Independent Bank Corp (Massachusetts) (INDB) 2016 Q4 法說會逐字稿

Good morning and welcome to the Independent Bank Corp. fourth-quarter 2016 earnings call -- conference call. All participants will be in listen-only mode. (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. 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. 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.

In addition, presenters on the call may speak to certain financial metrics that are considered to be non-GAAP. As such, please refer to Independent Bank Corp.'s earnings release filing for reconciliations of the non-GAAP information to GAAP.

Please note this event is being recorded.

I would now like to turn the conference over to Christopher Oddleifson, Chief Executive Officer. Please go ahead.

Thank you Daniel. 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.

We ended 2016 with a continuation of strong fundamentals and positive operating trends. Inclusive of M&A expenses, EPS on a GAAP basis was $0.64 per share in the fourth quarter. Excluding these costs, net income totaled $20.2 million, or $0.76 per share.

Rob will cover the quarter in more detail shortly. I'd like to focus my comments on the full-year just completed.

Our record financial performance for the year was marked by strength on many fronts, including organic loan growth despite rising competition, very strong core deposit generation, continued low funding costs, growing fee revenues led by our high-priority investment management business, disciplined expense management that has driven our operating efficiency ratio down further, steadily building capital trends. Tangible book value per share grew another 10% this year, even while absorbing another acquisition. And lastly, sound credit quality despite an increase in nonperformers in Q2, which Rob will cover in a moment.

Our loss rate for the full year was a paltry 1 basis point, but I've consistently said that we fully expect a return to mean loss experiences the benign credit cycle inevitably reverts.

Beyond the numbers, much was accomplished last year moving the Rockland Trust franchise forward. We considerably strengthened our southeastern Massachusetts presence with the New England Bancorp acquisition in Cape Cod, which closed in November, and agreeing to acquire Island Bancorp of Martha's Vineyard, which is expected to close in Q2. We are off and running on the former and focused on integrating the latter. Both are expected to be accretive to earnings and bring us attractive customer bases in familiar markets.

We continue to make strides in the coveted Greater Boston market by capitalizing on the former People's Federal franchise which we acquired in 2015. We are experiencing strong retention of these customers as well as compelling new business volumes, fee generation and net loan growth. We've operated in the Boston market for quite a while, but having an on-the-ground presence is proving very beneficial.

We continue to expand our product setting, given the needs and preferences of our customers. This includes for example adding equipment leasing for our commercial clients, implementing online mobile and tablet enhancements, including Apple, Samsung and Android Pay, along with various security features.

Our efforts to promote the Rockland Trust brand and have a sustained marketing presence throughout the year is clearly paying off. Brand awareness continues to grow even faster than expectations, especially in our newer markets, leading to new customer relationships.

Additionally, our ability to continue delivering exceptional customer service to our existing relationships has been demonstrated through studies that measure customer satisfaction in our industry.

And we continue to garner third-party recognition for our community and diversity contributions. We were named to the Boston Globe's Top Places to Work survey for the eighth consecutive year, and ranked number one among financial institutions this past year, and number two among all large employers in Boston. We also earned 100% on the Human Rights Campaign Corporate Index, an index that measures LGBT policies and practices in a workplace.

Turning to the macro environment, the local picture remains pretty promising with unemployment in Massachusetts hovering around 3% and GDP growth of 3.7% in Q3. Wages grew by over 6% in Q3 from the prior year.

So it does appear we are approaching full capacity in a tight labor market and scarcity of skilled workers cropping up in certain places. Yet pockets of unemployment to remain in the state.

On the real estate side, inventory remained (technical difficulty) especially in greater Boston, keeping prices relatively high and generating the need for more housing. In the Mayor's recent State of the State address, he recognized the need for housing to support economic growth.

Mortgage demand remains solid but could cool with the advent of rising rates. There are also signs that lenders are beginning to take a more cautious approach in some construction lending.

On the national side, much uncertainty exists for corporate America and the banking industry in particular in anticipation of the new administration being ushered in within a few short hours. The how, what and when the tax reform, regulatory relief, trade policies, infrastructure spending and pace of interest rate increases creates many different scenarios for all of us to digest. And like all our listeners today, we will monitor these developments very closely.

