Beacon Financial Corp. (BBT) Q1 2016 Earnings Report, Transcript and Summary

Good morning and welcome to the Berkshire Hills Bancorp Q1 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 Ally O'Rourke, Investor Relations Officer. Please go ahead.

Thank you. Good morning and thank you for joining this discussion of first 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 Mike Daly, Chief Executive Officer. Mike?

Thank you, Ally. Good morning, everyone. Thanks for joining us this morning for our first 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. She will comment on our guidance and then I’ll wrap it up. It was a good quarter for us. We executed on our planned initiatives. We delivered $0.54 and we managed through the volatility in the marketplace as well as absorbing a tax rate higher than we saw last year. We grew core revenue 3% sequentially, led by gains in most major categories of fee income. We also benefitted from disciplined expense management, the mild winter in New England and the identification of additional cost synergies and this helped to drive our core expense base lower and to improve our efficiency ratio. Commercial loan growth came in at a healthy 6% annualized pace. Our Syracuse team had their best quarter yet and the Albany and Boston markets continue to perform well. As I've said before, one of the key benefits of having a footprint like ours is the ability to capitalize on the strengths of different regions and this allows us to focus on relationship and be disciplined when it comes to extending credit. Our team work hard at getting the right relationships through the door and the pipeline for new business continues to be very good. We added and established SBA leader this quarter with a strong reputation for finding and executing on larger SBA deals and this aligns with our origin maintenance sales strategy and we're happy with the early results we're seeing. This also complements the acquisition of the 44 business capital team with their focus on driving SBA business in the mid Atlantic region and we expect to have that team on boarded very soon. In addition to the success we're seeing in commercial, we did have good growth in consumer loans this quarter and on the mortgage side, we took advantage of favorable market conditions to prune some seasoned loans. As a result of this strategy, total loan balances were flat quarter-over-quarter. Now we'll continue to evaluate market opportunities as we see them, as well as further develop our secondary market strategy across several product lines. In the second quarter, I’d expect to see overall loan growth in the mid single digits led by mid-to-high single digit commercial growth. On the deposit side, we realized 2% annualized organic growth in the first quarter and we also entered into an agreement to sell two smaller outline branches in New York. The branches have about $30 million in deposits between them and they are located in lower growth areas and the sale will occur later this year. Net of moving the deposits associated with these braches to held for sale, total deposits were flat at quarter end. We’d expect to see overall deposit growth close to a mid single digit rate in the second quarter and we continue to emphasize of course demand deposits. As you know we actively evaluate our branch network and we'll look for more opportunities to streamline and reposition when and where we can. We’re also developing new technology and service options for our customers and one of these new technologies is text AMEB. We rolled out the program in the first quarter and the early feedback has been just great. So rather than dialing the call center, customers can simply send a text message to AMEB1 and they receive a quick call back from one of our customer's service team members. So more on that and some other exciting initiatives will be forthcoming in the next few months. Turning to fee income, we posted 7% growth over the fourth quarter and 12% growth year-over-year. Now driving fee income to 30% of overall revenue is a key strategic initiative for us and we expect to continue to make strides here. We're building on the successes we had in wealth management and insurance, while further developing the secondary market channels for loan sales. So combined with a focus on customer penetration through cash management and other cross sales, this strategy should and I believe it will lead to improved ratios and less dependence on the margin in the coming quarters and frankly the coming years. Now with that, I’m going to turn it over to Josephine. She will walk you through more of the financial details. Joe?

