Independent Bank Corp. (INDB) Q3 2017 Earnings Report, Transcript and Summary

Good morning. And welcome to the Independent Bank Corp Third Quarter 2017 Earnings Conference 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 may be different. Factors that may cause actual result to differ include those identified in our Annual Report on Form-10k 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 Chris Oddleifson, CEO. Please go ahead.

Thank you, Austin. Good morning, everyone and thank you for joining us today. As always, I’m accompanied by Rob Cozzone, our Chief Financial Officer. My track record of consistent steady growth remained intact with another solid performance in the third quarter. We produced net income of $23.9 million or $0.87 per diluted share in Q3, on both a GAAP and operating basis. Once again, well above both prior quarter and prior year results. Rob will provide added color on our results following my comments. Our third quarter performance was marked by numerous positives, including rising net interest income and accompanied by a higher margin, a treasure group has positioned us quite well benefit from the rising rate environment; benign credit quality with another quarter of net recoveries and lower non-performers, expense management that has resulted in efficiency ratio below 60%; core deposits remaining above 90% of total deposits with particular strength in demand category, and attractive ROAs and ROEs. One area where we’re especially proud of has been the strong ongoing product of tangible book value by share. It rose another 3% in the past quarter and now stands 35% above where it was three years ago, despite absorbing several acquisitions. One factor in the third quarter that did give us some pause was the tapped loan and deposit growth. While our deposit growth on loan growth during the quarter were muted, looking beyond the balance sheet, indicates a strengthening core franchise. So for example, commercial loan of regulation during the third quarter totaled $305 million among the highest quarters ever but was nearly completely offset by historically lower line of credit utilization. This appears to be a reduction in demand on the commercial side, especially in CNI sector. As others in our industries have sided, our anecdotal signs that the ongoing uncertainty in Washington as to lowering the taxes, changes to trade packs, et cetera is weighing at the borrowing appetite of corporate America. The good news is that our lines are still in place and our pipelines remain in good space. So hopefully, things already resumed once greater clarity has reached. Either way we’ll continue in our disciplined approach to credit. And as we have mentioned on the last two calls, we continue to strengthen our franchise while building our commercial lending team with selective hires. On the deposit side, levels were adversely impacted by municipal declines. However, again, there were signs of the strengthening franchise. Excluding our recent acquisition, core account growth is up 2.5% year-to-date. Demand deposits are up 4.5% year-to-date, and now account for 33% of core deposits, an all time high. Consumer household growth year-to-date annualized is 2.3% and business household growth year-to-date annualized is 7%. And finally, our total household retention rate has increased to 94.5% year-to-date to on very higher level relative to benchmarks. And these rates look especially signing the context of a regional population growth rate at less than 1%. On a non-customer company strengthening point, I think it’s worth mentioning that we are making significant progress preparing for DFAST. We’re running models and have built the strong written plan, both which we believe to be DFAST compliant. We continue to work on weaving the process into our risk management framework and building out a documentation and validation process. Beyond that, we continue to make solid progress on the business side. Chief among this has been a terrific experience with our Island Bancorp acquisition at Martha's Vineyard. We're off to a flying start there in terms of customer retention and new business development. In just a few months, the Rockland Trust brand has resonated beyond our expectations, and we continue to add experienced professionals from other institutions in the island, while we established relationships with Island businesses and consumers. Another stand out business of ours lies with the investment management group, process center administration now have grown to $3.3 billion with year-to-date revenues up 9% over last year, and recent rate there rank in the top 25 of independent investment advisors in Massachusetts. And this is another business of ours that continues to recruit senior talent. Locally, the Massachusetts economy continues to perform notably well. The state has added nearly 300,000 jobs since 2007 with a labor force growing at 3.2% this year. This translates into unemployment rate of 3.9% as of September 30th. Massachusetts real growth [indiscernible] of product grew with 4% during Q2 and in June, and Mass benchmarks leading indicator suggest that state economy will continue to grow at a modernly strong pace of around 2.7% for the final six months of 2017. As we head into our budget season, we’ll continue to balancing the year and desire to keep speeding our growth businesses with maintaining an overall efficiency of operations. At all times, the improvement of the customer experience and maintaining of our high service standards cannot be compromised. This requires ongoing technology investments balance with continued streamlining of various networks, such as our branch configuration. We do not have an operating platform that can be -- we have in our brand, we do have an operating platform that can be leveraged further. And we hope to capitalize on that. And as always, we will stay grounded in our operating environment assumptions. We are confident that this disciplined approach which has served us so well over the years will continue to bear fruit for many years to come. Now, I'll turn it over to Rob. Rob?

