Independent Bank Corp (Massachusetts)
NASDAQ:INDB
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Independent Bank Corp (Massachusetts)
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Good morning and welcome to the Independent Bank Corp Third Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation there’ll be an opportunity to ask questions. [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 note that during this call we’ll 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 Relation section of our website to obtain the 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. Also please 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 sir.
Thank you, Rocco. Good morning everybody from Boston, our home with World Series-bound Red Sox. Thank you for joining us today. With me as always is Rob Cozzone, our Chief Financial Officer and Head of Consumer & Business Banking. Well, we were quite busy in many fronts in the third quarter but we didn’t miss our feat on the performance side, as we yet again produced record quarterly results.
Excluding M&A related charges operating net income grew to 34.9 million or $1.27 per share which represents more than 10% growth over the prior quarters and almost 50% over the prior year. This was a well landed performance with virtually every measure moving in the right direction. Rob will take you through the details in a few minutes but highlights included: continued modest loan growth in both the total commercial and consumer portfolios, strong core fee income growth led by robust customer activity, a steadily rising net interest margin as we continue to capitalize our long-held asset sensitive position, higher demand deposit levels that help keep our overall deposit costs comparatively low.
I want to note that less than 1% of our total households are CD only households, that’s 1% of our total households are CD only households and another 2.5% are loan only households. I think that speaks to the strength of our deposit franchise. Other highlights include ongoing credit quality with another quarter of lower nonperformers and minimal net charge-offs, improved operating efficiency driven by higher revenues and flattish operating levels, and tangible book value per share continuing its upward trajectory, up another 3% in the third quarter. This all resulted in very healthy returns with ROA coming in at 1.7% and ROE at 14% -- both on an operating basis. So very solid quarter by any measure.
The other major development this quarter was our reaching agreement to acquire Blue Hills Bancorp, a local community bank with 2.7 billion in assets and 11 Eastern Massachusetts branches which we announced just about a month ago. That is a healthy, profitable and well run institution that we're delighted to welcome in the Rockland Trust franchise.
The benefits of this transaction are many. It will significantly expand our presence in a coveted Boston market and surrounding towns, which have witnessed robust economic growth and business expansion in recent years, vault us in the number one deposit share position in Massachusetts of any bank headquartered in the state.
Our combined footprint will blanket Eastern Massachusetts from Greater Boston down to the Cape -- or through Cape Cod where the vast majority of the economic activity occurs. It also provides us entering in Nantucket with a commanding market position on the island and complements our growing presence on neighboring Martha's Vineyard. It provides us great opportunities to offer customers our deeper product set, especially investment management and home equity. And of course it's financially very attractive with expected EPS accretion of 4% plus in the first year inclusive of the added costs from across $10 billion asset threshold. Also the impact on tangible book value per share is expected to be very slightly positive.
Blue Hills under the terrific leadership of their CEO, Bill Parent, has really transformed itself from a neighborhood bank into a true commercial bank with steadily improving -- steadily improving its financial performance in an impressive fashion. We expect to close sometime in the first half of 2019 following all the required approvals. We're also eagerly looking forward to the eminent closing of our Milford National acquisitions which brings with it approximately $350 million in assets and 3 branches in Worcester county. This will definitely strengthen our position in that market, where we already have a solid base of customer relationships. Milford National has an attractive low cost deposit base, along with a complementary investment management arm. This transaction is also expected to be accretive to earnings in 2019.
As I've said many times before post M&A continue to opportunistic and disciplined. The acquisitions we've completed over these many years have added considerable franchise value to our company. However organic growth continues to be our primary engine for sustained financial performance and value creation. We therefore continue to selectively invest in our current franchise to sustain growth. Current initiatives include: we're opening a combined loan production and investment management office in Downtown Worcester. This obviously dovetails nicely with the Milford National acquisition. Similar office openings in Boston and Providence in the past few years have met with much success. And the new branch opening in Boston's financial district is planned for later this quarter. Many of our customers commute into Boston. Our new Boston branch will provide an added convenience for them. Also, our recent branch opening nearby Newton is off to a good start.
So we have been busy. Yes we take great pride in our ability to perform as well as we have so consistently over the years, while growing our company in multiple ways.
On the economic front, we continue to operate with the tailwind of a strong local and national economy and internationally with low unemployment levels and a GDP trending about 5% that the economies continues to accelerate. Locally the Massachusetts economy posted an extraordinary second quarter annualized GDP at 7.3%. This follows a more subdued Q1 growth of 1.6%. In addition unemployment remains at a near record lows at end of August. Despite these strong metrics, we recognized that the increasing macroeconomic growth associated trade tension, and increasing deficit and tight labor markets.
