Earnings Call Transcript - CAC Q3 2022

Operator, Operator

Good day, and welcome to Camden National Corporation’s Third Quarter 2022 Earnings Conference Call. My name is Drew and I will be your operator for today’s call. Please note that this presentation contains forward-looking statements, which involve significant risks and uncertainties that may cause actual results to vary materially from those projected in the forward-looking statements. Additionally, information concerning factors that could cause actual results to differ materially from those in such forward-looking statements are described in the company’s earnings press release, the company’s 2021 annual report on Form 10-K and other filings with the SEC. The company does not undertake any obligation to update any forward-looking statements to reflect circumstances or events that occur after the forward-looking statements are made. Any references in today’s presentation to non-GAAP financial measures are intended to provide meaningful insights and are reconciled with GAAP in your press release. Today’s presenters are Greg Dufour, President and Chief Executive Officer; and Mike Archer, Executive Vice President and Chief Financial Officer. Please note that this event is being recorded. At this time, I would like to turn the conference over to Greg Dufour. Please go ahead.

Greg Dufour, CEO

Thank you, Drew. Good afternoon, everyone. Welcome to Camden National’s Third Quarter 2022 Earnings Call. Earlier today, we announced third quarter net income of $14.3 million and year-to-date earnings of $46.1 million. This resulted in diluted earnings per share of $0.97 for the quarter and $3.12 for the year-to-date period. Total revenues of nearly $142 million through the first nine months of 2022 were up 2% from the comparable period in 2021 despite higher PPP loan income and record mortgage activity last year. We feel this demonstrates the flexibility and strong core operating capacity of Camden National. Underlying these results is our commitment to position and reposition the organization in light of the macroeconomic environment highlighted by rapidly rising interest rates, increased probability of recession and geopolitical risks. I’d like to take a few moments to further explain some of the actions we’re taking. We’re repositioning lending activities as we see the impact of the last remnants of PPP and the slowdown in the residential mortgage markets. This repositioning has actually been going on for several quarters and includes several points. First, a build out of our small business lending efforts leveraging two major strategies. First, we’ve hired five dedicated small business lenders in our markets, and piloted a very successful training program to enhance our banking center managers' capacity to generate small business loans. This effort has been driven by a complete overhaul of our small business lending process utilizing our FinTech partner Abrigo, as well as our own business process analysis group. We now have the capability to go from application to same-day decision and close within one business day depending on collateral. While early, we are very, very happy with our initial results using the new process. We also focused on streamlining our process for larger credit underwriting to build productivity and scale now and in the future. The results of these efforts allow for the expansion of capabilities in our existing markets while providing impactful tools as we look to new markets. There are several other areas where our prior investments and focus position us well, and we’ll continue to do so. Our asset quality is extremely strong in this period of economic uncertainty, and increased probability of recession. We have continued to fortify our allowance for credit losses, as demonstrated by our coverage, ACL to total loans of 95 basis points, and ACL to non-performing loans of 723%. Our ability to be productive continues to benefit us as shown through our 56.43% efficiency ratio. And our focus on deposits continues to be strong through both our retail network and our corporate treasury management areas. A deposit beta, which includes quarter pauses and CVS, was 14% for the first nine months of the year. These efforts are extremely critical at this point in time, as we see aggressive loan and deposit pricing throughout our various products and markets. Our priorities are to maintain asset quality within both our loan and investment portfolios, to maintain our efficient cost structure and to strengthen our balance sheet until we see economic projections turn more favorable. I would also highlight that we continue to focus on capital by being opportunistic in share repurchases as we repurchased just over 60,000 shares during the third quarter and provided a $0.40 dividend per common share. During the quarter, we also announced that Rebecca Hatfield, President and CEO of Avesta Housing, based in Portland, Maine, will be joining our board on December 31, 2022. In addition to her experience at Avesta, Rebecca has a strong background in banking, both in lending and credit areas, as well as previous experience in the technology industry. I’d like to now turn the discussion over to our Chief Financial Officer, Mike Archer.

