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Brookline Bancorp, Inc. (NASDAQ:BRKL)

Q2 2013 Earnings Call

July 25, 2013 1:30 pm ET

Executives

Paul A. Perrault - Chief Executive Officer, President, Director, Member of Credit Committee, Chairman of Brookline Bank and Chief Executive Officer of Brookline Bank

Julie A. Gerschick - Chief Financial Officer, Principal Accounting Officer and Treasurer

Analysts

Collyn Bement Gilbert - Keefe, Bruyette, & Woods, Inc., Research Division

Mark T. Fitzgibbon - Sandler O'Neill + Partners, L.P., Research Division

Bernard Robert Horn - Polaris Capital Management, LLC

Operator

Good afternoon, my name is Laura, and I will be your conference call coordinator today. It is my pleasure to welcome you to the Brookline Bancorp, Inc. Second Quarter 2013 Earnings Call. This conference call is being recorded and simultaneously webcast on the Brookline Bancorp website, where it will be archived after the call. [Operator Instructions]

I would now like to remind you that this call may contain forward-looking statements with respect to the financial condition, results of operations, and business of Brookline Bancorp, Inc. Actual results may differ materially from those forward-looking statements. Accordingly, Brookline Bancorp cautions you against undue reliance upon any forward-looking statements and disclaims any intent or obligation to update any forward-looking statements, whether in response to new information, future events or otherwise.

I would now like to turn the conference call over to Mr. Paul Perrault, CEO and President; and Ms. Julie Gerschick, CFO and Treasurer of Brookline Bancorp. Please go ahead.

Paul A. Perrault

Thanks, Laura, and good afternoon to you all. Thanks for joining us today. As many of you know, our strategy at Brookline Bancorp focuses on building a robust commercial franchise. This strategy provides a high level of specialized customer attention and centers on building those relationships one customer at a time. It is this strategic orientation that contributed to the strong organic loan and deposit growth we realized last year and it is this orientation that is fueling second quarter growth after a lull in the first quarter of 2013.

During the quarter, we've seen commercial loan growth return, despite all of the competitive pressures that we're all familiar with. Commercial pipelines are growing throughout the company, and we look forward to strong heading -- a strong pipeline heading into the third quarter of this year. And with the uptick in rates, new loan yields have improved to a degree, especially for short fixed-rate transactions. Asset quality remains a strong suit, and I'm happy to report that the ratio of nonperforming assets to total assets decreased by 17% to just 37 basis points at June 30, a statistic that continues to set Brookline Bancorp apart from the majority of its peers.

Deposit levels at mix continue to improve, which has helped us continue to lower overall funding costs. The net interest margin, which Julie will discuss in greater detail in a few minutes, increased quarter-over-quarter and on a linked-quarter basis standing at 3.78% for the 3 months ended June 30. Second quarter of this year represents a hallmark for Brookline Bancorp for other reasons. We successfully completed the third and final phase of our core systems conversion in May, and the infrastructure build that Julie has discussed with you previously is nearing its completion. As a result, I believe expenses are generally cresting in the second quarter of this year, allowing the company to report earnings in the second quarter of $9.5 million or $0.14 a share.

Importantly, the efficiency ratio has started to decline, from 65.5% in the first quarter to 63.4% in the second quarter. I fully expect that ongoing efforts to improve our funding sources, maintain lending momentum, and reduced expenses will contribute to an ongoing improvement in that efficiency ratio in the quarters ahead. On an overall basis, I'm pleased with the fact that our return on average assets continues to improve, reaching 74 basis points in the second quarter of this year.

And now, I'll turn the discussion to Julie, who will review results in greater detail.

Julie A. Gerschick

Thank you, Paul. As reported in yesterday's press release, the company reported second quarter 2013 earnings of $9.5 million or $0.14 per share on a fully diluted basis, up 8% from the first quarter of 2013 and up 26% from the second quarter of 2012. Commercial Real Estate loans increased $55.6 million during the quarter, growing at an annualized rate of 11% and offsetting declines realized in our C&I portfolio. Equipment financing was the bright spot in the C&I portfolio, growing $28 million in the quarter, or 25% on an annualized basis, compensating for the runoff in our indirect auto portfolio. Asset quality remains excellent as Paul highlighted earlier.

Consistent with prior quarters, our provision continues to exceed net charge-offs as we rebuild Bank Rhode Island and First Ipswich's allowances for loan lease losses, both of which were emanated at acquisition as required by GAAP. The allowance for loan and lease losses represents 1.05% of total loans and leases and 1.34% of originated loans and leases at June 30, 2013.

The second quarter saw the resolution of several problem assets, reducing NPL and NPA ratios accordingly. Net loan charge-offs were very low 6 basis points of average total loans and leases in the second quarter. Allowances include a $620,000 increase for certain acquired loan pools.

