Independent Bank Corp.
Q4 2013 Earnings Call Transcript

Published: 24 Jan 2014

[Operator:]

Good morning and welcome to the Independent Bank Corp., Fourth Quarter 2013 Earnings 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 in 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 Christopher Oddleifson. Please go ahead.

[Christopher Oddleifson:]

Hi, good morning everyone and thank you for joining us today. I’m accompanied by Rob Cozzone, who has nicely settled into his new role as Chief Financial Officer. Rob will take you through our financial results and outlook following my comments. Our Chief Operating Officer, Denis Sheahan is also with us today. We ended the year with another solid quarterly performance. Core earnings in our fourth quarter amounted to $14.2 million or $0.61 per share, bringing full year earnings to $55.2 million or $2.39 per share. As I’ve said, many times before it is the consistency and quality of our results that we take most pride in. Our fundamentals continue to lead the way and reflect the growing power of Rockland Trust brand throughout our markets. Our performances continue to be marked by robust origination volumes, diversified revenues, excellent credit quality, diligent expense control, a strong capital position and solid returns. On an operating basis for the full year EPS rose 11%, commercial loan portfolios (inaudible) organic growth of 7%. Core deposits increased by 8% organically and non-interest revenues grew by 10%. Credit losses were very low at 19 basis points. Tangible book value continued to grow up another 7%, return on assets came in at just about 1%. This performance is even more noteworthy considering the challenging banking environment that persists, especially the heavy pressure on interest margins and ramped up competitive intensity. At the same time we continue to focus on sustaining long-term growth by steadily investing in our competitive strengths to enhance our market presence, [business development] [ph] talent and product array and much was accomplished towards that end in 2013. Among our most notable achievements were growing our core deposit households by 5%, far outpacing the Massachusetts household growth rate of less than 1%; opening our first office in Boston, staffed by senior investor management and commercial banking personnel; assimilating our late 2012 Central Bank acquisition, which significantly increased our great Boston footprint; closing and converting our recent Mayflower Bank acquisition, which strengthens our number one position in the key local market. It is worth noting that both these acquisitions are accretive and were completed without a capital raise. Moreover we continue to expand electronic and mobile banking products in response to rapidly changing customer preferences. We conducted five major marketing campaigns, that have successfully led to expanded customer relationships and product usage. We completed a major organizational realignment in sync with our larger size and growth plans. This included Rob promoted to CFO, and Denis Sheahan becoming the Chief Operating Officer. These moves and others related to this were accomplished without a single outside hire, which speaks to the efficacy of our talent development program. We have also proactively responded to the more demanding regulatory environment, by stepping up our entire compliance programs and subjecting ourselves internally to the more rigorous risk assessment standards intended for much larger banks. Our performance and progress has been recognized in a number of ways by reputable third parties such as (inaudible) named as the top SBA Lender in Massachusetts, top places to work by the Boston Globe, top commercial lender in Massachusetts by the Banker and Tradesman’s. So I think it’s fair to say that 2013 was another excellent year for the Rockland Trust franchise. While we feel very proud of our track record and are confident of our future success, we are a grounded management team that takes nothing for granted. Beyond the macro headwinds they remain in strong force, the competitive challenges keep rising. Large banks are regaining their stride and leveraging their considerable scale, the pace of switching banks by customers has stabilized, so we have work, we have to work that much harder to gain new business. Our game plan is a simple one, to govern our strength and target customer segments where we can win. Our unwavering approach is discipline and customer focus has proven to be the winning formula for us and there is no reason to change course. We feel we are at a nice sweet spot competitively, having the capability of the large regional national banks while being able to deliver intimacy on a smaller community bank. While our overall approach is unchanged, we are certainly not standing [inaudible]. The key initiatives being led by Denis to take our business analytics and operational effectiveness to the next level is all part of meeting today’s competitive challenges and my colleagues are up for the challenge and are determined to win the battle for the customers hearts and minds. They bring incredible energy and enthusiasm to the task at hand. I am grateful to each and every one of them. The age-old maxim that organizations are only as good as the people inside has never been truer. I would like now to spend a moment on a few more specifics on the general economic outlook. In terms of the Massachusetts economy, the latter part of 2013 provided some mixed signals. Unemployment for the state raised above the national level to 7.1% in November. However, close to our core market, unemployment in Boston, Cambridge and Quincy, the stock rate was 5.8% in November, very strong. This is tampered somewhat by the south cost areas, New Bedford and Fall River, where unemployment exceeds 11%. On a positive side of our ledger in December Massachusetts had the best job growth, 10,000 jobs since the dot-com era. Growth state product in Q3 was a robust 3.5% far outpacing the national rate, Massachusetts tax receipts are up, [our apartment] [ph] values close to Boston are very strong, given demographic trends and the desire to ramp. We actually have some concerns over [apartment] [ph] values. Looking more closely at our customers’ activity, generally management prepared financial statements for 2013 showed increasing revenue, and our customers are anticipating a better year in 2014, although they are still just a bit hesitant. We are seeing new constructions in mixed use, health facilities, commercial, some new single-family home developments and of course apartments. We are seeing some weakness in smaller retail outside the Boston area, although that may improve as the year goes on. I think the real key here is employment and confidence and significantly improved consumer balance sheet should also drive consumer spending and impact confidence. I think it’s note worthy that household debt service is at the lowest level on record, which is, I think from 1980. So we add all that up, what’s our bottom line? Looking ahead to 2014, expectations that the year will be better as it progresses and so Rob will describe our anticipated loan and earnings growth that reflect a slower start to the year and we really haven’t built in an upside in the back half of the year, that some economist are predicting. Perhaps should that occur, we’ll do better than described. Before turning it over to Rob, I just wanted to end by saying that throughout the years Denis and I and now Rob have recognized the importance of maintaining a healthy dialog with the investment community. We really learnt a lot from our conversations with our owners and our prospective investors and analysts and really take to heart much of the feedback and reinforces our sense that we are in the right path to growing shareholder value. We fully understand our roles as stewards of capital invested in us and look forward to continuing to earn your loyalty and support. Thank you. Rob.

