Independent Bank Corp. (INDB) Q1 2016 Earnings Report, Transcript and Summary

Good morning, everyone, and welcome to Independent Bank Corp. First Quarter 2016 Earnings Conference Call. [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. 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 also note today's event is being recorded. This time I'd like to turn the conference call over to Chris Oddleifson. Please go ahead.

Thank you, Jimmy. Good morning, everyone, and thank you for joining us. With me as usual is Rob Cozzone, our Chief Financial Officer, who will provide any color [ph] on our financial results, following my comments. We began 2016 with another strong performance. Core operating earnings in the first quarter were $19.1 million or $0.72 per share. We typically experience a natural dip in income in the first quarter every year, but these results were pretty close to our strong fourth quarter and were well above the prior year. A milder winter certainly helped, but the steady momentum we've been building in our company is the real driving force here. It was another well-rounded performance from our side, modest loan growth, notwithstanding the heat of competition, core deposits that have risen to nearly 90% of total deposits, solid fee income generation from a variety of sources. Our investment management even performed admirably in turbulent market conditions, and the Bright Rock Quality Large Cap strategies has performed very well, continued exceptional credit quality and well-contained expense levels. We are particularly, pleased with the strength of our internal capital generation. Tangible common grew to a healthy 8.25% in the first quarter, likewise, our tangible book value per share continued its upward path. It is just about 10.5% above where it was a year ago. The most notable event in Q1 was our reaching an agreement to acquire New England Bancorp, parent of Bank of Cape Cod. While modest in size with $260 million in assets, and a transaction value of approximately $31 million, this deal will benefit us nicely. It certainly is financially attractive being accretive earnings by an estimate $0.05 next year and is expected to be neutral to tangible book value and improves our market position in Barnstable from fourth to third. It is an excellent fit for us, given Bank of Cape Cod's commercial orientation with 78% of their $230 million loan portfolio in CRE and C&I. And we'll be retaining 2 -- their 2 senior lenders, who know the local markets really, really well. We see an excellent opportunity to gain further business from their customer base with our stronger product set, especially home equity, investment management and cash management. We view this as a low-risk, easily digestible transaction, given our proven track record in successfully assimilating prior acquisitions. Turning to the operating environment. Many of you have heard us comment on the rising competitive loan environment and the gradual softening of underwriting practices that accompany it. Nothing really has changed in this regard. We still remain in the thick of deal flow and enjoy strong pipelines, but our pull-through rates continue to be pressured. As in previous cycles, we have no problem walking away whenever we feel terms turn dicey. As for the micro environment, the ongoing Fed watch as to the next rate hike seems to preoccupy and confound all the pundits. And our crystal ball is no better than anyone else's in that score. We try not to get ahead of ourselves in things we can't control, which is why we didn't include any rate increases in our forecast assumptions for this year. We will welcome them, of course, and remain well positioned to benefit, but don't depend on it for earnings growth. The local economy continues to show signs of strength. The Massachusetts leading index is forecasting growth of 3.3% in the first 6 months of 2016. And the unemployment rate remains low at 4.7%. In addition, in 2015, the Massachusetts economy expanded at a faster pace than the national level for all 4 quarters, as measured by MassBenchmarks. So as I said earlier, we're off to a good start this year. We're committed as ever to our strategy of disciplined growth, and we'll continue to work hard in diversifying revenues and expanding customer relationships. The cover of our annual report says it pretty well, growing our bank, one relationship at a time. The confidence we have in achieving continued success is readily evidenced by the recent approval of a very healthy 11.5% increase in our common dividend by our board. It is likewise a sign of our commitment to the shareholder returns of our many loyal owners. Before concluding, I'd like to take the time to acknowledge the enormous contribution to Rockland Trust's success, made by one of our executives, Jane Lundquist. Jane has headed up our broad-based retail and consumer businesses for the past 10-plus years, a period of considerable expansion, brand name recognition, product development and recognized service excellence. She recently announced her intent to retire sometime this summer. We're planning for the transition, an exact date has not been set. Jane will be sorely missed, and we wish her the very best. I will then -- I'll turn it over to Rob

