Cambridge Bancorp (NASDAQ:CATC) Q1 2023 Earnings Call Transcript

Cambridge Bancorp (NASDAQ:CATC) Q1 2023 Earnings Call Transcript April 25, 2023

Cambridge Bancorp misses on earnings expectations. Reported EPS is $1.58 EPS, expectations were $1.92.

Operator: Welcome to the Cambridge Bancorp First Quarter 2023 Earnings Conference Call. We’ll be making forward-looking statements during this call, and actual results may differ materially. We encourage you to review the disclaimer in our earnings release dealing with forward-looking information, which applies to statements made in this call. In addition, some of our discussions may include references to non-GAAP financial measures. Information about those measures, including reconciliation to GAAP measures, may be found in our SEC filings and in our earnings release. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask question. Please note, this event is being recorded. I would now like to turn the conference over to Mr. Denis Sheahan, Chairman, President and Chief Executive Officer. Please go ahead.

Denis Sheahan: Thank you, M.J., and thank you, everyone, for joining our earnings conference call today. I’m joined by our Chief Financial Officer, Michael Carotenuto; and our Chief Credit Officer, Peter Halberstadt. In a moment, Mike will speak to earnings for the first quarter and our current thinking on the outlook. To set the stage since the bank failures last month, things have quieted down demonstrably. While we experienced a modest amount of net deposit outflow in March, deposits have stabilized, and deposit repricing requests have decreased significantly. Beyond deposit levels, capital is strong and continues to grow. Liquidity is robust, uninsured deposits are materially lower and asset quality is excellent. We are strong and looking ahead, we will focus on opportunity.

Disruption brings opportunity, and we believe we will benefit from disruption through client and talent acquisition. With that context, my comments today will focus on two matters. First, the Northmark Bank systems conversion integration; and second, the recent events in our industry and their impact to our company. This past weekend, we successfully finalized our systems conversion with Northmark Bank. Former Northmark clients can now access their accounts across our online systems or through 22 locations in Massachusetts and New Hampshire. I want to thank my colleagues for their efforts as the process went smoothly, and we are pleased to now operate as one and look to build as a unified brand in these new markets. As you know, the events following recent bank failures have placed a heightened focus on a number of areas in our industry, namely deposit flows, level of uninsured deposits, liquidity, securities portfolio evaluation, and the likelihood of a recession and its potential impact on commercial real estate lending portfolios.

There’s a lot to unpack here, so let’s get to it. Let me begin with a couple of background items. Capital is strong and continuous to build. Tangible common equity ended March 31, 2023, at 8.32%, up from 8.12% at year-end ’22, and we expect it to continue to build through the rest of this year. While we have a buyback plan in place, I would not expect it to be executed until we see greater line of sight through this turbulent period. Loan asset quality remains superb. Delinquencies are well managed, and we are not seeing any significant issues to date. As you know, Cambridge Trust has managed through many periods of economic and industry stress in its 133 year history, and we expect to do so very effectively again in this period. To that end, our Chief Credit Officer, Pete Halberstadt, will join in a minute to speak to our commercial loan portfolio in detail and why we feel good about it.

Next, deposits. Deposits, excluding wholesale funds declined by $300 million or 6.8% during the quarter for two primary reasons. The first was a continuation of the trend we saw in the second half of last year with clients searching for higher yield in treasuries and other pricier deposit offerings. As the Federal Reserve reduced the size of interest rate increases in the quarter, we saw solid stability in deposit levels in mid-February following a reduction of $219 million or 4.9% since year-end. The second reason was the stress due to the bank failures. The net effect in March of both new deposits and deposits leaving was a net outflow in the month of March of $81 million or 1.9%. These deposits generally left to the larger banks, money market funds, treasury securities or to our wealth division.

As a matter of fact, of the $81 million in net outflows, nearly half, or $38 million went to our wealth dividend. Overall, I am very pleased with this outcome. Keep in mind, we are in close geographic proximity to the branch offices of one of the failed institutions and to another in significant stress. In this geography, the public saw lines outside of failing bank’s branch offices, which, of course, increases the panic factor. My team has done an outstanding job working with our clients to counsel and remind who Cambridge Trust is, a 130-year-old conservatively managed institution. We do not have significant and concentrated specialized businesses. We bank locally. Simply put, we take our client deposits and lend them locally as a responsible partner to our communities.

