Q2 2023 Cambridge Bancorp Earnings Call
Participants
Denis Sheahan; Chairman, President & CEO; Cambridge Bancorp
Pete Halberstadt; Chief Credit Officer; Cambridge Bancorp
Unnamed Company Representative
Mark Fitzgibbon; Analyst; Piper Sandler
Steve Moss; Analyst; Raymond James
Chris O'Connell; Analyst; KBW
Presentation
Operator
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 on 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.
(Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Mr. Denis Sheahan, Chairman, President, and Chief Executive Officer. Please go ahead, sir.
Denis Sheahan
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 Remis 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 Bankcorp, 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 expectations 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 30, 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 30.
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 30. 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 $0.91 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 the 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 has 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% from the prior year remains appropriate.
Within noninterest 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 will 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?
Pete Halberstadt
Thanks, Denis. Good morning, everyone. Overall asset quality remains steady. Nonperforming 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 Denis for conclusion.
Denis Sheahan
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 are 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 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 their 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.
Question and Answer Session
Operator
(Operator Instructions) Mark Fitzgibbon, Piper Sandler.
Mark Fitzgibbon
Thank you and good morning, guys. Denis, I wonder if you could share with us where did those four relationship bankers you brought onboard this quarter come from and how big was their book of business at their prior institutions?
Denis Sheahan
It 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.
Mark Fitzgibbon
And then do you have a sense for the timing, when you will have a new CFO on board?
Denis Sheahan
Yeah. The recruiting process is underway. I would expect over the next -- certainly, the next three to six months, we will have a new CFO. Interview process starts in the next week.
Mark Fitzgibbon
Okay. And then since we've got Pete on the call, Pete, I wonder if you could share with us what caused that 30-to-89-day delinquency bucket to pick up a bit this quarter? Was there any particular category or kind of spread across things?
Pete Halberstadt
No, it's fairly isolated to one loan. Actually, not office, it's another -- an assisted living facility. The borrower has been struggling a little bit with cash flow. It's early stages now, but it just crossover. So one loan fairly isolated.
Mark Fitzgibbon
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 do you think values have gone on those office loans in the Greater Boston market?
Pete Halberstadt
So 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 seeing. I wouldn't say there's material changes within the portfolio. Not a lot of movement within risk ratings. We have a pretty low overall [criticized] ratio in office. It's really just one loan.
Mark Fitzgibbon
Okay. And then last question, Denis, is assuming the Fed follow the forward curve -- I know you think the margin's going to get into the low twos by the fourth quarter, do you think that's the low? Does the margin start to stabilize do you think in early 2024?
Denis Sheahan
So 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 running roughly 40 basis points a quarter. So we're guiding the margins at what, 2.26% GAAP. 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, Mark, it's conceivable. It could tip below the 2% range, but we're working hard to try and avoid that.
Mark Fitzgibbon
Thank you.
Operator
Steve Moss, Raymond James.
Steve Moss
Good morning.
Denis Sheahan
Morning, Steve.
Steve Moss
Denis, 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 rate you're seeing competitors price different loans at.
Denis Sheahan
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, loan to values go up. 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're dealing with that. So we are 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.
The -- in the C&I space, there's better pricing. Pete, you agree with that?
Pete Halberstadt
Yeah.
Denis Sheahan
And 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.
Steve Moss
Okay. That's helpful. And in terms of just the -- on the innovation banking side, 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 where the loan pricing is for that portfolio?
Denis Sheahan
So some of it, I put it in two categories. And Pete, you jump in here if you -- you have other opinions, please. One is, what's happening -- there's less 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 that organization has 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 in and intrigued in for future growth. It's right here in our home territory and we believe we got a lot to offer in the space, not just on the banking side but also on the wealth management side. So we're excited about the potential there and really looking forward to further growth.
Steve Moss
Pete, would you add anything to that?
Pete Halberstadt
I think that's fair representation. I'd say, the investment itself is paying off now. Seven years in this space have a bigger market presence, so we're seeing a lot more activity even predating the March just in terms of borrowers reaching out and that market presence.
