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spk01: Welcome to the Cambridge Bancorp second quarter 2023 earnings conference call. We'll 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. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Mr. Dennis Sheehan, Chairman, President, and Chief Executive Officer. Please go ahead, sir.
spk02: Thank you, Marlise, and good morning, everybody, and thank you for joining our earnings conference call today. I'm joined by our Chief Credit Officer, Pete Halberstadt, our Interim Chief Financial Officer, Joe Sapienza, our Vice President of Finance, Joe Lombardi, and our Chief Marketing Officer, Danielle Remus-Hackel. In a moment, I will speak to earnings for the second quarter and our current thinking on the outlook. From a macro perspective, we see continued uncertainty regarding interest rates and recession in addition to equity market volatility. At Cambridge Bancorp, deposit levels have stabilized and pricing pressure, while not as elevated, still exists. Growth in deposits remains a priority and is very challenging due to the pricing pressure in the market. However, we are beginning to see green shoots. and I'm hopeful of deposit growth in the second half of this year. Beyond deposit levels, capital is strong and continues to grow. Liquidity is robust at approximately two times the level of uninsured deposits, and asset quality remains excellent. From a lending perspective, activity during the quarter was modest, as expected. Total balances were essentially flat as a result of slowing market activity and the continued disconnect between buyer and seller exportations in commercial real estate, combined with the reduction in consumer mortgage activity due to the level of interest rates and ongoing lack of housing supply. The one bright spot was in commercial and industrial lending, which achieved growth of 7% in the quarter in both the renewable energy and innovation banking sectors. I expect we will continue to see solid growth in the innovation banking segment in the second half of the year, as the opportunities are many. In commercial real estate lending, it is clearly slow. There is activity, but we are not attracted to either the loan structures or pricing offered in the market at this time. We are known for our credit discipline, and that will not waver just to achieve growth. In summary, aside from C&I lending, we would not expect significant loan growth in the second half of this year. Following the industry turmoil earlier this year, we are focused on benefiting from the disruption in the markets by acquiring new clients and talent. Specifically, we have hired four skilled relationship bankers to focus on acquiring deposits in Massachusetts and New Hampshire. Additionally, we hired a new head of wealth management, Jeff Smith, who brings decades of experience in growing wealth management business as our new head of wealth management, replacing Jennifer Pline who retired last month. I look forward to Jeff digging in and building a wealth management growth story in the coming months and years. A few highlights in the quarter. Deposits excluding wholesale funds totaled $4.09 billion as compared to $4.13 billion at March 31, and have been remarkably stable since the middle of March when comparing week over week changes during this period. Interest and non-interest bearing checking balances combined were also stable at $2.23 billion at June 30th as compared to $2.24 billion at March 31. Of note, approximately $50 million moved to interest bearing deposits via our insured cash sweep which has been a focal point for clients during the backdrop of recent bank stress and failures. The tangible common equity ratio ended June at 8.41% as compared to the March level of 8.32%, and tangible book value per share increased to just over $58 at June 30th. Loan asset quality remains superb. Delinquencies are well managed, and we are not seeing any significant issues to date. Pete Halberstadt will join in a minute to speak to our commercial loan portfolio in detail and provide an update on the office environment. Wealth management assets increased primarily due to market appreciation during the quarter, and client assets under management and administration totaled $4.4 billion as of June 30th. The total amount of available liquidity was $2.6 billion, remaining roughly two times the level of uninsured deposits at the end of the quarter. Moving to earnings, net income, profitability ratios, and earnings per share are all negatively affected by the weight of higher interest rates, and negative deposit flows in the latter part of 2022 and beginning of 2023. GAAP diluted earnings per share were 91 cents, and diluted operating earnings per share were $1.23 for the second quarter. The adjusted net interest margin, which excludes the impact of merger-related loan accretion, decreased by 37 basis points to 2.21% from the previous quarter. The cost of deposits excluding wholesale deposits for the quarter