Looking ahead, we never get overinvested in any one scenario and keep our assumptions grounded in current realities. The core of our strategic approach is an unwavering commitment to discipline and focus. We devote our resources to leverage our comparative advantage and aren't distracted by endeavors that detract from that. Basically, we know what we are good at and we go after that.

Among our priorities this year are sustaining our investment in the digital space. Customer preferences continue to ratchet up and the FinTechs are making inroads. Traditional banking services buy this medium, continuing to press ahead in greater Boston by our targeted marketing programs, including a brand-new marketing campaign focusing on communicating our unique ability to build strong relationships with our customers, leveraging our centers of (technical difficulty) network and exploring opportunities such as the large student population; continuing to make inroads into various customer bases of our recent acquisitions; our deeper product set, especially investment management in home equity is a natural fit in these markets; continuing to optimize our branch configuration to the full range of modernizing, consolidating, and closing options, along with opening a few select branches in target markets; and of course staying vigilant in our compliance efforts with cyber security being a major area of focus.

So, there's a lot going on in our company, but all focused on sustaining our momentum and continuing to build franchise value.

Before handing off to Rob, I'd like to welcome our newest director, Mary Lentz, who joined our board this past quarter. Mary has 34 years of commercial real estate experience and is a valuable addition.

I'd also like to once again acknowledge the enormous contribution to our success from each and every one of our Rockland Trust colleagues. Day after day and year after year, they never waver in their passion for service excellence, community involvement, and taking on new challenges.

With that, I'll turn it over to Rob.

Thank you Chris, and good morning. Before I review fourth-quarter and full-year earnings in more detail, a quick update on the acquisition front. As Christopher remarked, the integration of New England Bancorp and Bank of Cape Cod is complete, and thanks to our exceptional colleagues, the conversion was virtually seamless. The work to further enhance the former Bank of Cape Cod relationships has begun.

In addition, Edgartown National Bank integration plans are well underway, and all expectations for earnings accretion and customer inroads remain intact. We received a very warm welcome from both employees and customers, and we are excited to join forces with a very capable team. We still expect that transaction to close during the second quarter.

Acquisition activity in general will continue to be unpredictable, but we'll remain opportunistic and open to exploring discussions with willing partners.

Now, turning to earnings, inclusive of mergers and acquisition costs of $4.8 million in the quarter, net income and diluted earnings per share were $17.2 million and $0.64 respectively for the final quarter of 2016. For the year, net income and diluted earnings per share increased 18% and 16% respectively to $76.6 million and $2.90. When excluding items the Company considers non-core, full-year operating earnings and diluted earnings per share increased 12% and 10%, respectively, to $80.4 million and $3.04 for 2016, another record performance and consistent with the upper end of our most recent guidance.

Strong earnings results continue to drive growth in tangible book value per share, which increased by $0.37 to $23.45 at December 31, despite having absorbed the New England Bancorp acquisition and a rate-driven reduction in the unrealized gain on our available-for-sale securities. As Chris referenced, for the year, tangible book value per share has increased 10%.

Net interest income increased approximately 2% to $58.8 million in the fourth quarter as higher average earning asset balances and higher security yields were partially offset by lower loan prepayment penalties. Deposit costs and total funding costs remained very low during the fourth quarter at 17 basis points and 28 basis points respectively, despite the addition of higher cost funding from New England Bancorp.

The decrease in the net interest margin versus the third quarter is due to the reduction in prepayment penalties as the full benefit of the most recent Fed funds increase will not be felt until the first quarter of 2017.

Total loan growth of 4.4% for the quarter was primarily attributable to the acquisition of $226 million of loans from New England Bancorp. When excluding the acquisition, loans grew 0.5% for the quarter and approximately 4% for the full year, as can be seen by the organic growth tables near the back of the schedules attached our press release.

