Independent Bank Corp. (NASDAQ:INDB)
Q3 2016 Results Earnings Conference Call
October 21, 2016, 11:00 AM ET
Christopher Oddleifson - President and Chief Executive Officer
Robert Cozzone - Chief Financial Officer and Treasurer
Laurie Hunsicker - Compass Point
Collyn Gilbert - KBW
Good morning and welcome to the Independent Bank Corp. Third Quarter 2016 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [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 Mr. Christopher Oddleifson, President and CEO. Please go ahead.
Thank you. And good morning, everyone and thank you for joining us today. With me as usual is Rob Cozzone, our Chief Financial Officer, who will take you through our financial results, following my comments.
In the third quarter, we delivered another solid performance following on the heels of an excellent second quarter, net income came in at $20.5 million or $0.78 per share, 10% above prior year's level.
As I said many times before strong fundamentals led the way, once again commercial loans rose nicely despite various paydowns earlier in the quarter. Our loan officers are doing a great job in a very competitive environment without sacrificing our credit discipline.
On the consumer side, mortgage and home equity loan volumes have been strong. Core deposit remain a source of strength reaching 90% of total deposits for the third quarter and continue to keep funding cost on the low side.
Fee-based activity remains robust, our investment management unit continues to shine with assets under administration going to $2.9 billion. Credit quality remains stellar with lower non-performers and very modest losses in the third quarter. For the first nine months we were actually in a net recovery position. Expense levels were virtually flat as we continue to balance select investing with overall restraint. And lastly, capital continues to build thereby providing healthy growth in tangible book value per share, so a good quarter all around.
The other important news of course was our announcement late yesterday of having reached an agreement to acquire Island Bancorp of Vineyard and its and its Edgartown National Bank subsidiary. This is another wonderful move on our part to expand our footprint into an attractive contiguous market.
Here are few quick facts, Edgartown National is an approximately $194 million asset institution with branches in the three main a population centers on the island, it is the oldest bank in the vineyard with roots dating back to 1905. It is a well-managed profitable community bank with a solid credit profile.
The Vose family, who are the original founders and CEO Fielding Moore have done a terrific job in growing the bank and creating a very loyal customer base and a strong community image.
For us the benefits of this transaction are many, it’s a natural extension of our growing presence in Cape Cod, which is the primary access points in Martha's Vineyard. We already have many customer relationships in the vineyard and this will give us our first physical presence here.
And as many of you know, this is a major destination point for second homeowners and vacationers who bring significant economic activity to the island. It is also a good year round small business space. We see significant opportunities for deepening relationships with our products set, especially investment management and home equity, along with a much higher lending capacity. On the financial side, this is a low risk transaction, it is expected to be accretive to earnings and neutral in tangible book value.
Like our Bank at Cape Cod acquisition, which is expected to close next month, and others before it, we expect a seamless integration process and we waste no time in getting - going on advanced planning. In fact, Rob and I are conducting this call from Edgartown National's historic main office building which some of you may remember was featured in the movie Jaws as Amityville National Bank.
We are here with a number of our other Rockland Trust executives meeting with bank staff and other key constituencies to develop a sense of excitement and opportunity to hit the ground running in day one.
We are also pleased that Dee Lander, their head of business development who knows the local markets very well, will be staying on to lead our combined efforts on the island.
The important take away from our commentary today is that we continue to build franchise value through sustained organic growth and opportunistic transactions, it is also evident that community banks deciding to be part of a larger organizations are attracted in the power of the Rockland Trust brand our corporate values and our currency.
You have heard us talk about and respond to questions by preparing for the inevitable crossing of the $10 billion asset threshold and the increased regulatory oversight that comes with it. We have to way to go at $7.5 billion, but something that our board and management team across all levels of the organization spend a lot of time on.
This is readily evidence by the significant expansion of our compliance programs and our portfolio stress testing that is required of larger banks. We're also attentive to ensuring that our board composition continues to evolve with a proper depth of expertise and stewardship and that’s our growing size and sophistication.
A subcommittee of the board is been hard at work developing recruitment criteria to identify potential candidates who can further strengthen the board, as well as provide for orderly succession to card members expected to retire over the next few years.
