Berkshire Hills Bancorp (BHLB) Q4 2018 Earnings Conference Call Transcript

Image source: The Motley Fool.

Berkshire Hills Bancorp (BHLB -1.07%)
Q4 2018 Earnings Conference Call
Jan. 24, 2019 10:00 a.m. ET

Prepared Remarks:

Operator

Good morning, everyone, and welcome to the Berkshire Hills Bancorp Q4 earnings release conference call. [Operator instructions] Please also note, today's event is being recorded.At this time, I'd like to turn the conference call over to Ms. Erin Duggan, investor relations manager. Please go ahead.

Erin Duggan -- Investor Relations Manager

Thank you. Good morning and thank you for joining this discussion of fourth-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 on related factors, please see our earnings release and most recent SEC reports on Forms 10-K and 10-Q. As a reminder, today's discussion is not intended as a proxy solicitation. 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.

Please make sure you've selected a ticker.

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.

Richard Marotta -- Chief Executive Officer

Thank you, Erin. Good morning, everyone. Thanks for joining us today for our fourth-quarter call. This is my first earnings call as CEO.

I intend to present our perspective simply and directly and, of course, I want to be responsive to your questions. 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. We're going to begin today with some high level remarks around 2018 and Jamie will provide a financial overview of the fourth quarter. Afterwards, I'll discuss this strategic review we are currently engaged in.

We'll provide some additional concluding remarks and then, of course, we'll open it up for questions. So let's begin. 2018 was a good year. We fully integrated our commerce operations, delivered solid organic growth, improved our profitability metrics, announced our agreement to acquire Savings Institute in Connecticut and launched the diversity and inclusion initiative that we will look to expand on in 2019.

We delivered the core bottom line in accordance with the plan that we set out at the start of the year. We ended the year with $2.71 in core EPS, core ROA above 1%, and efficiency ratio below 60. Core return on tangible common equity improved to 13.5% and a return on equity improved to 8.1%. Our loan portfolio grew 9% year over year.

Our deposit base increased by 3%. We remain disciplined with operating expenses. Our asset quality remains strong with our credit metrics further strengthening in the final quarter of the year. We're moving forward together with a renewed focus on profitability and organic operations.

And I will speak more to this after Jamie provides you with some financial update. Jamie?

Jamie Moses -- Chief Financial Officer

Thanks, Richard. And good morning, everyone. We delivered $0.63 in core EPS for the fourth quarter, a 9% increase year over year. We reported GAAP EPS of $0.31 due to the impact of non-core charges, which I'll go over in a minute.

Core EPS for the year was $2.71 with GAAP EPS coming in at $2.29 and in GAAP ROA of 90 basis points. Now, on our last call, we had guided core EPS down from the third quarter and we met our bottom line guidance before the impact of the federal government shutdown, which delayed some revenue recognition in our SBA operations. Our margin had the benefit of higher purchase loan accretion and we recorded higher expenses related to various initiatives we had in progress. I'll move into those numbers now to help unpack the quarter for you.

Our NIM came in at 3.41%, which included 30 basis points of purchase loan accretion. Our workout team was able to bring in some unexpected larger recoveries before year end that may have otherwise been recorded in 2019. Measured before accretion, the NIM came in at 3.11%, which was down 4 basis points from the prior quarter. This reflected the higher average borrowings that funded our solid loan growth in the fourth quarter.

Our cost of deposits increased in line with our expectations at about the 40% beta level. The increase in net interest income offset much of the revenue impact from lower fee income. In addition to normal seasonality, we continued to see revenue headwinds in mortgage banking, reflecting industry conditions. We adjusted our mortgage expenses and have seen a rebound in revenues so far in 2019 as long-term rates have adjusted back down.

Turning to SBA, we gave up approximately $1 million in gain on sale as we were unable to sell a portion of the originated loans in our normal model due to the government shutdown. Also, the third quarter was exceptionally strong and volumes and margins tightened some in the fourth quarter as we expected. Overall, 2018 was a record year for volume and income in this line of business, and we're feeling good about what we have done and where we are headed there. Turning it over to expenses, we had an increase in total expenses due to both core and non-core activity.

