Independent Bank Corp. (INDB) Q4 2012 Earnings Report, Transcript and Summary

Good day and welcome to the Independent Bank Corp. Fourth Quarter 2012 Earnings Call. [Operator Instructions] Please note this event is being recorded. Before proceeding, let me mention that this call may contain forward-looking statements with respect to the financial condition, results of operations and business of Independent Bank Corp. Actual results may be different. Independent Bank Corp. cautions you against unduly relying upon any forward-looking statements and disclaims any intent to publically -- to update publicly any forward-looking statements whether in response to new information, future events or otherwise. I would now like to turn the conference over to Mr. Christopher Oddleifson, President and CEO. Please go ahead.

Good morning and thank you for joining us today everybody. Denis Sheahan, our Chief Financial Officer will elaborate on our quarterly performance following my comments. Well, the fourth quarter was a great end to a great year. Core earnings in the fourth quarter reached $13.7 million or $0.61 per share and is well above last quarter’s $0.55 per share and a $0.54 a year ago. We are certainly encouraged by these results especially in light of the tough operating environment that persists in our industry. Beyond the numbers though, it is the consistency and quality of our performance that is most notable quarter in and quarter out all throughout the financial crisis. Of course, there is no magic here to our success; we just good old fashioned community banking led by excellent products, superb relationship building service, local market know-how, an inner-devised [ph] team and a strong and growing brand. Once again, strong fundamentals led the way for us as marked by healthy organic growth especially in the commercial side where we once again generated double-digit annualized growth. Now our commercial bankers are really getting after it. They are complementing our growth in size with an increased sophistication while retaining the touch and feel of community bankers. Our recent expansion initiatives in asset based lending and the newer regional offices are really paying off. Core deposit growth has kept pace with loan growth. This is incurring in both the consumer and commercial segment plus in particular strength on the demand deposit side and not only does it serve as a low cost source of funds, but provides us with excellent customer relationships as well. Fee income is becoming a growing source of revenues. We are seeing nice trends in deposit interchange and mortgage related activity along with investment management or assets under management have steadily climbed over $2 billion. We haven't taken our eye off of the expense side. We've taken intelligent approach here while balancing their need to invest in our competitive strengths with efficiencies elsewhere. And that result has been an improvement in our operating efficiency ratio this past year. Turning to the balance sheet, we remain in excellent shape here too. Credit quality continues as a true point of distinction for us. In the fourth quarter, non-performing loan levels declined and our loss rate remained below 25 basis points. We have never wavered from our disciplined approach underwriting and I can assure you that our stellar loan growth has not been accompanied by relaxation in credit standards. Capital remains a reservoir of strength for us. We now have over $500 million of capital ratios comfortably above regulatory guidelines. We also expect to resume our growth in our tangible common ratio and book value following an increase in goodwill this quarter from the Central acquisition. Beyond our financial performance, much was accomplished in 2012 to advance Rockland franchise and lay the groundwork for future growth. We capitalized on our growth investments in the commercial business line, renewed business generation and our asset based unit [indiscernible] office has exceeded expectations and added many quality names to our client base. We aggressively promoted our brand of programs such as our action network campaign and other consumer acquisition marketing campaigns. The resulting growth in household and checking accounts helped drive double-digit growth in core deposits and debit card revenues. We made significant progress in selling through our digital channel with nice volume growth in online usage, mobile banking bill pay. We earned tax credit for the fourth time under the federal new markets program related to our community development efforts and we proactively beefed up our compliance and risk management and programs in response to the heightened scrutiny being brought to these areas by paying regulators. I am delighted that this success hasn’t gone unnoticed. We've been recognized in a number of ways. We are ranked #1 in Retail Banking in New England by J.D. Powers for Customer Satisfaction, remained in The Boston Globe's Top Places to Work for the fourth consecutive year; we were designated as the top SBA lender in Massachusetts over the past year and we were ranked 29th in the Forbes Magazine Best Bank List. And very recently one of the biggest highlights has been the closing of the Central Bank acquisition. This significantly enhances our presence in the highly attractive Middlesex County area near Boston. It brings us 9 branches, over $400 million of loans and $350 million in deposits. More importantly, it allows us to bring out broader suite of products and services to Central’s customer base. We have already hit the ground running in our new markets and are very pleased with experience thus far. We have a track record as a proven integrator and are very confident in achieving the strong accretion and shareholder return targets from this acquisition. So all-in-all, 2012 was another terrific year for us; our Rockland franchise is strong and with each year it goes by it keeps getting stronger. And we fully recognized that much uncertainty still exist in the macro front and our crystal ball is no better than anybody else’s, so we remain grounded in our assumptions and avoid getting overly invested in any one scenario. The economy appears to be in modest recovery mode. Our regions still generate -- compares favorably with many, many other parts of the nation, but is not immune to the very stresses that remain. Competition in the industry is definitely heating up as many seek to counter the heavy pressure on interest margins. Notwithstanding all this, we take a quiet confidence of how well we performed through all these tough years. There is no question that the Rockland plan is gaining traction and resonating with our customers in each of our markets and our rising business volumes attest to that. The other important engine to our growth track lies with my colleagues and I just simply can’t thank enough for the incredible energy and determination they bring to moving our franchisee forward. Now ours is still people business and there is no substitute for the team we have in Rockland; it was so motivated that we are the best in the marketplace. So we’ll continue to pursue our path of disciplined growth and building franchise value by intelligently and properly investing our shareholders capital. Thank you. I’ll turn it over to Denis.

