Berkshire Hills Bancorp, Inc.

Good morning and thank you for joining Berkshire Bank's third quarter earnings call. My name is Kevin Kahn, investor relations and corporate development officer. Here with me today are Nitin Mahatrye, chief executive officer, Sean Gray, chief operating officer, Brett Berbovich, chief financial officer, and Greg Lindenmuth, chief risk officer. Our remarks will include forward-looking statements and refer to non-GAAP financial measures. Actual results could differ materially from those states. Please see our legal disclosure on page two of the earnings presentation referencing forward-looking statements and non-GAAP financial measures. Our reconciliation of non-GAAP to GAAP measures is included in our news release. At this time, I'll turn the call over to Nitin.

Nitin? Thank you, Kevin. Good morning, everyone, and thank you all for joining us today. I'll begin my comments on slide three where you can see the highlights for the third quarter. I'm pleased to report that we had a strong quarter with robust improvement in operating earnings quarter over quarter and year over year. Operating EPS of 58 cents was up 5% linked quarter and up 16% year over year. Operating net income of 24.8 million was up 7% linked quarter and up 15% year over year. Operating RODSI was 9.91%, up 26 basis points linked quarter and up 64 basis points year over year. Asset quality and balance sheet metrics remain strong. Excluding the upstart loan sale charge-off, net charge-offs were 16 basis points of loans and our reserve for loans was flat to second quarter at 122 basis points. Of note, our total past two loans percentage at 53 basis points is at its lowest level in 15 years and our reserve for losses at 122 basis points is about five times the total non-performing loans. We increased our capital ratios linked quarter with CET1 at .9% and TCE at 9.1%. Liquidity remains solid with our -to-deposit ratio at 96% and average non-interest bearing deposits as a percentage of total deposits remains steady at 24%. We've updated the slides on overall tree, office, and multifamily portfolios. The information on those slides highlight that our portfolio remains granular, geographically diverse, and resultantly less risky. The performance on those loan books remains strong. Average loan balances were up 1% linked quarter and up 3% -over-year. Average deposits were up 1% linked quarter and down 3% -over-year. Our loans pipeline was stable versus third quarter and was up 20% -over-year. Deposit costs were up seven basis points in the quarter, reflecting a reduction in the We expect funding costs to decline as the Fed continues to cut interest rates and like many banks, we've already moved deposit rates lower late in the third quarter. We continue to make steady progress on strategic initiatives. The sale of ten branches in New York that was announced in March was completed this quarter, bringing our total branches to 83. The pre-tax gain on this transaction was $16 million, slightly lower than the $19 million we expected in March, given that client-selected deposit retention exceeded our expectations. This transaction tightens our footprint and enhances the efficiency and profitability of our network. We are now at about the right size for our branch network. A week ago, we announced the sale of $46.5 million of our upstart loan portfolio. The loans were priced at 96% of book value, resulting in $1.9 million charge-off related to the sale. The weighted average credit score for the remaining approximately $10 million upstart loans is $682 million, and we believe that our reserves against that book are sufficient. We continue to make banking with Berkshire, when, where, and how you want it, easier than ever. We continue the rollout of Berkshire One, an expanded suite of digital deposit products for our customers. We will continue to invest in digitizing the customer experience while investing in our bankers to accelerate growth in deposits-led client relationships. I want to thank all of my Berkshire bank colleagues for their continued hard work and commitment to the bank. Their commitment to our strategy and dedication to our customers is what continues to bring us together and truly set us apart. I'll now turn it over to Brett to talk through our financials in more detail. Brett? Thank you, Niten.

