Independent Bank Corp (Massachusetts) (INDB) 2010 Q4 法說會逐字稿

Good morning, and welcome to the Independent Bank Corp. fourth-quarter 2010 earnings conference call and webcast. All participants will be in listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions. (Operator Instructions). Please note this event is being recorded. I would now like to turn the conference over to Chris Oddleifson, President and CEO. Please go ahead.

Thank you, and good morning, everyone, and thank you all for joining us today. I am accompanied as always by Denis Sheahan, our Chief Financial Officer, who will elaborate on our financial results following my comments.

But first, the usual forward-looking statement content. This call may contain forward-looking statements with respect to the financial conditions, results of operations and business of Independent Bank Corp. Actual results may be different. Independent Bank Corp. cautions you against unduly relying upon any forward-looking statement and disclaims any intent to update publicly any forward-looking statements, whether in response to new information, future events or otherwise. Okay.

I am quite pleased to tell you that we ended the year with a very solid fourth quarter. Net income in the fourth quarter rose to $11.8 million, or $0.56 per share, $0.03 above third quarter.

For the full year, operating earnings and EPS grew by a healthy 44% and 33%, respectively, over 2009 levels. Both the fourth quarter and full year were once again marked by strong fundamentals and robust business volumes. Most notable has been our exceptional pace of activity in our commercial lending franchise, especially within the C&I sector.

Our C&I portfolio grew by 35% in 2010, and by 15% alone in Q4. And I can absolutely assure you we are achieving this remarkable growth without any relaxation of credit standards, nor from much [lift] from the economy. It is much more a case of a sustained shoe leather and relationship building effort on our part to take advantage of marketplace opportunities. We are continually getting in front of customers in need of a reliable provider of credit.

We have been steadily upgrading our expertise and product set in ways that are visibly paying off. Rockland Trust's reputation for stability and local market know-how has proven to be a real key differentiator. And the good news is the pipeline of high quality corporate loans remains flush.

We were also able to grow our commercial real estate portfolio by 5% in Q4. An issue here has been the ability to counter the elevated levels of pay-downs and refinancings. Our origination volumes have been quite strong as was in the case in Q4, and we still feel there is a good opportunity in this area.

Home equity is another area of emphasis for us and that is meeting with much success. Our portfolio has grown by 23% this year and is up 12% in Q4. We have an active marketing campaign underway for this product, and we have a keen sense of customer preferences.

Another area I'd like to highlight is our investment management business. Strategically, this is among our highest priority businesses and one we are very intent on growing.

It's a natural fit given our client base and demographics of the markets we operate in. Assets under management grew to nearly $1.6 billion at year end from $1.3 billion at the beginning of the year.

We began to truly transform this business in 2004, bringing in seasoned investment management professionals. Our model managing new business is a true investment shop combined with trained fiduciaries as relationship managers has resulted in assets under management over tripling since then.

In June, we launched Bright Rock Capital Management to extend our reach to the institutional side, and we have launched several Bright Rock mutual funds this year.

Bright Rock crossed the $100 million market in assets under management in December. This is inclusive within the $1.6 billion I previously mentioned. We are very excited about our prospects for the investment management business, and seek growth both organically and by very selective acquisitions.

Turning to the balance sheet, we ended the year as we have in many other prior ones in excellent financial condition. We grew capital by 6% over the prior year end, and we did this the old-fashioned way, by our retained earnings.

All our key capital ratios grew throughout the year and remain well above regulatory thresholds. Tangible book value was also up 7% in 2010.

Liquidity-wise, we are in great shape. Core deposits grew by another 3% in Q4, bringing total growth for the year to 19%. The growth in our commercial customer base is certainly a factor here, bringing lots of low-cost deposits, and our excellent retail branch network throughout the southeastern Mass and MetroWest. Core deposits now stand at 81% of total deposits.

Our positive story in credit quality continues. Both nonperforming loans and net charge-offs were down in Q4; problem loan levels were down substantially from the end of 2009.

Now I want to remind everybody back in '06 and '07, our loan growth notably lagged the industry. And our credit instincts told us to pull back as we knew more and more -- as we grew more and more uncomfortable with the landscape and competitive practices at the time. This has not only kept us out of harm's way but freed us of distractions so we could confidently pursue really good business as we have. So all in all, 2010 was a terrific year for us.

