Independent Bank Corp (Massachusetts) (INDB) 2002 Q3 法說會逐字稿

Good morning. My name is Rene and I will be your conference facilitator today.

At this time I would like to welcome everyone to the Independent Bank Corp. third quarter 2002 earnings release conference call.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you.

Mr. Sheahan, you may begin your conference.

Denis Sheahan (ph): Good morning, everyone, and welcome to the Independent Bank Corp's (ph) third quarter 2002 earnings conference call.

Our agenda for this morning is I will introduce the others on the call with me and then review our cautionary statement, followed by my review of our third quarter earnings release. Doug Philipsen, or President, Chairman, and Chief Executive Officer, will make a few comments and then I'll finish the call by reviewing earnings estimates for the fourth quarter and full year 2002.

With me on the call today are Doug Philipsen, our Chairman, President and Chief Executive Officer; and Barry Jensen (ph) and Rob Cazone (ph) of our Finance Department.

Now the cautionary statement. This conference call may contain certain forward-looking statements with respect to the financial condition results of operations and business of Independent Bank Corp. Actual results may differ from those contemplated by these statements.

Independent Bank Corp. wishes to caution listeners not to place undue reliance on any forward-looking statements and disclaims any intent to update publicly any such forward-looking statements whether in response to new information, future events, or otherwise.

I will now review the third quarter 2002 earnings release.

Independent Bank Corp. reported $7 million in net operating earnings for the third quarter of 2002, an increase of 32 percent from the $5.3 million of net operating earnings reported in the third quarter of 2001. This represents diluted operating earnings per share of 48 cents for Q3 '03 as compared to 37 cents in the comparable prior year period. Return on average assets was 1.23 percent and return average equity was 18.93 percent for the quarter on an operating basis.

Net operating earnings excludes securities losses of $25,000, after tax, on the sale of the remaining WorldCom bonds and securities gains of $147,000, after tax, for the third quarter of 2002 and 2001, respectively.

Net income for the quarter was $7 million, an increase of 28 percent from the same period last year. This equates to diluted earnings per share of 48 cents, as compared to 38 cents for the second quarter last year.

In October of 2002 the Financial Accounting Standards Board released a new statement, Number 147, entitled, Acquisitions of Certain Financial Institutions, allowing financial institutions meeting certain criteria to reclassify their unidentifiable intangible asset balances to goodwill and cease amortization beginning as of January 1 of this year.

As permitted by the FASB, the company adopted statement Number 147 as of September 30, 2002, and retroactively ceased amortization of goodwill. Amortization expense of $1.3 million, net of tax, has been added back to net income through September 30th of '02. The full-year impact of earnings net of tax if $1.8 million or 12 cents per diluted share.

I'll now review some balance sheet changes in the quarter. Investments were essentially flat for the quarter. However, the mortgage securities portfolio continued to decrease due to high prepayment activity in this low-rate environment. Re-investment purchases were concentrated in near-term U.S. government agency securities.

Loans grew by 41 million for the third quarter and 86 million year to date. Portfolio growth for the quarter was primarily in residential real estate, which grew $23 million. This growth was concentrated in adjustable rate loans. Commercial real estate construction also showed improvement for the quarter.

Core deposits, which we define as non-time deposits, improved by 33 million for the quarter and 172 million year to date. And time deposits were managed down by $15 million during the quarter and 62 million year to date. The changing mix of deposits contributed to a lower cost of funds in Q3 '03.

Now the income statement, I'll first review net interest income. The net interest margin for the third quarter and nine months ended September 2002 remained strong at 4.9 percent, attributable to the Feds easing of interest rates and the balance sheet changes discussed previously.

As discussed in the earnings release, management anticipates that the net interest margin will contract in the coming months as assets continue to re-price at historically low levels without corresponding decrease in rates paid. Management continues to take steps to protect the net interest margin and improve the bank's asset sensitivity such as emphasizing adjustable rate loan production, shorter-term investments, and longer-term funding.

Non-interest income, excluding security gains and losses, improved by $600,000 or 12 percent for the quarter, as compared to the same period last year. The primary drivers in this improvement were deposit service charge revenue, reflecting growth in core deposits and lower earnings credit rates.

Invested management income increased modestly for the quarter, $100,000, in the face of a difficulty equities market.

Non-interest expense decreased by $27,000 as compared to the third quarter of 2001. The impact of the non-amortization of goodwill was $665,000, pretax, for the quarter.

Salaries and benefits increased $1.1 million or 12 percent. The components of this change are increased headcount, performing space incentive compensation, mortgage commissions, and merit increases.

Occupancy and equipment expense decreased by 400,000 for the third quarter and other non-interest expense increased by $100,000 or three percent.

