Beacon Financial Corp. (BBT) Q2 2017 Earnings Report, Transcript and Summary

Good day and welcome to the Berkshire Hills Bancorp Second 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 also note that today's event is being recorded. I would now like to turn the conference over to Allison O'Rourke. Please go ahead.

Good morning and thank you for joining this discussion of second quarter results. Our news release is available on the Investor Relations sections of our website berkshirebank.com and will be furnished to the SEC. As a reminder, none of today's discussion is intended as proxy solicitation. Our remarks will include forward-looking statements and actual results could differ materially from those statements. For detail on related factors, please see our earnings release and most recent SEC reports on Forms 10-K and 10-Q. In addition, certain non-GAAP financial measures will be discussed on this conference call. References to non-GAAP measures are only provided to assist you in understanding Berkshire's results and performance trends, and should not be relied upon as financial measures of actual results or future projections. A comparison and reconciliation to GAAP measures is included in our news release. And with that, I'll turn the call over to CEO, Mike Daly. Mike?

Thank you, 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 Jamie Moses, our CFO. He'll walk you through some of the specifics in our financials, we'll discuss our outlook, our guidance, and then I'll wrap it up. So, it was a good quarter for us and we delivered 11% growth in core earnings. We had double-digit annualized loan growth. We had good operating leverage and we improved profitability. We also executed a merger agreement to take us over $10 billion. We completed an equity offering and we announced our plans to move our headquarters to Boston. So, it's been a busy few months for us, but I really believe that the benefits of a lot of hard work from a cohesive employee base and our previous acquisitions and organic strategies are coming together. And we boosted our returns this quarter, driving core ROA to 92 basis points and we believe this performance ratio will improve even further in the third quarter. Annualized loan growth was 13% quarter-over-quarter including 10% annualized commercial growth. This was led by significant gains in C&I and as you know, we've been working hard on driving more C&I growth. We're focusing our teams and hiring new lenders in several markets. So, I'd expect us to continue to see good results there. On the regional level, we're having success in Central New York where there's a fair amount of economic activity and our relationships continue to grow. We also saw growth in Western Mass and we're seeing a pick up in ABL activity in Eastern Mass in the Mid-Atlantic this year. Mortgage balances were up for the quarter, including growth in adjustable-rate mortgages as well as our short-term leverage strategy for the new capital and Jamie will touch on that in just a few minutes. But with a clear path past the $10 billion threshold and additional capital, we do expect to continue to produce solid commercial loan growth for the remainder of the year. Total annualized loan growth is expected to be in the mid-to-high single-digits for the third quarter. On the deposit side, we had 4% annualized growth in the second quarter and we expect seasonal commercial demand deposits to bounce back in the second half of the year. So, we expect overall annualized deposit growth to be no less than mid-single digits again in the third quarter. And deposit pricing has so far remained resistant to the move-up in fed funds. Base rates have seen little to no movement in our markets and while pricing on CDs has inched up as the deposits rollover, the betas remain significantly below the rate hikes. Meanwhile we're going to closely monitor our markets for changes in behavior. Our fee income grew 15% quarter-over-quarter in line with our expectations. The SBA business contributed $2.5 million to that number and mortgage banking fees were up 28%. We originated $680 million in held for sale mortgages this quarter with new production coming on 75% purchase that's up from 70% in the first quarter. For the third quarter, we expect to see fee income grow in the mid-to-high single digits, led by mortgage fee revenue, further growth in loans fee income and stable wealth management insurance and deposit fees. As we've noted in the past, some of this revenue will be offset by corresponding expenses, but the overall growth is expected to have a positive effect on earnings. Now with that, I am going to turn it over to Jamie who'll give you some additional financial detail and then I'll wrap it up, Jamie?

Thanks Mike and good morning, everyone. It was another strong quarter for us. We're demonstrating positive operating leverage, improving our profitability and maintaining a strong credit profile while growing the business. Core EPS was $0.58 for the second quarter and GAAP EPS came in at $0.53 primarily reflecting acquisition activity. Average earning assets grew 2.5%. Our net interest margin was 3.36% for the quarter and 3.24% excluding purchased loan accretion. The increase in margin this quarter was primarily due to the positive effects of the recent rate hikes, coupled with some outsized prepayment penalties. For the third quarter, we expect the short-term leveraging of a new capital to bring the margin down by about five basis points. I'll touch more on that in a minute. Purchased loan accretion for the second quarter came in at $2.6 million, $2 million of that attributable to recovery. We expect total purchased loan accretion to remain near this level in the third quarter. The provision was $4.9 million in the second quarter, exceeding net charge-offs. We don't expect any significant changes to our overall credit or charge-off levels in the third quarter and we anticipate our provision will be in the area of $5 million again. We continue to feel that credit is performing strongly and we are disciplined in managing our credit selection and concentrations. Moving on to expenses, the 6% increase in operating expense quarter-over-quarter was primarily tied to increased loan production, particularly in mortgage and SBA. The efficiency ratio improved slightly to 61.7%, importantly stripping out the First Choice mortgage business, the bank operated at a 58.7% efficiency in the second quarter. We expect a low-to-mid single-digit increase in operating expenses in the third quarter, relating to the fee income growth that Mike mentioned earlier. Our core tax rate for the second quarter was 30%, including the benefit of some small tax credit investments. This is slightly higher than we guided to last quarter as one of the historic tax credit deals we were working slipped into the third quarter. That particular deal has already closed and we expect a couple more deals to close this quarter bringing our core tax rate for Q3 down to the 25% to 27% range with a corresponding charge to noninterest income of approximately $3 million. We still anticipate the 2017 full-year core tax rate to be around 27%. Looking at the big picture, we expect to deliver $0.58 in core EPS in the third quarter, with only a $0.01 or $0.02 of non-core charges tied to acquisition. Factoring in the additional shares, this would result in a mid to high single-digit increase in core earnings quarter-over-quarter on the heels of the 11% increase in Q2. We are pleased with our progress this quarter toward our profitability goals. Core ROA improved to 92 basis points and we expect to do at least that well over the next couple of quarters. Core return on tangible equity came in at 12%. Due to non-core charges, GAAP return on assets was 84 basis points for the second quarter and return on equity was 7%. As a result of our recent capital raise at quarter our tangible equity was 9.2% of tangible assets. We initially used some of the $150 million in proceeds to pay down borrowings and then began the process of leveraging the capital. As discussed on our May conference call, $100 million of the raise will support the commerce transaction. So, we are intentionally investing in shorter duration assets including CMO's. This strategy impacts our NIM in the short run and factors into our Q3 guidance. As Mike mentioned, we also added to our mortgage portfolio and we will be increasing our [bully] exposure. The rest of the funds will be used to support commercial growth. The net effect of this strategy is to offset some of the share count drag on our EPS, while continuing to drive ROA North. We estimate that the diluted share count will average around 40.3 million shares in the third quarter. We are pleased with our performance this quarter and excited about our prospects for delivering solid results for the rest of the year. Our financial condition is good and we expect to continue to make progress on our strategic goals. With that, I'll turn it back over to Mike.

