Independent Bank Corp (Massachusetts)
NASDAQ:INDB
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Independent Bank Corp (Massachusetts)
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Good morning. Before proceeding, let me mention that this call may contain forward-looking statements with respect to the financial condition, results of operations and business of Independent Bank Corp. Actual results may be different. Factors that may cause actual results to differ include those identified in our annual report on Form 10-K and our earnings press release. Independent Bank Corp. cautions you against unduly relying upon any forward-looking statements and disclaims any intent to update publicly any forward-looking statements, whether in response to new information, future events or otherwise.
Please note that during this call, we will also discuss certain non-GAAP financial measures as we review Independent Bank Corp's performance. These non-GAAP financial measures should not be considered replacements for and should be read together with GAAP results. Please refer to the Investor Relations section of our website to obtain a copy of our earnings press release, which contains reconciliations of these non-GAAP measures to the most directly comparable GAAP measures and additional information regarding our non-GAAP measures. 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, Stephen, and good morning, everyone. And thank you for joining us today. With me as always is Rob Cozzone, our Chief Financial Officer and Head of Consumer and Business Banking. Our disciplined long-term approach produced another earnings record during the second quarter. Excluding M&A-related charges, operating net income totaled $31.4 million or $1.14 per share, which is significantly above all prior periods. The stars did align in our favor this quarter to generate superior results. Virtually every key financial measure moved in a favorable direction.
Rob will take you through the details in a few minutes, but the highlights included: resumption of healthy loan growth, especially in the commercial side; a significant improvement in the net interest margin as we continue to capitalize on our long-held asset-sensitive position; continued strong growth in core deposits that remained at over 90% of total deposits; every noninterest income category was up in the second quarter, led by our investment management business, which continues to drive across both our existing and newer markets; ongoing stellar credit quality with another quarter of lower nonperformance and minimal net charge-offs; improved operating efficiency along with lower noninterest expense this quarter; and the rising capital levels with tangible book value per share up 3% in the second quarter. All of this resulted in the operating ROA of 1.5% and an ROE of 13%. Everything worked in our favor this quarter, and while we know that the stars won't always align so optimally, our business model has a track record of solid performance and sustained growth over many years amid varying scenarios.
Coming back to our commercial loan growth this quarter. We're encouraged by the resumption of strong growth, some of which is attributable to our rebuilding of pipelines after year-end. There are some anecdotal signs of increased demand in investment spending, especially in the C&I and small business sectors, yet we really haven't seen any letup in the heated competitive environment we've alluded to in prior calls. The good news continues to be that we remain very much in the deal flow and employed the benefit from improving conditions.
Turning to other points of progress. The major development this quarter was our agreement to acquire MNB Bancorp, parent of Milford National Bank, with approximately $300 million in deposits and 3 branches in Worcester County. This is another in a series of attractive acquisitions in desired markets within our footprint. The acquisition strengthens our Worcester County presence, where we already have many customer relationships. Milford National is a profitable, well-managed institution, with deep roots in the local community dating back to 1849 and has an attractive low-cost deposit base, with many long-term relationships. Its approximately $130 million in assets under management provides an excellent fit with our own investment management unit. The execution risk is considered very low, given its small size and our proven integration skills, and it is expected to close in the fourth quarter and be accretive to 2019 earnings. We're also hard at work at our branch configuration efforts as we continually seek the right balance of traditional and modern style branches that best fit with each local market. Our new branch in Newton is off to a great start, and we're on target to open a branch in Boston's downtown financial district later this year.
Beyond that, we continue to move forward on other initiatives I've talked about before, that are aimed at improving areas such as speed-to-market; the overall customer experience; digital access; new product offerings; and cybersecurity. One such example that is already paying dividends is an initiative to expand our private banking efforts within our wealth management group that has led to an increase in secured lending balances.
On the economic front, the overall national macroeconomic indicators continue to portray a healthy economy despite the ongoing international trade tensions. Retail sales are posting strong growth numbers, acting as a stimulus for GDP. The national labor market is in good shape, with unemployment of 4%. Locally, the Massachusetts economy is expected to continue its 9-year expansions according to the June publication of MassBenchmarks. And lastly, the employment levels for Massachusetts continue to outperform the national market, with unemployment at 3.8% at the end of May.
In conclusion, I can confidently say that Rockland Trust is in great shape. We have an energized, motivated team that competes hard each and every day to earn the business and trust of our customers. None of our success would be possible without our valued colleagues, who I cannot thank enough.
