Independent Bank Corp (Massachusetts) (INDB) 2003 Q2 法說會逐字稿

Good morning. My name is Latoya, and I will be your conference facilitator today. At this time I would like to welcome everyone to the Independent Bank Corp. second quarter 2003 earnings 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 1 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.

Thank you. Good morning and welcome to the Independent Bank Corp's second quarter 2003 earnings conference call. With me on the call today are Chris Oddleifson, president and chief executive of Independent and Barry Jensen and Rob Cazone of our Finance Department.

This morning's agenda will include a review of the second quarter 2003 earnings release followed by comments by Chris Oddleifson, our chief executive. I will then provide guidance regarding expected balance sheet and income statement trends. We'll wrap the call up with a Q&A period.

Before I review the second quarter results, I will read the cautionary statement. This conference call may contain certain forward-looking statements with respect to the financial condition and 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 a review of the second quarter earnings release.

Independent Bank Corp reported net income of $9.2m, an increase of $4.9m from the quarter ended June 30, 2002. This represents diluted earnings per share of $0.63 for the second quarter of 2003 as compared to $0.24 in the same period a year ago. Net income and diluted earnings per share for the six months ended June 30, 2003, were 11.6m and $0.79, respectively.

Each period includes unusual items or adjustments that I will now explain to hopefully provide you with an understanding of the significant variances recognized. First, a favorable item occurred during the current quarter; namely, the company's recognition of a $2.1m after-tax credit to the provision for income taxes due to settlement of a state tax dispute. This equates to a benefit of $0.14 per share in the current quarter, and this credit follows a charge of 4.1m after tax, or $0.28 per share recorded in the first quarter of 2003 for the same tax dispute.

Second, in the second quarter of 2002, the company experienced an unfavorable item when it recognized a $2.5m charge, net of tax, or $0.17 per share for a write-down of WorldCom bonds. 2002 was also 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 goodwill effective January 1, 2002, and requires that prior periods be adjusted to reflect the new standard. The impact of this adjustment is an increase of $444,000t to net income, or $0.03 per diluted share in the second quarter of 2002, and $887,000t to net income, or $0.06 per diluted share, for the first six months of 2002.

In addition, the company wrote off $767,000t net of tax, or $0.05 per share, in the second quarter of 2002 and 1.5m net of tax, or $0.10 per share, for the first six months of 2002 of unamortized issuance costs related to the redemption of trust preferred securities as a direct charge to equity in accordance with GAAP. This charge, while not recorded in net income is included in the calculation of earnings per share.

Balance sheet changes from the first quarter of 2003 to the second quarter of 2003 -- investments increased by $20m, or 3%. Purchases and reinvestment runoff were concentrated in mortgage-backed securities and, to a lesser extent, agency securities. We continue to focus on shorter average life securities. The weighted average life of the available for-sale portfolio, the largest component of the securities portfolio at $557m, is 2.4 years. This is indicative of management's intent to retain the securities portfolio that is short in duration at a time when rates are at historical lows. Needless to say, this has a detrimental impact to the company's net interest margin and current period earnings, yet management views this position as important for long-term interest-rate risk management.

Loans grew by $49m, or 3%, for the second quarter. The increases were mainly in commercial and industrial, residential real estate, and commercial real estate loans, which increased 5.8m, or 4%; 20.1m, or 7%; and 20.7m, or 4%, respectively. The growth in residential real estate is concentrated in three- and five-year adjustable rates and 10-year fixed rate lending. The commercial loan and commercial real estate growth continues to be driven by the rate environment, the characteristics of the market in which we operate, and a solid group of experienced commercial lenders. Consumer lending, while growing in the home equity category, is essentially flat due to run-off in the indirect automobile loan portfolio.

Total deposits of $1.76b at June 30, 2003, grew by $75m, or 4%, during the second quarter. Core deposits grew by $79m, or 6.5%. A portion of this growth is due to increased balances in loan closing attorney accounts as a result significant refinance activity. The remaining asset growth was funded with increased levels of short-term borrowings.

And now the income statement -- the net interest margin for the second quarter of 2003 was 4.47%. Management anticipates that the net interest margin will contract in the coming quarters as assets continue to reprice 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 gradual contraction in the region of 10 basis points per quarter. This excludes the impact of minority interest, which will likely be reclassed into net interest income upon the company's adoption of FAS 150 in the third quarter of this year. The adoption of this new standard will not impact earnings but will have a negative impact on the net interest margin of approximately 20 basis points.

Non-interest income improved by $873,000t for the second quarter of 2003 as compared to the same period last year due to a combination of increased service-charge revenue, $387,000t; mortgage banking income, which increased $381,000t; and other non-interest income, which improved by $224,000t due, in large part, to loan prepayment fees on commercial and installment loans.