Ongoing growth in C&I, CRE, small business and home equity during the quarter was partially offset by a decline in the residential portfolio due to higher refinancing activity and lower portfolio volume. The notable increase in CRE simply reflects a large reclassification out of construction for those loans transitioning to permanent status.

Also impacting organic growth in the quarter was a decision to sell down some commercial credits as we have approached some internal concentration limits. Although down somewhat, loan pipelines remained healthy at the end of the year. Similarly, deposit growth of 2.3% during the quarter was attributable to the acquisition of $176 million from New England Bancorp. A planned reduction of higher cost CDs and seasonality in (technical difficulty) municipal deposits resulted in an organic decline in Q4.

Full-year organic deposit growth of 4.1% masks the very strong core deposit performance as it includes a 15% reduction in CDs. Demand deposits, for example, were up almost 10% organically for the year.

Provision expense of $4 million in the quarter was primarily associated with one large C&I relationship. Our relationship with the family which owns the business dates back to the 1960s. Although the customer was current as to principal and interest through December 31, 2016, the customer's operating results were declining and the customer notified us prior to year-end that it would need to transition to paying interest only beginning in January. As a result, we placed the relationship on discretionary nonaccrual as of 12-31-2016 and deemed it to be collateral dependent. We derived a $3.6 million specific reserve recorded for this customer based upon the value of the numerous pieces of heavy equipment which comprise our collateral.

As we have said in the past, losses tend to be lumpy and credit cycles tend to normalize. We don't believe the situation with this individual customer is a harbinger of things to come.

While we continue to feel good about the local economy, our extremely low losses experienced over the last couple of years are bound to normalize. For each of the past two years, our loss rate was a mere 1 basis point, which we do not project to continue indefinitely.

Noninterest income growth for the quarter was excellent at almost 7% unannualized. Slight seasonal declines in deposit related fees were more than offset by continued momentum in investment management and mortgage banking as well as a rebound in loan-level derivative income. Investment management and mortgage continue to benefit from strong internal referral networks and a widening COI network. This can be readily seen in our Greater Boston footprint where, as Chris stated, we are seeing encouraging growth.

Mortgage also benefited from a rate driven mortgage servicing assets adjustment of approximately $200,000 in the quarter.

Noninterest expense, when excluding $4.8 million of M&A costs, was essentially flat for the quarter and is up only 0.5% for the full year. We have long talked about ability to leverage the infrastructure we have collectively built over the years and the favorable trend in our efficiency ratio is a reflection of that leverage. We have also been able to carefully balance designed growth investing with overall cost restraint.

While we continue to describe our expectations on specific performance drivers, we will no longer provide you with guidance as to anticipated future earnings per share. Earnings per share results for us and the industry have the potential to be very volatile over the coming years. Varying assumptions about the pace of interest rate changes, tax rate changes and the path of regulatory burden can have a meaningful impact on earnings per share, and as we've seen in our own planning activities and is likewise evident in the range of analyst estimates for banks. Rest assured, however, that we continue to value healthy dialogue with the investment community and remain committed to discussing the expected future direction of our business. In that vein, we anticipate the following for 2017 -- loan and deposit growth, barring significant competitive changes, in line with recent experience and generally consistent with economic growth. Even without any further increases in rates, the net interest margin is expected to expand by 7 to 10 basis points in 2017. In addition to the recent increases in rates, the net interest margin will benefit from the gradual deployment of liquidity and a meaningful reduction in the cost of our trust preferred debt.

During 2016, we entered into a driven transaction which will help to reduce the annual cost of our trust preferreds by approximately $2 million beginning in January.

We are anticipating a reduction in mortgage volume associated with lower refinancing activity and a corresponding decline in mortgage banking income. However, continued growth in investment management assets and income, strong core household growth, and the addition of Bank of Cape Cod and Edgartown should lead to solid growth in total noninterest income.

Various expense is expected to increase 3% to 4% on a GAAP basis, and as stated previously, a gradual normalization of credit is anticipated in the years to come.

And finally, assuming no change in the tax code, a tax rate of approximately 34% due to higher earnings and the exploration of some new market tax credits is expected in 2017.

