Beacon Financial Corp. (BBT) Q3 2018 Earnings Report, Transcript and Summary

Good morning, and welcome to the Berkshire Hills Bancorp Q3 Earnings Release Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Erin Duggan, Investor Relations Manager. 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 section of our website berkshirebank.com and will be furnished to the SEC. Our remarks will include forward-looking statements and actual results could differ materially from those statements. For detail and related factors, please see our earnings release in most recent SEC reports on Form 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 of reconciliation -- 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, Erin. Good morning, everyone. Thanks for joining us today for our third quarter call. I'll provide an overview of the quarter, then I'll turn it over to Jamie Moses, our CFO. He'll walk you through the specifics in our financials, will discuss our outlook and guidance and then I'll wrap it up. So we had a good quarter. We brought in the bottom line unplanned. We delivered $0.70 in EPS with an ROA of 1.08% and a healthy core return on tangible equity of almost 14%. We do remain focused on executing on our internal strategies and building out the organic engine that I talked about last quarter. We've solid loan growth this quarter, including commercial loan growth, which came in at an annualized rate of 6%. We're seeing good production out of the teams that we added over the past year, and we're pleased with the growing activity in our Greater Boston and mid-Atlantic markets. Last quarter, we touched on the credit that made local news. I want to give you brief update on that. That credit is now in the hands of our workout crew. We placed the credit on non-accrual in the third quarter due to recent changes in resolution options. And at this point, I'm comfortable that our team will get us to the right place, as we move down the path to resolve this situation. And overall, our nonperformers are only up about 3 bps from earlier in the year. Now we continue to be careful to adhere to our credit and financial disciplines at this point in the economic and interest rate cycle. Our guidance at the start of the year was that we expected to deliver full year total loan growth in the mid- to high single digits and I think we're set to deliver on that expectation. Turning to deposits. Average deposits increased over the prior quarter, period end deposits decreased due to $75 million reduction in payroll deposits and they fluctuate daily due to the nature of that business. And all -- our payroll does cause some bumpiness in our deposit balances. This is a good business for us, one that benefits our fee and our funding profiles. Our guidance at the start of the year was for deposit growth of mid-single digits are better and I still expect us to end the year with mid-single-digit growth. As I noted, our business focuses on relationships and this includes loans and deposits, and we continue to stress this as a core focus in our approach to our markets. The third quarter was our first full quarter with fully integrated operation from Commerce. And with this behind us, it was an optimal time to look back on what we've built and ensure we had leaders in place to execute on the opportunities ahead of us. I was pleased to announce that we promoted 4 leaders to the position of Senior EVP and these promotions included Greg Lindenmuth, our Chief Risk Officer; George Melas, our Chief Credit Officer; Alli O'Rourke, our Chief Administrative Officer for Innovation and Strategy; and Gordon Prescott, our General Counsel and Corporate Secretary. Now in addition to these changes, president, Richard Marotta will now directly oversee our commercial banking team; and our Chief Operating Officer, Sean Gray, will take on Human Resources and Corporate Culture. Now at this point, I'm going to turn it over to Jamie, he'll provide you with the review of the quarter and then when he's done, I'll wrap it up. Jamie?