increased by 51 basis points to 1.52%, bringing the cumulative total non-wholesale deposit beta to 27%. The company had a return on average assets of 0.70% and return on tangible common equity of 8.51%, both on an operating basis for the quarter. Regarding the outlook, the expectations of the Fed continued to change during the quarter, given uncertainty about inflation and economic conditions. As a result, wholesale funding costs and deposit costs were elevated during the quarter, both as a continuation of client rate requests during the month of April and higher borrowing expenses in June. As it relates to client rate change requests, the level of activity is certainly diminished from the activity seen in March and April. And the spot cost of deposits at the end of the quarter was 1.66%. We believe based on the current forward yield curve and consistent with our previous guidance the net interest margin will likely continue to decline into the low twos toward the end of this year and could be further reduced if rates continue to move higher. Recently, we've been adding more derivatives to reduce the impact of higher interest rate increases. The remainder of the outlook also remains similar to last quarter. Consistent with prior guidance, we are expecting a reasonably flat year in terms of loan growth And while we are focused on deposit growth, we expect modest growth for the remainder of the year as we are looking to avoid the race to the top in interest rates and instead focus on relationship-based core deposits. We expect to monitor operating expenses closely for the remainder of the year, and a growth rate of 0 to 3 percent from the prior year remains appropriate. Within non-interest income, a reduction of between 0% and 5% from the prior year remains appropriate. For the allowance for credit loss ratio, we still expect that to remain between 0.9% and 1% for 2023, barring changes in unemployment or other macro-level items. The effective tax rate for the year is expected to be between 24.5% and 25%. for the full year. I'll now ask our Chief Credit Officer, Pete Halberstadt, to make a few comments on his observations regarding loan asset quality and, in particular, the commercial real estate loan portfolio. Pete?
spk06: Thanks, Dennis. Good morning, everyone. Overall, asset quality remains steady. Non-performing assets ended the quarter at 0.13% of total assets, largely unchanged from March 31, 2023, and year-end 2022. We are not seeing significant movement in risk rating changes, and early stage delinquency levels remain low relative to the size of the portfolio. Through the first six months, performance has remained strong within the consumer lending portfolio, and we continue to see a shortage of housing supply throughout our markets. On the commercial side, we've maintained a diversified commercial real estate loan portfolio overall, with a focus on multifamily as compared to other property types. Multifamily remains an attractive asset class for us, with a seasoned portfolio that is well dispersed throughout our New England market. Even with the potential for slowing year-over-year rental growth, we believe multifamily fundamentals remain sound within our markets, strengthened by a diverse workforce and continued pressure on housing supply that yields stable demand. As it relates to investment office properties nationally and within our own footprint, we are keeping a sharp eye on both sales activity and rental rates. While we recognize that we will not be immune to office trends nationally, we feel optimistic that our long history of conservative underwriting will help limit downside exposure. As a reminder, the weighted average loan-to-value on the total investment office portfolio remains strong at 56%, typically based on originated values and excluding any appreciation since loan inception. The office market is something that will need constant monitoring, and as such, we continue to dissect our portfolio at the loan level. Our lending teams have maintained close contact with our borrowers surrounding leasing activity, and as expected, more pressure is being seen within Boston as compared to the suburban office market. As noted in the past, our exposure to urban office is nominal at less than 3% of total loans. Moving to the provision for credit loss, In the second quarter, the provision consisted of two primary items, the first being the calculated reduction of the reserve due to slightly lower unemployment expectations. This reduction was offset by a slight increase in loan balances as well as prudent increases in qualitative factors given the environment, resulting in a small net provision overall. These items kept the ACL ratio at 0.95%. We continue to expect the strong asset quality that you have seen from Cambridge Bancorp historically, and the ending unemployment rate forecast within the CECL model for the fourth quarter of 2023 is estimated to be 4.08%. I will now turn the call back to Dennis for the conclusion.