The balance of the mortgage servicing asset was $2.3m and loans serviced amounted to 393.4m as of June 30, 2003. Security gains were $2m in the second quarter of 2003. In an effort to improve Rockland's overall interest rate risk position as well as to offset compression in the net interest margin, the bank prepaid $31.5m of fixed high-rate borrowings and sold $20m of investment securities during the second quarter. The prepayment penalty in the borrowings totaled $1.9m, while the gain in the sale of securities was $2m. This should not be construed as a major balance sheet repositioning; rather, in anticipation of the fed cut, this strategy swaps the fixed-rate bonds to floating and helped us to absorb the impact on earnings and the net interest margin of the repricing of all our prime-based assets. This proved to be important, given our limited ability to move lower on deposit rates.

Non-interest expense decreased by $4m, or 18%, in the second quarter of 2003 as compared to the same period last year. This decrease is mainly due to the pretax $4.4m charge taken in the second quarter of 2002 on an investment in corporate bonds issued by WorldCom. Excluding this item, non-interest expense increased by $370,000, or 2%.

Asset quality -- nonperforming assets represented 12 basis points of total assets at June 30, or $3m. Total reserve for loan losses, which we define as the allowance for loan losses and the credit quality discount on the acquired loans, as a percentage of loans was 1.5% at June 30, 2003. Delinquencies continue to be low, and management is not seeing negative trends in asset quality. Net charge-offs for the quarter were $382,000.

Pension expense -- as discussed in the first quarter earnings release, management anticipates a pension expense charge of $1.5m effective July 1, 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 reduction.

I'll now turn the call over to Chris Oddleifson, our chief executive officer, for a few comments.

Thanks, Denis. Good morning, everyone. I'd just like to add a couple of points of emphasis to Denis's thorough description of our financial performance, and I also would like to then make a few comments about my perspective of the future of Independent Bank Corp.

We have anticipated our net interest margin decline for quite some time now, and our objective in -- we've addressed this decline in three ways. First of all, as the numbers show, we've made up somewhat in more volume. The second is we've been very, very careful with our expense management. I would characterize our expense management effort as relatively easy saves, and our primary objective in this effort was to preserve our ability to generate revenue and not take any risks in that regard. And the third area in which we counteracted the decline of the margin is to emphasize a short-term opportunity in mortgage banking. With interest rates so low, there is a lot of short-term income opportunity, and we're taking advantage of it. We do recognize that this will not continue forever, but we're making hay as the sun shines, as the saying goes.

Looking forward, at our last earnings call, I described, as a new CEO, what I found attractive about our markets and about the company. I'd like not to rehash all that, but I would like to summarize it. Our primary markets, Plymouth and Barstow Counties, have shown good growth in the number of jobs and the number of businesses, population, over the last several years, and this trend is expected to continue -- way outpace the rest of the state and much of New England. We have a lot of road and rail infrastructure improvements that have been completed, and there are more on the drawing board and more underway, and this bodes really, really well for the overall growth of our primary market areas.

I also mentioned in our last earnings call that I found the culture at Rockland Trust Company to be one that really cares about making a difference not only to the customers but to the communities, to each other, and to the shareholders, and that there is overall -- I find a very high degree of energy to pursue sound growth. And thinking about pursuing the sound growth, we have found it useful over the last several months to use a simple -- what I'll call a "simple four-element framework," and I'd like to just briefly take you through each one of those, because I imagine, over the next several quarters, we'll be filling in some of our findings and insights that have come out of our work.

The first one starts with our mission and vision. I won't go over that today. I will say that, for the most part, there are words that you find recognizable in terms of missions and visions of other financial institutions, except -- so we haven't really focused on our words over the last several months, we've focused on the evidence and the stories in which we are really, truly living up to our vision and mission, and this has been very helpful and will continue to be helpful in the future, providing a beacon and a direction for our entire community here at Rockland Trust Company to drive forward.

The second element of the framework is in the economics element -- the economics in the firm. While we have done a good job over the years in understanding our profitability, we are taking it to the next level -- thinking more carefully about funds transfer pricing, cap and allocation. We are going to really begin to understand where we create shareholder value at a fairly discrete and low level, and where are areas in which we have some improvement that's required, and we'll be taking these measures down to the business, the divisions, products, customers, geographies, and this will really help us thinking about where we need to focus our improvement efforts and where we -- where investment is warranted -- so a very comprehensive view of the firm from the economic perspective.

The third element is a comprehensive business unit review. We have had that underway for quite some time here, and we'll continue to do that, refining it as we go, developing business scorecards, understanding our key capabilities by business unit, understand maybe some of our vulnerabilities, our opportunities, or our threats -- to have a good understanding where each business units stands in the scheme of the marketplace.

