Independent Bank Corp. (INDB) Q3 2015 Earnings Report, Transcript and Summary

Good morning and welcome to the Independent Bank Corp's Third Quarter 2015 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]. This call may contain forward-looking statements with respect to the financial condition, results of operations and business of Independent Bank Corp. Actual results maybe 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. Please note this event is being recorded. I would now like to turn the conference over to Mr. Christopher Oddleifson. Please go ahead.

Good morning, everyone and thank you for joining us this morning. With me is Rob Cozzone, our Chief Financial Officer, who will cover our financial results in more detail following my comments. We sustained our track record of delivering solid financial performance with a strong third quarter result. Core earnings came in at $18.6 million or $0.71 per share nicely above both prior quarter and prior year results. The quarter featured many positive trends, commercial loan activity was fairly robust with a portfolio growth of 5% annualized. Our loan pipeline remains pretty flush. Now the heated competitive environment has not eased at all, our pull through rate on origination is still pressured. Yet the positive here is that we are at the forefront of the deal flow and get a good look at a very large number of credits. Fee income generation has been encouraging with good growth in core areas such as deposits, interchange and mortgage banking in the third quarter. Investment management revenues have been tampered by the weakness in the equity markets, but it is most definitely the source of long-term growth for us. Liquidity is in great shape with core deposits at 88% of total deposits with a healthy demand deposit component, and this has served to keep our overall cost of funds at a low rate. Credit quality continues to be stellar with a loss rate of a few basis points this year along with non-performing asset levels [indiscernible] rates at very low levels. This is not a recent achievement, but a longstanding point of distinction for us as a highly disciplined lender. And we are certainly not naive to the ebb and flow of credit cycles and we know that credit costs have really nowhere to go up from here, but we do feel confident we'll continue to outperform our peers in this regard. Capital continues to steadily build providing an ample base of support to future growth. Tangible book value per share rose again and now sits at a 12% above where it was a year ago, and our tangible common is nearing 8% now. We continue to show an attractive returns with ROA of 1% and ROE approaching 10%, but beyond the numbers progress continues in a number of fronts. The acquisition of Peoples [indiscernible] is turning out be our to be a real homerun for us as it has accelerated our inroads into the highly desirable Boston markets and we're delighted that the Peoples' [senior lender][ph] has joined our team; he knows that market so well. He is doing a great job [creating] [ph] new business by capitalizing on our greater lending capacity and product set. We also continue to add experienced talent to our franchise in many areas across the bank. Customers are clearly responding to our aggressive promotion of the Rockland Trust brand, our consistently higher rankings in customer service and loyalties surveys bear this out as does the steady growth in new household and the new business volumes. So all in all, things are going pretty well. Locally, Massachusetts has fared well compared to the rest of the country; statewide real GDP grew at an estimated annual growth rate of 5.4% in Q2 versus about 2.7% for the U.S. and statewide unemployment rate is now 4.6% and lower than that in the Boston area. As we all know, market rates have been a subject of much debate especially over the last month or so, and regardless of Fed action we believe we are well positioned. Looking ahead, of course, this is time of the year where our planning efforts are - and for next year and beyond are in full swing, and it’s all about growing the franchise, how to best capitalize in our competitive advantage and adapting to the competitive environment and changing customer preferences. We will continue to intelligently invest in key areas while keeping a close eye on the bottom-line, and true to our nature we remain grounded in our assumptions about the operating environment especially in light of the prevailing economic and political uncertainty. One thing hasn't changed is our confidence in our ability to grow and add value to our customers, our colleagues and our shareholders. Thank you. Rob?

