Independent Bank Corp (Massachusetts) (INDB) 2003 Q1 法說會逐字稿

Good morning. My name is Jeff and I will be your Conference Facilitator today. At this time I would like to welcome everyone to the Independent Bank Corp. First Quarter 2003 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. If you would like to ask a question during that 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. I would now like to turn the conference over to Denis Sheahan, Chief Financial Officer. Please go ahead sir.

Thank you. Good morning and welcome to the Independent Bank Corp. First Quarter 2003 Earnings Conference Call. With me on the call today, are Doug Philipsen, Chairman of Independent, Chris Oddleifson, President and Chief Executive and Berry Gensimen (ph.), Rob Gazona (ph.) of our Finance Department.

First, I'll review the agenda for this morning's call. I will begin by reviewing the First Quarter 2003 Earnings Release. This will be followed by a comment by Chris Oddleifson, our Chief Executive Officer, regarding his early impressions of Independent Bank Corp, our colleagues and the market in which we operate, as well as his thoughts on the first quarter performance and outlook for the future. I will then come back on the call and give guidance regarding expected trends in loan growth, non-interest expense, the net interest margin, the provision for loan losses, as well as the provision for income tax. That will be followed by a few brief comments by Doug Philipsen, our Chairman, and then we'll open up the call to questions.

Before I review the first quarter results, I will read 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.

And now I'll review the earnings release. Independent Bank Corporate reported net income of $2.4 m; a decrease of $4.4m or 65%, from the quarter ended March 31, 2002. This represents diluted earnings per share of 17 cents for the first quarter of 2003, as compared to 42 cents in the same period a year ago. Both periods include unusual items or adjustments that I will now explain, to hopefully provide you with an understanding of the normal run-rate of the organization.

The first quarter of 2003 was negatively impacted by a retroactive change to Massachusetts tax law, which resulted in a charge of $4.1m after tax, or 28 cents per share. This charge is captured entirely in the provision for income taxes in this quarter. This quarter also include the modest $247,000 of pre-tax security gains.

The first quarter of 2002 was affected by the following unusual items. The company adopted the statement of financial accounting standards number 147, entitled Acquisition of Certain Financial Institutions, in the third quarter of 2002. This accounting standard provided for the non-amortization of good will, effective January 1, 2002 and requires the prior period to be adjusted to reflect the new standard. The impact of this adjustment is an increase of $443,000 to net income or 3 cents per diluted share in the first quarter of 2002. In addition, the company wrote off $738,000 net of tax of un-amortized issuance costs, related to the redemption of trust-preferred securities, as a direct charge to equity in the first quarter of '02, in accordance with GAAP. This charge, while not recorded in net income, is included in the calculation of earnings per share. Aside from the recharge already discussed, the primary factors in the first quarter's performance were the net interest margin and increases in the salary and benefit expense. I will review each in further detail in a moment. First, I will review balance sheet changes for the quarter.

Investments increased by $26m or 4%. Purchases and reinvestments of run off, was concentrated in mortgage-back securities and to a lesser extent, municipal securities. Management continued to focus on shorter, average life securities; this along with the dramatic shift in the yield curve, leads to a lower yield on the securities portfolio. Loans grew by $42 m, or 3% for the first quarter. The increases were mainly in commercial and industrial, residential real estate and commercial real estate loans, which increased $13.9m or 9%, $13.5m or 5% and $13.4m or 3% respectively.

The bank's loan portfolio, grew by a $161 m, from March 31,2002, to March 31, 2003. Adjustable rate loan products grew by a $164m for this period, while the fixed rate loan portfolio, decreased by almost $4m during the same period. This excludes fixed rate commercial real estate loans, even though the majority of these loans are written to reprize, five years from origination. This emphasis on shorter term securities and adjustable rate loans, as well as a lower treasury yield curve, has resulted in a decrease to the net interest margin, to 4.52% in this quarter, from 4.90% in the first quarter last year. This management team believes its asset generation philosophy, will create long-term value for our shareholders.