Thanks, Mike and good morning, everyone. As Mike said, we had a good quarter. We continued to demonstrate strong expense discipline and were able to leverage our diversified lines of business to take advantage of the best opportunities across our footprint. Our profitability profile is healthy and we're pleased to post strong year-over-year improvement through the fourth quarter. EPS came in at $0.70 right on top of our third quarter guidance and a 23% increase year-over-year. We again, had minimal noncore charges this past quarter, resulting in core EPS of $0.70 as well. The net interest margin came in at 3.32%. Now looked at before purchase loan accretion of about 17 basis points. The NIM was 3.15% in the third quarter and was about 3.17% before the onetime impact of the change in the nonaccruals. The NIM tightened a little in the third quarter due to changes in business mix which offset the benefit of the latest Fed tightening. Looking forward, we expect to further decline in the GAAP NIM due to lower purchase loan recoveries. Now we got some accelerated recoveries in the second quarter, which gave us $0.04 in additional EPS that could've otherwise come back into the back half of the year. Looking at NIM before accretion, we don't expect any significant changes, and we generally expect that market related changes in business mix will offset the benefit of the recent rate hike. The loan loss provision was $6.6 million in the third quarter, exceeding that charge-offs. We anticipate the provision to remain relatively flat in the fourth quarter. As we noted in our earnings release, loan related fee income had a record quarterly high on strong SBA loan production and other commercial lending related fees. So our niche commercial business is doing very well this year and delivering on the opportunities from our acquisitions and market expansion. Mortgage continues to feel the effect of lower refi volumes across the industry, and of course we scaled down our expenses to offset this volume change. I would note that our mortgage portfolio growth is mostly coming from jumbo portfolio opportunities in Greater Boston, where we're building brand and relationships until this volume is not coming into the fee income line like our other mortgage banking volume. Also on the fee side, the Durbin impact began for us in the third quarter. I mean, to remind you, that's about $5 million impact on an annual basis. Looking ahead to the fourth quarter, we expect to continue to see robust SBA business with some likely impact from pricing pressures there. Mortgage banking fees will be seasonally lower. Operating expenses were down quarter-over-quarter, including the lower mortgage banking expenses that I mentioned as well as the full quarter run rate from completed Commerce cost saves. Efficiency ratio came in at 57%, reflecting our continued expense discipline. For the fourth quarter, we expect operating expenses to come in relatively flat with the efficiency ratio again below 60%. Tax rate in the third quarter was 21%. We continue to expect our full year '18 core tax rate to be around 20% to 21% with the fourth quarter falling into that range. Turning to profitability. Our core ROA came in at 108 basis points, a 10% increase year-over-year with the GAAP ROA to match. Core return on tangible common equity remained healthy at 13.7%, while GAAP ROE was 8.3%. So we're on track to meet the 17% to 20% full year core EPS growth that we guided to at the start of the year. Fourth quarter GAAP EPS may include some noncore restructuring cost related to branch consolidations which we mentioned last quarter. We're targeting $0.65 in core EPS for the fourth quarter, give or take a penny, reflecting the accretion and seasonality factors that I've noted. With that, I'll turn it back over to Mike.

Jamie, thanks a lot. So we're expecting to end the year with around $2.74 in full year core EPS, that's a record for the company and it's at the higher end of our guidance. We're poised to deliver core ROA of 1.05% or better and an efficiency ratio of around 58% for the year. So we're hitting our targets. We're moving the ball forward. While we're dealing with heightened competitive pressures and the challenges of a flattening yield curve. So we're going to be good in a lot of ways. So for instance, we've completed the Commerce integration. And that was done on time and that was done on plan. And at this time, we've fully digested that merger which demonstrates the merits of a good deal and strong integration. I was likely to be opportunities in and around our markets on the M&A front and of course, we're in a position to be able to react if any really attractive opportunities arise. But having said that, I can tell you our main focus continues to be on growing our profitability without M&A. Now we're seeing good activity out of many of our lines of business. Our Boston teams are in full swing and our mid-Atlantic business is accelerating. Our specialty lending teams are delivering results and working cohesively across our footprint, including our SBA team which broke into the top 30 nationally, based on both units and dollar volume. My bankers are on the ground running, increasing visibility in our markets and growing their portfolios. On the retail side, we continue to manage our retail distribution strategies, with the goal of reducing cost and enhancing customer delivery channels. And of course, we're sticking to our credit and financial disciplines which create a strong balance sheet and basis for a sustainable growth and profitability. So I think you can see we're delivering on our franchise potential. And we feel good about the opportunities ahead. Now this includes our outlook for 2019, where we'll deliver positive operating leverage in another year of healthy earnings growth. And with that, I'll open it up for any questions.