spk02: Thanks, Pete. As I end my comments, I'd like to emphasize that while this has been a challenging period, we are optimistic about the opportunity ahead. We're investing in new talent acquisition and will benefit from the opportunity posed by the takeovers of SVB, Boston Private, and First Republic. Finally, an observation of Cambridge Trust's brand in New England. Recently, we brought on a commercial client whose offices are not located in our immediate footprint. What compelled them to make the change to Cambridge Trust from the previous bank was the safety and soundness of our institution, the expertise of our team, the exceptional personal attention they received, and the personalized solutions they needed and we deliver. This is our value proposition to our clients. And we will now open the line for questions.
spk01: We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. If you wish to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. And our first question comes from Mark Fitzgibbon from Piper Sandler. Mark, please go ahead.
spk05: Thank you, and good morning, guys. Dennis, I wonder if you could share with us where did those four relationship bankers you brought on board this quarter come from, and how big was their book of business at their prior institutions?
spk02: They came from a variety of different institutions, First Republic, Silicon Valley, and then two smaller organizations. And I don't know the size of their book, but they certainly – we were attracted to their capability and the contacts that they had in our marketplace and already seeing some of the benefit roll in from them. And we think in the coming months it'll have a really nice benefit. And we're not done yet in terms of picking up talent. I've actually been disappointed in our inability to pick up talent on the innovation banking side. but we have been able to do more on the traditional relationship banking team.
spk05: And then do you have a sense for the timing when you'll have a new CFO on board?
spk02: Yeah, the recruiting process is underway. You know, I would expect, you know, over the next, certainly the next three to six months, we will have a new CFO. My interview process starts in the next week.
spk05: Okay. And then since we've got Pete on the call, Pete, I wondered if you could share with us what caused that 30 to 89-day delinquency bucket to pick up a bit this quarter. Was it any particular category or kind of spread across things?
spk06: No, it was fairly isolated to one loan. Actually, not office. It's another Cree assisted living facility. Zabara's been struggling a little bit with cash flow. It's early stages now, but it just crossed over. So one loan, fairly isolated.
spk05: Okay. And then maybe just if we could spend a minute on the office book. I know you guys have talked in the past about downtown Boston struggling a little bit with vacancy rates, and I know you don't have a big book there, but are you seeing any signs of distress in your portfolio in that market? And also, I wondered if you could share with us where you think values have gone on those office loans in the greater Boston market.
spk06: So for Boston in particular, we probably updated a few of the ones in downtown Boston. Again, it's a very limited pool. We're seeing in that 20% to 25% decline since loan inception that seems to align with what the market's seen. I wouldn't say there's material changes within the portfolio, not a lot of movement within risk gradients. We have a pretty low overall criticized ratio in office. It's really just one loan.
spk05: Okay. And then last question, Dennis, is assuming the Fed, you know, follows the forward curve, you know, I know you think the margin is going to sort of get into the low twos by the fourth quarter. Do you think that's sort of the low? Does the margin start to stabilize, do you think, in early 2024? So...
spk02: the rate of reduction will decline for the rest of this year. So, you know, we've had two tough quarters in terms of margin reduction, I think roughly 40 basis points a quarter. So, we're, you know, the margins at what, 226 gap, you know, we're pointing towards the lower two. So, the rate of decline will slow. Looking into next year, I think we would continue to see margin compression unless we're successful in growing deposits, obviously at a rate that is less than wholesale funding, or that a lending picks up and we can achieve higher yield on loans. That's a challenge at the moment, particularly on the commercial real estate side. But, yeah, I mean, Mark, it's conceivable it could tip below the 2% range, but we're working hard to try and avoid that. Thank you.
spk01: Our next question comes from Steve Moss from Raymond James. Steve, please go ahead.
spk04: Good morning. Good morning, Steve. Dennis, maybe just following up in terms of the competitive and pricing environment on loans, if you could just give a little more color as to what rates you're seeing competitors price different loans at.
