CATC (2021 - Q4)

Welcome to the Cambridge Bancorp Fourth Quarter Earnings Conference Call. We will 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 our earnings release. All participants will be in listen-only mode. [Operator Instructions] 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. Denis Sh

Thank you and good morning. Thank you all for joining our earnings conference call today. I'll be brief in my comments assuming you've seen the earnings release. I'm joined this morning by our Chief Financial Officer, Mike Carotenuto, who will provide commentary regarding estimates for 2022. For your reference, those estimates are included on Page 22 of an investor presentation we posted along with the earnings release. I'm pleased to report another strong year of growth and solid financial performance at Cambridge Bancorp and Cambridge Trust Company. And with that, an increase to the common stock dividend by 5% to $0.64 per share. Core deposit growth was again a key highlight, with growth achieved of 32% or $1 billion in 2022. The majority of this growth was from existing clients deepening their relationship. It was buttressed by a more aggressive marketing and money market campaign to take advantage of the merger noise in the marketplace and it worked. Over one-third of this deposit growth was new clients to the bank and we look forward to working with those clients to deepen their relationships over time. I recognize this strong level of growth in core deposits has built significant liquidity on the balance sheet in both cash and securities. It will take some time to deploy this level of liquidity into loans and we're working on it. Mike is guiding to 6% to 8% growth in loans for 2022 and my hope is we can exceed that. Loans, excluding PPP redemptions grew by 9% for the year and in both our commercial and residential lending, we remain optimistic regarding continued growth in '22. So why are we optimistic about growth? Well, it's market conditions remain conducive for it. Economic conditions continue to improve. Strong life sciences, technology and innovation economy, that all benefit the lending sectors that we emphasize. Housing, multifamily, industrial, lab space, construction and unemployment in both Massachusetts and New Hampshire dropped nicely in the fourth quarter. 3.9% in Massachusetts and under 3% in New Hampshire. Recent bank consolidation should provide opportunity, as we are an alternative to the larger merged companies for both talent and clients. Demand continues to exceed supply for housing in both Massachusetts and New Hampshire. And finally, our team has a reputation of being stable and dependable in the marketplace with a proven ability to deliver. Returning to results for the year, asset quality remains superb, with continued low levels of delinquency, nonperforming assets and no charge-offs. Wealth Management assets and revenue grew by 16% and 18%, respectively, in 2022 and we achieved positive net flows for both the quarter and year-to-date periods. We announced during the fourth quarter the hiring of a team from a competitor institution that will cover New Hampshire, Massachusetts and Connecticut for the bank and we are delighted they joined Cambridge Trust. This and other sales initiatives will hopefully benefit this year and beyond. Core profitability remained solid with return on assets of 1.26% and return on tangible common equity at 15.10% on an operating basis. And growth in operating earnings per share of 13% for the year. These results are driven by consistency in strategy and solid execution. First, provide exceptional client service. This then presents opportunity to focus on our three core areas of business strategy: growth in core deposits; lend responsibly; and build high-quality fee revenue diversification. In summary, I'm immensely proud of my team's support for our clients, for one another and our communities throughout the last two years. A continuation of the 132-year history of caring for all who make Cambridge Trust a special place. We're having fun and look forward to executing again in 2022. So with that, I will ask Mike to make a few comments regarding the outlook for this year.

Thanks, Dennis. As mentioned earlier, on Page 22 of our investor presentation released earlier today, our set of 2022 financial expectations. Of note, these estimates do not include any impact of increased interest rates. Therefore, you can choose what, if any, rate scenario you believe to be the most likely. However, I would note that we are asset sensitive and we would expect a benefit in a rising rate environment. For further clarity, I would note that each 25-basis point increase in short-term interest rates with no change to long-term interest rates and no increase in our funding costs would provide approximately $2.2 million in pretax interest income on an annualized basis or an approximate 2% increase on net interest income. For additional rate scenarios, please refer to our disclosures included within the appendix of the investor presentation and our SEC filings. We will now open the line for questions.

[Operator Instructions] Our first question comes from Mark Fitzgibbon with Piper Sandler. You may go ahead.

Hey guys, good morning.

Good morning.

Mike, just to clarify, the adjusted net interest margin assumption for the full year of 2.50% to 2.60% with no rate hikes embedded in that. So that excludes purchase accounting adjustments, any residual impact from PPP. Is there anything else that we should be thinking is excluded from that?

No, that's correct, Mark. Just those two items.

