Beacon Financial Corp. (BBT) Q3 2019 Earnings Report, Transcript and Summary

Good morning and welcome to the Berkshire Hills Bancorp Q3 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 David Gonci, Capital Markets Director. 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 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 our results and performance trends, and should not be relied on 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, Richard Marotta.

Thank you. Good morning, everyone, and thank you for joining us today for our third quarter earnings call.With me this morning are Jamie Moses, our CFO; Sean Gray, our President; Georgia Melas, our Chief Credit Officer; and George Bacigalupo, our Commercial Leader. I’ll begin the call today with a high-level overview of the quarter and then turn it over to Jamie, who will dive deeper into our numbers.The third quarter was eventful on several fronts. Our teams have moved forward together on bringing to fruition the financial and cultural initiatives that we’ve had in the works since last year. In most ways, our financial performance was in line with our plans and previous guidance.Before I discuss our performance, I’ll take a few moments now to address the loan charge-offs that we announced last week. As you know, in September, we announced that we identified a $16 million problem loan, which resulted from potential borrower fraud. I need to mention upfront that there have been various articles in the media about this, but our policy is that we don’t discuss the names of borrowers or provide specifics about customer relationships.Given that, we have no comment on any news reports, but I will address our assessment of this situation, which resulted in us charging off the $16 million loan balance. And that reduced third quarter EPS by approximately $0.23 after tax. This credit is a loan participation and is secured by business assets. In situations with potential fraud, the realizability of loan collateral can be significantly impaired, and it was our judgment that we should charge off the balance based on the information available to us.We’ve reviewed our overall portfolio exposures in our loan participations and we remain confident of our overall credit quality. While borrower fraud is a business risk that we can never fully eliminate, we have strong underwriting and administrative disciplines. And we fully reviewed our practices to make sure we’re prudently controlling risk.Before this charge, we would have both achieved our earnings expectations as well as leaving unchanged our outlook for the year. Our strategies have produced solid results. Our initiative to reduce wholesale funding lowered our funding costs and supported our NIM. We bought back stock below book value and returned capital freed up by our loan strategies.We made further progress with our efficiency projects. We completed the integration of the SI Financial operations earlier this month, and are on track with our objectives for this acquisition. Our teams had solid progress in building our relationship-oriented 21st century community bank. I’ll let Jamie take you through some of the numbers for the quarter. Jamie?