In conclusion I just want to reiterate how excited we are about our process for the future. Competition does remain tough and macro uncertainty persists, sort of taking nothing for granted, but our brand keeps getting stronger and stronger, our footprint is expanding, our reputation for superior customer service is becoming even more well-known and the passion of our colleagues to excel and win is as strong as ever. These are the ingredients for our continued success and a source of our confidence. That concludes my initial comments. Rob?
Thank you, Chris. Good morning. I’ll now review the quarter results in some more detail. Net income of 33 million in the third quarter was 6% higher than the linked quarter and 38% higher than the same quarter last year. Operating net income and operating earnings per share which are adjusted for merger charges increased 11% versus the prior quarter, and 47% versus the same period last year. Profitability ratios improved again and continue to migrate towards industry-leading levels. With an operating return on average assets of 1.66% and an operating return on tangible common equity of 18.39% during the third quarter.
In addition, tangible book value per share increased another $0.78 to $27.56 at September 30th. Importantly, these results are being achieved while maintaining our long-held disciplined approach to building the business, one relationship at a time. Loan closing activity continues to be solid, yet loan growth was tempered in the third quarter due to lower utilization rates across C&I, construction and home equity which is common during this season.
Total commercial growth of only 0.4% during the quarter was also impacted by the reduced attractiveness of CRE projects as cap rates don't seem to fully reflect higher debt costs. Strong asset-based lending activity though did help drive 2.8% growth in the C&I portfolio. On the consumer side, despite slightly higher rates demand for purchase financing continues to result in solid residential mortgage activity with jumbo production leading the way; 70% of our residential volumes during the quarter was for home purchases. Although deposits were essentially flat on a quarter-over-quarter basis, demand deposits consistent with Chris’s commentary and core comp growth were up 13% annualized and represented more than a third of total deposits as of September 30th.
The decline in savings and interest checking accounts occurred within the government banking category, partially due to seasonality and partially due to the ongoing competitiveness within that sector; growth and higher rate categories was more modest than expected and will luckily accelerate a bit in the coming quarters. The favorable mix of deposit growth resulted in a low deposit beta, with the cost of total deposits up only 3 basis points to 30 basis points for the third quarter. The cost of deposits is expected to increase 4 to 6 basis points in the fourth quarter, including the addition of Milford Bancorp. We are not immune to deposit pricing pressures that are accompanying a rising rate environment, but due to our long-term focus we gradually acquire active personal and business checking accounts, emphasizing exceptional service and not price. A low deposit beta and healthy loan betas contributed to 5 basis points of net interest margin expansion in the third quarter. The quarterly net interest margin at 3.94% was almost 30 basis points higher than the same quarter last year.
Let me take a few moments to share some of the dynamics that influence on margin. Specifically the interplay between movements and LIBOR versus PRIME. These praising indices obviously move in line with changes in market rates but differ as to their relative timing. Currently about a quarter of our loan portfolio was pegged to LIBOR and about a fifth to PRIME. There has been sufficient commentary around the more modest movements than average LIBOR between the second quarter and the third quarter, up only 14 basis points. However, given the low level of current one month LIBOR, the increase in LIBOR for the fourth quarter should exceed that of the third. As a result, we believe our net interest margin can expand another 4 to 6 basis points in the fourth quarter despite the dilutive effects of a slightly higher deposit beta and the addition of Milford Bancorp. As a result we are comfortable increasing our full year net interest margin guidance once again to an increase of 30 to 32 basis points higher than the 3.6% for the full year in 2017.
Non-interest income increased approximately $1.4 million when compared to the prior quarter inclusive of $1.5 million gain on life insurance benefits. Good growth and checking account related fees such as deposit interchange and ATM fees reflects our ability to continue to attract core households to the bank. Increases were offset by 4% decline in investment management income in the quarter due to seasonal tax prep fees received in the second quarter. However assets under administration increased $78 million and new business activity is quite strong. Loan level derivative income continues to be difficult to predict quarter-to-quarter and at $400,000 was lower than anticipated.
Non-interest expense excluding merger and acquisition charges increased to modest 1% when compared to the second quarter reflecting higher performance based incentive compensation and higher marketing expense. The strong revenue growth and only modest expense growth, the operating efficiency ratio at 53% reached another record low for the company. As Chris said, all asset quality metrics improved during the quarter and the credit outlook remains quite favorable.
