Independent Bank Corp (Massachusetts) (INDB) 2016 Q3 法說會逐字稿

Good morning, and welcome to the Independent Bank Corp. third-quarter 2016 earnings call. (Operator Instructions)

This call may contain forward-looking statements with respect to the financial conditions, results of operation and business of Independent Bank Corp. Actual results may be different. Factors that may cause actual results to differ include those identified in our annual report on Form 10-K and our earnings press release. Independent Bank Corp. cautious 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 Mr. Christopher Oddleifson, President and CEO. Please go ahead.

Thank you. Good morning, everyone, and thank you for joining us today. With me as usual is Rob Cozzone, our Chief Financial Officer, who will take you through our financial results following my comments.

In the third quarter, we delivered another solid performance following on the heels of an excellent second quarter. Net income came in at $20.5 million, or $0.78 per share, 10% above prior year's level. As I have said many times before, strong fundamentals led the way. Once again, commercial loans rose nicely despite various paydowns earlier in the quarter. Our loan officers are doing a great job in a very competitive environment without sacrificing our credit discipline.

On the consumer side, mortgage and home equity loan volumes have been strong. Core deposits remained a source of strength, reaching 90% of total deposits in the third quarter, and continue to keep funding costs on the low side.

Fee-based activity remains robust. Our investment management unit continues to shine with assets under administration going to $2.9 billion. Credit quality remains stellar with lower non-performers and very modest losses in the third quarter. For the first nine months, we were actually in a net recovery position.

Expense levels were virtually flat as we continue to balance select investing with overall restraint. And lastly, capital continues to build, thereby providing healthy growth in tangible book value per share. So, a good quarter all around.

The other important news, of course, was our announcement late yesterday of having reached an agreement to acquire Island Bancorp of Martha's Vineyard and its Edgartown National Bank subsidiary. This is another wonderful move on our part to extend our footprint into an attractive contiguous market. Here are a few quick facts.

Edgartown National is an approximately $194 million asset institution with branches in the three main population centers on the island. It is the oldest bank on the Vineyard, with roots dating back to 1905. This is a well-managed, profitable community bank with a solid credit profile. The Vose family, who are the original founders, and CEO Fielding Moore have done a terrific job in growing the bank and creating a very loyal customer base and a strong community image.

For us, the benefits of this transaction are many. This is a natural extension of our growing presence on Cape Cod, which is the primary access point to Martha's Vineyard. We already have many customer relationships on the Vineyard, and this will give us our first physical presence here.

As many of you know, this is a major destination point for second homeowners and vacationers who bring significant economic activity to the island. It is also a good year-round small business space. We see significant opportunities for deepening relationships with our products set, especially investment management and home equity along with a much higher lending capacity. On the financial side, this is a low-risk transaction that is expected to be accretive to earnings and neutral potential book value.

Like our Bank at Cape Cod acquisition, which is expected to close next month, and others before it, we expect a seamless integration process, and we waste no time in getting going on advance planning. In fact, Rob and I are conducting this call from Edgartown National's historic main office building, which some of you may remember was featured in the movie Jaws as Amityville National Bank.

We are here with a number of our other Rockland Trust executives meeting with bank staff and other key constituencies to develop a sense of excitement and opportunity to hit the ground running on day one. We are also pleased that Dee Lander, their head of business development who knows the local market very well, will be staying on to lead our combined efforts on the island.

The important takeaway from our commentary today is that we continue to build franchise value through sustained organic growth and opportunistic transactions. This is also evident that community banks deciding to be part of a larger organization are attracted to the power of the Rockland Trust brand, our corporate values and our currency.

You have heard us talk about and respond to questions about preparing for the inevitable crossing of a $10 billion asset threshold and the increased regulatory oversight that comes with it. We have a way to go at $7.5 billion, but it's something that our Board and management team across all levels of the organization spend a lot of time on. This is readily evidenced by the significant expansion of our compliance programs and our portfolio of stress testing that is required of larger banks.

We are also attentive to ensuring that our Board composition continues to evolve with a proper depth of expertise and stewardship, and that's our growing size and sophistication. A subcommittee of the Board has been hard at work developing recruitment criteria to identify potential candidates who can further strengthen the Board as well as provide for orderly succession to current members expected to retire over the next few years.