Thanks, Richard. We had $0.46 in core income in the third quarter, and that would have been $0.69 before the $0.23 impact of the loan charge, which was on pace towards our full-year objective. GAAP EPS came in at $0.44 in the third quarter and included merger-related charges as we prepared for the systems conversion, which we completed earlier this month.Total loans declined in the quarter, including targeted runoff of indirect auto loans and accelerated mortgage prepays as interest rates declined. We moved about $50 million of commercial outstandings off the balance sheet based on our selective criteria for relationship benefit and return. We’ve had good experience with our acquired Savings Institute deposits and were up a little across the franchise.Total deposits decreased due to daily fluctuations in our payroll deposits and also due to a targeted reduction in broker deposit balances. We continue to focus on our strategy of reducing our use of wholesale funds, which decreased by about $100 million during the quarter and are down by nearly $0.5 billion since the start of the year. The ratio of loans to deposits decreased to 93% from 101% so far this year.The net interest margin increased quarter-over-quarter by 3 basis points to 3.22%. We benefited from higher accretion, and our teams brought in higher-than-expected recoveries in resolving purchased credit impaired loans. Measured before accretion, the margin decreased slightly by 2 basis points to 3.06% as we anticipated.Our strategy to reduce higher cost wholesale funds lowered our funding costs by 9 basis points, which mostly offset the impact of asset sensitivity in the falling interest rate environment. Including a full quarter of acquired SI Financial balances, net interest income grew by 6% quarter-over-quarter. Looking forward, we expect fourth quarter NII to decrease as a result of both margin and balance sheet changes, while advancing strongly year-over-year due to the SI Financial contribution.Turning to non-interest income. Total fee income increased by 17% over the prior quarter. Our SBA team had a strong quarter and achieved record quarterly revenue. For the fiscal year ending September 30, Berkshire was the 18th largest lender in the country based on SBA approvals of 7A loans. This was up from the 28th spot in the prior year. Commercial loan swap fees also improved in the third quarter due to volume gains, and our SI Financial team is experienced in delivering swap solutions to their markets.Deposit related fee income increased, including a full quarter benefit from our acquired SI Financial operations. We’re targeting to achieve further fee income gains in the fourth quarter based again on a higher contribution from loan related fees. Including the $16 million loan charge-off, total net charge offs were $22.5 million in the quarter. This also included a write down of commercial real estate balance that we have commented on in previous quarters, and that write-down was based on an updated appraisal. All other net charge-offs were within the range of recent quarters. We expect our provision in the fourth quarter to be within the range of those recent previous quarters.Looking forward to 2020, we’re well along with validating our methodologies for the new CECL reserving process, which will be effective at the turn of the year, but we won’t be providing estimates of the impact of this accounting change at this time. I would note as we’ve previously disclosed, the balance of non-accretable credit discount on purchased credit impaired loans will be transferred to the loan loss allowance when we implement CECL at the start of 2020. The balance of that discount was $91 million at September 30. Also, any future accretion on recoveries of these loans will be credited to the allowance rather than to interest income as we presently do.I’ll turn now to non-interest expense. GAAP expense decreased from the prior quarter due to lower merger charges. Core expense increased by 2%, including a full quarter of acquired SI Financial operations. We recorded a $1.9 million FDIC insurance premium rebate and anticipate another $1.4 million in the fourth quarter. Our efficiency ratio improved to 53% from 56% in the prior quarter. We brought down our headcount and expect to bring it down again in the fourth quarter as we complete our merger integration.We expect to achieve our merger related cost saves as planned and to keep total merger costs within our original estimate. We’re targeting to achieve an efficiency ratio in the area of 55% for the fourth quarter. Putting it all together, we expect to bring in our core EPS at the target of $2.60 or more for the year before the impact of the $0.23 loan charge-off that we have discussed.Our outlook anticipates that we will maintain our pace of share repurchases, which will, of course, depend on market conditions. We cannot provide GAAP EPS guidance for the quarter. We plan to record our final SI Financial merger costs, and our GAAP results will also be affected by FCLS mortgage results, including any potential sale impacts.This concludes my comments, and I’ll turn the call back over to Richard.

Thanks, Jamie. The strategies we put together at the start of the year are keeping us on pace for our target of core earnings at $2.60 or more before the $0.23 impact of the loan charge-off. In addition to our earnings release yesterday, we also announced that our Chair, Bill Ryan, is stepping aside from the Chairman responsibilities. We’re grateful for his vision and leadership that he has contributed since taking the position of Board Chair 5 years ago. While he’s reducing his role for health reasons, we’re pleased that he’ll continue to remain active on the Board of Directors. On a personal level, I’d like to thank Bill for the guidance and wisdom he provided me since I assumed the CEO position. Bill, thank you.The Board has elected Bill Dunlaevy to take the position of Chair effective December 1. Bill is also a career bank executive and have served on our Board since 2011. He fully supports our vision of building a 21st century community bank with a culture of belonging. Bill knows our markets and is well positioned to lead the Board’s oversight of our enterprise.I also like thank former Director Rick Murphy for his service. Rick has moved on due to increased professional opportunities. He will be missed. I’m pleased to report that during the third quarter, we were proud to partner with the Runway Project to create the Friends and Family fund CD, aimed at helping entrepreneurs of color access to seed capital they need in order to launch the businesses of their dreams.Together, we’re doing our part to help close the racial wealth gap by investing in communities of color. We also moved forward with our storefront initiative as we pursue our plans to open these collaborative workspaces to expand our support of under-banked communities and engage with community influencers. We’ll have more news on this in the coming months.Looking ahead to next year, we’ll be moving forward with the benefit of our strategic initiatives in our fully integrated Eastern Connecticut and Rhode Island operations. While we won’t be providing 2020 guidance in this call, I can share that we’ll be targeting to improve our profitability while investing in our 21st century community bank and providing leadership in meeting the diverse and evolving needs of all of our communities.At this time, I’ll ask the operator to open the call to questions.

