Independent Bank Q4 2007 Earnings Call Transcript

| About: Independent Bank (INDB)

Independent Bank Corp. (NASDAQ:INDB)

F4Q07 Earnings Call

January 18, 2008 10:00 am ET


Dennis K. Sheahan – Chief Financial Officer & Treasurer

Christopher Oddleifson – President & Chief Executive Officer


Damon DelMonte – Keefe, Bruyette & Woods, Inc.


Hello and welcome to the Independent Bank Corporation’s fourth quarter 2007 earnings conference call. All participants will be in a listen only mode. There will be an opportunity for you to ask questions at the end of today’s presentation. (Operator Instructions) Please note this conference is being recorded. Now, I’d like to turn the conference over to Dennis Sheahan.

Dennis K. Sheahan

Good morning everyone and thank you for joining us on the call. This morning’s agenda will include a brief review of our fourth quarter 2007 earnings and guidance for 2008. We’ll have some comments from Chris Oddleifson, our Chief Executive and we’ll end the call with a Q&A period.

Before I review our fourth quarter 2007 performance I will read the cautionary statements. This conference call may contain certain forward-looking statements with respect to the financial conditions, results of operations and business of Independent Bank Corp. Actual results may differ from those contemplated by the statements. Independent Bank Corp. which to caution listeners not to replace any undue reliance on 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.

I’ll now review our fourth quarter 2007 performance. Independent Bank Corp reported GAAP diluted earnings per share of $0.56 and $2.00 per share for the fourth quarter and year ended 2007 respectively, representing an increase of 4% and decrease of 8% respectively from the same periods in the prior year. There are no non-core items in the fourth quarter of 2007. There are a number of non-core items in the fourth quarter of 2006 and both full year periods as detailed in the earnings release. Excluding these one time items, diluted earnings per share on an operating basis were $0.56 and $2.13 for the quarter and year ended December 31, 2007, decreases of 2% and 3% respectively from the same periods in 2006.

Key takeaways from the fourth quarter and full year 2007 performance; continued strong net interest margin. The net interest margins for the fourth quarter of 2007 was 3.94%. Loan growth was strong in the fourth quarter led by commercial lending. We shared with you on our third quarter conference call, the commercial loan pipeline was very strong and that proved to be true with the loan closings experienced in the fourth quarter. Growth was well diversified and occurred across all commercial categories: C&I lending, commercial real estate and commercial construction.

Among the factors contributing to our fourth quarter commercial loan growth were the efforts of both our existing lenders and the new lenders hired in 2006, disruption at competitors, the successful deployment of our most recent new markets tax credit program award as well as, disruption in the capital markets. Some of the growth achieved related to deals that specifically went to the conduit space.

Deposits were down 3% as compared to year end 2006 levels in the prior year, consistent with balance sheet funding needs. We remain focused on controlling the cost of deposits as an important component of maintaining a strong net interest margin. We borrowed in the fourth quarter to take advantage of an opportunity for a modest amount of favorably priced structural funding as a component of managing our interest rate risk.

Core non-interest income growth up 13% year-to-date remained a key highlight driven by growth in our wealth management revenue, as well as the 1031 exchange business which we purchased at the beginning of 2007. With the close of the O’Connell acquisition in November which added $200 million in assets under management. Our investment management group now has a total of $1.3 billion in client assets under management.

Core non-interest expense increased 10% in the fourth quarter and 6% year-to-date driven by investments in growth initiatives such as additional commercial lenders, the addition of the 1031 exchange business, staff additions in our wealth management and mortgage businesses and higher incentive, compensation and commission program accruals. Non-performing assets were $8.3 million at December 31st 07 and represent just 30 basis points total assets. Loan delinquency was 93 basis points at year end 2007 as compared to 72 basis points at both September 30, 07 and December 31, 06. Net charge off performance is higher than last year, yet still very low at an annualized rate of 16 basis points.

The company’s reserved for loan losses was 1.31% of loan at year end 2007. The provision for loan losses increased in the fourth quarter to $1.4 million bringing total provision for 2007 to $3.1 million consistent with a level of net charge offs for the year and loan growth. Our effective tax rate for the quarter fell to 20% due to the strong execution of our new markets tax credit program and the reversal of a tax reserve pursuant to a relevant tax court ruling. Our effective tax rate for the full year was approximately 24%.

