Independent Bank Corp (Massachusetts) (INDB) 2003 Q3 法說會逐字稿

Good day ladies and gentlemen and welcome to the Q3 2003 Independent Bank Corporation's earnings conference call. As a reminder, this conference is being recorded.

I would now like to turn the program over to your host for today's conference Mr. Denis Sheahan, Chief Financial Officer of Independent Bank Corp. Please proceed.

Thank you, Mike. Good morning, everyone and welcome to the Independent Bank Corp. Q3 2003 earnings conference call. With me on the call today are Chris Oddleifson, President and Chief Executive Officer of INDB and Barry Jensen and Rob Cazone of our Finance Dept. This morning's agenda will include a review of the 3rd quarter earnings release, followed by comments by Chris Oddleifson, our Chief Executive , and then I will give some guidance regarding expected balance sheet and income statement trends, and we'll wrap up the call with a Q&A period.

Before I review the third quarter result, I'll 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 event or otherwise.

I'll now review the earnings release. Independent bank Corp. reported net income of $7.5 million, an increase of 8% from the quarter ended September 30, 2002. This represents diluted earnings per share of 51 cents per share for the third quarter of 2003 as compared to 48 cents in the same period a year ago. Net income and diluted earnings per share for the nine months ending September 30, 2003, were $19.1 million and $1.30 per share respectively.

Balance sheet changes from the second quarter to the third quarter; Investments decreased by $10 million or 2% during the third quarter. Cash flow slowed during the quarter due to the changing yield curve and reinvestment was concentrated in short duration CMOs backed by 15-year collateral as well as agency securities.

Loans grew by $26 million or 2% for the third quarter. The increases were mainly in commercial real estate loans and construction loans, which increased $14 million or 3% and $10 million or 16% respectively. Loan growth for the nine-month period ended September 30, was strong and totaled $117 million or 8%. Commercial lending in particular has experienced solid growth due to a combination of the rate environment, our market, and our experienced lending staff. Total deposits of $1.8 billion at September 30, 2003, grew by $43 million or 2% during the third quarter. Core deposits grew by $41 million or 3%, and as a result FHLB borrowings decreased by $45 million.

I'll now review the income statement. Net interest income; The net interest margin for the 3rd quarter of 2003 was 4.17%. Management anticipates that the net interest margin will contract in the coming quarters as assets continue to reprise at historically low levels without a corresponding decrease in rates paid. The current quarter's net interest margin includes the impact of minority interest, which was reclassed into the net interest income upon the company's adoption of Statement of Financial Accounting Standards No. 150.

The adoption of this new standard did not impact earnings but had a negative impact on the net interest margin of approximately 20 basis points for the quarter. In accordance with SFAS No. 150, prior periods may not be restated upon adoption. Non-interest income improved by $2 million or 39% for the third quarter of 2003 as compared to the same period last year.

Due to a combination of increased service charge revenue, an increase of $390,000, mortgage banking income which increased $1.2 million; and other non-interest income which improved by $296,000 due in part to loan prepayment fees. The balance of the mortgage servicing asset was $3.1 million and loan service amounted to $405 million as of September 30, 2003.

Non-interest expense increased by $396,000 or 2%. The primary variances are attributable to increased pension and incentive compensation accruals, offset by a lower level of executive retirement benefits. Asset quality; Non-performing assets represented 13 basis points of total assets as September 30 of '03 or $3.2 million. The reserve for loan losses as a percentage of loans was 1.49% as of September 30, 2003, and delinquencies continued to be low. Management has not seen negative trends in asset quality. Net charge-offs for the quarter were $299,000.

I'll now turn the call over to Chris Oddleifson, our Chief Executive, for a few comments.

Thanks, Denis, and good morning, everyone. Denis did a good job describing our financial performance. I'd just like to add a couple points of emphasis, then make my comments about my prospective for the future. First, we have anticipated our interest margin decline for quite some time now, and as Denis outlined our objective in addressing this decline our major source revenue has been to really focus on strong loan growth, 2% increase in loans for this quarter and year to date of 8.2% represents that focus.