I'll now provide some additional updates on the acquisition front. The Milford Bancorp acquisition is proceeding well and we are making final preparations for the closing of that transaction in mid-November. Our original financial expectations for the acquisition would have been intact. The Milford acquisition should add approximately $300 million to loans, $270 million to deposits and $165 million to assets under administration in the fourth quarter. In addition, we expect to incur approximately $6.3 million of merger charges after tax in Q4 including a modest amount for Blue Hills.
As Chris described, we are also very excited about the Blue Hills Bancorp acquisition. The transaction that is another natural expansion of our Eastern Mass franchise filling in important gaps in our current footprint.
Our approach to acquisition is relatively simple. Be absolutely obsessive about the people, which includes the staff, the management team, the board, 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 plan and execute well so that sellers view us as an attractive partner. To date, our experience of acquiring in market or contiguous franchises with community bank cultures has served us well.
Before I wrap up let me just summarize our expectations for the remainder of the year. In terms of the balance sheet, loan and deposit growth should be in the low to mid-single digit range for the fourth quarter and full year, excluding the addition of Milford. As mentioned earlier, the full year, net interest margin should be 30 to 32 basis points higher than last year’s 3.6%, with the fourth quarter net interest margin increasing 4 to 6 basis points. Most non-interest income categories with the exception of gain on life insurance benefits should be higher in the fourth quarter, relative to the third quarter and full year non-interest income is expected to increase at a low to mid-single digit rate. Non-interest expense is expected to be up only slightly in the fourth quarter even when including Milford and the efficiency ratio should improve yet again. And finally the tax rate for the fourth quarter to be approximately 23%. That concludes my comments.
Chris?
Great, thanks Rob. So, Rocco we’re ready for some questions.
Absolutely. We’ll now begin the question-and-answer session. [Operator Instructions] And today’s first question comes from Laurie Hunsicker of Compass Point. Please go ahead.
Rob, I wonder if you could take us through what accretion income is going to look like for 2019/ 2020, and then I know that it was probably almost a material amount but if you could just let us know how much accretion income was in third quarter?
I’ll take the last question first, the accretion income in the third quarter was about 500,000, so higher than typical but some of the other fluctuating items like prepayment penalties and return of interest accruals was lower in the quarter, so total kind of noncore investments were actually pretty flat quarter-over-quarter, Q3 versus Q2. In terms of accretion income going forward as we had said during the announcement of the Blue Hills acquisition, we expect total accretion income associated with the loan portfolio and held to maturity securities to be about $5 million to $6 million annualized. So depending upon the closing of the transaction we get some portion of that, obviously as interest rates fluctuate between now and the close, that number can change.
And then just on tax rate, I know that typically it drops down a little bit due to equity comp plans in the first quarter, can you just remind us what that should be looking like for the first quarter of '19 and then tax rate for the duration of '19? Thanks.
Laurie we'll provide full guidance for 2019 after our fourth quarter earnings conference call, so I don’t have those numbers for you at the moment.
And our next question today comes from Collyn Gilbert of KBW.
If we could we just talk a little bit about your outlook for loan growth and primarily kind of the composition as you see that unfolding as we go into next year. I know Rob you talked about -- you're still seeing good demand on the jumbo mortgage side, but maybe how you see that playing out? And then also to, I know the commercial construction portfolio is not a big part of your business but it had been running down and just trying to get a sense of where you see that business trending as well as we move into next year?
Yes. So I'll start with the commercial construction portfolio. I actually expected commercial construction to be up this quarter. But we had a high amount of projects reach the completion phase and transition to CRE. So it's close to $60 million that transferred from construction to CRE during the quarter. So it was the CRE, without that obviously would have been down. And as I mentioned in my prepared comments column, we are seeing CRE projects that are not meeting our threshold for cash flow. And that is concerning especially with rising rates you would expect overtime to cap rates for cap rates to increase. And we do expect that to happen at some point, but it hasn't happened yet. And so that's impacting our desire to do some CRE deals and could impact CRE growth in the near term. Hopefully that doesn't carry into 2019, but certainly a short term impact to our growth from that.
We're seeing good growth on the C&I side, partly because of the staffing that we've added there. And we expect that to continue -- it'll be quarter-to-quarter fluctuations but on average we would expect that to be our fastest growing portfolio. And then utilization on construction was low at the end of the third quarter. So assuming the utilization picks up we should see construction growth return as we head into the fourth quarter too.
Long term calling -- we are as you know a kind of low to mid-single digit organic grower. And I don't see any reason for that to change.
Okay that's helpful. And then just on the DDA side, as you had indicated you guys are seeing some good growth there. How do you sort to see those balances trending and just -- I mean obviously you're getting growth which as you indicated maybe it's more a function of new account growth, but just curious how you're kind of seeing account growth migration as well as balance migration within those DDA -- within that DDA segment?