We look forward to continued progress on many fronts here at the Bank. Hopefully, this new level of guidance provides you with sufficient information to assess the financial direction of the Company.

That concludes my comments. Chris?

Thank you Rob. Daniel, we are ready to take some questions.

(Operator Instructions). Laurie Hunsicker, Compass Point. Please go ahead.

Good morning. Rob, I wondered if we could just go back to your relationship that went nonperforming. And I appreciate the (technical difficulty) can you tell us how large that is currently?

The total exposure is $34 million.

$34 million, okay. And do you have any other loan relationships with this family, or is this it?

There are multiple credits within that $34 million number I gave you. Part of that is a working capital line, and the remainder is the number of term notes on specific collateral.

Got it, okay. And with respect to the mention that you had on the sale of the commercial loan decreasing the concentration, was any of that regulatory-driven?

No, just internal concentration limits associated with, probably not surprising, multi-family as well as hotel. Bank of Cape Cod, probably not surprising as well, had a fair number of hotel loans, so that increased our overall concentration.

Okay. Just remind me, what is your overall hotel exposure?

I don't have that number with me, Laurie, but I can get that for you.

Okay. Then just one more question here, obviously your stock price has gone up a lot since the election. Can you just I guess update us in terms of your thoughts on M&A? Are you seeing increased (technical difficulty) what are you seeing?

This is Chris. I would sort of give you a standard response that we would -- we'll be glad to talk to anybody who would want to talk to us. I can't -- things happen. Notably, sort of there hasn't been buzz -- increase in buzz or decrease in buzz and/or rumors. These things sort of happen, even from our perspective, to be sort of random. You can sort of speculate about different bank situations and where they are, but it's doesn't happen until it happens. So it's tough to really speculate.

I would say that there is certainly a lot of talk in the bank industry and the banking trade troops about the new administration's posture on regulatory relief. And I think, if President-elect Trump had not won the election, we would have seen -- sort of we would have believed that regulatory sort of rules would have increased. There's a lot of anticipation they're going to decrease, but it's really a question of in what form and what are the practical implications to us community banks here in local towns and cities. So there's a lot to be discovered, and I have to say it's interesting times.

I would just add, Laurie, it leads to the our value of our currency. Obviously, all of the banks' currencies have improved as well, and there is some evidence that seller expectations have gone up. So although it's nice to have a stronger currency, it doesn't necessarily help when expectations increase.

Okay, that makes sense. And then Rob, I'm sorry, just one last question for you. You had mentioned the $2 million savings beginning in January. Was that beginning in January 1 relative to the trust preferred (multiple speakers)?

Yes, it's right around the first. It might be the first week, Laurie, but we'll get the vast majority of that benefit in the first quarter.

Okay. Perfect. Thank you.

Collyn Gilbert, KBW.

Thanks. Good morning guys. Just not to start off on a bad note, but just back to the credit this quarter, can you give us a little bit more color as to the nature of the business? And was this something that took you guys a little bit by surprise? I know you said the borrower came to you at year-end, but just -- and then also how you sort of see this relationship and this credit playing out, kind of the process from here?

Yes, in terms of more color on the nature of the business itself, not something we are comfortable doing, because protecting the customers' privacy, they are in the heavy equipment leasing business.

In terms of how it's evolved, their business did kind of gradually decline over a period of time, but didn't get to a concerning level until the fourth quarter. And then how we expect it to play out is a little bit uncertain at this time. The customer is very cooperative and we are working through a couple of different scenarios since we wouldn't have taken that reserve if we didn't anticipate a corresponding charge-off with it. So at this point, our best guess is that we will take that charge-offs in the first quarter. However, there are some scenarios where we could potentially avoid that, but too soon to tell at this moment. From a long-term perspective, we'll be working through kind of a restructuring plan with the borrower to try to get them back on their feet.

Okay, that's helpful. And then was it, in your current footprint, the credit, or where does (multiple speakers) extend?

They are headquartered locally, yes.

Okay. Was it a national business?

It is a broad business, yes.