We also achieved some very nice third-party acknowledgments during the year that have been helpful in our corporate image and recruiting efforts. We have been named by the Boston Globe as one of the top 100 places to work for the second consecutive year. This year, we ranked number 12 in our category.

We are recognized in the Forbes Most Trustworthy Companies list for the 50 in a row. Less than 5% of US public companies are included. And we received the Small Business Administration's designation as 2010's Small First Mortgage Lender of the Year.

As for the macro picture, there are glimmers of hope and positive sentiment for an economic recovery that are beginning to emerge, but we prefer to take a wait-and-see approach and not get too far ahead of things in our planning efforts.

The Massachusetts picture does remain a bit better than the national composite in terms of unemployment rate is in the low 8%s. The depth of foreclosure and home value problems is less deep here. We have resilient industries, such as healthcare, education technology. And it is also true our state and local government budgets are under great pressure with most likely more painful cuts to come.

Looking forward, we enter 2011 with the confidence that derives from the strength of our core business lines and the momentum they are building with our growing customer base. This is balanced with our grounded assumptions regarding a near-term operating environment from the headwinds posed by a still weak economy and uncertainty surrounding a legislative agenda. We'll continue to make targeted investments in our priority businesses in order to capitalize on our competitive advantage and seize marketplace opportunities. This will be done while maintaining discipline on overall expense levels. We will also aggressively promote the Rockland Trust brand and product offerings to an increasingly receptive universe of consumers and businesses. Thank you. Denis?

Thank you, Chris, and good morning. Independent Bank Corp. reported net income of $11.8 million and diluted earnings per share of $0.56 in the fourth quarter of 2010 as compared to net income of $11.1 million and diluted earnings per share of $0.53 in the third quarter this year. For the full year 2010, net income was $40.2 million, and $1.90 per diluted share.

As Chris mentioned, the fourth quarter was characterized by solid fundamentals and a strong top line. It is worth pointing out that we achieved a return on average assets of 1% in the fourth quarter, an important benchmark for us.

Some of the key topics in the quarter, asset quality trends remained strong. Net charge-offs decreased in the fourth quarter to $2.9 million, or 33 basis points of loans annualized. Our track record throughout the recent downturn has been very solid, as evidenced by relatively modest loss rates of 43 basis points and 38 basis points for all of 2010 and 2009, respectively.

Nonperforming assets decreased modestly in the fourth quarter to 67 basis points of assets, and are more than 20% below where they were a year ago. In addition, delinquency trends were stable, with total loan delinquency at 111 basis points of loans and early-stage delinquency, which is the 30- to 89-day bucket, decreasing to 65 basis points of loans.

In terms of a 2011 outlook on asset quality, we continue to feel very good. Nonperforming assets could increase from this very low level, but we fundamentally do not see material issues on the horizon. Loan charge-offs will likely decrease in 2011 and be within a range of $12 million to $16 million for the year. The loan loss provision for 2011 will likely be in a range of $13 million to $17 million for the year.

Loan growth was very strong in the fourth quarter as the new business pipeline we spoke about in prior calls finally paid dividends. Both commercial and industrial and commercial real estate growth were robust in the quarter, with linked quarter increases of 15% and 5%, respectively. Home equity also realized strong growth of $61 million or 12%.

Deposits were stable in the quarter as we focused on using up the Company's excess cash position, which is now essentially completed. The favorable mix change into core deposits continued with core deposits now representing over 80% of deposits. The net interest margin improved to 3.91% in the fourth quarter as expected.

In terms of an outlook, while great uncertainty and volatility in the bond market continues to persist, we are in a better place than at the end of the third quarter as increases in rates have improved prospects for cash flow reinvestment. Other factors affecting the net interest margin forecast include the level of pricing competition, which we do see as increasing on both the asset and liability front.

That said, we expect stability in the net interest margin around this 3.9% level and possible expansion into the mid-3.9%s, in part due to runoff of more expensive wholesale funding in the first quarter.

Non-interest income grew 22% in the fourth quarter due to a combination of deposit service charge revenue improvement, up 25%, and revenue associated with our loan level derivatives program reflecting the strong growth in commercial loan portfolio outstandings.

