Independent Bank Corp. (INDB) Q1 2013 Earnings Report, Transcript and Summary

Good morning and welcome to the Independent Bank Corp., First Quarter 2013 Earnings Conference Call and Webcast. [Operator Instructions] 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 update publicly any forward-looking statements, whether in response to new information, future events or otherwise. Please note this event is being recorded. I would now like to turn the conference over to Mr. Christopher Oddleifson, President and CEO. Sir, please go ahead.

Thank you, and good morning, and thank you everybody for joining us today. Denis Sheahan, our Chief Financial Officer, will further discuss our quarterly performance following my comments. Well, we orchard [ph] into 2013 with our solid quarter, we continue to capitalize on our competitive strengths, expand our customer base, extend the reach of the Rockland Trust brand and drive organic growth. Core earnings in the first quarter amounted to $13.3 million or $0.58 per share. This represents healthy earnings growth of 9% over the prior year. Operating fundamentals remained strong. We generated growth in our commercial portfolio despite having to rebuild the pipeline after a remarkable Q4 and amidst stiffening competition. We continue to make excellent inroads to the C&I sector as our client base are [ph] quality midsized companies steadily grows and an increase in our construction portfolio strikes a new economic activity in our area. The investments we recently made in our commercial business are really paying off and we are very committed to its future growth. We continue to add seasoned bankers to our ranks and our desire to add depth greater sophistication to our relationship banking model. We have a large team of commercial bankers enabling us to see many potential deals throughout our footprint. We also recently decided to extend our new investment management office about to open in Boston to accommodate commercial banking as well. You may recall a similar effort in our Providence office has proved to be very successful. Total loan growth in the first quarter was tampered however by continued run-off in the [indiscernible] mortgage portfolio where refinancing activity remains high, as many of you know we sell the vast majority of the residential loans we originate. Core deposit levels remain in good shape holding at 83% of total deposits, providing ample liquidity to our company and indicate our relationship focus and service excellence approach is working. I should note that we continue to upgrade our online and mobile banking offerings to key takes in the ever changing markets in the preferences. We continue to be encouraged by growth in our investment management business, assets under administration or management have risen to $2.3 billion from $2.2 billion a year ago; quarterly revenues have grown 9% over that same period. Turning to the balance sheet, credit quality continues as a point of distinction for us. Net charge-offs were a low 11 basis points annualized in the first quarter. Non-performing asset and delinquency levels did pick up a bit and remained quite manageable with no change in our provision outlook. The picture in capital is quite good as well. Tangible common is heading back, up again following the Central Bank acquisition rising by about 20 basis points this quarter. Tangible book value growth has been a consistent story for us as well as again in the first quarter with its 4% of probably where it was a year ago despite absorbing the goodwill from the acquisition of Central Bank. Speaking of Central Bank, the integration is proceeding quite smoothly. We completed the branch and major systems conversions during the first quarter; [indiscernible] 9 branches added in attractive Middlesex County surrounding Boston; customers in this county have now full access to our deepest product set and banking service. We continue to enjoy high levels of customer satisfaction which will serve us well in these newer markets. We're in an aggressive marketing mode to capitalize on our brand and the added business opportunities there. And we remain fully confident in achieving a financial benefits of this combination. Turning to the macro picture, it's still hard to gain any conviction as to future direction of all the ups and downs of the economic indicators and the ongoing political paralysis in Washington. Massachusetts, particularly eastern part of the state has weathered the recession better than most in the nation. Through February, the state regained all the jobs lost this past recession with unemployment falling to 6.5%. The Boston area unemployment level fell to a seasonally adjusted 5.7%. Yet the impact of the sequestration cuts have yet to hit out sizeable research and defense based sectors, other than perhaps curtailing their hairline flight plans. There is no question that the interest margin pressure on the industry is formidable and no signs of abating soon. We are all trying hard to seek ways to counter that, not easy in the short term. So we are going to pursue a healthy growth, loan growth, fee income generation, deposit generation and intelligent expense control; what we won’t do is to take a short sided approach by loading up on security, investment securities; straying from our creditors poor discipline or taking a slash and burn expense program approach will undermine our ability to grow in the future. Many observers keep expecting industry consolidation to pick up given all the earnings and regulatory pressure out there, and they’re seemed too happy yet, but we remain optimistic to get disciplined on that front. Our game plan is to simply keep our eye on expanding customer relationships and profitably growing share. This is the best way to have a future value; we really like how our franchise is positioned in the marketplace, over that sweet-spot of being large enough to meet to its customer needs and small enough to minimally adapt to the changing environment; so we remain confident that we’re on the right path. Our strength is exemplified by the increase in a quarterly dividend at $0.22 per share recently approved by our Board. That concludes my comments, now I’ll turn it over to Denis.

