Cambridge Bancorp (NASDAQ:CATC) Q2 2022 Earnings Conference Call July 19, 2022 11:00 AM ET
Company Participants
Denis Sheahan – Chairman, President and Chief Executive Officer
Michael Carotenuto – Executive Vice President and Chief Financial Officer
Conference Call Participants
Mark Fitzgibbon – Piper Sandler & Co.
Christopher O’Connell – Keefe, Bruyette, & Woods, Inc.
Operator
Good morning. Welcome to the Cambridge Bancorp Second Quarter Earnings Conference Call.
We will 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 discussion 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 a 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 Mr. Denis Sheahan, Chairman, President and Chief Executive Officer. Please go ahead, sir.
Denis Sheahan
Thank you, and thank you for joining our earnings conference call today. My comments will focus on key items within the quarter and what we are seeing within our local markets. I’m joined today by our Chief Banking Officer, Tom Fontaine and our Chief Financial Officer, Mike Carotenuto. And Mike will provide commentary regarding estimates for the remainder of this year and in particular, the impact of rising rates as well as an outlook for loan and deposit growth and wealth revenue.
I’m pleased to report another solid period of robust loan growth, continued strength in asset quality, and an expanding net interest margin due to our asset sensitive position. This is balanced against a challenging period for wealth revenue led by market volatility and asset flows. We also announced during the second quarter the proposed merger of Northmark Bank into Cambridge Trust, which brings together two high-quality banks in terrific markets.
As expected, loan growth continued during the second quarter in both commercial and residential lending with 3% linked-quarter growth. Looking ahead, we feel good about continued prospects for growth in commercial lending. Asset quality remains superb with non-performing assets at just 12 basis points of total assets. Core deposits decreased by 4% from the first quarter as a result of tax payments and clients using funds for investment opportunities. We still see the opportunity for core deposit growth for the year and Mike will provide further commentary in a few minutes.
The adjusted net interest margin expanded by 14 basis points to 2.81% during the second quarter, reflective of our asset sensitive position and strong core deposit base. Wealth Management assets and revenue declined due to market performance and negative net flows by 14% and 5%, respectively. While wealth revenue negatively affected total fee revenue during the quarter, expenses remain controlled and core profitability remain good with return on average assets of 1.07% and a return on tangible common equity at 14.07% on an operating basis.
Importantly, we feel very good about progress on the Northmark merger approval process and integration effort. All appears on track to close early in the fourth quarter of this year, and we remain excited about the long-term potential of this combination.
Moving to our local markets and outlook. We remain optimistic regarding near-term loan growth opportunity, particularly in commercial lending. We see continued solid commercial loan demand in the next 90 days. And as always, it’s tough to see longer than that. We also expect residential lending to slow in the back half of this year due to the higher level of interest rates. From an economic perspective, in our markets, unemployment remains strong with Massachusetts around 4% unemployment and New Hampshire less than 3%. Upstream real estate activity that is activity above our lending size and focus, but affecting general market conditions is mixed.
In the life sciences category absorption of a vacant lease space was significantly positive, driven by large pharma. However, there is a clear tightening occurring within small private companies in the innovation space. Overall vacancy in this category remains low at just over 1%. The downtown office market activity has picked up particularly in Class A buildings, and data regarding both building occupancy and subway ridership are trending significantly positive.
So with that, I will ask Mike to make a few comments regarding the details of the quarter and outlook for the remainder of this year.
Michael Carotenuto
Thank you, Denis. Good morning, everyone. I will start with our lending pipelines. At quarter-end, the commercial and residential pipelines were approximately $110 million and $70 million respectively. Overall, slightly better than the pipeline at March 31. These levels combined with the market activity Denis mentioned allow us to update our growth range from the 6% to 8% range announced earlier this year to a revised range of 8% to 10% for the full-year and we will update you as the year progresses. We continue to see solid deposit opportunities for the remainder of 2022. However, our deposit profile allows us to be flexible in this environment.
We are first focused on client retention, retaining our high valued households and the cost of deposits, while secondly, adding new households. As such, we have recasted expectations for the full-year and the growth range is now expected to be 5% to 7% of total deposits from 8% to 10% previously. With this level of deposit growth, we would anticipate that the investment portfolio cash flow would be used to fund any excess lending growth.