From an economic standpoint, we have seen mixed results in terms of national economic data released of the past quarter, despite sluggish reports in GDP growth and sub 2% inflation, the expectations for the US economy remain mostly positive.
The recently released Fed Facebook survey found that most of the 12 districts are experiencing a modest or moderate pace of expansion and that job markets remain tight, with modest employment and wage growth.
Locally, our state economy continues to perform well with the Massachusetts unemployment rate down to 3.6%, a level not seen since 2001. Needless to say, it's easy to get distracted and at times overwhelmed by the myriad of political, economic, regulatory and global issues swirling around out that there, a way of countering this is by simply remaining laser focused on our customers and sharing we provide the best experience possible to them.
The other part of this is making sure we have the right people in place to accomplish this, and we do. We remain confident that our long-term strategy of discipline growth will continue to result in superior performance and bring us ample opportunities for future growth.
With that, I will turn it over to Rob.
Thank you, Chris and good morning. As Chris just described the third quarter was another solid one for us. Net income of $20.5 million and diluted earnings per share of $0.78 for the third quarter were both slightly higher than a very strong second quarter and 10% higher than the same period last year.
Included in the second and third quarters of this year were very modest M&A expenses. Performance ratios for the quarter were also quite solid, on an operating basis the return on average assets was 1.1%, return on average equity was 10.03% and the return on average tangible equity was north of 13.5% for the second consecutive quarter.
Solid earnings results continue to drive growth in tangible book value per share, which increased by $0.56 to $23.08 at September 30 from the prior quarter end and is now grown by 11% in the past year. In addition despite good balance sheet growth tangible capital to tangible assets increased a 11 basis points to healthy 8.33% at September 30.
Near record loan pipeline at June 30 led to very strong holding volumes during the quarter and despite elevated payoffs the total loan portfolio grew 1.3% to $5.75 billion at September 30.
All loan categories in both the commercial and consumer sides with the exception of C&I experienced growth during the quarter. However the reduction in the commercial pipeline to 166 million at September 30 from the over 200 million in the prior quarter will likely result in somewhat slower growth for the fourth quarter.
Still full-year organic growth is expected to be within the 3% to 5% range originally established for the year and most likely at the upper end of that range. Total deposit growth of $72 million matched loan growth and was primarily concentrated in the demand deposit category.
Strong growth in non-interest-bearing deposits allowed for continued reduction in higher cost time deposits. As a result demand deposits reached 32% of total deposits at the end of the quarter and the total cost of deposits declined another basis points to 17 basis points for the third quarter.
As described in previous quarters, the relative size of our core deposits a reflection of our intense focus on relationships and the growing recognition of the RTC brand across our geography.
Despite the reduction in the cost to deposits, a large average excess cash position during the quarter resulted in a 7 basis point reduction in the net interest margin. This was partially offset by higher prepayment penalty income. We still expect the full-year margin to be in the low 340s range which is consistent with our original guidance.
As anticipated, total non-interest income decreased versus a very strong second quarter. Loan level swap income which peaked in the second quarter declined by $1.3 million as many clients seem to be in a wait-and-see mode on the direction of interest rates.
Although there was a tax prep-related seasonal decrease in investment management income, we continue to experience positive asset flows and assets under administration grew to $2.9 billion during the quarter.
In addition, mortgage banking activity continued to accelerate with a record closing volume leading to a 44% increase in revenue. Low rates, excellent service levels, a strong housing market and a full complement of loan officers have combined to provide momentum in that business line. We also continue to make strong inroads into the customer bases of our various acquisitions.
Non-interest [ph] expense actually came in below the second quarter level versus the increase we anticipated. The most significant contributor to the differential being an $860,000 change in the reserve for unfunded commitments associated with a lower approved and committed pipeline quarter-over-quarter. In addition, the increase in advertising expense of approximately 430,000 was less than anticipated as certain projects were postponed.
And finally, cost associated with a branch closure have been delayed to the fourth quarter. The reduction in non-interest expense for the quarter resulted in efficiency ratio on an operating basis below 60%, a multi-year low for the company and year-to-date non-interest expense on an operating basis is essentially flat with 2015.
I'll now provide some additional updates on the acquisition front. As you may have seen we received all regulatory approvals for the New England Bancorp acquisition with its bank of Cape Cod subsidiary and we are making final preparations for the closing of that transaction in early November.