Switching to the liability side of our balance sheet, deposits grew $30.9 million during the quarter with a $22.7 million decline in certificates of deposits, offset by a $53.7 million increase in our core deposits. Strategically, management continues to focus on growing core deposits, and in particular, commercial deposits as a percentage of the total deposits.

As Paul also reported, the company reported net interest margin of 3.78% for the second quarter of 2013, up from 3.7% in the first quarter of 2013. In the second quarter, net interest margin benefited from $1.4 million in pre-payment penalties, which contributed 11 basis points to the net interest margin. Likewise, this quarter's net interest margin included 20 basis points of purchase accounting accretion. The net interest margin, after adjusting for these variables, remained constant quarter-to-quarter at approximately 3.47%. Other income of $3.1 million in the second quarter of 2013, included $321,000 in loan-related fees, $3.2 million in retail-related fees, and $201,000 in gains on sales of loans. Income level set compared favorably on a sequential quarter basis.

Offsetting this income were second quarter 2013 losses on investments in affordable housing projects of $624,000, which included a $336,000 adjustment taken on one property that rented out more slowly than originally anticipated. Non-interest expense of $30.8 million in the second quarter of 2013 was essentially flat on a linked-quarter basis. Increases in compensation expense, reflecting permanent and temporary adds as the company completes its infrastructure build and core systems conversions, and conversion-related increases in equipment and debt processing expense, were offset by declines in occupancy and other expenses quarter-to-quarter. The effective tax rate also remained relatively flat, declining slightly from 35.7% for the first quarter to 35.3% to the second quarter of 2013.

This concludes my prepared remarks, Laura. And I think we're ready to take calls and to take questions from our call participants.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today is from Collyn Gilbert of KBW.

Collyn Bement Gilbert - Keefe, Bruyette, & Woods, Inc., Research Division

Could you guys give a little bit of color as to what drove the linked quarter increase in commercial loan yield? I think it went to over 6% from 4.28%?

Julie A. Gerschick

The predominant increase -- the predominant reason for the increase is the $1.4 million of pre-payment penalties, were almost inclusively in that category of loans. That's the first issue. And then the second issue is that we had some pick up in the SOP 03-3 accretion that was concentrated in that loan category. So between the 2 of those items, Collyn, they withstood that yield up to the 6.16%.

Paul A. Perrault

Collyn, I'd add, in a lesser way, but I think still important way, is that our equipment financing units also had some very good growth, and obviously, those rates are at the high end.

Collyn Bement Gilbert - Keefe, Bruyette, & Woods, Inc., Research Division

What are you -- what kind of yields are you seeing within that -- those originations?

Paul A. Perrault

Of equipment finance?

Collyn Bement Gilbert - Keefe, Bruyette, & Woods, Inc., Research Division

Yes.

Paul A. Perrault

I believe it's like 5% to 7%.

Julie A. Gerschick

At 5% to 7%, depending upon the line of spend.

Collyn Bement Gilbert - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. And Paul, I think if I heard you correctly in your comments, you'd said that you're seeing better loan pricing. Did you say on some of the shorter fixed rate? What was it that you're seeing?

Paul A. Perrault

As I'm sure you know, we do a fair amount of Commercial Real Estate and the basic template for the structure of those loans is a 5-year fixed rate initial term. And they typically are priced at some number of basis points above the corresponding Federal Home Loan Bank basis or -- the 5-year Federal Home Loan Bank inventory. And so when rates went up, those FHLB rates went up as well. So 250 basis points above the rates from 6 months ago was a lot less than it is as the loan it goes today.

Collyn Bement Gilbert - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. So have you been able to push through that -- the full rate move into that pricing of that product?

Paul A. Perrault

Generally, I'd say yes. But I mean it's not just us, it's anybody.

Julie A. Gerschick

It's still affected by competitive pressures. But yes, I mean, we're seeing headway.

Collyn Bement Gilbert - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. And then just on the efficiency, do you -- you've indicated the expenses are going to continue to come down, especially when you wrap up the -- sort of the infrastructure spend. Where do you think the efficiency ratio can go by the end of next year?

Paul A. Perrault

Trick question. There's still a lot of regulatory change going on. And it's had a very big impact on us as we had formed this new company, if you will, over the last couple of years. So I would tell you that my initial target is for us to get to 60, and I'm not sure exactly when I can do that. But I think we need to get to 60. And then once we are there, then I think I might be able to give you a better sense of how much better than that we can do. Because it is a different environment, and this is a relatively new company.

Operator

And the next question will come from Mark Fitzgibbon of Sandler O'Neill.

Mark T. Fitzgibbon - Sandler O'Neill + Partners, L.P., Research Division

First question I have for you relates to those affordable tax credits. We've seen some volatility in that line item in recent quarters. I wonder, how should we be thinking about modeling that going forward? Are there any major factors that are going to drive it up or down in your mind?

