Independent Bank Corp. (INDB) Q4 2014 Earnings Report, Transcript and Summary

Good morning and welcome to the Independent Bank Corp Fourth Quarter 2014 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation there will be an opportunity to ask questions [Operator Instructions]. Please also note, this event is being recorded. 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. Factors that may cause actual results to differ include those identified in our Annual Report on Form 10-K and our earnings press release. 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. I would now like to turn the conference over to Mr. Christopher Oddleifson, President and CEO. Mr. Oddleifson. Please go ahead sir.

Thank you, Rocco, and good morning, everyone, and thank you for joining us today. With me as usual is Rob Cozzone, our Chief Financial Officer, who’ll be covering our financial results and outlook in more detail following my comments. We ended 2014 on a high note with our strongest quarter of the year. Core earnings in the fourth quarter rose to $16.6 million or $0.69 diluted earnings per share, is another well-rounded performance led by strong fundamentals as Rob will describe in a moment. I would like to focus my comments on the overall year we just completed. On the financial side, we had another great year in 2014 with record core earnings of $59.9 million or $2.50 diluted earnings per share. The key drivers were operating revenue growth of just about 6% for the full year, solid commercial loan and core deposit growth, strong double-digit increase in investment and management revenues, stellar credit quality, rising capital levels combined with double-digit growth in tangible book value per share and good expense control and all this was accomplished with a keen eye towards disciplined management of asset quality interest rate risk. Beyond the numbers, much was accomplished in moving our franchise forward and laying the ground work to sustain our momentum. Among our more notable accomplishments were continuing to grow our household base at a multiple of a staged growth rate in large part due to referrals from satisfied customers, capitalizing on our recent expansion initiatives in Greater Boston market by way of new business generation and increased brand awareness. For reaching agreement to acquire Peoples Federal Bancshares, which affords us our first retail presence in Boston and fits quite well with our historic strength in the business segment and compliments our recently opened Boston office, our Central Bank acquisition and our Ben Franklin acquisition. Collectively these actions give us the opportunity to accrue more experienced bankers and use our full product set including mortgage and investment capabilities and grow our brand awareness. We're on target for Q1 closing and it is still expected to be immediately accretive to both earnings and tangible book value. Keeping pace with the digital media age by introducing new and improved product offerings along with easier access especially in the mobile banking side, we launched a completely redesigned website that is much easier to use and incorporates more effective marketing capabilities. And investing in business intelligence and work flow analysis [indiscernible] further improve our prospecting, cross-selling and service delivery efforts and continuing to grow -- accrue experienced talent into our ranks and developing a committed and engaged work force. Looking ahead at all of our continuous improvement by looking for ways to make banking easier and more efficient for our customers and us. Of course we remain committed to our customer focus and disciplined risk management. The macro picture both nationally and certain locally certainly -- it does appear to be more promising than the years past and there is a reason for greater optimism towards key catalysts like increased business activity in an ongoing housing recovery. Yet this must be counter balanced against some other realities, first the global economy that is struggling a bit and more locally in its ever increasing competitive intensity, which puts further pressure on our margins already stressed by a low rate environment and creates an accelerated pay-offs and maybe hampers our origination volume and Rob will talk more about these factors. And then lastly the regulatory environment continues to introduce added complexity and cost. However, these are not new headwinds. We've faced these before and we continue to believe that we have the right value position, executed by a fantastic group of colleagues and I remain optimistic about winning in this environment. We know who we are, where our competitive advantages lie and what it takes to win in this marketplace. Before handing it out to Rob, I would like to once again thank my hardworking colleagues for another terrific year. Their passion for excellence is what truly drives our success. It's no surprise then, that in the latest Boston Globe Survey in the top places to work in Massachusetts, we're the top rated bank and fourth overall among the state's largest employers. On a final note, I would like to acknowledge the contributions of long-time Board member Ben Gilmore, who recently passed away after a lengthy illness. His counsel and stewardship as a Director over the last 20 years will be missed. Thank you and now on to Rob.