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Mark Fitzgibbon with Sandler O’Neill & Partners.

Hey, guys. Good morning.

Hey, Mark.

How are you doing, Mark?

Terrific. Jamie, I wonder if you could help us think about sort of the size of the balance sheet at the end of the year, given the planned runoff in some of those selected portfolios you discussed previously.

Yeah, I mean, I think the balance sheet will be slightly smaller than it is at the end of the third quarter by the end of the year. We’re going to continue to run down the indirect auto portfolio. And we’re going to continue to look for sales on the aircraft portfolio as well. So while we look at – the commercial pipeline is strong for us at this moment.We’re going to be very selective in the loans that we bring on to the balance sheet, making sure that the relationships are there as well as the profitability. So I think you’d still see the overall balance sheet to be slightly down, Mark.

And does that kind of continue for another couple of quarters do you think or…?

Yeah. I think so, Mark. When we look at it, we had almost close to $3 billion in wholesale funding on the balance sheet at the beginning of the year. We’re going to try to drive that down to much more manageable levels as we go forward. Ideally, we’d have no wholesale funding on the balance sheet, right. But that’s going to depend on our ability to drive core organic deposit growth.And we’re going to actively and prudently manage that in consideration of earnings and profitability.

Okay. And then, I heard your comments about NII, but I’m curious as to your thoughts on the margin?

Yeah. So, yeah, right, so we organically or ex accretion, I guess, I’ll say, we were down 2 basis points from third quarter to second quarter. In fourth quarter, we’re anticipating another rate cut here at the end of October. We had, end of September there was a rate cut. And so, when those two cuts sort of flow through the balance sheet, we expect probably 5 or 6 basis point decline in the NIM in fourth quarter.

The reported NIM, not the core NIM, correct?

Yes, that’s right. And so, if you assume that the accretion, the recovery and workouts that we do in the fourth quarter are the same as they were in the third quarter, you would expect that to decline also by 5 basis points or so.

And should we assume the effective tax rate will be around 20% going forward?

Yeah, I think that’s right. Maybe it could be 19%, 20%, somewhere in that range. If you’re flat, I think you’re in the right spot.

Okay. And then also, I noticed that you took a commercial real estate charge-off in the quarter. I assume it was related to that ski place up in Vermont. Are we sort of through most of that, do you think at this point or are there additional charges that are coming, because I thought I noticed that they filed for Chapter 7?

We don’t like to comment on our customers and the borrowers in this regard. We have previously mentioned this loan on other calls. It’s still kind of up in the air, but we feel comfortable where we are charged off on that loan at the moment.

And, Mark, as you know, as these situations go to their finality, the bank continues to update the value of the underlying collateral.

And then, lastly, I wonder if you could just help us think about this Be FIRST program and what the implications will be from a cost standpoint?

So, great question, Mark. I mean we continue to manage Be FIRST as part of our overall cost expense. Be FIRST is a cultural initiative that we’re very proud of, very excited about. And so, from that perspective, I don’t think you’re going see any additional expense gained or expense costs, right, that on a go-forward basis, we’re going to continue to manage the efficiency ratio in that 55%, 56% efficiency range.

Yeah, Mark. I mean it’s the core of who we are. And so that basically is a core expense to us, and it’s all built into all of the things that you’ve seen.

