Independent Bank Corp (Massachusetts) (INDB) 2006 Q3 法說會逐字稿

Greetings, ladies and gentlemen. Welcome to the Independent Bank Corporation third quarter earnings release conference call. [OPERATOR INSTRUCTIONS] It is now my pleasure to introduce your host, Mr. Denis Sheahan, Chief Financial Officer and Treasurer of Independent Bank Corporation. Thank you. Mr. Sheahan, you may begin.

Thank you. Good morning, everyone, and thank you for joining us on the call. This morning's agenda will include my brief review of third quarter 2006 earnings and earnings guidance for the remainder of this year. We'll have comments by Chris Oddleifson, our Chief Executive Officer, and we'll end the call with a question and answer period. Before I review our third quarter performance, 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 publically any such forward-looking statements whether in response to new information, future events or otherwise.

Now I will review the third quarter performance. Independent Bank Corp's performance in the third quarter of 2006 is consistent with management's continued focus on profitable asset and liability generation in a challenging rate environment. This has deliberately resulted in a smaller balance sheet, assets have decreased $107 million or 4% since year-end 2005. INDB reported net income of $8.6 million and diluted earnings per share of $0.58 in the third quarter of 2006, an increase of 4% from the $0.56 per share reported in the same period last year. For the nine-month period, GAAP diluted earnings per share improved by 3% to $1.63, while operating diluted earnings per share improved by 4% to $1.62. Key takeaways from the quarter. 4% operating earnings per share growth includes the impact of an additional Federal Home Loan Bank dividend in the quarter. This had a positive impact of approximately $342,000 pretax or $199,000 on an after-tax basis to our third quarter performance. It also positively impacted the net interest margin for Q3.

The reported net interest margin of 3.89% would have been 3.84% excluding this item. The net interest margin in the third quarter was negatively impacted by a higher cost of deposits than anticipated, as well as a large Fed Fund sold position created by excess liquidity averaging $44 million for the quarter. Both of these factors negatively impacted the margin by a total of 9 basis points. The stock buyback. The stock buyback was concluded at an average cost of $31.04 per share during the quarter. As mentioned on previous calls, I expect the Company's tangible equity ratio, currently 5.76%, will be around 6% by the end of 2006. We remain focused on commercial and home equity loan growth while decreasing other asset categories due to the rate environment and current profitability characteristics of those assets. On a very positive note the third quarter of 2006 represents the best net growth in commercial outstandings since the first quarter of 2005. As expected, deposits in the third quarter were essentially flat to Q2 levels.

In an environment where we are constantly shrinking the balance sheet, we are focused on pricing deposits for customer retention as well as core deposit growth and do not feel a need to aggressively grow non-core deposits to fund balance sheet growth. We also have good core fee income growth, it's up 6% year-to-date on a core basis, and good expense control, only up 1% year-to-date. Our third quarter key profitability performance indicators are strong, return on average assets 1.17%, return on average equity 15.6%. Non-performing assets increased to $7 million at September 30. We've provided expanded detail on non-performing assets in the press release for your information. Net charge-off performance continues to be very good at 9 basis points annualized and the Company's reserve for loan loss is at 1.31% as a percentage of loans.

The Company was awarded an additional $45 million of new market tax credit allocation in the second quarter of this year, which equates to $17.6 million in tax credits that will be recognized over a seven-year period. The timing of the recognition of these credits has not yet been determined. However, I expect we will probably begin to recognize some portion of these credits in 2007. Now, earnings guidance. Management previously announced that it expects diluted earnings per share for 2006 to be in an approximate range from $2.21 to $2.23. We currently remain comfortable with this estimate. Not included in this 2006 estimate provided are the following two items. First, I have not assumed any additional benefit from the recently announced second round of new market tax credit awards in the estimate. I will provide guidance on the timing of the recognition of the anticipated $17 million in tax credits during the next conference call.

In addition, management currently anticipates a trust preferred securities refinancing transaction in the latter part of 2006 that is not included in the diluted earnings per share estimate. This refinance, while not an operating event, would impact GAAP earnings. The Company's existing trust preferred securities are callable in December of 2006 and April of 2007. Should the call provision be exercised, management anticipates saving approximately $1 million on an annual basis in interest expense on the debt beginning in 2007. The Company would write-off unamortized issuance cost associated with the existing debt approximating $600,000 after tax or approximately $0.04 per share in both December 2006 and April 2007. I will now turn the call over to Chris for his comments.

Thank you, Denis. I continue to be very pleased with our overall performance for the quarter and encouraged by evidence that we are building an increasingly stronger franchise. I believe we're making responsible decisions with respect to our use of shareholder capital and we're focusing our management time on the right things. The third quarter ROA and ROE of 1.17% and 15.6% respectively and growing EPS demonstrates solid performance in this difficult banking environment. We've demonstrated excellent expense control, solid margin management and very good non-interest income growth, as Denis described. Equally important, perhaps more importantly is our focus on improved performance over time. One of the ways we manage the business is by first understanding at a very granular level where we create shareholder value. This is a non-trivial analytical undertaking and we're by no means at a complete understanding.

