Independent Bank Corp (Massachusetts) (INDB) 2007 Q3 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Independent Bank Corporation third quarter 2007 earnings and Slade's Ferry Bancorp. acquisition conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Denis Sheahan. Thank you, Mr. Sheahan, you may now begin.

Thank you. Good morning, everyone, and thank you for joining us on the call. This morning's agenda will include a brief review of our third quarter 2007 earnings performance, and I will give full-year guidance for 2007. That will then be followed with comments by Chris Oddleifson, our Chief Executive Officer, on our third-quarter earnings and the announced transaction with Slade's Ferry Bancorp. And we will end the call with a Q&A period. A copy of the presentation Chris and I will review on the announced definitive merger agreement with Slade's Ferry Bancorp. can be found at the investor relations section of our Web site, at www.RocklandTrust.com.

Before I review our third quarter 2007 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 publicly any forward-looking statements, whether in response to new information, future events or otherwise.

I will now review our third quarter 2007 performance.

Independent Bank Corp. reported GAAP diluted earnings per share of $0.60 and $1.45 for the third quarter and nine months of 2007, respectively, representing an increase of 3% and decrease of 11%, respectively, from the same periods in the prior year. There are no non-core items in either third-quarter period. There are a number of non-core items in the year-to-date periods, as detailed in the earnings release.

Excluding these onetime items, diluted earnings per share on an operating basis were $0.60 and $1.57 for the quarter and nine months ended September 30, an increase of 3% and decrease of 3%, respectively, from the same periods in 2006. I will now review a number of key takeaways from our third quarter and year-to-date performance.

First, continued strong net interest margin. The net interest margin for the third quarter was 3.98%, and we expect to be in this range for the fourth quarter as well.

Second, while loan growth remained challenging, overall activity certainly picked up in the third quarter. Commercial and business lending is up 3% year-to-date, with 65% of that growth coming in this third quarter. Home equity shows a similar trend, with approximately 50% of the year-to-date growth occurring again in the third quarter. These loan categories are now outpacing the reduction in the other lending categories of indirect automobile and residential lending that, as you know, we have strategically reduced. At this point we feel we are near the end of the balance sheet repositioning, and we expect the balance sheet to grow as we head into 2008.

Next, deposits were down 4% as compared to year-end levels, consistent with balance sheet funding needs. We remain focused on controlling the cost of deposits as an important component of maintaining a strong net interest margin. You will note that we borrowed in the third quarter, as the volatility seen in the capital markets provided an opportunity for a modest amount of favorably priced funding.

Stock buyback. We completed a second stock repurchase program in the third quarter of 1 million shares, or approximately 7% of common stock outstanding at a weighted average cost of $30.70. This second buyback brings the total common shares repurchased since January of '06 to approximately 12% of shares outstanding. The Company's tangible equity ratio of 5.95% remained strong at September 30th of '07.

Core non-interest income growth up 10% year-to-date remains a key highlight, driven by growth in our wealth management revenue as well as the 1031 exchange business. We are delighted to announce that assets under management have grown organically to $1.1 billion in our investment management group as of the end of the third quarter. At the end of 2004, assets under management totaled $564 million.

We've spoken to you previously of our desire to grow this business based on the opportunity we perceive, and are very pleased with both current results and expectation for the future. We will remain focused on this business, and expect to supplement growth with acquisitions, such as the O'Connell acquisition we expect to close in the fourth quarter of this year, which will add approximately $200 million in additional assets under management.

You may notice a decline in linked-quarter in our wealth management revenue. The primary reason for this is essentially seasonality and revenue to do with tax preparation. Tax preparation services in the second quarter added about $150,000 to the revenue stream in that quarter. Non-interest expense increased 6% in the third quarter and 8% year-to-date, driven by investments in growth initiatives such as additional commercial lenders, the 10-31 exchange business, retail wealth management, and the mortgage business.