Mike Archer, CFO

Thank you, Greg. Good afternoon, everyone. Earlier today we reported net income for the first nine months of 2022 at $46.1 million and diluted earnings per share of $3.12 compared to $52.5 million in diluted EPS of $3.49 for the same period a year ago. The drivers for the earnings compression between these periods can be directly traced back to the change in the global economic environment, creating a dynamic and rapid shift in the operating environment for us, not unlike other banks. Between periods we have seen interest rates rise considerably at an accelerated pace, the yield curve flattening and mounting pressures for a slowing economy, and many believe will lead to a near-term recession. Through the challenges, we’ve been able to maintain federal performance metrics for the first nine months of 2022, including our return on average assets at 1.13%, return on average tangible equity of 16.27% and maintain an efficiency ratio in the mid-50s. To further highlight the strength of our core operations and results for the nine months ended September 30, 2022, we reported an increase in non-GAAP earnings, which excludes income taxes, provision expense, and SBA PPP loan income of $4.5 million or 8% over the same period last year. In regard to our performance for the most recent quarter, we reported net income of $14.3 million and diluted EPS of $0.97 for the third quarter, each down 5% compared to the second quarter of 2022. On a non-GAAP basis, adjusting for income taxes, provision expense, and SBA PPP income, earnings decreased by $328,000 or 2%. Net interest income had a nice lift in the third quarter increasing by $1.3 million or 4% over the second quarter. Historically, we’ve seen an increase in our net interest margin in the third quarter each year due to seasonal growth in deposits within our markets, which we again saw this year. The average quarterly deposits increased by 4% quarter-over-quarter. The seasonality in our deposits and our shift in earning asset nets as we continue to redeploy investment cash flows to fund loan growth, each contributed to NIM increasing four basis points between quarters to 2.88% for the third quarter. Our NIM increase for the quarter was within our prior guidance. Our yield on interest-earning assets for the third quarter increased by 29 basis points to 3.4% over the second quarter and represented an asset beta of 20% for the period. Funding costs over the same period increased by 25 basis points to 0.54%. For the third quarter of 2022, our total deposit cost was 0.45%, an increase of 24 basis points over the second quarter, and represented a deposit beta of 17% for the quarter. Year-to-date, our deposit beta, which includes non-interest checking and time deposits, was 14%. End-to-end loans grew 4% during the third quarter and 13% through the first nine months of 2022. Our loan growth for the quarter was driven by residential mortgage and commercial real estate. Residential mortgage balances grew by 7% during the quarter while commercial balances grew by 2%. As noted in our earnings release, at the end of the third quarter, the residential mortgage pipeline was approximately $110 million, and our commercial pipeline is approximately $90 million. For the third quarter of 2022, we provisioned $2.8 million of expense for credit losses, which was an increase of $419,000 over last quarter. At this point in the cycle, our credit portfolio remains in excellent condition with no immediate signs of trouble or deterioration. The increase in the provisions for credit losses this quarter was due to a combination of solid loan growth and growing concerns of an economic slowdown. In the third quarter, we released the remaining reserves that were established for certain modified hospitality loans totaling $768,000. As of September 30, 2022, our allowance for credit losses on loans stood at 95 basis points of total loans, which was an increase of 3 basis points over last quarter and covered over seven times our non-performing loans. Our reserve levels continue to incorporate our long-term view of macro conditions as well as consider more local factors. We continue to proactively monitor and analyze various pockets of our portfolio to identify any leading indicators of risk; to date, we have not identified any trends of systemic risk or stress within our portfolio. Non-interest income for the third quarter of 2022 totaled $10 million and was down 11% compared to the previous quarter, as we were not immune to the effect of higher interest rates, pressuring mortgage banking income and the down markets affecting wealth management fees and loan income. Residential mortgage production for the third quarter was down 20% compared to last quarter, and correspondingly, sold production was nearly down 20% as well. Our non-interest income forecast for next quarter is in the range of $10 million to $11 million, like previous quarters. In the fourth quarter each year, we recognize our annual debit card incentive bonus and expect to do so again next quarter. Non-interest expense for the third quarter of 2022 totaled $27.1 million, which was 2% higher than the second quarter of 2022. Our non-GAAP efficiency ratio for the third quarter of 2022 was 56.43% compared to 55.42% last quarter. We estimate our fourth quarter expenses will be near $27 million as we’ve seen in the past quarters. Tangible book value per share decreased by $0.95 or 4% during the third quarter to $22.97 at September 30, while our tangible common equity ratio decreased by 38 basis points in the quarter to 6.13% as of September 30. Tangible capital decreased again due to rising interest rates, decreasing the value of our bond portfolio. Actions we took in the second quarter to move securities to held-to-maturity helped mitigate some of the impact of further rising rates on tangible capital. The company’s regulatory capital ratio has continued to be well in excess of regulatory capital requirements as of September 30, supporting the strength of our record capital position. During the third quarter, we repurchased 63,689 shares of our common stock, bringing our total shares repurchased for the first nine months of 2022 to 225,245 at a weighted average cost of $45.46 per share. This concludes our comments on our third quarter results. I will now open the call for questions.