While we've made some important decisions based on our work to date, our work with our indirect auto business to determine risk adjuster return on capital performance at the loan level led us to de-emphasize certain segments of that business. Similar analysis is completed for our residential lending portfolio, leading us to emphasize production for sale. Analysis of consumer behavior and response has likewise been instrumental to the design and implementation of our direct mail campaigns for home equity and deposit generation. Granular insight into our performance enabled us to strengthen our focus on building a solid core franchise. As Denis described, we are fortunate that we are not starved for deposits, so we can avoid the hot money only customer and instead focus on customers that desire relationship with Rockland Trust. Our strategy is to deliver a customer experience, an outstanding customer experience. We do that by building relationships, setting service standards, asking for feedback and acting on that feedback.

We survey our retail customers as well as conduct mystery shops and the results indicate that we are indeed providing a superior customer experience. We also track new consumer and business household formation or growth carefully. Although slowing somewhat we continue to add households at a pace above the market growth rate. We're focusing on core relationship household growth by targeting sales calling and targeted direct mail and retention of our existing customers. Our investment management business is also growing at a very healthy rate. We have now very clearly built an investment management group of top notch money management, asset allocation and advisory capabilities, which is very different from saying that we're a trust bank that manages money. Our assets under administration or management has grown by an annualized rate of 13% since the end of 2005. This business is not a commodity or a transaction business and our core capabilities and our relationship building skills are what matters here. In our commercial banking business we have the best set of commercial bankers ever.

During the year we've added six experienced bankers that have intimate knowledge of their respective markets, the markets in which they're located. The total number of bankers now total 34, up from 30 at the end of the year. Market conditions have led to a slowdown in construction lending. Our growth, exclusive of construction lending, is 7.4%, a very respectable rate. I'd also like to mention our mortgage origination business. We understand this business requires an excellent product line, an obsession about costs -- around costs, and a great deal of relationship skills, especially with realtors and our investors, our mortgage product investors. [Mike Nickley], who we recently hired to run our mortgage business, has the business and relationship orientation that is necessary for us to improve performance in that business. I would now like to comment upon the state of the residential real estate market and our credit quality. I have mentioned in previous calls that we're seeing single-family and condo listing volume up significantly. However, the sales price remains relatively flat.

We're now seeing the expected downward pressure on median sales price of single-family homes in our market. Initial multiple listing service data shows that the median sales price of single-family homes of Plymouth County decreased by 5% between the third quarter of last year and the most recent quarter. In Barnstable County, it is primarily Cape Cod, the comparable decrease is 2.5%. Interestingly, the median condominium sales price has increased slightly during the same period. Our NPA's are currently at approximately $7 million, an increase from $3.3 million at the end of last year. We have provided a detail on the NPA's in the financial sections of our earnings release. Of the $3.7 million increase commercial real estate is $2.7 million, C&I is $0.3, home equity $400,000, and we have a [hard] at one oil property, about $200,000. As we discussed in the past, the largest increase in the NPA's is due to a single commercial credit in which we do not foresee potential loss beyond levels already reserved and we remain hopeful that this specific situation will be resolved in the fourth quarter.

We are seeing some softening credit indicators, such as our increase in NPA's, house pricing pressure and market foreclosures accelerating. I will note that we had one foreclosure in the third quarter, our first in many years. I will also note that the vast majority of the foreclosure increase is from banks, a large mortgage bankers outside of our market operating within our market. Our strong credit underwriting process for both commercial and consumer, the strong FICO and LTV characteristics of our portfolio, and our strong underlying collateral and our general conservative nature lead us to believe that we will weather any softening well. We have seen extraordinarily good performance over the last several years across our portfolios. One example of which could be the fact that we've had net recoveries in our commercial portfolio for a number of years. Residential and home equity portfolios we've had zero foreclosures and zero losses for a number of years as well. Our recent credit history has been extraordinary good. While I remain confident in the quality of our credit portfolios, there is, of course, some possibility of loss in the future.

In summary, our Q3 performance is a continuation of what we have told you all year. We're focused on discipline, balance sheet management, effective expense control, growth in non-interest income, good and strong credit management, and a focus on understanding the drivers of increasing shareholder value. And those are my comments.

Thank you, Chris. I'd now like to open the call for questions.

[OPERATOR INSTRUCTIONS]

Mr Sheahan, there are no questions at this time.

Thank you, everybody, for your attendance on the call. We look forward to speaking to you in January when we discuss our full year earnings. Thank you.