Thanks, Chris, and good morning. Independent Bank Corp. reported net income of $12.3 million and GAAP diluted earnings per share of $0.54 in the first quarter of 2013, as compared to net income of $10 million and diluted earnings per share of $0.45 in the fourth quarter of last year. Both quarters included merger and acquisition charges and this first quarter included severance associated with the outsourcing of the banks' mortgage operations as discussed last quarter. Excluding these items, diluted earnings per share on an operating basis were $0.58 in the first quarter of 2013, as compared to $0.61 in the fourth quarter of last year. Year-over-year diluted earnings per share improved by 4%. I’ll now review a number of key topics; as anticipated, following the robust period of growth in 2012 and in particular a gangbuster fourth quarter loans were essentially flat through year end. However, commercial pipelines are rebuilding and prospects for reemergence of growth look good. Asset quality trends were generally favorable and as expected the net interest margin continue to compress. I will expand on each of these items in greater detail in a moment. Key performance ratios were solid in the first quarter with return on average assets and return on average equity on an operating basis at 96 basis points and 10.04% respectively. Commercial loans grew at 5% on annualized basis; commercial and industrial continue at a respectable growth path and of note construction activity is solid with linked quarter growth of 12% on annualized and year-to-year growth of 43%. The growth in construction continues to be driven by a good mix of commercial and residential development, the latter due to limited inventory. Commercial growth was offset by a reduction in the residential real estate portfolio due to refinancing activity combined with the slowing on the home equity side as expected. The commercial loan approved pipeline has rebuilt to over $180 million, a 43% increase since last quarter and we expect good growth to occur particularly in the second half of the year. While it is certainly competitive, we have sufficient business development capability to generate the kind of opportunities we like. As an early indication loans are up 1% already in April. In addition as Chris mentioned we plan to open an IMG office in Boston later this year and we've decided to expand that office to include a commercial lending presence. Deposits were essentially flat in the first quarter which is not unusual for us due to seasonal fluctuations. We are also seeing the beginning of business customers using excess funds to invest in new activity which we view as an early sign of an improving economy. While this will negatively affect business deposit levels it will in time be positive for lending activity. As we begin the second quarter advertising ramps up and we are optimistic of improved activity as the quarter progresses. Asset quality trends remain excellent. Net charge-offs were a very low 11 basis points on an annualized basis. Non-performing assets increased to $47 million in the quarter with overall levels quite manageable at 82 basis points of total assets. Loan delinquency increased to 1.05% from 82 basis points at year end. Most of this increase is in the commercial loan category and we have the credits well under control. Any loss associated with these credits is within the loss estimate for the year we provided last quarter. And finally there we continue to feel really good about the state of our credit profile. The net interest margin decreased as anticipated to 358 from 368 in the fourth quarter, 6 basis points of the compression is due to purchase accounting which inflated the fourth quarter number. Although we continue to expect it to drift lower from here due to the ongoing pressure on earning assets yields facing our industry, the pace of compression should moderate such that the average net interest margin for the year will be in the low-350s. Noninterest income decreased by 8% largely due to tax credits, loan fees and income on call securities all recognized in the other non-interest income category in the prior quarter. We did experience growth in several other categories most notably investment management. Non-interest expense on an operating basis grew 4% due to the inclusion of Central Bank’s expenses for a full quarter, as well as snow removal and advertising. The Central Bank integration is well underway. We converted the bank to INDB Systems in February and we look forward the potential the new market brings. On the cost savings front we targeted 40% in costs saves. At this point, we've accumulated 43% in saves. Quite honestly we've been very successful in assimilating the banks we've acquired over the years and we've learned how to take costs out quickly and efficiently. In light of the interest rate environment, I thought it would be useful to provide greater insight into our interest rate sensitivity and we will provide greater detail in our 10-Q with a range of impacts in various rate scenarios for your information. In summary, we are positioned for rising rates. Assuming a static balance sheet that is no loan growth, no asset growth, and the current interest rate environment, net interest income would decrease by 2% over the next year. Alternatively assuming an instantaneous 200 basis points increase in rates, net interest income would increase 6% over the same one year period. It’s important to remember these estimates are based upon a static balance sheet. So again we are positioned for rising rates as we believe that is appropriate in this operating environment. We feel that any near-term opportunity cost of being so positioned is far outweighed by the greater risk of being on the wrong side when rates move up quickly. I will now cover our earnings guidance for the rest of the year. At our last conference call, we anticipated operating diluted earnings per share performance for this year of between $2.28 and $2.38, which equates to 6% to 10% earnings per share growth. We continue to expect that performance. There are few items worth noting as we move forward in to the year. Importantly, while loan net charge-offs were particularly low in this first quarter, we expect the full-year guidance of $10 million to $14 million to remain the same. In other words, don’t continue to expect 11 basis points charge-off performance. We expect charge-off to increase modestly in the coming quarters, ending the year somewhere around 20 to 25 basis points. The provision for loan losses is anticipated to stay in the range of $12 million to $16 million. The remainder of the full-year guidance is essentially the same. So no doubt the interest rate environment is quite challenging. Clearly with a declining margin, non-interest revenue growth and expense control are paramount. We've spoken frequently of our progress in growing non-interest revenue, but rest assured we are placing a keen eye on non-interest expense and practical steps we may take the reduce the rate of growth in light of our operating environment. This by no means to use Chris’s words, signals the slash and burn efficiency program, which is not our style but rather common sense attentiveness to cost and day-to-day running of the company. We are fortunate to operate a terrific franchise in great markets and look forward to achieving the growth expected for this year. That concludes my comments. We'll now open the call for questions.