Our original financial expectations for the acquisition remain intact. We expect the transaction to be neutral to tangible book value per share, $0.05 accretive to 2017 earnings per share and to generate an internal rate of return of approximately 20%.
The bank of Cape Cod acquisition should add approximately $225 million to loans and $190 million to deposits in the fourth quarter. Also as Chris described we are very excited to announce the acquisition of the Island Bancorp, the holding company for Edgartown National Bank. A transaction that is a natural expansion of our increased presence on Cape Cod and provides a similarly attractive financial metrics , post closing we'll be the only bank with a top three market share position in the two counties that make up Martha's Vineyard and Cape Cod.
In addition we have the number one market share in Plymouth County, the populous county that borders the Cape to the north making of the logical choice for residence, second homeowners in the many local vacationers. We expect the Island Bancorp acquisition to be neutral to tangible book value per share provide $0.03 to $0.04 of earnings accretion in 2018 and to generate an internal rate of return of approximately 20%.
Based on our stock price, the evening before last, the transaction is valued at approximately $24.5 million. Although we don't intend to close any Edgartown national branches we believe we can achieve these financial results primarily through efficiency gains.
Our approach to acquisition is very simple, be absolutely obsessive about the people, that includes the board, management team, the staff, the customers, the community and the shareholders. Be disciplined with pricing and conservative with assumptions, don't bite off more than you can chew and maintain and capitalize on a strong currency and execute well so that sellers view you as an attractive partner.
To date, our experience of acquiring smaller end market or contiguous franchises has served us well, while we are not fundamentally opposed to a more transformational sort of transaction, we are that much more cautious as we believe the relative risks of such a transaction are much greater.
Finally, a quick update on 2016 guidance. During our last conference call we increased our original operating diluted earnings per share guidance to between $3 and $3.05. We remain comfortable with that guidance.
That concludes my comments. Chris?
Great. Thanks, Rob. Okay, we'd love to open up for questions now.
[Operator Instructions] And our first question comes from Laurie Hunsicker with Compass Point. Please go ahead.
Yes, hi. Good morning, Chris and Rob.
Just wanted to go back to the $10 billion cross. Can you take us a little bit through where you are - there's an echo. Sorry. Can you take us through where you are in the expense piece of that with respect to enterprise risk, compliance, you had mentioned hiring, and so forth? Can you just take us through where you are with that?
Yes, you know, in terms of where we are on a percentage basis, little bit hard to say a Laurie. But we have as we've said in the past and gradually making incremental investments across various areas, including the hiring of a Director of Enterprise Risk Management, the former CFO of Peoples Federal Bank.
So obviously he's been on board since that acquisition closed in February. We've brought on a capital planning manager to build out our DFAS capabilities and that individual is hired more than a year ago.
We added an individual in our portfolio risk management area to help with the loss modeling for DFAS, as well as for Cecil. We gradually added BSA and AML folks over the years and really those addition in that area will continue to be incremental as our deposit base and loan base grows. So we don't expect that to be a sort of one-time investment, we expect that to continue to expand.
And then we are starting to make investments in things like data and software, less so on the software front, but we have recently subscribed to some movies analytics data, again to help with our DFAS modeling.
So we've made expenditures in a number of different areas that are already embedded in our runway - run rate. But we think we've been able to do pretty effectively is leverage those expenditures in other way.
So for example, our director of enterprise risk management, he is not just working on preparing us for the $10 million threshold, he is overseeing enterprise risk management for the entire bank. He is heavily involved in due diligence on acquisitions.
So - and then similarly the individual that we hired to be our capital planning manager is really taking a lead role in our loan level swap program. And so we are hopeful the expenditures we are leveraging to the fullest extent possible.
And how many people are part of your compliance team total?
Well, total is probably 15. We have a compliance department and then we have five people in each of the individual business units as well.
Okay. And then how many do you have just focused on consumer compliance?
I don't have that number exactly.
Okay. And then just sort of more generally, as you think about the ramp to the $10 billion cross, various banks have thrown out numbers, $6 million, $7 million, $8 million in terms of the cross to get prepared with systems. And I realize it's different in every bank.
How – I mean, would you say that that number is in line with your thinking, and then how far you are or is there a different number? Or can you give us any kind of color?