That's it for me. Now Rob?
Thank you, Chris, and good morning. As Chris just described, things came together especially well for us in the second quarter. Net income of $31.1 million was 13% higher than the linked quarter and 51% higher than the same quarter last year. On an operating basis, net income and diluted earnings per share increased 14% quarter-over-quarter and approximately 40% year-over-year. The primary driver of earnings improvement for the quarter was an 8% increase in revenue as the net interest margin expanded nicely again, and all fee income categories resumed growth, coupled with contained expense levels.
Strong earnings results translated into enhanced profitability. On an operating basis, second quarter return on assets, return on equity and return on tangible common equity improved to 1.53%, 12.98% and 17.24%, respectively. As anticipated, with healthy loan pipelines at the end of the first quarter, loan growth resumed in the second quarter. Total loans increased 1.8%, with very strong activity within C&I and small business, which were up 8% and 10%, respectively. Also, ongoing demand for jumbo residential financing contributed to a 2% increase in total consumer real estate.
Solid pipelines at the end of the second quarter bode well for the third quarter closing activity, but a seasonal decline in C&I utilization will likely temper overall growth. As Chris stated, we are closely assessing recent signs of progress and customer activity for sustainability. Deposit growth accelerated in the second quarter as our seasonal markets resumed activity. Also, as described in the press release, a single customer inflow benefited growth by almost 1.5%. However, even when excluding that inflow, core deposit growth was impressive at almost 2.7% for the quarter or 10% annualized, with low-beta categories leading the way. The cost of deposits was up a modest 3 basis points during the quarter to a still very low 27 basis points. However, with June Fed funds increase, incremental deposit pricing pressure is likely, we expect the cost of deposits to increase another 4 to 5 basis points in the third quarter.
Continued low deposit betas and higher loan yields resulted in 12 basis points of net interest margin expansion in the quarter. Although loan yields were enhanced somewhat by loan payoffs, the June Fed funds increase should drive further net interest margin expansion in the third quarter, as we continue to capitalize on our balance sheet positioning. As a result, we now expect 25 to 30 basis points of net interest margin expansion this year versus the 3.6% in the full year 2017.
All fee income categories enjoyed an increase in the second quarter, with many benefiting from seasonal activity, such as springtime mortgage volumes and tax preparation services. Although we don't anticipate meaningful increases to fee income in the third quarter, healthy pipelines in both mortgage and wealth management should help offset typical declines in those categories. As a result, total fee income should be flat to slightly higher in the third quarter. As expected, noninterest expense, excluding merger and acquisition expense, was down $1.2 million versus the first quarter as decreases in snow removal and payroll taxes were only partially offset by increases in consulting, legal and directors' fees.
With strong revenue growth and good cost control, the efficiency ratio for the quarter declined to 55%. Excluding future merger acquisition expenses, the efficiency ratio is likely to decline further during the remainder of the year despite continued investment in important initiatives. Asset quality metrics improved again, with only $305,000 of net charge-offs or 2 basis points of loans annualized, provision for loan loss of $2 million was primarily needed to support loan growth. As for the Milford National acquisition, our integration efforts are underway. And as Chris said, we expect to close the transaction in the fourth quarter. With the exception of onetime charges, our financial expectations remain intact. Onetime charges, which were originally expected to total $5.3 million after-tax, are now anticipated to be approximately $6.3 million after-tax.
Before I wrap up, let me summarize our expectations for the remainder of the year, when excluding the impact of the Milford National acquisition. Loan and deposit growth will likely moderate in the third 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 25 to 30 basis points higher than 2017, with deposit costs increasing 4 to 5 basis points per quarter. Most noninterest income categories should be in line to slightly ahead of Q2 levels, and full year noninterest income is expected to increase at a low to mid-single-digit rate. Noninterest expense is expected to be relatively flat in future quarters, and the efficiency ratio should continue to improve. Regarding credit quality, as we have said time and time again, while we don't foresee any near-term pressure, a gradual normalization of credit within the industry is inevitable. And finally, when excluding discrete items, the effective tax rate for the quarter was 23.3%. That tax rate for the remainder of the year -- our tax rate for the remainder of the year should approximate that level.
That concludes my comments. Chris?
Thank you, Rob. Stephen, we're ready for questions.
[Operator Instructions] And our first question comes from Mark Fitzgibbon with Sandler O'Neill + Partners.