We've had good expense control, overall non-interest expense increased by only 2.2% for the comparative quarters. Salaries and benefits increased 2.6%, and that includes a reporting of a pension expense amounting to $375,000 and no pension expense was necessary in the same period of 2002. And an [inaudible] equipment expense decrease by 5.2% just to highlight a few. We've had good non-interest income growth, that improved 39% for Q3 primarily in the mortgage banking area. I want to address this again in a moment.

Service charge revenue improved posting a 15% increase over the comparative period. I want to point out that despite our declining margin we continued to enjoy a relatively high margin in the industry. We also continue to maintain outstanding credit quality with very low delinquencies and a very, very low net charge-off rate. As I think you all know, we have a very strong provisioning position.

And all in all despite an uncertain overall economic picture nationally, we have fared well. I'd like to turn my comments to the general outlook for our future growth. You may recall in our last call I discussed 2004, 2006 planning process that's underway that included work in several areas, both qualitative areas focusing on our customer promises, our promises to our community, our shareholders, and to our colleagues, but also spending some emphasis on better understanding the economics of our business at various [granuar] levels, taking a look at performance metrics by business units, doing a comprehensive review of the market, understanding customer needs, our market penetration, competitive position, and opportunities as emerged from that analysis.

What I would characterize as ,what is, emerging is while the prime practice is not done, I'd say what is emerging is a foundation strengthening, what I might call block and tackle base growth, with heavy emphasis on the customer. Let me give you a couple of examples to illustrate these two points. In our retail branch franchise we are introducing a score card, to give better visibility on performance on across operational sales efficiency and so on, and we're also developing improved sales and relationship management approaches, not only for relationships with customers but how things are managed, and the whole process.

In our commercial lending business we are adding one good lender at a time with an emphasis to the north, and west of our traditional core market, and as our loan growth shows, we're having some success there. What I'll coin for now in our smaller business banking, we're in the process of developing a lower cost platform so that we can originate smaller loans as well as depository relationships more economically than we do today.

In the mortgage area, we are expending product to the addition of new investors and we're adding to our origination staff and we have recently brought in new management, an experienced mortgage banker to run our residential lending area that is already having results, in mitigating the impact of a rising interest rates.

My last example for today is as we are also installing performance metrics, financial operational customer compliance, so on, to improve the tracking of our current performance and more clearly enhances accountability throughout the entire organization. Now, in ending I'll say that it's - I've spoken to them myself new, I've been here now for nine months. I've been very pleased with the energy of the INDB team. We're very focused on building on our solid set of fundamentals and I anticipate the track record of excellent performance continuing in the future.

Thank you, Chris. Before I provide guidance on some balance sheet and income statement trend for the fourth quarter, I just wanted to spend a moment discussing for those of you who may not have followed us for some time, you may be wondering why our income tax provision year to date is rather high. If you look at our pretax earnings through the first nine months of this year, we are up 17% but on an after-tax basis we're up 6%.

The reason for that is in the first and second quarters of this year we recorded a REIT settlement with the Massachusetts Department of Revenue that equated to about $2 million on an asset tax basis or 14 cents per share.

I'll now review some of these income statement and balance sheet trends for the fourth quarter of 2003. Loan growth. Loans grew at 8.2% for the first nine months of the year. I expect total growth for 2003 to be 10%. Non-interest income, our targeting $6 million in non-interest income for the fourth quarter.

The change in the mortgage banking environment, due to really the end of the refi boom, will cause a decrease in revenue in the fourth quarter. We're targeting non-interest expense to be consistent with the third quarter at around $18 million with a net interest margin should be in the region of 4% for the fourth quarter.

Loan loss provision is expected to be in the region of $700,000 and a tax provision at 32% for the fourth quarter.

This concludes the presentation and I will now open the call for questions.

The first question comes from Chris Mutascio with Legg Mason. Please proceed.

Good morning, Chris. Good morning, Denis. How you all doing today?

Good. Thanks.

A couple quick questions, Denis, you were alluding to it in terms of fourth quarter as it relates to mortgage. If I did my math correctly, the servicing asset is about 76 basis points.

Yes.

Versus 59 in the second quarter. Kind of want to get your thoughts on the on that. What you're seeing Does it stabilize at 76. Do you see some reversal? Was there some reversal in the second quarter to pad mortgage banking? And then also maybe a little bit of the pipeline as you're going into fourth quarter because we all no refinancing are slowing. And then as a follow-up to that, what would be the offsets to slowing mortgage origination?