Thank you, Chris, and good morning. I will provide more detail on our third quarter results. Independent Bank Corp. reported net income of $18.6 million and GAAP diluted earnings per share of $0.71 in the third quarter of 2015. This compared to net income of $17.5 million and GAAP diluted earnings per share of $0.67 in the prior quarter. The prior quarter included a number of items that the company considers to be non-core, while the third quarter had no such items. When excluding non-core items, operating diluted earnings per share increased 4.4% versus the linked quarter, and year-to-date operating and diluted earnings per share have increased 12% versus 2014. As Chris mentioned, return on average assets and return on average equity were strong at 1.03% and 9.75% respectively for the quarter. In addition, return on tangible common equity was north of 13.5% in the quarter. Strong earnings results continued to drive growth in tangible book value per share which increased by $0.59 during the quarter and now stand at $20.81 or $2.15 higher than a year ago. Likewise, tangible common grew nicely to 7.9% in the quarter. Results for the quarter were largely as expected as solid new business opportunities continued. Total loans increased 1.2% during the quarter with a commercial book continuing to lead the charge. Within the commercial portfolio, typical seasonal utilization led to a 10.6% increase in the construction book, that increase was partially offset by 1.2% decline in the C&I book as business sale-related pay downs were on the rise. The home equity portfolio also continues to experience healthy growth as our direct mail offers continued to resonate with existing customers and in markets prospects. Our ability to penetrate acquired geographies with home equity product has steadily improved. As expected, the rate of decline in the residential book slowed during the quarter as a reduction in refinancing related pay-offs was coupled with higher closings. All loan pipelines remained healthy at the end of the third quarter and with an improved commercial loan pipeline of approximately $163 million at September 30, moderate organic growth should continue despite the intense competitive environment. Total deposits declined approximately 1% during the quarter largely due to a decrease in the company's more volatile tax section 10/31 exchange business, along with the seasonal decrease in government banking deposits. Despite those decreases core deposits with a sizable demand component are up 7.2% organically year-to-date, and at September 30, as Chris mentioned, represented 88% of total deposits. As a result, the company's cost to deposits held at low 20 basis points for the third quarter. The net earnings margin contracted as expected by 4 basis points to 3.39% during the quarter. The decline is reflective of higher average short-term investment balances along with ongoing pressure on loan yields partially offset by a 3 basis point positive impact from the prepayment of the security. Barring a rate increase, the core margin is likely to continue to gradually contract over the next few quarters as a result of lower loan yields. The positive asset quality trend continued in the third quarter with net charge-offs of only 4 basis points of average loans. The provision for loan loss increased $100,000 versus the prior quarter to $800,000 as we added to reserves to accommodate loan growth. In addition, non-performing asset levels continued to be very low at only 45 basis points of total assets at September 30. Non-interest income on an operating basis was relatively flat versus the strong second quarter. Deposit account fees and interchange and ATM fees were up 6% combined and continued to benefit from core customer acquisition and cross-selling activity. Investment management income declined 10% primarily due to tax prep fees received in the prior quarter and a market driven decline in assets under management in the current quarter. However, strong new asset flows continue. Mortgage banking benefited income which is up over 20% during the quarter continued to benefit from increased home purchase activity, low rates and a gradually expanding complement of experienced residential loan originators. Loan level derivative income which varies considerably with customer demand was healthy at almost $1 million for the quarter, although down from a very strong second quarter. In total, fee income represented 26% of revenue for the quarter. Subsequent to quarter end, the Federal Home Loan Bank of Boston initiated an excess stock repurchase plan which resulted in the repurchase of approximately 23 million of Home Loan Bank stock. That repurchase is expected to reduce Federal Home Loan Bank dividend income which is reflected within other non-interest income by approximately $200,000 in the fourth quarter as compared to the third quarter. Non-interest expense on an operating basis was consistent with the prior quarter at approximately $47 million. Now shifting to 2015 guidance, during our last conference call, we refined our 2015 operating diluted earnings per share guidance to be at the upper end of the original range of between $2.63 and $2.73. With our strong third quarter results, we anticipate achieving the upper end of that range. That concludes my comments.

Thanks Rob. So now we're ready for some questions.

We will now begin the question-and-answer session. [Operator Instructions]. At this time, we will pause momentarily to assemble our roster. The first question comes from Mark Fitzgibbon of Sandler O’Neill. Please go ahead.

Good morning, gentlemen.

Good morning, Mark.

The first question, I have for you. You guys have done a great job of sort of driving down your funding cost, but your cost of funds is pretty low compared to your peers today. Do you think you still have any room to kind of push on that side of the balance sheet?

Yeah. The remaining room is certainly pretty marginal on the deposit front, Mark. On the wholesale front, we don't expect to see a significant decline during 2016, but heading into 2017 we do have some wholesale funding that will [re-price] [ph] lower assuming no significant increase in rates before them. So I wouldn't expect much relief on the funding cost side over the next four quarters or so. As we head into 2017, we will see some [indiscernible].

Okay. And then given that it looks like rate increases could still be a ways off and your balance sheet is really asset sensitive. Are you doing anything to reduce the asset sensitivity of the balance sheet or are you going to hold the rate sensitivity position as it is?

