Berkshire Hills Bancorp (BHLB +0.00%) is one of the few banks that did not emerge from the brunt of the pandemic in better shape than it was in before. Not only does Berkshire Hills' stock remain below pre-pandemic levels, but the bank has had to deal with a lot of turnover among management and is now in rebuild mode. With the stock trading at the lower end of the sector, especially for a bank of its size ($12.4 billion in assets), investors considering Berkshire Hills are now looking at whether the depressed valuation indicates a value stock -- or a value trap. Let's take a look.
A lot of work to do
Berkshire Hills struggled in 2020, with its stock falling below $10 per share at one point that August. The bank took a significant goodwill impairment that substantially cut its tangible book value (TBV). TBV is a bank's equity minus goodwill and intangible assets, and shows what a bank would be worth if it were to be immediately liquidated. Banks trade relative to their TBVs, so it's not good to see TBV take a significant hit. Berkshire Hills' board of directors also took heat last year from one of its shareholders, HoldCo Asset Management, after the bank did not repurchase shares when it traded below TBV, or consider a sale of the bank before essentially hiring a new management team.
But since then, the bank has struck a cooperation agreement with HoldCo and added one of its co-founders to its board; begun repurchasing shares; and launched a new strategic plan to turn the bank around. Called Berkshire's Exciting Strategic Transformation (BEST), the plan seeks to have the bank achieve a 10% to 12% return on tangible common equity (ROTCE) within three years. ROTCE is the technical return on the bank's shareholder's equity minus intangible assets and goodwill, and it's a good representation of how much the bank is making on shareholders' investments.
BEST is also hoping to achieve a 1% return on assets (ROA), a measure of how well the company uses its assets to generate a profit. Berkshire Hills plans to achieve these goals by doing things like growing business banking, U.S. Small Business Administration (SBA) lending, asset-based lending, wealth management, and the bank's MyBanker program, in which mobile personal bankers meet clients where they are to make banking more convenient and personal. Part of BEST also means transforming the balance sheet to change the asset and deposit mix, which the bank has already begun to do by running off non-strategic loan portfolios such as its indirect auto loan business, and with the recent sale of its insurance business to Brown & Brown.
Image source: Getty Images.
Some improvement
The second quarter did show some early progress for new CEO Nitin J. Mhatre. In the quarter, the bank generated a nearly 8% ROTCE and a 0.70% ROA. But there was nothing particularly exciting on the top line, as net interest income (essentially the profits banks make on loans and securities) didn't show any improvement. We also know that the upcoming sale of the insurance business is going to hurt non-interest income in the near term as well.
The bright spots in the quarter can largely be attributed to an improving deposit base and credit outlook. Berkshire Hills does not historically have a good deposit base, but like much of the sector, it took the last year to drastically improve this very important characteristic that bank investors watch. Non-interest-bearing deposits, meaning those that the bank doesn't pay any interest on, are up 19% from the second quarter of 2020 and 10% from the first quarter of 2021. They now make up close to 30% of the bank's total deposits. Berkshire Hills has also done a good job of reducing high-cost sources of funding such as brokered certificates of deposits (CDs) and other higher-cost borrowings. Additionally, the bank said that 84% of customer CDs will reprice over the next 18 months, which will further bring down deposit costs.
Credit also improved in the quarter. COVID-related deferrals dropped 54%, and delinquencies and net charge-offs (debt unlikely to be collected, a good representation of losses) decreased. Berkshire Hills hasn't necessarily had a credit problem in the past, but credit quality has been bumpy over the past several quarters, unlike in most of the rest of the banking industry. This is also the first quarter during the pandemic that Berkshire Hills hasn't had to take a provision for potential credit losses, while most banks have been releasing reserves previously built up for loan losses over the last few quarters.
Is there value?
Mhatre got off to a solid start in his first real quarter at the helm of Berkshire Hills, but I don't think I'm ready to call Berkshire Hills a value stock yet. While there was some good improvement on the deposit and credit fronts, I'm looking for more consistency on credit, and will also be interested to see how well those non-interest-bearing deposits stick around once liquidity in the banking system normalizes. There also needs to be more evidence of improvement on the lending side, and I'm looking to get a better grasp of the overall strategic plan. Mhatre says he wants to partner with fintechs to boost the bank on the consumer side, but I still am not fully sure what that will look like, or if it will give the bank any kind of differentiation or leg up in a certain banking niche. The markets Berkshire Hills operates in are not particularly exciting economies.
Lastly, while a 10% ROTCE and 1% ROA are solid, stronger peers of Berkshire Hills' size already do much better than that, so three years is a long way to wait to essentially get back to the middle of the pack. Berkshire Hills might be more appealing if it traded below TBV, as it does have more scale than most smaller banks trading below TBV, but the bank already trades above TBV. With all of that said, I do not consider Berkshire Hills to be a value stock right now.