The fourth element is a market review, and that is having a fairly comprehensive understanding, both on the business and the consumer side, of our current market areas and adjacent areas in terms of market size, our penetration, our competitive posture, pricing posture, and the opportunities that yield from that work.

Those four elements -- the vision and mission, the economics, the business unit review, and the market review will lead to what we are calling a "growth agenda," going forward. I expect the first draft of this work will be completed by mid-fall. Of course, this is an ongoing, ever-evolving, ever-refining process, but I expect that the earnings call in the third quarter, or the fourth quarter earnings call, we'll be speaking more about what we've learned from this work.

In addition to the four elements leading to a growth agenda, there are a number of areas that we have jumpstarted -- just have -- we believe that there is opportunity based on what we see, and we've begun some work in that area. The first, as I mentioned, is the mortgage-banking arena. We think there is a near-term opportunity, and we have increased our fee income there, and we will anticipate that -- with the interest rates to improve over the next couple of quarters. But, as importantly as the next couple of quarters is in preparation of the incline in the interest rates. We are doing some work to look at how we can mitigate the impact of an increasing rate environment.

The second area that we are jumpstarting is in the smaller business arena. We have an initiative underway to take a look at how we can have some immediate impact in improving our value proposition business model and business approach to the smaller businesses in our marketplace. We believe that there is an opportunity to increase our performance there as well.

The third and last one is in the whole deposit arena. We have a number of tests -- product and pricing tests out in the marketplace, and we're watching how they are performing, and we will be rolling that out more aggressively as the results come in.

At our last earnings call, I shared my take on our future prospects out of this summary, and I said that I believed our prospects are very strong, and having been here for another three months, I still believe that to be the case, and there is actually significant opportunity in each of our businesses. Our commercial area is strengthening and moving west; small businesses, I've discussed; consumer, with a higher-than-average population growth, I believe we can improve our position there as well; and, of course, investment management, the trillions of dollars continues to flow from generation to generation. We have an excellent track record in our investment management group, and I believe we can leverage that as well.

So all in all, I am very excited about our future. That's it, Denis.

Thank you, Chris. I'll now review some key balance sheet trends we expect over the next couple of quarters.

As discussed in the previous earnings conference call, management will not provide specific EPS guidance, due to our desire to focus on long term and not short-term performance. However, I will share with you our outlook for key items for the remainder of 2003.

First of all, loan growth. Loans grew at 6.4% for the first six months of the year. I expect total growth for 2003 to be in the region of 10%. Non-interest income -- we expect third and fourth quarters to be approximately $6.7m per quarter. Non-interest expense -- second quarter 2003 actual was 18.1m. We expect a fairly consistent level in the third and fourth quarters. Net interest margin, as previously discussed, we expect a 10-basis-point contraction for each quarter remaining in 2003 and, again, this excludes an additional 20-basis-point impact due to the reclass of minority interest per FAS 150. The loan loss provision will be relatively consistent with second quarter levels, approximately 800,000 to 950,000 per quarter. And, finally, the tax provision we estimate at 32.5% for the remainder of the year.

This concludes the formal part of the presentation. I'll 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 1 on your telephone keypad. We'll pause for a moment to compile the Q&A roster.

Your first question comes from Kelly Hinkle, McConnell Budd.

Hi, Chris. Hi, Denis.

Hi, Kelly.

Good morning.

Hi. Chris, you spoke of some easy cost saves, I believe, and, Denis, you talked about mitigating the increased pension expenses with these cost saves. Could you just talk a little bit about them -- where they're going to come from or coming from?

Sure, Kelly. This is Denis. As Chris mentioned, they're sort of the easier cost saves, because we're not taking actions that would, you know, for example, make a random percentage decrease of staff or anything of that nature, because we're focused on revenue growth. But there are areas like consulting; some occupancy costs that we're looking at very hard; office supplies; those kinds of things and trimming some of the smaller employee benefits in an effort to offset what we believe is a very important benefit, which is our defined benefit pension plan.

Okay, thank you, and I guess, you know, we saw some of that this quarter. You sort of beat your projections on the expense side, so that's great. Thanks.

Yeah, and, you know, we're going to continue to focus very attentively to the non-interest expense line over the remainder of this year and well into 2004 because beyond the pension expense, we have, as you all know, margin compression, and we want to make sure we're doing the right thing on the expense line.

Thank you.

Sure.

If you would like to ask a question, please press star, then the number 1 on your telephone keypad.

Your next question comes from Chris Mutascio, Legg Mason.

Hi, Denis. Hi, Chris, how are you guys?

Hey, Chris -- well, thanks.