And now, earnings guidance for 2008. I will first discuss what we anticipate for Independent Bank Corp and then separately provide our current estimate of the anticipated 2008 earnings impact from our pending acquisition of Slade’s Bank. I will end by providing you with our current combined 2008 earnings estimate. Independent Bank Corp on a standalone basis expects loan growth to continue during 2008. However, due to the general expectation of a slowing economic environment we are moderating our growth expectations. We do however, anticipate that loan growth particularly in the commercial lending area which we expect to increase by about 5% for the year, and to a lesser degree in home equity will out strip reductions in the other loan portfolios such as automobile lending, providing total net loan growth for the year of approximately 3%.

The deposit growth will be challenging in 2008 but, we expect to grow deposits by about 2% while remaining very cautious regarding our cost of funds. We will supplement or replace deposit growth with wholesale funding if it proves to be more attractive. Securities growth will not be a focus for us and we currently expect our securities portfolio to decrease in 2008. Non-interest income will continue to benefit from a focus on our investment management business and is expected to grow by about 12%. We anticipate that non-interest expense will also grow in 2008 by approximately 6%.

From a credit perspective we expect net charge offs to grow, especially in the consumer portfolios to a total of $3.7 million and the provision for loan losses will increase to $4.5 million for the year. Our tax rate is expected to be 26% and the net interest margin should be in a range from 3.9 to 4%.

We are currently considering the sale and lease back of some of our bank owned real estate during 2008 and have retained a broker who has recently begun marketing our properties. We have not included any impact from a sales leas back transaction in our earnings guidance. When we announced the Slade’s Bank acquisition we anticipated the transaction would be $0.01 to $0.02 accretive in 2008 excluding one time charges. We expect to close the Slade’s acquisition on March 1st of 2008 and continue to anticipate that it will be $0.01 to $0.02 accretive in 08 excluding one time charges.

After taking the anticipated accretion from the Slade’s transaction into account, Independent Bank Corp currently estimates that 2008 diluted earnings per share will, on an operating basis, be in the range of $2.12 to $2.16. Chris?

Christopher Oddleifson

Good morning everybody. I’m pleased with our overall performance for the quarter and for the year. I know we’ve maintained a stable net interest margins, we have not had and do not anticipate significant credit issues, we’ve generated a responsible loan growth especially during the fourth quarter. We’ve taken advantage of our opportunities such as the O’Connell Investments acquisitions and the Compass Exchange Advisors’ acquisition at the very beginning of the year and the pending acquisition of Slade’s Bank. Earnings quality improved evidenced by 58% of our company’s loan portfolio is now in the business of commercial lending. Our securities portfolio is now only 18% of earning assets.

Our fee revenue and diversity in growth is improved. Non-interest revenue has grown to 25% of total revenue and this has been driven by improved wealth management revenue and our 1031 exchange business acquisition. The consumer assets under management in our investment management group is, as Dennis mentioned, now about $1.3 billion up significantly since the end of last year.

All of these positive results come from our focus on the essentials of our business. As we’ve discussed before we’ve really been aggressive in refining and retuning our business models for the past few years and we’re in great shape to leverage this platform. We’ve pushed beyond the traditional community banking model and not only do we have a terrific retail franchise but we’re working to make the most of the growth opportunities in commercial banking and wealth management. Our customers tell us that they [inaudible] satisfied and we’re fortunate that parts of Massachusetts in which we operate had growth rates that outpaced the store rates in other parts of the state.

Our results, I think, are even more impressive when you consider the extremely challenging economic environment in which we’re operating. I don’t think I have to remind everybody that we’ve had a challenging yield curve. We’ve had a lot of intense loan and deposit pricing competition. I’d say housing, amid housing market pressures probably understands I think significant of that and I think credit markets are in a bit of a disarray. And, in this tough environment of course, the easiest thing to be is to hunker down and sit back and hopefully wait for the weather to improve but that’s not the path we chose. We decided to take a hard look at where our capital and resources were put to use and we also resolved not to do anything stupid to produce nominal earnings as we worked through these difficult times.