Thank you.

Our next question comes from Dave Bishop with D.A. Davidson.

Yeah, good morning, gentlemen.

Good morning, Dave.

Good morning, Dave.

You mentioned the outlook for fee income and some confidence, I guess, in terms of maintaining the level of fee income related to maybe some of the contribution from the SIFI. Maybe just remind us in terms of where you’re seeing some of their core competencies sort of flow through the fee income generation this quarter and anticipating moving forward?

Yeah. So there was some gains on the – on swap income. The SI Financial team, as we said in the call is experienced and delivering swaps to their markets. So I’m very pleased with how they deliver that to their customers and markets. And then also, obviously, on the deposit side, right, you add in $1 billion or so of deposits, you’re going to get higher fees based off of that as well. So that’s generally how they’re delivering in the – on the fee income side of things. And from an overall perspective, we think there’s a little bit of room in Q4 on the fee income side. We think we’ll do a little bit better than we did here in Q3.

Okay. Got it. And then you’ve talked about sort of focusing on the core loan and deposit relationship generation here in the past several quarters. And any sort of success story or early indications that you’re winning more on the core sort of commercial side and any sort of success stories on core deposit generation thus far?

So I guess, what I’ll say, Dave, is from an individual success story, it’s probably not. Overall, we’re looking at what we would consider our organic deposit growth throughout the year has been healthy, right? So this – we wouldn’t count payroll or brokered deposits in this number. And I think we’re doing very well in that regard. So go ahead.

And I also think one of the other successes is, I think, as the SI acquisition and integration has happened, I think there’s been minimal, if any, runoff there. If anything, there’s actually been some growth.

Yeah. That’s a good point.

And so we’ve done that, I think, consistently historically as we’ve gone in and gone into new markets. I guess the other thing that I would say is as we start to go into the underbanked communities, and we start to tie it to some of the things that we talked about in here, the Family and Friends CD, our anticipation is that we’re going to start to drive some core deposits through that whole process. So we will have, I’m assuming, very good win stories in the not-too-distant future.

Got it. And then maybe just any sort of update on the aircraft portfolio, the outlook for that? Just any update you can provide?

Yeah. We continue to market that portfolio. In the meantime, we are letting it runoff as an existing operation. So that’s basically the only update I have for you on that, Dave.

Got it. Thank you.

Our next question comes from Laurie Hunsicker with Compass Point.

Yeah. Hi, good morning.

Good morning, Laurie.

Just wanted to go back to the aircraft for a minute. So when would you expect that, that book would be completely run to 0 if you don’t actually sell it?

We were looking at 3.5- to 4-year weighted average life.

Okay. And just remind me, what is the coupon on that?

It’s in the mid-5s.

Okay. And are there currently any delinquencies in that?

None that are material. I’m sure there must be a delinquent loan or 2 in there. I can get back to you offline on that, Laurie.

Okay. And then just same question in terms of charge-offs because, obviously, your C&I charge-offs were elevated, even excluding that $16 million. Was there anything from aircraft in that number?

No.

Okay. Great. And then, what were your total substandards? Where did those come in at relative to last quarter, they were $150 million?

Yeah, Laurie. We’re going to kick that over to Georgia.

Hi, good morning, Laurie. It’s Georgia. The total criticized of the total, you’re looking just for the substandard?

Just the substandard.

Okay. So the total there is roughly $162 million.

$162 million. Okay. And then how much of that is C&I?

C&I is roughly – well, $50.5 million. It’s actually down a little bit from last quarter.

Okay. And then how – and how much is [CRE] [ph]?

[CRE is 1.12 million] [ph], and that’s up roughly $25 million from last quarter, and that’s due primarily to the – to a hand – well, actually, 3 accounts from Savings Institute.

Okay. And that includes the Hermitage – or, I guess, you’re not mentioning by name, that includes the ski resort? Is that in that number?

Yeah. This is total commercial, yeah.