Total deposits of $1.7 b at March 31, 2003, were consistent with year-end 2002. However, core deposits increased by almost $10m or 1%, which enabled the company to manage down the balance of the more expensive time deposits, by $9.5m or 2%, contributing to a reduction in its overall cost of funds, from 2.26% to 2.09%, from the fourth quarter 2002 to the first quarter 2003. Asset growth was funded with increased levels of short-term borrowings.

And now, the income statements. The net interest margin for the first quarter of 2003 was 4.52%. Management anticipates that the net interest margin will contract in the coming quarters, as assets continue to re-price at historically low levels, without a corresponding decrease in rates paid. My expectation for the net interest margin for the remainder of this year, is a gradual contraction towards 4.4%, and possibly high 4 30's by the fourth quarter. Non-interest income improved by $446,000 for the first quarter of 2003, due to a combination of security gains; $247,000, mortgage banking income, which increased $400,000 and service charges and deposits, which improved by $300,000. The balance of the mortgage-servicing asset was $2.2m and loans serviced amounted to $374 m, as of March 31, 2003. Investment management revenue decreased $600,000 or 36% through the general performance of the equities market and higher estate and trust distribution fees of $0.3m experienced during the first quarter of 2002. Non-interest expense increased by $1.1m or 7% in the first quarter of 2003 as compared to the same period last year. The primary contributor to the increase was in salaries and benefits, $1.7m or almost 19%.

Salaries increased due to normal merit increases as well as in four specific areas. First, the company is carrying salaries for both the chairman and a chief executive. One of these salaries will be eliminated upon Doug Philipsen's retirement at the end of June 2003. Second, management has expanded the compliance function due to increase activity in their lending businesses as well as to address customer privacy initiatives. Third, the marketing function has expanded. We believe this will better position the company for future revenue growth through improved intelligence regarding our customers and our market area. And fourth, we've improved controls in our IT function, specifically in the areas of IT risks, IT security and disaster recovery.

Employee benefits increased due to various market driven insurance coverage increases and payroll taxes associated with salaries, commissions for the mortgage business and additional accruals associated with an executive retirement plan. This cost specifically amounted to $250,000 in the first quarter and is attributed to changes in tax law associated with split dollar life insurance policies. And similar levels will exist for only the second quarter.

Occupancy expenses increased primarily due to the extraordinary winter and are recognize by increased utility and snow removal costs. Other non-interest expense decreased by $686,000 or 14% due to decreases in consulting, advertising and executive recruitment.

Asset quality --non-performing assets represented 18 basis points of total assets at March 31'03 or $4.1m. Total reserves for loan losses, which we define as the amounts for loan losses and the -- plus the credit quality discounts on the acquired loan, as a percentage of total loans with 1.52% at March 31, 2003. Delinquencies continue to be low and management does not see negative trends in asset quality. Net charge offs for the quarter was $393,000.

Pension expense. As discussed in the earnings release, management anticipates a pension expense charge of $1.5m effective July 1st 2003. The impact on 2003 earnings is expected to be $750,000. Management expects to wholly or partially mitigate the impact of this charge to earnings through a combination of revenue enhancements and expense reductions. I will now turn over the call to Chris Oddleifson, our Chief Executive Officer for a few comments. Chris?

Thank you Denis and good morning. Before I comment on Q1 I would like to share a couple general observations, then my sense for the company and our future. I joined at Independent Bank Corp and Rockland Trust Company just a few days over three months ago and I am in my eighth week as CEO. I spent the majority of my time in extensive meetings with senior management team, individually and collectively, meetings with department heads throughout the bank, meetings with their teams, as well as with customers, legislators, and other community leaders. The purpose of these meeting was to simply to get up to speed on the bank's performance, structure, the issues and opportunities and begin to establish important relationships outside the bank. I believe I covered a great deal of ground and I think I have an increasingly good handle on the organization, the culture and our performance.

One of the things that I observed over and over again, and all the news I've had within the bank is that my colleagues here at Rockland Trust Company truly care about making a difference--it came up repeatedly. We've been making difference to the customers, the community in which we live, to each other, and to the performance of the bank, to our shareholders. And there is a very clear alignment side, a clear understanding that they need to perform; they need to produce results for Independent Bank Corp. to remain healthy, grow, and to remain independent. There is also a high degree of energy to pursue sound growth and a willingness throughout the bank to work hard to accomplish this growth.

