Independent Bank Corp (Massachusetts) (INDB) 2013 Q2 法說會逐字稿

Good morning and welcome to the Independent Bank Corp.'s second quarter 2013 earnings call. (Operator Instructions).

This call may contain forward-looking statements with respect to the financial condition, 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 statements and disclaims any intent to update publicly any forward-looking statements, whether in response to new information, future events, or otherwise. Please note this event is being recorded.

I would now like to turn the conference over to Christopher Oddleifson. Please go ahead.

Good morning, everyone, and thank you for joining us today. Unfortunately, our CFO, Denis Sheahan, could not be with us today as he had to travel unexpectedly to Ireland to tend to a family illness. Filling in capably for Denis is our Treasurer, Rob Cozzone.

It was business as usual for us in the second quarter, and that is a good thing. The Rockland Trust story continues to be marked by strong origination volumes, deepening of customer relationships, growing recognition of our brand, and an adherence to discipline as the competitive environment heats up.

Core earnings in the second quarter totaled $13.2 million, or $0.58 per share. Once again, fundamentals led the way. Commercial lending remains a pillar of strength for us with the portfolio growing at a double-digit annualized rate again in the second quarter. The C&I sector has been especially strong for us. Deal flow in the commercial real estate side, the CRE side, has been good as well, and the commercial pipeline continues to build nicely.

Competition for credits is steadily ratcheting up, especially for the smaller credits by smaller banks anxiously seeking growth. We have been able to counter this pretty successfully thus far, but will keep a watchful eye on trends here.

As before, total loan growth was muted by heavy refinancing volumes that persist in the resi mortgage space and by their own practice of selling a high percentage of originations in the secondary market.

Deposits grew sharply in Q2 and continue to serve as a low-cost funding source. Core deposits have now risen to 85% of total deposits. The cost of total deposits declined further, helping us to mitigate the strong pressure on earning asset yields from the low rate environment.

Fee revenues were up nicely in Q2 with strength in the investment management and deposit related services more than compensating for the expected decline in mortgage banking revenues.

The balance sheet remains in very good stead. Capital levels continue to be solid; tangible book value is steadily rising. Our credit picture is an excellent one with comparably low charge-offs at nonperforming levels. And we also continue to prudently add to loan-loss reserves in line with our portfolio growth and the value we place on maintaining a strong balance sheet. This reinforces the quality of our earnings performance.

So all in all, another solid quarter, and we will continue to stay focused on generating organic growth.

I should say that, nonetheless, we are mindful of the relentless pressure on interest margins facing our industry, along with the ongoing uncertainty from all the [bogardies] of the economy and Beltway politics. So we continue to remain well grounded in our assumptions and such are increasingly intent to build low expense levels.

What we are doing is we are seeking an intelligent approach to balance ongoing investing in our franchise with efficiencies in other parts of the Company. I think this is evidenced by the flat expense levels you saw in Q2. These select investments are absolutely critical to sustaining future growth in our competitively advantaged businesses. Recent growth initiatives in our commercial businesses, for example, have proven quite successful.

So we continue to add senior talent to our high-quality investment management and middle market lending units as a way to spur new business development. We are also about to open our first office in Boston in the financial district. That will be staffed by senior investment management and commercial lending team members, and we are expecting good things here.

The other notable development in Q2 was reaching a definitive agreement to acquire Mayflower Bancorp, a profitable, well-managed institution with an excellent deposit base and strong credit quality. This is a financially attractive in-market acquisition that further strengthens our number one position in a key local market. It builds franchise value in the attractive southeast Massachusetts footprint and provides valuable low-cost liquidity by adding approximately $235 million in deposits. We are well along in our integration planning efforts and continue to expect a Q4 closing.

We bring a great deal of confidence to this combination, given our recent success in assimilating Central Bancorp with its 10 branches and over $300 million in deposits in the greater Boston market. Central was fully converted to our operating systems within three months of closing. Extensive training of branch staff and managers to the Rockland Trust way was conducted. On sales, production volumes have notably risen in these acquired branches, and we have achieved all our cost-reduction targets.

The fact is that despite all the advances in technologies, our business is still very much a people business. We place a tremendous value on our employee base, training, motivating, empowering them. We have a phrase here, Where each relationship matters, and it's more than just a marketing slogan. But it's a beacon that really guides my colleagues to win customers' hearts and minds in the marketplace. We are certainly very grateful to all of them and their hard work and devotion.

