Independent Bank Corp (Massachusetts) (INDB) 2018 Q3 法說會逐字稿

Good morning, and welcome to the Independent Bank Corp. Third Quarter 2018 Earnings Conference Call. (Operator Instructions)

Before proceeding, let me mention that 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 that during this call, we will also discuss certain non-GAAP financial measures as we review Independent Bank Corp.'s performance. These non-GAAP financial measures should not be considered replacements for and should be read together with GAAP results.

Please refer to the Investor Relations section of our website to obtain a copy of our earnings press release, which contains reconciliations of these non-GAAP measures to the most directly comparable GAAP measures and additional information regarding our non-GAAP measures. Also, please note that this event is being recorded.

I would now like to turn the conference over to Chris Oddleifson, President and CEO. Please go ahead, sir.

Thank you, Rocco. And good morning, everybody, from Boston, home of the World Series-bound Red Sox. Thank you for joining us today. With me, as always, is Rob Cozzone, our Chief Financial Officer and Head of Consumer and Business Banking.

Well, we were quite busy in many fronts in the third quarter, but we didn't miss a beat on the performance side as we yet again produced record quarterly results. Excluding M&A-related charges, operating net income grew to $34.9 million or $1.27 per share, which represents more than 10% growth over the prior quarters and almost 50% over the prior year. This was a well-rounded performance with virtually every measure moving in the right direction.

Rob will take you through the details in a few minutes, but highlights included: continued modest loan growth in both the total commercial and consumer portfolios; strong core fee income growth led by robust customer activity; a steadily rising net interest margin as we continue to capitalize our long-held asset-sensitive position; higher demand deposit levels that help keep our overall deposit costs comparatively low. I want to note that less than 1% of our total households are CD-only households. That's 1% of our total households are CD-only households and another 2.5% are loan-only households. I think this speaks to the strength of our deposit franchise.

Other highlights include: ongoing stellar credit quality with another quarter of lower nonperformance and minimal net charge-offs; improved operating efficiency, driven by higher revenues and flattish operating spend levels; and tangible book value per share continuing its upward trajectory, up another 3% in the third quarter. This all resulted in very healthy returns, with ROA coming in at 1.7% and ROE at 14%, both on an operating basis, so very solid quarter by any measure.

The other major development this quarter was our reaching agreement to acquire Blue Hills Bancorp, a local community bank with $2.7 billion in assets and 11 Eastern Massachusetts branches, which we announced just about a month ago. This is a healthy, profitable and well-run institution, and we're delighted to welcome their Rockland Trust franchise. The benefits of this transactions are many. It will significantly expand our presence in the coveted Boston market and surrounding towns, which have witnessed robust economic growth and business expansion in recent years; vault us in the #1 deposit share position in Massachusetts of any bank headquartered in the state. Our combined footprint will blanket Eastern Massachusetts from greater Boston down to the Cape -- or Cape -- through Cape Cod, where the vast majority of the economic activity occurs. It also provides us entry into Nantucket with a commanding market position on the island and complements our growing presence on neighboring Martha's Vineyard. It provides us great opportunities to offer customers our deeper product sets, especially investment management and in-home equity. And of course, it's financially very attractive, with expected EPS accretion of 4%-plus in the first year, inclusive of the added costs of crossing the $10 billion asset threshold. Also, the impact on tangible book value per share is expected to be very slightly positive.

Blue Hills, under the terrific leadership of their CEO, Bill Parent, has really transformed itself from a neighborhood bank into a true commercial bank with steadily improving -- while steadily improving its financial performance in an impressive fashion. We expect to close sometime in the first half of 2019, following all the required approvals.

We are also eagerly looking forward to the imminent closing of our Milford National acquisition, which brings with it approximately $350 million in assets and 3 branches in Worcester County. This will definitely strengthen our position in that market, where we already have a solid base of customer relationships. Milford National has an attractive, low-cost deposit base, along with a complementary investment management arm. This transaction is also expected to be accretive to earnings in 2019.