We’ve taken some specific actions as part of a multi faceted game plan designed to seize on the growth opportunities, improve our balance sheet and manage discretionary resources intelligently such as reducing the lower hurdle assets in our securities portfolio, our balance sheet residential mortgage and auto. We’re growing in competitive advantage of loan business, we’re growing fee income activities, as I say especially in wealth management, improving our funding mix, managing core expenses while also funding growth initiatives, adopting an opportunistic and very selective approach to acquisitions. As you know we’ve turned excess capital [inaudible] shareholders our last couple of years.

We are extending our existing businesses by way of key hires and very selective new branch locations. We’ve also completed a number of technology driven improvements in efficiency and effectiveness such as loan services consolidation, computer support outsourcing, technology organization streamling and a number of contract renegotiations that work out favorably for us and the improvement in our information infrastructure. We’ve also in 07 concluded our branding work and implemented our new tagline, “where each relationship matters”. And, we’re also investing in our employees in a variety of ways to expand our capacity to great value.

One of the results when you add all this up is that we have conscientiously sacrificed near term earnings and this is not an easy thing to do, of course. Our focus however, has been and continues to be to add long term value by better positioning us to realize opportunities. More specifically with respect to our acquisition activity in 07, the Compass Exchange Advisors and the O’Connell Investment Service teams are fully onboard and it’s working out very, very well. We’re extraordinarily excited about the pending Slade’s Bank acquisition. The Slade’s franchise is a hand-in-glove set and it really is truly a great cultural compatibility between our organizations. Integration is proceeding very smoothly and on target for a March 1st closing. And integration of these acquisitions complements our product offerings, our geographical reach and our earnings.

I’d like to spend a little bit of time now talking a little bit more than usual about credit given that is a deep topic that most everybody’s focusing on. While our non-performing assets grew from $7.2 million at the end of 06 to $8.3 in 07, a modest growth and a few points are worth noting. A non-performing loan to gross loans stand at a modest 37 basis points. Our allowance for loan lost for total loans stands about 431 basis points. Our loan loss coverage ration is about 370%. Overall delinquency stands at 93%. And, we believe all these measures on the face of them are very strong.

While there may be some – I’m sure there credit softening in the future, the current status of our loan portfolios is good. We believe our commercial portfolios are in good shape. We just had our first annual net charge off that are positive in eight years or so. Our delinquency is down. I really think it’s worth noting that we have no delinquency in our construction portfolio and we have not had any construction defaults since 2004. Credit quality appears to be stable. We’re also very comfortable with the asset quality of our indirect auto portfolio. With an average price of 703 and that is based on a recent restoring of our entire portfolio our portfolio on average is strong and our losses in this portfolio have been tracking very well with our forecast over the last several years. We do recognize however, the growing stress in the consumer from issues such as increased energy cost and we’re going to continue to watch this portfolio very, very closely.

Our residential portfolio has an average price of 733 and a wetted average LTV of 64%. I will say that we have identified, we do have a number of adjustable rate mortgage loans and a number of those will reset in 08 and we’ve done the analysis to identify the ones that are in a higher risk category. We will be monitoring them very carefully and handling them on a case-by-case basis if repayment at the higher rate becomes an issue. Regarding our home equity portfolio as well as our line and loan portfolios we have an average FICO of about 750 and a weighted average CLTV of just over 50%. We’re also monitoring these loans very, very carefully.

While our loan portfolio metrics are strong overall economic indicators singles the potentials for troubles ahead. Nationwide and local employment rates – nationwide unemployment has raised up and our Massachusetts rate is actually down somewhat. Bankruptcies are edging up somewhat. Core inflation seems to be holding steady, does as we know give the feds some room to move as [inaudible] of the future is anticipated to move. While we only foresee some foreclosure activity in our portfolio overall mortgage foreclosures in our market were way up mostly by national originators of home loans.