From an economic standpoint, we have seen mixed results in terms of the national economic data released over the past quarter. Despite sluggish reports in GDP growth and sub-2% inflation, the expectations for the US economy remain mostly positive. The recently released Fed Facebook survey found that most of the 12 districts are experiencing a modest or moderate pace of expansion and that job markets remain tight with modest employment and wage growth.

Locally, our state economy continues to perform well, with a Massachusetts unemployment rate down to 3.6%, a level not seen since 2001.

Needless to say, it's easy to get distracted and at times overwhelmed by the myriad of political, economic, regulatory and global issues swirling around out there. Our way of countering this is by simply remaining laser-focused on our customers and ensuring we provide the best experience possible to them. The other part of this is making sure we have the right people in place to accomplish this, and we do.

We remain confident that our long-term strategy of disciplined growth will continue to result in superior performance and bring us ample opportunities for future growth.

With that, I will turn it over to Rob.

Thank you, Chris. Good morning. As Chris just described, the third quarter was another solid one for us. Net income of $20.5 million and diluted earnings per share of $0.78 for the third quarter were both slightly higher than a very strong second quarter and 10% higher than the same period last year. Included in the second and third quarters of this year were very modest M&A expenses.

Performance ratios for the quarter were also quite solid. On an operating basis, the return on average assets was 1.1%, the return on average equity was 10.03% and the return on average tangible equity was north of 13.5% for the second consecutive quarter.

Solid earnings results continue to drive growth in tangible book value per share, which increased by $0.56 to $23.08 at September 30 from the prior quarter-end and has now grown by 11% in the past year. In addition, despite good balance sheet growth, tangible capital to tangible assets increased 11 basis points to a healthy 8.33% at September 30.

Near record loan pipelines at June 30 led to very strong closing volumes during the quarter. And despite elevated payoffs, the total loan portfolio grew 1.3% to $5.75 billion at September 30.

Our loan categories on both the commercial and consumer sides, with the exception of C&I, experienced growth during the quarter. However, the reduction in the commercial pipeline to $166 million at September 30 from the over $200 million in the prior quarter will likely result in somewhat slower growth for the fourth quarter.

Still, full-year organic growth is expected to be within the 3% to 5% range originally established for the year and most likely at the upper end of that range.

Total deposit growth of $72 million matched loan growth and was primarily concentrated in the demand deposit category. Strong growth in non-interest-bearing deposits allowed for a continued reduction in higher cost time deposits. As a result, demand deposits reached 32% of total deposits at the end of the quarter, and the total cost of deposits declined another basis point to 17 basis points for the third quarter. As described in previous quarters, the relative size of our core deposits are a reflection of our intense focus on relationships and the growing recognition of the RTC brand across our geography.

Despite the reduction in the cost of deposits, a large average excess cash position during the quarter resulted in a 7-basis-point reduction in the net interest margin. This was partially offset by higher prepayment penalty income. We still expect the full-year margin to be in the low [340s] range, which is consistent with our original guidance.

As anticipated, total noninterest income decreased versus a very strong second quarter. Loan-level swap income, which peaked in the second quarter, declined by $1.3 million as many clients seem to be in a wait-and-see mode on the direction of interest rates.

Although there was a tax prep-related seasonal decrease in investment management income, we continue to experience positive asset flows, and assets under administration grew to $2.9 billion during the quarter. In addition, mortgage banking activity continued to accelerate, with a record closing volume leading to a 44% increase in revenue. Low rates, excellent service levels, a strong housing market and a full complement of loan officers have combined to provide momentum in that business line. We also continue to make strong inroads into the customer bases of our various acquisitions.

(inaudible) expense actually came in below the second-quarter level versus the increase we anticipated. The most significant contributor to the differential being an $860,000 change in the reserve for unfunded commitments associated with a lower approved and committed pipeline quarter-over-quarter. In addition, the increase in advertising expense of approximately $430,000 was less than anticipated as certain projects were postponed. And finally, costs associated with a branch closure have been delayed to the fourth quarter.

The reduction in noninterest expense for the quarter resulted in an efficiency ratio on an operating basis below 60%, a multiyear low for the Company. And year to date, noninterest expense on an operating basis is essentially flat with 2015.