Non-performing assets represented 16 basis points of total assets at September 30th of '02 or $3.7 million. Total reserves for loan losses, which we define as the allowance for loan losses plus the credit quality discounts on the acquired loans - as a percentage of loans was 1.55 percent at September 30th, 2002 and reserved covered non-performing loans six times. Delinquencies continue to be low and management does not see negative trends in asset quality.

Net charge-offs for the quarter and nine months ended September of '02 was 318,000 and 954,000 respectively.

I'll now turn it over to Doug Philipsen for a few comments.

Doug Philipsen (ph): Thank you, Denis.

As you just heard, we had a strong third quarter in spite of a weak national economy. As I have said many times, the absence of large employers in our marketplace, which enjoys a diverse universe of small businesses, reduces the impact on our communities from the misfortunes that have beset the high-tech and dotcom businesses elsewhere in Massachusetts, the State of California, and certain other states.

Banks are mirrors of the economic conditions in their marketplace. While southeastern Massachusetts, and, therefore, Independent Bank Corp., will not totally escape the adverse impact of this downturn if it continues for a while, I believe that our marketplace will remain relatively strong. This, combined with our sound loan underwriting practices, should continue to minimize the impact of the weak national economy on our financial statements relative to the industry as a whole.

Quarter-end non-performing assets dropped to the $4 million level way back in March of 2001. Non-performing assets had remained before that level at the end of each and every quarter ever since, even as the national economy has deteriorated. As a percentage of total assets non-performing assets at September 30th, 2002, amount to .16 percent of total assets, compared to .20 percent of total assets at the end of March 2001, an improvement of four basis points over the 18-month period.

While non-performing assets at September 30th are two basis points higher than the yearend 2001 level of .14 percent of the total assets, that yearend level was the lowest achieved in my nearly 11 years at INDB. It is interesting to note that total delinquency at September 30th was 20 basis points better than at yearend 2001.

There's been a lot of speculation nationally about a so-called residential real estate bubble. Given the unprecedented run up in real estate prices across the country, it would not be surprising to see a drop in values. It has happened before, it can happen again. However, there's some differences between now and the late 1980's in southeastern Massachusetts. I believe most of the listeners to this Webcast are aware that it was residential and commercial real estate problems that caused this institution to nearly fail in the early 1990's.

Neither builders nor local lenders have forgotten the lessons learned during this period. Specifically, underwriting criteria have remained much tighter over the past 12 years than during the 1980's. Currently our residential loan delinquency in dollars on September 30th, 2002, is at the lowest level since September 2000, when our portfolio was much smaller by almost $100 million whereas I'm very pleased with our current position my 30 years of banking experience in the Commonwealth of Massachusetts causes me to be concerned in the vent of a prolonged national economic downturn.

Concerning earnings guidance, Dennis has consistently indicated a range of operating earnings amounting to $1.75 to $1.80 per share for the year 2002 ever since January of this year. This range obviously excluded the benefit attributable to the recent FASB pronouncement concerning the non-amortization of good will as well as the write off of the trust deferred securities reissuance cost in the first quarter and the Worldcom bond impairment charge taken in the second quarter.

In a moment you will hear Dennis reaffirm that guidance increased to include the favorable annual impact of 12 cents per share due to the FASB pronouncement. In my opinion, recent events across corporate America reaffirm the wisdom of abandoning earnings guidance. I believe that management of public companies should be focused on creating long term shareholder value. The urgency irrationally imposed by the market on quarterly performance conflicts with the long term focus that is in the interest of most shareholders.

And in spite of my reservations, I will provide a brief commentary on the outlook for 2003. Some analysts have issued aggressive earnings targets for 2003 ranging from $1.90 to $2.00 per share prior to and, therefore, excluding the recently announced good will benefit of 12 cents per share.

INDB is well positioned for long term earnings growth yet we see much uncertainty in the coming year for us and the entire industry. As discussed in our third quarter earnings release, management expects margin compression from these high levels.

However, I believe INDB will still experience increased earnings through a combination of balance sheet growth and expense control. On the matter of expensing stock options, doing so would cost us about two cents per share or about 1.5 percent of 2001 last year operating earnings.

However, due to flaws (ph) and blacksholes (ph), we are reluctant to do so without additional guidance from FASB. I recently wrote a letter to the chairman and CEO of Nasdaq copied to the chairman of the SEC which outlines my views on this and other matters regarding standards of corporate governance. If you are interested, my letter is attached to our ticker symbol, INDB, on (OFF-MIKE). Dennis.

Thank you, Doug. And now I'll review our earnings estimates for the fourth quarter and full year 2002. The numbers I'm about to share with you do not include first of all the total impact of the trust deferred securities issuance comps write off for 2002 of 10 cents per share or $1.5 million after tax. These write offs occurred in the first and second quarters of 2002.

