Independent Bank Corp (Massachusetts) (INDB) 2005 Q2 法說會逐字稿

Greetings, ladies and gentlemen. And welcome to the Independent Bank Corp. second quarter earnings conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star, zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Denis Sheahan, Chief Financial Officer and Treasurer of Independent Bank Corp. Thank you, Mr. Sheahan, you may begin.

Thank you, Dan. Good morning and thank you for joining us on the call. This morning's agenda will include my review of the second quarter 2005 earnings release, comments by Chris Oddleifson, our Chief Executive Officer. I will then provide earnings guidance for 2005 and we'll end the call with a Q&A period. With me on the call today are Chris Oddleifson, President and Chief Executive of Independent Bank Corp. and Barry Jensen and Rob Cozzone of our Finance Department. Before I review our second quarter earnings release 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.

I'll now review the earnings release. Independent Bank Corp. reported net income of $8 million, an increase of 1.4 million, or 21% for the quarter ended June 30, 2005. A net income of $16 million, an increase of 2.6 million, or 20% for the six months ended June 30, 2005 as compared to the prior year periods. This represents GAAP diluted earnings per share of $0.52 for the second quarter of '05 and $1.03 for the six month period ending June 30, '05. Excluding securities gains, and merger and acquisition expense from each period diluted earnings per share on an adjusted basis improved to $0.51 and $1.00 for the quarter and six month periods ending June 30, '05. Increases of 11% and 16% respectively from the $0.46 and $0.86 for the same periods last year.

I'll now review balance sheet changes in the quarter, beginning with the Securities Portfolio. The securities decreased by $72 million in the second quarter, or almost 9% due to the sale of $53 million in longer duration securities and the absence of reinvestment opportunities due to the flattening yield curve environment. Securities represented 25% of total assets at June 30, '05, a significant decrease from 30% of assets a year ago. The Company's Loan Portfolio showed another good quarter of good steady growth, particularly in commercial and home equity lending. Loans grew by $56 million, or 3% in the second quarter of 2005, and $94 million, or 5% for the first six months of '05. The growth for the quarter was contained in the following categories -- Commercial loans grew by $25 million; residential loans, $7 million; home equity, 23 million; business banking, 3 million; and indirect auto declined by $5 million as the flattening yield curve has dampened indirect auto profitability. The majority of loan production for the remainder of 2005 is expected to continue to be in the commercial lending and home equity lending categories. Deposits grew by $10 million in the second quarter. Core deposits grew by $25 million, or 2%, and the time deposit category decreased by $15 million, due to the maturity of 20 million of brokered CDs. Total deposits grew by 89 million, or 4% for the six month period ended June 30, 2005.

And now the Income Statement. Net interest income, the net interest margin for the second quarter and year-to-date 2005 was 3.84%. This represents good stability in the net interest margin due to a lower securities portfolio and targeted growth in variable rate loan categories. Both commercial and home equity lending are the primary drivers of loan growth and we expect that to continue. With prudent liability management, this positioning will lead to net interest margin expansion in the second half of the year as the Fed continues its measured pace.

Now Non-interest Income. Excluding securities gains from both periods, non-interest income was essentially flat in the second quarter and year-to-date 2005 as compared to the same periods last year. When adjusted for securities gains, as well as large unusual loan prepayment penalties, non-interest income improved by 5%. On a year-to-date basis, service charges and deposits improved by 3% and investment management revenue improved by 14%, as assets under administration increased to $603 million. Mortgage banking income decreased by 5% on a year-to-date basis, and 32% for the second quarter of 2005, as production has been affected by overall market interest rate conditions. The balance of the mortgage servicing asset was $3 million and loans serviced amounted to 363 million as of June 30, '05. Other non-interest income decreased by 390,000 or 21% on a year-to-date basis, primarily due to decreases in commercial loan prepayment fees.