As I've said many times before, post M&A, we continue to be opportunistic and disciplined. The acquisitions we've completed over these many years have added considerable franchise value to our company. However, organic growth continues to be our primary engine for sustained financial performance and value creation. We, therefore, continue to selectively invest in our current franchise to sustain growth. Current initiatives include we're opening a combined loan production and investment management office in downtown Worcester. This obviously dovetails nicely with the Milford National acquisition. Similar office openings in Boston and Providence in the past 3 years have met with much success. And the new branch opening in Boston's financial district is planned for later this quarter. Many of our customers commute into Boston. Our new Boston branch will provide an added convenience for them. Also, our recent branch opening in nearby Newton is off to good start.

So we have been busy. We take great pride in our ability to perform as well as we have so consistently over the years while growing our company in multiple ways. On the economic front, we continue to operate, with the tailwinds of a strong local and national economy, nationally with low unemployment levels and GDP trending above 4% that the economies continues to accelerate. Locally, the Massachusetts economy puts in an extraordinary second quarter annualized GDP of 7.3%. This follows a more subdued Q1 growth of 1.6%. In addition, unemployment remains at near-record lows as of the end of August. Despite these strong metrics, we recognize the increasing macroeconomic risk associated with the trade tension and increasing deficit in tight labor markets.

In conclusion, I want to -- I just want to reiterate how excited we are about our prospects for the future. Competition does remain tough, and macro uncertainty persists, so we're taking nothing for granted. But our brand keeps getting stronger and stronger. Our footprint is expanding. Our reputation for superior customer service is becoming even more well known, and the passion of our colleagues to excel and win is as strong as ever. These are the ingredients for our continued success and the source of our confidence.

That concludes my initial comments. Rob?

Thank you, Chris. Good morning. I'll now review the quarter results in some more detail. Net income of $33 million in the third quarter was 6% higher than the linked quarter and 38% higher than the same quarter last year.

Operating net income and operating earnings per share, which are adjusted for merger charges, increased 11% versus the prior quarter and 47% versus the same period last year. Profitability ratios improved again and continue to migrate towards industry-leading levels, with an operating return on average assets of 1.66% and an operating return on tangible common equity of 18.39% during the third quarter. In addition, tangible book value per share increased another $0.78 to $27.56 at September 30. Importantly, these results are being achieved while maintaining our long-held disciplined approach to building the business one relationship at a time.

Loan closing activity continues to be solid, yet loan growth was tempered in the third quarter due to lower utilization rates across C&I, construction and home equity, which is common during this season. Total commercial growth of only 0.4% during the quarter was also impacted by the reduced attractiveness of CRE projects, as cap rates don't seem to fully reflect higher debt costs. Strong asset-based lending activity, though, did help drive 2.8% growth in the C&I portfolio.

On the consumer side, despite slightly higher rates, demand for purchase financing continues to result in solid residential mortgage activity, with jumbo production leading the way. 70% of our residential volume during the quarter was for home purchases. Although deposits were essentially flat on a quarter-over-quarter basis, demand deposits, consistent with Chris' commentary in core account growth, were up 13% annualized and represented more than 1/3 of total deposits as of September 30. The decline in savings and interest checking accounts occurred within the government banking category partially due to seasonality and partially due to the ongoing competitiveness within that sector.

Growth in higher-rate categories was more modest than expected and will roughly accelerate a bit in the coming quarters. The favorable mix of deposit growth resulted in a low deposit beta, with the cost of total deposits up only 3 basis points to 30 basis points for the third quarter. The cost of deposits is expected to increase 4 to 6 basis points in the fourth quarter, including the addition of Milford Bancorp.

We are not immune to deposit pricing pressures that accompany a rising rate environment. But due to our long-term focus, we gradually acquire active personal and business checking accounts by emphasizing exceptional service and not price.

A low deposit beta and healthy loan betas contributed to 5 basis points of net interest margin expansion in the third quarter. The quarterly net interest margin at 3.94% was almost 30 basis points higher than the same quarter last year.

Let me take a few moments to share some of the dynamics that influence our margin, specifically the interplay between movements in LIBOR versus prime. These pricing indices obviously move in line with changes in market rates but differ as to their relative timing. Currently, about 1/4 of our loan portfolio was pegged to LIBOR and about 1/5 to prime. There has been sufficient commentary around the more modest movements in average LIBOR between the second quarter and the third quarter, up only 14 basis points. However, given the level of current 1-month LIBOR, the increase in LIBOR for the fourth quarter should exceed that of the third. As a result, we believe our net interest margin can expand another 4 to 6 basis points in the fourth quarter despite the dilutive effects of a slightly higher deposit beta and the addition of Milford Bancorp. As a result, we are comfortable increasing our full year net interest margin guidance once again to an increase of 30 to 32 basis points, higher than the 3.6% for the full year in 2017.