Thank you, Chris and good morning. I'll now review the earnings for the fourth quarter and full year in more detail. Following those comments I'll provide earnings guidance for 2015. Independent Bank Corp reported net income of $16 million and GAAP diluted earnings per share of $0.66 in the fourth quarter of 2014. This compared to net income of $15.7 million and GAAP diluted earnings per share in the third quarter of $0.66. Both quarters included items that the company considers to be non-core including $0.03 of M&A expenses in the current quarter along with minor gains on security sales. Excluding those items, operating diluted earnings per share were $0.69 in the fourth quarter, compared to $0.67 in the third quarter. For the full year in 2014, operating diluted earnings per share improved by 4.6% and reached a record of $2.50. Performance ratios for the quarter were strong. On an operating basis, the return on average assets was 1.02% and the return on average equity was 10.29%. In addition, our core return on average tangible common equity exceeded 14% for the quarter. Loan origination activity was relatively consistent with prior quarters as we continue to -- in our fair share of new business, yet an uptick in competitive driven payoffs and a decrease in line utilization hampered overall loan growth, which came in at an annualized rate of approximately 2% for the fourth quarter. There is no question that the competitive environment in our region has intensified, but as we've said in the past, we will not do transactions that in our view destroy shareholder value. We continue to believe however that we can generate sufficient opportunities to maintain our current growth trajectory. During 2014, we grew total loans by 5.4%, which is slightly above the original guidance we expected and we expect a similar level of organic growth in 2015. Total deposits were 1.7% lower for the quarter as seasonal outflows, reductions in higher cost term deposits and a $36 million reduction in the more volatile 1031 exchange deposit business, more than offset customer acquisition. With a large cash position at the end of the third quarter, there wasn’t much need for additional deposit funding. However, core deposit growth for the year was excellent at 7.5% and the total cost of deposits declined another basis point to 20 basis points for the quarter. Tangible book value per share increased $0.52 during the quarter and now stands at $19.18. Year-to-date, tangible book value per share has increased by $2. In addition tangible capital, the tangible assets was a healthy 7.44% at December 31, over 50 basis points higher than a year ago. During the quarter, the company issued $35 million of setback in a private placement. The tenure debt is priced at a fixed rate of 4.75% for the first five years and then resets quarterly to Libor plus 298 basis points. As a result of this issuance and the fact that the $30 million of bank level sub-debt has begun to lose full Tier 2 capital treatment, we anticipate paying off the $30 million of bank level sub-debt sometime later this quarter. Carrying both issuances temporarily had a negative impact on the cost of funds in the fourth quarter of about two to three basis points and will have a similarly negative impact in the first quarter. The net interest margin stabilized in the fourth quarter at 3.42%. The margin has temporarily benefited from the deployment of liquidity and the steadying of asset yields; however, with intense competition and lower medium term rates, we expect asset yields to resume at a gradual decline. Asset quality continued to be excellent. Net charge-offs were 13 basis points for the quarter, non-performing loans were 55 basis point and non-performing assets were 61 basis points. All near post-crises lows. For the full year net charge-offs were only 18 basis points lower than originally forecast. Non-interest income on an operating basis increased 7% versus the third quarter with the most notable increases coming in loan level derivative income. Other income also increased as yearend capital gains distributions were realized on certain equity securities and higher income was generated from CRA investments. We continue to be very pleased with the progress we have made in growing the fee income category over the past few years and it remains a focus for us. Non-interest expense on an operating basis increased 4% for the quarter reflecting increased performance based incentive accruals as well as increases in the number of other areas as detailed in the press release. The full year efficiency ratio on an operating basis declined 2% from 66% in 2013 to 64% in 2014. This decrease occurred despite continued investment in strategic priorities and is indicative of the benefit from successfully integrating acquisitions. As Chris mentioned, the Peoples Federal transaction is on track to close in the first quarter. Our financial expectations have not changed. We still expect the transaction every $0.02 to $0.03 accretive to 2015 and approximately $0.03 accretive thereafter. In addition we anticipate a slightly positive impact on tangible capital measures. The acquisition of Peoples Federal will help solidify our position in an important expansion market. I’ll now turn to earnings guidance for 2015. As has been our practice, we will describe anticipated financial performance for the full year and then provide quarterly update till the year progresses. As Chris alluded to, the estimate we provide incorporates a view of the macro operating environment that may be more conservative than other share. Including a $0.02 to $0.03 benefit from the Peoples Federal transaction, we anticipate that 2015 operating diluted earnings per share will be in the range between $2.63 and $2.73. I would like to remind you that our first quarter usually trends noticeably below the fourth quarter due to a variety of factors including fewer days, higher employee benefit expense and increased marketing expense. In addition, the first quarter of 2015 will include M&A expenses of approximately $11 million in connection with the Peoples Federal transaction. Key assumptions in our 2015 outlook include the following. A stable rate environment, should short rates arise in the latter half of 2015, both net interest margin and earnings will benefit. Total loans grew organically by 5.4% in 2014 with only a slightly improving economic environment and with the increased competition for loans we expect organic loan growth to be similar to 2015 and are guiding to 4% to 6%. Much of this growth will continue to come from the commercial portfolio. We're focused on maintaining a favorable deposit mix and will continue emphasizing core deposit growth over absolute growth. We expect to grow total deposits organically 3% to 4% in 2015. We continue to pressure on loan yields and with the addition of the Peoples Federal balance sheet, the net interest margin is expected to contract slightly in 2015 and will likely be in the high 330s and again substantial relief in the net interest margin won't come until short rates rise. Following strong performance in 2014, the asset quality outlook is expected to be stable in 2015. As a result, the provision for loan loss is anticipated to be in a range of $10 million to $13 million versus $10.04 million in 2014 and net charge-offs are expected to be in the $8 million to $11 million range versus $8.5 million in 2015. Core non-interest income excluding the addition of Peoples Federal is anticipated to grow at 3% to 4% in 2015 as continued growth in the core customer base should lead to moderate growth across most fee income categories. However as Chris stated, our consistent focus on growing our investments management business is expected to contribute to double-digit growth in investment management related revenue in 2015. Core non-interest expense will be well contained and is expected to increase 3% to 4% organically. The addition of Peoples Federal of course will add additional growth to -- a few percentage points of additional growth to that number. We'll continue to look for ways to improve the efficiency ratio via positive operating leverage and we expect 2015 efficiency ratio to be approximately 1% lower than 2014. However we will also continue to invest prudently in those areas that we anticipate will improve long-term profitability. We expect the tax rate to be slightly higher than the 28.5% realized in 2014 and finally we expect capital to continue to grow with tangible common equity increasing to a range of 7.75% to 8% by the end of 2015. That concludes my comments. Chris?