Thank you, Chris and good morning. I'll now review third quarter results in more detail. Net income of $23.9 million in the third quarter was 16% higher than both the prior quarter the same quarter of last year. Operating net income, which is adjusted for merger and other charges that occurred in earlier quarters, was up almost 7% versus the second quarter and 16% versus the prior year. And most importantly, diluted operating earnings per share of $0.87 was 6% high than last quarter, and almost 12% higher than the third quarter of 2016. Additionally, profitability experienced further improvement in the third quarter. On an operating basis, third quarter return on assets, return on equity and return on tangible common equity, improved to 1.18%, 10.2% and 13.8% respectively. Strong earnings translated to healthy growth and book value and tangible book value. On a per share basis, tangible book value increased $0.64 to $25.12 at September 30. As Chris mentioned, modest balance sheet growth during the quarter masked the significant amount of customer activity taking place. Within commercial, 305 million of new booked commitments boosted total commitments by more than 6% annualized. However, that robust activity was offset by 4.5% drop in utilization rates on lines of credit, a trend that seems to be corroborated by industry reports. Fortunately, loan pipelines remained strong at the end of the third quarter. And should utilization rates improve, growth will accelerate in the fourth quarter. The strong growth we experienced in construction balances is a combination of new projects and additional draws on seasoned projects. The construction portfolio continues to be well diversified across geographies and property types, with the largest component being residential related. The total consumer real estate portfolio grew by 3.5% annualized during the quarter, and demand for home purchase financing seems resilient despite increases in rates and home values. Although, the total deposits were essentially flat on a quarter-over-quarter basis, as Chris mentioned, demand deposits were up 12% annualized and represented 33% of total deposits as of September 30. The decline in savings and interest checking occurred within the government banking category, partially due to seasonality and partially due to the competitiveness we have described previously. The increase in term deposits is pretty typical behavior in a rate increase cycle. As expected, the cost deposits increased 2 basis points versus the 18 basis points recorded in the second quarter, while our total cost to funds increased only 1 basis point. Deposit cost will likely increase modestly again in the fourth quarter. It is also worth pointing out the steady increase in our customer repo balances, which are essentially sweep accounts and serve as another valued funding source. Despite the slight increase in deposit cost, the benefit of our asset sensitivity was evident once again in the results for the third quarter. The net interest margin was up 5 basis points to 3.65%, and all major loan categories expanded an increase in yield versus the second quarter. We now expect the full year net interest margin to be at the upper end of the range most recently provided, which would translate to approximately 3.6%. Non-interest income declined 3% versus the strong second quarter results as increases in interchange and ATM fees and mortgage banking income were offset by decreases in loan level derivates and other income. The increase in interchange and ATM fees is reflective of a continued success in adding core households. Loan level derivate income continues to be difficult to predict quarter-to-quarter, and was impacted by the lower number of longer term loan closings in the third quarter. As Chris noted, excellent momentum in our wealth management business is open in stable revenues despite the boost the prior quarter received from tax preparation fees. New business activity remains robust within our wealth management division, and we are on track for a record year. In an effort to maintain that momentum, we recently added an experienced team to our roaster of highly credential investment professionals. Non-interest expense, excluding merger and acquisition charges, increased 2.8% when compared to the second quarter and was higher than anticipated due to $1.5 million of loan workout costs, mostly related to a previously recognized large problem credit along with additional advertising expense associated with the promotion of our J.D. Power recognition. The loan workout cost should be money well spent and has certainly better positioned us. A significant decrease in workout cost and lower advertising expense will result in a lower efficiency ratio for the fourth quarter. Asset quality metrics improved during the quarter. And if adjusted for the single commercial relationship just described, non-performing asset and delinquency rations would be at multi-year lows. Additionally, the credit outlook remains quite favorable. With net recoveries and only modest loan growth, no provision for loan loss was justified in the third quarter. In terms of guidance for the remainder of the year, we expect the following. Loan and deposit growth should increase in the fourth quarter, but will likely be less than originally anticipated for the full year. As mentioned, the net interest margin for the full year should be about 20 basis points higher than 2016, or approximately 3.6%. But as I mentioned, last quarter, is expected to down slightly for the fourth quarter, given the likely increase in deposit costs. Fee income is expected to increase in the fourth quarter, but will be subject to volatility and derivative income. Non-interest expense should decline in the fourth quarter and the efficiency ratio is expected to improve to the mid 50% range. And then finally, the tax rate for the fourth quarter is expected to approximate 34.5%. That concludes my comments. Chris?

Great, thanks, Rob. Austin, we're ready for Q&A.