Non-interest expense increased by 7.7% in the second quarter of '05, as compared to the prior year quarter, and 6% on a year-to-date basis. Salaries and employee benefits increased by a little over $2 million, or 22%, and by $3 million, or 14% for the three and six months ended June 30 '05 as compared to the same periods in the prior year. Salaries increased by almost $900,000, or a little over 11%, and by $1.3 million, or 8% respectively for the three and six months ended June 30, '05, compared to the same periods in '04. The acquisition of Falmouth Bancorp, two de novo branch locations, the annual merit program, and select additions to staff to support strategic initiatives are the reasons for that variance. Accruals for incentive compensation increased by $1 million and $1.2 million for the three month and six month periods ended June 30, '05, as compared to the same periods last year due to improved operating performance.

Occupancy and equipment-related expense increased by $388,000, or 18%, and almost $700,000, or 15%, for the three and six months ended June 30, '05, compared to the same periods in the prior year, primarily due to the Falmouth Bancorp acquisition, de novo branches, and snow removal expense in the first quarter of the year. Data processing and facilities management expenses decreased 162,000, or 14%, and 257,000, or 12% for the three and six months ended June 30, '05, compared to the same period in '04, as a result of a new data processing contract finalized in the latter part of '04. Other non-interest expenses decreased by 746,000, or 14%, and by 959,000, or 10% for the three and six months ended June 30, '05, due to lower telephone and consulting expense. Asset quality continues to remain strong. The level of nonperforming assets, $2.1 million, continue to be a strong positive highlight for the Company, representing just seven basis points of total assets and loan delinquencies as the percentage of loans outstanding represent a very manageable 50 basis points. The allowance for loan losses as a percentage of loans was 1.3% at June 30, '05. Net charge-offs for the quarter were $560,000 and $1.18 million year-to-date.

Now Capital Management. The Company and the bank are well-capitalized by all bank regulatory measures at June 30, 2005. The Company's tangible equity to tangible assets ratio improved to 5.57% at June 30, 2005 and on an adjusted basis to account for the deductibility of the majority of the Company's good will, adjusted tangible equity improves to 6.07% at June 30, '05. I'll now turn the call over to Chris for his comments.

Good morning. Thank you, Denis. I'm very pleased with our overall performance delivering $0.52 per share this quarter, up from $0.45 per share in the second quarter of last year. And $1.03 per share year-to-date, up from $0.90 per share year-to-date last year. On an adjusted basis I'm also very pleased we delivered $0.51 per share this quarter up from $0.46 per share in the second quarter of last year. And $1.00 per share year-to-date versus $0.86 year-to-date last year, an increase of 11 and 16% respectively. As Denis will share with you later in the call, we continue to expect our quarterly earnings per share will increase during the year leading to approximately a $2.15 -- $2.18 EPS for the entire year on a GAAP basis. This performance in a challenging banking environment is a result of good execution of our business unit and Company strategies, expense control, and prudent balance sheet management.

First, I would like to share with you some key points about our businesses. Commercial banking, as you well know, is a key strength of the bank, and our Commercial Loan Portfolio has grown 6% year-to-date. This strong performance is a result of a set of very seasoned, experienced lenders who know the market well and have solid relationships with our customers. This is coupled with very strong underwriting. As Denis reviewed with you our credit quality is very good. In the commercial lending divisions, we continue to have net recoveries of trends that began more than six years ago. Our commercial lending has also been enhanced by our community development entity created for our new market tax program. We have funded the CD by $15 million and we're on track with the deployment of those assets. This has allowed us to expand our commercial relationships in new markets and use the program to support worthy business projects enhancing our development in our communities. To better serve our branch-based business customers, typically smaller businesses, we created a new market -- a new business banking division. We're making good progress in this area with the implementation of streamline. You have prudent underwriting processes for small business loans and lines. With the ability to [decision] our request in as little as four hours and close in the same day. On the deposit side, our new streamline business checking accounts are attracting new business relationships and in the first six months of 2005 our core business deposit relationships generated by commercial bankers, business development offers, and branches have grown by just a little over 6%.

