Berkshire Hills Bancorp, Inc. (NYSE:BHLB) Q4 2023 Earnings Call Transcript

Berkshire Hills Bancorp, Inc. (NYSE:BHLB) Q4 2023 Earnings Call Transcript January 25, 2024

Berkshire Hills Bancorp, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Berkshire Hills Bancorp, Inc. misses on earnings expectations. Reported EPS is $0.47 EPS, expectations were $0.5.

Operator: Good morning, ladies and gentlemen, and welcome to the Berkshire Hills Bancorp Fourth Quarter 2023 Earnings Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded on Thursday, January 25, 2024. I would now like to turn the conference over to Mr. Kevin Conn. Please go ahead, sir.

Kevin Conn: Good morning, and thank you for joining Berkshire Bank’s fourth quarter earnings call. My name is Kevin Conn, Investor Relations and Corporate Development Officer. Here with me today are Nitin Mhatre, Chief Executive Officer; Sean Gray, Chief Operating Officer; David Rosato, Chief Financial Officer; and Greg Lindenmuth, Chief Risk Officer. Our remarks will include forward-looking statements and refer to non-GAAP financial measures. Actual results could differ materially from those statements. Please see our legal disclosure on Page 2 of the earnings presentation referencing forward-looking statements and non-GAAP financial measures. A reconciliation of non-GAAP to GAAP measures is included in our news release. At this time, I’ll turn the call over to Nitin. Nitin?

Nitin Mhatre: Thank you, Kevin. Good morning, everyone, and thank you for joining us today. I’ll begin my comments on Slide 3, where you can see the highlights for the fourth quarter and the full year. While the rate environment remains challenging, we are encouraged by the early trends in deposit balances. We executed a security sale late in the fourth quarter and used those proceeds to pay down wholesale borrowings, eliminating the negative carry associated with those securities. We also incurred a severance charge of $3.7 million related to a workforce reduction across the organization. For 2024, expense optimization, deposit growth and credit management will be our top priorities. We intend to self-fund investments in strategic priorities that support our vision to be a high performing relationship focused community bank.

David will review these items and our 2024 guidance in more detail in a few minutes. Operating net income for the quarter was $20.2 million, and operating EPS of $0.47 declined 6% linked quarter, primarily from a decline in net interest income. Full year 2023 EPS of $2.14 was down 2% year-over-year. We are encouraged by the trends in asset quality and deposit growth in the quarter. Our credit costs have trended down, and our loan books are performing well. Non-performing assets and net charge-offs declined 14% linked quarter and we increased our loan loss allowance by 3 basis points to 1.17% of loans. Average deposits were up 3% linked quarter, largely driven by an increase in money market and time deposits. Our liquidity position is robust and our available liquidity coverage of core uninsured deposits was 146%.

We’ve included a page in the appendix with more details. Our average loan balances were up 11% year-over-year and up less than 1% linked quarter given lower loan demand and disciplined underwriting. Our balance sheet remains strong. We ended the quarter with a common equity Tier 1 ratio of 12% and a tangible common equity ratio of 8%. We repurchased 328,000 shares in the fourth quarter and 1.1 million shares in 2023, which reduced our share count by 3% over the year. Our Board has authorized and regulators have approved a new share repurchase program of 40 million in 2024, and we expect to continue share repurchases opportunistically. We’ve updated pages in our earnings deck on our overall commercial real estate portfolio and the page that provides details on our office portfolio.

Both of these pages highlight that our portfolio is granular, geographically diverse and resultantly less risky. David will cover some of these metrics in more detail in a few moments. We continue to make steady progress on our strategic priorities. Optimizing real estate, branch network and balance sheet. In 2023, we consolidated four branches and exited two office buildings. We will continue to look for opportunities to lower our occupancy expenses further. Our team successfully converted our digital banking platform for consumer and small business clients to improve the client experience and platform efficiency. Our employee engagement and customer Net Promoter Score were at their highest level in 2023, and we were recognized by Newsweek as one of the best regional banks in the country and we’re the only bank headquartered in Massachusetts with an overall 5 star rating.