Thank you. We will now begin the question-and-answer session [Operator Instructions]. Our first question comes from Mark Fitzgibbon with Sandler O'Neill. Please go ahead.

Good morning gentlemen. This is Nick Cucharale filling in for Mark. So, you’ve been able to keep your deposit cost remarkably low at 20 basis points this quarter. And just from listening to your opening remarks, it looks like there is a little bit of pressure. Could you just help us figure out where that’s coming from in your markets?

As we’ve talked about in the past, it initially started within the government banking business, that’s where we saw the most amount of pressure. And as I mentioned just in my comments, we have seen some outflows as a result of that pressure. And so costs there have gone up about 10 basis points, I would say, over the last couple of quarters. Then it gradually transition to the larger commercial clients that had alternatives elsewhere to place their funds with high yields. And now in the last quarter or so, we’re starting to see that trickle down to the consumer categories. So, we have made some adjustments in some of our consumer products, thing that is evidence in third quarter results is the increase in term deposits and that’s where we have decided to offer some special rates to retain some of those consumer deposits.

And then you touched on this in your opening remarks. But in terms of loan growth, certainly influenced by a decline in CNI this quarter, I know it’s early. But is your sense to CNI rebounds in the fourth quarter?

Our general sense would be that for sure and most importantly because we wouldn’t expect to have the significant headwind or an additional drop in utilization. So if we were to do just the same level of volumes we did in the third quarter and do not have the headwind of utilization, we would see growth.

And then would you mind sharing the size of your commercial pipeline and how it compares to the previous quarter?

Yes, it’s little over $160 million at the end of the quarter, and it was $155 million at the end of second quarter.

And then lastly assets under administration steadily climbed to $3.3 billion, which is up quite a bit from a year ago. I was hoping you could share with us how much of that increase is due to client inflows as opposed to market appreciation?

Majority of it is certainly due to client inflows. We had total new assets, including additions to existing accounts of almost $400 million year-to-date, which would be a record for us. So, I don’t have the exact math on the market appreciation. I think it’s around 2% to 3%.

That of course is offset by distributions of accounts under trust administration, et cetera.

Our next question is from Varun Bhandari with Piper Jaffray. Please go ahead.

Good morning everyone. I am on for Matt O'Brien. Just one question, I just wanted to start up by asking a little bit about the margin expansion. You guys do expect to see if this flatter yield curve remains?

Certainly, not sure exactly what your question is. My expectation is that the margin will contract slightly in the fourth quarter, assuming no further fed increases early in the fourth quarter, and certainly that’s not expected. The December fed increase would not really benefit the fourth quarter margin. So we’ll have an slight increase in deposit cost with no real relief on the asset side. Going forward, additional fed funds increase will continue to benefit the margin. We are more sensitive to the front end of the curve and less sensitive to the ultimate shape of the curve. So as long as the front end of the curve continues to go up, we would expect to see additional margin expansion. Does that answer your question?

Our next question is from Chris O'Connor with KBW. Please go ahead.

So just wanted to drill down on the operating expenses so for the 1.5 million of worked out cost this quarter. Will all of that be flowing out in the fourth quarter, or just the majority of it?

Just the majority of it. As you can imagine, we constantly have work out costs associated with any credits that are in the work out group. But I would expect that to decline by about $1 million in the fourth quarter relative to the third quarter.

And then look out further into 2018. Would the DFAST prep that you guys been working on lot accelerate historical OpEx growth rates at all?

I'm sorry, accelerate what?

Expense…

No, certainly not. We have gradually added to our capabilities there and incurred expense all along the pathway to get into a place where we have something or comfortable ultimately submitting. The additional expense that we will incur will be related to validation and building the governance frame work around that. So there will be some additional expense associated with those things, but would not expect to see an acceleration of expense associated with overall DFAST.

And then just moving to growth rates looking out into 2018, if there is only a single rate hike by the fed or no rate hike by the fed at the end of this year. We get a pretty stagnate yield curve in 2018. Do you think that will weigh on your growth outlook at all in order to keep the margin by not growing too much in deposit costs? Or do you think the competition will be if there is not too many rate hikes?

I would expect -- certainly, if there are anymore rate hikes, I would expect the competition to abate. But you would still likely have a couple of quarters of increases in funding cost just to catch up to the rate increases that have already taken place.

[Operator Instructions] Our next question is from Laurie Hunsicker with Compass Point. Please go ahead. Ms. Hunsicker, your line live, please go ahead with your question.

Austin, we cannot hear anything.

And I'm showing no more questions. I will turn the conference back to Chris Oddleifson for any closing remarks.

Great. Thank you very much, Austin and thank you everybody for joining us. And we look forward to discussing full year results in three months. Bye.