Okay. And so you guys did update us on that loan about a year ago. About a year ago, I had it at $17 million, no specific reserve against it, 50% LTV. Can you just help us think about that? I mean, I guess, that loan is still about $17 million?

No. We’ve written it down to the liquidation value. We received an appraisal earlier in the third quarter with a lower liquidated value and we did write it down to that level.

Okay. And so what is that number? I mean, right. Actually, you did have $3 million, $2.7 million in NCO. So if it’s related to that, that brings it down to what, about $14 million?

Hey, Laurie, this is Richard. So we’re not going to comment on specific deals like that for a couple of reasons. And one of the reasons is when we’re in a situation that we are now, which is I think someone mentioned Chapter 7, so we are a secured creditor. We are not going to give out what we’re carrying on our books for many reasons, and a lot of them revolve around just the legality of it.

Got it. No, that makes perfect sense. Okay. So sorry, just a few more questions here on credit. So looking at your C&I charge-offs, they were $19 million for the quarter. Obviously, $16 million related to the C&I fraud. What was the other $3 million because that’s an outsized number relative to where you guys have been running?

Well, actually…

Can you give us any color around that?

Well, the $3 million in charge-offs for the quarter, when you take out the fraud and the real estate transaction, is right in line with what we’ve been running on a quarterly basis. We typically run between $3 million and $4 million. So it is right in line with where our charge-offs have been. And I think you’re asking is there anything else significant in there? And there really isn’t. It’s just the quarterly charge-off number.

Okay. I mean because your C&I chart, I’m just looking back over the last many, many quarters, they’ve been bouncing around between a low of $200,000 and a high of $1.5 million, right? So I guess let me ask this a different way. So you’re – within that – within the C&I charge-offs, was there anything related to Firestone or Taxi?

No. There was no charge-offs in Firestone. Actually, they had a small recovery. And there was nothing in there for the Taxi Medallion portfolio.

Okay. And then where are the taxies on a net basis?

Right around $26 million.

Oh, I’m sorry, balances. I apologize. So balances are actually down to $24 million.

$24 million.

We had about $2 million reduction this quarter. So they’re just around $24 million.

Okay. Great. And then can you just update us where you are on Firestone?

Balances for Firestone are about $266 million.

Okay. And then what were the originations this quarter?

Firestone, $32 million.

$32 million. Okay. And are you guys – how are you thinking about Firestone as we head into CECL? Will there be any changes? Or you’re still going to be running at around the same run rate?

There will not be any business impact or decisioning based on a new accounting change. So I think we’ll continue to run Firestone the same way.

Okay. Great. Very helpful. And then just one last sort of more macro question. As we head into fourth quarter, obviously, we’re going to see some more merger charges. Round numbers, you’ve got about $8 million or so left off of what you were initially stated. Are you still on track for that? And I guess more importantly, as we look forward to next year, absent anything going on in the aircraft, are we done with merger and restructuring charges? How should we think about that?

Yeah. That’s absolutely how you should think about it, Laurie. We’re probably going to do a little bit better than the $8 million left in terms of merger charges. The – so as we look forward, we’ll get to our clean quarters that we’re all hoping for, and we all want. So we’ll get there. The only other thing I mentioned here in the fourth quarter is there’s a potential for our mortgage group, FCLS, those are showing up in discontinued ops on our balance sheet and income statement here. And so just we’re excluding anything that we’re talking about with that team.

Okay. Great. And actually, I’m sorry, Jamie, one last question here.

Yeah.

Going to the other, other non-interest income line?

Yeah.

So the $609,000 compared to a loss of $216,000. And I know embedded in that number is the tax-advantaged commercial project investment that linked quarter that was roughly unchanged, right? A loss of $1.9 million in each one. You had an $800,000 swing there. Can you help me think about what’s in that, what’s nonrecurring? Or how that should look going forward?