Slide 4 shows an overview of the third quarter. As Niten mentioned, operating earnings were $24.8 million, or $0.58 per share, up $0.03 linked quarter. Net interest income of $88.1 million was down less than 1% linked quarter. Operating interest income was $21.5 million, up 7% linked quarter. Total operating revenue was up 1% linked quarter, and operating expenses were $72.3 million, up 1% linked quarter, and down 2% year over year. Net charge-offs were $5.6 million, or 24 basis points of average loans, and included $1.9 million of charge-offs related to the upstart loan sale. Provision expense was $5.5 million, and the reserve coverage ratio was flat linked quarter at 122 basis points. Slide 5 shows our average loan balances. Average loans were up $76 million linked quarter, or 1%. This was primarily driven by growth in the commercial lending. We've updated a page in the appendix which shows data on the upstart and firestone runoff portfolios. Including the recent upstart loan sales, the combined runoff portfolios are down by $66 million to $58 million, or 60 basis points of total loans, and are performing as expected. Slide 6 shows average deposit balances. Average deposits increased $64 million, or 1%, linked quarter. Year over year deposits were down 3%, but excluding the New York branch sale deposits from prior year balances, our deposits were up 1% year over year. Non-interest bearing deposits as a percentage of total deposits remained at 24%,

consistent

with the prior two quarters. Deposit costs were 242 basis points, 7 basis points linked quarter, and our cumulative total deposit beta is 44%. While it's early in the cycle, we expect deposit betas in a down interest rate environment to be higher than the beta on the way up as we remain focused on managing deposit costs. Turning to slide 7, we show net interest income. Net interest income was down 1% linked quarter and down 3% year over year. Net interest margin was down 4 basis points linked quarter to 316 versus 320 in the second quarter and 315 in the first quarter. Our historical range for NIM, excluding the pandemic years, has been between 310 and 340. We expect the fourth quarter NIM to be between 310 and 320. While we have had winds of floating rate loans repricing lower short term, we also have several tailwinds. We have 1.6 billion of CDs or 67% of that book maturing in the next six months. And we have about 400 million of FHLB funding that matures over the same time period. Further, we have 600 million of low yield received fixed swaps maturing over 2025 and 2025 and 2025 and 2026. And we have low yield fixed rate securities and loans that will mature and reprice at higher yields. Slide 8 shows operating non-interest income up 1.4 million or 7% linked quarter and up 4 million or 23% year over year. The growth in fees was primarily related to higher swap volume. This was the third quarter in a row where we've seen solid growth in overall fees. Slide 9 shows expenses. Operating expenses were up 1% linked quarter to 72.3 million and down 2% year over year. Occupancy and professional services expense declined linked quarter and were offset by slightly higher compensation and higher other expense. Other expenses include check fraud expenses, a line that impacts the entire industry in which can be volatile. This quarter that line item was 1.5 million higher than the average of the prior eight quarters due to one isolated incident. Slide 10 is a summary of asset quality metrics. Non-performing loans were up 12% linked quarter and down 10% year over year. The increase in Cree non-performing loans linked quarter was driven by one isolated multi-use property in upstate New York. Net charge-offs of 5.6 million were up 4 million linked quarter and up 193,000 year over year. Net charge-offs included 1.9 million related to the upstart loan sales. Charge-offs excluding that sale were 3.8 million or 16 basis points of loans. We've included a chart in the appendix with Berkshire's net charge-off rates versus the industry since 2000, which reflects relatively better asset quality than the industry over 2009. Slide 11 shows that our Cree book is well diversified in terms of geography and collateral type. The credit quality of the Cree portfolio remains solid with non-acral loans at 22 basis points of period and loans. Slide 12 shows details on our office portfolio. As noted last quarter, the weighted average loan to value ratios are about 60% and a large majority of the portfolio is in suburban and Class A space. We have very limited exposure to Boston's financial district and 80% of our office properties financed are under 150,000 square feet, suggesting our portfolio has much lower default probabilities. Slide 13 shows details of our multifamily portfolio. The multifamily portfolio is $664 million or .2% of loans. The book is well diversified across our footprint with a weighted average loan to value of $65,000. While current credit quality metrics are strong, we recognize that economic uncertainties exist and we are monitoring both new originations and existing portfolios carefully. As Nitten mentioned, we have strong capital levels. The annual book value per share was $24.53 and increased 6% linked quarter and 16% year over year. Our CET ratio is up 30 basis points to .9% and our TCE ratio rose 94 basis points to .1% due to higher retained earnings and a lower bond markup in our AFS securities. Our top capital management priority is to support organic loan growth. Here to date, we've repurchased $17.4 million of stock at an average cost of $21.94. All of our repo this year has been completed below tangible book value per share. We paused our stock repurchase in the third quarter to support expected balance sheet growth. We expect to continue to be opportunistic with stock repurchases and I'd note that since fourth quarter of 2020, we've reduced our share count by 18%. With that, I'll turn it back over to Nitten for