Yes. Operator, we are ready for questions.

[Operator Instructions] Our first question is from Mark Fitzgibbon with Sandler O'Neill & Partners.

This is Matt filling in for Mark. Just a quick question, I am sorry I missed this. But the approved loan pipeline, did you say Denis that it was a 183?

Yes, it's up 43% from year-end and we expect it to continue to build from here, activity is very good here as we enter into the second quarter.

And how about a weighted average rate?

I am not going to get into that Matt, I could in to sort of a more competitive pricing. I am not going to get into it, how we price our loans.

Okay. And how about the mortgage banking pipeline can you give us a sense of that absolute level as well as the pricing that you are seeing in the secondary market?

Yes I think our pipelines around $70 million, and what was your second part of your question?

To give the pricing you are seeing in the secondary market, I am trying to get at gain on sale margins that we can expect?

I don't know that I have that, still on the 1.75% to 2% range.

Perfect. And then just broadly you know the TCE ratio looks like it's on track to accrete to about 7% by year end as you guys have projected and CVK appears to be integrating smoothly, currency strong. When might you do another deal and in which direction might you like to extend the franchise just broad macro question for you?

Yes, Matt this is Chris, we have always said in the past, doing a deal is completely sort of optimistic and given the number of franchises out there, beginning increasing sort of a random event. So if a Board of Director were to raise their hand and say, "let's see we want to consider strategic alternative", we would like to be at the table, but other than sort of national basis which I predict consolidation nationally, I cannot sort of, predict anything locally. In terms of where we would like to expand and what we have said is that we believe that the vast majority of the economic activity in Massachusetts sort of 495, a little bit beyond 495 east. So now we have done well with our acquisitions slades, Ben [ph] and central. So we are looking to expand sort of incrementally out from where we are has sort of been our past M.O. and that’s worked well.

The next question is from Aaron Brann with KBW.

One of the things that we’ve heard from many banks this earnings season is that loan price in particularly for commercial loans is intensifying. Are you seeing that as well?