Julie A. Gerschick

Not that we're aware of. We do on a quarter -- on an annual basis, true-ups, some tax returns, because you're basing those initial entries off of projected balances. I would say, Mark, that we're looking for something around -- somewhere between $300,000 and $400,000 on a quarterly basis. And the adjustments that we booked this quarter was truly an anomaly with one type of project that was very different than the other projects then we don't expect that to continue going forward.

Mark T. Fitzgibbon - Sandler O'Neill + Partners, L.P., Research Division

Okay, great. And then secondly, I wondered if you could share with us your thoughts for headcount at the bank over the next couple of quarters and whether you have any plans for new branches?

Julie A. Gerschick

Well we actually opened a branch in this last quarter, so that was terrific. I'll let Paul speak to new branches going forward. We will see a small increase in headcount for the quarter ended June 30, in part for infrastructure adds, which we're almost complete on, but also because of seasonality and temps that we bring on during summer to staff the branches for vacation.

Paul A. Perrault

We've got 2 more branches that are planned, Mark. One that will probably open late this year and one that will open, I'd say, maybe mid-year next year. So it's not a huge thing, but we do prune them a little bit and we add one here and there if business conditions warrant it. And the way that we approach it is more, is this a good business of location for us to have customers be able to get to us and have our bankers be able to get to customers, focusing primarily on commercial business. So we're not trying to darken the skies with branches or on a convenience basis in that sense.

Mark T. Fitzgibbon - Sandler O'Neill + Partners, L.P., Research Division

And you had said the loan pipelines were very strong. Could you share with us the size of the pipelines?

Paul A. Perrault

Well, I don't add them up like that. But I'd say across the company, in the commercial and commercial real estate areas, it could be several hundred million. But that doesn't mean that all of those close or when they close, and -- all that kind of thing or if we can land all the deals. So it's -- to me, it's an interesting number that will float up and down. It will give you some gauge of the level of activity. But I wouldn't just take it and add it to the outstandings or so.

Mark T. Fitzgibbon - Sandler O'Neill + Partners, L.P., Research Division

Okay. And then in terms of the margin outlook, based on what you said about loan pricing improving and you probably still have some flexibility to take down your funding cost, do you think you can hold the margin? The core margin experts, accounting adjustments, at a level similar to what we saw in the second quarter?

Julie A. Gerschick

We're sure going to try. We're going to give it our all, we're going to try to keep bringing that cost of funds down as we improve the mix, number one. We are pushing forward on the rate side of the fence, on the heel side of the loans, as much as we possibly can. And so, our hope is that, that is going to be able to offset the vagaries of the pre-payment penalties. You just never know what you're going to have in any 1-month on that side of the fence. On a purchase accounting adjustment, probably going to be an ongoing kind of tick down of 3 basis points a quarter, I'm guessing, unless repayments really go crazy. So is it possible that with the prepayments not being able to forecast those and purchase accounting adjustments that we could have a 10 tick decline a quarter, it's possible. But we're going to do everything we possibly can in turning the other levers to offset that so that we can hold steady at that core rate.

Mark T. Fitzgibbon - Sandler O'Neill + Partners, L.P., Research Division

Okay. And then the last question I had is for you Paul. I wondered if you -- now that BARI is fully integrated, do you think there are acquisitions likely to be part of the strategy in the near-term? Do you think the acquisition market is attractive now and there are targets for you there?

Paul A. Perrault

There are always companies that are interesting out there, Mark. But it has never been a strategy of ours to make progress, primarily via acquisition. So we've still got a lot of stuff we can do here to improve this company. A lot of things we should do and will do. And if something comes along that's relatively irresistible for us, we'll take a good hard look at it. But I'm not spending all my evenings having dinner with other CEOs or anything like that.

Operator

[Operator Instructions] And our next question is from Bernard Horn of Polaris Capital.

Bernard Robert Horn - Polaris Capital Management, LLC

I got a few questions. The first is, on the conversion cost, I know that they were a little bit higher than expected in the last few quarters, and it sounds like you're kind of nearing the end of that in May. I'm wondering if you're going to begin to realize any efficiencies on that. And similarly, I think you had some inefficiencies related to the headquarter and some additional costs. So with the resolution of those 2 items, mean that we should start seeing some cost reductions or cost saves?

Julie A. Gerschick

We should -- Bernie, I would suggest that it's going to start next quarter and drift down over the next couple of quarters. The conversion took place literally over Memorial Day weekend.

Paul A. Perrault

Yes, so it's just 7 weeks on that.