Thank you, Chris. And good morning in the fourth quarter Independent Bank Corp. reported GAAP diluted earnings per share of $0.45 per share as compared to $0.53 per share in the third quarter, excluding merger costs in both quarters related to the acquisition of Central Bank Corp. as well as goodwill and impairments and proceeds from a life insurance policy that accrued in the prior quarter. Diluted earnings per share on an operating basis were $0.61 in the fourth quarter as compared to $0.55 in the third quarter of this year. For the full year 2012 Independent Bank Corp reported operating diluted earnings per share of $2.16 as compared to $2.12 in 2011. I will now cover a number of key topics. The Central Bank Corp. acquisition closed during the fourth quarter and we are pleased with the cost saves achieved thus far and are on-track to covert the Bank to Independent Bank Corp. systems in the first quarter of this year. As Chris mentioned, we are pleased with our integration progress and we are also on-track to deliver the 7% earnings per share accretion targeted for the acquisition. Loan and deposit levels were up sharply at year end inclusive of the acquired balances. Organic growth was excellent as well and we included an additional schedule in the financials accompanying the press release to help you understand these growth components. Commercial loans grew very strongly in the fourth quarter at 3% organically on an unannualized basis. As a result, the approved pipeline of new business at year end was at a 12 month low due to this high volume of closing activity much of this affected by tax driven loan activity at the end of the year. As we begin 2013, we expect slow growth in the first quarter as we rebuild the loan pipeline during that period. The conditions that led to a 12% organic commercial loan growth rate in 2012 are largely intact and we feel good about our business development prospects. The home equity portfolio grew organically by 14% in 2012 with growth tapering off as anticipated in the fourth quarter as we didn't want to engage in the competitive loan pricing trends during that period. Core deposits also grew nicely in the fourth quarter at 2.8% unannualized. Importantly, the mix of deposits continued to be solid as core deposits are 83% of total deposits and demand deposits now account for 28% of total deposits. Total costs of deposits were below 25 basis points in the fourth quarter. Asset quality trends were stable and our metrics remain strong. Non-performing assets were $42 million in the quarter with overall levels quite manageable at 74 basis points of total assets. Loan delinquency remained very good at 82 basis points at December 31 and early stage delinquency, that's the 30 to 89 day bucket, was 43 basis points in loans. Loan net charge offs were 21 basis points on an annualized basis for the fourth quarter and for the year they amounted to 36 basis points. Consistent with prior quarters, our provision exceeded net charge offs as we prudently add to loan loss reserves given our strong loan growth. As expected, the net interest margin decreased to 3.68% in the fourth quarter from 3.72% in the prior quarter reflecting the challenging interest rate environment. We continue to expect it to drift lower from here due to the ongoing pressure on earning asset yields facing our industry. In addition, the fourth quarter net interest margin was positively impacted by 5 basis points due to the impact of purchase accounting related to unanticipated acquired loan payoffs. Net interest income growth was robust in the fourth quarter up 15% excluding the third quarter’s tax exempt insurance policy benefit of $1.3 million. The improvement was across a number of categories including mortgage banking, service charge and interchange revenue as well as in the other non-interest income category due to a variety of items including tax credits, commercial lending fees and realized equity gains. Non-interest expense excluding merger charges in both periods and goodwill impairment in Q3 increased 6% largely due to a higher incentive compensation accrual and the inclusion of Central Bancorp’s expense base. The purchase accounting marks were very consistent with our