As of April 21, the level of deposits, excluding wholesale has stabilized and is actually modestly grown as a result of new business efforts and reaching out to our clients and outlining the safe and sound insured options we have in place. Moving to uninsured deposits. To no great surprise, our business model and client base will typically have a higher level of uninsured deposits. Our clients have a high degree of faith in Cambridge Trust, and they should. We, however, worked with clients to build greater deposit insurance levels in reaction to the learnings from the recent bank failures and stress. I’m happy to share at March 31, our uninsured level of total deposits has dropped significantly to 33% from 52% at year-end. And so total uninsured deposits were $1.5 billion at March 31, and the total amount of available liquidity was $2.7 billion or just about 2 times the level of insured deposits.

I would now ask our Chief Credit Officer, Pete Halberstadt, to make a few comments on his observations regarding loan asset quality and, in particular, the commercial real estate loan portfolio. Pete has been with Cambridge Trust for 19 years and has been a leader in building the credit culture we are so proud of. Pete?

Copyright: maridav / 123RF Stock Photo

Peter Halberstadt: Thanks, Denis. Good morning, everyone. Overall, asset quality remained steady. Non-performing assets are 0.13% of total assets, which is largely unchanged from year-end 2022. We are not seeing significant movement in risk rating changes and early-stage delinquency levels are consistent with year-end 2022. Despite rising interest rates, we are not yet seeing any notable impact to performance within the consumer lending portfolio, and we note that housing supply remains tight throughout our core markets. On the commercial side, we continue to maintain a diversified commercial real estate loan portfolio overall with a larger focus on multifamily as compared to other property types. This is consistent with our approach for several decades.

And even with the potential slowdown in rental growth in the near term, we maintain a positive outlook on this portfolio. We added Slide 14 to our investor presentation as we recognize the concern with investment office properties nationally and within our own footprint, given the shift to a longer-term hybrid work environment. We have been assessing this portfolio coming out of the pandemic and note that while only 7% or $291 million of total loans are classified as office just about 6% or $259 million of our total loan portfolio is held as investment office or non-owner occupied properties. Getting more granular on investment office less than 3% of total loans is located in a more urban setting, including Boston and Cambridge, and the majority is geographically dispersed throughout our suburban markets.

Given our conservative underwriting approach, the weighted average loan to value on the total investment office portfolio remains strong at 56%, which is typically based on originated values and excluding any appreciation since loan inception. While we expect the office market may show some property value declines from its peak, we feel we are well positioned to absorb any market correction based on our historically strong underwriting fundamentals. The other area of focus has been on interest rates and the impact from loans maturing in the near term were repricing at current market rates. For investment office, we have a relatively low percentage of borrowers that fit either of these criteria. We note only 14% of the portfolio is maturing over the next two years and just 4% subject to a rate reset during the same period.

While these loans would not be immune to potential rate pressures should they stay high longer term, the near-term impact is more limited. We continue to dissect our portfolio at the loan level and keeping close contact with our borrowers. Moving to the provision for credit loss. In the first quarter, the provision consisted of three primary items: the first being the calculated reduction of the reserve due to decreased loan balances which is offset by both slightly increased unemployment expectations and prudent increases in qualitative factors given the environment. This brought the ACL ratio to 0.95%. We continue to expect the strong asset quality that you have seen from Cambridge Bancorp historically and the ending unemployment rate forecast within the CECL model for the fourth quarter of 2023 is estimated to be 4.26%.

I will now turn it over to Mike.

Michael Carotenuto: Thanks, Peter. Good morning, everyone. GAAP earnings per share were $1.58 and diluted earnings per share were $1.62 for the first quarter. The adjusted net interest margin, which excludes the impact of merger-related loan accretion, decreased by 43 basis points to 2.58%. Loan accretion during the first quarter was $643,000 or 5 basis points on a GAAP basis. The cost of deposits, excluding wholesale deposits for the quarter increased by 56 basis points to 1.01%, bringing the cumulative total non-wholesale deposit beta to 18%. The company had a return on average assets of 0.93% and a return on tangible common equity of 11.52%, both on an operating basis for the quarter. Within deposits, the insured cash suite product offered through IntraFi is currently within the interest-bearing checking line item on the balance sheet.