Thanks Mike. Good morning, folks. I’ll begin by saying we feel good about this start to the year. We continue to be focused on profitability and we're demonstrating solid growth and disciplined expense management in what remains a challenging environment. Core EPS came in at $0.54 for the first quarter, which was in line with our guidance. We reported $0.50 per share for the same period in 2015. Our GAAP EPS was $0.52, reflecting the non-core charges related with the recent acquisitions and restructuring. As Mike noted, due to opportunistic loan and deposit sales, balances netted flat this quarter. Excluding accretion impacts, loan yields have been holding up and improving in some cases. That being said with the outlook of additional rate hikes retreating we do expect loan pricing to remain under pressure in 2016. Our net interest margin for the quarter was 3.33%. The margin before loan accretion contracted one basis point to 3.21%. Funding cost increased, including shifts in our deposit mix and the roll on of our forward starting balance sheet swaps. This swaps will continue to add incremental cost over the next couple of quarters. Outside of that we may see an additional one to two basis points of compression in the margin excluding accretion in Q2. Purchase loan accretion for the first quarter decreased to $2.1 million. We expect recoveries to continue to be bouncy and scheduled accretion to continue to track at a little under $0.5 million. Total purchase loan accretion including recoveries should come down further next quarter. Our fee income continues to improve and we expect further progress here in Q2. This includes the expected gain on sale benefit from our SBA program as well as seasonal improvements in deposit and mortgage banking fees. Overall revenue is expected to be up in Q2. Moving to expenses, I’m pleased with the discipline we continue to demonstrate here. Core non-interest expenses were down 2% quarter-over-quarter as we managed our headcount, successfully negotiated decrease and some facilities related costs and continue to promote Six Sigma disciplines within the organizations. Naturally expenses will up in Q2 as we absorb the new SBA business. We also expect to continue to reinvest in revenue producers throughout our expanding footprint. Our core tax rate for the first quarter was 28% including the benefit of some small existing tax credit investments. We still anticipate the full year core tax rate will be in the 20% range and that the tax credits will be more back loaded in the second half of the year. Now for the second quarter, we see the core tax rate in the area of 25% with a corresponding offset charged to non-interest income for the book amortization. So we won’t see the further boost to EPS on the tax credit until the second half of the year. Stepping back we expect to deliver $0.54 in core EPS in the second quarter. This would result in a 6% increase year-over-year with stronger revenues offsetting a higher tax rate. Non-core charges for the first quarter were tied to the branch sales and Firestone conversion. Core return on tangible equity came in at 12.2% and at quarter end -- at quarter end, our tangible equity was 7.7% of tangible assets up from 7% a year ago. Tangible book value grew 3% quarter-over-quarter to $18.44 per share. Credit remains very strong and we intend to remain selective taking advantage of our diverse footprint and emphasizing relationships, margin and profitability. We do expect a small increase in provision expense related to our targeted portfolio growth in the second quarter, but no significant changes to our overall credit or charge-off level. So as I said, we're happy with our start to the year and our prospects for delivering solid results in Q2. While there our headwinds, we see opportunity for growth and we're making strides and diversifying our income streams. Our financial condition is good and we expect to make further progress towards our profitability goals throughout the balance of the year. With that I’ll turn it back over to Mike.

Thank you, Josephine. Nice job as always. So as Joe said, we're looking for second quarter core EPS that’s in line with what we reported this quarter and of course we will work hard and look to do better if we can. Now despite concerns over a slowing U.S. economy, the local region does feel like its continuing to make progress and we remain cautiously optimistic. Growth remains solid in the Boston market and the New York markets are slowly, but surely benefiting from the broad technology investment going on there. While I would say the opportunities are good, but we will continue to be disciplined from a credit and pricing standpoint as we move forward and we built a strong franchise at Berkshire and a culture that thrives on meeting the market challenges of today’s market. We remain focused on developing our revenue channels and closely monitoring expenses leading to improved profitability and ultimately increasing shareholder returns. As I've said in the past, M&A opportunities will continue to come up from time to time, but our focus remains on leveraging our existing business and taking advantage of the synergies we can develop here. Our footprint, our teams and our America's most exciting bank culture I believe will continue to be differentiators for us. I’m confident about the opportunities in front of us and our team's ability to capitalize on them. And with that we’ll open it to any questions.

We will now begin the question-and-answer session [Operator Instructions]. The first question comes from Mark Fitzgibbon of Sandler O’Neill. Please go ahead.

Good morning and thanks for taking my question.

Hey Mark, how are you?

Great, thanks. Mike I wondered if you could, I heard what you said on the loan growth numbers but I wondered if you could share with us what the pipelines look like, maybe the mix in the pipelines as well?

Sean you want to fill that.

Hey, Mark Sean here. The pipeline remains robust. From a commercial perspective we're talking in the $150 million to $160 million range with a good balance between CRE and C&I. On the consumer and mortgage pipelines, we’re talking about a $100 million to $120 million with also a good mix of product.