The reason I find this all worth sharing with this morning is that in my experience --this very important [inaudible] to performance, cannot be [inaudible] but it has to be earned over time by the management and culture of the company and it is often so lacking in other institutions, including some of our major competitors. This culture gives us gradually is -- an important element of competitive strength.

I also spent some time looking at our market, South Eastern Massachusetts and Cape Cod and my conclusion was in short, that we are in great place to do the business and a place that many community bankers would love to operate. Here are just a couple factoids that I thought was worth sharing this morning --it led me to believe that we have a good growth potential.

The growth in the number of businesses in our twelve markets, Clement [ph] and Barnes McCloney [ph], has outpaced the state average over the last six years. This is according to the Massachusetts Department of Economic Development and that state department believes the trend will continue, specifically between 1996 and 2002 Massachusetts – the number of businesses have increased 9.9 % and this is verses 11.2 in Barnes McCloney [ph] and 12.3 in Clement [ph] so a sizeable increase over the state run rate.

That would be expected when the you infer a base grow, start at number of jobs located in our markets and over the last six years the rate of job growth in our market has significantly outdone the state average as well, but the (inaudible) trend is expected to continue. Interestingly the job growth in Massachusetts was 8.1% and Clement 10.4, Barnes McCloney (ph.) 3.9.

The increased population growth in our core market should also help to continue to support the growth of our retail franchise. Both Clement and Barnes McCloney [ph] are expected to outpace the state population growth over the next seven years. When you look at the projections in 2010 the Clement growth rate is 1.3 times the state average and Barnes McCloney is 2.5 times the state average, so there's fundamental growth. In addition, there are some good transportation works that has been completed in the (inaudible) region that will facilitate growth in our markets. We've talked about this before, but it's just reminding everybody of existing commuter rail lines that extend south of Clement and Middleborough, the potential restoration of a third railway. Route 44, which is a major east west highway in our region, is being relocated and expanded. There's a potential of widening route three. All these things support the --- our regional growth.

Overall my sense of our future prospect is strong. I believe that there's opportunity in each one of our major lines of business. In the commercial business strengthening for the in market and moving to adjacent markets moving west, small business as a traditional strength of Rockland, and I think is right for some additional focus efforts that could tell some good, sound growth. The consumer market as we expect is growing at a good clip and investment management we're having good success, even with the poor marketing conditions and it looks like momentum is building.

That's my overall sense. Let me talk a little bit about first quarter results. I'm not going to repeat any of Denis's points, but I would like to make a couple observations.

The first observation on the salary benefit growth, as I'm sure it did for you, the growth number jumped right off the page for me. And as Denis did a nice job laying out - - what were the primary drivers of this growth are, in my mind, these are a result of Rockland Trust Company reaching a scale where we needed to strengthen certain operational areas. And it's just that investment was absolutely required. However, the net income add impact of these adds, needs to be offset by efficiencies gains elsewhere, as well as incremental revenue growth to grow into those strip costs. Certainly as Denis pointed out, we are clearly entering a period of margin compression and this also leads to need for incremental revenue growth. And lastly I believe we need strengthen our (inaudible) component of our income statement.

The – wrapping this all up what made the market work with the team here, so far these teams believe that Rockland Trust Company is well seated for growth not only because of the rising tide, but also because our cultures aren't of the making a difference in your stock and is really receptive to responsible incremental growth. And I anticipate that over the next several months I'll be working very, very closely with the team, the management team here, as well as others throughout the bank to build upon our solid foundation and establish ways to expand our franchise within not only our existing footprint but also in our adjacent periods.

One last comment before I turn it back to Denis is that I'll like to make sure Doug Philipsen and I have been working very, very closely together since before my arrival on January 9, to effect a smooth transition and that transition internally, is largely complete and externally it is going very, very well. Denis, thank you. That completes my comments.