[Operator Instructions]. The first question will come from Laurie Hunsicker of Compass Point.

Mike, I just wanted to start with something you just said and I just want to make sure I heard you right. In terms of growing, going forward, the thought of growing profitability without M&A, did I hear you right?

Yes, I mean this is consistent with what we've been saying since the beginning of the year, Laurie. We're really putting our time and effort. We feel like we've built a pretty good sizable organization across a really good footprint and -- so our energies are into creating profitability with the institution we have now. Having said that, if a great opportunity comes up and we look at it and it make sense, we'll take a look. But right now, that's not our focus.

Okay. And then just refresh me in terms of your Boston deposits and loan. I know your round numbers are about $700 million or so in deposits?

Yes, and I'll ask you to Jamie or Sean to give you a quick update on that, but Boston is going well. We're pretty pleased with -- I think, we're actually exceeding our own expectations. But Jamie, you or Sean want to get on that one?

Yes, no I think total Boston deposits are around $700 million as you noted there Laurie, in our four branches that we have and loans are right around $2 billion in that area. So I think, we're very happy with how things are going. We're continuing to develop relationships with the largest centers of influence in those areas, and we think these results are reflective of headway that we're making to the people in that region.

Okay. And then any plans on that de novo front in Boston?

No. Right, Sean?

Yes, not at this time. We'll be opportunistic if something comes up, but not at this time.

Okay, great. And then -- thanks. On to credit, can you just give us a little bit more details regarding the Hermitage club loan exposure i.e. what's the gross exposure? What's the specific reserve? What's the LTV? What was the dollar amount of interest income that was potentially reversed out of net interest income this quarter? Just any other details that you can give us around that?

I mean, we can -- I don't know how much we can give you about an individual credit.

Yes, what I would say is that the outstandings are mid-teens. LTV is sub-50 and we feel very comfortable with the outcome in the future.

And is there any specific reserve on this set of loans?

Not when you have an LTV of sub-50.

Okay. And then do you have any other exposure, either on the corporate side or even individually to loans that are in and around this Hermitage club exposure?

No.

Okay. And then, I guess, just staying on the topic of credit, can you just update us in terms of where we are with the Taxi buck?

Yes, Laurie, the outstandings are about $28 million. I think, last time I told you there were sub-30. So there are around $28 million. There's been no charge-offs in that portfolio and they continue -- over 50% continues to be on a current basis.

Okay. And then same thing with Firestone, if you can just....

Yes, Firestone -- the balances remains flat quarter-over-quarter of about $256 million. Originations were about $40 million, charge-offs were sub-200,000 and then the NPLs were basically flat at about a couple of million bucks. I guess the one thing I'd like to talk about Firestone and sometimes you don't get into this. Jamie and Mike both mentioned that the niche business is that we purchase, Firestone has become a major feeder to the 44 Business Capital folks from an SBA standpoint. So we've really seen synergies developing between those 2 companies and we're very happy about that.

Okay. Great, thanks. And then just one last question, can you help us think about accretion income going forward? What'll that look like in 2019? Obviously, we're still somewhat outsized to 17 basis points. If you can just help us think about what that looks like for 2019 and even into 2020?

So. Yes, thanks, Laurie. So for the fourth quarter here 2018, we think, there are going to be around $3.5 million to $4 million in accretion income. And again, that's lumpy and that depends upon whether certain loans get worked out and whatnot. I would think we would say for 2019, you should probably expect about half of what you saw this year in terms of accretion income. As you know, this income, sort of, comes in front-loaded over time and then it sort of vain as you go out in the future. So I think half is a probably good number for '19.

The next question will come from Sean Tobin of FIG Partners.

Can you give us a little more color on current terms and expectations for SBA loan sale gains, given recent pricing pressure?

Sure.

