Independent Bank Corp (Massachusetts)
NASDAQ:INDB
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Independent Bank Corp (Massachusetts)
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Good day and welcome to the Independent Bank Corp’s First Quarter 2018 Earnings Call and Webcast. All participants will be in a listen-only mode. [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 also 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.
Thank you, and good morning, everyone and thank you for joining us today. As always, I’m accompanied by Rob Cozzone, our Chief Financial Officer and Head of Consumer & Business Banking. We kicked off 2018 with record quarterly earnings of $27.6 million or $1 per share in the first quarter. Rob will walk you through our results in a moment, but the highlights include very healthy returns with an ROA of 1.4% and an ROE of 11.7%; a strong increase in our net interest margin; further growth in core deposits that remain over 90% of total deposits; continued pristine credit quality; ongoing growth in assets under management despite first quarter market volatility; and tangible book value per share continuing its upward trajectory, which now sits 9% above its level of a year ago.
I’d like to note that our earnings growth within the first quarter of each year is typically subdued due to a combination of factors such as seasonality of deposit related in transactional fees; winter-related costs and snow removal, and we had a great deal of that this year; payroll taxes kicking back in; and fewer days in the quarter.
As such, in our opinion, linked quarter comparisons in this case aren’t as meaningful a parameter of growth as prior year ones. Compared to last year’s first quarter, our total revenues grew nearly 12% and pretax income, excluding M&A charges, was up 13.8%. With our long-term track record of solid performance, we are confident in our outlook for the rest of the year and beyond.
Regarding the minimal loan growth in the first quarter, some of this is attributable to our own need to rebuild the commercial pipeline after robust activity in the fourth quarter. And we’re also beginning to see a further ratcheting up of competitive loan pricing. The good news is that we’re still very much in a deal flow, and we have walked away in a number of instances where pricing became just too low. We simply won’t chase below quarter rate deals for the sake of short-term growth and favorable balance sheet optics.
I do wish to reiterate that it’s still too early to ring alarm bells and to decide whether this is a new state of affairs in a commercial lending. We do remain optimistic that loan growth will resume in subsequent quarters. We also have confidence in the other levers of growth within the company. Beyond all that, we’re working hard in multiple fronts to advance our franchise and plant the seeds for continued long-term growth.
As stated last quarter, we’ll be redeploying some of the savings from the lower effective tax rate in 2018 to accelerate or undertake various growth initiatives this year. These include continued reconfiguration of our branch network across the range of opening, closings and modernizations. We recently opened a new branch in Newton and have on plan late this year in downtown Boston.
New product introductions include an expanded credit card offering, implementation of process improvements to accelerate speed to market in our business lending operation, customer experience improvements in our home equity business, and continued investment in technology to keep pace with the rapidly changing customer preferences in the digital space.
Overall macroeconomic indicators indicate – continued to portray a healthy economy. Nationally, real gross domestic product grew at a rate of 2.9% in the fourth quarter of 2017, while unemployment remains at 4.1%. Massachusetts is in its ninth year of economic expansion, with relatively consistent economic growth as well as employment.
Real GDP for the state grew at 3.3% in the fourth quarter, slightly quicker than the national rate. The state’s economic growth is expected to continue at a moderate pace in the first half of 2018. The labor [ph] market for Massachusetts continues to improve with the unemployment rate reaching 3.5%, and it’s lower in the Boston area.
In conclusion, I want to touch upon our engagement cycle, which I described in my recently published annual shareholder letter. We believe creating outstanding work environment leads to highly engaged colleagues, which is a must to have engaged customers. And engaged customers leads to a high-performing company, which allows us to fund investments to build an even better company. This is not rocket science, but requires our relentless discipline and commitment, which has been the core of our strategy for quite some time.
We also intend on rewarding our many loyal shareholders with healthy returns. This is readily evidenced by the sizable 19% increase in our common dividend recently approved by our board. This is on top of last year’s 10% increase. You see another sign of confidence in our outlook and our ability to deliver over the long term.
Thank you. Rob?
Thank you, Chris, and good morning. I’ll now cover the quarter’s results in more detail. Net income of $27.6 million and earnings per share of $1 in the first quarter of 2018 were both records for the company and were 25% higher than the prior quarter’s GAAP results. On an operating basis, net income and earnings per share increased 12.8% and 12.4%, respectively. The primary drivers of earnings improvement were net interest margin expansion and a lower tax rate.