further comments.

Nitten?

Thank you, Brad. Quick comments on macroeconomic environment. The operating environment for banking industry is improving. As I noted last quarter, the yield curve has been in its longest period of inversion in recorded history, but it's starting to normalize as the Fed lowers short-term interest rates starting last month. The potential net interest income increase for the industry during periods of yield curve steepening is substantial. As Brad mentioned, we're already starting to reduce our funding costs and expect a more normal operating environment in the quarters to come. A lower interest rate environment will not just lower the funding cost, but it will also help improve credit, raise property values, and increase loan demand. I'm proud of what our team has accomplished and how far we've come. Notably, we're starting to gain traction on our new deposit generation initiatives. We still have work to do. Our focus near term is to accelerate our deposit growth engine, continue to tightly manage expenses and credit, and further improve client acquisition and retention through enhanced client experience and our digital banking offerings. In closing, it was a strong quarter and we'll continue to focus on managing the headwinds and tailwinds towards further improving long-term profitability and shareholder value. With that, I'll turn it over to the operator for questions. Operator?

Thank you, ladies and gentlemen. We will now begin the question and answer session. Should you have a question, please press star followed by the one on your touchtone phone. You will hear a prompt that your hand has been raised. Should you wish to decline from the polling process, please press star followed by the two. If you are using a speakerphone, please lift the handset before pressing any keys. One moment, please, for your first question. Your first question comes from Christopher O'Connell with KBW. Your line is now open.

Hey, morning. We're just hoping to check in. Is the guidance not included in this slide deck? Is the guidance still valid, I guess, for the 2024 updated guidance provided last quarter?

Yeah, so I think we're still expecting to see or we said in our call, we're expecting the NIM for the fourth quarter to be between 310 and 320. We're expecting revenue to be flat to slightly down in Q4 with expenses modestly down. And then from a net charge off standpoint, I think we're expecting it to be stable when you exclude the upstart loan sale charge off from this quarter.

Okay, great. That's helpful. And then just curious on the commentary around the cutting cycle and the deposit beta is expected to be higher on the way down than on the way up, which is I think somewhat different than many of your peers. Any color about why you guys feel that way or how you expect to achieve that?

Yeah, I think, Chris, qualitatively speaking, we do have a number of tailwinds that we've identified where we could have the opportunity to manage that deposit beta and the margins better in the down cycle. We have significant amount of CEDs coming up for maturity, almost two-thirds of our portfolio comes up for maturities in the next two quarters. We've got some swaps rolling off and so on and so forth. So we believe we have those tailwinds. And then on the front line, the teams are working hard to manage the deposit pricing sharply, keeping a good balance of volume versus spread. So I think there will be more opportunities in this cycle. And we're beginning to see market react to that as well. Some of it depends on how the competition reacts. And we're beginning to see, there are always outliers, but we're beginning to see more and more of our peers bringing down the deposit rates starting late September.

Great. And you mentioned you've already moved a bit on those rates. Do you guys have a spot, either interest-bearing or total deposit cost, post the sale and after the rate moves?

The spot for September was 310, Chris. And I think our spot nymph was about 310 for September. And I think we believe for the fourth quarter, we should be between 310 and 320.

God, do you have anything spot on the overall deposit cost?