I'm very pleased with our branch banking strategy and the division's performance. We have focused on increasing the effectiveness of the branch network in a variety of ways. First we continue to provide a relationship development and sales training for our staff. Managers provide coaching feedback to reinforce the training and improve skills. In the second quarter, a quarterly incentive program was introduced to reward all branch employees for meeting sales service and operational goal. Every branch has goals in deposits, new accounts, loans, business calling and referrals to other service areas, and referrals to other service areas of the bank. The retail areas developed a new service standards with the goal of creating the best-in-class customer experience. Most of our branch staff are long-term employees who are deeply committed to our customers and community and the caring attitude of our staff is really what makes banking at Rockland Trust so enjoyable and friendly. And, in fact, as I've been traveling around the community over the last few months talking to both our customers -- our customers both businesses and individuals, I am frequently told that they find our staff to be the -- positively different than what they find in the competition. We've extended our branch hours across the network, including Sunday hours in busy retail markets and started a number of branch appearance improvements.

Our Home Equity Portfolio has grown nicely to $230 million, an increase of 18% over year-end. This is a result of our branch network, our call center, and a targeted direct-mail program that is rooted in an analysis intensive test-and-learn approach. Our Investment Management Group has demonstrated good fee income growth as a result of solid assets under administration growth, which Denis mentioned has grown to slightly over $600 million. Our open architecture and asset allocation approach for our core product is complemented with institutional shares and mutual funds, as well as the excellent teaming of the referrals among the Rockland business units is the basis for this growth. Our market sweet spot in this business are clients that prefer the personal service and financial planning provided by the staff in our Investment Management Group that those same people fall below the personalized thresholds in our larger competition. Now, these increasing levels of performance require increasing levels of human capital. And we have a real focus on this. And in addition to the intensive branch staff development work I mentioned earlier there are two quick points I'd like to make. First of all, we are supporting our capability development with a new officer performance-based incentive program that is driven by -- overall by Company performance and includes meaningful leverage for individual performance. As well, we have implemented individual producer plants in several areas of the bank. And as I have mentioned before on our previous calls we are successfully training mortgage loan officers who have solid sales experience, but no mortgage experience. We have just graduated our third class and expect the fourth class to start in the fall.

Shifting gears somewhat, a key objective of ours is to improve the efficiency and effectiveness with which we operate. Our work to integrate a number of upgraded systems will further realize efficiency improvements and improve our customer experience as well, and these are on track. We are installing a new deposit origination system in branches by the end of the year. A new integrated ATM system this quarter. And upgraded online banking system by early next year. We're upgrading our profitability system by the end of the year as well. And we'll have a antimoney laundering system implemented in the third quarter. And later this year we're also going to have online a Web-based mortgage application decisioning engine. Our year-to-date efficiency ratio is 61.8%, down from 65.2% year-to-date last year. And we'll continue to seek improvements in our operating efficiencies. Now, I'm encouraged by our progress and believe these indicate a very positive trend that is a result of our focus on satisfying customers throughout our region. Now as a reminder, Rockland Trust is an established brand and has been since 1907. And we have dominant market share in our primary county. Now most importantly, interesting with all the merger and acquisition activity in our region, we find ourselves in an increasingly unique position. Now we're large enough to have the full compliment of products and services our market -- our retail small businesses and commercial customers -- would expect at a larger bank, yet we're small enough to be viewed by a community bank with a commitment to the high touch service with more convenience in our primary county than anybody else.

Now, before I conclude I'd like to address three -- what perhaps we can call "hot topics." First of all, now the biggest challenge we have, like most banks is, right now is generating deposits. Our strategy is to focus on growing core checking relationships with consumers and businesses. We have found great success; that is, when bank mergers occur when -- by moving quickly with direct-mail campaigns to attract the disenfranchised customers. We're also testing different marketing offers to attract new customers to the bank. Our strategy is simple, provide an offer to get customers to try Rockland Trust and have them experience our tremendous service to make them long-term loyal customers of the bank. This year we've tested CD specials, where new money in an active checking account is required. $50 gas cards, for example, for new checking accounts with direct deposits. A short-term premium rate on money market accounts; when a premium checking account is opened. We found in our test that after 12 months nearly 90% of the new households remain customers, active customers of the bank. And as I mentioned earlier, commercial bankers, business banking officers, and branch staff are actively calling on prospects to move them in the bank as well. Even with all these efforts, I would say growing deposit balances will remain a challenge.