The year-to-date period also includes a legal settlement amounting to $1.4 million pre-tax associated with an early 1990s disagreement between the Bank and Computer Associates, in addition to executive early retirement costs. Excluding these items, non-interest expense increased by 5% year-to-date.

Non-performing assets were $6.6 million at September 30 and represent just 25 basis points of total assets. Net charge-off performance is higher than last year, yet still very low at an annualized rate of 16 basis points. The Company's reserve for loan loss at 1.32% of total loans is consistent with year-end 2006, and loan delinquency with 72 basis points at both September 30th '07 and year-end 2006. We consider asset quality to be strong.

Tax rate. Our effective tax rate for the quarter fell to 21%, representing the benefit of the strong execution of our new market tax credit program. We have been particularly successful in the Brockton, South Coast, Massachusetts and New Bedford and Fall River and the Rhode Island markets in implementing this program. You will note that Slade's Ferry Bancorp. has a material presence in the South Coast region, and our merger with Slade's bank will support our efforts in these markets. The benefit of the new market tax credit program in the third quarter amounted to approximately $1.2 million, and is currently anticipated to have a $3.6 million benefit for the full year, with $900,000 being realized in Q4. The effective tax rate for the full year is expected to be approximately 25%.

And now, earnings guidance. We are well-positioned as we enter the fourth quarter of 2007. Independent Bank Corp. has strong capital levels with excess capital deployed in a share repurchase program. We have a solid interest rate risk positioning. The net interest margin has been maintained in the 3.8 to 3.9% range since mid-2004, and has recently expanded to the 4% region. We expect that to continue for the remainder of '07. Continued strong asset quality. And the balance sheet repositioning is largely behind us and we expect to grow in 2008.

We previously announced operating diluted earnings per share guidance for 2007 in a range of $2.05 to $2.10. We expect to certainly be at the upper-end of that range, and possibly beat the $2.10 level. The $0.60 diluted earnings per share performance in this third quarter included a cumulative catch-up adjustment due to better-than-anticipated new market tax credit performance. This diluted earnings per share estimate for '07 begins with GAAP diluted earnings per share and excludes the following items management believes to be non-core -- the write-off of debt issuance costs associated with the junior subordinated debenture call in the second quarter of 2007, the litigation expense of $1.4 million pre-tax in Q2 of '07, and the early executive retirement costs in Q1 of '07. Again, we feel very good about hitting the upper-end of the range and could certainly exceed it.

I will now turn the call over to Chris for his comments.

Good morning. Thank you, Denis. Denis is in Rockland, Massachusetts, and I am delighted to be at Slade's Banc this morning in Somerset (inaudible) a topic I'll speak more about in a few minutes. Denis did a thorough job reviewing our performance. Before I talk about our Slade's acquisition, I'd like to make a few points of emphasis.

I, too, am very happy with the results. While there is a lot of turmoil in the market, a challenging yield curve, (inaudible) competition, housing market pressures (technical difficulty) a bit of turmoil, I am pleased to report these strong earnings. And more importantly, I am really pleased to talk about the strong underlying performance. And to be pointed about it, we have had and expect to have a stable margin. We do not have nor do we anticipate credit issues. We have really kept our powder dry to take advantage of opportunities, as we'll discuss with respect to Slade's Bank.

Earnings quality has certainly improved over the last year, as evidenced by the 57% of the Company's loan portfolio is in business commercial lending. Our pipeline is strong. Denis mentioned the new market tax credit program also at a very, very [fine pace]. Fee revenue diversity and growth has improved. Non-interest revenue has grown to 24% of total revenue. Denis mentioned 1031 exchange business and our improved wealth management revenue, mortgage banking operations and such has really helped that along.