As Chris described, strong earnings improvement also resulted in enhanced profitability ratios. Return on assets for the quarter was 1.39%, and return on tangible common equity was 15.69%. Also, despite a rate-driven decline in evaluation of our available-for-sale portfolio and its corresponding impact on other comprehensive income, tangible book value per share increased $0.42 to $26.02 as of March 31.
As expected, a modest year-end commercial loan pipeline, which had declined to approximately $65 million from $116 million in the previous quarter, resulted in minimal Q1 loan growth. Within commercial, C&I growth of 6.6% annualized was offset by a decline in commercial real estate. And within consumer, residential grew 3.7% as a result of demand for jumbo product, while home equity remained flat. All loan pipelines were stronger at the end of the first quarter when compared to prior year-end, and loan growth should resume in the second quarter.
However, as Chris noted, the competitive environment seems to have intensified since year-end and certainly bears watching. Seasonal first quarter deposit fluctuations resulted in muted overall deposit growth, but a favorable mix of deposits was maintained, with the demand component comprising nearly a third of the total.
Deposit growth should also accelerate in the second quarter as our seasonal markets resume activity. The cost of deposits, as anticipated, was up another 2 basis points during the quarter to a still very low 24 basis points. Although we are not immune to upward pressure on deposit pricing, the combination of long-term loyal customers and the true operating nature of many of our accounts should keep us in good stead as rates continue to rise. With that said, we expect the cost of deposits to increase another 2 to 3 basis points in the second quarter.
The combination of low deposit betas, liquidity deployment and higher loan yields resulted in 13 basis points of net interest margin expansion in the quarter. With the March Fed fund increase still to be fully reflected, our prior full year net interest margin guidance will likely prove too conservative. Assuming no additional rate increases, we now expect 15 to 20 basis points of net interest margin expansion this year versus the 3.6% in the full year 2017.
Since the fourth quarter of 2016, when the tightening cycle began in earnest, our cost of deposits has increased 7 basis points and our net interest margin has expanded by 41 basis points. Total noninterest income declined approximately $2 million versus the fourth quarter as most categories tend to experience a seasonal decline. Virtually all fee income line items, with the exception of deposit account fees, should experience growth in the second quarter.
Interchange and ATM fees and mortgage banking income will benefit from typical spring activity. Loan-level derivative income should benefit from higher commercial closing volumes, and investment management fees will benefit from tax preparation fees and growth in assets under management. Following a year of record new business within the investment management group, we continue to be encouraged by the amount of activity we are seeing.
Noninterest expense, which increased 3.9% versus the prior quarter, tends to be higher in the first quarter due to payroll taxes, medical insurance and snow removal expense. This year’s first quarter was also impacted by the closure of a branch, which will result in future cost savings; a higher provision for unfunded loan commitments due to the refreshment of the pipeline; and new accounting for the unrealized gains and losses on equity securities.
Noninterest expense is expected to be flat to down in future quarters, and the efficiency ratio should decline materially for the remainder of the year. Asset quality metrics improved again in the quarter, with only $281,000 of net charge-offs or 2 basis points of loans annualized and a lowering of nonperforming assets to 0.59%.
Before I wrap up, let me just re-summarize our expectations for the remainder of the year. Loan-to-deposit growth should accelerate in the second quarter, with full year growth expected to be in the low single-digit range.
Assuming no further rate increases, the full year net interest margin should be 15 to 20 basis points higher than 2017. Almost all noninterest income categories should experience an increase in the second quarter, and full year noninterest income is expected to increase at a low to mid-single-digit rate.
The efficiency ratio should improve materially for the remainder of the year, and full year noninterest expense is expected to increase at a low to mid-single-digit rate, including the impact of investments and the important initiatives, Chris highlighted. Regarding credit quality, we certainly don’t foresee any near-term pressure, but a gradual normalization of credit within the industry is inevitable.
And then finally, as described in the press release, when excluding discrete items, the effective tax rate for the quarter was 23.3%. The tax rate for the remainder of the year should approximate that level.
That concludes my comments.
Thank you, Rob. Rochelle, we’re ready to take questions.
[Operator Instructions] Our first question comes from Mark Fitzgibbon with Sandler O’Neill & Partners.
Hey guys, Happy Friday.
Thank you.
Rob, I wonder if you could break out for us that $1.2 million of tax benefits this quarter. How much of that was tied to stock compensation? And how much of it was other stuff?