Thank you, Chris. I will now provide some information on guidance. As discussed in our last earnings conference call, management will not provide specific earnings per share guidance due to our desire to focus on long term and not short-term performance. However I will now share with you our outlook for certain key items in 2003. First loan growth, the first quarter experience extraordinarily good loan growth when considering the poor weather in the region. It is my expectation that much of this growth is from the fourth quarter pipeline and the weather impact may actually be felt in the second quarter.

I still expect good Q2 loan growth, but not necessarily at the same pace as the first quarter. For the year I anticipate loan growth in the region of 6% to 8% with the strong possibility we'll fall the upper end of that range. Non-interest expense all provided the quarterly trends of non-interest expense. First quarter actual's $18.4m, second quarter $18.8m, third quarter $18.4m and fourth quarter $18.4m, respectively. The net interest margin, as previously discussed, I expect contraction toward 4.4% by the fourth quarter and possibly the high 430s. I must qualify this statement by mentioning that the Financial and Accounting Standards Board is expected to release a new standard in the second quarter, that would require the reclassification of minority interest associated with our trust preferred securities to the net interest margin.

Loan loss provision. Consistent with first quarter levels approximately $900, 000 to a million dollars per quarter. And finally the tax provision, I'm estimating at 33% for each of Q2, Q3 and Q4. I'll now turn the call over to Doug Philipsen, our chairman for a few comments.

Thank you Denis. As previously mentioned, Chris assumed the CEO title of Monday, February 24th, this year. Subsequently I have been entirely focused on assisting him with accomplishing a smooth transition. Smooth transitions at the CEO level simply don't occur on their own. It takes a great deal of thought and planning on the part of the outgoing as well as the incoming CEO.

I would like to repeat a portion of the statement that I made when introducing him at our annual meeting of shareholders held last Thursday, April 10th in Plymouth, Mass. And I quote, "Chris is about two years younger than I. However, he has already had more business experience to date than most executives obtain in the course of a full career."

I consider myself to be privileged to have been associated for nearly 12 years with exceptional colleagues and an outstanding board of directors. I am delighted that the board chose Chris as my successor. Coupled with a very favorable demographics in the marketplace in the south and eastern Massachusetts and Cape Cod, I believe the future is bright for Independent Bank Corp. And I would just like to correct the error I made, Chris is not two years younger than I.

Thank you Doug. For pointing that out to me.

He aged considerably.

Thanks Doug. 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.

The first question comes from Jared Shaw of KBW.

Good morning gentlemen.

Good morning Jared. Hi Jared.

I had just a few questions for you. First, can you give a little detail on your NBS portfolio? Specifically, I guess, what you have been buying on this past quarter and what your gross un-amortized premium is on portfolio?

Sure. Rob you want to take over buying and I look up the premium.

Sure. We've been concentrating on primarily 15-year collateral, Jared. When we have the opportunity we've been also looking at 10-year collateral. If we are not buying just collateral, we are buying well-structured CMO sequentials and pack one.

Jared, why don't you move on to your next question and we will get the answer for you on the unadvertised premium and mention it before the end of the call.

Sure, okay. I guess the second question is the mortgage banking pipeline could you comment on what you are seeing in terms of current loans that are in the process of being refinanced or current new origination or new purchases?

Sure, I mean our mortgage banking pipeline remains very strong. I think we are all aware of the refund and how high the index has been recently. And we are, you know, we will benefit from that just like many of our competitors. But we have a strong mortgage pipeline; you know right around record levels. I'm not sure if that answers your questions. Is there any thing specific other than that that you are looking for Jared.

Yeah, I guess so it has been just as strong as it has been at any point of during the last few months.

Absolutely, yes.

And can you just give an update on the tax situation and I guess what your specific – where you are in the trend in the line of trying to appeal the new tax law?

Well we and most of the other financial institutions believe that, you know, we understand and respect the commonwealth's, you know, right to the change the tax law. The problem I think that most of the financial institutions have with this is that the change was retroactive in nature. And that being retroactive 1999 trough 2002, when the law went into effect in the first quarter of 2003. We believe that it is unconstitutional and we – you know, independently as well as looking what other institutions plan to do; are looking to appeal it. However, that said, you know, we will do everything in our power to try and come to some meeting of the mind with the commonwealth on this issue. But at this point it is early on to say which way that this is going to go. But clearly we think that it's something that was unconstitutional and we plan to fight it.