Okay. That's helpful. And then just I guess, given your tax guidance, Rob, do we assume that you guys did not apply for any new market tax credits for the year, or how is that business?

We did apply, but we did not receive them. It's very -- it's become extremely competitive for us, as you might imagine, and somewhat political.

Okay. And then one area -- I guess surprising on the derivative income, and I know obviously it's lumpy every quarter, it's hard to predict. But just in general, are you guys anticipating greater transaction volume from your borrowers as we move into 2017, or do think 2016 was maybe a peak year for some of that?

2016 was -- our current expectations are that we won't revise the level of derivative income that we realized in 2016, and certainly that was a meaningful increase over 2015. But they are unpredictable and we will continue to have customers with longer durations swap if they want a fixed rate. So that creates some base level of business for us. However, in 2016, we benefited from customers taking advantage of the decline in rates and re-swapping existing swaps prior to maturity, so that is business that will likely decline meaningfully.

Okay. That's helpful. And then just in the NIM guidance, 7% to 10% for the year, I was just curious if you could update us on how you guys are thinking about deposit data going into that assumption.

Yes, our model for deposit data, total core deposit data, is about 25 basis points in our net interest income simulation, so that includes demand deposits in that calculation, but excludes CDs, because CDs reprice over time. And for CDs, we typically use about a 75% beta. So that's the general assumption to get to that level but, again, we haven't assumed any further rate increases, just what's already occurred in December of 2016.

Okay, so no rate increases. Okay, that's helpful. In general, have you guys seen much of a move in deposit pricing post the rate hike just in the market?

No, we haven't really seen any with the exception of kind of the municipal business. There is some elevated competition for municipal banking deposits.

Okay. That's helpful. And then just one final question, I guess maybe kind of just broadly bigger picture, and I appreciate you not giving EPS guidance. This isn't where I'm going with this question. But just in general, as you kind of look at the business, you guys have created really good momentum in almost every line. As you look out over the next couple of years, is there one area over another that you think will be a key driver to improving earnings growth for the Company?

The composition of our balance sheet is basically commercial. So, how commercial goes, so goes the whole Company. And we are optimistic that we are going to continue our modest growth rate into the future. You're not going to see us with giant growth rates as some other banks in our area, but we are disciplined and focused. We will continue sort of our past minus growth rate. And consistent with that, we think that the deposit franchise is going to continue to improve. The deposit franchise is one of our amazing strategic assets. I mean core deposits being 89%, 90% of deposits is extraordinary. And with our branding and our awareness, that's going to keep on strengthening. And as our general franchise increases, we are able to translate that into an expanding investment management business. So we're slow and steady, one step ahead, modest growth on all fronts.

Okay, that's great. That's awesome. Thank you very much.

(Operator Instructions). Varun Bhandari, Piper Jaffray.

Most of my questions have been answered, but I just wanted to ask you guys about commercial real estate in Boston and what you guys have been seeing in terms of yield coming on post-election and as the rates have moved up.

The larger banks are certainly moving up. We've moved up. We have a disciplined pricing process. And when market rates move, we move our rates. And we did see an increase in our average new volume rate in the fourth quarter, which is good, because we only had a piece of that increase in the fourth quarter. But we saw a decent increase in our average new volume rate.

The other thing that is impacting pricing is the fact that a number of banks are pulling back from multi-family construction in particular, so there are less banks participating in certain spaces as we are. And so pricing has adjusted as a result of that as well. So, I wouldn't say the increase is fully felt yet, but it looks like it's moving in the right direction.

And so in terms of the yield that we saw in 4Q not fully felt, but in terms of things as they've been coming on early in the year, potentially we could see that?

Yes, just when looking at Q4 versus Q3, I'll just remind you that we had significant prepayment penalties in CRE in Q3 which we did not have recur in Q4, so that's the reason you saw the decline in the CRE yield from Q3 to Q4. But yes, we would expect that to gradually extend up from here.

Okay, thank you.

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

Thank you Daniel. Thank you, everybody, for joining us today. We look forward to talking with you in three months about our first quarter. Have a good weekend.

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