Thank you, Jamie. So as Jamie said, we're expecting mid-to-high single-digit growth in core earnings next quarter, but of course with the increased share count, our core EPS is expected to be flat. Importantly these results would translate into a core ROA in the mid-90s and stable efficiency and for the full year, we continue to anticipate core EPS growth in the 3% to 4% range, which is the equivalent of the high end of our original guidance when you take into account the impact of the recent share issuance. We also expect stronger loan growth and the core ROA to improve into the 90s for the year. Now this guidance doesn't include the impact from commerce as the expected timing of close is of course still unknown. Our local regions continue to show signs of optimism and we're looking to capitalize on that while continuing to adhere to our credit disciplines. Now the team at commerce has been terrific to work with and we look forward to solidifying that partnership in the months ahead. Our strong integration history gives me confidence in our ability to hit the ground running and continue to build on expanded platforms. We're anticipating a great cultural fit and in smooth transition for customers and employees. I've been spending much of my time in the Boston Area lately, meeting with customers and employees as we thoughtfully build out our present there. I'm pleased with the response we've gotten so far and the relationship we've been able to further develop. We've also been identifying talent in this market and we're pleased with the reception we're getting in this regard. As you know, it's a competitive market, but also one where we believe we can be effective. Now let me touch on our preparations for crossing $10 billion. We're comfortable with the work we've done leading up to the commerce acquisition and we've been running internal DFAST ready stress test for two years now and we had anticipated a dry run with regulators next year ahead of our first official filing in 2019. And as I've said in the past, we've got the people and the systems in place to support our growth well past these asset levels. Over the next several quarters however, we're going to be entirely focused on growing our organic business, closing and integrating our acquisition of Commerce Bank and opening our new headquarters in Boston. We expect to deliver strong results over this period and that momentum should benefit all of our constituents. And with that, I'm going to open it up to any questions.

Thank you. We'll now begin the question-and-answer session. [Operator instructions] Our first question comes from Mark Fitzgibbon of Sandler O'Neill. Please go ahead.

Hey guys. Good morning.

Good morning, Mark.

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

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

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

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

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

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

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

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

Okay. And Sean, I know it's early, but the Boston off Congress Street there, can you share with us any early data on loans and deposits out of that location?

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

Thank you.

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

Hey. Good morning.

Good morning, Laurie.

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

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

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

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

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

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

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

No. No. It was about two thirds related to commerce and a third related to First Choice. There will be a small pale in Q3 related to First Choice, but not more than a $0.01 or $0.02 in terms of non-core charges in Q3.

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

This is small sale -- there's just a small sale that's left in Q3. We thought it was all going to be finished up in Q2. Some things came in towards the end.

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

Okay. And then with respect to your Commerce, can you update us on your $103 million tax A portfolio?

We really can't get into a lot of detail on Commerce right now. The S4 will be out probably in the next several days Laurie and so we're kind of precluded to get into any information on Commerce at this point.

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

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

Okay. Thanks.

Thanks Laurie.

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

Thanks. Good morning, everyone.

Hey Collyn.

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

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

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

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

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

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

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

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

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

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

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

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

Okay. Okay. That's helpful and then just one final question. You mentioned -- and if you guys talked about last quarter, I apologize, what's the relationship with Costco and I am assuming that acronym was First Choice or whatever the acronym was in the press release?

Okay. What's the specific question is…

Oh! I just didn't know what that relationship was cost like what that even was about, like what is that?

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

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

No, something First Choice has had for a long time, a good long-standing relationship.

Okay. I'll leave it there. Thanks guys.

Thanks, Collyn.

Our next question comes from Matthew Breese of Piper Jaffray. Please go ahead.

Just to follow-up on that Costco question, I know when the deal was first announced, that they had, they were with Costco and then Costco did a lot of refi business, but now the competition has switched right, some more purchase versus refi and not I was curious if Costco has moved in kind? Have they moved more towards purchase?

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

And of the overall mortgage banking activities how much stems from Costco.

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

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

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

Okay. But that's all inclusively like you're not backing out the prepayment and then applying to their five-basis point decrease.

No. That's all inclusive. Our guidance of five basis point is where we think we'll be.

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

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

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

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

Okay. Can we quantify the upside or is it more or less gravy if it works out well?

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

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

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

Understood. That's all I had. Thanks for taking my questions.

You bet. Thank you.

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

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

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