acquisition model assumptions overall and are reflective of the low risk nature of the acquired bank balance sheet. And now turning to earnings guidance. We always try to provide you with our expectations of future performance along with updates as the year plays out. For 2013, we anticipate operating diluted earnings per share performance of between $2.28 and $2.38. This represents a meaningful increase in earnings per share over 2012’s performance. In comparing the 2 years, there are a number of factors that need to be taken into account, including a modestly improving economy, a more compressed interest margin, favorable asset quality and improved growth in non-interest revenue combined with continued solid organic business growth, the accretive benefit of Central Bancorp and the strong long-term growth prospects for our newer markets. As a reminder, our first quarter usually trends notably below the fourth quarter due to a variety of factors including fewer days, higher employee benefit expense and increased marketing expense. Key assumptions in our 2013 outlook include loans grew organically at 8% in 2012 and we expect to somewhat slower rate of growth in 2013 in the 4% to 5% region, while we expect continued strong growth in commercial due to our strong business development capability, we have tempered the growth rate in home equity lending due to the near-term pricing consideration cited earlier. We're focused on maintaining a favorable deposit mix by emphasizing core deposit growth over absolute growth and we expect to grow total deposits 3% to 4% in 2013. The margin is expected to range from a high of 3.6% at the beginning of the year and steadily declining to a low of 3.5% in the latter part of the year. Please keep in mind the challenging nature of predicting the net interest margin with the volatility created by purchase accounting. We will endeavor as always to give you our best insight at a point in time. The asset quality outlook is expected to be stable to improved in 2013. As a result, the provision for loan losses anticipated to be in the range of $12 million to $16 million as compared to $18 million in 2012, and loan net charge offs at $10 million to 14 million as compared to $14.5 million in 2012. Non-interest income on an operating basis is anticipated to grow 6% to 8%. We expect continued growth in deposit and interchange revenue as we continue to build our core customer base. We also expect continued growth in mortgage banking revenue. In that arena, we recently outsourced to [indiscernible] and aligned with a partner to stabilize our cost per unit while taking advantage of the scale benefit to garner improved technology and compliance effectiveness in a rapidly changing regulatory environment. We are hopeful that with an improved foundation, we can better take advantage of the low rate environment to improve profitability of the mortgage banking operation and we remain focused on growing our investment management business as we look for double-digit growth in revenue. We plan to open an investment management office in Boston in the near future to help in that effort. This business also lines up well with the demographics of the Central Bank marketplace. Non-interest expense on an operating basis will be well contained as expected to increase 7% to 9% largely due to the Central Bank Corp. acquisition. We have quietly improved the bank’s efficiency as the operating efficiency ratio improved from 66.3% in 2011 to 64.5% in 2012. We expect this ratio to be in the 65% region in 2013 and while we have achieved the cost savings targeted in the Central Bank acquisition until we scale it up, it will represent a modest efficiency drag. We will also continue to invest prudently in those areas to provide improvement in long-term profitability. Our tax rate is expected to be approximately 25% in 2013. We expect capital to continue to grow with tangible common equity unadjusted reaching back to the 7% region at the end of 2013. The first quarter will include further M&A charges due to the systems conversion. We expect those charges to be approximately $2 million to $3 million pretax. That concludes my comments and we can now open the call for questions.