Okay, great. And then Josephine on the efficiency ratio, it looked like you guys made great progress this quarter, you had a below 60%. Can you hold it there? Is that the goal?

Hey Mark, yeah, obviously we’ve had a disciplined expense management I do expect that to pick up in Q2 as we continue to expand our SBA platform you might see a small uptick there.

Okay. And then Mike, I am just curious if you had a chance to look at the Chicopee deal before they announced their deal with Westfield and if that deal would have made some sense for you guys?

We weren’t involved in that one Mark, but I meet with all these guys regularly and I think it's fair to say that both Jim and Bill wanted to do an market deal with two banks that are headquartered in that community and kudos to them and I think they execute on their strategies. They’ll be fine and their shareholders will be happy and there is plenty of deals out there and there is plenty of business for everybody. So that’s about all I can tell you at this point.

Thank you.

You're welcome.

The next question comes from Casey Haire of Jefferies. Please go ahead.

Hi, good morning guys.

Good morning.

Just wanted to follow up on the expense front. Typically the balance FICA hits, you guys actually had comp lower. What was the payroll tax hit this quarter and what was it that came in lower to allow you to keep expenses, to keep the comp line down in this seasonally challenged quarter?

Hi Casey. Generally as you say the FICO hit, they're roughly about a $1 million that we see coming through there. I'll tell you overall, it’s really just a managed pace as we see the opportunities layer in revenue producers and accelerate that in periods when we can.

Okay. And then just switching gears on the C&I yields if I look and obviously purchased accounting is in play here and it was over this quarter. But the C&I yields were down 50 basis points roughly after the Fed hike. As I said, purchase accounting was lower but how come we didn't see, why such a big downdraft in the wake of a Fed hike?

Yes Casey again a lot of that degradation is the recoveries. We did see a bump in overall new originations. You have some of that -- relatively stayed flat once you strip out the accretion and you still have a little bit of the roll off effect in there, but overall they were relatively flat for the quarter.

Okay. And just lastly, on the loan growth front, consumer, you guys had a very nice growth period in consumer which you guys were kind of in the back half of 2015 anyway pulling away from due to overheating in auto. I missed the pipeline remarks but is consumer expected to be a growth driver for you going forward?

Casey, Sean here. We did see some growth in indirect. We’ve been strategically moving away from the super-prime business not liking the economics. We're able to evaluate our portfolio and in the sweet spot of about 720 FICO score we actually saw expanding margins within the quarter. So it gave us an opportunity to grow the business a little bit. We don’t see it as a huge growth play because their overall strategy is to originate and sell in that business as well. But we did see some good healthy growth within the quarter with good expanding margins.

Okay. Thank you.

Our next question comes from Collyn Gilbert of KBW, excuse me. Please go ahead.

Thanks, good morning, everyone. Could you -- I don't know, Jo, if you want to run through it or Sean or whomever, just some of the detail on what you sold this quarter and maybe what the related yields were on what you sold within each bucket?

So predominantly Collyn, we had a great quarter as Mike mentioned, we were able to pare down and sell some seasoned portfolio loans and really took advantage of some really good economics there. We monitor our gain on sale margins. We monitor them against our competitor and what I can tell you is its very strong this quarter. So our goals were predominantly from selling mortgage in that respect. As we mentioned I think in the last call as well as we 44 capital closures and we continue to invest in SBA, we will start to see some additional gains there. From the commercial side, it was predominantly moving out commercial assets that didn’t meet either a relationship hurdle for us or a margin hurdle for us. So no real gain on sales on that piece this quarter, but we will look for that opportunity as we go forward.

Okay. So the intention -- are you managing to a balance sheet level or are you looking at more it on an individual the profitability formula for each transaction?

Hi Collyn, Jo here. Yes, so we'll look at those opportunities as they come up. It's less about any strategic level and more just as the teams identify opportunities and making sure there is room for solid possible relationship growth.

Okay. Okay. And then just tying into the comment about 44 Capital closing, can you just kind of give us an update on how you are thinking about the SBA business and how much of a contributor you expect that to be either this year or next?