Certainly, it’s competitive, but we are not at the -- we see the occasional sort of ’05, ’06 kind of pricing, but it’s not overwhelming, I mean we still have, we have enough business development capability that we are able to generate the kind of both pricing and underwriting terms that meet our desire. Last year, we looked at I think $1.08 billion of credit opportunity. We closed just shy of $900 million. So we are bringing enough new opportunities and that I guess perhaps we can be somewhat selective, but it is competitive, we do see pricing pressure, also term pressure, but it’s not overwhelming, like it was back in sort of ’05, ’06.

Okay. And then secondly, I saw in the press release that your securities portfolio expanded in order to strengthen your liquidity position, do you believe that process is complete or should we expect further additions to your securities portfolio.

You shouldn't expect in the near term robust changes in our securities portfolio. The portfolio increases now generally for collateral purposes but also to improve our liquidity position. I think longer term, this bank will have a bigger securities portfolio. If you just look at from a where -- from a regulatory perspective, guidance is pushing for greater on-balance sheet liquidity. So I think longer term, this bank will have bigger securities portfolio, but we are not particularly enamored with a big securities portfolio in today's rate environment. And you can see that by the way we've managed it, the portfolios you know sub-10% of assets. So we are not a big, not very enamored of a large securities portfolio today.

Okay. And my final question is, your salary and compensation line increased obviously, part of that is probably the normal seasonality, part of it is the full quarter of Central Bancorp, could you just quantify what was the seasonal impact on a dollar basis this quarter that may drop off into 2Q?

I'm not sure I have that here. Also keep in mind, there was severance in category as well. There's about $350,000 of severance associated with our mortgage operation that inflates it too. Beyond that, it’s a payroll tax category, which is a little bit higher here in the first quarter. I'm not sure I have the detail of the number, but yes, I don't have that level of detail with me Aaron.

Okay. And I am sorry, I do have one more question. I believe in your prepared remarks, you mentioned that you've already realized 43% of the costs saves with respect to the Central Bancorp acquisition, are there more to be had or in the months since the deal is closed, have you gotten basically everything now that you think you can get?

We are largely done, you know there may be some modest saves beyond this, but we worked very hard and very diligently right around the time of closing and the time of systems conversion to get out the vast, vast majority of the saves and that’s where we are now.

Our next question is from Mac Hodgson with SunTrust Robinson Humphrey.

Denis, a question on the guidance. I may have missed this, but just curious if there was any change to the loan guidance, the expense guidance and the fee income guidance, given that relative to what you gave in the last conference call?

No, we think we will be ball parking in the same areas and each of those. I think we guided deposit growth 3% to 4%, loan growth 4% to 5% if I remember correctly, it will be in those ballparks. Yes, loan growth, 4% to 5%, deposit 3% to 4%, that’s what we're still thinking. You know certainly we expect it will happen in the first quarter, little -- we actually did 70 basis points reduction in the loan portfolio and no deposit growth. So those were expected, no significant variance from what we anticipated. So we still feel good about those loan and deposit numbers and similarly on the expense and the fee income side, no real surprises.

You continue to have excellent asset quality. There was a little bit of an uptick in new non-performers, just curious if you can give some color there?

It's a handful of commercial credits that migrated in to either delinquency or in to non-performing. We're not concerned about the loss associated with those. We knew that there was some weakness there, but overall it's very modest Mac. When you look at that level of increase on a $3.1 billion commercial portfolio, it's very modest. Our commercial team is confident that we have them well in control and any losses associated with it are in the guidance we gave you in January and that we just reaffirmed now in April. So we are not concerned, we are actually feeling pretty good about what's going on, on the consumer side, even though that’s a smaller side of our portfolio, about a third of our loan portfolio is in our consumer real estate side and that appears to be improving quite significantly. So we are feeling pretty confident relative to the guidance that we have provided in January and just reaffirmed today.

Okay, great. Just one last topic, I was curious on the Boston -- kind of Boston officer just add in the commercial bankers to the Boston investment management office, just curious will those be new hires and will there be any sort of different approach or kind of like target business side that you would be going after or would be kind of the same typical quarter?