The second hot topic is there's been a lot of discussion these days about the regionalized real estate bubbles. Now we have been proactively monitoring the current economic conditions, potential impact in our loan portfolios. We employ -- as I trust you all recognize -- very prudent underwriting practices in each of our real estate portfolios, including maintenance of comprehensive loan policies that address, among other things, the service coverage, LTV requirements. Our Commercial Real Estate Portfolio, in particular, benefits from seasoned lenders who are lending in a market with which they are intimately familiar and hold superior market knowledge and key strength. Now our Residential Home Equity Portfolios have a superb pristine credit track record as well.

Last thing I'd like to make a point -- on a couple of points in our balance sheet management. As Denis mentioned, we reduced our Securities Portfolio by almost 9% in the second quarter of this year and are unlikely to restore the portfolio to its previous level for the remainder of the year. We are focused on commercial and home equity loan generation and view the residential mortgage business as primarily a secondary market opportunity. While these actions provide a smaller balance sheet, the mix of the earnings assets is more favorable both from a profitability and interest rate risk perspective. These actions, in addition, to our effective liability, I've mentioned, have led to a less liability sensitive balance sheet and improved net interest margin stability. Denis, that concludes my comments. Back to you.

Thank you, Chris. I'll now review our earnings guidance for 2005. We expect GAAP diluted earnings per share for 2005 in a range of 215 to 218, representing GAAP EPS growth of 6 to 7%. On an adjusted basis diluted earnings per share is expected to be 213 to 216, representing 11 to 13% adjusted EPS growth. Adjusted EPS calculations exclude the benefit of security gains in 2005 and 2004, and merger and acquisition expenses and gain on sale of branch in 2004. A smaller securities portfolio, lower loan growth than we originally anticipated as we have de-emphasized indirect auto and residential portfolio lending, and lower mortgage banking non-interest income than expected contribute to the tightened guidance. I would not expect material growth, if any, in the securities portfolio, given the current yield curve. As mentioned previously, loan growth is expected to be primarily in the commercial and home equity lending categories, with overall growth anticipated at 9% for the full year, versus the originally anticipated 11%. Deposit growth, and particularly deposit pricing has been challenging so far this year as Chris mentioned. However, I expect deposit growth to reach our targeted 8% for the year. The net interest margin should expand modestly in the second half of the year to the high 380s. In summary, the second quarter of 2005 represents another solid quarter. The Company's earning asset mix has improved, deposit momentum is good, and the net interest margin is headed in the right direction. We look forward to the second half of the year and 2006 with great enthusiasm. This concludes the presentation and I will now open the call for questions.

Ladies and gentlemen, at this time we'll be conducting a question-and-answer session. [OPERATOR INSTRUCTIONS]. Our first question is coming from David Darst of FTN Financial. Please proceed with your question.

Good morning.

Good morning. [multiple speakers].

You commented that you are improving your asset sensitive, liabilities sensitive position. While you're still liability sensitive you're expecting some margin expansion. Is it driven by your ability to hold down your deposit pricing expected in the second half of the year, or is it more of a funding shift?

I think it's a combination of our ability to effectively manage the cost of liabilities exactly on the deposit side, as well as we are originating more and more assets that are tied to either Prime or LIBOR, and so we do get some relief as the Fed increases rates on the -- it affects those asset categories and that helps us.

Okay. And also you've referenced a direct mail campaign -- a targeted direct mail campaign both for home equity and checking. And could you give us some of your success rates and what are you doing different to make that an efficient campaign?

Sure. I don't -- I prefer not to sort of quote sort of statistics in terms of response rates, and so on, since that's fairly proprietary. But what I will -- let me just give you a couple of minutes on how we think about this. Our direct mail campaigns are rooted in sort of a test-and-learn approach, where it is developing hypothesis of what different offers may work, and then mailing that into a broad population. From the responses we develop proprietary response models that we then can segment the responders into high responders and low responders.