I will now provide some additional updates on the acquisition front. As you may have seen, we received all regulatory approvals for the New England Bancorp acquisition with its Bank of Cape Cod subsidiary. And we are making final preparations for the closing of that transaction in early November. Our original financial expectations for the acquisition remain intact. We expect the transaction to be neutral to tangible book value per share, $0.05 accretive to 2017 earnings per share and to generate an internal rate of return of approximately 20%.

The Bank of Cape Cod acquisition should add approximately $225 million to loans and $190 million to deposits in the fourth quarter.

Also, as Chris described, we are very excited to announce the acquisition of the Island Bancorp, the holding company for Edgartown National Bank, a transaction that is a natural expansion of our increased presence on Cape Cod and provides the similarly attractive financial metrics.

Post closing, we will be the only bank with top three market share position in the two counties that make up Martha's Vineyard and Cape Cod. In addition, we have the number one market share in Plymouth County, the populous county that borders the Cape to the north, making us the logical choice for residents, second homeowners and the many local vacationers.

We expect the Island Bancorp acquisition to be neutral to tangible book value per share, provide $0.03 to $0.04 of earnings accretion in 2018 and to generate an internal rate of return of approximately 20%. Based on our stock price the evening before last, the transaction is valued at approximately $24.5 million. And although we don't intend to close any Edgartown National branches, we believe we can achieve these financial results primarily through efficiency gains.

Our post acquisitions is very simple: be absolutely obsessive about the people. That includes the Board, the management team, the staff, the customers, the community and the shareholders. Be disciplined with pricing and conservative with assumptions. Don't bite off more than you can chew. And maintain and capitalize on a strong currency and execute well so that sellers view you as an attractive partner.

To date, our experience of acquiring smaller end-market or contiguous franchises has served us well. While we are not fundamentally opposed to a more transformational sort of transaction, we are that much more cautious as we believe the relative risks of such a transaction are much greater.

Finally, a quick update on 2016 guidance. During our last conference call, we increased our original operating diluted earnings per share guidance to between $3 and $3.05. We remain comfortable with that guidance.

That concludes my comments. Chris?

Great. Thanks, Rob. Okay, we would love to open up for questions now.

(Operator Instructions) Laurie Hunsicker, Compass Point.

Just wanted to go back to the $10 billion cross. Can you take us a little bit through where you are -- there's an echo. Sorry. Can you take us through where you are in the expense piece of that with respect to enterprise risk, compliance, you had mentioned hiring, and so forth? Can you just take us through where you are with that?

In terms of where we are on a percentage basis, a little bit hard to say, Laurie. But we have, as we have said in the past, been gradually making incremental investments across various areas including the hiring of a director of enterprise risk management, the former CFO of People's Federal Bank. So obviously he has been on board since that acquisition closed in February.

We brought on a capital planning manager to build out our DFAS capabilities, and that individual was hired more than a year ago. We added an individual in our portfolio risk management area to help with the loss modeling for DFAS as well as for Cecil. We gradually added BSA and AML folks over the years. And really those additions in that area will continue to be incremental as our deposit base and loan base grows. So we don't expect that to be a one-time investment. We expect that to continue to expand.

And then we are starting to make investments in things like data and software, less so on the software front. But we have recently subscribed to some Moody's analytics data, again, to help with our DFAS modeling.

So we have made expenditures in a number of different areas that are already embedded in our run rate, but what we think we have been able to do pretty effectively is leverage those expenditures in other ways.

So for example, our director of enterprise risk management -- he is not just working on preparing us for the $10 million threshold. He is overseeing enterprise risk management for the entire bank. He is heavily involved in due diligence on acquisitions. So -- and then, similarly, the individual that we hired to be our capital planning manager is really taking a lead role in our loan-level swap program. And so we are hopeful that these expenditures, we are leveraging to the fullest extent possible.

And how many people are part of your compliance team total?

Total is probably 15. We have a client's department -- include BSA and AML. And then we have compliance people in each of the individual business units as well.

Okay. And then how many do you have just focused on consumer compliance?

I don't have that number exactly.

Okay, okay. And then just sort of more generally as you think about the ramp to the $10 billion cross, various banks have thrown out numbers -- $6 million, $7 million, $8 million -- in terms of the cross to get prepared with systems. And I realize it's different in every bank. How -- would you say that that number is in line with your thinking, and then how far you are? Or is there a different number? Or can you give us any kind of color?