As I look at your income statement, your loan loss provision expense is three times that of net charge offs. You're one of the few bank out there that are providing well in excess of net charge offs and/or the salaries related to mortgage production fall as somewhat of an offset with origination slowing? That's kind of a mouthful but I want to get your thoughts on that.

I hope I cover all these, Chris. If I don't, please ask. First of all in the servicing asset you are correct, obviously the servicing asset is a percentage of loan service did increase into the mid 70 basis point range from the high 50s. The reason for that is the third quarter brought a high degree of refi to our servicing portfolio. The servicing portfolio I think grew by only $10 million in the third quarter, but we originated about $100 million of loans to be sold in the secondary market.

So what that did is, if you have prepayment at an average of servicing fee in the 50s and you originate new loan production at, let's say, in the 90s, it's going to bring up the weighted average servicing revenue as a percentage of the servicing asset.

Do I see it continuing at this level? Well, I think, you know, the production is certainly down. If we do have another refi boom, I think we will certainly take some hits to our servicing asset, but if you look at the magnitude of it, again, in the mid-70 basis points, it's not terribly aggressive I think we're reasonably conservative in terms of how we recognize servicing and perhaps it will be less effective than most. Keeping in it perspective, it's about $3 million servicing assets. So it's not particularly material in the whole scheme of things.

Right.

Secondly, in the pipeline, our pipeline has slowed dramatically. I'm sure we and others who have had a nice run this year in the mortgage banking arena are seeing the same thing. We are very focused on developing the purchase market, you know, we have gotten away from that clearly and I'm sure most others have as well due to the rate environment and the refi boom, but the pipeline has slowed dramatically, and that's why we're bringing down expectations of non-interest income for the fourth quarter.

In terms of offset, you are correct in both your observations. Provisioning levels, we expect those to come down as both Chris and I mentioned. Delinquencies are low, non-performing assets are low. We had, certainly had our concerns in terms of the economy. We still are watching very closely the impact of the economy, that the national economy may have locally.

We have been very well insulated thus far from local down turns due to any malaise there is at the national level, but we're certainly very conscious at looking at that, but we're reasonably confident in this point in saying that we don't see asset quality problem on the horizon and feel that we can comfortably reduce our provision for loan losses in the fourth quarter and perhaps into next year. Certainly salaries on the mortgage production, due to the mortgage production commissions will drop.

Aside from that, I think we have shown in this third quarter that we are very keyed into the non-interest expense line with 2% growth and as Chris pointed out, a large reason for that growth was the new pension expense that we have. We didn't have in prior years. And as we said we were going to do, we've worked hard to mitigate the impact of that and to have an increase of just 2%, we think is reasonably good. We're not done there.

We're going to continue to focus on non-interest expense, and I think, as our strategic plan evolves here through this fourth quarter, we will be looking in 2004 for new and better ways to enhance our performance both in the non-interest income line as well as non-interest expense and continue the great engine that we have for loan growth that I think will position us well into 2004 and 2005.

If I could just ask one follow-up on the pension.

Yes.

Being that it's, what, $400,000 or so accrued in the third quarter, what's the expectations going forward, in other words, you're talking about a fourth quarter being somewhat flat with third quarter levels. Could it actually be down absent in terms of expenses, absent the pension funding cost?

Yes. Yes. That's correct. When I say that we're targeting Q4 to be pretty consistent with Q3 in terms of expense, that includes that additional pension number.

It includes it in the fourth quarter?

Yes, it does.

Okay. Thank you.

Sure.

And our next question comes from Albert Savastano with FTN Midwest Research. Please proceed.

Good morning, gentlemen. How are you?.

Good morning.

I was wondering if you could comment on the indirect lending for the auto portfolio, you had a little decline year-over-year. Can you just tell me what's going on in the markets there?

Sure. While indirect lending, indirect automobile lending is certainly a good part of our loan portfolio, it's about $230, $240 million or so, it has been in decline for most of this year, and there's a number of reasons for that. We felt and felt through most of 2002 that the pricing on indirect automobile loans was at a level that we didn't think covered the risk. as well as -- it's tough to compete with the captives when they offer zero percent financing. We're certainly not going to compete with that. So it's a very, very competitive arena.