Moving to the adjusted net interest margin. We expect to continue to benefit in this rising rate environment. If fed funds were to increase to 3.60% by year-end, we would expect our net interest margin to be in the range of 2.80% to 2.95% for the full-year of 2022, better than the prior quarter net interest margin guidance of 2.7% to 2.85%. This would put our fourth quarter 2022 adjusted net interest margin above 3%.
Moving to non-interest income. Non-interest income growth is going to be less than previously contemplated due to declines within the equity markets, corresponding wealth revenue and lower sales of conforming mortgages. If the equity markets stay at current levels, our forecast estimates of non-interest income are minus 3% to minus 6% for the full-year of 2022 as compared to 2021. While we are not immune to rising rates on our available for sale securities portfolio, it makes up only 14% of total investments and 3% of total assets. It is expected that there will be a small continued negative impact to tangible common equity as rates rise, but it is manageable given our use of the held to maturity portfolio and our outlook for the remainder of the year.
As you can see within this quarter’s release, despite continued increases within interest rates, both tangible common equity and tangible book value per share grew nicely during the quarter. We also expect to be on the lower end of the 26% to 27% range for the operating effective tax rate previously provided. As shown within the non-operating reconciliation during this quarter, we surrendered a bank owned life insurance policy, which created an increase of approximately 2.3% in the income tax expense rate for the quarter, which was completely offset by increased bank owned life insurance income. The rest of our estimates from last quarter remain intact.
And we will now open the line for questions.
Question-and-Answer Session
Operator
Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question today comes from Mark Fitzgibbon of Piper Sandler. Please go ahead.
Mark Fitzgibbon
Hey, guys. Good morning.
Denis Sheahan
Good morning, Mark.
Mark Fitzgibbon
A couple of questions around deposits. You guys have had sort of pretty impressive deposit costs at 8 basis points on those business deposits. I guess, I’m curious, are you starting to feel any deposit pricing pressure there from commercial customers?
Michael Carotenuto
Sure. Mark, so – it’s Mike. In the last cycle, we saw 26% deposit beta and certainly this cycle is going to be different than that. We’re modeling a higher beta in our expectations that you’ll see within the asset liability slide that we have within interest rate risk. So we’re expecting higher than that and we’re hoping to do better.
Denis Sheahan
I would add to it Mark, Denis. It’s no great surprise with the fed increasing rates this quickly. We’re certainly getting some questions from clients is to be expected. It’s not overly aggressive, but certainly clients are questioning deposit rates to be expected.
Mark Fitzgibbon
Okay. But it sounds like from your guidance on deposits you’re not expecting more deposit run-off in 3Q. Is that fair?
Michael Carotenuto
Yes. That’s fair, Mark.
Denis Sheahan
We have a big seasonal component associated with tax payments. It was certainly exacerbated somewhat this quarter by some clients taking advantage of investment opportunities, some of our larger clients. And so those are the two key factors this quarter.
Mark Fitzgibbon
Okay. And then I heard your comments about the employment picture and economy, et cetera, being pretty good. Are you seeing any sort of hints of distress in any of the portfolios related to either consumers or businesses out there, things that you’re sort of watching or a little concerned about?
Denis Sheahan
No. None. We feel very good about asset quality delinquency. I mean, certainly if we do go to recession, there’ll be some weakness one would imagine, but we always think about when we’re making loans about bad times and the conditioning of this organization and we feel very, very good about asset quality.
Mark Fitzgibbon
Okay. Last question I had Denis was sort of around the Wealth Management business. Obviously, difficult market so far this year. I guess, I was curious sort of about customer behavior in that space. Are people sort of shifting asset classes? Are they holding [pad] or what are you all seeing in terms of client behavior?
Denis Sheahan
So certainly stress that – and we’re conditioned to work with our clients through that stress. You get a lot of questions about what’s going on in the markets. There are the rare occasions where a client wants to go totally to cash and we try and coach them not to do that. And most of the time, the vast majority of the time, we are successful; on occasion, we are not, but that’s the nature of the relationship that we have with our clients is that we’re there to coach them through these stressful periods. But you can expect with this kind of volatility, you’re going to have more conversations with clients and we certainly are doing that.
Mark Fitzgibbon
Okay. And then just one final one to clarify, Mike, did you say the loan pipeline was $110 million?