The disruption in our markets has enabled us to opportunistically hire deposit and relationship-focused frontline bankers. These bankers have strong deposit books and complement our existing team. Gaining even a small part of the opportunity presented by the market disruption would be meaningful for Berkshire. Slide 4 shows our progress on five key performance metrics. Our full year 2023, we are near the low end of our target range for operating return on assets at 79 basis points and our operating return on tangible common equity was 10.1%, above the lower end of our target range. Our full year PPNR grew to $142 million. Our ESG score remains in the top quartile nationally and our full year Net Promoter Score improved further to 45. We have made steady progress over the last three years and are energized about significant opportunities for improving our financial performance further.

I want to use this opportunity to thank all of my Berkshire Bank colleagues for their continued hard work and commitment to our vision to be a high performing relationship focused community bank. Through this difficult external environment and corresponding changes being made internally, their commitment to our strategy and dedication to our customers and communities is what brings us together and truly sets us apart. With that, I’ll turn the call over to David to discuss our financials in more detail. David?

David Rosato: Thank you, Nitin. Slide 5 shows an overview of 2023, but I’ll jump to Slide 6, which details the fourth quarter. As Nitin mentioned, operating earnings were $20.2 million or $0.47 per fully diluted share, down $0.03 linked quarter. Our net interest margin was 3.11% down 7 basis points linked quarter, and net interest income declined $1.9 million or 2%. Operating non-interest income was $16.7 million, down 5% linked quarter. I note that several fee line items are below historic quarterly run rates and should recover over the coming quarters. Operating expenses were $75.3 million, up 2% linked quarter. Average loans increased $38 million linked quarter, while average deposits increased $306 million or 3% from Q3.

Provision expense for the quarter was $7 million, at the lower end of our July guidance and down $1 million from the third quarter and down $5 million year-over-year. Net charge-offs of $4.4 million or 20 basis points of average loans were down 38 basis points year-over-year. We increased our allowance for credit losses by $2.6 million in the quarter, bringing our allowance for credit losses to 117 basis points of loans. Slide 7 shows more detail on our average loan balances, which were up $38 million linked quarter. We had growth of $84 million in commercial real estate and $38 million in residential with a $69 million decline in C&I and a decline of $15 million in consumer, which reflects runoff of nonstrategic loan portfolios. Slide 8 provides details of our security sale.

We sold $267 million of securities and incurred a pretax loss of $25.1 million or $0.44 per fully diluted share after tax. Our earn-back period is about three years, and proceeds were used to pay down wholesale funding. FHLB borrowings were down $419 million and ended the quarter at $385 million, which was down 52% linked quarter. Our securities to total assets was 13% at year end. Slide 9 shows our average deposit balances. Average deposits increased $306 million or 3% in the quarter. As expected, the deposit mix shifted with a modest decline in the non-interest-bearing deposits and an increase in money market and time deposits. Non-interest-bearing deposits as a percentage of total deposits were 25% in the fourth quarter versus 26% in Q3.

Deposit costs were 211 basis points up 30 basis points from the third quarter. Our cumulative total deposit beta is 37% through 525 basis points of Fed tightening. Borrowings were 6% of total funding, down from 9% in Q3. Turning to Slide 10, we show net interest income. Higher deposit costs contributed to the $1.9 million or 2% decrease in NII. Our net interest margin was 3.11%. Slide 11 shows operating fee income down $791,000 or 5% linked quarter. Loan-related fees were down $821,000 linked quarter driven primarily by lower swap income that was about $600,000 below our normal quarterly run rate. Gain on sale of SBA loans were down $166,000 due to lower premiums in the market. A line item that is also running about $900,000 below normal run rate.

Other fees were up $594,000 from fair value adjustments on equity securities. Slide 12 shows expenses. Operating expenses were up 2% linked quarter to $75.3 million. Importantly, there was a modest fourth quarter technology expense true-up so I’d encourage you to look at our ’24 guidance for thoughts on run rate expenses. Compensation expense was flat to the third quarter and increases in technology and professional services expense were partially offset by declines in occupancy and equipment. GAAP expenses of $79 million includes $3.7 million of severance charges or $0.06 per share after tax related to the aforementioned workforce reduction. As I’ve said previously, we are committed to managing expenses with discipline and transparency. We are taking a very granular approach to expense management that will have the desired impact of reducing our expense base.