You guys had terrific C&I growth this quarter. I wondered if you could give us some color on this. Is it a function of increased line utilization or new relationships that are driving the increase? And also, is it coming from any particular industries or geographies?
It's a function of both, Mark. Our utilization rates do tend to peak in the second quarter within C&I. And we expect utilization rates to decline in the third quarter, which also typically happen seasonally. But also, very good production during the quarter. Total commercial production was near record highs for us in the third quarter. And the majority of that was made up with C&I. In terms of industry, it's pretty broad-based. A high percentage within our general ABL bucket, but even the production within that bucket is relatively broad-based, both across industries as well as geographically.
Okay. And then, I guess, I'm a little surprised that guys have been able to hold your funding costs as low as you have. Could you talk about the competitive environment there and what you're seeing? I know you'd mentioned a couple of basis points up in deposit costs going forward, but it seems that a lot of your competitors are paying some really outrageous rates, and I'm surprised it hasn't had more of an impact on you guys yet.
Yes. They certainly are paying very competitive rates. The rates tend to be premium priced within the time and money market categories. And if you look at our mix of deposits, there is a pretty low relative percentage of our deposits in those categories. We certainly are seeing pressure within those categories, and it's been little bit of a challenge for us to keep up. But fortunately, we have 1/3 of our deposits in demand, which are -- have proven to be completely price-insensitive, even with the ability to shift into higher-rate categories. And then we also have a high percentage in our, what we call, our free savings category and our interest-checking category, both of which also tend to be very insensitive, right? Those are operating accounts and small savings accounts. Lots of small accounts. So the benefit to those smaller accounts of getting an extra percentage point even on their balances is very minimal and likely not worth switching. But we do expect, as you alluded to, more pressure in total deposit cost, but because of that favorable mix, the bottom line impact is not as significant as others see.
Okay. And then lastly, I know MNB is small, but it does nudge you guys a little bit closer to the $10 billion threshold. Could you update us on, sort of, where you are in terms of preparations for that?
Yes, Mark. This is Chris. So we have, over the last couple of years, been well on our way. We've sort of built out more compliance staff, built out more BSA staff. We have folks in the treasury working on a stress test, and while we don't need to submit this stress test results as a result of the recent legislation, all that work will remain in place and will continue sort of that methodology. We have worked closely with our regulators. With each passing billion dollars, the exams teams become bigger, longer and more in-depth. So working with them, we're strengthening areas across the bank. So we're well on our way, and we feel very comfortable that we are prepared to cross $10 billion today. And the only remaining thing to be done, when we cross $10 billion, is to establish a risk committee at the board, which would be -- the board is focused intensely on risk already, but it will just be formalizing a committee structure.
Our next question comes from Laurie Hunsicker with Compass Point.
Just a follow on to Mark's question. So as you're thinking about M&A and you have super strong currency here at over 3x tangible book, how are you approaching what you're looking at? Can you just refresh us in this post 21-55 landscape, how you're thinking about M&A?
Sure. Yes. So I mean the heyday of M&A in our region is sort of over as the number of potential banks for sale -- stock-based banks for sale has diminished to great deal over the last decade. So we're very much in the mode of opportunistic and keeping lines of communication and relationships open. Now the banking community see always as a tight community. We see each other at banking industry functions and so on, so having a good relationship helps. Our performance, I think, helps even more having that strong currency. I think our reputation for excellent integrations and saying what we intend to do and following through on what we said we're going to do, that all bodes in our favor. Now I would love -- I'd love to, Laurie, be able to go to the bank store and sort of pick out the banks I'd like to buy every 1.5 years because that would be a nice pace. Every 1.5 years or every year do an acquisition. That is completely contingent upon the boards and the management teams sort of getting to the point where they think it's appropriate to look for a strategic alternative. So we think we're -- as you pointed out, we're a really great potential partner. I think, I would imagine, I don't know this to be the case, but I would imagine that anybody thinking to sell their bank in our region would actually -- would like to talk to us because we have such a good record, and we'll see how that plays out.
Okay. And then just to the extent, obviously, the MNB deal was just announced. Could you have the appetite and the bandwidth to still do a deal before you close that? Or should we look to see that -- you do?
Oh yes, absolutely. This is the deal is -- we're well underway. We -- everything is on schedule. Applications have been filed. Regulatory auditors are engaged. Our technical integration teams are well on their way. We're working without -- [ with ] the outside core of processing vendors. A lot of a technical and simulation work and cultural assimilation work. We've already identified over half of the folks at the bank that we're going to be bringing on. We're looking for opportunities for the other half. There is a lot of momentum, and we could very easily do another one, and one of size, too.