Michael Carotenuto
The commercial loan pipeline, yes, Mark, $110 million.
Mark Fitzgibbon
Great. Thank you.
Operator
Your next question comes from Chris O’Connell of KBW. Please go ahead.
Christopher O’Connell
Hi. Good morning, gentlemen.
Denis Sheahan
Good morning.
Michael Carotenuto
Hey, Chris.
Christopher O’Connell
Hey. So I was hoping to follow-up on the deposit question. And I know you guys said you’re assuming betas above the 26% from last cycle. But within the guide given that you have not moved deposit rates as of yet for that core NIM to 2.80% to 2.95% guidance. Are you assuming that there is a significant move at some point during the third quarter here because we’re getting to close to a third of the way through the quarter? So I’m just wondering when those betas are kind of starting to become effective and if that’s included in your guidance as being above the 26%, or if it’s – if those betas kind of start a little later in the third quarter that there could be some upside to that NIM guide?
Michael Carotenuto
Yes. Certainly, Chris. So to the extent that we’re able to do better from a deposit cost standpoint, there’s the potential for that NIM guide to be at the higher end of that range for sure. We are expecting some increased funding costs as we move forward here, and that’s included within that forecast.
Denis Sheahan
Also, Mike, you might clarify for Chris that the 2.80% to 2.95% is full-year.
Michael Carotenuto
It’s for the full-year.
Denis Sheahan
You expect to be over 3%.
Michael Carotenuto
In the fourth quarter.
Denis Sheahan
Yes, in the fourth quarter.
Christopher O’Connell
Yes. Thank you. Okay, great. And then as far as you guys are thinking about the cash balance this year dropped pretty low during the quarter. Does that stay there until at least the deal gets closed?
Michael Carotenuto
Yes. We think it’ll be around these levels for at least to your point – at least still the deal closes. I think that’s a fair assessment.
Christopher O’Connell
Okay. Great. And then as you’re thinking about the deposit flows, and I know this quarter seem to be seasonally impacted fairly substantially. How are you thinking about the sources of growth on the deposit side going forward? I mean, is it primarily the core commercial customers? They continue to get growth from and kind of have the rest of the factors that were present in this quarter normalized or you getting good traction in any particular pockets that are kind of giving confidence to the growth guidance?
Michael Carotenuto
Yes. Chris, so when we think about growing deposits, I mean, certainly, we first think about growing operating accounts from a commercial standpoint, which would be our desired way to continue to grow deposits and from consumer households, which are important to us. And when we look at consumer households, we’re looking to grow consumers both from a checking standpoint, whether they need money market or savings options. So we’ll use all of our available tools to grow that deposit base. And when you look back at what we did last year, we had over a $1 billion worth of deposit growth. So we intend to continue to grow in that – in the ways that we were able to grow in prior year.
Christopher O’Connell
Okay. Got it. And on the loan growth side, I mean, I understand the positive with the revised core growth guidance at 8% to 10% up from prior. Given the stronger pipeline, particularly on the commercial side and quite frankly, a fairly solid pipeline relative to where you guys were at last quarter on the resi side. That seems like that could even still end up being a bit light on a core basis given that if the pull through rates kind of stay the same going to the third quarter unless even if commercial ends up being flat in the fourth quarter and resi ends up being down, it still seems like a fairly easy bogey to get to that 8% to 10% range. Am I thinking about that right? Or you guys just kind of want to be conservative given it’s hard to see out much more than the third quarter right now?
Michael Carotenuto
I think, Chris, it’s hard to see out more than 90 days in the commercial standpoint. We’ll update you next quarter to the extent that we’re able to overachieve there certainly it’s going to be a positive both from an earnings and NIM standpoint.
Christopher O’Connell
Great. And then last one for me. And I apologize if you guys mentioned I missed it, but you mind walking us through the origination yields and where those are coming on for both the commercial and the resi side?
Michael Carotenuto
Sure. On the commercial side of the house, it’s in the mid-fours, depending upon the product, it could go up and down from there. On the residential side of the house, I would say it’s the high-fours.
Christopher O’Connell
Okay. Great. That’s all I had. Thank you.
Operator
[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Denis Sheahan for any closing remarks.
Denis Sheahan
Thanks, everybody. We look forward to speaking to you at the end of our next quarter.
Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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