Noninterest income increased approximately $1.4 million when compared to the prior quarter, inclusive of a $1.5 million gain on life insurance benefits. Good growth in checking account-related fees, such as deposit, interchange and ATM fees, reflects our ability to continue to attract core households to the bank. Increases were offset by a 4% decline in investment management income in the quarter due to seasonal tax prep fees received in the second quarter. However, assets under administration increased $78 million, and new business activity is quite strong. Loan level derivative income continues to be difficult to predict quarter to quarter and, at $400,000, was lower than anticipated.

Noninterest expense, excluding merger and acquisition charges, increased a modest 1% when compared to the second quarter, reflecting higher performance-based incentive compensation and higher marketing expense. With strong revenue growth and only modest expense growth, the operating efficiency ratio at 53% reached another record low for the company. As Chris said, all asset quality metrics improved during the quarter and the credit outlook remains quite favorable.

I'll now provide some additional updates on the acquisition front. The Milford Bancorp acquisition is proceeding well, and we are making final preparations for the closing of that transaction in mid-November. Our original financial expectations for the acquisition remain intact. The Milford acquisition should add approximately $300 million to loans, $270 million to deposits and $165 million to assets under administration in the fourth quarter. In addition, we expect to incur approximately $6.3 million of merger charges after tax in Q4, including a modest amount from Blue Hills.

As Chris described, we are also very excited about the Blue Hills Bancorp acquisition, a transaction that is another natural expansion of our Eastern Mass franchise, filling in important gaps in our current footprint.

Our approach to acquisition is relatively simple: be absolutely obsessive about the people, which include the staff, the management team, the board, 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 plan and execute well so that sellers view us as an attractive partner. To date, our experience of acquiring in market of contiguous franchises with community bank cultures has served us well.

Before I wrap up, let me just summarize our expectations for the remainder of the year. In terms of the balance sheet, loan and deposit growth should be in the low to mid-single-digit range for the fourth quarter and full year, excluding the addition of Milford. As mentioned earlier, the full year net interest margin should be 30 to 32 basis points higher than last year's 3.6%, with the fourth quarter net interest margin increasing 4 to 6 basis points.

Most noninterest income categories, with the exception of gain on life insurance benefits, should be higher in the fourth quarter relative to the third quarter, and full year noninterest income is expected to increase at a low to mid-single-digit rate. Noninterest expense is expected to be up only slightly in the fourth quarter, even when including Milford, and the efficiency ratio should improve yet again. And finally, the tax rate for the fourth quarter should be approximately 23%.

That concludes my comments. Chris?

Great. Thanks, Rob. So Rocco, we're ready for some questions.

(Operator Instructions) And today's first question comes from Laurie Hunsicker of Compass Point.

Rob, I wonder if you could take us through what accretion income is going to look like for 2019, 2020? And then I know that it was probably an almost immaterial amount, but if you could just let us know how much accretion income was in the third quarter.

I'll take the last question first. The accretion income in the third quarter was about $500,000, so higher than typical. But some of the other fluctuating items like prepayment penalties and return of interest accruals were lower in the quarter, so total kind of non-core investments were actually pretty flat quarter-over-quarter, Q3 versus Q2. In terms of accretion income, going forward, as we had said during the announcement of the Blue Hills acquisition, we expect total accretion income associated with the loan portfolio and held-to-maturity securities to be about $5 million to $6 million annualized. So depending upon the closing of the transaction, we'll get some portion of that. Obviously, as interest rates fluctuate between now and the close, that number can change.

Great. And then just on tax rate, I know that typically, it drops down a little bit due to equity comp plans in the first quarter. Can you just remind us what that should be looking like for the first quarter of '19 and then tax rate for the duration of '19?

Laurie, we'll provide full guidance for 2019 after our fourth quarter earnings conference call, so I don't have those numbers for you at the moment.

And our next question today comes from Collyn Gilbert of KBW.