So in subsequent mailings we can, using those models, have a more defined targeting, thus reducing the marketing expense and increasing the overall effectiveness. We have had success in our home equity arena and beginning to see our success in checking as well. This requires, not only is there process skills in doing this in terms of working with list mail houses, but also some analytical skills to build the economic and the response models on the home equity side. Of course, it's [indiscernible] and a pretty good -- or good understanding of our expected loss by various segments and FICO scores and so on.

Okay. Is that a process that you're continuing to refine, or do you expect that you'll grow it throughout other parts of your business?

It is a process that is -- will be in continuous refinement and improvement for as long as we do it. It's a never-ending sort of process loop. I expect we'll probably focus primarily for the balance of this year on home equity and checking and not expand into other products this year.

Okay. Thank you.

[OPERATOR INSTRUCTIONS]. Our next question is coming from Ryan Kelley of Friedman, Billings, Ramsey. Please proceed with your question.

Good morning, Chris and Denis.

Good morning. [multiple speakers].

Couple of questions. First, on the -- one more follow-up question on the net interest margin guidance. What sort of movement in the -- in interest rates are you looking -- are you modeling in?

We're assuming that there will be another couple of moves by the Fed between now and the end of the year, so that we get to 4% Fed Funds.

Okay. So 4% Fed Funds by the end of the year?

Yes.

Okay. And then I was wondering if you could give us an update -- a little bit more update on the tax planning, as far as if you plan on making any more investments? And then a kind of unrelated note, also just talk a little bit about any update on your auto portfolio, what sort of average life or FICO score it's at right now?

Sure. I think at this point, Ryan, we're confident in our ability to meet our objectives under the new market tax credit program for 2005. We do plan on making additional investments into the community development entity and we're confident in being able to execute on that program for the rest of the year. As far as the auto portfolio goes, I can give you FICO -- just a second. The average indirect auto new FICO score in the second quarter was 713, and is for the full year is 719.

Okay. Great. And just on -- back to the tax question, so would around a 31% rate be about right for the rest of the year?

Yes.

Okay. And then the assets under management, you had some very nice growth there in the quarter, about 7%. I was wondering if that was new accounts brought on or just sort of appreciation in the assets under management or what you sort of saw there?

Well, it would be nice if our investment performance was 7%. But I'll -- so I'll say it was -- it's primarily new accounts. And that is a result of being a lot clearer, of adding capability to our core investment product, and having the asset allocation capability. And we also have really brought our Investment Management Group and our other business units together in a very sustaining way where we were able to identify more customers and satisfy more of their investment management needs. It's nice growth. We're very pleased with it and we hope it will continue.

Great. And one last question just as far as -- at this point in time, what sort of expansion plans might you have going and any sort of branching -- anything about it or is it just working within the branches in the market that you have right now?

We are actively looking at adjacent markets. And we are well into sort of a set of analyses that the market is going to lead to a prioritization of the markets we want to move into. At this point I'm not comfortable with sort of identifying the top two or three markets. But as soon as we're comfortable in sharing that and sharing more definitively what our plans are, we will do so.

And could that also include potential merger and acquisitions -- or acquisitions of other banks?

We are -- our posture in acquisitions is opportunistic. That the roll-up game is over for -- in our region, so we do not -- we're not relying on an acquisition strategy to meet our shareholder expectations. We believe that our organic growth is going well and we can meet our shareholders' expectations in that matter. However, there are -- I mean if there are selected franchises that are within and adjacent to where we are now, then if they were to be available for sale, we'd like to take a good hard look at it, absolutely. Our acquisition of Falmouth Bancorp is -- went really, really well. I mean it was small enough where we would get our hands around it very nicely. Implementation was smooth and it was more accretive than we had anticipated. So we've had -- that is a success that we'd like to repeat, but we're not counting on it.

Okay. Great. Thank you very much.

Our next question is coming from Al Savastano of Janney Montgomery Scott. Please proceed with your question.

Good morning, guys. How are you?

Good morning, Al. [multiple speakers].