[Rob Cozzone:]

Thank you Chris and good morning. I’ll now review the earnings for the fourth quarter and full year in more detail. Independent Bank Corp. reported net income of $10.6 million and GAAP diluted earnings per share of $0.45 in the fourth quarter of 2013. This compared to net income of $14.7 million and GAAP diluted earnings per share of $0.64 in the third quarter. Both quarters included items that the company considers to be non-core, including $0.17 of M&A expenses in the current quarter, along with some minor gains on security sales and life insurance proceeds. Excluding those items, operating diluted earnings per share was $0.61 in the fourth quarter compared to $0.63 in the third quarter. For the full year in 2013, operated diluted earnings per share improved by 11% and were a record for the company at $2.39. On an operating basis the return on average assets was 0.94% and the return on average equity was 9.81% for the quarter. As Chris mentioned the Mayflower acquisition closed on November 15 and the branches and the systems were fully converted that weekend. The integration has gone very well and cost savings targets have already been achieved. As a result we are on track to deliver immediate earnings accretion. Within the press release you will see a summary of the assets and liabilities acquired, as well as an additional schedule to help you better understand organic loan and deposit growth rates for the quarter and the year. Not surprisingly, Mayflower’s balance sheet was very clean. On a fair value basis 64% of the loan portfolio was consumer real estate with the remained being primarily commercial real estate and almost 70% on the deposit book is core. Total loans including the acquisition increased 3.6% during the quarter and we are up about 1% organically. Organic growth continues to be driven by the commercial book, which is up almost 7% for the quarter annualized and for the year as well. A good close in volumes during the fourth quarter was partially offset by a couple of large payoffs, however these payoffs were not due to competitive pricing, but rather improving economic conditions, resulting in increased asset values for real estate investors. We believe this type of activity is a positive sign for the regional economy. The approved commercial loan pipeline ended 2013 at $244 million, which is down from the third quarter but it’s still very strong when compared to previous year-ends. Frankly we were expecting a little better closing volume in the fourth quarter, but some deals were pushed past year-end, which bodes well for Q1. Consumer real-estate loans, mortgage and home equity when excluding the acquisition were down 1.4% during the quarter, as total originations have declined in-line with industry trends and conforming 30 year product continues to be sold. The average yield on the loan portfolio only declined one basis point in the quarter as the benefit of a high yield curve has begun to materialize. Total deposits excluding the Mayflower acquisition were essentially flat for the quarter as seasonal outflows offset new customer acquisition. With a large cash position at the end of the third quarter, there wasn’t much need for additional deposition funding. However as Chris mentioned, organic core deposit growth for the year was excellent at 8%. The total cost of deposits remained flat at a low 23 basis points for the quarter and our total cost of funds declined three basis points to 42 basis points for the quarter as $50 million of Federal Home Loan Bank Advances matured during the quarter and the full benefit of the sub-debt that re-priced in the middle of the third quarter was realized. The securities portfolio excluding the acquisition increased by $27.8 million in the fourth quarter as the company continued to deploy liquidity. Offsetting purchases of agency mortgage backed securities in the quarter was the sale of the company’s only two private label mortgage backed securities. The average yield on the securities portfolio increased one basis point to 2.67% in the fourth quarter. The approximately $80 million of securities that came over with the Mayflower acquisitions was comprised mostly of agency debt and agency mortgage back securities. As expected the net interest margin stabilized in the fourth quarter and a 3.45% was two basis points higher than the third quarter. The margin has benefited from the deployment of liquidity; the stabilization of asset yields resulting from higher medium-term rates and the restructuring of dollars. Following any significant changes in rates, we expect the margin to level off going forward and as previously stated we’ve been in position to rising rates. Overall asset quality improved during the quarter. Net charge offs were higher as expected and included a loss on a commercial real-estate credit which was previously provided for in the third quarter, and beyond that delinquencies, NPAs and NPLs were all lower. This positive trend accompanied by improved historical loss experience and better regional economic conditions led to a slightly low allowance at the end of the year. As Chris mentioned, net charge offs for all of 2013 were only 19 basis points and were lower than originally forecasted. Non-interest income on an operating basis decreased 2% versus a very strong third quarter as solid increases in deposit fees and investment management income were offset by decreases in mortgage banking income and low-level swap income, both of which were a bit lower than we had anticipated. We continue to be very pleased with the progress we have made in growing the fee income category over the past few years and it remains a focus for us. Non-interest expense was well contained and on an operating basis increased 3% for the quarter, reflecting the addition of Mayflower, high loan workout cost and as expected an increased adverting spend. The $6.2 million in M&A charges related to the Mayflower was consistent with our expectations. Strong core earnings for the quarter offset the dilutive capital impact of the Mayflower acquisition and as a result capital ratios and tangible book value per share were essentially flat for the third quarter. I will now turn to earnings guidance for 2014. We always try to provide you with our expectations of future performance along with quarterly updates as the year progresses. Before I provide our earnings per share guidance for 2014, I would like to remind you that the tax credit recognition period for one of our new market tax credit awards ended in 2013. As a result, our effective tax rate is expected to rise in 2014 to about 30%, which will negatively impact earnings per share. Based upon an anticipated 2014 effective tax rate of about 30%, we anticipate that 2014 diluted earnings per share will be in a range between $2.42 and $2.52. As a reminder, our first quarter usually trends notable below the fourth quarter, due to a variety of factors, including fewer days, high employee benefits expense and increased marketing expense. Key assumptions in our 2014 outlook include the following