The usage of this product accounts for the majority of the shift between demand deposits and interest-bearing checking during the quarter. When demand and interest-bearing checking are combined, the total reduction is less than 2% from the prior quarter. Additionally, 49% of non-wholesale deposit accounts are consumer and 51% are commercial. Approximately 70% of commercial deposits are within demand or interest-bearing checking accounts. As expected, loan activity during the quarter slowed. Balances were reduced by $45 million or 1.1% as a result of slowing market activity and the continued disconnect between buyer and seller expectations, combined with a reduction in consumer activity due to level of interest rates and ongoing lack of supply.

Wealth management assets increased primarily due to market appreciation and a modest amount of positive net flows during the quarter. Client assets under management and administration totaled $4.3 billion as of March 31, 2023. Within non-interest expense, total operating expenses were $27.9 million in the first quarter, or a reduction of 4.5% from the fourth quarter of 2022. This was driven by lower professional services, marketing and data processing expenses. We have made reductions within expenses associated both with roles from staff attrition that have not been replaced and a reduction in force within consumer lending due to lower activity levels. As we indicated last quarter, we continue to look for other areas to reduce spend where it’s prudent.

Tangible book value per share increased from $57.15 as of year-end 2022 to $57.98 or 1.4% as of March 31, 2023. Moving to the outlook. A lot has happened in the past three months that affects the previously provided full year guidance. The net interest margin in the second quarter will decline into the 220s. From there, we expect modest compression to continue, which, of course, is dependent on further action from the Federal Reserve. Our conversations with clients regarding deposit pricing have slowed and deposits are stable. This gives us confidence that the reduction in net interest margin will slow. We are opening new relationships and expect progress on deposits from the level in March and we’ll update you again at June 30. For loan growth, when we had previously provided an estimate of flattish loan growth for 2023, that has proven to be true.

We are down modestly since the beginning of the year, and we expect that trend to continue in the short term, due to borrower demand, including the need to absorb the impact of higher rates. But recent originations, however, have seen improved yields into the mid-6s. We had previously commented that spreads between new loans and funding costs were lower than desired, but that is beginning to change. If market activity picks up, either due to clarity on Federal Reserve rate movements or a narrowing of buyer and seller expectations that could further improve the outlook. Within non-interest income, if the equity and bond markets remain stable that would put the full year reduction between 0% and 5%. Again, assuming limited market volatility, second quarter levels will be slightly lower than the first quarter as a result of approximately $500,000 in success fees and community development fund income that occurred during the first quarter.

Operating expenses will continue to be managed closely and a growth range of 0% to 3% for the full year still makes sense. We expect the second quarter levels will be between 2% and 4% lower than the first quarter due to the seasonality of first quarter expenses and the full quarter impact of recent cost savings. As you heard Peter discuss, credit quality remains excellent. So we expect the allowance for credit loss ratio to be between 0.90% and 1% for the year, barring changes in unemployment or other macro-level items that present themselves. I will now turn it back to Denis for final thoughts.

Denis Sheahan: Thanks, Mike. Clearly, this has been a unique and stressful period for clients, shareholders and my colleagues. This occasion has afforded additional opportunity to engage with our clients and it’s truly fortified relationships. We hear again and again the faith and trust our clients have in Cambridge Trust Company and the value they place in us. Disruption may be painful, yet it also brings opportunity, and we are engaged and optimistic about the potential. We’ll now open the call for questions.

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Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. Today’s first question comes from Mark Fitzgibbon with Piper Sandler. Please go ahead.

Mark Fitzgibbon: Hey, guys. Good morning.

Denis Sheahan: Good morning.

Mark Fitzgibbon: I wonder if you could share with us what your sort of spot deposit rates are currently?

Michael Carotenuto: At the end of the first quarter, market spot deposit rate was 1.26% ex wholesale.

Mark Fitzgibbon: Okay. And then, Mike, on your guidance, I think you said in the 2.20% range for the second quarter for the margin and declining modestly from there. How are you thinking about modestly? Does the margin get down close to 2% by the end of the year, do you think, assuming you follow the forward curve?