Housing weakness has definitely accelerated in the last quarter. Home sales data suggests that the median quarterly sales price in Massachusetts, or more specifically our primary county have fallen nearly 10% from the peak in 2005. Our latest data shows that the Massachusetts economy is actually still growing and we’ll be watching things very closely, as I would imagine you’d expect. In all of our loan portfolios there’s always a possibility that conditions will change that loan which are not an issue, now suddenly become problematic. The best thing we can do is to monitor each portfolio very, very careful and that’s exactly what we’re doing.

These are uncertain times and we’re proceeding cautiously. Clearly, our goal is to grow net income over time and we have shown our ability to do this over the long run. Our modest expectations for 08 are a reflection of the current overall environments and our prudent approach for focus on responsible growth [inaudible], adding select key personnel who can generate more value, opening branches in attractive markets, [inaudible] our existing branches and engaging in acquisitions as we can, for example.

That concludes my comments this morning.


Operator, this concludes the formal part of the presentation. We’d now like to open the call for questions.

Question-and-Answer Session


(Operator Instructions) Our first question is from Damon DelMonte with KBW.

Damon DelMonte – Keefe, Bruyette & Woods, Inc.

I was wondering if you could talk a little bit about your commercial construction portfolio? You’ve had sustainable growth in that portfolio and I was just wondering if you could give a little color on some of the sizes of projects that these loans are for? And, kind of what projects they are for? Are they for mix use? Property? Medical buildings? Office? That kind of thing.

Christopher Oddleifson

Sure. It’s actually pretty well diversified Damon. Our construction portfolio – this construction growth for us in the quarter was quite good because our construction portfolio really has been down from 05 to 06 levels as construction projects matured so we were happy to see this growth come in. Some of it is associated with our new market tax credit program. You mentioned a medical building, one of the larger spurts of growth in the fourth quarter was a medical building which is part of our new market tax credit program. Some of it is also residential development, office buildings; the growth in the fourth quarter a good chunk of it was in the office building category. To give you a break down of the construction portfolio the balance at December 31st was $133 million. Of that about $88 million is in the residential construction category, the remainder in office buildings, medical buildings, that sort of thing.

Damon DelMonte – Keefe, Bruyette & Woods, Inc.

Also with respect to the home equity, are all those loans in market? Meaning your greater area of your footprint in Massachusetts? Or, do you guys have any non New England exposure

Christopher Oddleifson

No, we do not.

Damon DelMonte – Keefe, Bruyette & Woods, Inc.

Do you know what percentage of those loans you guys have the primary loan on?

Christopher Oddleifson

The primary meaning the first? Or, the second?

Damon DelMonte – Keefe, Bruyette & Woods, Inc.

The first.

Christopher Oddleifson

Not off hand.

Dennis K. Sheahan

We can get that for you.

Damon DelMonte – Keefe, Bruyette & Woods, Inc.

What’s the highest combined loan-to-value that you guys will write to? I know you said what the average is.

Christopher Oddleifson

The highest at this point is 80%. However, we have also restored and have done other re-valued the real estate through AVMs for the entire home equity portfolio. So, we do have loans in there that are in excess of 90%, are up to 90/10 and sometimes in excess of 90%. The ones that are in excess of 90% are mostly due to housing depreciation and so we’re watching that very carefully.

Damon DelMonte – Keefe, Bruyette & Woods, Inc.

One final question, this is more of a detail question for you Dennis. In the non-interest expense portion of the income statement, other non-interest expenses was $5.2 million this quarter. Anything in there that should be excluded for a run rate going forward?

Dennis K. Sheahan

Yeah, we had a little bit of an up tick in consulting expenses in the quarter that we wouldn’t expect to continue. We also had a $60,000 loss on the sale of one of our branch buildings. So, there were some modest expenses that won’t continue going forward. But, Damon as I mentioned in my comments we expect overall expenses to grow by 6% in 2008. So, if you use that across the categories, particularly salaries and benefits you should be okay.


(Operator Instructions) Sir, it appears that there are no further questions at this time.

Christopher Oddleifson

Thanks very much.

Dennis K. Sheahan

Thank you everybody for joining us on the call. I look forward to speaking to you when we finish our first quarter earnings. Thank you very much.

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