The growth in deposit service charges is due to the promotion of our overdraft privilege program, which, to remind you, is a positive to us as we were conservative in the prior implementation of the program.

Not-interest expense increased in the fourth quarter by 6% due to a variety of reasons outlined in the press release, including incentive compensation, loan workout costs and a software write-off.

Tangible common equity to tangible assets increased to 6.89% at the end of the fourth quarter. Tangible book value also rose to 14.86%, continuing its steady growth throughout the year.

And now turning to 2011 earnings guidance, we always try to provide you with our own expectations of future performance, along with updates as the year plays out. We anticipate diluted earnings per share performance in 2011 of between $2.02 and $2.12. As a reminder, our first quarter usually trends notably below the fourth quarter due to a variety of factors, including fewer days, higher employee benefit expense, increased marketing expense, etc. The range of $2.02 to $2.12 includes the absorption of an increase in our tax rate from 23% in 2010 to 27% in 2011, which reflects the expiration of some of our new market tax credit, as well as increased earnings. On our 2010 income base, this would have equated to about $0.10 per share.

Beyond that, we expect core business growth to continue. Our key assumptions include, while our loan growth was exceptional in this past fourth quarter, we can't extrapolate that over a full year. We believe the banking industry will be challenged for growth in 2011 and are reflecting that assumption in our estimate of loan growth in the region of 2% to 3% for the year. This includes continued strong growth in the commercial and home equity portfolios, partly offset by ongoing reductions in other portfolios, especially residential mortgage.

Likewise, deposit growth is expected to be somewhat constrained due to the lack of need to fund asset growth. However, we expect to kick off a new marketing initiative around consumer deposit acquisition that may improve growth prospects. We'll report further on this initiative at the next conference call.

The net interest margin, as previously discussed, is expected to remain in the high 380's to low to mid 390 range. Also as previously discussed, the provision for loan losses is expected to be in a range of $13 million to $17 million with net charge-offs approximating $12 million to $16 million.

Non-interest income is expected to improve, particularly in the deposit service charge category, in addition to wealth management, although this will be somewhat mitigated by lower mortgage banking revenue and loan level derivatives fee revenue. The estimate for 2011 is between $48 million and $52 million. Non-interest expense will be well-contained and is expected to grow at 2% to 3% for the year.

So, we head into the new year feeling good about the state of our franchise. We look forward to continuing to demonstrate our consistency of performance, risk management disciplines and open communication with investors. That concludes my comments.

Great. Thanks, Denis. Okay, operator, we can open it up to questions now.

(Operator Instructions). Mark Fitzgibbon, Sandler O'Neill.

Good morning, guys. First question I had for you relates to the service charges. Do you think the rise that you saw in service charges is sustainable, or do you think customers will modify their behavior to sort of avoid those new overdraft privilege fees (multiple speakers)?

This is a very interesting human behavior phenomenon we are observing here. You may recall that prior to a lot of the Congressional attention, we really had a very, very low-key program that we didn't publicize at all. And we did not allow any overdrafts at ATMs or point of sales. They were just declined flat out, no option.

With the increase in the visibility in the program and the basic desire to be more -- to be a little clearer with our customers of what programs we offered, we developed two programs, Overdraft Privilege and Overdraft Privilege Plus.

Overdraft Privilege is simply letting people know that in fact if they have appropriate standing with the bank that they are allowed to overdraft their account. And we're very transparent with the fees.

Overdraft Privilege Plus is the opt-in product that if you want to opt in for overdrafts at ATMs and point of sales, you can. We have actually been very modest with our marketing; we have notified all our customers. And we will continue to do that on a very sort of -- not frequent but periodic basis. Of course, any new customers that have come onboard, we notify.

The penetration we have so far for the Overdraft Privilege Plus is quite low. It's only about 10% of our deposit base. And that seems relative to what we've been hearing other banks, it seems very low. We're not quite sure whether we're comparing apples to apples but that's 10% of our overall base.

What we're finding is that simply by notifying and being more clear about the program, and I hate to even say marketing, because we're not really marketing; we're just disclosing it through some communication, we're finding customers actually are modifying their behavior to in fact overdrafts, to say well I didn't realize I had this privilege, I'm going to start overdrafting.