Virtually, all of it is tied to stock compensation. We had a high number of options exercised in the quarter and a low – and we haven’t issued our options to executives in a long period of time, so these were options that folks have had for quite a long period.
And then secondly, it looked like you grew the securities portfolio by like $50 million. What was the kind of thought process on that? And what kind of securities did you purchase?
Well, certainly the steepness for the increase in the middle part of the yield curve mark has provided us an opportunity to deploy some liquidity. And also our asset sensitivity positions us well to place some assets out on the yield curve a bit. So we decided to grow the book and are purchasing agency securities, primarily some dust [ph] bonds, some mortgage-backed securities, some SBA pools, a bit longer in duration, but getting average yields north of 3%.
Okay. I know you’d mentioned, Chris, I think, in your comments that the pipelines have built. Could you share with us how large those are now? And also from a competitive standpoint, you had talked about the environment getting tougher. Is that a function of bigger banks? Is it a function of new entrants into the market or local community banks that are really pressuring pricing?
I’ll answer the latter first and Rob will talk about the former. So the pressures coming are mostly from sort of midsize to smaller banks. The bigger banks tend to be a little more rational. And the – it is, I think a function of people really looking for earnings growth. And in some cases, in Massachusetts, we have a lot of mutuals, so they tend to have capital to deploy and are looking to grow at this and are, quite frankly, not as disciplined as we think we ought to be.
The commercial pipeline is up to about $125 million mark from about $65 million at the start of the year.
Okay. And then also I was wondering – you guys, your capital ratios have built a little bit. Can you give us a sense if M&A activity is picking up or not? Are you guys still focused sort of on that Eastern Mass and Southern New Hampshire markets or would you sort of broaden your search to some other areas?
Yeah. This is an interesting topic. We talked about this. We believe our strength over the years is in expanding in this in a very sort of tight, concentric semi-circle fashion. And when we take a look at the economic activity in New England, if you start in Westchester and do a sort of semi-circle arc to the oceans down through Rhode Island and through New Hampshire. we think that’s where all the growth is going to come from over the next number of years. So we would prefer to expand in a fashion that we have – in acquiring a fashion as we have in the past.
Now having said that, I think if an opportunity would come up, we would look at it and sort of question our assumptions and review whether our current thinking is appropriate. But we’ve had a lot of success on that approach and a deviation of that would require a great deal of sort of thoughtfulness.
And do you think M&A activity is likely to pick up, not necessarily with you but just in general in your markets?
Well, I can make a prediction, for sure, that M&A activity will continue over time, and we’re going to see the secular decline of banks over the next 20 years. And so that would suggest to me that there will be deals in our area overtime. Since you know we don’t have a lot back in – 10 years ago, we had a lot to actually predict. Right now, it’s very sort of almost a random event. I mean, it’s sort of depends on individual circumstances. Now we’re considered a strong buyer, both in terms of our currency and we have a reputation of executing deals well and communicating well. So should a board raised a hand or CEO, I think we have at least an opportunity to have a conversation.
Thank you.
Our next question comes from Laura Hunsicker with Compass Point.
Chris and Rob, good morning.
Good morning. Hi, Laura.
Rob, I wonder if you could help me with expenses, so specifically and I realized things were elevated in the first quarter, but can you break out for us what is the dollar amount delta between first and what we could see in second with respect to payroll drop in taxes, also the dollar amount of snow removal? And then help us think about the branch closures, and then the de novo openings you’ve talked about. Just sort of those three components within noninterest expense, just in terms of how we think about that linked quarter first into second?
Maybe, I’ll just stop with kind of top of the house, and our expectation is that overall large expense will decline modestly into the second quarter, because there are some things that will offset those onetime items in the first quarter, such as higher advertising spend, merit increases. We get essentially a full quarter impact of merit increases that happened in late March and early April. And then expenses associated with new business activities and revenue activities like mortgage origination. Those expenses will go up as mortgage production goes up. Expenses associated with debit card activity, so more modest line items, but in the aggregate, offset some of the decline from the items we described in the press release. In terms of explicit items in the quarter, the branch closure totaled about $300,000 between leasehold improvement write-offs and lease termination. Snow removal was a little bit north of $700,000.