So looking at core expenses, we were up quarter over quarter in compensation and professional fees. Fourth-quarter compensation bounced back to a more normalized level from the third quarter, which had gone down a little bit due to the timing impact of some accrual adjustments that we made. Professional fees reflected legal and consulting across several fronts due to the various initiatives we have been working on. While we don't view these as reflective of our current run rate into the first quarter of 2019, improvement here will tend to be offset by the normal seasonal increase in benefits expense in the first quarter as payroll taxes reset at the start of the year.

As we have previously reported, we have six branch consolidations in progress, which we expect to complete in the coming months. And we are also adjusting certain branch operating hours to more efficiently serve customers as retail traffic becomes more digital. Moving to non-core expenses, the biggest piece was an $8 million charge related to a strategic restructuring of our technology provider relationship. During 2018, we conducted an extensive strategic technology review, including of core systems RFP, due diligence, and competitive vendor proposals.

This came to a completion in Q4 in the form of restructured master contract that gives us new flexibility in managing our technology development and service providers, along with a better cost benefit formula as we scale our enterprise. The project included some consulting as we pursued best-of-breed solutions. And we're confident that this investment that we've made will have an earn-back within three years based on lower marginal costs to support our growth in product development. In addition to that systems costs, we had charges related to the CEO transition.

The transition involves the separation payment and also included the forfeiture of certain existing accrued benefits. The net expense impact was about $2 million, which we recorded in the fourth quarter, and there's no further obligation related to the former CEO. We also had a $3 million charge for the settlement of a purported class action claim, which we have previously reported as pending litigation in our SEC filings. We also recorded $3 million in merger-related charges during the quarter due to the pending Savings Institute acquisition.

So turning back to the broader picture, as Richard stated in his opening, we delivered our core EPS for the year in line with our guidance and we did good work in managing profitable organic growth while integrating our new eastern Massachusetts operations and keeping to our efficiency targets. We now look forward to more opportunity in 2019 to strengthen our franchise while bringing Savings Institute on board. Most of the earnings accretion from that acquisition, just to remind you, is not expected before 2020. As we look forward at our organic operations, we are entering a new phase in managing the franchise that we have assembled.

As an acquiring bank, purchase loan accretion has contributed significantly to our revenue stream and our workout team has further strengthened their credit profile by resolving these acquired impaired loans. As we noted in our last call, accretion income will be down by at least 50% in 2019. Before accretion in the first quarter, we expect to see a modest revenue pickup from loan growth, a steady NIM, a seasonal rebound in fee income, and flat expenses. Core EPS is expected to decrease from Q4, including the impact of the change in accretion.

Now our team, led by Richard, is working on a full strategic review to examine various operational and financial structuring options as we move forward. This includes structural balance sheet options, including capital management and the possibility of stock buybacks as a potential way to improve capital returns. Now I'm committed to working with Richard and our team to assess the opportunities in front of us with his leadership and strong focus on profitability and shareholder returns. At this time, I'd like to note that the company will be filing for the renewal of our universal shelf registration in the coming weeks.

This is done every three years in order to keep the shelf available. This is a routine filing and is not tied to any present plans for the issuance of securities under the shelf. In addition, our acquisition of Savings Institute continues on schedule and we anticipate filing the S4 proxy statement prospectus with the SEC for the proposed acquisition in the coming weeks. With this in mind, we will not be as granular in some of our forward-looking statements today.

With that, I'll turn it back over to Richard.

Richard Marotta -- Chief Executive Officer

Thank you, Jamie. Jamie has just brought you up to date on what we did for the fourth quarter and comment on the factors that we face in the current environment. Most significant factor is that our accretion revenue will go down by about $15 million in 2019. We had accelerated recoveries in 2018 due to the excellent work by our workout team.

This level of purchase loan accretion has benefited shareholders and had the compounding effect of immediate credit quality improvement, but these levels are not repeatable in 2019. In addition, there are continued revenue challenges in mortgage banking. We will continue to execute on expense efficiencies in order to offset those revenue challenges, which should essentially neutralize the impact of that business on the bottom line. In order to move ahead of these challenges, we are focusing on further developing clean and sustainable earning streams.