Operator, Operator

Thank you. We will now begin the question-and-answer session. Our first question today comes from Damon DelMonte from KBW. Your line is now open. Please go ahead.

Damon DelMonte, Analyst

I guess first question is regarding the provision this quarter. I thought I heard you say you guys released the remaining 700,000 or so of COVID-specific provisions or reserves that you had before. Is that what you said?

Greg Dufour, CEO

That’s correct, Damon. It is about 750,000 roughly.

Damon DelMonte, Analyst

So if you didn’t have that to release this quarter, can we assume that the provision would have been closer to around 3.5 million?

Greg Dufour, CEO

That is correct. Yes.

Damon DelMonte, Analyst

So is that how we should think about the level of provisioning going forward? Or do you think it’s going to be closer to this quarter’s level?

Greg Dufour, CEO

On a go-forward basis, we feel pretty good right now, where we are around 95 basis points from a total loans perspective. Certainly, loan growth will be a factor as we move forward in terms of what provision looks like on a go-forward basis. But we’ve been pretty proactive in terms of setting aside reserves for potentially a looming recession or slowdown. And we’d hope that as we move forward, the level of reserve or provision needed starts to slow down as well. Again, there are many factors that go into play there, but right now, we feel good about our reserve levels and would think that potentially there would be less of an impact on a go-forward basis should the macroeconomic conditions continue as we expect.

Damon DelMonte, Analyst

And then with respect to loan growth, I’m looking at two strong quarters, actually three strong quarters in a row, and I’m just kind of wondering how you’re looking at the year closing out and kind of what the pipeline’s indicating as we head into 2023?

Greg Dufour, CEO

Yes, I think our pipeline at the end of the quarter is pretty strong. Residential home...I think I mentioned there’s about $110 million in the pipeline. We have been throughout the year portfolioing about 80% of our production in residential. I think we’ll likely see a similar number for the fourth quarter as well. So again, I would expect fairly strong residential growth there. The commercial pipeline too is very strong, continuing to remain stable at about $90 million. So I do think as we enter into the fourth quarter here, we’ll probably have loan growth in the 2% to 3% range.

Damon DelMonte, Analyst

And then I guess just one last question. I think your guidance for non-interest income was $10 million to $11 million in the fourth quarter. Does that include the annual debit card incentive or not?

Mike Archer, CFO

It does; it’s a bit of a wildcard, if you will, there Damon, more on the mortgage banking side. I think to the extent that we did have some valuation adjustments run through this quarter, and that’s kind of compressing our mortgage banking income for the third quarter. To the extent that we don’t see something similar, we will likely be on the upper end of that range. But the short answer is yes, we do have debit card income in that number as well.

Operator, Operator

Our next question today comes from Matthew Breese from Stephens Inc. Your line is now open.