Okay. Rocco, we’re ready for questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Mark Fitzgibbon of Sandler O’Neill & Partners. Please go ahead.

Hey, guys good morning.

Good morning, Mark.

Your net interest margin seems to have held up better than you guys had suggested over the last couple of quarters and I wondered if you could talk a little bit about loan pricing in your commercial real estate and C&I portfolios today and what you're seeing from a competitive standpoint out there?

The margin, you're right has held up a little bit better than we had suggested. I'll just remind you that part of the benefit this quarter Mark was the reduction in cash balances that contributed about two basis points, but certainly loan yields have held up and we're able to hold pricing relatively stable and our overall loan production, it's been surprisingly consistent. I think some of that though is due to the mix of the business. So we tend to get higher yields on construction and some of the C&I deals that we're doing like asset base lending and so the overall yield of production has been stable. If you look at yields by category, there is a decrease in especially in the commercial real estate category, but that is largely due to competition. So we do expect loan yields to gradually compress in total and I think the benefit that we've seen over the last couple of quarters is not something that’s going to hold up.

And then I was curious, are you seeing any of the bigger banks in your markets sort of pulling back at all from any of these lending niches?

We have and we actually are seeing -- we actually are seeing BofA more consistently than we have in the past.

Okay. And then lastly, actually two more questions, could you share with us what the loan pipeline is today and may be what the average contract rate is?

We actually don’t have the loan pipeline finalized yet Mark. I usually include that in my comments. I apologize for that, but we do expect the loan pipeline to be lower than what it was in the third quarter due to some of the competitive factors that we talked about. So I don’t have that or the yield on that.

Okay. And then last question is on the effective tax rate, I know in your prepared comments you said you would expect it to be a little bit higher than the 28.5%. I could be mistaken, but I thought at some point early in the year you had suggested that sort of a longer-term effective tax rate would be 31-ish, is that where the rate will migrate up to do you think...