Julie A. Gerschick

So we're very -- it's very new and there's still some cleanup and some ancillary work that needs to be done around the edges of the core conversions. So they will have us retaining some of the costs for a little bit of time here. But on an overall basis, our goal is certainly to focus on getting those expenses to come down on a longer-term basis.

Bernard Robert Horn - Polaris Capital Management, LLC

Okay. Do you have a number that, let's say, for the first 6 months was more than the normal run rate as result of those 2 items?

Julie A. Gerschick

It was several $100,000 just in terms of cost of consultants and de-conversion costs or in some cases, that couldn't be capitalized, et cetera. So it was up there.

Bernard Robert Horn - Polaris Capital Management, LLC

Okay. And the capitalized cost, any sense for that?

Julie A. Gerschick

I don't have the capitalized costs. That's also several $100,000 on a quarterly basis, somewhere between $300,000 and $400,000 this quarter -- this quarter alone.

Bernard Robert Horn - Polaris Capital Management, LLC

Okay. Very good. And the second question is on -- I noticed that you -- there was a deterioration in the acquired loan portfolio, and I'm just wondering if -- it reminded me after the BARI acquisition where you had kind of a deterioration shortly after the closing or thereabouts. And I was just wondering if -- I think it was a rather large amount. And I thought you said you were going to be pretty well. You didn't reserve us much as I think, maybe you might have had to, because you felt like you were pretty well secured. Now I'm just curious if those issues were part of this deterioration or you have -- in the subsequent periods, were able to recover what you thought you are going to on those loans?

Paul A. Perrault

Let me start, Bernard, by separating those 2 things, because they're really totally unrelated. One, is that shortly after the deal closed, Bank Rhode Island originated a nasty loan that went bad very quickly. We acted promptly, got our arms around it. We had a pretty good resolution, if you will. And we -- but we did have to take a sizable charge-off and we took it in maybe the second quarter of last year.

Julie A. Gerschick

We did and $4.3 million on the quarter.

Paul A. Perrault

And that's kind of a done deal. There's still a trailing outstanding, but it's in good shape.

Julie A. Gerschick

Right, and it's performing at...

Paul A. Perrault

Behaving as is. So the books are just about closed there. The other side is the free acquisition loans that still remain. Saw us some ratings downgrades, if you will. There's nothing terrible in there. It's not like it's behaving a lot worse than we thought that it would, but apparently, and I'll let Julie correct me here when I go off the rail, according to the purchase accounting, you have to look at these things and if you have some ratings downgrades, you have to re-up the provision in order to reflect that. In that review, that's kind of what happened. So it's not like we've got a bunch of nonperformers or expecting a lot of charge-offs. But our provisioning is based on factors that go into loan rates.

Julie A. Gerschick

The -- it's isolated into a couple of pools, Bernie. And the offset to it is the set -- some of the other pools are performing much better than we had anticipated initially when we put those marks up. The problem with GAAP accounting is that if it deteriorates, you have to book the loss, or book the deterioration. If it improves, you don't get to take that and then you don't get to take that immediately. You get that dribbled in overtime into interest income.

Paul A. Perrault

Hardly seems fair but...

Julie A. Gerschick

Yes, it hardly seems fair, but the fact of the matter is, the fact there is offset, but just the timing is different for the 2. So to Paul's point, we don't see any significant or worries from trends, but we've done what we needed to do from a GAAP standpoint.

Bernard Robert Horn - Polaris Capital Management, LLC

Okay. And then the last question is, I noticed that there was a bit of a run-off in the indirect auto loan, and maybe just a little bit more color on that. And I'm wondering if there was any yield tick-up as it sounded like the CRE portfolio kind of made up for some of the difference and didn't know if there was much of a difference in loan rates.

Julie A. Gerschick

Well, the runoff has been pretty consistent, actually, at about $10 million a month. And it's our -- it reflects our unwillingness to play in the market at what we would characterize as unreasonable interest rates. So the market has been inundated with very large banks that have come in and kind of bought the business and we just aren't going to go to the rates that they would go at. Conversely, although it's not a strategic initiative, conversely, the money that's coming in from there are being redeployed across the portfolio. But that's where you'll see, as an example, huge growth, almost exactly dollar-for-dollar growth on the equipment financing side of the fence. And so where we're giving up yields at somewhere between 3% and 4% on the indirect auto portfolios, we're gaining somewhere between 5% at 7% yields on the equipment financing loans that are being put on the books.

Operator

This concludes our question-and-answer session for today. I would like to turn the conference back over to management for any closing remarks.

Paul A. Perrault

Okay. On behalf of Julie and myself, I'd like to thank everyone for their participation and we look forward to reporting third quarter results with you on October. Until then, enjoy the summer. Thank you, Laura.

Julie A. Gerschick

Thank you.

Operator

And thank you. The conference has now concluded. We thank you for attending today's presentation. You may now disconnect.

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