[Operator Instructions] And our first question today comes from Mark Fitzgibbon of Sandler O'Neill.

First question is on the cost of funds; your cost of funds is great at 49 basis points, it’s well below your peers. I guess the question I have for you is, do you feel like you still have some flexibility to take bills liability cost lower?

Mark, not particularly. If we do it's very modest. I mean you know that the rate is decreased in our cost of funds has really slowed and you know 25 basis points of cost of deposits it’s challenging. It’s slight though we are very focused on growing core DDA and that's a very effective, have been very effective for us and we are going to continue to focus on that in 2013. But to answer your question directly there isn't much more room to reduce that cost of funds unfortunately.

Okay, and then secondly on the Central deal sort of a 2 part question, first any big surprises, positive or negative that would come out of the transaction? And secondly, I thought you had mentioned in your earlier comments that all of the cost savings were extracted already from Central but you are happy you are not doing the systems conversion until sometime in the first quarter here. I guess I wondered if you could just clarify that and perhaps give us a sense for what the exact timing of extracting all those costs will be?

Sure, just on the cost savings one first. My reference was that we've reached our cost savings target that we established which was 40% in cost saves but there still is some, we still have some staff remaining until we get through the conversion process which is scheduled for mid-February so there will be further cost saves so in other words we expect to modestly exceed our 40% cost saves targets. Those costs, the remaining costs we expect to be out by the end of the first quarter. So we should, that's essentially the timing of when we expect the remaining costs to be removed.

And with respect to the surprises I mean Mark, I think we are pretty much right on track sort of across the board from an expectation point of view, we are in good shape and we have a lot of the other momentum carrying out before we convert it we have some new team members out there and they are hitting the ground running and now we feel very good where we are.

Okay. And then lastly on the investment management expansion into Boston, could you just maybe give us some sense of how many people or how much space, rough cost of doing that might be?

Well it’s going to be sort a modest entry first, I mean I'm not sure exact how much space it is, but it will be an office and kind of accommodate.

It’s about 3000 square feet, it’s not a major expansion, it’s a reasonably sized office. We are anticipating about 3 to 4 employees and about the effect next year will be about $600,000 to $700,000 pre tax.

And our next question comes from David Darst with Guggenheim Securities.

Dennis within your guidance with the M&A charges, is that included in your earnings per share range.

No the earnings per share range was an operating estimate.

Okay got it. As far as the tax rate are you looking at any more applications for the new market tax program this year?

Sure. Assuming that, we believe there is another program, I'm looking at one of my colleagues here. Yes there's another program for this year and we will apply. We’ve had a very effective program with our commercial team in terms of executing on these new market tax credits and we are very hopeful we will be successful on another application.

It does not incorporate another excess application is not included in the projections we put out [indiscernible].

It’s not but that would be late, and I guess it should happen.

No the application is too late this year and we probably wouldn't even hear the result until first quarter of next year.

But is there one we are actually waiting on as well.

No.

No.

Okay, and then you indicated you are going back off on the home equity and some consumer lending due to the competitive pricing. Are you seeing anything changing on the commercial side that could change your outlook or your desire to lend?

From a pricing perspective, there is the occasional. We're not quite back at the ’06 timeframe where things got a little nuts, but we do hear the occasional, very aggressive pricing on particular deals and we're reticent to match that kind of pricing. But overall we’ve had enough of a pipeline that’s where we can sort of pick and choose the deals that we want to be involved in. So it's not too bad on the commercial side. Home equity, with the drop-in sort of rates, refi rates in the consumer real estate arena, it's been more challenging to grow that portfolio, but we're certainly still like the business a lot, and it’s more a matter of pricing right now.

And our history shows. I mean we not only are reticent, we will not participate in deals that have pricing in terms of that are unacceptable at our range.