Yes we like the business, we've really spent the time to make the investment in our foundation. From a unit’s perspective, we're number nine in the country now. So good relationship business. We think that business also helps our deposit base. So from a contribution perspective, I think we've guided in the past to between $400,000 and $500,000 in gain on sale that you'll start to see in that business as we move towards the summer. I think that’s where we were last quarter as well. So we like the business. We think it will be a great strategic fit with what we've got going on.

Okay. Okay, that's helpful. And then just finally, Josephine, on your comments on the tax, so in the second quarter you said 25% core tax rate which would be offset by the negative adjustment on the fee side. I think I had like a $2 million negative adjustment for the second quarter. Is that about right or what are you anticipating that negative adjustment to be?

You know what Collyn I would back into it from a net perspective. I don’t expect there to be any contributions to EPS bottom line. So $2 million is probably the right number I have to go back and do the math.

Okay. Okay. All right, I will leave it there. Thanks.

Thanks Collyn.

The next question comes from Laurie Hunsicker of Compass Point. Please go ahead.

Yeah, hi Good morning. Just wanted to follow on Collyn's question of tax. So as we look, Jo, at the back half of the year if we get to September, December, is that taxes advantage project line item in the noninterest income that is going to be tracking around the $2.9 million, $3 million loss? Are you thinking about that the right way?

Yeah, that should be probably get you to the overall, if you're looking at an effective tax rate for the year in that 20% range and knowing that we were at 28 guiding to 25, that’s probably the right run rate.

Okay. And so for the -- then again for the back two quarters we are going to be probably 17%, 18% in terms of a tax rate? Getting us to that?

I would expect it to be somewhere south of 20% yes.

Okay. And then how should we think about that for 2017?

Laurie we really don’t give guidance out for 2017. I will tell you, this has been a very successful effort here. Our guys, the commercial guys are sourcing these projects. They are coming from solid relationships. They've built a robust pipeline and I expect it to continue.

Okay. And then just jumping over to your comments on core margin, so the core margin excluding accretion was 3.21, if it is down a basis point call it to 3.20. But your reported margin if we see a drop in that accretion income, if that is going from 3.33 to somewhere in the high 3.20s, 3.27, 3.28, is that probably a good number? I realize accretion income jumps around but how should we think about that?

You are in -- I would say you are in the ballpark yep.

Okay. And then on your marketing expenses which had a nice drop linked quarter, is that a good run rate for this year or are we going to see that ramp back up?

Yeah, Laurie we don’t generally breakdown line item expenses in terms of our guidance. I do expect there to be an uptick in overall operating expenses for Q2. Again I think that it's probably going to stabilize where you see it, that will bounce around as we see our markets and our footprint opportunities.

Of course Sean has got his finger pointing up in the air. He would like to see that go a little higher wouldn't you.

All right, Sean and I partner up.

We're a growing bank.

Okay, good. And then just one more line item here on the expense side. The merger charges you guys took of $780,000 relating to Firestone, do we see any more merger charges related to Firestone or when do those stop?

Those are mostly behind us. At this point, the remaining tail was really around some of the conversions that happened here in the first quarter.

Okay. And then the two branches that are closing, do we see a charge associated with those two come through in June or was that rolled in?

Those two branches -- those two branches will close in Q3. So generally you will see the final economics getting trued up in that quarter. You move them to held for sale as your best estimates, but until they settle you could see a refinement there.

Okay. And then Mike and Jo, this is both for you. So share buyback that you announced in December, it doesn't look like you repurchased any shares in the quarter. How, Mike, are you thinking about that here? And, Jo, any color on directionally what share count does going forward?

I don’t think there is any change in strategy, Laurie from our standpoint on buybacks. It’s not at the top of the list but when and if it’s appropriate, we'll do some repurchase of our stock and I don’t think it gets a lot more strategic than that unless you have something to add to that Jo.

No we just reloaded. We got approval under our old program and so as Mike said opportunistically is there and ready to go.

Okay, great. Thanks. And then just lastly, can you just give us an update on the Firestone balances, where we stand total, what originations were in the quarter and where non-performers were? Thanks.

This is Richard Marotta. The balances went up about $17 million quarter-over-quarter. The non-performing piece of this was approximately 1% of our total NPLs and every single metric from credit perspective looks fantastic.