spk02: So it's not just pricing. Specific to commercial real estate, From our perspective, it isn't just pricing. It's also structure. We're seeing amortization lengthen. You know, loan-to-values go up. I mean, there's less equity being put into the opportunities. So that's problematic for us. And then when you add to that pricing, in some case, Pete, in the fives in commercial real estate, that's tough. You know, you're dealing with that. So we are, you know, we're not attracted to that kind of growth. And one would hope that some more logic prevails in the market, but this happens from time to time. So that's the one that specifically is problematic. In the CNI space, there's better pricing. Do you agree with that?
spk00: Yes.
spk02: You know, we're having some nice success in the innovation banking category. I think that will continue here through the rest of the year. We're having a lot of conversations in that area. And for obvious reasons, with some of the bank failures that happened, we think that we can pick up some nice client business in that category. And that's nicely yielding.
spk04: Okay. That's helpful. And in terms of just the, you know, on the innovation banking side, you know, you mentioned growth is likely to continue here. Just kind of curious the dynamics you're seeing there that's driving the growth and just, you know, where loan pricing is for that portfolio.
spk02: So some of it, I put it in two categories. And, Pete, you jump in here if you have other opinions, please. One is what's happening, there's less interest. VC money in the space today than there was a year ago or two years ago. So companies may be inclined to borrow more to help from a cash flow perspective. One would hope that the VC funding comes back in time. And then the second reason is clearly there's been some disruption in the marketplace with the unfortunate demise of Silicon Valley Bank. And, you know, That organization is gone, so clients are looking for other options. Some of the talent went to larger institutions, and so we are an option. We've been in the space for now seven years, and we're building credibility day by day, borrower by borrower, private equity firm by private equity firm, and it's an area that we're definitely interested and intrigued in for future growth. It's right here in our in our home territory and we believe we got a lot to offer in the space not just on the banking side but also in the wealth management side so we're excited about the potential there and you know really looking forward to further growth Pete, would you add anything to that?
spk06: No, I think that's a fair representation. I'd say the investment itself is paying off now seven years in the space to have a bigger market presence. So we're seeing a lot more activity, even predating March, just in terms of borrowers reaching out and that market presence.
spk04: Okay, that's helpful. And one last question for me. Dennis, I believe you mentioned that you're using derivatives to adjust the balance sheet here a bit, maybe just a little more color as to how you're making your adjustments and the notional value of any adjustment.
spk02: Yeah, I think the notional, I don't have that in front of me, Steve, but somewhere around $500 million we have in derivatives here, and we'll continue to add where appropriate, that is protecting against the up. It's essentially their pay fix swaps that are helping to protect against the up. It doesn't eliminate all of the upward rate sensitivity, but it certainly protects to a degree. So we've been adding those over time and did some more here in the second quarter.
spk04: Okay. Great. Appreciate all the color. Thank you very much. Sure. Thanks, Steve. Sure.
spk01: And let me remind you now that if you would like to pose a question, press star one. Our next question comes from Chris O'Donnell, I'm sorry, O'Connell from KABW. Chris, please go ahead.
spk03: Morning. Hi, Chris. I was hoping to, you know, start off on the deposit side. You know, obviously a tough environment. you know, it seems like you still had some mixed shift out of non-interest bearing here into the second quarter. How are you thinking about, you know, those flows? You know, did they continue to outflow or mix out of non-interest bearing in, you know, so far in July? And do you think that that mixed shift is, you know, slowing down to stopping or is it something that's going to, you know, persist in the back half of the year?
spk02: It's definitely slowing, Chris. But look, safety is definitely an element of a conversation with clients today in a way that it wasn't a year ago. So it's one of the sort of elements of the arsenal of things that you talk to clients about. And for some clients, they want an insured product. And so we're facilitating that for them, acting in their best interest. So, but just as the level of discussion around rates has slowed somewhat, the level of discussion around safety and stability in the industry, I would pose, has slowed, and certainly for us. So, I would expect that mixed shift to slow.