I'm a strong believer in driving profitability, and a strategic review is the first logical step in that process. I am leading this review with input and participation from our executive team and the support of our Board. The review will address the following: the size and composition of our balance sheet, business line profitability, organizational expense structure, and capital management practices, including the potential for share buybacks. Our goal for this review is to support 2019 earnings at the same level as 2018 moving to a clean sustainable earnings growth thereafter.

I will provide more direction on this front on our next earnings call. I am grateful for the support of the Board of Directors through the leadership transition. I've spoken with some investors and our analysts and plan to be visible and accessible, along with Jamie and Sean, as we move forward. I am encouraged by the support of the management team and the initial progress of the plan I just outlined.

We're poised to move forward together in 2019 and deliver on the promise of this franchise. With that, I'm going to open it up to any questions.

Questions and Answers:

Operator

Ladies and gentlemen, at this time, we'll begin the question-and-answer session. [Operator instructions] Our first question today comes from Mark Fitzgibbon from Sandler O'Neill Partners. Please go ahead with your question.

Mark Fitzgibbon -- Sandler O'Neill Partners -- Analyst

Hey, guys. Good afternoon or good morning, I should say.

Richard Marotta -- Chief Executive Officer

Hey, Mark.

Mark Fitzgibbon -- Sandler O'Neill Partners -- Analyst

Jamie, I wondered if you could run through the guidance you gave on purchase accretion and the NIM for this year? I kind of missed part of that.

Jamie Moses -- Chief Financial Officer

Yes, sure. So, as we guided to purchase loan accretion on the last call that we had -- our expectations were that in 2019, we'd have half or maybe even less than half of the purchase loan accretion that we had in 2018. And so, here in the fourth quarter we pulled some of that accretion. We had some unexpected larger recoveries happen in the fourth quarter.

So that kind of moved those things into 2018, where they may have happened in 2019 before. So, our updated guidance on this is that we expect to have about $15 million less in accretion in 2019 than we did in 2018.

Mark Fitzgibbon -- Sandler O'Neill Partners -- Analyst

OK. Great. And then secondly, Richard, when do you expect the strategic review to be completed and start to implement actions from that?

Richard Marotta -- Chief Executive Officer

We are in the process. We're probably 30% or 40% of the way through. The game plan is to get this in front of the Board for final approval and then talk about it at our next earnings call.

Mark Fitzgibbon -- Sandler O'Neill Partners -- Analyst

OK. Yes, I mean, it would seem with the stock down as much as it was last quarter, that buybacks would make a lot of sense. Do you -- I can't recall, do you have a buyback program in place today where you could begin executing immediately?

Richard Marotta -- Chief Executive Officer

So, we have a very minimal buyback program in place right now, but we are unable to execute on that at the moment, given the pending acquisition of standard -- Savings Institute in Connecticut there.

Mark Fitzgibbon -- Sandler O'Neill Partners -- Analyst

OK. And then on expenses, I know you mentioned you expected them to be flat for the year. So, if you sort of take out some of the unusual items, if you will, this quarter, it's sort of a normalized expense run rate in that sort of $70 million, $71 million range kind of doable, do you think this year?

Richard Marotta -- Chief Executive Officer

I think, I guess, what I'm going to say to you, Mark, is that we're in the middle of a proxy vote. And so, it's tough to give kind of granular guidance like that into next year. What I can offer in terms of guidance is that we do -- we expect similar EPS this year in 2019 as we had in 2018. I guess, I'll leave it at that in those terms.

Jamie Moses -- Chief Financial Officer

What I would add to that it's going to be cleaner more sustainable earnings stream and that is reliant on recovery income.

Mark Fitzgibbon -- Sandler O'Neill Partners -- Analyst

And then lastly, the $3 million legal settlement, you had mentioned it related to a class action. What specifically did that entail?

Richard Marotta -- Chief Executive Officer

It was a purported class action. It's been in our SEC filings, the Qs and Ks over the past year. And so you can take a look at it in those documents.

Mark Fitzgibbon -- Sandler O'Neill Partners -- Analyst

Thank you.

Operator

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