This has been a positive result of our really intense focus over the last couple of years. For those of you who have followed us over these years, you know that we really have been refining and retooling our business models over the last 18 to 24 months, and we're in really great shape to leverage our platform, and really push beyond this sort of traditional banking, community banking role. And not only do we have a terrific retail franchise, but we feel some of our best growth opportunities lie with commercial banking and wealth management. Our customers tell us through quantitative surveys they're very loyal and very satisfied. And as I have been talking a lot about, while Massachusetts is commonly perceived as a slow growth region, the specific markets we operate in really outpace the Massachusetts growth rates by a large margin. This has and will continue, mainly driven by the commuter rail line expansion, the recent announcement of a gaming site right in the middle of our territory, influx of (inaudible) into Cape Cod, and major retailing sites being established.

So in this tough -- this has been a tough environment the last couple of years; there's no question about it. And the easier thing to do might have been to step back and wait maybe for conditions to improve. That was not the path we chose. We decided to take a hard look at where we deploy our capital, how resources are being put to use. And all of the shifts in the balance you've seen really is a result of that hard look, the results of the hard look. As I have said again and again, we are resolved not to do anything stupid to produce nominal earnings as we go through these times.

Some of the specifics we've taken are really a multi-faceted game plan designed to seize on growth opportunities, improve our balance sheet, manage discretionary resources intelligently, such as reducing below-hurdle assets, our securities, our residential loans and balance sheet; indirect auto; grow (inaudible) loan businesses; grow the fee-based businesses, especially wealth management; improve our funding mix; managed expenses tightly, but while also funding growth initiatives; and adapt an opportunistic and selective approach to acquisition, which of course I will expand on in a moment. And as you all know, we've returned a good deal of capital to our shareholders.

One of these results is that we have consciously sacrificed short-term earnings, which is not an easy thing to do in unforgiving markets. If I were to sum up and sort of put in context what I would like to really spend my time talking about this morning, that is the recent acquisition announcement, is our work and focus has better positioned us for realizing opportunities. And the Slade's Bank opportunity is the most recent opportunity that has really -- we have come upon, and I would like to move on to that and talk about that a little bit. And as Denis mentioned, there is a presentation that you can follow with me at RocklandTrust.com. So, if you're following (inaudible) also try to make it so that if you don't have access to that presentation, I'll make it so you don't (technical difficulty) having that in front of you.

On slide 2, that second page, we're very, very excited about this. This is just terrific news, and we're delighted to announce our agreement to acquire Slade's Ferry Bancorp., owner of Slade's Bank in Bristol County, Massachusetts, which is contiguous to our own presence. This is a very important market extension move for us into southeastern Massachusetts. We operate in the fastest-growing region of our state, and Slade's will provide us with a real presence in the attractive Providence to New Bedford corridor, which parallels our existing strength in the Boston to Cape Cod loop.

Beyond the added footprint, Slade's will bring to us a solid and compatible loan portfolio that is fully funded by its current deposit base. We're also confident in our ability to provide the Slade's customer base with our deeper product set, especially on the commercial and wealth management side. And this is a strategic transaction. It is financially attractive as well.

What is also really important to know is to say there is really no work is a point I'd like to make on culture. It really is an excellent fit. It's hand in glove. I have known Mary Lynn Lenz, the CEO, for a number of years, become familiar with what she has been doing at Slade's Bank, the reputation of Slade's Bank. And then, of course, I've spent the early hours this morning meeting with a number of people. And my conclusion from all that is that they are very, very customer-focused and customer-oriented, just like us. They are very team-oriented and working together with each other and with their customers. And I'll say that there's a high desire, from Slade's and, of course, from us, to really make this deal work. And we all know that deal integration takes a lot of hard work and focus and commitment. And I -- there is a lot of evidence that that exists.

Page 3, just to give you a quick profile, as of June 30, total assets at Slade's of $628 million, loans of 434 million with a strong commercial orientation, with solid, reputable clients that match up well with our orientation and skill set. We had a very extensive due diligence across the entire business, and are comfortable with the loan portfolio.