Thank you, Chris, and good morning. I'll now review the first quarter results in more detail. Independent Bank Corp. reported net income of $18.6 million and GAAP diluted earnings per share of $0.71 in the first quarter of 2016. This compared to net income of $19.5 million and GAAP diluted earnings per share of $0.74 in the prior quarter. There were 2 noncore expense items in the current quarter, $334,000 associated with the recently announced acquisition of New England Bancorp, and $437,000 associated with the early retirement of $49 million in home loan bank advances. When excluding those items, operating diluted earnings per share were $0.72 in the first quarter of 2016, an increase of 14% when compared to the same period a year ago. Performance ratios for the quarter were strong. On an operating basis, the return on average assets was 1.07% (sic) [ 1.04% ], and the return on average equity was 9.75% (sic) [ 9.52% ]. As Chris stated, strong earnings results continue to drive growth in tangible book value per share, which increased to $21.90 at March 31. Over the last 3 years, tangible book value per share has increased by more than 30%, inclusive of several acquisitions we'd completed in that period. In addition, tangible capital, tangible assets grew to 8.25%, an increase of 27 basis points just in the past 3 months. Now I'll turn to the balance sheet. Although loan growth tends to be muted in the first quarter, 2016 is off to a good start. Total loans were up 3% annualized with the commercial real estate portfolio leading the way. New originations in the CRE book continue to be well diversified across our geography. The growth in CRE was partially offset by a decrease in construction, which is a bit deceiving, as both categories were impacted by the reclassification into CRE of completed projects as we enter the permanent financing stage. The small business loan category continues to experience strong growth as our enhanced focus on this customer segment has improved awareness and increased sales. Growth in CRE and small business was partially offset by a decline in the C&I portfolio. The combination of intensively competitive environment in a highly liquid client base has constrained our ability to grow C&I outstandings in the short term. Total consumer real estate was essentially flat for the quarter with ongoing growth in home equity, offsetting attrition in the residential real estate category. With the spring season upon us, growth in the combined consumer real estate portfolios should begin to accelerate. Aggregate loan pipelines were healthy at the end of the quarter, as a reduction in the commercial pipeline to approximately $150 million was largely offset by increases in all other book loan pipelines. With robust regional economic activity, we continue to benefit from substantial deal flow. Total deposits were essentially flat for the quarter as strong new core account volumes were offset by fluctuations in the more volatile 1031 and municipal banking categories. Our continued effort to remix deposits has resulted in a further reduction on our cost of deposits to 19 basis points versus 20 basis points in the prior quarter. The more expensive term deposit category now only comprises 11% of total deposits. The 5 basis points of increase in the net interest margin versus the fourth quarter was nice, but less than anticipated. As the benefit from the December Fed increase was partially offset by lower purchase accounting adjustments and lower prepayment penalties. With the 10-year treasury well below 2%, reinvestments rates for the security portfolio are challenging. For this reason, we felt using some of our excess cash to pay down home loan bank borrowings was a better alternative. Asset quality continues to be excellent, with another quarter of net recoveries and 9% reduction in NPAs, loan-loss provision of $525,000 was primarily needed to support loan growth in a single credit on our watch list. Although we believe the credit metrics will eventually migrate towards long-term averages, the strength of local economy may continue to extend that transition. Now moving to fee income and expense. Noninterest income decreased 3% versus a very strong fourth quarter, but was up 16% versus the same period last year. Seasonal activity decreases in most fee income categories were offset by a 70% increase in low-level derivative income. As the December Fed increase and a flattening of the yield curve provided sufficient incentive to some borrowers to lock in rates. As mentioned, in the first quarter, the company incurred costs associated with the pending acquisition of New England Bancorp and the early retirement of home loan bank advances. When excluding those items, noninterest expense was almost 2% lower than the fourth quarter, as decreases in incentives, consulting and reserves for unfunded loan commitments were only partially offset by typical first quarter increases in payroll taxes and advertising. The efficiency ratio in the first quarter dropped to 61.7% on an operating basis. As we have discussed in the past, we believe we have the infrastructure to support a much larger balance sheet and we continue to expect to leverage that infrastructure. I will now provide some additional color on the pending New England Bancorp acquisition. In our March 17 press release announcing the transaction, we described our anticipated summary financial outcomes, which included and expected internal rate of return of 20%, a transaction that would be neutral to tangible book value per share as of the close of the transaction, and earnings accretion of $0.05 in 2017. The following assumptions are what drive those expectations. Approximately 65% cost savings, given the level of branch overlap, we expect to consolidate 3 of the 4 Bank of Cape Cod branches, including the main office. As a result of branch closures, we expect to write off all fixed assets. We anticipate a net loan mark of 1%, which is approximately equivalent to Bank of Cape Cod's current allowance. Bank of Cape Cod has experienced minimal loan losses. The core deposit intangible of approximately $2 million to be amortized over 10 years and onetime expenses of approximately $3 million after-tax, the majority of which will be recognized in the fourth quarter. In addition, due to the relatively high cost of Bank of Cape Cod deposits, we have planned for a meaningful deposit runoff. And finally, shifting to 2016 earnings guidance. During our last conference call, we provided 2016 operating diluted earnings per share guidance of between $2.90 and $3. And now with the first quarter under our belt, we reaffirm that guidance. Excluding the impact of New England Bancorp acquisition, the rest of the full year guidance, which I provided previously, remains unchanged. The one exception could lie with the net interest margin, which we originally guided to be in the lower 3.40s, which may turn out to be a bit of a stretch in light of the current yield curve. We'll have a better feel for this in the months ahead. And again, as Chris stated, our net interest margin guidance assumes no rate increases during 2016. That concludes my comments. Chris?