So 1% of $21 million?

Yes approximately.

Laurie this is Ally. That compares to the overall -- Firestone makes up about 3% of the assets, but it’s only 1% of the NPLs to put that in perspective.

Got it. Okay. I am sorry just so one more question, I'm sitting here looking at it. So Firestone then is sitting at about $200 million total and your non-performers on that are $210,000. So nonevent, is that correct?

You got it.

Yes.

Okay, thank you.

The next question comes from Matthew Kelley of Piper Jaffray. Please go ahead.

Yes, a question for Josephine. Just on the guidance on the margin and the outlook there, if rates don't change, the $300 million in forward starting swaps I believe that is supposed to be -- it works out to like a 6 to 8 basis point drag on the margin. How much of that is already reflected or how much of that is to come again if rates don't change?

Sure, hey Matt good morning. So I would tell you in Q1 you probably saw to slightly more basis points of compression with the first tranche picking in and the second quarter the tranche, the second $100 million will kick in and you will probably see another three basis of compression related to the swaps and then the rest of flow through in the third quarter once they are fully face in.

Okay. Got you. So another basis point or two in 3Q just pressure there if rates don't increase?

Yeah, two basis points give or take.

Okay. So it seems like the core margin will continue to drift down then throughout the course of year as a result of that if there is no change in the shape of the curve.

Yeah, you are definitely going to have the impact of the swaps and overall yield and loans I’d say one to two basis points we’ve been very intelligent at what we will or won’t do and I think that discipline is holding strong there as we observe the swaps you will see some further degradation.

Got it. Okay. And then on the loan related fees, I assume that is mostly new back-to-back swaps that are being booked. During the first-quarter, what percent of the commercial real estate loans included a back-to-back swap and how many customers were taking those?

Yeah, the loan fees has swap income and service fees as well as some of the season loan sales that we did in the quarter, From a percentage perspective, I don’t know do we…

We can calculate it as a percentage of customers and get back to you.

Okay. How much of this $3 million then was the seasoned loan sales again?

Will get to the detail there Matt. It wasn’t a significantly high quarter for us, but there was some activity there this quarter.

Got you. Got you. And then just a big picture question on the tax planning program. Is that something that you believe the net bottom line EPS and capital growing benefits are worth it relative to some of the uncertainty that it introduces into the model? Are you okay with that kind of give and take between a clear net benefit to earnings and capital versus volatility to the quarter to quarter that makes it a little bit more challenging in the forward outlook?

Let me just say this. Any time you can put more money in the pockets of your shareholders, you probably ought to do it. And so we have to balance that versus the value proposition because of the volatility, but I find hard to believe that most of our shareholders wouldn’t want us to take advantage of those and add that kind of respective EPS into our retention of earnings Joe?

Yeah one other comment I would say there Matt, when we think about these tax projects there is really kind of three basic risks around them and one has to do with the project development, the construction needs to be competed per the plan. Now these are again the bank is providing construction generally on these projects and the underwriting of part of the bank's normal construction and management process. So that’s really mitigated. The other one being more around the tax benefits and making sure that we're working with third part tax and legal resources and we certainly go through that level of due diligence. And lastly the bank would need to generate their operating capital gains in order -- the on the income tax liability that we're going to offset those tax credits and we’ve done a lot of tax planning strategies during the last two years and we are seeing that pay off.

Got it. Okay.

Hey, Matt its Ally, just want to follow up on your question about swaps. So when you look at the swap fee, the loan fee income line its less than half of that is what is made up on swap fees and of the deals we did this quarter its around 20% probably less than 20% were head swaps attached to them.

Got it. Okay. That makes sense. And one last quick one. Do you anticipate any additional uptick in just kind of the core deposit rates that we are seeing here? The money market was up 10 basis points year-over-year. And CDs, are new CD offering is coming in right around 100 basis points or what is the trajectory of the deposit cost?

Hey Matt its Joe. We'll probably see some additional re-pricing in some of time deposits from the fed rate hike. I don’t expect any major changes but you could see a slight uptick.

Okay. Thank you.

Thank you.

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

Okay. Well, we want to thank everyone as always for joining us. We look forward to speaking with you again in July to discuss our second quarter results. Thank you.

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