Yes, we saw a little bit of pressure here in Q3 on that front. Still pretty healthy. It's one of the things that we're focused on. We saw that at the end of the quarter, we're continuing to monitor as we go forward whether or not that was just related to market conditions at that point, and we're going to keep looking at it. But we're comfortable with where we're at and we think it's still going to continue perform really well for us.

Okay. Thank you, that's very helpful. And then, can you help us think about purchase accounting accretion kind of on a quarterly basis in 2019, if possible?

Yes, Sean. So I think what we're saying it's going to be about half in '19 than we saw in 2018. And if I were thinking about a model, I guess, I would straight line it Q1 down to Q4 so that those numbers come in at about half of what you would do for '18.

The next question will come from Collyn Gilbert of KBW.

Just to start with following up on the SBA question. So Jamie, can you just give us what you're anticipating all in SBA gains to be for the full year 2018 and then what you're anticipating kind of that growth rate and what you're targeting for a growth rate for next year to be on that -- in that business?

So it's a good question, Collyn. Thanks. So it's -- we think that the SBA is seasonal in nature. So Q4 is going to be down a little bit for us here in '18. And then as you move into '19, that's going to go up. And so we're going to expect that to be out $10 million or so into next year.

Okay. And what were the total or year-to-date SBA fees?

Sorry, Collyn. I meant we were going to go north of $10 million next year in 2019, $10 million is where we're at in '18.

Okay, okay. That's helpful. And then just a question on the expense side. So it looked like you guys saw a big drop-off in marketing expenses, and I think Jamie, you had indicated that expenses you expect them, sort of, to be flat in 4Q. Is there a strategic change happening with how you're allocating your marketing dollars or just trying to understand that because it seems like that's going to be a big swing factor relative to what you guys have been doing in the past.

Yes, no. There's no strategic change for us. There's some seasonality factors in terms of our overall noninterest expenses that we're going to see, but no strategic changes in marketing.

Okay, okay. And then just color around the NIM. So you had indicated core NIM maybe to be flat into the fourth quarter. Just trying to understand sort of the assumptions that are going into that. Obviously, you saw some big compression this quarter and why you see that not occurring in the future and just all in pricing pressures and opportunities you're seeing on the assets and liabilities.

Yes, right. So what we saw this quarter specific to Q3 versus Q2 is, we saw 2 or 3 basis points of compression based just going on that non-accrual that we spoke about earlier. There were probably 2 or 3 basis points again in prepayment activity. It was lower this quarter than last and then we also have this phenomenon with LIBOR that probably cost us another 2 or 3 basis points, it's not reacting to the FED funds the way that sort of it normally has. So when you take all those things into consideration, we think, we're going to be roughly flat Q4. We expect to get some seasonal deposits back in the bank, which should affect the mix a little bit. We're expecting to have a strong DDA quarter next quarter, which is going to be led by payroll, which as Mike had noted was down $75 million or so here in Q3 and we expect that to bounce back in a pretty big way.

Okay, okay, that's helpful. And then just, finally, on the credit that moved into non-accrual this quarter. Do you have sort of an anticipation of kind of the timeline for resolution there? I mean, is this like a multiyear resolve that you see happening? Or maybe just a little bit of color as to how that's going to -- you anticipate that moving through resolution?

Yes, Collyn, this is Richard. I would anticipate that the resolution is going to happen between the next 3 to 9 months. There's a whole legal process that we go through and things happen along that way. But it certainly not going to be a multiyear resolution.

Okay. And just with the 50% LTV that you referenced.

Yes.

Is that include the overall borrowers capacity -- is that just on the property alone? Or there are other things that are going into sort of the assumed collateral that's backing that loan?

Yes, when I quote an LTV on a basic real estate, it's the collateral that we have the first security interest in.

The next question will come from Brody Preston from Piper Jaffray.

I guess, I just want to go back to mortgage real quick. Just wanted to sort of get your broader thoughts on First Choice and has it performed the way you would hope relative to initial expectations?