That concludes my brief comments. Now I will turn over to Rob. Rob?

Thank you, Chris, and good morning. I will now review our earnings release in more detail.

Independent Bank Corp. reported net income of $12.8 million and GAAP diluted earnings per share of $0.56 in the second quarter of 2013. This compared to net income of $12.3 million and diluted earnings per share of $0.54 in the first quarter.

Both quarters included M&A charges and the first quarter included severance associated with the outsourcing of the bank's mortgage operations, as previously discussed. Excluding these items, diluted earnings per share on an operating basis was $0.58 in both quarters. Year over year, diluted earnings per share on an operating basis improved by 35% as the prior-year quarter was negatively impacted by an isolated loan fraud.

I will now speak to some key items for the quarter. As anticipated, with healthier pipelines, strong commercial loan growth resumed in the second quarter. The C&I category was up almost 23% annualized during the quarter and total commercial, including C&I, increased at an 11.2% annualized rate during the quarter. Also, the approved pipeline ended the quarter at a year-to-date high of $260 million.

However, aggressive competitive pricing, especially from smaller institutions, went unabated during the quarter. This seemingly irrational pricing at times and our strict discipline is resulting in lower pullthrough rates and higher payoffs.

In addition, our consumer real estate portfolios continued to experience declines in the second quarter as refinancing activity lingered. With the recent and significant increase in mortgage rates, this refinancing activity should diminish as we head into the second half of the year. The combined results of these loan portfolios changes is just under 1% growth in total loans for the quarter.

As Chris mentioned, core deposit growth was particularly strong in the quarter. Demand deposits increased 7% unannualized and savings and interest checking increased 5%. As we mentioned in the first quarter, advertising ramps up in the second quarter and we benefit from some seasonal flows. This core growth contributed to a total cost of deposits of only 23 basis points for the quarter.

In addition our total cost of funds declined two basis points to 46 basis points for the quarter.

Asset quality trends remain strong, and importantly, realized and expected losses are very low, at only 18 basis points annualized.

Higher net charge-offs and improved loan growth with the higher provision level for the quarter as we prudently added to reserves. Nonperforming assets increased $1 million to $48 million in the quarter, with declines in OREO being offset by an increase in home equity nonperforming.

Importantly, the increase in home equity is being driven by borrowers that are current with us, but have delinquent first positions at other institutions. You will recall that there was clarified guidance issued by the regulatory bodies on this topic in 2012. In fact, our total delinquency for home equity loans and lines at June 30 is only $3.8 million, as compared to $10 million of nonperforming home equity loans and lines.

As stated in the first quarter, we continue to feel really good about the state of our credit profile and our credit quality outlook for the year has actually improved, which I will touch on shortly.

The net interest margin was only down one basis point during the quarter as it benefited slightly from purchase accounting adjustments, as well as an improved balance sheet mix.

We continue to expect it to drift slightly lower from here. However, the increase in market rates, combined with our asset sensitivity, should provide modest relief for the remainder of the year.

Should the increase in rates hold, next year's net interest income, assuming a static balance sheet, is expected to improve by 2% to 2.5%. And although there are many interest rate scenarios that could potentially play out, we are fundamentally positioned for rising rates.

Noninterest income increased by 6% quarter over quarter and represented 27% of total revenue. Our continued focus on core checking accounts, both business and personal, has resulted in strong growth in interchange revenue, and the increase in commercial loan business has led to increased loan level derivative income.

The noninterest income category also benefits from seasonal tax preparation fees in the quarter. Offsetting these improvements was an interest rate-driven reduction in mortgage banking income.

Noninterest expense on an operating basis was essentially flat for the quarter, as decreases in salaries and benefits and snow removal were offset by increases in advertising and mortgage outsourcing.

As a reminder, in the fourth quarter of 2012 we outsourced our mortgage operations in an effort to stabilize our cost per unit while taking advantage of improved technology and compliance effectiveness, a decision we expect to pay off as rates rise. This increase in mortgage outsourcing expense is offset by a decrease reflected in salaries and benefits and contract labor.

As mentioned on the first-quarter call, the Central Bank integration is well underway and we have already exceeded our cost-savings objectives. We are now focused on capitalizing on the substantial opportunities the market presents. As we do this, we are methodically planning for the Mayflower Bancorp integration. The regulatory application process is on track and, as Chris mentioned, we expect to close on the transaction during the fourth quarter. The acquisition of Mayflower will strengthen our position in a key market and provide liquidity to fuel future growth.