It will be close to the 29% next year.

Okay. Great. Thank you.

You're welcome. Thanks.

Our next question comes from Laurie Hunsicker from Compass Point. Please go ahead.

Yes, hey, good morning. Rob, I was just hoping for just a little bit more clarity regarding net interest income? Specifically I am looking for the accretion income just comparable September to December, I am just trying to get to that core net income?

Yes, the accretion income was about the same, little bit less than it was last quarter. So around $0.5 million level little more for that.

Then -- so really on an absolute core basis, your core net interest margin increased, so your reported margin of $3.42 to $3.42 your core margin that went from $3.37 to $3.38, is that correct?

Yes, but it was benefitted -- I haven't officially done the calculation, which you call the core margin where we first of all -- again we did have a couple of basis points benefit from the deployment of cash. So depending upon whether you include that in your core calculation...

What it does do -- right, okay. Yes good point, okay. And then as we look -- as we look out this year in 2015, can you give us any guidance, and obviously there is a lot of moving parts in accretion income, but can you give us some sort of general guidance especially as we see PEOP come over. What the accretion will look like?

Yes, we actually don't -- well as you said, there are a lot of moving parts, but as I had mentioned previously, Peoples had a practice, especially in the commercial side of doing 5/1 Arms in the commercial real estate book. So that would suggest from an interest rate mark perspective that the interest rate mark on that book would be lower than we would have seen with previous acquisitions. On the credit side, the credit is pristine. So we expect minimal credit marks on their portfolio and so I would expect the overall accretion from that book to be less than what we’ve seen with prior acquisitions.

Got it. Okay. Perfect. And then just one sort of last follow-up is we look at Peoples, everything is on track, can you just share with us, Chris, your vision for how you think about M&A, what your appetite is for 2015? Thanks.

Certainly, we've had a really great track record over the last number of years in bringing on board quality franchises that have fit very, very well with our legacy -- [indiscernible] to the legacy footprint. In terms of thinking about M&A going forward, I think our posture will be that we would like to continue if there are opportunities to arise to expand our footprint in adjacent or very near adjacent opportunities going forward. Having said that, banks are sold not bought and our only hope is that if the Board of Directors sort of thinks about that, then we're invited at the table for discussions.

Okay. And in terms of the size of your focus, I guess what is your appetite and how do you think about yourselves as you approach that $10 billion?

Well that's an interesting question and first of all as banks come up, I sort of think about banks sales as sort of almost in our region is a random event now, since there are so few banks really that are sort of even capable of selling themselves from an ownership perspective, but most are mutuals. So I would consider a bank of any size. The $10 billion threshold question is a good one and as we -- the management is paying -- increased the -- is increasingly focused on it. It is just our organic growth and no smaller acquisition that will put us within range. And what we're doing quite a bit of work in understanding sort of as you approach $10 billion, so what are the areas that we need to strengthen and improve because we know from folks who are in the flight path ahead of us that our regulators are not going to sort of change their stance on a stepwise function that we're going to be a regulated one way at 9.9 and at 10.1, we're going to suddenly have a completely different sort of approach. We're going to be sort of as we hit the $10 billion threshold, we will have to have the risk processes in place that are consistent in what is expected with a $10 billion enterprise. So as a result, we're already at the pro forma $7 billion making further investments in for example some stress testing capability in Rob's area to really begin to sort of build our capabilities there. So we're going to be on a -- we're very much thinking this as a sort of a gradual upward flight path from a capability point of view. So there are no sort of, for lack of a better word, sort of emergencies in terms of capabilities that we need to build as we're nearing it. That's little long winded Laurie. I hope that gives you some color.

It does. Thanks. I'll let someone else jump in. Thank you.

Thank you. [Operator Instructions] Our next question comes from Collyn Gilbert of KBW. Please go ahead.

Thanks. Good morning, guys.

Good morning, Collyn.

Rob, I was just wondering if you could give us a little bit more color in your loan growth targets for this year. I guess specifically how much of that maybe coming from assumptions that line utilization improves or kind of the geographic drivers of that or subsector drivers of that. Just trying to understand a little bit more how that growth rate is breaking down in your eyes?