[Christopher Oddleifson:]

Okay, thank you Rob. Operator, we can open up the questions.

[Operator:]

(Operator Instructions) Our first question comes from Mark Fitzgibbon of Sandler O'Neill & Partners. Please go ahead.

[Mark Fitzgibbon:]

Hey guys, good morning.

[Rob Cozzone:]

Good morning.

[Christopher Oddleifson:]

Hey Mark.

[Mark Fitzgibbon:]

The first question I had for you Rob, you mentioned the new market tax credit, some of it burning off in 2013. Does the remainder of it sort of burn off during the course of 2014 or is that all out of the numbers for the tax rate right here in 1Q?

[Rob Cozzone:]

The one award that we’re speaking to, these tax credits, we get a benefit over a seven year period Mark and so the award that we received in 2007, we finished recognizing the benefit for that award in 2013 and so that particular award will end this year and so we won’t be getting the benefit of that in 2014. The remainder of our awards are scattered throughout the next several years and so should we not receive any additional awards those will gradually fall off in the coming years. There’s a schedule in our 10-K that details the awards we’ve received and how they are scheduled to amortize over time and so you’ll see that in the upcoming 10-K as well.

[Mark Fitzgibbon:]

Okay. And then secondly, I wondered if you could discuss with us the timing of recognizing all the cost synergies on Mayflower?

[Rob Cozzone:]

We’re pretty much there Mark. We have already closed the branches, we have expected to close four out of the eight, all of the staff is out, the systems are converted, so by the end of 2013 we had already really got all of the cost savings out there. There should be minimal that carries over into 2014.

[Mark Fitzgibbon:]

Okay, thank you. And then lastly, I wondered if you could just sort of comment on the competitive environment as it relates to commercial loans, particularly pricing trends that you’re seeing out there?