I've got a couple of quick questions and maybe a follow-up to the previous question before that -- the balance sheet again -- there was a significant restructuring, but I noticed at the end of the period, federal home loan bank borrowings and investment securities were still up over first quarter despite the fact you prepaid some fixed borrowings, and you sold 20m of investment securities. Can you give me your thoughts a little bit on that? I maybe expected some of that to come down with a little bit of the restructuring going on. Or is that part of the offset to the pension costs just alluded to? Is it this plus a little bit lower provision expense? Because your provision expense is well in excess of your net charge-offs. And then, you know, thirdly, some revenue growth -- you have almost a combination of the three offsetting the pension charges coming in third quarter.

First of all, Chris, I'll take the one on the pension expense first. The size of the securities portfolio has nothing to do with offsetting pension expense. That is not part of the answer to that question at all. The part of the -- the way I can answer the size of the securities portfolio is for the remainder of the year, we expect our securities portfolio to remain around this level, and actually we had securities set right at the end of the quarter that was preinvestment for the third quarter. So there is perhaps some timing there that you are seeing. But none of it was associated with the pension expense.

The pension cost will be absorbed, not just through non-interest expense reductions but also through the non-interest income enhancement that you've seen so far, particularly in mortgage banking and service charges and deposits, as well as overall normal balance sheet growth. There is no aspect of leverage here to cover pension costs in the securities portfolio.

Does that help answer your question?

It does. I was just looking at -- I mean -- it seems like you're still having some growth in the investment securities portfolio, but you're saying that some of the growth that maybe occurred at the end of the quarter was really earmarked for third quarter?

Yeah, and what I'd also say to you is the securities portfolio is actually lower. There were times during last year that the securities portfolio was about $750m. So it's lower now than it was at that point in time, and that's, frankly, managed because, you know, we've had pretty good loan growth and, to the extent that we can grow loans and lower the securities portfolio, I'm all for it.

Right, right.

For the remainder of -- our earning asset growth for the rest of the year will, by and large, be in the loan portfolio and not in securities.

Right, and how does that impact -- do you take that into consideration when you look at the margin? In other words, were you looking at 10 basis points or so each quarter of compression? If loan growth were to come in above your current expectations for the second half of the year, is that somewhat of a positive offset to maybe your 10 basis points of compression?

Yes, it would be. Yes, because -- in -- the level of our portfolio now at around $715m, there is going to be reinvestment of runoff, and that certainly will be detrimental to the margin. But to the extent that loan growth outpaces our expectations, it's likely we'd let the securities portfolio drop.

Okay, all right. Thank you, gentlemen.

Your next question comes from Albert Salvistano, FTN, Midwest Research.

Good morning, Denis. Good morning, Chris.

Good morning, how are you doing?

Good, how are you?

Good.

Chris, I was just wondering if you can comment on your transition and how is it going, so far, and if everything is meeting expectations?

That's a big question. I'd say that it's going very, very well. As you know, Doug retired just a couple of weeks ago, so I have moved into his old office. He continues to be a phone call away. My focus for the last several months has been meeting as many people as I possibly can in the company, in the community, and in New England -- not only the broader community, but the New England finance community. And it's coming along just fine. I feel like I'm drinking from a fire hose. I'm learning more and more each day. I'm very impressed with the folks at Independent Bank Corp Rockland Trust Company. As I mentioned in my comments, the clarity with which everyone understands the need to perform, to do well, to remain independent is -- the line of sight is very, very clear. As I anticipated, I am delighted to be here.

On a personal note, my commute to and from Charlotte has stopped as a couple of weeks ago. My family is in the area, so we're -- that transition is complete, too. Thanks for asking.

Great, congratulations.

Thanks.

There are no further questions at this time.

I'd just like to make a follow-up answer, I think, to one of Chris Mutascio's questions pertaining to the level of provisioning -- provision for loan losses. As I mentioned in the guidance part of the call, you know, we see the provision being in the region of 800,000 and 950,000 for the rest of the year, and that's somewhat contingent upon the level of asset quality for the rest of the year. We don't see any blips coming. We've a strong loan -- reserve to loan ratio and strong coverage of non-performing assets, and you'll see our coverage and NPAs at the end of the second quarter were something like eight times the level of NPAs. That can be somewhat misleading. When NPAs are as low as they are, you know, a $500,000 or $1m commercial loan can quickly change that coverage level. But, nonetheless, we continue to feel very positive about our asset quality, and we'll look for opportunities to decrease the provision for loan losses in the coming quarters, if appropriate. So, Chris, I hope that follow-up answers that part of your question.

Any other questions, Operator?

There are no questions at this time, sir.

Okay, thank you, everybody, and we look forward to speaking with you following our third quarter earnings announcement.

Thank you from me, too.

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