Okay. And then secondly, it looked like your cost of deposits rose a bit this quarter. Obviously, it's still very low. But I guess, I'm curious, where is the upward pressure coming from? From high net worth clients, corporations or somewhere else?

This was more -- Mark, this was strategic from us. With all the merger noise in the marketplace, we wanted to go out aggressively. We increased our marketing spend and went out aggressively as clients are sort of -- our prospects are sticking their head up and looking around for other financial institutions when they're going through the mergers. It was an opportunity for us to try and capture some share and that's exactly what we did. As I referenced in my comments, one-third of our deposit growth in last year was new to the bank households which is really strong.

Okay, great. So I guess, as we think about sort of balance sheet growth, does it probably slow a little bit in the first quarter as you sort of remix out of short-term securities and cash into loans? Would that be fair?

Yes, I would think so, yes. I mean, it was quite a frenzy of activity, particularly on the deposit side in '21. We'd expect it to slow somewhat in '22.

Okay. And then, could you share with us the size and complexion of your loan pipelines, maybe the average rate as well?

Sure, Mark. So on the commercial side of the house, we have about $60 million net of a few expected payoffs. On the residential side, we have about $83 million in terms of pipeline. So it's about $143 million in terms of total loan pipeline. And then in terms of rates, depending upon the product, right, it's anywhere in the low 3s to mid-3s.

Okay. And then lastly, I guess I was curious what your new wealth management system allows you to do. And I'm curious, does it facilitate more of an open architecture approach?

Sure. So on the wealth systems, it will improve. There is a new front end for clients that has the ability to do account aggregation. So you can aggregate all of your relationship, both inside the company and wherever else, all in one place. That's in the client-facing portal. In terms of the core system and it's use throughout the wealth division, it's a much more efficient, more productive way of executing business, much less paper intense. There's also advantages that the old system didn't have, such as the ability to sleeve our strategies into one account for a client. Previously, we had to open up multiple accounts. So there's a number of benefits that will help us in terms of scaling that business. In terms of being -- having a more open architecture, we have that. So the system itself doesn't necessarily facilitate the ability to expand that or not; that's more strategic.

Thank you.

Sure.

[Operator Instructions] Our next question comes from Chris O'Connell with KBW. You may now go ahead.

Good morning, gentlemen. So in looking at the buildup of liquidity here, just wondering, as you guys are kind of putting more work into the securities book, what are the new securities yields coming on at?

Yes. So anywhere between, I would say mid-1s to low 2s.

Okay, great. And as far as future growth in the securities book, how do you see the pace of that going throughout 2022?

Yes. So Chris, obviously, our priority would be to continue to grow loans and use the liquidity for that, to the extent that deposit growth is ahead of loan growth. We will continue to put into the securities portfolio. As Denis mentioned, it's going to take some time for us to remix from cash and securities back in the...

Understood. And as far as the money market campaign goes, what was the rate on those?

Yes. We're not going to talk about the rate on it, Chris. That's very sort of part of business strategy. So we're not going to get into that.

Okay. I guess what I'm getting at is, you could see the increase in the money market deposit rate this quarter. Was that -- was the campaign spread evenly throughout the quarter? Like, should we be expecting another uptick in interest-bearing deposit costs for next quarter?

No, it was throughout the quarter. So we're going to do our best to continue to work down that funding cost as we have in the past, Chris but it was -- that campaign ran all during the fourth quarter.

Okay, got it. Understood. And then, I was just hoping to get some clarity or color on the fee guide. In particular, how you guys are expecting derivative income going forward after a little bit of a jump this quarter?

Yes. I mean, certainly, derivative income is based upon client preference but we would expect to continue to grow that in that range that we put out there, Chris.

Great. And was the level of loan prepayment up considerably this quarter? I mean, it seems like the fees were up in other income a lot. But was that -- how much should that hamper net growth relative to the past few quarters?

I mean, certainly, there was some payoff activity that happened during the quarter as we've seen throughout the full year. I mean, there was a little bit -- what was it, about $250,000 worth of prepayment activity during the quarter that impacted noninterest income.

And -- But like as far as how much was paying off versus previous quarters, was it a greater headwind to kind of net loan growth this quarter?

I wouldn't say that. It was about the same, Chris.

Okay.

Prepayments, overall in the back half of last year were not as significant as they were in the prior year. So they certainly happened from time to time, Chris, where there'll be some payoffs every quarter but it wasn't significant in the back half of last year.