Two questions here for you. Can you give us an idea of how much of the loans are tied to Prime or LIBOR now and how much they were maybe a year ago and where you expect that to go?

Sure. The almost 40% of the loan portfolio, I don't have it as of June 30th, Al, but I have it as of March 31st. Almost 40% of the loan portfolio is either variable or adjustable, compared to the planning time I pick -- is about three years ago, that was 20 -- in the high 20%. So we've done a lot of work on that, emphasizing variable commercial real estate, home equity, lines of credit that are tied to Prime, and we'd like to keep it in that region -- in the 40% region, perhaps even get it a little bit higher. But the difficulty is, particularly on commercial real estate loans, the majority of our customers are interested because of their expectations of where rates are going. They're interested in fixed rate loans, so we do still originate the majority of our commercial real estate as fixed rate. But we can use derivatives and plan on using derivatives to improve the interest rate sensitivity of those loans.

Great. And then just on the expense base. Is this a good run rate, or were there some kind of unusual items in the second quarter?

I think it's a reasonably good run rate for the rest of the year. We do expect the fourth quarter to drop somewhat. I'd say -- we would be around -- let me see, 19 -- high 19 million, like maybe 19.8 million or so in the fourth quarter, versus $20 million in the third. So it's -- this quarter was certainly a little bit higher than it will be for the third and fourth quarters of the year. But there won't be a material drop in non-interest expense.

Okay. Very good. Thank you.

Sure.

Our next question is coming from Bryce Rowe of Legg Mason. Please proceed with your question.

Thank you. Good morning, guys.

Good morning, Bryce. [multiple speakers].

Couple of topics. First one is capital and your appetite for repurchasing stock. Denis, what kind of target tangible capital ratio do we have and what is the repurchase program as it stands now? And then the second topic would be just the mortgage banking. You mentioned inclement weather that affected mortgage banking production in the second quarter. I'm wondering what that pipeline looks like right now?

Sure. First of all, on the capital we don't have a repurchase plan at the moment, nor would I expect us to entertain a stock repurchase program until tangible equity were in excess of 6%. So that's our current plans. We would expect to hit that threshold some time in 2006, and then we would consider either a combination of stock repurchase or perhaps increasing dividends more than we have traditionally. But that remains to be seen in 2006. One of the wild cards there, of course, and we do watch this very carefully, is the depreciation on the securities portfolio. But our securities portfolio is, as you know from my comments earlier, is lower than it has been for some time. It's only 25% of assets. We've had it even over 30% in the not too distant past. So that depreciation we believe is under good control, and we look forward to tangible equity being 6% or above hopefully sometime in '06.

As far as mortgage banking, the weather issue was primarily first quarter. It did go into the April time frame. But it really did dampen our production in the first four months of the year. At this point our pipeline is -- I'm looking back -- it's about the highest that it's been for the entire year. And this is from a seasonality perspective, right around now is -- should be -- the third quarter should be strong for our mortgage business, and we hope that that will continue for the rest of the year. We haven't hit our targets in mortgage banking. We're working hard at it. And we hope that we can hit them for the rest of the year.

Okay. Thank you.

Sure.

[OPERATOR INSTRUCTIONS]. Our next question is coming from Kelly Hinkle of McConnell Budd Romano. Please proceed with your question.

Hi, guys.

Hey, Kelly.

I was just wondering how your asset management generation is going on the Cape?

You're talking about investment management assets?

Yes.

Very well. That is -- the Cape is a very attractive demographic. It is growing at a rapid rate. There are a lot of retirees buying in on the Cape as a significant investment. There are a lot of liquid assets that are associated with those folks. So it is -- it's significant. Significant increases over prior years generation. It's going very well.

Okay. Thank you.

We've also opened up, Kelly, we have a dedicated investment management office that we opened last year in Osterville and that's helping us in that regard as well.

Okay. Thanks.

Thank you.

We show no further questions in the queue at this time.

Okay. Thank you, everybody for joining us on the call and we look forward to speaking with you after our next earnings release. Great. So long.

This concludes today's teleconference. Thank you for your participation.