Cambridge Bancorp (NASDAQ:CATC) Q3 2022 Earnings Conference Call October 18, 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.
Chris O’Connell – Keefe, Bruyette, & Woods, Inc.
Operator
Welcome to the Cambridge Bancorp Third 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 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, Marlins, and good morning everyone. Thank you for joining our earnings conference call today. I’m joined by our Chief Financial Officer, Mike Carotenuto who will provide an update for the remainder of this year.
To begin, I would like to welcome our new colleagues who recently joined from our merger with Northmark Bank. The merger closing was completed on October 1st representing about 4.5 months from announcement to close. Over these past few months I’ve gotten to know the team from Northmark and I look forward to working with each of them as we build the Cambridge Trust brand in these new markets.
I am also pleased to report another solid quarter. As expected, loan growth continued; asset quality remains excellent; and the net interest margin expanded, all balanced against the challenging period for deposit growth and wealth’s revenue as a result of market volatility.
The key highlights were loan growth continued during the third quarter in both commercial and residential lending with 3% linked quarter growth. Asset quality remains superb, non-performing assets are just 12 basis points of total assets and we are not seeing concerns in either consumer nor commercial credit at this point.
Core deposits decreased by 2% from the second quarter as a result of clients using funds for real estate purchase, business investment opportunities combined with market competition and certainly search for yield. The adjusted net interest margin expanded by 12 basis points to 2.93% during the third quarter reflective of our asset sensitive position and our core deposit base.
Wealth management assets declined due to market performance and negative net flows by 4.5% during the quarter. While provision for loan loss expense and funding and cost increased during the quarter, non-interest expenses remained controlled and core profitability remained good with return on average assets of 1.15% and return on tangible common equity of 14.94% both on an operating basis.
Moving to our local markets and outlook, we are once again entering a period of considerable economic uncertainty. What distinguishes this cycle versus prior ones is obviously the speed of change, especially as the Federal Reserve makes sizable rate increases in an attempt to combat high inflationary forces. The Greater Boston and Southern New Hampshire market however still provide both near and long-term growth opportunity and remain attractive despite potential near-term challenges.
Our crystal ball is no more accurate than any others, but it is pretty assure that growth will slow. This is already evident in the significant decline in residential mortgage volumes occurring throughout the industry and at our company. While the net interest margin is poised to increase over the near term, deposit rates which typically lag the repricing of loans and other earning assets are increasing competitively to meet client demands for higher rates.
The good news is our deposit base exceeds our loan book by a healthy margin. Given the scenario of potentially slower growth, we will look to continue to generate new loans as our local market is home to dynamic industries such as the innovation economy, healthcare and education. We will evaluate and slow the pace of investment spending where needed. We look to maintain superb asset quality and a high percentage of core deposits and we will look to continue attract wealth management professionals given recent consolidation in our marketplace.
And lastly, our Northmark Bank merger is expected to be immediately accretive to earnings right here in this fourth quarter. So all in all, we intend to be proactive in advance of this looming environment. The real goal for us is to be prepared to hit the ground running to capitalize on opportunities that are available now as they present themselves whenever the economy inevitably turns positive.
Mike will now make a few comments including the details of the quarter and outlook for the remaining – of remainder of this year. Mike?
Michael Carotenuto
Thanks, Denis. Good morning, everyone. First I will discuss our interest rate position strategy and margin. As Denis mentioned, we remain positioned for rising rates particularly over a two year period. We are asset sensitive in the latest model scenario based on a static balance sheet include the total deposit beta in line with the last rising rate cycle, which as a reminder was at 26% during 2015 to 2019.
Additionally, 26% of our loan portfolio reprices on a short end of the yield curve. These items combined with lagging on funding costs have contributed to the expansion of our adjusted net interest margin of 12 basis points during the third quarter. This was expected and prior adjusted NIM guidance of 2.80% to 2.95% for the full year of 2022 remains unchanged at this point and we expect the fourth quarter to be just over 3%.
What has changed is the deposit outlook for the remainder of this year. Given the pace and magnitude of the recent Federal Reserve rate hikes and market competition, we now expect deposits to end the year flat to Q3 levels. While we will look to exceed this updated guidance, we are also in the process of creating our budget and we will provide 2023 guidance in the first quarter as we have done in the past few years.
We remain first focused on client retention retaining our high valued households and the cost of deposits while secondly adding new households. Our office and banking teams have done an incredible job thus far and we look for that to continue. We anticipate that investments and loan portfolio amortization cash flows would be used to fund any excess lending growth for the remainder of this year and/or reduce wholesale funding.
Despite lower deposit growth than previously anticipated, we have the liquidity and flexibility to manage in this environment given expected securities cash flows, our core deposit beta expectations, borrowing capacity and the positive impact of Northmark’s cash position, which has already been used to reduce outstanding borrowings in the fourth quarter.