We are committed to ensuring that every dollar we spend is thoughtful and necessary to run the bank efficiently or to grow our revenue and earnings. Slide 13 is a summary of asset quality metrics. Non-performing loans were down $5.2 million linked quarter and $9.7 million year-over-year. Net charge-offs of $4.4 million or 20 basis points were down $1 million versus the third quarter and down $7.3 million year-over-year. We’ve included a chart in the appendix with Berkshire’s net charge-off rates for the industry since the year 2000. We’ve moved some of the credit pages from the appendix into the body of our deck. Slide 14 shows that our CRE book is well diversified in terms of geography and collateral type. Credit quality of the CRE portfolio remains solid with non-accrual loans at 10 basis points of period end loans.

Slide 15 has more details on our office portfolio. As noted last quarter, the weighted average loan to value ratios are about 60% and a large majority of the portfolio is in suburban and Class A space. We have also shared more granular credit data for the office book. We believe our office portfolio is very well underwritten, diversified and the asset quality of this portfolio remains solid. While current credit quality metrics are benign, we recognize that economic uncertainties exist and we are monitoring both new originations and existing portfolios carefully, and we have modestly increased our reserves. Slide 16 shows returns over the past five quarters on a GAAP and an operating basis. As you know, the current operating environment is presenting headwinds, but we remain focused on improving our medium-term performance and look forward to a more normal operating environment.

Recall, we added several new roles to the financial tables starting last quarter. Prior to last quarter, we have been reporting return on tangible common equity with a denominator that excludes the negative AOC mark from our AFS securities portfolio. We are now also reporting ROTCE with a denominator that includes the negative AOC mark, which lowers the denominator and increases ROTCE. Most of our peers calculate return on tangible common equity this way, so we have simply aligned our reporting to be more consistent with both peers and larger banks. Slide 17 shows our capital ratios. With the decline in rates and our security sale, our AOCI improved by $75 million from a negative $218 million to a negative $143 million. Common equity Tier 1 declined 10 basis points to 12%.

The TCE ratio improved to 8%, and our tangible book value per share increased 7% linked quarter to $22.82. Our top capital management priority is to deploy capital to support organic loan growth. Secondly, we remain biased to stock repurchases, given that our stock price is trading below intrinsic value. In Q4, we repurchased $6.6 million of stock at an average cost of $20.15 versus our ending tangible book value of $22.82 and in 2023, we repurchased $24 million of stock at an average cost of $20.85. We believe Berkshire stock is undervalued given our growth potential and low-risk business model. We will continue to opportunistically repurchase shares. Slide 18 shows our 2024 guidance. Our guidance incorporates five rate cuts. However, one of which is in December of 2024 and does not impact guidance which is in line with current Bloomberg and market consensus.

We expect loan growth of 5% to 7% off end-of-period loans. Payroll deposits were elevated at year-end, so we’d encourage you to model deposits off an adjusted ending balance of $10 billion, which excludes payroll balances above normal run rates. We expect 2% to 3% normalized deposit growth. Recall that we are also adopting PAM accounting for our tax credit business in 2024 which lowers the amortization expense impacting fee income, thereby increasing fees and increasing our effective tax rate. Our 2023 fees adjusted for PAM would have been $75.9 million, and we expect growth of 0% to 3% off that base. We expect provision expense to be $33 million to $36 million, and expenses to be down 1% to up 1%. Our tax rate increases with the change in accounting, and we believe it will be in the range of 20% to 22%.

Our Board is authorized and regulators have approved a new $40 million stock repurchase program, which we expect to use opportunistically. With that, I’d like to turn it back to Nitin for further comments.

Nitin Mhatre: Thanks, David. 2023 proved to be a challenging operating environment for the banking industry given the historic increases in interest rates to quell inflation. The industry proved resilient amidst the failures of three large banks, which had idiosyncratic business models. We expect that in 2024, the operating environment will continue to be challenging. While we cannot control the macro environment, we are focused on controlling what we can and have several levers, including rigorous expense management, opportunistic hiring for deposits and loan growth and de-risking the balance sheet. We look forward to a more normal banking environment later in 2024 and into 2025. When I started as the CEO in early 2021, we faced rapidly declining loan balances that we steadily turned into loan growth.

We will similarly overcome the current challenges, including deposit growth and expense management. We remain focused on selective, responsible and profitable organic growth. With that, I’ll turn it over to the operator for questions. Laura, please open the line for Q&A.

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Q&A Session

Operator: Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Our first question comes from the line of Billy Young from RBC. Please go ahead.

Bill Young: Hey. Good morning, guys. Can you hear me, okay?