Management does not consider the impairment charge in the Worldcom bond of 17 cents per share as part of the operating earnings run rate of the company similar to our prior exclusion of securities gains from operating earnings. This charge occurred in the second quarter of 2002.

The operating earnings estimate for full year 2002 is $1.87 to $1.89. Fourth quarter 2002 should be in the range of 46 to 48 cents per share. This concludes the presentation and I will now open the call for questions.

At this time I would like to remind everyone in order to ask a question please press star then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Gerad Shaull (ph), KBW (ph).

Shaull (ph): Good (AUDIO GAP).

Good morning, Gerad (ph) . . .

Mr. Shaull (ph), please press star one again please.

Shaull (ph): Hello.

Hello. Go ahead, Gerad (ph).

Shaull (ph): OK. Thank you. Could you comment briefly on the auto portfolio and what you're seeing there in terms of some of the captive finance offers that are being offered and then the decline in used car values? Is that causing delinquencies to rise and the cost of disposing of repossessed cars to go up?

As you know, last year - late last year some vented (ph) rates were once again offered by the auto companies and frankly I expected that the value of used cars would decrease as a result and people would start handing us their keys. That didn't happen in the first quarter of this year.

And, likewise, it hasn't happened since. So vented (ph) rates have clearly worked to depress used care prices and there's no question that that's happened. I think a combination of our underwriting standards and other factors have left us clean on that - and by the way, this is Doug Philipsen on these comments.

Shaull (ph): And then in terms of the trends that we've - you've seen in the delinquencies and actual asset quality of those remain steady or have you seen them start to deteriorate?

Delinquency has not gone up. It's amazing. I keep expecting every month to see delinquency turning up and it's not doing it.

Shaull (ph): OK. And then also separate from that, we've seen some acquisition activity pick up in the north - northern parts of Boston. Do you expect to see that consolidation continue to the south or do you see that as an opportunity for the bank?

Well, I think - some of you may know my background is in M&A work before I came into banking so I think I understand that. You know if you look at Massachusetts they're still - I can't remember roughly the exact number but roughly 250 institutions in the state. There's too many. There's too much capacity. All the experts agree on that and something's got to happen.

Beyond that, I think there's a lot of exposure on the part of smaller institutions for operational risk. They have every bit of the same risks that we do. They do all the things that we do. Unfortunately, for us I believe we have the benefit of thorough examinations of our MIS function by the regulators. I really am concerned in the future in terms of what might develop in terms of some of those smaller institutions in that regard.

Shaull (ph): OK. Thank you.

Your next question comes from David Mudd (ph) of Hartland Advisors (ph).

Mudd (ph): Good morning. Just had a quick question regarding the provision for taxes with the restatement what those numbers were for the first and second quarters.

With the restatement?

Good will.

Mudd (ph): Yes. What were the provision for income taxes for the first and second quarter? Would you happen to have those numbers? If they were adjusted.

Are you looking for the impact of taxes on the good will change?

Mudd (ph): Yes.

OK. Well, the good will is $2.8 million a year pretax and 1.8 . . .

Use about 34 percent on 2.66 million. That'll get your number, 2.66 being the annual number. So, just divide that by four and apply 34 percent.

Mudd (ph): Thank you.

Your next question comes from Kelly Hinkle (ph) of McConnell, Butt and Romano (ph).

Hinkle (ph): Hi. I was wondering if you can give us more detail on the mortgage banking income side in terms of how gain on sale (ph) loans compared to last quarter and how much of the decline in income was related to the servicing amortization?

We certainly did - you know, we certainly did have some write offs of our servicing assets during the quarter, Kelly. But just to give you an idea of you know the size of our servicing business, our servicing asset is $1 and-a-half million . . .

A little bit more . . .

So right around that number. So it's not exactly a large issue for us.

Yes.

The gain on sale of loans if I were to give you - let's see now, the gain on sale of loans was about $75,000 better in the third quarter of this year than it was in the prior year. The amortization of the servicing asset which would include any write downs was $160,000 greater in the third quarter of '02 as compared to '01.

Hinkle (ph): OK.

But we certainly did - we did have a hit to our servicing asset in the third quarter as you can well expect given where you know where mortgage rates are at the moment. But we don't seeing a substantial issue for us going forward.

Hinkle (ph): OK. I was wondering if you could also give us a color on your thoughts about loan growth in the coming quarter?

Well, loans have grown at a little north of six percent thus far . . .

Hinkle (ph): Yes.

. . . year to date. I mean I originally established for this year loan growth in the region of six percent for the entire year. So, it was quite good in the second and third quarters.

You know, going forward, I - you know six to seven percent annualized loan growth is I think a reasonable rate for us. Our fourth quarter should be reasonably good again on the residential side given that - given where market rates are and given what we know that we have in application volume.