Okay. And just to your point, if you could go to the bank store, what would ideally be the asset size you would be shopping for?
The -- I'm not going to answer that question exactly. But I will tell you that our track record it that we would go smallish, right? Because we think that even small acquisitions like Bank of Cape Cod, Edgartown National, Milford National Bank are incredibly powerful, sort of, additions to our franchise. Our largest acquisition to date was about $1 billion with Ben Franklin about 10 years ago. And we think we could go higher than that. And one thing that there needs to be -- one thing that is important to us is that -- with any merger, is that there is clear direction as to the leadership, the mission and the culture of the remaining entity. We're not really interested in doing a mash-up. We like doing deals with banks that really appreciate our culture, appreciate what we can do for colleagues, appreciate what we do in the market, how we approach the market. And there's a real 1 -- and there's 1 plus 1 and equals 3 sort of characteristics.
Okay. Great. And then just on loans, I have 2 questions there. If we look at the C&I, which Mark referenced, was very strong, how much of that was organic versus purchased?
Define purchased -- I mean, yes, we do participations.
A club deal or something. Right, in other words, how much of it was you all versus somebody else bringing you in?
Probably -- I don't have the exact number, but there was a fair amount of club deals in the mix this quarter. Probably close to half.
Okay. Okay. Okay. And then also on construction, there was a big drop there. Can you talk a little bit about that?
Yes, that was primarily just deals reaching the permanent phase and shifting into CRE. So even though CRE experienced modest balance growth in the quarter, if it hadn't been for those construction deals moving into CRE, we probably would've been down a little bit in CRE. We do have a number of new deals that kind of came into the pipeline during the quarter, and some that even closed in the second quarter but did not advance. So we expect good growth in construction in the third quarter. It will probably be one of our stronger growth categories as we head into the third quarter.
Our next question comes from Collyn Gilbert with KBW.
Just to follow up first on Laurie's question. Rob, what was -- the fact that maybe half of the C&I growth came from club deals, what sort of drove the dynamic of that this quarter more so than perhaps what you've seen in past quarters?
Well, it's just when we find a deal that we like. I mean, there's nothing strategically that's changed. We have -- our asset-based lending group is kind of regularly looking for those opportunities to participate in larger deals that we like generally within our region, but they ebb and flow. So there was no deliberate change. We just happened to find a couple of stronger deals that we liked, that some of our partners came and asked if we were interested in, and so the result is what you see in the balance sheet. So there's nothing really to read into it, Collyn, but just a fortunate quarter for us in that regard.
Okay. Okay. That's helpful. And then just what was the circumstance you had mentioned, the deposit -- 1 large deposit relationship?
Yes. The sale of a business. Obviously, significant proceeds.
Okay. So that -- could -- do you...
I will say those balances are not in -- the majority of those balances are not in business accounts. They're actually in the consumer accounts, but they were from the proceeds of the -- of sale of the business.
Okay. So the likelihood of that liquidity leaving the bank is probably pretty high, is that -- would you say?
Yes. That's correct. Yes.
Okay. Okay. Okay. And then just in general, I mean, you guys have just done a phenomenal job with the business and your performance and profitability. As we look at the landscape, I mean, I guess my short question is, where do you think your ROA can go over time? Because, I guess, as we look at this, right? The NIM trajectory to me seems like it's going to continue to migrate higher, obviously, with the benefit of rates. And then, Rob, what you've described on the funding side, and you have tight -- I know this is a stellar quarter, but you just have exhibited tight controls in all other areas. I mean, as you kind of look at the business, where do you think that ROA could potentially migrate to?
Yes. So it's tough question, obviously. A lot of assumptions you need to make. Obviously, if we continue to get the rate increases that are suggested either by the forward curve or by the Fed dot plots, we would expect to continue to see margin expansion, although to a lesser extent, and as a result, return on average asset expansion. So it would not be unrealistic with 3 or 4 more rate increases to see us get to certainly 1.6%, maybe 1.7% sort of ROA numbers.
[Operator Instructions] And our next question comes from Matthew Breese with Piper Jaffray.
I wanted to follow up on the question and your response there on the NIM trajectory. Your guidance for the year, 25 to 30 basis points higher, I don't think has any more rate hikes in it, but it does seem like we might get 1 or 2 more. So is it possible by the end of the year with 1 or 2 more hikes that we reach a 4% margin either late this year or early next year?