The unrealized gain loss and the equity securities portfolio was almost $500,000 that is unpredictable. It’s going to depend on what happens with the value of those equity securities and certainly could rebound or depreciate further. And then payroll taxes, we’d expect that to decline by about $1 million between Q1 and Q2. So I think overall though, Laura, the message is that we’ll see a slight decline into the second quarter and then additional – likely additional reductions in Q3 and Q4.
Great, that’s great color. And just one last thing is as we think about the broader tax windfall reinvestment expense, which you had quantified, would be around $2 million or so annually. Where are we in terms of seeing that baked into the process?
Pretty modest so far. As Chris mentioned, we opened a new Newton branch kind of mid-first quarter here, and so we have start of the run rate expense associated with that. But our other initiatives aren’t really going to get going until the middle part of the year, so it’ d be more weighted towards the back end of the year.
Okay, that’s helpful. And then last question, how much accretion income was in your NII this quarter?
Little bit lower this quarter, just north of $200,000.
$200,000, okay. And then do you actually have the fourth quarter? I’m missing that.
Actually, I think it peaked in the fourth quarter, so typically, we’ve been averaging $300,000 to $350,000, I think the fourth quarter was close to $500,000, and then this quarter was a little north of $200,000.
Okay, great. Thank you very much.
You’re welcome.
Our next question comes from Matthew Breese with Piper Jaffray.
Good morning guys.
Good morning.
Good morning.
Chris, I was just hoping to get some color around any changes you might be seeing in terms of borrower behavior. With tax reform, there’s a lot of hope that the benefits would show up and increased loan growth and economic activity, just wanted your thoughts on whether or not that’s actually occurring.
Hi, Matt, that’s a good question. Because we would have anticipated a little more enthusiasm expressed in the higher loan demand as a result of the tax reduction. I mean the business optimism is actually pretty high in our area, and it was – and going higher. And it was pretty high prior to tax reform. So we thought that the icing on the cake of the tax reform and things would really kick in. Well, what we’re seeing is not as much as we expected and what encompasses is that potentially people – we were seeing a lot of good cash flow and companies and they are with slightly rising rates, they’re paying a little more attention to their interest rate cost, so maybe managing their cash position a little tighter. And therefore that is mitigating some of the loan demand we would have anticipated. We don’t know for sure, but that’s sort of our – one of our hypotheses. Rob, would you?
Yeah. We are seeing increased activity on the small lending in our – what we refer to as our business banking portfolio. And we have a number of business banking officers out on the street, and they are seeing increased activity at the very small end of things. But that has not translated to the upper end of the market as of yet.
Interesting, okay. And then another bigger picture one, Chris, you mentioned the strength of the Massachusetts economy, Boston is now in its ninth year of economic expansion. Just wanted your thoughts on how much longer you think the cycle has and what are some of the indicators you’re watching that are flashing green, red, yellow?
Well, bankers get nervous when things aren’t going so well, and they get nervous when they’re going well. So we look around at all that’s expanding, and you say, how long can this fast? Well, we’re not seeing any sort of clouds on the horizon. I will point out that Massachusetts is a very attractive place for companies to move because of all the intellectual capital produced by the universities. One of the issues that I’m very close to have worked in is the issue of housing availability for a lot of the folks who want to move into our area. That is – and the governor and the mayor of Boston have put forth significant initiatives recently. And it’s the Mayor who’ve put some in place a couple of years ago so we’re making progress in that arena. That is going to be gating issue if we don’t build housing for just to support those people who are producing the economic growth.
Others in Boston will point to a need for transportation improvements, general infrastructure improvements. It’s a whole ecosystem. So I – but I’ll tell you the reality always sort of does better than sort of what I think some of those limiting factors may – remember, we are seeing more companies moving into the square area, the Cambridge, into Somerville. And we’re seeing a lot of building and a lot of employment and a lot of positive employment announcements. So I don’t have a crystal ball for sure, but things look good. But we need to pay attention to some of the things that could gate our growth. I guess that’s the short answer.
Okay. And then a couple of different ones. You noted elevated competition for loans. Are you seeing the competition more on like degradation of terms and structure? Or are you seeing spread compression, can you just give us an idea to what extent?
Yeah. But primarily, spread compression, matt, especially most recently just in the first quarter here, and to the tune of 50 basis points, I don’t know if that’s banks building in the benefit of tax reform and the impact that has on their return of capital on a deal. But we’ve seen some pricing get even tighter than that. There is, on the fringes, a little bit of loosening of terms as well, especially when it comes to the amount of leverage allowed in the deal, so that certainly concerns us, that I would say that’s less common, but we see start to see that around our fringes. It’s really been pricing as of late that has gotten especially aggressive.