We in fact have gotten positive feedback and in fact thank you letters letting us know that our customers appreciate this service.

So that all sort of tells me that there's some unintended consequences going on in here and gives me some modest confidence that this will continue. Although we did see I believe -- correct me if I'm wrong -- we did not continue our fourth-quarter run rate for the year. We pulled back on that a little bit.

The seasonality and the flows of overdrafts, typically the beginning of the year, they slow down in the first quarter and then pick up in Q2.

So we've got some seasonality based on the fourth quarter. Mark, it's a difficult question to answer for us right now because as you can see we've had a material increase in revenue. Time will tell what happens here. Our projections as they stand today are assuming that there will be a material increase in service charge revenue. If that changes, as soon as we know we'll let you folks know about it.

Okay. And then second question, there's been a fair amount of deal activity in your market recently, and you guys haven't participated in any of those. I assume that you've looked at some of them and maybe even bid on some of them.

There's a relatively small universe of remaining companies in eastern Massachusetts, and presumably not all those are for sale. Does it make sense to sort of -- if you're not going to be able to do acquisitions, to maybe shift your strategy and ramp up your de novo activities to grow the franchise that way? And also, in your 2011 projections, does that assume any de novo branches?

Our strategy has never been an acquisitive strategy. It's always been very much of an opportunistic strategy. And the deals we've done in the past have sort of fit in that category of opportunistic and the board's raising their hands, us coming to the table and being able to work something out.

We have de novo'ed a couple branches in the past. We actually are very aggressively looking at sort of the next set of markets that we like to get into. Of course, our area is fairly well branched. And if you go into a market you want to go into a very, very good location. So part of our strategy is having lots of -- no, not lots, but a longer than two-hand list of potential markets we'd like to enter and keeping a very, very good eye out for good locations.

That is going to be -- you can't predict it. You certainly could predict going in a new market if you didn't care about your location, but it's going to be pretty location-driven.

We are also evaluating some LPO locations. We really had great momentum in our commercial banking business, but we have a set of lenders that is just I think is an extraordinary set of seasoned, knowledgeable, market savvy, good credit lenders. And we will look for those opportunities.

One thing I do want to remind -- I don't know if you brought out the line items, but I just want to make clear that we are not looking for anything too far afield. Our strategy has been to stick to our knitting, stick to our home areas, stick to adjacent areas. You don't expect us to make any leaps into markets far afield.

Thank you.

Damon DelMonte, KBW.

Hi, good morning, guys, how are you? I was wondering if you could talk a little bit about the C&I growth during the quarter. Are you seeing this in the way of increased utilization from existing customers, or are these new relationships?

The latter. It's new relationships. We have been -- we've had a real focus on C&I, both starting with and increasing our expertise in the C&I lending area, going back many years. And C&I relationships don't move very easily or very quickly. So the growth that we've had this year in C&I throughout the whole year, not just in the fourth quarter, has been on the back of a lot of efforts over the past five years to increase our expertise in that business.

So it's not based on line growth from existing customers or outstandings -- drawing down lines from existing customers. It's gaining opportunities from other institutions, no question about it.

Okay, great. And then with regards to the timing of a lot of the growth that you saw this quarter, but judging by the average loan balance for the quarter end versus the period end, it looks like a lot of the growth came out towards the last month of the quarter. Is that a fair statement?

Yes, you're absolutely right. We don't rush to get the deals done by year end.

Okay.

You know, some of the reality around this is we definitely saw, with the spike in rates upward in the fourth quarter, many borrowers get more aggressive about closing their financing, getting it done. There was a definite feeling from talking to our lenders. The borrowers felt that rates were going to continue their upward momentum, and they had better try and capture the lower rate environment now. There was a lot of that happening in the latter part of the quarter.

Got you. Okay, great. That's helpful. And then I guess, Denis, I missed the number you gave for a projection for non-interest expense for 2011.

Yes, I said that we expect that it will grow in the region of 2% to 3% from the full-year 2010 number.

Okay, great. And then lastly, could you provide a little color on your outlook for the mortgage banking income? As we head into 2011, obviously it's grown throughout 2010. And how sustainable do you think this quarter's result was?