The deposit base of $426 million. Capital of $51 million. Slade's is a very well-capitalized company. There is a high efficiency ratio; 76% in '07 so far, which presents us with (inaudible) opportunity in the deal financials and adds attractiveness to the transaction. Slade's has an excellent credit profile with MPAs of [39] basis points of loans and zero charge-offs so far in '07.

Moving to, for those of you following, the next slide, with the map. The blue dots are where we are, Independent Bank Corp., Rockland Trust. And you can see it complements (inaudible) complements our franchise very, very well. It has nine branches running just below Providence, with a presence in the bigger towns of Fall River and New Bedford as well. Bristol County has a nice mixture of working-class and wealth components, with a strong small-business base.

We are familiar with this market. We, Rockland Trust, have a loan production office of our own in New Bedford. We have been (inaudible) in the area. We have been (inaudible) in Rhode Island, as has Slade's. We know the area and we are comfortable with the area.

Moving on to the next page, this transaction takes us from a de minimis market share to number 7 with room to grow. And nearly all the banks with higher share are the much larger Northeastern or national banks, and we believe that provides opportunity. We, as I mentioned, do have familiarity with the area. And adding these branches will provide our existing Rockland Trust clients an opportunity to consider now (inaudible) deposits to Rockland Trust. Many of our clients at Rockland Trust are not clients of Slade's; they're clients of the bigger banks. So we think that presents some opportunity for us.

The next page, the growth market infrastructure, it (technical difficulty) the red lines are rail lines in existence. And as I said earlier, our market in this area is the fastest-growing in the state. It has population growth and wealth profiles well in excess of the state averages. There is a huge effort underway to extend the rail system down from Boston and (inaudible) from Providence will be, obviously, a boom to the region. So the purple lines you see in this slide are proposed rail lines. Rockland Trust has really benefited from the red lines at the right, those rail lines, because it opened up that whole geography. Real estate is still sort of less expensive in this region, and there's a lot of undeveloped land.

You'll see where the potential gaming site is indicated. The governor of the state has put his support behind the gaming legislation, with one potential site right smack dab in the middle of our market. As I say, great -- a fair amount of undeveloped land. We feel that Bristol County will inevitably take on many of the growth characteristics of our current markets.

Moving on to the next slide, if I could talk about the loan portfolio. This pie chart shows sort of a distribution of Slade's loan portfolio. You'll see that 65% is commercial, and it's higher than our 56%. I mentioned that we did due diligence, and we're comfortable; we're in the markets; we're familiar with the market. Virtually all its consumer exposure is in residential mortgages. We believe that if we combine Slade's (inaudible) expertise with ours that that will produce a great opportunity to grow the home equity portfolio, an asset class that we find attractive. And impressively, zero net charge-offs (inaudible) the year-to-date in this portfolio.

The next slide is an exhibit that shows some examples of how our product set will be brought to bear to Slade's. We think there's a lot of great opportunity. I've talked with a number of people here already this morning. There's a lot of excitement.

Just focusing on a couple. Our wealth management area is -- will be brand-new. We do have trust powers. We have a -- as I've talked (inaudible) before, highly capable investment managers that perform very well. We have three investment centers, and we believe there is a lot of opportunity in the 1 to $5 million client size range in this market, and will add nicely.

I will say in our financial projections, we were very, very, very conservative in terms of that. So we think that may be a bit of an upside. We have a new market tax program that, as Denis mentioned, we've done a lot of lending with that program in this area. They will help -- Slade's will help. Our 1031 exchange business will be a nice complement as well. So I believe that with some of our capabilities, with their excellent relationships with customers, that we will be able to produce good results.

The next slide, we expect -- on page 9, we expect a very smooth integration. Our own operating platform has been honed and improved over the last few years. I think we can definitely leverage it over a larger base. And we in fact have negotiated contracts in the past that sort of anticipated our growth of this nature, and we think (inaudible) in a favorable way. Our management group is experienced. We have successfully -- we had a very successful integration (inaudible) Cape Cod a few years ago. And before that we handled a large integration of the Fleet Bank of Boston divested branches on the Cape. We conducted, as I say, a very thorough due diligence, and we expect no surprises to emerge. And as I say, equally if not more important, there's a lot of teamwork orientation (inaudible) Slade's team to make this a successful [integration].

