Berkshire Hills: Earnings will fall due to lower loan balance and higher provision charge (BHLB)

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Earnings at Berkshire Hills Bancorp (NYSE: BHLB) will most likely fall this year due to a higher provision charge. Additionally, although the downward trend in loans will most likely reverse soon, the average loan balance in 2022 will likely remain lower than last year’s average balance. On the other hand, a slight expansion in margins will probably limit the decline in profits. Overall, I expect Berkshire Hills to report earnings of $1.51 per share in 2022, down 20% year-over-year. The current market price is above the year-end target price. Additionally, the company offers a low and unattractive dividend yield. Based on the expected total return, I adopt a Hold rating on Berkshire Hills Bancorp.

The loan portfolio should soon bottom out

Berkshire Hills Bancorp’s loan portfolio fell sharply by around 27% from June 2020 to September 2021. After the sharp drop, the decline in the portfolio slowed in the last quarter of 2021, raising hopes for a brighter future. In addition, the recovery in economic activity and the improvement in the unemployment rate will likely stimulate demand for credit through 2022. Management mentioned in the earnings presentation that it expects growth in loans is in the low to mid-single digit range this year.

Overall, I expect the loan portfolio to grow by 3% by end-December 2022 compared to end-December 2021. Despite the turnaround, the average loan balance in 2022 will likely still be 5% lower % to the 2021 average, due to the sharp drop in lending last year. Meanwhile, deposit growth will likely nearly match loan growth. The following table shows my balance sheet estimates.

EX17 EX18 FY19 FY20 FY21 FY22E
Financial situation
Net loans 8,248 8,982 9,439 7,954 6,720 6,924
Net loan growth 26.8% 8.9% 5.1% (15.7)% (15.5)% 3.0%
Other productive assets 2,210 2003 2,281 3,708 4,073 4,114
Deposits 8,750 8,982 10,336 10,216 10,069 10,272
Loans and sub-debts 1,137 1,518 828 572 111 109
Common Equity 1,456 1,512 1,718 1,188 1,182 1,233
Book value per share ($) 36.7 32.7 34.8 23.6 23.9 24.9
Tangible BVPS ($) 22.6 20.8 22.6 22.9 23.3 24.3

Source: SEC Filings, Author’s Estimates

(In millions of dollars, unless otherwise indicated)

Margin to partially offset lower average loan balance

Due to the nature of its earning assets and funds, Berkshire Hills Bancorp’s balance sheet is not very sensitive to changes in interest rates. According to management’s interest rate sensitivity analysis presented in the third quarter 10-Q filing, a 100 basis point increase in interest rates can increase net interest income by slightly less 2.0% the first year and less than 6.5% the first year. the second year of rate hikes.

Although higher interest rates do not benefit the margin much, I still have a positive view of the margin as the company has many opportunities to benefit from balance sheet optimization. Berkshire Hills has accumulated a large amount of excess liquidity in recent quarters as deposit growth outpaced loan growth. The company has already shifted some excess cash into higher yielding securities in the last quarter of 2021. Cash and short-term investments fell from $2.1 billion at the end of September 2021 to 1 $.6 billion at the end of December 2021. Nevertheless, the cash balance is still well above the historical trend, showing that Berkshire Hills has plenty of room to improve the performance of its earning assets. Management mentioned in the presentation that it will continue to focus on opportunistically deploying cash into securities.

Additionally, Berkshire Hills expects to reduce its portfolio of high-cost brokerage certificates of deposit (“CDs”) by more than 75% by the end of the second quarter of 2022, as mentioned in the conference call. Additionally, the company is considering repurchasing subordinated debt totaling $75 million with a significantly high coupon of 6.85%. Even if rates rise 100 basis points this year, Berkshire Hills can still replace outgoing subordinated debt with much cheaper financing.

Given these factors, I expect the net interest margin to improve by four basis points in 2022, from 2.6% in the last quarter of 2021.

The provision charge is expected to increase this year but remain below normal

Berkshire Hills released a significant portion of its loan loss reserves through 2021. As a result, provisions fell from 1.71% of total loans in December 2020 to 1.56% of total loans at the end December 2021. Management mentioned in the presentation that they expect allocations to trend towards Day 1 CECL reserves by Q3 2022. Day 1 reserves are not reported, but we can we get a good idea by considering the allocation at the end of the period. Abatements represented only 1.22% of total loans at the end of March 2020.

Management’s target seems overly optimistic given that net write-offs were quite high in the fourth quarter of 2021. As noted in the earnings presentation, net write-offs represented 0.23% of average loans last quarter. This means loan loss provisions were less than seven times actual annualized loan losses, which is a pretty small cushion in my opinion.

