Beacon Financial Corp annual report, FY2017

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Filing summary

Entity and period: The supplied filing is Berkshire Hills Bancorp, Inc.’s Form 10-K for the fiscal year ended December 31, 2017—not a filing identified as Beacon Financial Corp. It covers the full year; fourth-quarter figures are noted where relevant.

Business context

Berkshire Hills is a regional bank holding company headquartered in Boston, operating through Berkshire Bank and Berkshire Insurance Group. Its 113 full-service branches served New England, New York and the Mid-Atlantic; mortgage banking and specialty equipment finance also operated nationally. The company completed its acquisition of Commerce Bancshares in October 2017, expanded its Greater Boston presence and exceeded $10 billion in assets.

Financial performance and condition

  • Revenue and earnings: Total net revenue rose 41% to $420.5 million; net interest income increased 27% to $294.8 million. GAAP net income fell 6% to $55.2 million, and diluted EPS declined to $1.39 from $1.88. Pretax income rose 29% to $99.7 million.
  • Adjusted results: Management-reported adjusted net income, a non-GAAP measure, increased 33% to $90.8 million; adjusted diluted EPS rose 4% to $2.29. Adjusted results exclude items including acquisition and restructuring charges, securities gains, hedge-termination losses, employee/community spending and the deferred-tax-asset write-down.
  • Margins and returns: Fully taxable-equivalent net interest margin was 3.40%, up from 3.31%; fourth-quarter margin reached 3.50%. GAAP return on assets was 0.56% versus 0.74%, while adjusted ROA improved to 0.93% from 0.86%. The efficiency ratio increased to 59.97% from 58.27%.
  • Cash flow: Operating cash flow was $78.1 million, compared with $98.1 million in 2016. Investing activities used $282.9 million and financing activities provided $340.5 million. Cash and cash equivalents ended the year at $248.8 million, up from $113.1 million.
  • Balance sheet and growth: Total assets were $11.57 billion, up 26%; loans were $8.30 billion, up 27%; deposits were $8.75 billion, up 32%. Excluding Commerce, management reported organic loan growth of 8% and deposit growth of 6%. Commercial loans represented 61% of total loans.
  • Debt and liquidity: Borrowings totaled $1.14 billion, down from $1.31 billion; this included $1.05 billion of Federal Home Loan Bank advances and $89.3 million of subordinated notes. The loans-to-deposits ratio was 95%, versus 99% a year earlier. Unused FHLB borrowing capacity was $1.11 billion. Brokered deposits were $1.2 billion, or 14% of deposits.
  • Capital: Shareholders’ equity increased 37% to $1.50 billion, aided by the May stock offering and Commerce stock consideration; year-end shares outstanding rose 27% to 45.3 million. Consolidated total risk-based capital was 12.43%; the Bank’s was 11.17%. The Bank met the regulatory “well capitalized” criteria.
  • Credit quality: Net charge-offs were 0.19% of average loans, down from 0.21%. Nonperforming assets were $24.0 million, or 0.21% of assets; nonperforming loans were 0.28% of loans. The allowance for loan losses was $51.8 million, or 0.62% of loans, compared with $44.0 million and 0.67% in 2016.

Changes versus prior year and unusual items

  • The Commerce acquisition contributed approximately $1.8 billion of assets, including $1.24 billion of loans and $1.7 billion of deposits at acquisition. Acquired loans were recorded at fair value without a carried-over loan-loss allowance. Commerce’s loan portfolio included Boston-area taxi medallion loans; the acquired loan balance was marked down by $86.5 million, primarily reflecting taxi-medallion and other specialty/commercial credit risks.
  • Federal tax reform reduced the federal statutory tax rate from 35% to 21%, but required an $18.1 million provisional, non-cash write-down of net deferred tax assets. The effective tax rate was 44.6%, compared with 24.3% in 2016; before the deferred-tax charge, 2017’s effective rate was 26%. Fourth-quarter GAAP results were a net loss of $2.8 million, including the tax charge.
  • Non-interest expense rose 47% to $299.7 million. Acquisition, restructuring, conversion and related expenses were $31.6 million; management’s non-GAAP reconciliation also excluded $3.4 million of employee/community investments. The company said $21 million of its targeted $32 million in Commerce merger expenses had been recorded, with the remainder expected in 2018.
  • Fee income rose 79% to $122.8 million, notably as mortgage-banking income increased to $54.3 million with the first full year of First Choice operations. Securities gains were $12.6 million; a $6.6 million hedge-termination loss was recorded in non-interest income.
  • The company issued $153 million net of costs in common stock in May and issued common and preferred shares as Commerce consideration. The quarterly common dividend increased to $0.21 per share in 2017 from $0.20 in 2016; management declared a further 5% increase in January 2018.

Outlook, risks and contingencies

  • Management targeted adjusted ROA above 1.00% and long-term ROE above 10%. It expected Commerce integration savings of approximately $8 million annually, with systems integration targeted for March 2018. These are management targets, not guaranteed outcomes.
  • Management estimated a 22%–24% effective tax rate under the new tax law, subject to business, market and tax developments. It also expected a $5–$6 million annual reduction in card-fee income from the Durbin Amendment beginning in the second half of 2018.
  • Interest-rate risk is a key exposure. At year-end, modeled net interest income was modestly sensitive to higher rates, while a 200-basis-point shock was estimated to reduce economic value of equity by 5%. Deposit repricing and deposit withdrawals remain uncertainties; the company estimated a 47% beta on interest-bearing deposits.
  • Risks include commercial real estate and commercial-loan concentrations, geographic expansion, acquisition integration and execution, increasing regulatory and compliance costs after crossing $10 billion in assets, funding access and deposit sensitivity, cybersecurity and technology disruptions, and valuation changes in securities and acquired loans. The company expected higher future credit-loss allowances under the forthcoming expected-credit-loss accounting standard.
  • Two lawsuits were disclosed: a purported class action alleging electronic-funds-transfer and consumer-protection violations, and a trust-beneficiary complaint alleging fiduciary-duty and consumer-protection violations. The company denied the allegations and was defending both; it said probable future losses could not be estimated. Management reported no other pending proceedings believed material.
  • PwC was dismissed as auditor in August 2017 and Crowe Horwath was appointed. The filing reported no disagreements or reportable events with PwC. Management and Crowe concluded internal control over financial reporting was effective; Commerce was excluded from the control assessment and audit scope as a 2017 acquisition.

Investor verification priorities

  • Confirm the registrant identity: the filing is for Berkshire Hills Bancorp, Inc., despite the request metadata naming Beacon Financial Corp.
  • Review the Commerce purchase-accounting marks, especially taxi-medallion and other acquired-loan assumptions, subsequent collections and integration savings.
  • Reconcile GAAP earnings with management’s adjusted, non-GAAP measures and assess whether the excluded items are truly nonrecurring.
  • Track deposit costs, brokered and uninsured deposits, payroll-processing balance volatility, and refinancing of the substantial 2018 FHLB maturities.
  • Assess whether credit quality and reserves remain adequate as commercial lending expands and the expected-credit-loss standard is implemented.
  • Monitor the tax-reform measurement-period adjustments, projected tax rate, regulatory costs and card-fee reductions, as well as the outcomes of the disclosed lawsuits.