Denis, would you like to take it from here?

Sure. Thank you, Chris. Slide 10 gives you a summary of the significant terms associated with this transaction.

First of all, the structure. It's a 75% stock 25% cash mix. The exchange ratio for the stock component is fixed at 0.818 Independent Bank Corp. shares for each Slade's Bancorp share. Cash price is -- for the cash component of the transaction is $25.50 per share, giving an approximate aggregate value of $105 million.

The customary regulatory and Slade's Ferry Bancorp. shareholder approval will be necessary. We are hoping to close this transaction in the first quarter of 2008. And then [I'll] just review a number of the different transaction multiples for you.

The transaction represents a little bit over two times book value. Multiple is virtually the same on a tangible book basis. Core deposit premium, a little less than 17%, which we think is reasonable. The price on a last 12 month earning basis at 28 times appears to be rich on the surface. But we think that a more valid way to look at this is after factoring in the expected cost savings. And on that basis, it's a more reasonable valuation. That's certainly how we look at it.

On slide 11, some of the key assumptions here. There are material cost savings assumed, 40% of the Slade's Ferry Bancorp. base, which represents a pre-tax cost savings assumptions of $6 million. We expect to realize the majority of those savings in 2008, with 100% recognized in 2009.

Also provides some detail here on restructuring and other transaction charges. There are just two components to share with you. The capitalized after-tax restructuring charge is $9.3 million. There's various components in that charge, both management contracts, technology contract buyout, as well as a securities portfolio and borrowing portfolio restructure, which I provide some details on in the appendix.

If you were to look at slide 13, we mentioned a possible reduction of $70 million in the Slade's Bank securities portfolio, and we've built that into the capitalized restructuring charge. There are also some onetime after-tax merger-related expenses of $600,000.

Core deposit intangible we expect to be amortized over a seven-year period. Financing cost of 5% pre-tax cost of cash. And the earnings impact. Based on the analyst consensus estimate for 2008, which is $2.12, our expectation is that this transaction will be $0.01 to $0.02 accretive to that EPS estimate in 2008, excluding onetime charges. Now, I would mention here that we just guided you to the upper-end of our previously announced range and possibly beating that range of $2.10. The mean analyst estimate for next year is $2.12, so one could certainly argue that the analyst estimate will likely be higher for 2008, and we are comfortable with that. We have evaluated this transaction against our own internal expectations for 2008, which we will share with you on the January conference call, as we traditionally do. And this transaction is still accretive to that internal expectation. The pro forma valuation and model that we have done also computes, roughly, a 15% internal rate of return.

We have included in slides 12 through 15 some further information that I won't go into at this time -- it's there for you -- that gives some pro forma information for the combined entity, some detail on the loan mix, as well as on the funding mix of the pro forma entity.

This concludes the formal presentation, and we'd be happy to entertain your questions at this point.

(OPERATOR INSTRUCTIONS). David Darst, FTN Midwest.

Congratulations, Chris and Denis. Could you comment on your appetite for expansion going forward? And are you more likely to move (inaudible) to Boston, or would the direction be into Providence in Rhode Island?

Good question. Our [appetite] -- let me try to answer to that in a couple ways. We've been very clear on the investment management side that we are actively looking for smaller transactions that sort of fit well with our business and add incrementally. And we announced our -- hopefully what will be the first of several that closes in a few weeks. There are many, many investment firms, hundreds, and so the field is pretty deep.

On the bank side, as you well know, there has been a flurry of acquisition activity over the last decade. And combined with the banks that are sold, not bought, I would say that we're going to have to be opportunistic and sort of take the opportunities one by one and evaluate them. We would hope that, as we were with Slade's, that we would be invited to the table when the opportunities arise from time to time. And we'd evaluate them on a one-by-one basis. Denis, would you have anything to add to that?