Deposit cost. Just give us one second, Chris. No problem. That's 242, which is fine. That's the whole quarter.

The whole quarter. The first spot for just September alone, it was 241.

Great, thank you. And then just last one for me, and I'll step out. It seems like the swap tees picked up quite a bit this quarter. Are you guys seeing, just in general, the change in the rate environment, increased demand for that product?

I think the demand, because we see that in the pipeline, the pipeline seems to suggest that it'll be relatively flat in the fourth quarter. Difficult to predict beyond that, beyond what's in the pipeline. But yeah, I think the momentum seems to be holding going into the fourth quarter.

Great. Appreciate the time. Thank you.

Thank you, Chris.

The next question comes from Lori Honeysucker with Seaport Research. Your line is now open.

Yeah, hi. Thanks. Good morning, gentlemen. Good morning, Lori. If we could go back to expenses, you know, the comments you gave, Chris, expenses are going to be in the fourth quarter. That makes sense. But maybe you can just help us think about, you know, what's reinvested, what's dropping to the bottom line, right? So we look at your expenses. They were 72 million this quarter, 1.6 million of fraud comes out, and then the 10 branch closures. Previously, you all had said that the six and a half million expense savings, so 1.6 million in the quarter, which would then take us down to 69 million, maybe just help us think about what's being reinvested or just in terms of dollars, how we should be thinking about the expense line in the fourth quarter.

Thanks. Yeah, I would. Hi, Lori. This is Brett. I would say from an expense standpoint, some of the expenses that we had related to those branches were already captured in the current quarter. So there will be some falling to the bottom line. You do remove the 1.34 million dollars of the fraud losses that we saw. You know, I think we're looking to be in the range of, you know, right around approximately 71 million of Q4 operating expenses, give or take. Okay.

Okay, great. And then just going over here to office, and I appreciate all the details you guys provide. Can you just update on a couple things with respect to your criticized book, that 24 million specifically? It looks like 14 million in Class A and 10 in Class B. Just what are the occupancies on those and when do they mature? Are there any specific reserves, any concerns you're seeing there? And then same on that Class B non-performer, that's three and a half million. What's the occupancy and when does that mature?

Sure. Greg, you

want to take that?

Sure thing. Hi, Lori. How are you?

Hi

there. On, for the Class A, it's a single credit. Basically, it's an 80% occupancy. It does mature in December 2024 and we're working closely with the client to refinance that credit and it'll likely be an improved structure. As far as the Class B, it's a couple handful of credits that range in occupancy from 25 to 50% occupancy. And one of those credits happens to be one of the MPLs as well. And those mature in 26 to 2028.

Got it. Okay, got it. And then what's the reserve on your whole office book?

And just to answer your prior question, there are no specific reserves on those criticized assets. None of them warrant specific reserves and I would approximate it at about one and a half percent based off the lower risk profile of our office book.

Got it. Got it. Okay, great. That's helpful. And then just last question, upstart. Obviously, you got a great price here at 96 on the dollar. Can you just talk a little bit about how that came together and then just remind us when specifically in the quarter that closed and what was the FICO on those? And then I just want to confirm too as I'm looking at this. So your upstart sale had 1.9 million in charge off. Then you had another 2 million in charge off related to your book and you said the FICO on that was 682. So I just want to understand that a little bit too.

Thanks. You got it. Go ahead. Sorry. No, go ahead, Dan. Yeah. So the sale criteria, the purchaser's investment policies were basically nothing past due and anything over 660. Now there's an intricacy I think with the past due piece, even if it was one day late, that was not included in the sale. So actually 40% of the book that we were retaining was one to 30 days past due and that has a similar risk profile including loans that are in their grace period. Similar risk profiles are existing books. And that's why you see a weighted average credit score in the book of 682. Of the loans that we sold, the weighted average FICO was slightly above our overall average in around 711. And that sale closed right in the middle of October on 1016. As far as the losses, the 2 million in losses, that was just our quarterly run rate for our basically our $67 million book at the end of 2Q. That was our losses for the whole quarter.