Now I will move to our lending pipelines. At quarter end, the commercial and residential pipelines were approximately $90 million and $35 million respectively, down from the last quarter, particularly on residential lending as we had anticipated.
Our loan growth range for the full year of 2022 is now low double-digits, around 10%. However, as Denis alluded to, loan pricing is now in focus. We want to ensure that new loan yields are at the appropriate level to reflect both risk and return on equity in this environment. Right now it’s not a matter of demand but loan pricing not increasing at the same level as funding cost.
Moving to non-interest income, during the quarter, non-interest income included approximately $450,000 in revenue associated with the seasonal tax preparation fees within our wealth management revenue line. Additionally, as a reminder, Q2 included approximately $1.2 million in BOLI income associated with the death claim and policy surrender which was non-recurring.
Non-interest income growth for the full year remains unchanged from our prior guidance of minus 3% to minus 6% from 2021. Within non-interest expense, I would note that we anticipate marketing spend to remain elevated in the fourth quarter as we are active in a new marketing campaign.
Moving to capital, as you can see within this quarter’s release, despite continued increases in market rates, tangible common – excuse me – tangible book value per share grew during the quarter and while the tangible common equity ratio declined slightly during the quarter, we expect TCE to be approximately 8% by year end inclusive of the impact of Northmark.
We continue to guide lower – excuse me, we continue to guide to the lower end of the 26% to 27% operating effective tax rate previously provided. As a reminder, the operating tax rate removes the impact of the prior quarter’s BOLI policy surrender and offsetting income received. There are no changes to other estimates from last quarter.
Finally, we are in the process of finalizing the Northmark’s fair value market impacts and we expect to include a fair value table as a disclosure within our 10-Q. Northmark brings an engaged team, wonderful clients, logical expansion markets and a healthy balance sheet with approximately $370 million in loans and $373 million in deposits prior to the finalization of the accounting for mark-to-market.
While rates have risen and the numbers will change from initial estimates, the updated results appear to be well contained. Based upon preliminary estimates, we expect tangible book value dilution to be below 3% and have an earn back under the crossover method of less than three years.
We will now open the line for questions.
Question-And-Answer Session
Operator
[Operator Instructions] Our first question is coming from Mark Fitzgibbon from Piper Sandler. Please go ahead, Mark.
Mark Fitzgibbon
Good morning, and thanks for taking my question. Mike, just first could you just clarify, I kind of missed your comments on the expense outlook.
Michael Carotenuto
Sure, Mark. So what I said for the fourth quarter is that we anticipate marketing spend to remain elevated as we are active in a new marketing campaign.
Mark Fitzgibbon
Got you. Okay, great. And then secondly, I wondered if you guys could kind of remind us of the timing of when you expect to extract all the Northmark synergies? When should we expect all those synergies will be out?
Michael Carotenuto
Yes, so, Mark, they’ll just be left 75% here in Q4 and then our systems conversion is until April. So you’ll have the 100% by the time we get to the systems conversion.
Mark Fitzgibbon
Okay, great. In that margin that you referenced being just over 3%, that – that’s kind of a combined adjusted margin for you guys and Northmark was any restructuring that you contemplated being incorporated in that?
Michael Carotenuto
That’s correct.
Mark Fitzgibbon
Okay, great. And can you help us think about the provision for the next couple of quarters? I know that everybody’s crystal ball is a little fuzzy but any guidance you can give there would be great.
Michael Carotenuto
Yeah, Mark, so it depends upon two things. The level of our loan growth and what happens kind of with economic factors, particularly unemployment, right? So generally speaking, if unemployment is rising, provision expense generally rises alongside with it. And then if loan growth is up, you’d expect some provision as well.
What I would say though is that, we continue to be very – we continue to perform very well from an asset quality standpoint. So, from an overall allowance for credit loss ratio, we are at just about 96 basis points today. We’ll probably in that range into the future and it may climb higher depending upon what happens with unemployment expectations.
Mark Fitzgibbon
Okay. And then, and this is really not a question for you guys, because your asset quality has been so good historically and delinquency is so low. But I guess, I am curious as you look at sort of the market around you, are there any areas of concern from a credit perspective in either commercial real estate or C&I things that you guys are sort of shying away from or a little cautious on? Thank you.
Denis Sheahan
Sure. Mark, it’s Denis. I think, clearly, there is a big unknown relative to the office market broadly I think throughout the industry and we would share that concern. If – I think the answer there though will be sort of it will take years to fully answer what’s going to happen in the office market. There is greater occupancy.
Occupancy is growing but it’s certainly not back to pre-pandemic levels. You can look at data from the large real estate firms, look at transportation data, we are not back to pre-pandemic levels. So, that’s an area clearly of concern. We have limited exposure there, but that is the one that I would highlight the most.