Not. The magic number in mortgage appears to be with the mortgage rates get over 5% now, that's just -- volume just falls off. And we expect it to fall off pretty significantly once you get by the first and second quarter. The second quarter hopefully would be a good spring market. But the latter part of the year, we are assuming that mortgage banking revenue tails downward area.

Okay. Great. That's all I had for now. Thank you very much.

Sure.

Bryce Rowe, Robert W. Baird.

Good morning. Denis, can you talk a little bit -- you talked about the opportunity for some wholesale funding running off. Can you give a little more detail behind that?

Yes.

And then I want to also ask about the margin loan yields, security yields, kind of what you expect to see over the next few quarters there.

Sure. On the wholesale funding, we have about, in the region of $50 million, I think it's $45 million that is maturing in the first quarter. Rates between 2.90% and 4.5% -- 4.8%, actually; Ron just showed me here.

So they clearly are going to be replaced at much lower rates. So that is a very nice benefit to have for the net interest margin.

As far as loan yields and deposit cost, we work very hard on our cost of funds. I think it's the real gem in our net interest margin. We've got such a solid core deposit base and we will continue to do that.

Loan yields, we have been -- I think we haven't been greedy here, is probably the best way I can describe it over the past couple of years. We've swapped a lot of our commercial real estate book to variable, locking in that spread, and the view towards an increasing rate environment. And we're now modestly asset sensitive. So we will welcome rates going up.

As far as the absolute yields going forward, clearly, competition is back. For smaller commercial deals, the pricing is tightening, and we have seen some instances of pricing that go back to that 2006, 2007 range that is getting perhaps in our view a little too tight. So we are trying to hold onto our disciplined manner but competition is definitely increasing.

Is the -- the margin guidance you gave, what's kind of the driver from a funding cost perspective in that? Are you going to continue to see deposit costs, funding costs, move down outside of this wholesale opportunity?

Yes, modestly though, Bryce. There isn't a lot of room to move downward, but we do think they're, over time, we will continue to work that aggressively.

And from kind of a deposit mix perspective, obviously, you've had good movement away from the CDs. Where's --

Yes. That will continue. That will definitely continue. Our focus on DDA will continue. The commercial business brings with it very good deposit mix. And we are very focused there on our cash management services, and we are going to continue to do that throughout 2011.

Okay. And last question, you guys mentioned a deposit campaign. Any kind of color around what that is, or what that will look like?

No.

No, okay.

This is Chris. No, we don't want to provide any color on that right now. Thank you. We will, Bryce. (multiple speakers). As we -- producers also talk about it, but we don't want to let any cats out of the bag right now.

Sure, I understand. Thank you. Appreciate it. Thanks, guys.

David Darst, Guggenheim Partners.

Good morning. Could you comment on the derivative income? Were you booking mostly variable rate loans and then swapping that to fixed? And then is that also primarily related to the new loan generation or some of it related to current accounts?

Sorry, David, I missed the last part of your question. Can you repeat that? I got your question about the derivatives income, but what was the last part?

Is the derivative income related to the loan growth, or is any of it related to current loans?

Absolutely -- it's related to new loan growth.

And so are your projections -- I mean should we continue to see some of that as you continue to grow C&I?

Yes. It's actually more real estate. Because we are taking a fixed rate commercial real estate that is any scale, any size, and we swap it to variable at the loan level. So it's primarily from new opportunities to the bank, but there are also -- if one of our existing customers comes up for maturity, we are able to offer them the opportunity to get into a fixed rate -- longer-term, fixed rate loan. The benefit to us is we can swap it to variable.

What that does is, David, it takes frankly some current income off the table in terms of absolute yield in the commercial real estate portfolio, but it protects the spread, the credit spread, over the life of the loan.

Has that increased your percentage of variable rate loans over the past year?

Absolutely, yes.

Do you have that number?

Well, we have $300 million of these loan level derivatives; you'll see it. There will be detail in our 10-K coming up that shows how much progress we've made. That number is up from zero about two years ago. So that's just on the commercial real estate portfolio.

Beyond that, our home-equity portfolio, a large percentage of that is variable, and obviously, components of the C&I portfolio were variable. So we've come a long way in terms of moving from being traditionally a liability sensitive company to being much better matched and frankly a little asset sensitive at this point.

Okay. How much runoff should we expect to see this year in the residential real estate portfolio, and the commercial construction book?