I guess I would just say, David, we are expanding somewhat northward as well. We plan on opening a new branch location in the [Quincy] market, which is a city at the northernmost part of our market. So we certainly are interested in expanding in that direction as well. And as far as Rhode Island goes, we already have a significant presence from our Attleboro lending center, in terms of lending into the Providence and Rhode Island region. So we already are pretty active in the Rhode Island market. And with the complement now of the Slade's Bank activities in those markets, I think, we'll have a good presence from a commercial lending perspective in Rhode Island. And that's how we like it.

Does that mean that if the right opportunity came up, you would look at a whole bank acquisition to the north of Boston and jump over the core of the city?

I don't want to say yes or no to anything (inaudible) right now. What I will say is that if there is a bank that we would consider leaping over geography, if the opportunity is interesting enough. But that -- those opportunities would be -- have to be evaluated as they come along, on an individual basis.

Okay. Denis, could you give us an idea of what the tax rate for '08 might be, or is it too early to [post that]?

It's a little too early. We'll give you some better color on that in January. It depends -- the new market tax credit program has certainly been very effectively rolled out. It depends what other earnings would be outside of this program. If we're in an earnings growth mode instead of declining, unfortunately taxes don't go down as you earn more; they typically go up. So we will talk about that in more detail in January.

And then, you brought your relative reserve down a few basis points this quarter. Your unallocated reserve has grown this year. So is there more opportunity for you to reduce that? I would assume that also your indirect auto reserve will continue to decline.

The reserve -- I think what we've talked about on the past number of quarters, it would be in that 130 to 135 range. That's our expectation. We are a commercial bank. We view very cautiously the risk that is inherent in a commercial lending portfolio. We think that range is about right for us at this point in time, around that 130, 135. We evaluate it every quarter. We look very carefully at what's happening on delinquency, non-performing, upgrades, downgrades, etcetera. And we're very comfortable with that 130, 135 range at the moment. I don't think you will see us below 130 going into year-end or in the near future. I don't think that's on the horizon at all.

As far as indirect, yes. I will just comment on charge-offs. Our charge-offs are up. Indirect auto is actually pretty stable, meeting our expectation. The area that we've seen a little bit more charge-offs is in our small-business lending area, and that's really just more general economic conditions. The small electricians, plasterers, contractors -- because of the real estate construction slowdown, some of those are struggling. And we're seeing some modest amount of charge-offs there; nothing we're terribly concerned about. But it's one of the reasons why our charge-offs are up. But we are certainly content and happy about our asset quality.

Gerard Cassidy, RBC Capital Markets.

Most of my questions were just asked. But, I have another one on the transaction. Slade's Ferry seems to have a higher concentration of time deposits than you folks. What's their average cost of those time deposits? It looked like you in your release had about a 4%, a little bit over 4% cost of your time deposits. What was theirs?

We'll pull that for you, Gerard. I'll just make a comment on their level of time deposits. They do have some brokerage CDs at June 30th that subsequently they no longer have. They have some other deposit strategies that they have been successfully implementing that have allowed them to pay down the brokerage CD base. So that's a component of the higher cost as well. We're just searching for the deposit cost here --

As you're searching, you also gave us some detail on their portfolio, loan portfolio. And what percentage or how much of the commercial real estate portfolio is actually in construction loans versus commercial real estate mortgages?

Sure. Bear with me just a moment. First of all, time deposit cost overall is -- and this is as of, I believe, second quarter -- 443.

Okay.

Construction overall, I think their portfolio is about $25 million in commercial construction.

There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

Thank you everyone for joining us on this quarter's conference call. We look forward to speaking with you in January when we announce full-year earnings for '07 and guidance for 2008.

Thank you.

Ladies and gentlemen, this does conclude today's teleconference.