If we could just talk a little bit about your outlook for loan growth and primarily kind of the composition as you see that unfolding as we go into next year. I know, Rob, you talked about you're still seeing good demand on the jumbo mortgage side, but maybe how you see that playing out. And then also to -- I know the commercial construction portfolio is not a big part of your business, but it had been running down. I'm just trying to get a sense of where you see that business trending as well as we move into next year.

Yes. So I'll start with the commercial construction portfolio. I actually expected commercial construction to be up this quarter, but we had a high amount of projects reach the completion phase and transition to CRE. So it's close to $60 million that transferred from construction to CRE during the quarter, so it was the -- CRE, without that, obviously, it would have been down. And as I mentioned in my prepared comments, Collyn, we are seeing CRE projects that are not meeting our thresholds for cash flow, and that is concerning, especially with rising rates. You would expect, over time, to cap rates -- for cap rates to increase. And we do expect that to happen at some point, but it hasn't happened yet. And so that's impacting our desire to do some CRE deals and could impact CRE growth in the near term. Hopefully, that doesn't carry into 2019, but there's certainly a short-term impact to our growth from that. We're seeing good growth on the C&I side partly because of the staffing that we've added there, and we expect that to continue. And there will be quarter-to-quarter fluctuations, but on average, we would expect that to be our fastest-growing portfolio. And then utilization on construction was low at the end of the third quarter. So assuming that utilization picks up, we should see construction growth return as we head into the fourth quarter, too. Long term, Collyn, we are, as you know, a kind of low to mid-single-digit organic grower, and I don't see any reason for that to change.

Okay. Okay, that's helpful. And then just on the DDA side, as you had indicated, you guys are seeing some good growth there. How do you sort of see those balances trending? And just -- I mean, obviously, you're getting growth, which, as you indicated, maybe it's more a function of new account growth. But just curious as to how you're kind of seeing account growth migration as well as balance migration within those the DDA -- within that DDA segment.

We're having lots of continued success in adding new core households at a nice flip if you compare it, certainly, to the rate of population growth but also expanding existing relationships via new checking accounts. And so our rate of new checking accounts reached a new high for us in the third quarter relative to any previous third quarter. The business rates do tend to fluctuate on a seasonal basis, and I'm pretty sure, year-to-date, we have a new record of both consumer and business DDA accounts. So the momentum continues. Chris talked about the brand resonating our larger footprint. We've got good coverage of a dense geography in Eastern Massachusetts with a strong economy, so we expect that momentum to continue. Balances will fluctuate a little bit quarter to quarter, but we think kind of low to mid-single-digit growth in DDA is certainly achievable for us. And it's a combination of new customers joining the bank and existing customers adding balances to their current accounts.

And Collyn, I'll just add that we have been very, very steady in our sort of view of what our major business strategy with respect to all our customers, and that is building relationships. We are very much not a product counter or pusher. Year in, year out, quarter after quarter, this is something that we talk about a lot. We train to it. We role model it. And we're just sort of super consistent out there, and I think that really is sort of yielding the sort of results that Rob just described.

Okay, that's great. That's very helpful. And then just one last housekeeping item. Do you guys have, by chance, a tighter close date for Blue Hills? I know you had indicated one -- first half of '19 when you guys announced the acquisition. Any updated thoughts on the time line for close?

Not yet. And I don't think -- it's not necessarily tighter. I mean, we're --- we talked about first half, and we announced...

Pretty typical time frame. What did you mean...

No, no, no. Sorry. I just meant within like a quarter. Like do you think -- no -- yes, it is a short time frame. That's not what I meant. I apologize. But just -- is it first quarter or second quarter? That type of thing.

Yes. Well, the merger agreement -- within the merger agreement, we have some flexibility, meaning we don't have to close in the last month of the quarter. So that would mean March is out, for example. So chances are it would push us into the second quarter. But as soon as we have more color on that, we'll provide that to you.

(Operator Instructions) Today's next question comes from Matthew Breese of Piper Jaffray.

Just thinking about the Blue Hills acquisition, is there a shot we could see you prepare the balance sheet in any way before the close date maybe by remixing or adding to the securities portfolio? Is anything like that likely to happen?