Commercial construction, I don't have that number for you. But residential, we are assuming it will continue to drop by about $70 million or so.

Okay, thank you.

Laurie Hunsicker, Stifel Nicolaus.

Hey, good morning. I have actually a question [if we're busy], maybe, Denis, starting with you. So the expiration of the new market tax credits, sort of a big deal jumping your tax rate to 27%. Can you just talk about what you might be putting in place going forward to get that number back down, and --

Sure. I mean that is not -- that is a component of the increase in the tax rate. It's not the only reason. It's about $800,000 after-tax, is the drop in the tax credits. The rest of it is frankly we are growing earnings, and in growing earnings we are growing them in less tax-advantaged earning asset categories. For example, commercial loans versus a municipal bond. A municipal bond is going to have a tax advantage to it; a commercial loan does not unless it's part of the new market tax credit program.

So it's a fact of life, you make more money, you pay more in taxes. But we -- we periodically submit applications to increase our new market tax credit awards. And there is an expectation that there is going to be some announcements in the first quarter relative to awards. We would hope that we are included in that, because this is a program that has done a lot for economic development in our communities. And so we would be happy to be a recipient of those awards again.

So that's one of the primary activities that we have. We don't have plans, for example, to make significant purchases of municipal bonds to get the tax rate down. Probably the timely thing would be the new market tax credit program. And I guess aside from that we're just going to be paying more taxes.

Okay. As we look to 2012, I mean potentially assuming things trend right, potentially your tax rate still will continue to go up?

Yes.

28%, 28.5%, 29%, the --?

You know, I'm looking at a number right here now. There would be another -- it won't jump as much just because of new market tax credits from 23% to 27%. We would have another $1 million running off or so -- excuse me, another $800,000 running off in 2012. So whatever $800,000 is as a percentage of our pretax is how much the tax rate would go up.

Okay, perfect

It's about 1%, 1%, 1.5%, something like that.

Okay. Okay, great. And Chris, I have a question for you.

(multiple speakers) off the topic.

We obviously -- we saw people (inaudible), and I wondered if you could just guess there why Danvers was not a fit for your franchise?

Yes, we can't comment on that. I will sort of repeat sort of our point of view that we -- two things about acquisitions on an opportunistic basis. And we hope to be the tables for [sport] that raised our hands, but I can't comment on any specific deals.

Okay. Well, let me ask you another question. Would it be way out of the ballpark for you to look to buy a $2.5 billion asset bank?

I think as opportunities come up, we need to evaluate them one by one. There have sort of been many examples around the country of mergers of banks that have sort of comparable size or similar sizes, and it sort of all depends on the circumstances and the economics, etc., etc.

Okay, fair enough. I guess to your point that you were discussing earlier with Mark, and that is de novo branches, as you're looking into new sets of markets and you're thinking more about de novo to your existing 70, how many would you conceivably open per year? Do you have an idea of what you're looking at?

Well, yes, we probably -- I mean it's -- unfortunately in Massachusetts it takes forever, to sort of, once you find a location to get something rolling; I am exaggerating. It takes longer than you really would hope.

We would -- we don't have any sort of anything on the [significant] drawing board right now. So you can say that probably in 2011 we are not going to open new branches unless there is something -- [sort of like] a unique opportunity comes up.

But as we said, we [already] thought about our de novo strategy. Now it wouldn't be sort of out of the question to think about between two and four a year; Denis, is that a good number, do you think? In '12 and '13, '14, something along those lines. But that is a really rough number. There are no specific plans. It actually depends a lot on our ability to find good locations in some considerable markets.

I mean there clearly are; there are communities that we are interested in being in, but we don't have specific locations at this point.

And so if you were to identify, I mean what are your top three communities you're interested in outside of you can't find locations. What would be the top three markets?

Our top three? I don't want to talk about our top three. That would be sort of showing our (multiple speakers)

Showing your hand, okay. Fair enough. Okay, thanks. Nice quarter.

Okay, thanks, Laurie.

(Operator Instructions).

Okay. Well, there are no more questions?

No more questions.

Okay, well, thank you very much. We appreciate everybody's interest. (inaudible) with the year, and we look forward to giving you an update in three months.

Thank you.

Thanks, bye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.