Well, we continue to think the prudent thing is to do what we have been doing which is focusing on generating primarily floating rate assets, so certainly on the loan side of the book and we continue to anticipate doing that. However, we have not just recently, but over the last several quarters because of our asset sensitivity, have been comfortable putting slightly longer-term investments into our investment books, so some of the investments that we have purchased really over the last couple of years have had a longer duration than maybe we would've done on an historical basis. So that's given us some flexibility to take on a little bit of duration risk there, but from a lending perspective the plan is to kind of stay the current path. And just a follow-up to your first question, Mark, you should have noticed on the balance sheet that we had a wholesale repurchase agreement that paid off -- matured during the quarter and that will have a benefit to our cost of funds heading into the fourth quarter to the tune of about a basis point.

Okay. And then lastly, I think you said previously that advertising expenses would drop in the fourth quarter. If you take that into consideration, should we expect non-interest expenses to be sort of flattish overall with the third quarter, do you think?

No, you should expect them to be lower.

Lower, okay. Great, thank you.

Thanks, Mark.

The next question comes from Laurie Hunsicker of Compass Point.

Yeah, hi, good morning, Chris and Rob.

Good morning.

Just a follow-up on Mark's question on advertising, so I know in June you were a $1.9 million in advertising expense versus March you were around 800. What was the number in September? Does the number vary and the other…

It's about $1.5 million.

$1.5 million, okay. And approximately where does that drop to in fourth quarter? Is that back to that 800 run rate or…?

I don't remember the exact number for the fourth quarter, Laurie, but you should expect to see in total [indiscernible] expense at least $1 million decline heading into the fourth quarter.

Okay. And then, is the advertising going to sort of be a seasonally up number in June or September or was that just more in conjunction with the closing of the PEOP?

Historically, those have been the most active periods for us for advertising.

Okay, great, thanks. And then accretion income in the quarter, what was that?

That was pretty consistent with last quarter at about $600,000.

Okay, so that's roughly 4 basis points or so of your margins.

Yeah, 3 to 4, yeah.

3 to 4, okay. And then, I noticed your investment management income is down slightly. Where are assets under management and how do you think about that going forward?

They are currently at $2.5 billion so rounded we’re down $100 million versus last quarter and that is entirely market driven. As I said in my prepared comments, the new business flow is strong. We're having a lot of success in our Boston office and all the assets are growing nicely, and the pipeline looks good. So we expect new business volumes to continue at strong levels like they have been over the last couple of years. One thing that’s happening a little bit though is that all asset classes are down and some asset classes down even more than equities and so that's causing the drag on the total portfolio.

Okay. And would you all look to do an acquisition in that area to build assets or how do you think about that?

Laurie, we would love to do an acquisition in an area and we've actually over the years sort of gotten to know the market. The difficulty in sort of that space is cultural integration, as you know profoundly different, when you are thinking about integrating IRAs versus integrating banks. And the one acquisition we made back in 2007 the principals were clearly ready to retire due to sort of age and health reasons, and so the more junior principals had worked in the bank years ago, so they integrated very well with our culture. The IRAs, they are typical of the size that we would be interested in purchasing, very, very entrepreneurial and very sort of firm on their view on their approach and integration is difficult. So I’d say, yes, but it's a lot tougher to do it in the bank space.

Okay, then Chris, I guess last question to that point, how do you think about bank acquisitions? Now that Peoples is digested, how are you looking at that landscape?

Well, we have had a great track record in acquisitions, when you take a look over the last decade, it actually is very important in terms of our where we are today, the scale [they have] [ph], our ability to cover some of the increased regulatory expense, so I'd love to do more acquisitions, but the banks are sold not bought, and as Board of Directors decided that's something that I want to explore I hope - hoping [indiscernible].

And just to that point, geographically, will you refresh us on directionally how far outside of your footprint you would consider expanding?

I will cover for now Laurie. What we have said is, we certainly like eastern Massachusetts as you know the vast majority -- the economy is within eastern Massachusetts for all of New England we’re comfortable going out west as far as Wister probably not further than that, north as far as southern New Hampshire and Southern Maine, so maybe into Rhode Island we already have obviously a loan production office and an investment management office in Providence, but no branching currently in Rhode Island. So that's generally the geography that we are focused on and comfortable with.