We've felt that we have plenty of availability of loan growth in other areas of the loan portfolio, primarily commercial lending, home equity, other forms of direct lending and residential mortgage. So we will look at and we will continually look at the indirect auto business for what we believe is the right time and the right risk profile and the right return to increase that portfolio.

It is some very nice attributes from an asset liability perspective, the cash flow comes back reasonably quickly, but clearly it's not been a very strong emphasis of ours. We will look to increase that emphasis at the opportune moment.

The pricing pressure is coming from local competitors or more from the captive in the zero percent financing?

A combination of both. Quite frankly, you know, I think we have some very good competitors locally who it is a strong emphasis as part of their business model, and we will certainly look to see how we can compete more effectively with them in the future.

Great. You guys had some good loan growth so that was nice.

Yes. Again, Al, you know, commercial lending is the focus of this bank and we do it very well. We did a very strong quarter, a great loan growth year to date, and we see that continuing. That loan growth has been buoyed by the rate environment, as I said earlier, as well as our market and our lending staff, so we've had a very good year in commercial certainly.

Great. One more question. Any significant changes in your shares outstanding this quarter? Did you repurchase any shares or issue any -- or did people exercise options in.

No. Let me point out one thing there. Some of you may be wondering why, again, it's one of these unusual accounting items, why our net income for the nine months is up 6% but our earnings per share is up almost 16%. The reason for that is in the prior year period we refinanced the Trust Preferred Securities, and the accounting for that was that the issuance costs were charged directly to equity. Weren't charged to earnings.

Yet, the amount that was charge to equity had to be included in the diluted earning per share calculation, so it's one of these unusual accounting contrives that is resulting in sort of a funny picture here. We're up 6% on a net income basis and up 16% on an EPS basis. We do not have a buy back program in place, and so we did not repurchase any shares. Any additional increase in the shares outstanding has been due to stock option exercises.

Great. Thank you.

You're welcome.

The next question comes from Kelley Hinkle with McConnell Bud. Please proceed.

Hi Chris, hi Denis. Just a follow-up question on the servicing aspect. Just to make sure I understand this correctly, the change in value was more of a function of loan service being added versus a change in the valuation of existing loan service?

Yes.

Okay.

That's true.

There wasn't any kind of income statement there or was there?

Well, I mean certainly the mortgage banking income for the quarter would have, you know, the growth and net position would be, the growth would be new origination at a higher servicing rate because the loans are new and the servicing hasn't been amortized yet. And the net position would reflect the prepayment. So we've taken certain charges against our servicing asset for the prepayment of loans.

Okay.

Does that answer your question?

I just want to make sure. (inaudible) in terms of there wasn't any sort of recapture that was not income statement?

No. No recapture.

Secondly, if you could just comment at all on your position on buy backs in general.

Well, Kelley, at this point, you know, we'll be looking very closely in our planning in the fourth quarter looking out into 2004, '5 and '6. You know If and when we would do a buy-back or a dividend increase. There's nothing planned for the fourth quarter. Our position is we monitor very closely our tangible capital level and our tangible capital is about 5-1/2%. Growth in the balance sheet is held at around that level, you know, assuming if growth were to slow down our tangible capital position would get up to 6% or in excess of 6% we'd certainly be considering buy-back or dividend increase or a combination of the above.

Thank you.

Sure

Thanks, Kelley.

The next question is a follow-up from Chris Mutascio with Legg Mason. Please proceed.

I'm sorry, guys. Denis, the tax rate you they said around 32% is that a fully taxable equivalent? My tax rate I add back the interest income on the full taxable equivalent margin so I'm looking at a tax rate for the quarter, third quarter of about 35, 35-1/2%. So your 32%, is that an effective tax rate? In other words, what does that compare to third quarter? Is this a fall in the tax rate for fourth quarter vis-à-vis third quarter or is it stable?

Yes, I think our third quarter was 32-1/2 or so.

Okay.

So we're look for an improvement in the tax rate in fourth, its a modest improvement. But in that region, 32, 32-1/2. That's where we are going to fall.

Thank you very much.

There are no further questions at this time.

Thank you, everyone, and we will look forward to speaking with you in January following the announcement of our earnings for 2003 and fourth quarter 2003.

Thank you from me, too. Thank you. Bye.

This concludes your conference call. Thank you for your participation today. You may now disconnect.