Commercial lending, we also have a very good pipeline at the moment. You know I've said this before and I'll say it again the commercial people tell me that they're as busy now as they've ever been. The difficulty is turning some of those projects you know closing the loans as opposed to just having them in process state.

So, we expect reasonably good loan growth in the fourth quarter. But, looking into next year, I would expect a six to seven percent annualized loan growth.

Hinkle (ph): OK. Great. Thank you.

Sure.

Your next question is from Dan Varner (ph), The Bank Fund (ph).

Varner (ph): I was wondering about your views on - you guys have kind of maintained a - or kind of had a target capital level as you've operated throughout the years and I'm wondering if your views on that has changed given the uncertainty in the economy. And if it hasn't do you anticipate doing some sort of buy back say middle of next year if things stay the same?

Dan, this is Dennis Sheahan here. We have targeted you know a tangible equities assets level of between five-and-a-half and six percent. And we're pretty close to that level. You know at this point and time I think we'll be there at year end or early next year.

And the reason for that is - the reason that our tangible equities assets was under a degree of stress is due to the branch acquisition and we actually ended up acquiring 16 branches when we originally planned to acquire 12. So, that put a degree of stress on our capital ratios.

Certainly, when we're in the realm of five-and-a-half to six percent tangible equity you know we would consider doing a stock buy back. That doesn't necessarily mean that we would. But we will look at stock buy back and/or increased dividends when our capital is at that level.

Varner (ph): OK. Thank you.

Sure.

At this time I would like to remind everyone in order to ask a question, please press star then the number one on your telephone keypad . . .

Your next question is from Chris Mistassio (ph) of Legg Mason.

Mistassio (ph): Hi. Good morning, gentlemen.

I apologize. I'm late on the call. I was on another one. So, you've probably answered this already, and so, again, forgive me on that.

Dennis (ph), could you give me the margin outlook? You actually came in stable during the quarter versus second quarter, which was somewhat surprising to us. I thought you'd be down in the quarter. Can you kind of rehash what you're looking for fourth quarter into 2003, given maybe a cut from the fed, here, in the next couple of months, and then, maybe some tightening in the fed - by the fed, say, mid next year?

Sure. You know, we did a pretty good job, I think, of maintaining the margin in the third quarter. I see - and we spent a lot of time on this, obviously. With the margin as wide as we have, we do what we can in the current period to try and protect the margin in the coming quarters. The fourth quarter net interest margin I see probably declining probably five basis points, or so, to the mid-480s (ph). Beyond that, next year, of course, the future is cloudy. As there are rate cuts coming, will rates increase?

But, I think even in a steady state environment, our net interest margin will compress. And when I say that, the reason for it is, obviously, assets will continue to re-price at these low levels. And, how much more can we take out of borrowing costs and other costs of funding - deposit costs - to offset that decrease?

I think it will be a challenge to continue to maintain the margin in the 480 to 490 range. I would see us gradually getting towards the 450 to 460 range by the end of next year.

Mistassio (ph): (INAUDIBLE) put it a different way as well. Looking on a net interest income dollar basis - I mean, if you have the margin compresses, you know, 30 to 40 basis points over the course of the year. But, looking at your loan growth assumption, or, you know, your thought process of six to seven percent, or so, next year, are we looking at still some slight growth in net interest income dollar amount for the year?

Yes. Yes, I think so, because the challenge will be you have to continue to grow earnings with a declining margin. Net interest incomes should grow, you know, modestly, and our challenge will be to - on the operating expense line, what can we do to make ourselves run the organization more efficiently?

Mistassio (ph): Right.

So, you know, growing the balance sheet in conjunction with growing non-interest income, and trimming non-interest expense where we can is what we'll do next year in terms of growing earnings.

Mistassio (ph): OK. And if I can follow up with one question? On the asset quality front, it looks like non-performing loans were, you know, about 3.6, 3.7 million in the quarter. Now, you sold off the rest of WorldCom - is that correct?

Yes.

Mistassio (ph): So, you have, I guess, some slight pressure in the quarter. Your numbers, actually, still look extraordinarily good. Where are you seeing that - you know, the little bit of pressure you saw in the quarter versus second quarter, in terms of non-performing loans?

You know commercial real estate increased modestly in the non-performing category. You know, nothing has any great significance - a couple of small loans. So, it was in the commercial real estate area.

Mistassio (ph): Right. And it looks like net charge-offs (ph) are still around 10 basis points, or so, which is unbelievably low.

Yes.

Mistassio (ph): OK. I appreciate your time. Very nice quarter.

Thank you.

At this time, there are no further questions.

Thank you and we look forward to talking to you for our fourth quarter 2002 earnings conference call.