Yes. And as we work through those plans, Matt, we will certainly communicate those. As you know, their mix of funding is not where we'd like it to be. So there's likely a chance that we would, probably immediately after the acquisition, downsize their securities portfolio and relieve some of the brokered CD balances they have on their books to improve some of the funding mix and then work to aggressively transition some of the remaining funding that is a little bit more inconsistent with how we've been able to grow deposits historically. But that's going to take time, for sure, to do that, but we are very acutely aware of what needs to be done there and are working on some of those plans now.

Right. Do you think that the time frame for being able to take your demand deposits or 1/3 of balances today is going to go down to about 27%, 28% post close, excluding any of the brokered stuff that you can get rid of? How long before we can get back into the 30s? Is that a 2- or 3-year kind of time frame or shorter? Just give us some frame there.

Yes. Typically, it would probably be a little bit shorter. I think the complicating factor here is the rising rate environment and whether that continues or not. So I'm not prepared at this point to provide a specific time frame, but the market dynamics will certainly impact our ability to transition that as rapidly as we've been able to do with prior acquisitions.

Understood. Okay. And then maybe just a couple of big picture questions. First, we've heard more recently that there's a couple of large competitors coming to Boston. JPMorgan and M&G is talking about it, too. So how does that change the landscape for you? And I could see it going both ways, maybe providing some M&A opportunities, but it also certainly makes an already intense competitive environment that much more so. So I'm just curious what your thoughts are on there and how it all plays out.

Now we're watching that very, very closely. JPMorgan, for example, is known to be a great consumer bank. I will point out that they are focusing mostly on sort of Boston. I mean, we are -- we have a franchise that extends far, far beyond, and that's where a lot of our great core funding comes from. In fact, Plymouth County, where we've -- or sort of our legacy county, we have about a 23% market share and a very solid and low cost of funds. Having said that, we're not sort of resting on our laurels. I mean, we're going to be asking ourselves how do we pick up our game even better from where we are today, and we're very good today. We have a very highly-rated customer service. We have a great brand. It resonates. Our retention of our current customers is just way high in terms of relative to peer. So that's all -- that's a good starting point. Now you want to be starting in a position of strength when a competitor like that comes in. But I think we will continue to push on all the things we've been pushing on as to how do we provide solid relationships, more advice. We have a great digital offering. That's going to improve even more. We have great branch coverage. That, historically, has been a huge strategic advantage for us. We have a lot of dense network. That's going to be very helpful. So Matt, I don't have sort of the magic pill right now. I'll tell you this is a -- we're going to be working on this one very hard.

Okay, understood. The last one I had is just on the commentary around cap rates versus interest rates. You know that there's somewhat of a mismatch there. So maybe, first, to what extent is there a mismatch? And then secondly, if we do see that correct itself, what does that imply for any sort of valuation trends for commercial real estate and whether or not things are overvalued here? Is that a looming credit issue?

Yes. Our opinion, Matt, is that it could certainly possibly be a looming credit issue, which is why we're treading lightly. And in terms of where the metrics are today, cap rates haven't moved. There are projects that are sub-5% cap rates and projects that are not high-quality projects that are at 5%. We were talking about one example with the board yesterday, as a matter of fact. And those levels just don't line up with what's happened with the 10-year treasury as of late, and as the 10-year treasury continues to move, that situation will get worse. There's obviously -- that's all happening in a backdrop of a very strong local economy and still presumably a lot of liquidity looking for investments. So it may take some time for that to play out, and maybe it will be a little bit softer reversal than it has been historically, especially if the increase in the 10-year is gradual. But we're being cautious, for sure.

I want to point out and remind you, this management team has -- remembers '05, '06, '07, and you may recall that we performed very well going into that and throughout the recession. And well, it looks a little frothy now. We are not stretching for yield. I mean, we're being -- we're applying our same conservative underwriting now as we did during the old drought, so there's that's constant. So I think we're being very methodical and disciplined here.

And ladies and gentlemen, this concludes the question-and-answer session. I'd like to turn the conference back over to Mr. Oddleifson and the rest of the team for any final remarks.

Okay. Thank you very much, Rocco. Thank you, everybody. We look forward to reporting full year results in January. Have a good rest of the day.

Thank you.

And thank you, sir. Today's conference has now concluded, and we thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.