If you're not including Durbin amendment impact --

Yes, not including Durbin.

Yes, that's higher than what we anticipated.

Okay. And how far are you under the process in terms of the spend?

Well, for DFAS, for example, we expect to be ready by the end of -- actually really mid-2017, but at the latest by the end of 2017, be ready to have a model that we could submit should we need to.

In terms of the other spends, they will continue to be incremental. There'll be things like increased FDIC assessment, which is no pre-investment there. It just happens when you cross the threshold. Board risk committee is an additional requirement that does not necessarily have any additional expense with it. If it does, it is pretty minor in the scheme of things.

I know I didn't completely answer your question, but $6 million seems like a big number for us. We have some in-house knowledge management capabilities that are going to help us build out the DFAS model without acquiring any sort of expensive softwares or without having significant consulting expense. We do think we will have consulting expense on things like model validation, but it shouldn't approach those sorts of numbers.

Okay. Then the data software IT update that you mentioned you were just starting, when will that be completed?

That actually has been an ongoing effort, Laurie, for the last decade. We built that business intelligence capability to drive all sorts of analytics, including a lot of our customer analytics. It's a natural extension of a process we started a long time ago. We were a little bit unusual 10 years ago about getting obsessed about building a data mart -- a structured data mart and building analytical tools and hiring people who are able to use it. So we are a bit ahead of the curve on that.

Okay, great. Then just going over to M&A, obviously you have had a fantastic track record on the smaller acquisitions from the standpoint of clean banks, accretive to earnings, accretive to your franchise, mutual to book. Just a home run. And you have said you are not opposed to a transformational deal, but it was, I guess, less likely if I heard you correctly. What are the circumstances that would make it more likely, and what would be the max size that you would potentially digest as you cross the $10 billion mark?

Yes, there's a lot of hypotheticals in there, which I'm not going to go into specific -- the hypotheticals. I will just say -- I will reiterate that you are absolutely right. We are on a bit of a roll. And working with smaller banks and very small -- smaller banks that are -- I would say that are attractively accretive to our earnings potential, and our ability to not dilute book is quite noteworthy.

There -- the wonderful thing about smaller transactions is you really can take your time and make sure you do it right, not only from the technical perspective, which we are getting better and better at, but, as I was talking a lot about this morning to my future colleagues at Edgartown, the whole culture piece, which we think banking is fundamentally a people business. You have got to get the people piece right to make a successful M&A work.

So as banks get bigger, they are tougher. I think our largest to date was Ben Franklin at $1 billion. That one went very well. Now, I think we are very capable of acquiring a bank and a (inaudible) on a culture perspective at $1 billion. And I would say probably since then, we would be comfortable with a merger bigger than that from a technical and a culture perspective.

I think when it -- the waters get really treacherous. And from a culture perspective is when you are beginning to think about MOE territory. I think that's when you begin to make -- it is very difficult -- very, very difficult to get the people side. I'm not talking about senior management; I'm talking about the people side throughout the organization. In fact, more importantly, throughout the organization than the senior team to get that exactly right. And I would be very, very cautious, and we have to be extraordinarily thoughtful about an acquisition that size.

Great. That's great color. Okay, just two other quick things. Rob, do you have the accretion income for this quarter?

Yes. It was a little less than [$400,000], Laurie.

Okay. Then one last thing. Can you help us think about the tax rate? It was a little bit higher this quarter. How do we think about that into 2017?

We do have new markets -- tax credit award that will be rolling off at the end of this year, and we currently have a pending application for new market tax credits. So, should that new market tax credit roll off and we not get a new award, our tax rate will go up. Then obviously, our tax rate will go up the more money we make, and we anticipate seeing more money next year.

If we do get this new award, which we should find out in November, then that will -- we never know how much of an award we're going to get. And so, depending upon how much of award we get and how much we think we can deploy in the current year, that will determine how much of a benefit we get from that new market tax credit award. So that would go -- if we do get an award, go towards offsetting, to some extent and maybe to a great extent, the new market tax credit award that is scheduled to roll off.

Okay. So if we were using something in the neighborhood right now of 33%, that wouldn't be out of the realm?