I will now provide updated earnings guidance for the remainder of the year. Please keep in mind that this guidance does not include the impact of the Mayflower Bancorp acquisition, which, aside from M&A costs, should be minimal in 2013. At our last conference call, we confirmed our operating diluted earnings per share performance guidance for this year of between $2.28 to $2.38, which equates to 6% to 10% EPS growth. We continue to expect that performance.

However, now that we are halfway through the year, we can provide some more clarity. First, with 15 basis points of charge-offs, or $3.3 million year to date, we now expect to be slightly lower than the original range of $10 million to $14 million provided. Second, given competition primarily from smaller, less disciplined financial institutions, we now expect total loan growth to be lower than the originally guided 4% to 5% and closer than to the 1% to 2% experienced in the first half.

These two factors will lead to lower provisioning expense and lower net interest income for the year. The remainder of the full-year guidance is essentially the same.

We are fortunate to operate a terrific franchise in great markets and look forward to achieving the EPS growth expected for this year. That concludes my comments. Chris?

Thank you, Rob. Chad, we are ready for some questions.

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

I wondered if you could share with us the size of your loan pipelines at present.

Yes, Mark. The commercial loan pipeline, the approved pipeline, that is, is at $260 million, which is the highest it has been year to date. Our residential pipeline is at about $70 million, which is actually pretty close to where it ended last quarter.

Secondly, your efficiency ratio is around 68%, and I know you've got some noise in there from acquisitions and somewhat higher costs related to your fee-based businesses. But do you have a target that you are driving toward over time?

I think we would like to be, over time, and this is not any sort of forecast, in the lower 60%s. We don't anticipate ever getting into the 50%s, given the nature of our branch network.

But Rob had mentioned of managing to an efficiency ratio, per se. We are managing to overall shareholder value creation, and we are balancing explicit expenses and are not providing a return immediately, but will provide a return in the future -- for example, this Boston office we are opening up -- and the additional expense we are incurring on business development.

We are doing -- we have done in the past a lot of consolidation and efficiency work and we continue to do that throughout the Company. But to give -- say we will achieve X% by X date, I don't want to put a number like that out there.

Okay. And then, Rob, just to clarify on your point about the loan-loss provision in the second half of the year, I think your provision in the first half of the year was $4.4 million. Should we assume that it's going to be lower than that in the second half of the year, based on your comments on asset quality?

No, I wouldn't assume that it would be lower, Mark. It's going to be lower than our original guidance, which was $10 million to $14 million, but should be fairly consistent with this quarter.

Okay. And then the last question, Chris, I wondered if you could just share with us what you are seeing out there on the M&A front. You have been successful recently in doing a few small bank acquisitions. Do you sense that there are a lot of other transactions out there and are you optimistic on your ability to do more in coming quarters?

Mark, you know how I can and cannot answer that question. But I will make this observation, that the number of publicly traded firms in our area over the last decade has diminished pretty dramatically, so now that there's just a handful of independent stock traded banks, making now the M&A more of what I'd call a random event than any sort of trend.

So we could see some or we could not. It depends. It depends on the mood of the board, their boards.

I guess the important thing is that we are a proven successful acquirer, integrator. We deliver what we say we deliver to the [quiry] shareholders. And we hope that when boards decide they would like to look at strategic options, we will be on the short consideration list.

Matthew Kelley with Sterne Agee.

I was wondering if you can just talk about how much you have seen commercial loan yields improve, but particularly with the pipeline yield for commercial real estate. I think that's the area that most have been anticipating obviously a pretty significant improvement in yield, given the uptick in rates. What have you seen?

We typically don't get into specific pricing, as we think that can cause a threat competitively.

I will tell you that, as we mentioned, we are not seeing the smaller institutions in our footprint react to the increase in rates yet, especially in regard to the commercial loans, which is why we are finding it more difficult to get some of these loans to closing. The smaller institutions are extremely competitive and they seem to be less inclined to adjust their rates when market rates increase.

And the five-year has gone from, what, 60 --

The five-year has gone from just over 60 basis points to 160 basis points, and the swap has done the same, which is where many of those medium-term commercial real estate deals you would expect to price off of. However, we do expect our new volume yields to gradually increase in commercial.

Okay, got you. And then, on your securities portfolio, if the intermediate and longer-term parts of the yield curve, the Treasury yield curve, hold where they are right now, do you think you can put a bottom here in the securities yield at [260], [275]?