Yes, I mean, if you are not including Durbin amendment impact…
You are not including Durbin?
Yes. That’s higher than what we anticipate.
Okay. And how far are you under the process in terms of the spend?
Well for DFAS for example we expect to be ready by the end of 2000 - actually really mid-2017 but at the latest by the end of 2017, be ready to have a model that we could submit should we need to.
In terms of the other spends you know, they will continue to be incremental. There will be things like increase FDIC assessment which is no pre-investment there, it just happens when you cross the threshold, forward risk committee is an additional requirement that does not necessarily have any additional expense with it or you know, if it does its pretty minor in the scheme of things.
So I know I didn’t completely answer your question, but $6 million seems like a big number for us. We have some in-house knowledge management capabilities that are going to help us build out the DFAS model without acquiring any sort of expensive software's or without having significant consulting expense. We do think we'll have consulting expense on things like model validation, but it shouldn't approach those sorts of numbers.
Okay. Then the data software IT update that you mentioned you were just starting, when will that be completed?
Well, that actually is been an ongoing effort Laurie for the last decade. We build that business intelligence capabilities that derive all sorts of analytics, including our – one of our customer - customer analytics. It’s a natural extension of processes we started long time ago.
A – Robert Cozzone
We were a little bit unusual 10 years ago getting obsessed about building a data mart, a structure data mart and building analytical tools and hiring people who are able to use it. And so we're a bit ahead of the curve on that.
Okay. Okay, great. And then, just going over to M&A, obviously you have had a fantastic track record on the smaller acquisitions from the standpoint of clean banks, accretive to earnings, accretive to your franchise, mutual to book. I mean, just a home run.
And you have said you are not opposed to a transformational deal, but it was, I guess, less likely if I heard you correctly. What are the circumstances that would make it more likely, and what would be the max size that you would potentially digest as you cross the $10 billion mark?
Yes, there is a lot of hypotheticals in there, which I am not going to sort of go into specific, the hypotheticals I'll just say – that we reiterate that you're absolutely right, we are in a bit of a roll and working with smaller banks and very small - smaller bank - this I would say that are attractively accretive to our earnings potential and our ability to not dilute book is quite noteworthy.
There - the wonderful thing about smaller transactions is you really can take your time and make sure you do it right, not only from a technical perspective which we're getting better and better at, but as I was talking a lot about this morning to my future colleagues at Edgartown the whole culture piece, which we think banking is fundamentally people business and you've got to get the people piece right to make a successful M&A work.
So as banks get as bigger they are tougher, I think our largest to date was Ben Franklin at $1 billion that went very well. I think were very capable of acquiring a bank in a culture [ph] and culture perspective at a $1 billion, I would say probably since then we'll be comfortable with a merger you know, bigger than that from a technical and culture perspective.
I think when it – the waters get really treacherous and from a culture perspective is when you begin to think about MOE territory. I think that's when you begin to make – it’s very difficult, very, very difficult to get to the people side. And I am not talking about senior management, I am talking about people, the people side throughout the organization. And in fact, more importantly throughout the organization than the senor team to get that exactly right. And I would sort of be very, very cautious and we have to be extraordinarily thoughtful about sort of an acquisition that size.
Great. That's great color. Okay, just two other quick things. Rob, do you have the accretion income for this quarter?
A – Robert Cozzone
Yes, it was little less than 400,000 Laurie.
Okay. And then one last thing. Can you help us think about the tax rate? It was a little bit higher this quarter. How do we think about that into 2017?
A – Robert Cozzone
We do have new market tax credit award that we'll be rolling off at the end of this year and we currently have a pending application for new market tax credits. So should that new market tax credit role off and we not get a new award, our tax rate will go up and then obviously our tax rate will go up the more money we make and we anticipate seeing more money next year.
If we do get this new award which we should find out in November, then that will - we never know how much of an award we're going to get and so depending upon how much award we get and how much we think we can deploy in the current year that will determine how much of a benefit we get from that new market tax credit award.
So that would go if we do get an award go towards offsetting to some extent and maybe to a great extent the new market tax credit award that is scheduled to roll off.
Okay. So if we were using something in the neighborhood right now of 33%, that wouldn't be out of the realm?
A – Robert Cozzone
Wouldn't be out of the realm, but I'll provide more guidance in January.