Matthew Breese, Analyst

Good afternoon. I wanted to follow up regarding the composition of loan growth. It feels like it will continue to be weighted towards residential loans, and maybe just thinking about the overall asset sensitive profile of the bank's balance sheet. Is there a broader strategy many are undergoing this, bringing the balance sheet into a more interest rate neutral position? How far away are you from that?

Greg Dufour, CEO

It is, as we mentioned earlier, as the residential mortgage market is slowing down. We’re focusing on the commercial side and small business side. We’ve been investing in that area and building that up. We think that will help offset further declines in residential.

Matthew Breese, Analyst

Maybe just follow on that thread a little bit. How far away do you think we are from seeing meaningful impacts on the balance sheet from SBA lending?

Mike Archer, CFO

Again, we generally refer to it as more small business lending, which could include SBA. When we mention growth expectations, that is built in there; as we expect residential to drop, we expect those other areas to pick up. That’s what we’ve been seeing in our existing pipelines shared this quarter: $110 million in residential and $90 million in commercial.

Matthew Breese, Analyst

And then just thinking about the outlook for deposit growth, curious about your thoughts there, the composition of it, and in the broader scheme of funding the balance sheet. Should we expect a similar pace of securities run off in the quarters ahead to help fund some of the loan growth?

Greg Dufour, CEO

Yes. We do expect continued cash flows from the investment portfolio at around $12 million a month, and it will continue to be redeployed into higher earning assets. We’ll continue to focus on generating core deposits, primarily checking accounts. We have some promotional products out there that are a bit more expensive than before. But we are also managing from a perspective of overnight funds and what is cost advantageous for us. It will be a combination of both non-interest checking and money market accounts. We continue to manage towards our guidance for an overall funding beta of 25%. For the first nine months, we’ve stuck to that.

Matthew Breese, Analyst

Just to be a little more specific thinking about demand deposits. The composition of your deposit book is vastly improved in the wake of the pandemic with demand deposits up to 27% of total. Do you expect to see much attrition or erosion in that line? Or are you seeing anybody kind of make the transition from demand to other categories and what’s been the recent drivers of growth?

Greg Dufour, CEO

Customers are obviously interest rate sensitive, and there is that risk of moving it out of the demand because the rates are more favorable. Not just prompted by the small basis point changes but meaningful moves. To combat that, we have products that can assist our customers in keeping deposits in-house. We maintain a strong core deposit base, but we also continue investing in corporate treasury management to keep business deposits stickier as well. We have several levers to adjust to customer demand.

Matthew Breese, Analyst

And then just maybe tying this all together any thoughts on the near-term margin outlook, and whether the pace of NIM expansion we saw this quarter is something we should expect, at least in the relative near term?

Greg Dufour, CEO

Yes. I mentioned this in my comments; generally, Q3 is a stronger quarter for the NIM due to some seasonal flows. We do anticipate that in the fourth quarter we could see some seasonal outflows which is normal for us. That said, if we focus on margin and deposit betas, we aim to be flat on a quarter for the fourth quarter from a margin perspective, understanding some downside risks in terms of seasonal outflows, but we think we can manage that.

Matthew Breese, Analyst

Last one for me. Just thinking about capital adequacy, and obviously, your regulatory capital ratios are very healthy; any concerns there? Or has this popped up in conversations with regulators at all?

Greg Dufour, CEO

We’re monitoring it, and we feel good about it. When you take out the impact from the AFS portfolio, it jumps up significantly. We have good core capital. I don’t want to comment much on our conversations with regulators just to say we feel confident about our capital levels while still monitoring.

Operator, Operator

As we have no further questions, this concludes our question and answer session. I would like to turn the conference back over to Greg Dufour for any closing remarks.

Greg Dufour, CEO

Great. Well, thank you, Drew. I just want to thank everybody who’s taking the time to listen to the call and for your interest in Camden National. Have a good afternoon. Bye now.

Operator, Operator

The conference has now completed. Thank you for attending today’s presentation. You may now disconnect.