Excuse me, Mr Sheahan, we did have two participants that queued up. Our question comes from Damon Delmonte with KBW.

Hi, good morning, guys. How are you? Just a quick question on the income statement, the other non-interest expense items were a little bit lower linked quarter. Just wondering if there was anything of note in there that we should be aware of?

No. We've had very good control in our advertising, our marketing expense this year. We're putting a lot of effort into understanding when we spend a marketing dollar what the return is associated with that dollar. So I think we're just progressively showing better control of that number.

Okay. And just with regard to the share buyback, now that you've completed that 800,000 share authorization, any thoughts on looking for new authorization to continue that?

Well, I have said pretty consistently is we're targeting a 6% tangible equity level and we're there or thereabouts, we're at 5.76 I think at the end of Q3. We expect to be around 6% at the end of the year and we'll give you more detail to answer your question on the January call. As I've said for some time, the kind of things that would prevent us from doing a buyback are an acquisition or dramatic balance sheet growth in 2007. We'll provide some guidance on that at the next call.

Great. Thank you very much.

Sure.

Our next question comes from David Darst with FTN Securities.

Hello.

Hi, David.

Chris, could you comment on how much more run-off you would like to see in the indirect in the residential mortgage and then, given where we are today, what would you like to see within your markets or within the environment that would cause you to change your balance sheet strategy from where it is at this time?

Sure. I think Dennis and I will both sort of handle that question. Let me sort of address the indirect. What we have done in our indirect portfolio is -- has done the careful analysis to understand, given the expected loss, given the yield, given our operating expenses, given the amount of capital you have to layer in that's a function of the expected loss, what are the return characteristics of various loans characterized by a number of factors. That has led us to a running rate of new originations of about $5 or $6 million a month. And then our attrition from that same portfolio I believe is about $10 million a month, Dennis?

10 to 13.

$10 to $13 million a month. So you will see the net reduction of $6 million or so per month. At some point that will level out. And what would change our point of view is that if market pricing sort of rationalizes to a point where we can earn our threshold returns in more segments of that business, and then we would begin to increase the origination. In any case, you may recall that indirect auto was a fairly large percentage of our overall balance a few years ago, we wouldn't anticipate that re-occurring. Let's see, what was the -- ?

Residential.

Residential. Residential portfolio, I mean we -- the economics really strongly favor production for sale and the asset that we put on our balance sheet are mostly ARMs, they are repriced in three to five years. The long-term fixed rates of residential asset is something that really is not appropriate for balance sheet, our balance sheet, and nor do we ever think it would be appropriate for our balance sheet. You probably will see sort of the current run-off in that portfolio that you're seeing right now continue through next year. And it is what we do.

Basically ditto. I agree wholeheartedly that on both auto and residential real estate that's the picture we view into the future.

So is it safe to say that in this environment we'll continue to see a relatively stable earning asset mix and loan mix for -- ?

I think it has been, David, increasing more towards commercial and home equity and we view that to continue. As I said in my comments on the call, the third quarter was our best quarter of net commercial growth since Q1 '05. It was a good quarter and we're going to hope for that to continue.

Under the remixing, I guess, given the work you've done, the pace of the remixing was slow, can you still maintain relatively stable margin?

The margin is benefited by this remixing. It is mixing into better yielding categories, less securities, less auto, less portfolio residential should imply, when you're investing in commercial and home equity, better yield on assets. That's one component of the margin. The other component, though, is cost of liabilities. And our third quarter did see our cost to deposits increase quite a bit, so we're going to be very focused on that in an effort to maintain the good margin stability that we've had for a long period of time here. We've been in the 380's, low 390's to mid to high 380's for quite sometime. I think we've done a good job of stabilizing our margin and we're going to continue to focus on that.

Okay. Then how is your commercial real estate pipeline look in the commercial pipeline?

We did have a very good third quarter that used up a lot of the pipeline. This is typically our better performing quarters in the summer months for commercial. We will rebuild that pipeline going into next year, but in New England things typically slow in the winter months and we would expect that to be the same trend this year. But, we'll build it again going into next year and look for continued good growth in that business. Construction, though I will say, we have and I think most have seen a slowdown in construction, both driven by the rate environment, the increased listings that Chris talked about. I think we can expect to continue to see construction be slow for the near future.

Okay. And so purposes of modeling now on the tax rate, until we have more information on the tax credits, is roughly 31% tax rate good for next year?

Yes. Okay. Yes. We'll provide -- we're hopeful that we'll have the allocation agreement in place. We thought we would have it in place by now, but it just takes a little bit of time to work through the details and we should have it in place going into January. Then we can begin to talk about how we will invest those credits into 2007.

Okay. Sounds good. Thanks.

Sure.

Thank you, David.

Mr Sheahan, there are no further questions at this time.

Okay. Thank you, everybody, and we'll speak to you in January.

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