Okay. Perfect. I'll leave it there. Nice work again on Island; love seeing that. Thanks so much, guys.
A – Robert Cozzone
[Operator Instructions] Our next question comes from Collyn Gilbert with KBW. Please go ahead.
Thanks. Good morning, guys.
Just in regard to the Edgartown deal, and then obviously think of Cape Cod, what's your strategy for how you harvest business or customers, kind of the second homeowners in these seasonal markets? I would think it's a hard market to crack. So I'm just curious to know how you guys approach that in building that - those households.
The fortunate thing about Edgartown National is they've been around longer than we have, so they have a lot of established relationships with permanent residence and seasonal residence. And the power of these acquisitions, and sort of the extra juice is not sort of accelerating customer acquisition, but it is simply bringing our additional products set to the market.
So we would expect that there - we don't expect any extraordinary in terms of accelerated customer household growth above and beyond what they've been able to do historically, but what we do expect is able to bring our increased lending capacity, our home equity capability, our attracted consumer technology to the table to expand the existing relationships. That’s where we sort of [indiscernible]
Okay, that's helpful. And that ties in to my second question in just terms of your -- kind of the longer-term outlook and longer-term just meaning maybe end of the -- not really longer-term, but into the beginning of next year. But mortgage banking -- you guys have made a lot of traction there. Obviously it was really strong this quarter. How do you see that business evolving especially now given some of these newer markets as you look out into next year?
Yes, and we said this in the past call we kind of had a broken mortgage model for a number of years, so our performance really prior to this year or maybe late 2015 was a significant deficit relative to our potential and that's because we just didn't have the right processes in place and weren’t executing well. We now feel like we have all that in place and we are executing exceptionally well.
However rates are still low and that is benefiting us from a refinancing perspective, about 40% of a volume in the quarter was still from refinance. So you know as will happen with the rest of the industry our volume will ebb and flow with refinancing activity.
However we feel like we are in a very good position with our kind of core base of originators systems we have in place, the processes we have in place, a leadership we have in place that we can now leverage that model as we expand geographically, as we expand with new branches, and as we acquire additional end market customers.
So we think the business has a nice potential for us, it is not going to be the revenue driver for us in the future, but we think we can keep up the momentum that we currently have.
Okay, that's helpful. Then just a couple housekeeping things. What were the amount of paydowns that you guys saw in the third quarter? Do you have a dollar amount?
A – Robert Cozzone
Yes, significant. If you put it all together kind of across our portfolio, I think it was greater than $600 million.
Okay, that's helpful. Then you mentioned that you postponed an advertising project. I'm just curious as to why or if you see that coming online at some point.
A – Robert Cozzone
Yeah, it was just delayed a couple months, we expect that expenditure to be incurred in the fourth quarter.
Okay. Then it is the drop in occupancy - and, again, if you covered this, Rob, I apologize -- but the drop in occupancy in the linked quarter. I know you guys were redesigning some branches. Is it attributable to that, or was there something else going on there?
A – Robert Cozzone
Yes that’s a piece of that. We also had believe it or not, some snow removalcosts in the second quarter and fortunately we didn't have any in the third quarter. We had some snow in April and that was a larger number than you might of thought, and then just a couple of other, kind of nuance things nothing really to read into that.
But in the fourth quarter we do expect to close another branch and we will have some costs associated with that.
Collyn, I just want to correct something I said, the $600 million was our total closings for the quarter, not total payoffs, payoffs I believe were kind of closer to the $400 million.
Excluding paydowns and obviously.
Oh, and that's what I was curious about was the paydown. Because going into the third quarter, you guys were anticipating, I thought, if I recall, a large C&I paydown.
Well, a number of C&I and CRE, so and then excluding amortization.
Okay. So those are more the unusual items versus just your regular course of paydowns, amortizing loans. Got it. Okay. And then just one final question: was the Edgartown deal a negotiated transaction?
No it was competitive.
In the process.
Got it. Okay. That's all I had. Thanks, guys.
This concludes our question-and-answer session. I would like to turn the conference back over to Christopher Oddleifson for any closing remarks.
Thank you very much everybody, it's a delight to be speaking with you from Martha's Vineyard and we look forward to talking with you in January. Have a good fall.
A – Robert Cozzone
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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