, again we are not giving much guidance yet on 2016. I will share that in the fourth quarter. I’d expect there to be about $500,000 of scheduled accretion. And in terms of recoveries, they were certainly elevated here in the third quarter based on what the teams are telling me and what they're saying is in their pipeline. You could see around a million, a million plus. But again, from a 2016 perspective as we kind of take a look at Firestone here once the dust settles, we’ll be sharing a little bit more color on the next call.

And it’s hard to gauge exactly what quarter our recovery is going to come in. It could come in in the fourth quarter. It could come in in the first quarter. We just don’t know. I mean, those are complicated things to be really specific about.

Sure, okay. And so, but obviously that’s a moving number, but to the extent that it comes in at $1.5 million, that’s roughly comparable to the $2.7 million you reported this quarter in posting accretion?

The same component, yes.

Right. Okay.

We had about $500,000 of scheduled accretion in Q3 as well.

Okay, great. And then just to go back over to Firestone here. So you’re expecting high single digit growth. If we exclude the SPA component that your Firestone people are focusing on and we just look at the core business here of amusement carnival fitness, what is that growth expected to be for 2016?

I think -- This is George. Now, the Firestone folks are very well engaged. They like their opportunities now as part of the bank group and so we expect their growth to be fairly healthy. As mike said, similar to the rest of the bank, we are looking at margins and making sure that it’s smart growth. So we feel very good about their ability to originate, but we are not growing at any cost. We are using smart cross sell opportunities et cetera to make sure that what they do fits well into what the bank’s strategy has been in 2015.

Okay and then hand in hand with that, you had a jump here in your CNI non-performers from $3 million to $8 million. Was that Firestone?

Hello. It’s Richard. No. It had absolutely nothing to do with Firestone. Both the increase in the non-performer and the charge-offs were linked to one CNI transaction and not at all related to Firestone.

Okay and what are Firestone’s non-performers as of September 30?

We’re getting that, Laurie.

Okay and then just going to one time charges, I realize most of it was Firestone. Was there still some Hampden in that one time charge number that you took?

In Q3 yes. Yeah, we had some severance rolling off and there was just some cleanup left still with the conversion.

Okay and you mentioned we’ll continue to see that bleed through I should say at least Firestone, the one-time charges into fourth quarter. Do you have a number as to what that will be?

Yeah. I think you’ll see some charges coming through. I wouldn’t say they're material. I also think they will be offset with the tax benefit. So from a GAAP EPS perspective, you should be relatively neutral.

Okay. And then I guess one last question while you’re still looking up that other information. Your assets under management, where does that stand right now?

Laurie, this is Ally. It’s about flat with where it’s been, right about 1.4. We haven’t seen --- they're outperforming the index modestly, but we are just not seeing much change there.

Okay, thanks.

So Laurie, the number for Firestone from over 90 days non-accrual is minimal it’s $500,000, $600,000 and most of that, if not all of that, has been marked.

Right. Okay.

From due diligence to now there has been no additions at all.

Great. Perfect. 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.

Thank you everyone for joining us. We look forward to speaking with you again in January. At that time we’ll discuss our yearend results.