Okay great. Thank you very much.

Jared, the net on amortized premium, Rob is this it?

$1.6m

And that's net of (discounts)?

That's right.

Do you have the gross number there?

$3.2m

Great thank you very much.

Sure.

Your next question comes from Chris Mutascio with Leg Mason.

Good morning gentlemen, Denis a couple of quick questions. You've long said that the normalized margin for the company is around a 440 measure, I didn't expect you to get close to that so quickly, can you talk about anything that you did in the quarter to protect the margin longer term and thus sacrificing year term margin? And then second of all—you have to forgive me I've been hopping on and off conference calls all morning long, when I hopped on you were talking about a charge that you would overcome with revenue enhancement and expense saves or flash expenses maybe I misinterpreted what you said, what you said. Can you kind of elaborate a little bit on that for my getting in on the call so late?

Yes sure Chris. First of all on the net interest margin yes management as been indicating for some time now how the net interest margin would contract and we have indicated in the 440 range for sometime. We still believe that we think that by the end of the fourth quarter the things that we have been doing for a long period of time here to protect the net interest margin for the long term is focusing on adjustable rate lending and the purchase of shorter term securities. Rob mentioned in the first quarter yes, we focused on some mortgage fact security particularly in the 15 year range but prior to this we have increased the size of our agency portfolio from I want to say $70m in the fourth quarter in 2001 to about $180m at the end of 2002, that really, you know, with the focus on reinvestments of those cash flows when they mature, when rates begin to kick upward. That will protect our net interest margin for the long term. So a combination of those adjustable rate lending and securities portfolio purchases has -- they've brought a contraction in their net interest margin pretty rapidly in the first quarter. But they allow us to focus on the long term. The second part of your question Chris pertaining to the charge that we will take in the second half of this year pertains to our pension plan and we expect to take a charge of $1.5m pre-tax in July, that will be amortized over a 12 month period through June 30th of 2004. So the impact gross is $750,000 in the second half of 2003.

However, we already have under way and will continue to do so, our plans to look at our expense levels to try and get as much efficiency as we can to wholly or partially offset that charge. The second part of that is revenue enhancements. We are working very hard to see what we can do on that front to offset, not just this charge, but other increases to salaries and benefits that both Chris and I have already alluded to as part of this call.

Okay, thank you.

At this time I would like to once again remind every one in order to ask a question please press star then the number one on your telephone keypad. Your next question comes from Kelly Hinkle of McConnell Budd & Romano.

Hi there.

Good morning.

Could you just repeat what you said the retirement accruals were for the first two quarters of this year? (Inaudible) $250,000?

Oh the executive retirement, yes. This is a supplemental executive retirement plan and first quarter was $250,000, the second quarter will be $250,000 and we expect that that accrual will no longer – we will no longer have additional accruals in third and fourth quarter 2003.

Okay, secondly can you just explain for me how you are managing to keep the tax rate around the same levels as last year besides the on going REIT.

Sure, I'll be happy to. We anticipated that this REIT issue, I mean may impact the curve, you know, we have been disclosing it for some time in our SEC filings. And so, I guess the writing was on the wall in terms of the REIT. So there are other vehicles that financial institutions have available to them to effectively manage our state income tax position. And we began a process of, you know making adjustments to how we manage the balance sheet to take the maximum efficiency available to us. So we redistributed assets into other vehicles that we have to minimize that state tax obligation. We actually anticipated that our tax provision would decrease from-- I think we were ballpark 33% last year. We anticipated that it would decrease to some where in the region of 31.5 for 2003. Obviously with the REIT happening that will not take place. So we are estimating again 33% for 2003.

Okay, so this is – is this taking advantage of securities corporation?

Yes.

Alright, that's it. Thank you.

At this time there are no further questions.

Thank you and we look forward to speaking to you again following our second quarter 2003 earnings release.

This concludes today's conference call. You may now disconnect.