Steve Moss
Okay. That's helpful. And one last question for me. Denis, I believe you mentioned that you're using derivatives to adjust the balance sheet here, but maybe just a little more color as to what -- how you're making your adjustments and the notional value of any adjustments?
Denis Sheahan
Yeah. I think the notion was -- I don't have that in front of me, Steve. But somewhere around 500 million we have in derivatives here and we continue to add where appropriate. That is, protecting against the up. It's essentially their pay-fixed 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 overtime and did some more here in the second quarter.
Steve Moss
Okay. Great. Appreciate all the color. Thank you very much. [Cheers].
Denis Sheahan
Thanks, Steve. Sure.
Operator
(Operator Instructions) Chris O'Connell, KBW.
Chris O'Connell
Morning. I was hoping to start off on the deposit side. Obviously, a tough environment and it seems like you saw some mix shift out of noninterest-bearing here into the second quarter. How are you thinking about those flows? Did they continue to [outflow] or mix out of noninterest bearing in -- so far in July? And do you think that that mix shift is slowing down to stopping or is it something that's going to persist in the back half of the year?
Denis Sheahan
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 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 mix shift to slow.
Chris O'Connell
Okay. Got it. And as far as your strategy on a go-forward basis regarding the use of wholesale or brokered CDs versus wholesale borrowings, I noticed you shifted more to the borrowing side and let some of those higher cost CDs run off this quarter. How are you thinking about the trade-off in using each of those products for funding going forward?
Denis Sheahan
It comes down, really, to cost, which is the best -- better economic decision between the two. That's really what comes down to it. And from time to time, and 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?
Unnamed Company Representative
Absolutely, Denis.
Chris O'Connell
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 now?
Denis Sheahan
It's fairly competitive. It's in the sevens.
Pete Halberstadt
Yeah. Sevens plus.
Denis Sheahan
Seven plus, some in the eights.
Pete Halberstadt
Depending on the credit.
Chris O'Connell
Great. And as far as what you're seeing over the course of the back half of '23 and '24 on the loan side that is maturing, where are those yields in general coming off that?
Denis Sheahan
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 seeing?
Pete Halberstadt
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.
Denis Sheahan
Yeah. But we can follow up with you with a sense of what the amortization portfolio will be (multiple speakers)
Chris O'Connell
Just trying to get a sense of -- for the CRE, obviously, that you guys have on the books already, that is coming due. Obviously, it sounds like you guys are looking to put on some of the new CRE at the 5% range here. But for the credits that are refinancing and maturing, that you already have within the portfolio, where is the pricing, I guess, that you can get on those credits if you choose to refi those?
Denis Sheahan
So would be rolling off is probably in the threes, the mid threes. And for smaller opportunities, you could be achieving in the mid sixes. Pete, do you agree with that?
Pete Halberstadt
Yeah.
Chris O'Connell
Got it. And appreciate the guidance and the color on the expense side here. And with the convergent being done this past quarter, is it fair to say that next quarter still have expenses down even with some of these new hires and that puts you into the guidance range as things flatten out into the fourth quarter?
Denis Sheahan
So excluding the non-operating -- excluding the merger charges, that's pretty flat down modestly, I think. Pretty flat for the rest of the year compared to the second quarter. And that should get us into that range.
Chris O'Connell
And was there any true ups or accruals happening in the FDIC line this quarter or is that a good run rate?
Pete Halberstadt
Current quarter should be a good run rate.
Chris O'Connell
Okay. Thanks. And then as you guys are well capitalized here and there's not too much balance sheet growth it seems like in the near future, how do you guys think about the capital management from here and specifically, is there any opportunity to be doing a buyback over the next couple of quarters?
Denis Sheahan
I think the likelihood is low, certainly over the next quarter 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 yeah, I would absolutely welcome perhaps heading into next year buying back stock.
Chris O'Connell
Great. All right. That's all I have for now. Thanks for taking my questions.
Denis Sheahan
Thanks, Chris.
Operator
And this concludes our question-and-answer session. I would like to turn the conference back over to Denis Sheahan for any closing remarks.
Denis Sheahan
Thanks, everybody. We look forward to talking to you again after our next quarterly report.
Operator
And the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