Nitin Mhatre: Yes, we can. Good morning, Billy.

Bill Young: How are you? I guess let’s just first start on NII and the margin. Can you elaborate first how much do you think the repositioning this quarter should benefit kind of 1Q and the run rate going forward?

David Rosato: Yeah. Well, it’s about a three year payback on the securities transaction. It’s worth about $7 million on an annualized basis increase in net interest income.

Bill Young: Got it. That $7 million at beginning of 2024.

David Rosato: Yeah. Well, that’s a full year number. But yes, so the security sale occurred very late in December, third week in December. So it really had no impact of any significance in Q4 margin, which as reported was 3.11%. So we’ll see a step-up from that. As you know, we don’t provide margin guidance, but it’s obviously in the NII guide.

Bill Young: Understood. Thanks. And then just to follow up on that theme. Kind of how does timing of the rate cuts impact your outlook if we start seeing more aggressive Fed rate actions earlier in the year versus if the Fed cuts rates less than the five be contemplated kind of how does that impact the NII trajectory?

David Rosato: Sure. Let me — so a couple of comments. The first is the transaction obviously occurred late in the quarter, it increased asset sensitivity for us because we paid down wholesale borrowings, which were short, had longer term securities. That’s why you also see an elevated cash position at 12/31. You saw a large jump in cash on the balance sheet. That’s not steady state, right? So the transaction is accretive to the margin and net interest income dependent on where rates go over the course of 2024, we could put more securities back on the balance sheet. We’ve telegraphed rather consistently over the last year that were just have been plus or minus neutral from an asset liability perspective. So three rate cuts or five, which is really only four from an NII perspective because the last meeting in December 18, 2024.

Will has a very modest impact on us either way, whether it’s three or five. I think more importantly, you didn’t ask the question, but when we think about the margin over the course of 2024, I think our work is basically in line with what we’re hearing from a lot of other banks. We expect the margin to bottom into late in the second or in the third quarter of this year, and then you will see margin expansion. That’s whether the Fed eases as telegraphed by them or weather a little bit more aggressively by what the market has priced in. So that’s a real important message, I think Billy.

Bill Young: I appreciate that. That was actually one of the follow-ups I had, but just I guess shifting gears to just expenses. I appreciate kind of the flat expense guide for this year versus last. Are there any additional efficiency actions being assumed within that guidance, firstly? And then secondly, is there a target efficiency ratio you’d like to exit this year at when all said done? Thanks.

David Rosato: Sure. Two questions there, one of which I’ll answer in detail, one of which I’ll not answer. The first part is the important part. So Nitin alluded to in his opening comments, our focus on expenses and other initiatives. So we had a modest workforce reduction, which was broad based across the organization at the beginning of this year. Going forward, we still recognize the need for expenses. We should think about that in a more targeted manner as the year progresses. So thinking about how we do things and how we’re staffed. So they are — it’s technology, its process. It’s a lot more granular. And I think that the end results can be significant, but they take more time to achieve. So that’s what we’re focused on in 2024.

That some of our thoughts around that is obviously embedded in the expense guide. Holding expenses flat year-over-year when you think about merit increases and escalators in real estate contracts and other contracts, software contracts, etc., is a lot. And we’re one of our focuses besides making sure that we continue to get more efficient and manage costs and I’ve talked about that every quarter since I’ve been here, the granular approach we’re taking is to make sure we don’t hurt the revenue generation capabilities of the company. So we spent also a lot of time making sure as we continue to work on controlling expenses and lowering expenses that we don’t damage the growth potential of the company. So Billy, so your second question was essentially a targeted efficiency ratio.

I think at this point, we’ll just decline to put that number out there. What I would say is, our efficiency ratio has been going up. It went up in 2023. We’re not excited at all about it. We need — we recognize it needs to come down and improve, and we’re very committed to that.

Nitin Mhatre: Hey, Billy. If I may just add a little bit of comment, I think David laid it out well. And I just want to connect it to what you’ve heard us say before as part of our best plan where we talked about optimization as being our key lever and within those, we talked about — we have — we believe and we still do have significant opportunities on rationalizing real estate, procurement, optimizing our channels, processes and deploying business process automation to improve efficiency. So all of those levers have been deployed and will continue to deploy. So this is an ongoing thing. It’s not a one activity, it’s an ongoing activity at Berkshire.