Great. Jamie[ph], I think we're ready for questions.

[Operator Instructions] Our first question today comes from Mark Fitzgibbon from Sandler O'Neill and Partners.

First question I have for you is on the average balance sheet. It looked like there -- on the residential real estate, average yields went up quite a lot about 27 basis points from the linked quarter. I'm just wondering, was there something unusual in there that cause that slip up.

Yes. The biggest impact to that yield, Mark, was some interest recoveries on a handful of credits. So that had the most significant impact. There were also -- we're also benefiting partially from increases in our adjustable portfolio, which are typically tied to a 1-year LIBOR or 1-year home loan bank, and that has gradually increased over the past couple of quarters. So that portfolio in total has increased about 6 or 7 basis points yield. And then finally, the fact that the residential portfolio has an accrual basis of 33 60, and what we show in our financial statements in the average earning balance sheet is annualized based upon actual number of days. We just do that across the board in those calculations. So if you adjust for that, that impacts those yields by another couple of basis points. It was really combination of things. The most significant of which was interest recoveries.

So if you back up the interest recovery, it would add sort of a couple of basis points on the margin?

Not a couple of basis points on the margin. It probably be about a basis point, maybe a basis point and some change.

Okay. And then secondly, I have been noticing the gains and losses you've been taking on your equity securities portfolio. I wonder if you could just sort of update us on the size of that. And what kinds of -- is it mostly bank stocks? Or are there are a lot of other equities in there as well?

You're probably referring to what took place in the fourth quarter. And the equity portfolio is really just equity that we have associated with Rabbi trust investments. So they're not -- it's not really a bank portfolio. The Rabbi trust is to support benefits. And so those are very unusual and typically only occur in the fourth quarter.

Okay. But it just didn't...

Total is $29,000 in the first quarter.

Okay. And then lastly, Rob, did you -- I'm sorry if I missed this. Did you say your loan pipeline today is a $150 million?

The commercial approved pipeline is about $150 million, yes.

Our next question comes from Laurie Hunsicker from Compass Point.

Rob, if you could just tell us what the accretion is for the quarter, that would be helpful.

The accretion, which is reflected in the -- I think what you asked us about in the past, Laurie, is associated with the accretable yield. As you know, just associated with purchase credit impaired loans, not the total purchase accounting marks. That is pretty flat versus the fourth quarter at around $400,000. And you recall the fourth quarter was down versus the couple of prior quarters. But that is just a piece of our purchase accounting adjustments. That is the...

Right. That's the piece that flows into the net interest income. So it's $400,000. I had fourth quarter at $250,000. Maybe I had that incorrect. So you're saying fourth by comparison linked quarter, fourth quarter was $400,000 also?

Yes, I think fourth quarter was closer to $350,000.

$350,000, okay. Perfect. Okay. And then, Chris, just a more macro question for you. Obviously, we've now seen you do yet another small, almost immediately accretive deal on both on book and earnings. Can you talk a little bit about your acquisition strategy, your acquisition appetite, how you think about the $10 billion mark?