Wouldn't be out of the realm, but I will provide more guidance in January.

Okay, perfect. I will leave it there. Nice work again on Island; love seeing that. Thanks so much, guys.

(Operator Instructions) Collyn Gilbert, KBW.

Just in regard to the Edgartown deal, and then obviously think of Cape Cod, what is your strategy for how you harvest business or customers -- kind of the second homeowners in these seasonal markets? I would think it's a hard market to crack, so I'm just curious to know how you guys approach that in building that -- those households.

Well, the fortunate thing about Edgartown National is they have been around longer than we have. So they have a lot of established relationships with permanent residents and seasonal residents. And the power of these acquisitions -- the extra juice -- is not accelerating customer acquisition, but it is simply bringing our additional products set to the market. So we would expect that they are -- we don't expect anything extraordinary in terms of accelerated customer household growth above and beyond what they've been able to do historically. But what we do expect is to able to bring our increased lending capacity, our home equity capability, our attractive consumer technology to the table to expand the existing relationships. That's where we really (inaudible) choose.

Okay, that's helpful. And that ties in to my second question in just terms of your -- kind of the longer-term outlook and longer-term just meaning maybe end of the -- not really longer-term, but into the beginning of next year. But mortgage banking -- you guys have made a lot of traction there. Obviously it was really strong this quarter. How do you see that business evolving especially now given some of these newer markets as you look out into next year?

Yes, I -- and we have said this in the past call, we had a broken mortgage model for a number of years. So our performance really prior to this year or maybe late 2015 was a significant deficit relative to our potential. And that is because we just didn't have the right processes in place and we were not executing well. We now feel like we have all that in place, and we are executing exceptionally well.

However, rates are still low, and that is benefiting us from a refinancing perspective. About 40% of our volume in the quarter was still from refinances. So as will happen with the rest of the industry, our volume will ebb and flow with refinancing activity.

However, we feel like we are in a very good position with our core base of originators and systems we have in place, the processes we have in place, the leadership we have in place that we can now leverage that model as we expand geographically, as we expand with new branches and as require additional end-market customers.

So we think the business has a nice potential for us. It is not going to be the revenue driver for us in the future, but we think we can keep up the momentum that we currently have.

Okay, that's helpful. Then just a couple housekeeping things. What were the amount of paydowns that you guys saw in the third quarter? Do you have a dollar amount?

Yes. Significant. If you put it all together across our portfolio, I think it was greater than $600 million.

Okay, that's helpful. Then you mentioned that you postponed an advertising project. I'm just curious as to why or if you see that coming online at some point.

Yes, I was -- it was just delayed a couple months. We expect that expenditure to be incurred in the fourth quarter.

Okay. Then it is the drop in occupancy -- and, again, if you covered this, Rob, I apologize -- but the drop in occupancy in the linked quarter. I know you guys were redesigning some branches. Is it attributable to that, or was there something else going on there?

Yes, that's a piece of it. We also had, believe it or not, some snow removal costs in the second quarter, and fortunately we didn't have any in the third quarter. We had some snow in April, and that was a larger number than you might have thought. And then just a couple of other nuanced things, nothing really to read into that. But in the fourth quarter, we do expect to close another branch, and we will have some costs associated with that.

Collyn, I just want to correct something I said. The $600 million was our total closings for the quarter, not total payoffs. Payoffs, I believe, were closer to the $400 million.

Okay.

Excluding paydowns, obviously.

Oh, and that's what I was curious about was the paydown. Because going into the third quarter, you guys were anticipating -- I thought, if I recall -- a large C&I paydown.

Well, a number of C&I and CI rates. So, I meant excluding amortization.

Okay.

So payoffs --

So those are more the unusual items versus just your regular course of paydowns -- amortizing loans. Got it. Okay. And then just one final question: was the Edgartown deal a negotiated transaction?

No, it was competitive.

Okay.

And a process.

Got it. Okay. That's all I had. Thanks, guys.

This concludes our question-and-answer session. I would like to turn the conference record over to Christopher Oddleifson for any closing remarks.

Well, thank you much -- thank you very much, everybody. It's a delight to be speaking to you from Martha's Vineyard, and we look forward to talking with you in January. Have a good fall.

Thank you.

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