Yes. Certainly. And you are correct, it does not have any further rate increases built into that assumption.
If you had to kind of gauge it per hike, what's the NIM expansion? Could you give us that?
Well, it's less and less, right? I mean, we are seeing the impact on our cost of funds. We had margin expansion of 13 basis points last quarter, 12 basis points this quarter. A few basis points of which was attributable to kind of higher prepayment penalties and some other nonrecurring items. But certainly, high single-digit impact from the next increase, and then maybe mid- to high single-digit impact from an increase after that. But I will caution you that once rates stop going up, assuming they don't head back down, we would expect liability cost to continue to increase for some period of time.
Understood. Yes, so with that, I mean, the yield curve result are flat, 1 or 2 more hikes might flatten things even more. Do you've a read on that, whether or not it's "different this time" as far as indications of a recession along that kind of thinking? Or is it going to stop you in any way?
So I'm not sure exactly what -- is the question around what do I think it's going to happen with the yield curve, or whether or not we're going to enter recessionary environment sometime soon?
Are there greater frictions to your business as the yield curve flattens?
No. We are positioned -- the balance sheet certainly just from a pure interest rate perspective to perform well as the front end of the curve rises almost despite what happens with the middle and longer end of the curve, unless you have a dramatic inversion. But a flattening of the curve is not very painful for us. However, that typically does not bode well for the economy.
Understood. Okay. The other one I had was just a 2 parter on your key lending segments. You noted some positive signs for C&I. I'm just curious anecdotally, what are you seeing from your borrowers that give you more confidence there? What are some of their behaviors that they are exhibiting? And then going to commercial real estate, how optimistic are you on that business category?
Yes. So first on C&I, we actually saw it in the latter half of the first quarter a lot of demand from small businesses. And they were starting to make some incremental investments in plant and equipment. We saw a lot of activity in one of our smaller equipment financing products. This quarter, that seemed to extend a little bit more into the larger C&I segment. But this quarter tends to be a busy quarter for C&I. But it was certainly more busy this year than it has been previous years. So there may be some sense that the uncertainty of tax reform has lifted. Now certainly trade is not helping anybody in terms of their crystal balls, but there was -- seem to certainly be a short-term pickup in demand. And as I said previously, it was pretty broad-based where we saw the growth and the activity in terms of industry. On the CRE front, interestingly, there we are seeing some of the trade policies and tariffs impact commercial real estate, and specifically, obviously, commercial real estate development. And we're seeing some changes to development contracts, where developers are either looking to fix the cost of goods and materials in those contracts or they're requiring any buyers to pay for changes in the cost of materials. So they are either fixing with their suppliers or passing it on to the buyers. So that is a new dynamic that we've just seen this quarter and hadn't seen previously, really.
Interesting. Okay. My last question, just on capital, it's slowly but surely just pushing a little bit higher. Anything we could see you do with it, greater dividend increases or building securities portfolio a bit more?
Yes. Certainly, the former. We have been steady -- steadily increasing our dividend. Our payout ratio is still pretty modest because of tax reform, but we didn't (sic) [ did ] increase the dividend, as you know, more significantly on an per share basis this year than we had previously. I would expect, as long as our earnings are as strong as they have been, us to continue to do that, and maybe expand that a little bit further. This quarter, we actually deployed a little bit of capital. We saw our capital ratios decline. So it's nice to get that organic growth and use up some of that capital. I hope to be -- that to be the case in the future and in periodic quarters. But certainly, it's something that we -- a question we live in, Matt, is when do we think we can use this capital? And we think about it over long periods of time, and we expect to build capital when times are good, and certainly -- so that we have it when times aren't so good. So although we've built capital in the last several years, we're looking over the long term at opportunities to deploy that capital. And we've mentioned before that when the economy enters a recession, that's typically when we see our strongest balance sheet growth because we have plenty of capital to lend.
And we don't have -- with our disciplined lending, we don't have losses and workout distracting us.
I'm showing no further questions. This concludes our question-and-answer session. I'd like to turn the conference back over to Chris Oddleifson for any closing remarks.
Thank you, Stephen, and thank you, everybody, who has listened today. And thank you for all the good questions. And we look forward to talking to you in early October, and in the meantime, have a wonderful rest of the summer. Goodbye.
Thank you.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.