[Rob Cozzone:]

Yes, sure. It continues to be very competitive as you can imagine. As Chris said, we continue to find that we are uniquely positioned in a number of different areas. One area where we’re seeing a lot of success in particular now is in construction. We have a lot of expertise in the construction area and we never exited construction for the prices, so a lot of borrowers in that business have lots of confidence in us. You know the new asset based lending group, it’s been a couple of years now, is having a lot of success and wining some good deals and our now, kind of official location in Boston is also helping. Competition is certainly stiff. You know from the smaller institutions we see both pricing in terms being somewhat relaxed and the larger institutions are particularly competitive on those high quality relationships.

[Mark Fitzgibbon:]

Great, thank you.

[Rob Cozzone:]

[Inaudible] disciplined.

[Mark Fitzgibbon:]

Thank you, Rob.

[Operator:]

The next question comes from David Darst with Guggenheim Securities. Please go ahead.

[David Darst:]

Good morning.

[Christopher Oddleifson:]

Hi David.

[David Darst:]

Chris, I guess it feels like a lot of the run offs in some of these loan categories that you’ve been de-emphasizing should be complete and that with your commercial banking trends we should begin to see more of a lift in loan growth. Do you have any comment on your perspective?

[Christopher Oddleifson:]

Well, when you say the run offs you are talking about the run off in the resi portfolio.

[David Darst:]

Correct, resi and just other categories.

[Christopher Oddleifson:]

And the other which was our indirect auto portfolio, which is virtually gone now. Well the resi portfolio, we’re expecting that to be – the run offs to continue somewhat, but sort of diminish in its rate and the – in the commercial portfolios we’re actually anticipating a fairly detailed organic growth of…

[Rob Cozzone:]

Yes, it’s very similar to this year David. We think commercial will grow, and our assumption on residential is that that will continue to amortize down to the tune of $5 million a month. We are looking at some portfolio programs that could offset some of that run off, but in terms of growth from an historic perspective where you don’t have the traction on the home equity book that we’ve had over the past couple of years, just because the REFI market has dried up. So the growth rate in home equity certainly declined significantly in 2012. We’re expecting a bit of an increase - in 2013, we’re expecting a bit of an increase in 2014, but certainly not to the extent that we saw in the prior years.

[David Darst:]

Okay. And then it seems like you really built out a well-rounded franchise around Boston and in your markets now. Are you comfortable where you are and now that you’re in a larger market, more fully to penetrate organically or do you think you need to continue to do more acquisitions.

[Christopher Oddleifson:]

That’s a question we’ll always ask, always in a little bit different form. Our stance in acquisition is entirely sort of opportunistic. You can take a look at the number of stock held banks, sort of adjacent in the territory and there were very few. So we cannot sort of rely on an acquisition strategy to fuel growth. However if our Board of Directors wants to sell, we’d love to be at the table and talk about it. So our focus really has – I mean the thing that we can control is our organic growth and thus going into Boston was a really key move for us. You may recall a couple of years ago we opened a similar office in Providence that’s been very successful on the commercial, on the wealth management side, we don’t have any retail branches. We expect the same result from Boston. If you take a look at a couple of our recent acquisitions, I mean the central area and Ben Franklin, we think there’s just a lot of upside potential in those markets, you know right in our backyard. We are going to continue to look in selected markets for additional branches here or there. We’ll continue to – you know as we have and as you know continuously over the last decade trimmed the branches, consolidated some branches, built some branches, we’ll continue to do that. I would anticipate that there will be well probably sort of closing in on our opportunity for our new branch in 2014 that we’ll probably will talk about at the first quarter call. So all in all, I mean bottom line is I think we have a lot of opportunity within and adjacent to our markets to grow organically and should an acquisition sort of present itself, opportunity, we’d love to talk about it.

[Rob Cozzone:]

But as you know probably Boston 40% of New England’s GDP is in Boston, so that’s certainly significant opportunity for us to capitalize on there.