Yeah, you should – that was a BOLI income, Laurie. So there was a – we had a premium capture in – yeah, in death benefit in Q3. So hopefully, you won’t see a change in that next quarter.

Oh, got it. Okay, so that death benefit was about 800?

That’s right.

Okay, perfect. Thanks. I’ll leave it there.

Our next question comes from Collyn Gilbert with KBW.

Thanks. Good morning, everyone.

How are doing, Collyn?

Good, thanks. So just wanted to first start on the loan book, what kind of just – if you could offer us a little bit of color as to what the pipeline is looking like, where you’re seeing some good kind of organic demand? And then, what some of the blended origination yields are running on that pipeline book?

Collyn, this is George. Our pipeline is doing pretty well. It’s north of $200 million. And we’ve been continuing to be selective in terms of both pricing and credit. So we feel good about the totals. And we’re continuing with our relationship approach. We’ve seen that Boston continues to be strong. There’s good opportunity on the real estate side in the Greater Boston area. But we also have some strength in various places around the footprint, some good pipeline in – for ABL, but also in New Jersey markets. So we feel good about contributions from our various regions.

Okay, okay. And then, just tying into the broader balance sheet moves so, Jamie, obviously, you’re building a lot of cash, and I would expect that to continue as portfolios are running off. Do you have kind of a near-term and a long-term plan for the cash or how you’re going to manage that part?

Yeah, I mean, I think near-term is we’re going to continue to deploy that in to stock buybacks. When we get through the $2.4 million share authorization that we have, we will go back to the Board and ask for more is our thinking at the time. And I think what you do see is we are building capital even though we are buying back some shares. So I think that’s kind of how we’re thinking about it right now is until and unless we see more and better opportunity to deploy that capital into asset generation we will continue to return it in the form of buybacks.

Okay, okay. And then, just breaking into the NIM a little bit, some of the drivers of that, can you just kind of talk about it? I mean, obviously, you’re shifting the mix significantly and getting the wholesale part of the funding off the balance sheet. But just in terms of your core customers and where your deposit pricing strategy is right now as we look into the fourth quarter and with the rate cut coming tomorrow.

Yeah, so I think that we expect our deposit cost will be reduced in the fourth quarter. I don’t think it’s going to be a major reduction in deposit costs. Where we’ll see the benefit is in funding costs, where we are continuing to reduce the reliance on wholesale funding there. The markets, I guess, I’ll let Sean comment in a minute here on just those things. But from my seat, what I see is muted competition, right, the same thing we’ve experienced over the last couple of quarters, where there are less and less rates out there at the high end of things.We’ve been able to reduce our CD rates over the past quarter-and-a-half or so. I think we’re generally seeing people follow the market in that regard, other competitors follow the market in that regard. Sean, do you have anything else you want to add?

Where there is discipline in markets, the price is staying flat from a competitive perspective.

Okay, okay. That’s helpful. And then, just on the expense side, so should we assume that if a similar FDIC credit is going to run through this fourth quarter, that the expense will be 0 on that line? And then does it normalize in the first quarter of next year?

So we’re going to see about $1.4 million rebate in Q4for the FDIC. Right, so $500,000 swing to the negative in Q4 on that. And then you will see a normalized run rate after that starting in Q1.

Okay. Okay. Okay, that’s helpful. And then, just on – thoughts, Richard, on M&A, I mean, you guys are – you had a lot in your plate. You’re changing and restructuring and such. But just curious if you could give us some thoughts as to how you’re thinking about M&A as you look into 2020?

Yeah, Collyn, the short answer is I have absolutely no thoughts on it, just because it’s not on anybody’s radar. But it’s certainly not in my radar.

Okay. All right, that’s good. I’ll leave it there. Thanks, guys.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to CEO, Richard Marotta, for any closing remarks.

Thank you for joining us today. We look forward to speaking again in January to discuss our results for the fourth quarter and for the full year. Thank you.

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