spk03: Okay, got it. And as far as, you know, your strategy on a go forward basis regarding, you know, the use of, you know, wholesale, you know, or, you know, brokered CDs versus wholesale borrowings, you know, I noticed you kind of, you know, shifted more to the borrowing side and let some of those, you know, higher cost CDs run off this quarter. You know, how are you thinking about the trade off and using each of those, you know, products or funding going forward?
spk02: It comes down really to cost, which is the best, the better economic decision between the two. That's really what it comes down to. And from time to time, Joe, you correct me if you feel differently, but the brokered market can get out ahead of the federal home loan bank curve and vice versa. So it's really looking at the best economic solution. Do you agree, Joe?
spk04: Absolutely.
spk02: Yes.
spk03: Got it. And then I don't know if you mentioned earlier, but for the innovation banking space on those new loan originations, where are you seeing that pricing at?
spk02: Do you know? It's fairly competitive. Is it the sevens? Yeah. Yeah, sevens plus. Sevens plus some in the eights. Depending on the credit.
spk03: Great. And as far as what you're seeing over the course of the back half of 23 into 24 on the loan side that is maturing, where are those yields in general coming off at?
spk02: I don't know specifically, Chris. I mean, we could follow up with you, but... Do you have a sense, Pete, from just what you're saying?
spk06: I mean, similar to what we posted on Office, we actually don't have that much of the portfolio maturing in the next two years. So it's a small subset that's maturing in the next two years.
spk01: Yeah.
spk02: But we can follow up with you with a sense of what the amortization portfolio will be.
spk03: Just trying to get a sense of, you know, for the CRE, obviously, that you guys have in the books already, Um, you know, that, that is coming due, uh, you know, obviously, you know, it sounds like you guys aren't looking to put on, you know, some of the new CRE at, you know, the 5% range here, but for the credits that are, you know, refinancing or maturing and that you already have within the portfolio. You know, where is the pricing, I guess, that you can get, you know, on those credits, you know, if you choose to, you know, refi them?
spk02: So what would be rolling off is probably in the threes, the mid threes. And, you know, for smaller opportunities, you know, you could be achieving in the mid sixes. Yes. Do you agree with that? Yes.
spk03: And, you know, appreciate, you know, the guidance and the color on the expense side here. And with the conversion being done this past quarter, is it fair to say that next quarter, you know, still have expenses, you know, down, even with some of these new hires? And that kind of puts you, you know, into the guidance range as things slide down into the fourth quarter?
spk02: So excluding the non-operating, right, excluding the merger charges, it's pretty flat, down modestly, I think, but pretty flat for the rest of the year compared to the second quarter. And that should get us into that range.
spk03: And was there any, like, true-ups or, you know, accruals happening in the FDIC line this quarter, or is that a good run rate?
spk06: Current quarter should be a good run rate.
spk03: Okay, thanks. And then as you know, you guys are, you know, well capitalized here. And you know, there's not, you know, too much balance sheet growth, it seems like in the near future. I mean, how do you guys think about, you know, the capital management from here and specifically, You know, is there any opportunity to be doing a buyback over the next couple quarters?
spk02: I think the likelihood is low, certainly over the next quarter. You know, maybe we'll get a greater clarity around outlook for recession and that sort of thing as we head through the rest of this year. But I think we want to be prudent here and retain capital until there's greater certainty. And then, yes, I would absolutely welcome perhaps heading into next year buying back stock.
spk03: Great. All right, that's all I have for now. Thanks for taking my questions. Thanks, Chris.
spk01: And this concludes our question and answer session. I would like to turn the conference back over to Dennis Sheehan for any closing remarks.
spk02: Thanks, everybody. We look forward to talking to you again after our next quarterly report.
spk01: And the conference has now concluded. Thank you for attending today's
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