With the residential mortgages that you sold from the acquisition, and then the rundown in your organic loans, is that going to impact more the front half of this year and your guidance for loan growth, and does that accelerate in the back half?

Yes, exactly, and that’s largely on the commercial side. You know, that's our portfolio that has grown the most for us and our pipeline at the end of the year was about $130 million that’s just to give you a sense of it, our improved pipeline that’s a $100 million down from September. So it’s the lowest in the last year, but the good news is we have very strong business development capability, we are confident we will be able to grow it again, but what it means is the first quarter is likely to be slow. But we feel pretty good about the back half of the year.

[Operator Instructions] And our next question comes from Matthew Kelly of Sterne Agee.

I was curious the C&I growth that you saw on a sequential basis, how much of that was just kind of new business wins versus changes in utilization rates by your existing customers?

Matt it’s mostly new business wins, I can give you the utilization actually if you bear with me for a moment. It’s mostly new business. Do you have another question Matt?

The second question I was just curious about in the mortgage bank just talk about your gain in sale margins during the quarter and then where they have been trending most recently any changes for the first quarter and also pipeline commentary for Q4 and then more recent trends?

Do you have a sense of gain on sale?

Yes, the gain of sale in the fourth quarter is probably in the 102 range or 2 points. We have had to adjust pricing there to get a little bit more competitive, so we would expect that to decline heading into the first quarter, and our pipeline right now is down to around $80 million to $85 million, which decreased from where we were in the fourth quarter on average.

On the utilization, utilization on the asset based side is actually down Q3 to Q4 from 45% to 43%. It’s been as I said mostly new business generation.

Okay. And then last question, how much did home equity pricing actually changes over the last couple of months, you mentioned a couple of times become a lot more competitive. Could you just quantify that at all?

Well, just to give you sense of it and Rob you can jump in here too. The product that we were originating the most over the past 2 years has been our first position home equity, which is really, it’s a refi product, it’s an alternatives to conventional mortgage process and for us it was the reason we liked it is typically smaller balanced seasoned mortgages, low LTV, very good credit quality, and very convenient from the borrowers perspective, low cost of entry. But what’s happened is with the drop in 15, 20 year, 30 year conventional mortgage rate, it’s more challenging for us to originate at that the kind of pricing we were getting. So we’ll reevaluate here as we enter 2013 and see if there are areas, markets spots where we can be more competitive from a pricing perspective, but we felt pretty good quite frankly about the growth, we were going to achieve in commercial on the second half for the year that we were comfortable backing off on home equity. Rob, you agree with that.

Yes, so just a point of clarity of just a pricing competition is not in the home equity products offering, it’s the alternative in conventional mortgage lending and the gap created there.

And the next question is from Damon DelMonte of KBW.

Denis just a question for you on the forecasted expense growth, how much of that is actually organic growth versus is it still layering on of centrals expense base.

Yes, the organic is about 2.2% growth, so we think we've got pretty good expense control. I referenced our efficiency ratio earlier at the core. So that's what we are targeting for the core. Central as I said while we are achieving our cost sales, we will be a little bit of a drag in 2013 until we begin the process of scaling up in that market and we are confident we are going to be able to do that.

With respect to the margin I think you had said that it’s going to trend down to like from 360 down to 350 by the end of the year. Is the starting point for the first quarter then did you say was 360 or did you say in to 360s.

In the 360s; Damon if you think of it this way and obviously this purchase accounting stuff can create some volatility in the margin. But we were at 368 in the fourth quarter, 5 basis points of that, you know the margin was benefited by 5 basis points by unanticipated loan payoffs from the acquisition. So if you will a normalized margin, 363. So start from there and we will unfortunately work our way down to the 350 region by the end of the year.

[Operator Instructions] Showing no further questions, we will conclude the question-and-answer session. I would like to turn the call conference back over to Mr. Oddleifson for any closing remarks.

Great, well thank you very much everybody for joining us today. We wish you a Happy New Year, and we look forward to talking with you again in 3 months. Have a good weekend. Bye.

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