Yes, I think that's fair to say. You might see a couple more basis points of decline, but should these yields hold, that should be true.

Okay, got you. And then, in your mortgage banking business, you said as you outsourced that, so there will be a commensurate decline in any type of expenses there. You don't have any issues with negative operating leverage as revenues come down in that business?

That's right.

We now have minimal fixed expense associated with that operation.

Got you. And were the pipelines in there for loans originated for sale? What is the outlook and what you are seeing just the last couple of weeks?

Obviously, it's down. Certainly nationally it's down meaningfully. But just keep in mind, the mortgage operation contributes very little to our bottom line. So we are fairly insensitive to what happens with mortgage production, especially now with the outsourcing.

Last question, you just look through your 10-Q, and a parallel shift up 200 basis points results in NII up 3.5% is what you displayed in the March 31 10-Q. What about the type of bear steepener that we are seeing with the long end moving higher, so a steepening of the yield curve? How does that impact projected NII? What magnitude of improvement beyond the 3.5% would you expect?

I mentioned in my comments that for this year, we would not expect significant improvement as a result of the shift because obviously it takes time for those cash flows to reprice. But next year, on a static balance sheet, we would anticipate 2% to 2.5% improvement in net interest income as a result of the shift that has already taking place.

David Darst with Guggenheim Securities.

Chris, could you maybe talk about a few more items that are on your list to invest in, and how that might impact the cost structure? I guess marketing was up this quarter. You have talked about the Boston growth management office. Is there anything else or should we think about these as --

We are adding seasoned commercial lenders. We've added business development folks at the smaller business level. We have a full complement of a very large, relatively speaking, business development group in our investment management group. I think there are about 14 of them altogether, which is significant, which has really yielded some great results. We have taken that business from losing money to making a meaningful contribution to the bottom line.

We are contemplating, and we have talked about the Boston office, and we are evaluating how to think about our branch network, both on the trimming side and the expansion side. So we're -- why do we want to optimize that? There are a few more examples.

Rob, as you were discussing the margin and the steeper curve, you are thinking about just maybe one more quarter of compression before you begin to see the stabilization and improvement?

I think we will continue to compress the remainder of this year, but it should be fairly limited.

As you know, a high proportion of our loans are tied to the shorter end. However, our investment portfolio, our fixed commercial real estate portfolio, and our residential real estate portfolio will benefit from this increase in the middle part of the curve.

What percentage of loans are tied to the short end of the curve?

It might take me a minute to get that, David. Do you have another question you can ask?

No, I think that's it.  I think you've covered everything.

I might have to get back to you on that, David.

We will continue to look for it as we try to answer some other questions. We may answer it later in the call or we may get back to you.

Collyn Gilbert with KBW.

First question, I guess, Rob, maybe you could address it, is just the jump in cash this quarter, what facilitated that and what you anticipate the uses of that cash to be, maybe in the next quarter.

I guess my thought would be that that would be a positive impact to the NIM going forward, but perhaps not. So if you could just give a little bit more color around that?

No, Collyn, this should be a positive impact to the NIM. However, a large portion of that increase in cash comes from our municipal business, where we get influx of growth, deposits at the end of the quarter. So some of that will not be maintained, but certainly a portion of it will and a portion of it we will likely deploy into investments.

What percent of your investment in trust revenues are tied to market values?

On our investment management business?

Yes, yes.

I would say the vast majority of the revenues in our investment management group are a function of the fees associated with the level of assets in our customer accounts. We do have some tax prep fees as such in the second quarter and a few other fees.

But that said, we're looking up the -- let me get the details right here. So, yes, the vast majority. So if we were to -- if the market were to jump up 25%, you'd see a material increase in our revenue. And likewise in our (multiple speakers)

Is there a bit of a lag in terms of when those fees (multiple speakers)

Those fees are charged on a monthly -- gosh, is it monthly or quarterly?  I believe it's a monthly basis to the account, based on the asset levels at the end of the month. So it would be pretty (multiple speakers)

Pretty immediate. Got it. That's helpful. Okay, and then, you may -- I don't know if you guys addressed it, and I apologize. The drop in compensation expense this quarter, what was driving that?

That's due to the --

Just a seasonal change in payroll? Okay.

(Multiple speakers) tax associated with the incentive payouts in the first quarter.