Michael Carotenuto: Yeah, I think that’s about right, Mark.

Mark Fitzgibbon: Okay. And then how are you thinking about balance sheet growth? Denis, I heard your comments about growing capital and putting the buyback on hold. Does the balance sheet grow much at all this year?

Denis Sheahan: So Mark, it’s — when we look out certainly for this quarter, we don’t see a lot of loan demand. My hope would be in the second half of the year that, that will change. There are pockets of opportunity for sure that we’re seeing some in our innovation banking capabilities, some in renewable energy. But broadly, its demand is down. So hopefully, in the second half, we’ll see some improvement. And then in terms of the margin, your margin question, Mark, what I take some confidence and faith is the degree of deposit repricing requests have slowed materially. Through the panic period, if you will, we’re talking to clients about insured deposits, et cetera, there was a lot of requests for deposit repricing. That has slowed materially.

So my hope is we’ll outperform on Mike’s guidance on the margin. But it’s really dependent, I think, on — if the Fed keeps moving, it’s going to continue to be highlighted in the media and clients are going to ask for repricing. But as of now, that has slowed materially.

Mark Fitzgibbon: Okay. And then maybe a question for Pete. On Page 14, the slide deck, you suggested a 25% reduction in appraised value on the office book. Is that just a hypothetical decline or did you actually have the office book reappraised and the values were down in that 25% neighborhood?

Peter Halberstadt: No. We continuously update based on when we’re renewing loans. So there’ll be some updated appraisals in there. That’s on a stress against the entire portfolio. So an additional 25% would put it under 75% overall. There have been some updates within the portfolio.

Denis Sheahan: So it’s our stress. It’s not — we did not reappraise the book, Mark. There’s routinely updates and new appraisals, but the stress that Pete is referencing is the stress that we completed.

Mark Fitzgibbon: Okay. And last question for me is, I heard that you completed the systems conversion with Northmark this weekend. Can you remind us what the expected cost synergies from that will be?

Michael Carotenuto: Yeah, Mark. So we guided to 35% cost savings, and we achieved them.

Mark Fitzgibbon: Thank you.

Denis Sheahan: Thank you.

Operator: Thank you. Our next question comes from Steve Moss with Raymond James. Please go ahead.

Thomas Reid: Hey. Good morning, everybody. This is Thomas stepping in for Steve.

Denis Sheahan: Good morning.

Thomas Reid: Thank you. First question for me is, I know you guys hit on this in your prepared remarks, but I just missed it. Why was it that interest-bearing checking balances increased on most other core deposit balances sell?

Michael Carotenuto: There was a shift between demand and interest-bearing checking because of the use of the IntraFi product you combine demand and interest-bearing checking, it was down modestly, about 2% between the quarters.

Thomas Reid: Okay. Got you.

Denis Sheahan: Thomas, when you — when clients move into that insured deposit product, it’s an interest checking product. So you move out of demand into interest checking.

Thomas Reid: Understood. Okay. Thank you for that. Next question. You guys said recent originations are in the mid-6s. Is that — so that’s what’s coming on right now or that’s what people are committing?

Michael Carotenuto: That’s what we saw during the first quarter, and we continue to see improvement between funding costs and loan yields.

Thomas Reid: Okay. Great. And just last one for me. What does the pipeline look like about now in terms of unfunded commitments?

Michael Carotenuto: So pipeline for loans or unfunded commitments. Can you just clarify?

Thomas Reid: Pipeline — the pipeline for loans, excuse me.

Michael Carotenuto: Sure. So we talked in our prepared comments that we think we’re going to have slower activity here during the near term, but we’re hopeful that the longer-term outlook continues to improve as there’s greater clarity either on Federal Reserve rate movements or a narrowing of buyer and seller expectations.

Thomas Reid: Okay. All right. That’s great. Thank you, guys so much. That covers it for me.

Denis Sheahan: Thank you.

Operator: Thank you. The next question comes from Chris O’Connell with KBW. Please go ahead.

Chris O’Connell: Hey. Good morning. On the expense guide were down 2% to 3% next quarter, is that inclusive of the Northmark cost saves?

Michael Carotenuto: It is, and it was 2% to 4%.