Mark Fitzgibbon
Okay. And then lastly, Denis, I wonder if you could sort of share your thoughts on the M&A environment? I know bigger transactions are a little tricky to do right now. But do you think that some concerns about the credit environment might prompt more consolidation, more small banks to seek out a partner like Cambridge and do you get that sense that that’s likely in the coming quarters?
Denis Sheahan
I think it’s too early to say that, Mark. I think this – we are all living with sort of individually and collectively a degree of uncertainty about where the Fed is taking rates and ultimately the consequence of it and then the longer term impacts on that to financial institutions. We know there is a lot of temporary or not tangible book value dilution out there.
You add a credit problem on top of that, that could spur some consolidation. I think it’s too early to say. I do know though that I have a lot of confidence in my team. We’ve done three very good mergers in a little over three years and I have a lot of confidence in my team’s ability to execute. You look at this, we closed this merger in 4.5 months.
That isn’t happening today and there is a reason it happened is because of the quality of the two firms here. So, I have confidence in our ability to do it. I think it’s too early to say that that this – this particular cycle will drive more consolidation. That’s the obvious challenge of the mark-to-markets, the fair value accounting. Mike referenced we feel good about where we are with Northmark, but in this rate environment, I think that’s a hurdle realistically.
Mark Fitzgibbon
Thank you.
Denis Sheahan
Sure.
Operator
[Operator Instructions] Our next question is coming from Chris O’Connell from KBW. Please, Chris, go ahead.
Chris O’Connell
Morning.
Denis Sheahan
Good morning.
Chris O’Connell
Wanting to start out with some of the deposit commentary and some of the flows this quarter. These CDUs were up fairly materially. I was wondering what the pricing was in terms of what they were coming on at. And then, what you are hearing from your customers obviously a little bit more of a tepid growth environment on deposits into the year end here, but just what you are hearing from your customers as far as the flows going forward?
Michael Carotenuto
Yes, Chris, on the deposit side of the house, we did used some brokered CDs during the quarter. When you back that out, the spot cost of deposits excluding wholesale was 28 basis points. So I think that might be where you are seeing some increase in total CDs there.
And then in terms of deposits during the quarter, as Denis mentioned, we had clients used funds to purchase businesses, purchase real estate and certainly some money has moved into treasuries or competitor CDs. But some of that has also moved into internal wealth strategies or off balance sheet into a sweep. We talked about we expect deposits to be flat to Q3 levels and that’s kind of our current outlook right now.
Chris O’Connell
Got it. And for the brokered CD, go ahead.
Denis Sheahan
And just to add to what Mike said there, it’s understandable clients to a degree are searching for yield and when – if you are bombarded in the news every night about the Fed increasing rates, it’s understandable our team is well conditioned to have conversations with our clients and to find a solution for that. So, these are normal conversations that happens in our industry and we are ready for that.
Chris O’Connell
Got it. And for the brokered CDs, what did those come on at? What rates and what was the duration?
Michael Carotenuto
It’s short duration. So three months and under and their blended rate was between 2.50 and 3.
Chris O’Connell
Got it. And on the loan side from what you are seeing in your pipeline today, what are the origination yields coming on at?
Michael Carotenuto
Yes. So, as of today, the new production today, we are looking for mid 6s to 7s for 30 year residential fixed. It’s mid 5s to 6s in residential arms. For commercial pricing, fixed rates are generally today in the mid 6s. But we are looking for more variable pricing there.
Chris O’Connell
Got it. So, I mean, given where your guys betas have been in the past even if it runs a little above that, is it fair to say that the momentum for the margin maybe less aggressive of pickups in the first half of 2023, but still an upward trajectory for the first couple quarters at least?
Michael Carotenuto
Yeah, I think it’s fair, Chris. I mean, conceptually, we are going to put – you are right conceptually, but we are going to put out some 2023 guidance in the first quarter. But it also depends upon what happens with the – where the Fed moves – how quickly they move. So there is a lot of – there is a lot of moving pieces to that.
Chris O’Connell
Got it. And could you just outline – you mentioned some balance sheet movement post quarter end with Northmark and cash paying down borrowings or wholesale funding and just what the levels of movement were there?
Michael Carotenuto
Yeah, so, Northmark had about $95 million worth of cash in securities. That was used to pay down some wholesale early in Q4.
Chris O’Connell
And I hear you on the marketing expense remaining elevated in the fourth quarter. I think the last quarter you might have mentioned organic expenses around 4% to 5% for the year. Does that changed that outlook at all?
Michael Carotenuto
Well, you also got to include Northmark, but I think that’s about right, yes.
Chris O’Connell
Okay. Alright. That’s all I had to ask about for now. Thanks.
Michael Carotenuto
Okay.
Operator
And this concludes our question and answer session. I would like to turn the conference back over to Denis Sheahan for any closing remarks. Please go ahead.
End of Q&A
Denis Sheahan
Thanks everybody for joining the call. Look forward to speaking to you after our next quarter.
Operator
Thank you for attending today’s conference. You may now disconnect.
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