Independent Bank Corp (Massachusetts) (INDB) 2017 Q3 法說會逐字稿

Good morning, and welcome to the Independent Bank Corp. Third Quarter 2017 Earnings Conference 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. 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.

Please note this event is being recorded. I would now like to turn the conference over to Chris Oddleifson, CEO. Please go ahead.

Thank you, Austin. Good morning, everyone, and thank you for joining us today. As always, I'm accompanied by Rob Cozzone, our Chief Financial Officer.

Our track record of consistent steady growth remained intact with another solid performance in our third quarter. We produced net income of $23.9 million or $0.87 per diluted share in Q3 on both the GAAP and operating basis, once again well above both prior quarter and prior year results. Rob will provide added color on our results following my comments.

Our third quarter performance was marked by numerous positives, including rising net interest income and accompanied by a higher margin. Our treasured group has positioned us quite well, benefiting from the rising rate environment, benign credit quality with another quarter of net recoveries and lower nonperformers, expense management that as a result of an efficiency ratio below 60%, core deposits remaining above 90% of total deposits with particular strength in the demand category and attractive ROAs and ROEs.

One area we're especially proud of has been a strong ongoing growth of tangible book value per share. It rose another 3% in the past quarter and now stands 35% above where it was 3 years ago despite absorbing several acquisitions.

One factor in the third quarter that did give us some pause was the tepid loan and deposit growth. While our deposit growth and loan growth during the quarter were muted, looking beyond the balance sheet indicates a strengthening core franchise. So for example, commercial loan origination during the third quarter totaled $305 million, among the highest quarters ever, was nearly completely offset by historically lower line of credit utilization. This appears to be a reduction in demand on the commercial side, especially in the C&I sector. As other -- others in our industries have cited, there are anecdotal signs that the ongoing uncertainty in Washington as to lowering of taxes, changes to trade pacts, et cetera, is weighing on the borrowing appetite of Corporate America. The good news is that our lines are still in place and our pipelines remain in good shape. So hopefully, things will resume once greater clarity is reached. Either way, we'll continue in our disciplined approach to credit.

And as we've mentioned on the last 2 calls, we continue to strengthen our franchise of building our commercial lending team with selective hires.

On the deposit side, levels were adversely impacted by municipal declines. However, again there are signs of a strengthening franchise. Excluding our recent acquisition, core account growth is up 2.5% year-to-date. Demand deposits are up 4.5% year-to-date and now account for 33% of core deposits, an all-time high. Consumer household growth year-to-date annualized is 2.3%, and business household growth year-to-date annualized is 7%. And finally, our total household retention rate has increased to 94.5% year-to-date, a very high level relative to benchmarks. And these rates look especially strong in the context of a regional population growth rate of less than 1%.

On a noncustomer company strengthening point, I think it's worth mentioning that we're making significant process preparing for DFAST. We're running models and have dealt a stronger written plan, both of which we believe to be DFAST compliant. We continue to work on weaving the process into our risk management framework and building out a documentation and validation process.

Beyond that, we continue to make solid progress on the business side. Chief among this has been the terrific exclusivity with our Island Bancorp acquisition of Martha's Vineyard. We're off to a flying start there in terms of customer retention and new business development. In just a few months, the Rockland Trust brand has resonated beyond our expectations. And we continue to add experienced professionals from other institutions in the Island from the established relationships with the Island businesses and consumers.

Another standout business of ours lies with the investment management group. Assets under administration now have grown to $3.3 billion with year-to-date revenues up 9% over last year. In a recent survey, they were ranked in the top 25 of independent investment advisers in Massachusetts. And this is another business of ours that continues to recruit senior talent.

Locally, the Massachusetts economy continues to perform notably well. The state has added nearly 300,000 jobs since 2007, with the labor force growing at 3.2% this year. This translates into a unemployment rate of 3.9% as of September 30. Massachusetts' real gross domestic product grew at 4% during Q2. And in June, the MassBenchmarks Leading indicator suggested the state economy will continue to grow at a moderately strong pace of around 2.7% for the final 6 months of 2017.

As we head into our budget season, we'll continue to balance the end desire to keep feeding our growth businesses with maintaining an overall efficiency of operations. At all times, the improvement of the customer experience and the maintaining of our high service standards cannot be compromised. This will require ongoing technology investments balanced with continued streamlining and various networks such as our branch configuration. We do not have an operating platform that can be -- we have an -- we do have an operating platform that can be leveraged further, and we hope to capitalize on that. And as always, we will stay grounded in our operating environment assumptions. We are confident that this disciplined approach, which has served us so well over the years, will continue to bear fruit for many years to come.

Now I will turn it over to Rob. Rob?