In addition, loan additions will require provisioning for expected loan losses. Given management’s guidance and the factors noted above, I expect the provision charge to be higher year over year, but still below the historical average. I expect provision charges to be around 0.17% of total loans in 2022. By comparison, provision charges were 0.30% of average loans from 2016 to 2019.

Revenue is expected to decline 20% year over year

The higher provision will likely drive the earnings this year. In addition, non-interest income will likely decline after an exceptional year due to the sale of the insurance business. In addition, the average loan balance will likely be lower this year compared to last year, which will hurt turnover.

On the other hand, the expected expansion of margins will probably limit the decline in profits. Additionally, management plans to further reduce its expense base by streamlining procurement spend and real estate footprint in 2022, as mentioned in the conference call. As a result, I expect the efficiency ratio to drop to 73% by the end of Q4 2022 from 77% in Q4 2021.

Overall, I expect the company to report earnings of $1.51 per share in 2022, down 20% from normalized earnings for 2021. The following table shows my account estimates for results.

EX17 EX18 FY19 FY20 FY21 FY22E
income statement
Net interest income 291 356 365 317 291 282
Allowance for loan losses 21 25 35 76 (1) 12
Non-interest income 74 74 84 66 143 97
Non-interest charges 253 267 290 840 286 278
Net income – Common Sh. 55 105 96 (533) 119 75
BPA – Diluted ($) 1.39 2.29 1.97 -10.60 2.39 1.51
BPA Normalized – Diluted ($) 1.93 2.17 1.92 0.33 1.88 1.51

Source: SEC Filings, Author’s Estimates, Seeking Alpha Normalized EPS

(In millions of dollars, unless otherwise indicated)

Actual earnings may differ materially from estimates due to risks and uncertainties related to the COVID-19 pandemic, particularly the Omicron variant.

Small negative return calls expected for a holding rating

Berkshire Hills Bancorp offers a dividend yield of 1.6% at the current quarterly dividend rate of $0.12 per share. Earnings and dividend estimates suggest a 32% payout ratio for 2022, well below the 2016-19 average of 47%. As a result, there are chances of an increase in the level of dividend. Management also mentioned on the conference call that they will be evaluating increasing their cash dividend in 2022. Nevertheless, to be on the safe side, I assume there will be no change in the level of the dividend for my thesis of investment.

I use historical price/book tangible (“P/TB”) and price/earnings (“P/E”) multiples to value Berkshire Hills. The stock has traded at an average P/TB ratio of 1.23 in the past, as shown below.

EX18 FY19 FY20 FY21 Medium
T. Book value per share ($) 20.8 22.6 22.9 23.3
Average market price ($) 38.2 30.2 15.6 25.0
Historical P/TB 1.84x 1.33x 0.68x 1.08x 1.23x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/TB multiple by the expected tangible book value per share of $24.3 yields a target price of $29.9 for the end of 2022. This price target implies an upside of 0.8% compared to the closing price on January 25. The following table shows the sensitivity of the target price to the P/TB ratio.

Multiple P/TB 1.13x 1.18x 1.23x 1.28x 1.33x
TBVPS – Dec 2022 ($) 24.3 24.3 24.3 24.3 24.3
Target price ($) 27.5 28.7 29.9 31.2 32.4
Market price ($) 29.7 29.7 29.7 29.7 29.7
Up/(down) (7.4)% (3.3)% 0.8% 4.8% 8.9%
Source: Author’s estimates

The stock has traded at an average P/E ratio of around 15.5x in the past, as shown below. I excluded the outlier for 2020 in my calculation.

EX18 FY19 FY20 FY21 T. Average
Standard. Earnings per share ($) 2.17 1.92 0.33 1.88
Average market price ($) 38.2 30.2 15.6 25.0
Historical PER 17.6x 15.7x 47.4x 13.3x 15.5x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/E multiple by the expected earnings per share of $1.51 yields a target price of $23.5 for the end of 2022. This price target implies a decline of 21.0% from at the closing price on January 25. The following table shows the sensitivity of the target price to the P/E ratio.

Multiple P/E 13.5x 14.5x 15.5x 16.5x 17.5x
EPS 2022 ($) 1.51 1.51 1.51 1.51 1.51
Target price ($) 20.5 22.0 23.5 25.0 26.5
Market price ($) 29.7 29.7 29.7 29.7 29.7
Up/(down) (31.2)% (26.1)% (21.0)% (16.0)% (10.9)%
Source: Author’s estimates

Equal weighting of target prices from both valuation methods gives a combined result target price of $26.7, implying a 10.1% decline from the current market price. Adding the forward dividend yield gives an expected total return of minus 8.5%. Therefore, I adopt a Hold rating on Berkshire Hills Bancorp. I would not consider investing in the stock unless its market price corrects significantly more than 18% from the current level.

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