We're fortunate that we're sort of smack up in the middle of the economic centroid of New England, so thinking about expanding sort of in concentric circles from where we are now a little more north, a little more south, little more west. Try not to go into ocean in the East, is sort of a logical thing for us. It's been quite successful for us in the past.

Great. Thank you very much.

Thanks, Laurie.

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

Thanks. Good morning, guys. Can we just talk a little bit about your construction portfolio? I know you'd indicated that you know there is some seasonal uptake that you see in the third quarter. But just in general, I know you guys, I think in the beginning of the year, were talking optimistically about your opportunities within construction, just sort of give us an update on where things stand and what you think you could do into next year within that portfolio?

Well, the increase, as I said in my comments, [imbalances] [ph], so outstandings was pretty much all driven by drawdowns on existing lines that had been booked in previous quarters. Heading into the fourth quarter call and as you might expect that tends to reverse, so we wouldn't expect a further increase in the construction book in the fourth quarter. In terms of a longer-term view, certainly there continues to be a lots of activity within our footprint and especially within the Greater Boston area, some of which makes us a little bit nervous and we're not interested in participating in. So we've been pleased with the discipline growth that we've had to-date. At the current time, we expect to have a similar trajectory over the next several quarters [indiscernible] for both the seasonal changes. But there certainly is some concerning signs within construction and within commercial real estate in general, within the Greater Boston area.

Okay. What are the types of projects where you are feeling comfortable underwriting to and pricing that you're seeing on some of those types of projects?

It's really no change. It’s been our standard bread-and-butter that we've been involved in all along. A lot of it is multifamily, it's not the premium luxury multifamily priced towers you see going up in Downtown Boston, but at the smaller units you know that still have attractive price points. There is mixed used commercial development in there. So really no change in what we have done historically. The loan sizes are a little bit larger on average than what we've done historically, but [indiscernible] very consistent from geography perspective, it's pretty well spread out across our geography. Certainly the deals within Greater Boston are larger, so they tend to make up a higher percentage of the dollars, but not to a great extent.

Okay. That's helpful.

In terms of pricing, pricing is very competitive, and we've been able to hold the line for the most part. In construction you do get a little bit of the premium over general CRE. It's nice -- it tends to be floating rate, so that's good too.

Okay, that's helpful. And then just thinking about the trends again a little bit longer-term within the swap income line. What are you guys seeing with your borrower behavior? What are you anticipating going into the year? Is there any fallout from what we've seen globally with what your borrowers are -- the confidence that some of your borrowers have, I guess when we’re looking at the Beige Book, I think it indicated that refinancing started to slow overall for the first time in many years. So just trying to see how that translates into what your customers are thinking and doing?

We've been pretty successful with refinancing some of our existing swap book, so that generates a new swap fee when we are able to do that and that's attributed to the fact that rates are in many cases lower today than they may have been when the original swap was put on. So some of the activity we've seen is related to that. Borrower perception can vary significantly. We have a segment of our borrowers that recognize that rates are at historic lows, they are not interested and may be gambling with rate increases, [indiscernible] very comfortable with the low fix rate that they can get and so we'll swap their loans all day long to get that longer-term fixed rate. Other borrowers that may be a little bit more sophisticated have been paid to sit by and float, and so they pay close attention to what's happening with interest rates and what interest rate expectations are, so they are often comfortable staying non-swap at a floating rate. So it varies pretty considerably. We have a pretty good pipeline of loans [indiscernible] swap heading into the fourth quarter, but quarter-to-quarter that number will continue to be volatile.

Okay, that's helpful. And then just one last question on credit, Chris, I know you, you know in your opening comments, you'd indicated your awareness of the credit cycles and you guys certainly are -- credit quality has just been super strong. Is there sort of a range that you are all thinking about where that provision goes or range of net charge-offs, just trying to see the recognition that we're at a low level and it inevitable is going to need to go higher, but how are you thinking about that into next year?

We're not ready to sort to give direct guidance for next year, but I'll say this that the skies look really clear. I mean they look really good as far as we can see. But being folks who have lived through a few cycles that by definition makes you nervous. So we can't point to anything or see anything anything on the horizon, but we do know the business cycles probably have not been repealed.

Okay. I'll leave it there. Thanks guys.

Great. Thanks, Coll.

[Operator Instructions]

Okay. So there are no more questions.

There are no further questions at this time.

Well, thank you very much everybody and we look forward to talking with you in the year 2016. Thank you. Bye.