Got it. Okay. Thanks for taking my question.

Thank you, Lauren.

Your next question comes from Mark Fitzgibbon with Piper Sandler. Your line is now open.

Hey, guys. Good morning. Morning, Mark. First question, just to follow up on a question my esteemed colleague Laurie just asked about. I'm curious, is it likely we'll see more upstart or firestone loan sales in coming quarters? Is the plan to sort of fire sale those out?

No, I think, Mark, we believe we kind of run those portfolios off. Upstart is really down to that 10 million and is sufficiently provided for at this point of time. And firestone is, in terms of performance, while it is liquidating and runoff mode, its performance is actually exceeding our expectations and, in fact, this quarter had a net recovery. So I think we've done it's a very tiny piece of our portfolio, roughly about 50, 60 basis points of the entire loan portfolio. So it's really in the runoff mode and we don't see any difference in direction anymore. Okay.

And then secondly, wondered if I could dig in a little bit to the check fraud situation you mentioned. I know you all kind of downplayed it as a unique thing for the industry, but it's still a million and a half dollars. And I guess I wonder why couldn't that be 15 million or 150 million? You know, I guess I'm curious if you could give us share any color on what happened and how you're going to prevent similar kinds of things from occurring.

It was really a commercial check kind of fraud, check washing. And I think across every forum that you attend, there is an increase in that activity. And this is one of those situations where you have all the controls, but the fraudsters somehow are able to slip one through. It will be protected to the extent that there'll be some re coming off it because of the insurance. But by and large, our trend on the on the fraud losses is consistent with what we're seeing in the industry or marginally better. This is really one of those are check washing things that just kind of escaped through to our controls.

OK, so is there like a diligence process you're going through to kind of figure out what happened and how to change that process so this thing doesn't occur again?

Yes, and the good news part is that we have been noticing the increase in fraud in the industry over the last 12 months or so, and there have been significant number of changes that have been made, including updating some of the processes and platforms. And I think everything that we have now should certainly help prevent repeat of such instances.

OK, and then next, I was curious, Nitin, if you could share with us kind of your priorities for capital today. You've got a little bit of excess capital, you know, as you think about buybacks, dividends, growth, M&A, you know, your thoughts on prioritizing.

Yeah, I think the sequence remains similar, Mark. I think, you know, we want to, the first dollar want to be allocated to the organic growth, right? And we're beginning to see momentum, as I mentioned in my remarks, our loans growth was kind of roughly 1% in the quarter, but our loans pipeline was up about 20% year over year. So we have a pipeline there. We just being judicious, being careful, selective, and in fact leading with clients that have deposit relationships as well across the board. So, yeah, first of all, it goes to organic growth and then followed by, you know, dividends, buybacks. And, you know, if there are opportunities outside of that, we'll explore those as well. But that's the sequence.

Do you feel like Berkshire Hills is ready to consider an acquisition at this point? Have you kind of got your house in a place where you feel like if an opportunity came along, you'd be positioned to capitalize on that?

We have, I think, it does feel like through everything that we've done through our transformation, we are in the, you know, best possible situation to earn the right to be able to grow our currency and look for options. There are opportunities outside, but right now pretty much the team is focused on how do we improve, continue to improve our performance, improve our currency, and if something comes along, we take a look at that.

Okay. And then last question I had is, when can we expect sort of an update on your best goals?

I think we're going to give annual guidance in January, and at that point of time, we could even look at some midterm guidance as part of that guidance.

Great.

Thank you. Thank you, Mark.

There are no further questions at this time. I will now turn the call over to Nitin Mahatre. Please go ahead.

Thank you, Joel, and thank you all for joining us today on our call, and for your continued interest in Berkshire, have a great day and be well. Joel, you can close the call now.

Thank you, ladies and gentlemen. This is the conference call today. We thank you for participating and ask that you please disconnect your lines.

Thank you.