Sure. Thanks for asking, Laurie. So as I have said in the past, banks are sold not bought. And we would love to continue our, in a perfect world, our pace of an acquisition every year, year and half. And as we said, march our way on to $10 billion. Our criteria for the acquisition, as you know, were very financially disciplined. I think we are not going to do a "strategic deal" that's sort of compromises on earnings or earnings accretion or has adverse impacts on the tangible book value. We're often asked sort of how do you sort of plan to approach and cross the $10 billion mark. I wish I could just sort of - take that Bank A, Bank B, Bank C in that order, and we'll get the $9.9 billion, dwell there for a year, as we really are prepared and jump over to about $12 billion or $13 billion and continue going. But of course, the world isn't that perfect, and we have to sort of be very sort of I think it's very situational as to sort of what opportunities comes up and how we think about it. Now to the second part of your question, how are we preparing for the $10 billion? Well, we are -- that is very much on our minds. I mean, we're at 7 -- pro forma $7.5 billion now. So that is a 33% increase from where we are today, which could come in, depending on the acquisition, the organic growth, the timing could be a couple of years out, it could be many years out. Nevertheless, we are adding a number of folks and capabilities and robustness in the bank that we need to prepare. For example, Rob has hired a capital planning manager, who is getting us prepared for DFAST. We have added folks in compliance. We've added folks in internal audit. We have had some additional sort of outside auditor types come to help us figure out, how we get -- how do we make this place even more resilient. I will say, interestingly, while no regulations sort of change until you get to $10 billion. I mean, the regulatory environment is such that, regulators want you to be prepared too. I mean, we do not likely get to $9.9 billion, and then have a transaction having not completely prepared to cross $10 billion. And so we're finding our regulatory exams to be longer, more robust, going in deeper. And our -- are also helpful in understanding how we really need to get prepared. So by the time we get to the $9 billion mark, the $9.5 billion, I suspect that we're going to be 100% ready to jump over to $10 billion.

[Operator Instructions] Our next question comes from Collyn Gilbert from KBW.

Just a couple of questions. One, Rob, do you think on the deposit remix, I mean, it's amazing to me you guys are still able to do this. Is there more -- is there still a potential there to take that down even more on some of the higher cost more than even high cost, but you know what I mean, the other deposit?

Yes. I think there's potentially another basis point or 2, Collyn. We continue to have a whole lot of success in growing our core checking DDI -- DDA, 0 interest accounts both in the commercial and consumer side. And we're also having a lot of success growing our traditional savings accounts, which we only pay 2 basis points on. So I think there is the potential, certainly, to go another basis point or 2, but not much beyond that.

Okay. Okay. And in terms of the derivative income, how are you thinking about that business in just sort of the transaction volume this year? I know you sound a little bit more optimistic as to how the loan growth will develop as the year goes on. Do you think that, that derivative income is -- can also grow as the year progresses?

Yes. This was our strongest quarter ever for derivative income. So I wouldn't expect us to be able to kind of repeat this quarter on any sort of regular basis. I wouldn't annualize this quarter and suggest that, that would be a number. But there certainly is more demand for swaps even what's happened with the yield curve, with the front end coming up, and the middle part of the curve dropping. And so that kind of current cost for a customer to fix a rate is less than what it has been in the last several years. So it seems like a higher percentage of our borrowers are desiring to swap versus taking the risk of a floating rate asset. And so if the yield curve stays where it is, I think there's a chance that we'll continue to see pretty good volume there. Again, anybody that desires a longer-term fixed rate of any sort of size, we require them to swap, but some of those are deciding to float.

Okay. Okay. And kind of along those lines, I know you said in your budget process, you guys are not assuming a rate hike this year. Is that -- does that align with your economic views, I mean, as you're running the bank and thinking about some kind of totality of the business?

Do you have a crystal ball that works better than ours?

Well, I asked that, because you are highly -- asset sensitive, and I just didn't know if that's just going to change the way you're thinking about the balance sheet at all?

Yes, well, it's interesting, we've sort of had the question 8 -- when we start, we're really focusing on becoming asset sensitive by 8 years ago. And we sort of have been wrong for the first 5 years and so. And we're hoping that -- we've been really preparing for the rising rates. And we think that -- we believe there is a higher probability of that happening than us staying down for prime rate given that the cyclical nature is during the history of mankind here. So Rob, how...

Yes. I mean, we don't have any intention of really changing our balance sheet strategy at this point, Collyn. We have been willing to take on a little bit more interest rate risk in the investment book and to extend the duration there a little bit because we're so asset sensitive in the loan book. But we haven't exposed ourselves really to a flat rate environment to any great degree or to even a down-rate environment. And we're still-- current earnings are pretty well protected in any environment while we still benefit from a rising rate environment. Now we, of course, have been given up some current income to get ourselves in this position, but we don't intend to change our strategy at this point.

Okay. Okay. That's helpful. And then just one final question. You mentioned a single credit that popped up on the watch list that led to some of the provision this quarter. What was the nature of that credit?

Yes. It had some environment issues is really the reason we had to take that reserve, which are -- it's a little bit tough to size. We've been pretty conservative, I think, in what we've assumed. But it was a very unique situation.

Okay. And how big is that credit?

I don't recall off hand. Sorry.

[Operator Instructions] And at this time, I'm showing no additional questions. I'd like to turn the conference call back over to management for any closing remarks.

Thank you very much, Jamie [ph]. We look forward to talking with everybody again in 3 months, and goodbye.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your telephone lines.