Yes, thanks, Brody. So there's definitely headwinds in the mortgage business today. Now with that being said, mortgage can be a good relationship acquisition strategy for us in our footprint. So any mortgage that we're putting on the books in terms of the checking account and then obviously, the ability to sort of cross sell other bank products along with that. And I would say, again, part of what attracted us to the FCLS group is there proven ability to manage to every environment, and I think we've proven again this year with reduced revenue out there, but still good efficiency overall from that business. So I think we're getting what we expected out of those guys.

Okay, all right. And I guess maybe just sticking with mortgage, with the hurricanes and everything, just want to know if there are any weather related impacts that you expect to occur in the fourth quarter beyond just the seasonal?

No, I don't think there's any material impact, is there, Sean? No.

No.

Okay. And then just on the tax rate, just given the New Jersey exposure that you guys have. I think, you say you expected in the fourth quarter to come in between 21% and 24%. Should we expect to that maybe start trending towards the higher end of that range, just given the change in New Jersey tax laws?

Yes. So Broderick, the 20% to 21% is the guidance for fourth quarter and I think that's still good. We anticipate no material change to our tax rate based on anything that happens in New Jersey.

All right. Great. Thank you very much. Then I guess maybe just circling back to SBA, Mike, you had said that you guys busted into the top 30 this year from a volume perspective and from a transaction perspective. And when I look at the data, just based on 6/30 that you guys are on pace to almost double your production from last year and, I guess, I just wanted to better understand. I know you said that Firestone has been a nice feeder for the SBA business, but I wanted to better understand what's driving that large increase?

Well, I'm -- I'll turn this over in a minute. But one of the things that I do want to say is that this is a business that takes a lot of time, energy, effort and infrastructure to do really well and that's one of the reason you don't see a lot of people doing really volumes in SBA lending. So having then infrastructure in place does a lot -- allow us some competitive advantages because the barriers to enter this market are pretty enormous. So efficiency matters and the fact that we have bank wide feeder system for us, which includes Firestone, it includes our ABL, it includes, in some cases, our mortgage people. There's a lot of feeder systems that we have in the company and so the cohesiveness between departments and divisions and the company is very important in feeding that. I don't think there's any magic beyond that. But if there is, and I've missed something, Jamie, Sean, Richard, if you have anything to add to that, just please do.

No, I just tackle, Michael said, I think it's just a fact that they've become more and more entrenched within our culture is one of taking care of business and taking care of clients and that's what happens.

Okay, great. On the loan growth outlook, Boston is obviously, a really competitive market. I know you said you're having good success there, but just when I look sort of the mix this quarter, it seems like residential drove the bulk of the growth and not so much on the commercial side. I wanted to better understand the geographic dispersion of that and if you expect the commercial to maybe pickup in the quarters ahead?

I think our commercial was what around 6%?

6%?

So we're not unhappy with that number and it's geographically dispersed. And that's one of the advantages that we believe is a strength of the company. Richard, you look like you want to add to this.

Yes, no. And I think 6%, and just being as selective as we are, I think it's a very good number. I had speak to our geographic area that we cover and had also speak to something that we've talked about in the past and also earlier today, which is our employees. We get the top lenders in the areas. They bring in top clients. They bring in top referral sources. They know who to deal with. So we're selective in who we do business with.

And then last one for me on the loan-to-deposit ratio, you guys busted through 100% this quarter. I just want to understand if that would be a limiting factor on growth, moving forward? And where -- if you could frame for us where do you think that's heading?

So we think the loan to deposit ratio is going to go back under a 100 here in the fourth quarter. As I've mentioned earlier, we expect our payroll business to sort of come back in a big way here in fourth quarter as well as some seasonal things that we see from corporate clients. So we think that's going to go back under 100, Broderick.

And this concludes today's question-and-answer session. I would now like to turn the conference back over to Mike Daly for any closing remarks.

Okay. So thank you and thank you all for joining us. We certainly look forward to speaking with you again when we do our fourth quarter call.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a great day.