Thank you, Chris, and good morning. I'll now review third quarter results in more detail.

Net income of $23.9 million end of third quarter was 16% higher than both the prior quarter and same quarter of last year. Operating net income, which is adjusted for merger and other charges that occurred in earlier quarters, was up almost 7% versus the second quarter and 16% versus the prior year. And most importantly, diluted operating earnings per share of $0.87 was 6% higher than last quarter and almost 12% higher than the third quarter of 2016.

Additionally, profitability experienced further improvement in the third quarter. On an operating basis, third quarter return on assets, return on equity and return on tangible common equity improved to 1.18%, 10.2% and 13.8%, respectively.

Strong earnings translated to healthy growth in book value and tangible book value. On a per share basis, tangible book value increased $0.64 to $25.12 at September 30. As Chris mentioned, modest balance sheet growth during the quarter masked a significant amount of customer activity taking place.

Within commercial, $305 million of new booked commitments boosted total commitments by more than 6% annualized. However, that robust activity was offset by a 4.5% drop in utilization rates on lines of credit, a trend that seems to be corroborated by industry reports.

Fortunately, loan pipelines remained strong at the end of the third quarter. And should utilization rates improve, growth will accelerate in the fourth quarter.

The strong growth we experienced in construction balances is a combination of new projects and additional draws on seasoned projects. The construction portfolio continues to be well diversified across geographies and property types with the largest component being residential related.

The total consumer real estate portfolio grew by 3.5% annualized during the quarter. And demand for home purchase financing seems resilient despite increases in rates and home values.

Although the total deposits were essentially flat on a quarter-over-quarter basis, as Chris mentioned, demand deposits were up 12% annualized and represented 33% of total deposits as of September 30.

The decline in savings and interest checking occurred within the government banking category, partially due to seasonality and partially due to the comparatives we described previously.

The increase in term deposits is pretty typical behavior in a rate increase cycle. As expected, the cost deposits increased 2 basis points versus the 18 basis points recorded in the second quarter, while our total cost of funds increased only 1 basis point. Deposit costs will likely increase modestly again in the fourth quarter.

It is also worth pointing out the steady increase in our customer repo balances, which are essentially sweep accounts and serve with another valued funding source.

Despite the slight increase in deposit cost, the benefit of a high asset sensitivity was evident once again in the results for the third quarter. The net interest margin was up 5 basis points, 3.65%, and all major loan categories experienced an increasing yield versus the second quarter. We now expect the full year net interest margin to be at the upper end of the range most recently provided, which would translate to approximately 3.6%.

Noninterest income declined 3% versus the strong second quarter results, as increases in interchange and ATM fees and mortgage banking income were offset by decreases in loan level derivative and other income. The increase in interchange and ATM fees is reflective of our continued success in adding core households. Loan level derivative income continues to be difficult to predict quarter-to-quarter and was impacted by the woven number of longer-term loan closings in the third quarter.

As Chris noted, excellent momentum in our Wealth Management business resulted in stable revenues despite the boost the prior quarter received from tax preparation fees. New business activity remains robust within our Wealth Management division, and we're on track for a record year. In an effort to maintain that momentum, we recently added an experienced team to our roster of highly credentialed investment professionals.

Noninterest expense, excluding merger and acquisition charges, increased 2.8% when compared to the second quarter and was higher than anticipated due to $1.5 million of loan workout cost mostly related to a previously recognized large problem credit, along with additional advertising expense associated with the promotion of our J.D. Power recognition. The loan workout cost should be money well spent and has certainly better positioned us. A significant decrease in workout cost and lower advertising expense will result in a lower efficiency ratio for the fourth quarter.

Asset quality metrics improved during the quarter. And if adjusted for the single commercialization relationship just described, nonperforming asset and delinquency ratios would be at multiyear lows. Additionally, the credit outlook remains quite favorable. With net recoveries and only modest loan growth, no provision for loan loss was justified in the third quarter.

In terms of guidance for the remainder of the year, we expect the following. Loan and deposit growth should increase in the fourth quarter, but will likely be less than originally anticipated for the full year. As mentioned, the net interest margin for the full year should be about 20 basis points higher than 2016 or approximately 3.6%, but as I mentioned last quarter, is expected to be down slightly for the fourth quarter given the likely increase in deposit cost. Fee income is expected to increase in the fourth quarter, but will be subject to volatility in derivative income. Noninterest expense should decline in the fourth quarter, and the efficiency ratio is expected to improve to the mid-50% range. And then finally, the tax rate for the fourth quarter is expected to approximate 34.5%.

That concludes my comments. Chris?

Great. Thanks, Rob. Austin, we're ready for Q&A.