It's going to be a combination. We are -- it's important to sort of when you open up a new office like that not to have everybody new because you want the company culture and approach to be sort of present in the office. So it will be a combination of both the investment side and the commercial lending side. And we are not going -- it's not going to be a target all this much, we have a good chunk of our commercial portfolio in Boston right now, I think it's 9% of commercial well outstanding. So we are in there now, we did not have an office, having office will give us more of a presence and more of a visible commitment to the study.

Your next question is from David Darst with Guggenheim Securities.

I guess part of the acquisitions central was it would require some significant investment in those branches, is that in the run rate for this year or is that something that’s been capitalized?

It’s generally all capitalized because it’s a leasehold or owned facility improvement, so a vast majority of that will be capitalized unless it was relatively immaterial. We are not finished with the renovations, we are going to renovate all the facilities and central, they really needed it. And I think 6 of the mine are done, the other 3 are more significant projects that will be done, 2 of the 3 will be done later this year, the third one might fall into winter early next year, but 6 of the 9 are done. And therefore, would be in the current run rate.

I guess are you seeing an increase in branch activity and kind of new business development in those 6 that you've done the renovations?

It’s early, Dave.

Yes, it's really early, Dave. I think the probably more significant factor is that we have been able to bring our -- the Rockland Trust products so this is an, sort of customer service approach to the market and that has generated some nice business. It's separate and teasing that apart from having a fresh coat of paint and new counters and new logos, it's tough to tell. I think it’s mostly the people driving the increased activity. And I would say let's be clear here, these are early days, we've essentially -- the focus initially is close, convert, cost saves, yes some renovations but now it's on growth and these are clearly early days here. There's lots of opportunity in that footprint and we want to go after it in a very methodical way. So activity will increase. We've just begun, for example, across our footprint but certainly there's big emphasis in the newer footprint. We've just begun our spring marketing campaign. So we feel good about our prospects there, but it’s going to take some time to execute it.

Okay, Denis as are you talking about your [indiscernible] position is that a discussion that you are having with the regulators and are they may be encouraging you or your peers do you think to become more asset sensitive?

No, I mean certainly we have conversations with our regulators relative to many things, but certainly one of the biggest risks today in banking has got to be interest rate risk, and we think we are managing it pretty effectively. The regulators don't sit down and encourage you one way or the order, but let's just say our dialogue with the regulators relative to our interest rate position is very good. So this being asset sensitive here is somewhat painful, but we believe it’s the right thing to do. We can't necessarily form an opinion on when rates are going up or if they are going up, but there's a lot of danger that can be created by putting a lot of fixed rate products on your books today and that's sort of philosophically how we think about it.

Okay. Both of you in your comments used the word slash and burn in regarding expense management, are you seeing other banks more aggressively take that approach and then doing that they are withdrawing from the market and from some of their customer service avenues?

I think it’s one of sort of reaction, but our comment there is really getting at sort of what we've been doing over time. We've accomplished a lot at Rockland Trust over the last several years through operational consolidation, branch closure, branch consolidation, renegotiation of major contracts. Re-thinking fees, getting in to the swap business for example which is good for the customers and good for the team. We've really been very sort of step wise methodical and careful about this. We've also deliberately maintained our investment and things like that and that's the management business development group. We have 14 people who are focused exclusively in business development. That's why we are seeing increased performance there. We are reluctant to cut significantly in the muscle. We have all experience in our careers and I won't sort of name names, but large organizations take in a very significant sort of one-time, let's get out 10% of the cost structure and our experience has been it completely decimates an organization’s ability to grow and serve customers. So while we’ve recognized we have a expense ratio that needed to come down and we are looking at a number of ways to do that and both on the revenue enhancement and the expense reduction. There are other banks who have announced major sort of cost reduction programs and sort of laid out sort of expectations. We're going to continue our AMO which is focusing in a disciplined way how we can increment the take-out cost without impacting the viability and sustainability of our business going forward there and our ability to generate shareholder value. The is probably more than you wanted to hear. Denis, what would you add to that?

No, I think that’s absolutely right. That's how we continue to think about it.

[Operator Instructions] Showing no further questions in our queue, this will conclude the question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

Thank you very much, everybody. We appreciate you joining us on our call this morning. We look forward to getting another update in 3 months. Have a good weekend. Thank you. Bye.

The conference is now concluded. Thank you for attending today’s presentation. Please disconnect your lines.