There was also a shift -- you know, we outsourced our mortgage operations. So we had a decline there, as well.

Okay, that's helpful. Rob, I know you said that for competitive purposes, you generally don't offer what the pricing you are seeing on your loan segments is. But of all your lending buckets, where are you seeing the best pricing and what is giving you the best yield at this point?

It's funny, and you probably wouldn't expect it, but it's actually on the larger deals where the larger institutions are adhering to some pricing discipline.

It's really the deals that are $5 million and less, where the small banks compete, where we are seeing irrational pricing. But as you go upmarket, the larger banks seem to be pricing off of market rates and so we are seeing better pricing there.

Interesting. Okay. All right, that was all I had. Thanks, guys.

Just to get back to David Darst's question, regarding short floating assets, we have approximately [$1.8 million] of our loan portfolio primarily made up of commercial loans and home equity lines that are tied to either LIBOR or prime.

That was $1.8 billion. Right, okay.  Chad, are there any more questions?

(Operator instructions) Bernard Horn with Polaris Capital.

Just a quick question again on loan growth. I know in response to Mark's question, it looks like the pipeline is reasonably flat. And then I think in Matt's question, you talk about commercial being somewhat competitive from the small banks, but probably not seeing a lot of reductions. I think in terms of the guidance going forward being a little bit lower, it looks like the residential loan portfolio is where you are seeing most of the prepayments coming through. I'm wondering if you can just give us some sense for the term structure or the yield structure of your in-house portfolio. Is it consisting of a lot of variable rate, fixed rate? What sort of exposure do you have to a lot more prepayments?

Rob can answer that, but Bernie, the pipeline is actually quite strong on commercial, relatively speaking. I think you characterized it as flat.

Well, I thought it was flat quarter to quarter.

No, that's actually up 60% or so.

Oh, sorry.

The commercial pipeline. The residual pipeline is flat quarter to quarter.

[260] and [70], respectively, I think it was.

That's right. Commercial was about [180] last quarter, so up meaningfully.

So I guess that would -- so my sense would be that maybe you are -- either you're being modest or that there's a lot of prepayment exposure on the residential in order for your guidance to be 1% to 2% loan growth.

It's actually not the case that we expect the prepayments in the residential portfolio to continue to increase. It's in the commercial portfolio, where we are seeing stiff competition as it relates to commercial credits, and again, it's especially from the small institutions.

Last year, we looked at about $1.9 billion in credits in commercial and we closed on $900 million. Year to date, we've looked at, I think, almost $1 billion and have only closed about $300 million. So our pullthrough on commercial has declined.

Then we are also seeing both payoffs and paydowns. Some of the paydowns are lines that are remaining open, but it's companies that have excess cash and are choosing to use that cash to pay down their lines of credit.

Okay, but are you seeing -- even though the pipeline is up strongly, then it sounds like you are still expecting to see a fair amount of essentially offsetting payoffs and paydowns for total loans to be up 1% to 2% for the second half, if I'm getting that right.

That's correct. One of the advantages we have with such a substantial commercial [relationship] and bankers out in the field is that we're able to look at a lot of deals. We have a lot of looks, and we are able to then work and pick the deals that fit our pricing expectations and let the rest go to the folks who don't have the pricing discipline we have right now.

We expect that the smaller banks over time are going to catch up. This is not permanent phenomenon. The rates have rocketed up, and they don't have the sophistication, I think, that the bigger banks do, like us. So hopefully, we are not going to be -- look at this too long.

And then, just on capital, with the new guidance from FDIC and so forth, are you -- obviously, you've got some balance sheet growth due to the acquisitions. Any other thoughts on capital or where that is going or how you might deploy that going forward?

It's all positive news for us. As you know, being under $15 billion, the areas that we are concerned about is the trust preferred, that being eliminated over time; the other comprehensive income on your available for sale and your cash flow hedges, having to flow through regulatory capital. We had the opportunity to opt out of that. And risk weighting of residential loans was positive as well. So we are feeling even more comfortable than we already did about our capital position and don't have any plans at the moment to change anything structurally.

So with 9%-plus leverage ratio you, should either be able to do stock buybacks, which I'm not saying you should do, I'm just asking, that or the trade-off between just continuing to grow the balance sheet through M&A, because the loan growth doesn't sound like it's going to be able to grow the balance sheet enough to drop the capital ratio?

Certainly, we prefer the latter, continue to grow.

There appears to be no further questions at this time.