[David Darst:]

Longer term do you think you’ve build the economies of scale or you can maybe get your efficiency ratio down as you approach $10 billion, I realize all things change at that point, but…

[Christopher Oddleifson:]

Yes, we are given the brand strategy, your never going to see an efficiency ratio in the mid-50’s for us or lower. I mean I would anticipate as we grow, especially if the interest rate a short end, if the interest rates go up, you’re going to see our efficiency ratio improve quite nicely. I mean we are well positioned for the upside when that comes and our strategy has been to really focus on co-relationships throughout our network. I mean should we want to really do some part of profit generation we have the distribution to do that. You’ll notice our CD book is diminishing, while we could turn that around in a nanosecond if we wanted to and really generate some good growth there. In terms of scale, I mean this is the key goal. When I talked to my fellow bankers around the country, what is often discussed these days is the scale required to have robust compliance and regulatory functions, so internal audits, compliance, whole BSA departments, internal council and we’re at a scale where we can do all that and strengthen all the processes. So I feel pretty good about where we are there. Of course as we get bigger, I mean there will be additional operating leverage that will come with that and then of course the big question of crossing the $10 billion mark is the determined implications, but that’s a few years out.

[David Darst:]

Okay, yes great. Thank you.

[Operator:]

(Operator Instructions) The next question comes from Collyn Gilbert of KBW. Please go ahead.

[Collyn Gilbert:]

Thanks, good morning guys.

[Christopher Oddleifson:]

Hi Collyn.

[Collyn Gilbert:]

If you guys covered this in your comment, I apologize, but just as we look at kind of the loan yields and asset yields, I guess honing in specifically on the loan yields you know they’ve been fairly stable. Do you expect that stability to continue and is that something that your managing to? I know you guys are really mindful of sort of margin preservation and balance that with growth. But just trying to get a thought on how your seeing that loan yield evolve here over the next year or so or few quarters or whatever?

[Christopher Oddleifson:]

Sure, sure Collyn. I wouldn’t say we specifically managed to the absolute level of the loan yield. We managed to appropriate pricing on each deal that comes across. I would expect the loan yield to decline slightly heading into 2014. Certainly not nearly at the pace that we saw in 2013 or in prior years, but I wouldn’t say we’ve reached the bottom on the loan yield.

[Collyn Gilbert:]

Okay, okay. And then the assets under management that you’ve seen such good increases from, how much of that would you say is market related versus just new client related?

[Christopher Oddleifson:]

The market was very good to us in 2013. Now I don’t have that. We can get that to you Collyn. I mean we can just put that out. We don’t have any at our fingertips.

[Collyn Gilbert:]

Okay, just try…

[Christopher Oddleifson:]

Let me say this. We also had a record origination year. We originated close to $300 million of new assets. So we have one of the key – we really have cracked the code on working with our franch bankers and our commercial bankers to expand our relationships into wealth management by tapping a really, really good product and I’m just anxious that it happened, instilling the confidence in our internal folks that even for the referrals and so we have a very high level of referral and we have new business close to $300 million for 2013.

[Collyn Gilbert:]

Okay, okay that’s helpful, that’s great. And the decline in the derivative income in the quarter, was there timing associated with that or do you think that’s a new level that’s just given a change in activity or how should we think about that business going forward?

[Rob Cozzone:]

Well the third quarter was an exceptional quarter for us Collyn and the decline in the fourth quarter, that’s closer to a run rate for us. That is going to be a pretty lumpy line item though from quarter-to-quarter. We would expect in 2014 to see a bit of a decline in swap income, both as rates rise, but also as we have more capacity for fixed rate deals on our books. We have shifted a little bit of some of those deals being fixed rate versus swap.

[Collyn Gilbert:]

Okay, okay. And then I guess the same question kind of for mortgage banking. You guys in the third quarter didn’t seem to hold up much better than the industry, but then it settled in the fourth quarter. Is that catch up and now is that the new level or do you think it migrates even lower from here?

[Christopher Oddleifson:]

Yes, I think we probably hit a bottom in the fourth quarter. We had $42 million of close-ins in the fourth quarter. We are expecting to do on average north of $50 million in 2014, so I think the fourth quarter was probably a floor in our terms with mortgage banking income.

[Collyn Gilbert:]

Okay, that’s helpful. And then just how are we keeping on the tax rate. What should we think about going forward for the tax rate?

[Christopher Oddleifson:]

Well as I mentioned in my comments, 2014, our expectations right now should we not get any new market tax credit award, its 30%.

[Collyn Gilbert:]

Okay, okay. That was all I had. Thanks guys.

[Christopher Oddleifson:]

Thanks Collyn.

[Rob Cozzone:]

Thanks Collyn.

[Operator:]

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

[Christopher Oddleifson:]

Well, thank you again everybody for your support and interest and we look forward to talking with you just after the first quarter of 2014, I think in the next few months. Bye.

[Operator:]

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.