Okay, got it. And as far as the NIM guide, the 25 basis point color is super helpful. And you guys mentioned the asset sensitivity which is clear in that color. I was just wondering, like, what the differences or what the variables are for the up 100 basis point shock that you guys disclosed being down 1.6%. Is there higher betas being assumed in that versus like the 25 basis point increase that you're talking about? Or what the variance is between those two?

Sure. So the guide that I talked about in terms of that $2.2 million pretax increase assumes no change in our funding costs, Chris. The shocks assume an immediate increase on the entire deposit portfolio of 100 basis points. So given the fact that our deposit portfolio is larger than our loan book, you can see it's going to have an impact in terms of NIM from a shock scenario. So we probably tried to provide some color what would happen on really, the pure floating rate assets of the institution and you can look towards ramps within the appendix if you feel like there's a more gradual expectation of increased interest rates.

Got it. And what are the -- do you have what the betas being assumed in the shock scenario or...

Yes, they're consistent across all of the scenarios, Chris. So the beta assumptions, in each one of them are -- we're not changing them between shocks versus ramps.

Yes. No. I guess, that I just meant more of like what the actual beta being assumed is. Because you guys have had in the past cycle, a fairly low beta. I was just wondering how conservative the estimates are versus to what you guys have kind of put up in the past?

Yes. So we're not going to -- I'm not going to put out our exact betas. But if you look at the last rising rate cycle, our beta last time was 26%. We believe that we're appropriately conservative in our assumptions for rising interest rates included within the appendix materials.

Understood. Makes sense. Okay, great. And then, just a couple of cleanup questions. One is how much is the PPP fees remaining now?

A little over $600,000.

Great. And do you have any outlook as to accretion income for next year?

Yes, somewhere between $1 million and $2 million is our guess on fair value accretion on the loan side.

Great. And lastly, just -- I was wondering how the efforts were for lender hires or general hire and taking hires and taking kind of advantage of the M&A disruption in your guys' markets. The wealth team, I saw that, is there -- are you guys making good progress there? Or do you expect to add some people from that disruption in 2022? And if so, is that incorporated in kind of the overall OpEx guide?

So this is Dennis, Chris. Yes, there was a team of five on the wealth side. I'm very happy that they joined us. We also brought on two lenders in the later part of the year and we'll keep looking. There are conversations still to be had. Not everybody wants to work in the larger organization and we're a very good alternative for them. So we'll keep looking. We certainly have opened positions that are included in the estimates. But we're not afraid to go beyond what Mike has assumed in terms of operating expense growth for the right candidates for sure.

Great. That's all I had. Thank you.

Sure.

Our next question comes from William Wallace with Raymond James. You may now go ahead.

Thanks. Just a couple of quick follow-up questions. Mike, if -- I just want to talk about liquidity. So you said that you're not really planning on investing in the securities portfolio and less deposit growth outstrips loan growth. I'm curious how that decision matrix changes? Could you -- would you get more aggressive if you do get Fed hikes and the securities yields start to look a little bit more attractive? Or do you really want to hold all that cash on balance sheet just to make sure you have enough liquidity to fund loan growth?

So Wally, for the first part, I think I just need to clarify that. What I was saying was that we're actually going to continue to invest in the securities portfolio. The magnitude of it depends upon how quickly or if deposit growth outstrips loan growth during this period of time. It's just not going to be at the pace that you saw in 2021. In terms of what happens in a rising rate environment, we're going to look to see what's happening around us, the environment that we're in, what's happening with inflation before we make any decisions regarding holding in cash versus, I would say, a more aggressive stance to the investment portfolio. So time will tell.

Okay, fair enough. And then, as you think about the kind of optimizing your earning asset mix, if you maybe think two-three years from now, assuming some of this liquidity leaves the system. Your average loans are 73% of earning assets right now. Where do you think kind of an optimized mix would be?

I would say -- Wally, it's Dennis. Certainly, 85% or better. The securities portfolio, say, 10% to 15% in cash.

Great. And then, just last question, just a cleanup on the expense guide slide, that non-operating -- I'm sorry, the expense, the slide that has the guidance, the expense guide, is that growth based on the -- based excluding the non-operating expenses in the year in 2021?

No, that's stated GAAP expenses. It's about 105 is the starting point there, Wally.

Okay, great. Thank you very much. I appreciate it. That's all I have.

Thanks, Wally.

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

Thank you everybody for joining us. We look forward to speaking to you after our next -- speaking to you after our next earnings release.

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