Got it, okay. And then the last one’s really around the margin. Obviously, this year’s shaping up to be a bit better than initial expectations. And just curious, if we get the two more Fed hikes this year and the yield curve is a bit flatter, but we continue on this tightening path, do you think we could see again double-digit kind of margin expansion in 2019 kind of continue?
Yeah. That is a tough one. We’re definitely seeing more pressure on deposits. We are very fortunate in the percentage of our deposits that are in demand categories, our interest-bearing categories. And frankly, I expected that, at this point in the cycle that we would see more of those funds, either transition out of the bank or transition into some of the higher-cost categories because it seems as though folks are holding excess funds and checking accounts. But it hasn’t really happened to date, so I’m encouraged by that.
However, I do believe that with continued increases in rates, that we will have kind of the speedboat effect and acceleration of increases on the deposit side. Not dramatic acceleration, I don’t think, but some acceleration. We’ve gone through a couple of quarters here with 2 basis points of increase in deposit cost, expecting 2 to 3 basis points as we head into the second quarter. So a little bit more pressure. And I would kind of expect that kind of continued pace if rates continue to increase.
I just said, thank you. That’s all I have. I appreciate it.
Yeah. Thank you.
[Operator Instructions] The next question comes from Collyn Gilbert with KBW.
Thanks. Good morning guys. You guys have given some great color, but just a couple more questions, I guess, Rob directed at you. Mark had asked about kind of the securities activity this quarter. But just thinking about it more broadly, I guess now it’s kind of been – you’ve seen the last two quarters where you’ve kind of absorbed some of the cash positions and been building securities. How do you sort of see that trending through the remainder of the year? Is there a targeted securities book that you want to maintain, either relative to assets or just in total dollars size? That’s part one of my question.
Yeah. We’re kind of comfortable at the 11, 12, 13 range. And we’ve deployed a lot of liquidity as you’ve referenced, Collyn, in the first quarter here. So we certainly won’t see that level of growth for the remainder of the year. But we’ll probably have another, call it, 5%, 6% growth in the portfolio for the remainder of the year, but not much more than that.
Okay, okay. That’s helpful. And then just on the fee side, you gave good color as to what your outlook is, but just wanting a little bit more on the composition of that and you’d mentioned derivative income picking back up, but I guess kind of broadly how you’re thinking about mortgage banking? I know it’s been an initiative of your all and you’re seeing demand flow through the remainder of the year. And then also what your outlook would be beyond just the second quarter, but again, a little bit longer term on the wealth side.
Yeah. I think actually, on most fee income categories we’re looking at last year’s trends is instructive. One thing with mortgage, we did booked more in the portfolio in the first quarter than we anticipated. We hit our overall production targets and actually exceeded them a little bit. But there was more demand for jumbo product and most of that, we’re putting in portfolio. So I would expect to see trends fairly consistent with what we saw last year when it comes to the majority of our fee income line items.
Okay, okay. That’s helpful. And then justly, what are the rates you guys are offering right now on your kind of new CDs? Or if you’re running any CD promotions, where is the pricing on that?
Yes. Well, we do have some promotions out there and they kind of range right now from call it, one in a quarter to one in three quarters. But the competition is ramping up quickly, there’s plenty of folks out there with a 2% handle on fairly short-term CDs.
Okay. And if you – I know you indicated 2 bps to 3 bps of increase in deposit cost next quarter. Is that – what does that kind of assume in the mix or where you’ll see the growth? Is that just coming through on your sort of basic kind of money market accounts? Or is that your – spending you’re going to need to ratchet up the pricing on the CD side?
Yeah. We anticipate both having to be ratcheted up.
Okay. That’s all I have.
That’s not just interest-bearing, Collyn, keep that in mind. That is total deposit cost, 2 basis points to 3 basis points. So the cost of interest-bearing will be more than that.
Yeah. Okay, okay. That’s helpful. Thanks very much.
Thanks, Collyn.
Thanks, Collyn.
This concludes our question-and-answer session. I would like to turn the conference back over to Chris Oddleifson.
Thank you, Rochelle. Thank you everybody, for joining us today. We look forward to talking to you in three months as we report out our second quarter. Happy weekend. Bye.
The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.