Okay. The first part of your question, very little left is from line utilization increasing and when we talk to our senior lender, the opinion of most of the businesses that we talk to is still that they're not willing to make incremental investments and don't see the need to make incremental investments and so we've not -- and they're still relatively flushed with cash. So we don't expect a meaningful increase in line utilization in 2015. In terms of the mix of growth, we expect it to be relatively consistent with what we saw in 2014, both across portfolios, but also geographically and we're having a lot of success in Boston and that's been the largest area of production for us if we compare that to the other cities and towns that we do business in. But it's not significantly outsized. We expect it to be pretty well geographically diversified, but with our enhanced emphasis on the Greater Boston market, we expect more production to come from there than from our other territories.

Okay. And any change in expectation on paydowns and I don't know how much paydowns have maybe dragged on net growth in '14, but just wanted to understand that a little bit.

Yes, that's a great question. In this quarter we did see accelerate paydowns in the commercial book, which is why we were only up 0.5% because our new commitments were consistent with prior quarters. So that's a bit of a wild card for two reasons. One is the competitive pressures. The other is just lower rates in general and have lower rates customers look at opportunities to refinance transactions. So we do expect an elevated level of payoffs heading into 2015.

Okay. Okay.

I will add that on the origination side that we had a record origination year in the commercial side and about $950 million and we probably looked at deals as sort of where legitimate from calling out to enter into our threshold pipeline about double that. So we see a lot of volume in our region and we've some strong originations, which are accounted in of course the payoffs.

Okay. Okay. That's helpful. And I think -- I ask this you guys this every time. To that point Chris, is there something that you need to see in the broader economy or maybe within these loan structures that would see that sort of pass through rate on what you're seeing versus what you're actually booking increase?

Yes, I think what we're -- stating out there are two reasons we let loans go, one pricing and one is terms and we're absolutely adamant about not giving up terms, no way, knowhow. And on pricing, I would say it's sort of -- one that there is tight price when we sort of take -- we look at the total relationship and see if there is anything we can do to compromise there. So what we would have to see is -- this gives a little bit, kind of little bit like '06, '07 where things are getting little bit elusive and we really think they ought to be. So what happens as this passes prologue now there folks who have tightened up a little bit and if that's the case, we will see less run off in growth rates. Well Rob, what do you think?

I echo your comments -- we just have -- seem to have thresholds that are higher than others in our region.

Okay. Okay. That's…

And we think shows prudent.

The thresholds that our owners appreciate are sort of drawing the distinct line.

Yes. Okay. That's great. That's good color, thank you for that. And then just kind of tying in together again Rob, your guidance on core operating expense was up 3% to 4%. And then some of your comments Chris just about moderate growth in getting ready for the $10 million mark, just curious in the expense growth numbers Rob that you're assuming, have you broken out how much of that is just regulatory related, whether it's just on a day to day needs or preparing for the $10 million mark?

Yes, we haven't broken out specifically and as Chris said in his comments, we're trying to take a very incremental approach to preparing not only for just the $10 million of threshold, but for the cost of being a larger bank in general.

I'll just interrupt for a second. One interesting side bar here is the cyber security, we made a couple very highly qualified, more expensive hires there to sort of deal with that whole arena.

Yes, so that's a perfect example Collyn of an incremental approach. That's an area we have some incremental spend. There is some technology spend that is information, security related, but and as Chris said in his comments as well, we're assuming the hiring of somebody in my area to help with capital stress testing. So their individual numbers that I wouldn't expect add up to much more than a few hundred thousand dollars for 2015.

Incremental numbers.

Incremental right, but nonetheless are additional investments we're making.

And so in the past years, we've sort of expanded our compliance. We expanded internal audit. We've expanded our BSA. So we feel we have a pretty robust run rate every year and adding a little bit more this year.

Okay. That's great color. Thank you, guys very much.

Welcome.

[Operator Instructions] I am showing no more questions. This concludes the question-and-answer session. I would like to turn the conference back over to Mr. Oddleifson for any closing remarks.

Okay. Thank you very much Rocco and thanks everybody for joining us today and we look forward to talking to you about our first quarter results in three months. Have a good weekend.

Thank you.

Thank you for your time sir. And the conference has now concluded. We thank you all for attending today's presentation. You may now disconnect and have a great weekend.