(Operator Instructions) Our first question comes from Mark Fitzgibbon with Sandler O'Neill.

This is Nick Cucharale on filling in for Mark. So you've been able to keep your deposit cost remarkably low at 20 basis points this quarter. And just from listening to your opening remarks, it looks like there is a little bit of pressure. Could you just kind of help us figure out where that's coming from in your markets?

Yes. As we've talked about in the past, it initially started within the government banking business. That's where we saw the most amount of pressure. And as I mentioned just in my comments, we have seen some outflows as a result of that pressure. And so costs there have gone up about 10 basis points, I would say, over the last couple of quarters. Then it gradually transitioned to the larger commercial clients that had alternatives elsewhere to place their funds at higher yields. And now in the last quarter or so, we're starting to a see that trickle down to the consumer category. So we have made some adjustments in some of our consumer products. A thing that is evidenced in third quarter results is the increase in term deposits, and that's where we have decided to offer some special rates to retain some of those consumer deposits.

Okay, great. And then you touched on this in your opening remarks. But in terms of loan growth certainly influenced by a decline in C&I this quarter. I know it's early, but I just sense that C&I kind of rebounds in the fourth quarter?

Yes, our general sense would be that, for sure, and most importantly, because we didn't expect to have the significant headwind of an additional drop in utilization. So if we were to do just the same level of volumes we did in the third quarter and did not have the headwind of utilization, we would see growth.

Okay. And then would you mind sharing the size of your commercial pipeline and how it compares to the previous quarter?

Yes, it's a little over $160 million at the end of the quarter, and it was $155 million at the end of the second quarter.

Okay. And then lastly, assets under administration have steadily climbed to $3.3 billion, which is up quite a bit from a year ago. I was hoping you could share with us how much of that increase is due to client inflows as opposed to market appreciation?

Majority of it is certainly due to client inflows. We had total new assets, including additions to existing accounts, of almost $400 million year-to-date, which would be a record for us. So I don't have the exact math on the market appreciation. I think it's around 2% to 3%.

That, of course, is offset is by distributions of accounts under trust administration, et cetera.

Our next question is from Varun Bhandari with Piper Jaffray.

I'm on for Matt Breese. Just one question, I just wanted to start off by asking kind of a little bit about the margin expansion you guys do expect to see if this flatter yield curve remains?

Yes, certainly. Not sure exactly what your question is. My expectation is that the margin will contract slightly in the fourth quarter, assuming no further Fed increases early in the fourth quarter, and certainly that's not expected. The December Fed increase would not really benefit the fourth quarter margin. So we'll have an -- a slight increase in deposit costs with no real relief on the asset side. Going forward, additional Fed funds increase will continue to benefit the margin. We are more sensitive to the front end of the curve and less sensitive to the ultimate shape of the curve. So as long as the front end of the curve continues to go up, we would expect to see additional margin expansion if -- does that answer your question?

Our next question is from Chris O'Connell with KBW.

Filling in for Collyn. So just wanted to drill down on the operating expenses. So for the $1.5 million of workout costs this quarter, will all of that be flowing out in the fourth quarter or just the majority of it?

Just the majority of it. As you can imagine, we constantly have workout costs associated with any credits that are in the workout group. But I would you expect that to decline by about $1 million in the fourth quarter relative to the third quarter.

Okay. And then looking out further kind of into 2018, will the DFAST prep that you guys have been working on, will that accelerate historical kind of OpEx growth rates at all?

I'm sorry, accelerate, what expense?

No, certainly not. We have gradually added to our capabilities there and incurred expense all along the pathway to getting to a place where we have something we're comfortable ultimately submitting. The additional expense that we will incur will be related to validation and building the governance framework around that. So there will be some additional expense associated with those things, but would not expect to see an acceleration of expense associated with overall DFAST.

Okay. And then just moving to kind of growth rates looking out into 2018, is there only a single rate hike by the Fed or no rate hike by the Fed at the end of this year and we get a pretty kind of stagnant yield curve in 2018? Do you think that will weigh on your growth outlook at all in order to kind of keep the margin by not growing too much in deposit costs? Or do you think the competition will kind of abate if there is not too many more rate hikes?

Yes, I would expect -- certainly if there aren't any more rate hikes, I would expect the competition to abate. But you would still likely have a couple of quarters of increases in funding costs just to catch up to the rate increases that have already taken place.

(Operator Instructions) Our next question is from Laurie Hunsicker with Compass Point.

Austin, we cannot hear anything.

And showing no more questions, I will turn the conference back to Chris Oddleifson for any closing remarks.

Great. Thank you very much, Austin, and thank you everybody for joining us. And we look forward to discussing full year results in 3 months.

Thank you.

Bye.

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