We're having lots of continued success in adding new core households at a nice flip if you compare certainly to the rate of population growth. But also expanding existing relationships via new checking accounts. And so our rate of new checking accounts reached a new high for us in the third quarter relative to any previous third quarter. The business rates do tend to fluctuate on a seasonal basis and I'm pretty sure year-to-date we have a new record of both consumer and business DDA accounts. So the momentum continues. Chris talked about the brand resonating. Our larger footprint we've got good coverage of dense geography in Eastern Massachusetts with a strong economy. So we expect that momentum to continue. Balances will fluctuate a little bit quarter-to-quarter but we think kind of low to mid-single digit growth in DDA is certainly achievable for us and it's a combination of new customers joining the bank and existing customers adding balances to their current accounts.
I’ll just add that we’ve been very-very steady in our sort of view of what our major business strategy with respect to all our customers and that is building relationships. We are very much not a product counter or pusher and year in, year out quarter after quarter, I mean this is something that we talk about a lot, we train to it, we role model it and we’re just are super consistent at there, and I think that really is yielding the sort of results that Rob just described.
Okay, that’s great. That’s very helpful. And then just one last housekeeping item, do you guys have by chance a tighter close date for Blue Hills, I know you had indicated one -- first half of '19 when you guys announced the acquisition, any updated thoughts on the timeline for close?
Not yet and I don’t think -- it’s not necessarily tighter and we talked about first half and we are now in…
Pretty difficult timeframe. What do you mean…
No, no, no, sorry I just meant within like a quarter -- like do you think -- yes it is a short timeframe, that’s not what I meant, I apologize. But just is it first quarter or second quarter, that type of thing?
Well the merger agreement -- within the merger agreement we have some flexibility meaning we don’t have to close in the last month of the quarter, so that would mean March is out for example, so chances are it would push us into the second quarter, but as soon as we have more color on that we’ll provide that to you.
[Operator Instructions] Today’s next question comes from Matthew Breese of Piper Jaffray. Please go ahead.
Just thinking about the Blue Hills acquisition, is there a shot we could see prepare the balance sheet anyway for the close date maybe by remixing or adding to the securities portfolio? Is anything like that likely to happen?
Yes. And as we work through those plans, Matt, we’ll certainly communicate those. As you know their mix of funding is not where we’d like it to be so there’s likely a chance that we would probably immediately after the acquisition downsize the securities portfolio and release some of the brokered CD balances they have on their books, to improve some of the funding mix and then work to aggressively transition some of the remaining funding that is little bit more inconsistent with how we’ve been able to grow deposits historically. But that’s going to take time for sure to do that. But we’re very acutely aware of what needs to be done there working on some of those plans now.
Do you think that the timeframe for being able to take your demand deposit or third of balances today it’s going to go down to about 27%, 28% post close excluding any brokerage stuff that you can you can get rid of? How long before we can get back into the 30s? Is that a 2 or 3 year kind of timeframe or shorter? Just give us some frame there.
Yeah typically it would probably be a little bit shorter. I think the complicating factor here is rising rate environment and whether that continues or not. So I'm not prepared at this point to provide a specific timeframe, but the market dynamics will certainly impact our ability to transition that as rapidly as we've been able to do with prior acquisitions.
Understood okay. And then maybe just a couple of big picture questions. First we've heard more recently that there is a couple of large competitors coming to Boston -- JPMorgan and M&T is talking about it too. So how does that change the landscape for you? I mean I could tick on both ways maybe providing some M&A opportunity but it also simply makes already intense competitive environment that much more so. So just curious what your thoughts are there and how it all plays out?
We're watching that very-very closely. JPMorgan for example is known to be a great consumer bank. I will point out that they're focusing mostly on sort of Boston. I mean we have a franchise that extends far far beyond and that's where a lot of our great core funding comes from. In fact Plymouth County where we started our legacy county, we have about 23% market share and a very solid and low cost to funds. Having said that, we are not sort of resting on our laurels, I mean we are going to be asking ourselves how we pick up or gain even better from where we are today. We are very good day. We have very highly rated customer service. We have great brand that resonates, our retention of our current customers is just way high in terms of relative to peer. So that's a good starting out. Now you want to be starting at position of strength when a competitor like that comes in. But I think we will continue to pushing all of things we can push on -- how do we provide solid relationships and more advice. We have a great digital offering and that's going to improve more. We have great branch coverage and that historically has been a huge strategic advantage for us. We have a lot of dense network that's going to be very helpful. I don’t have sort of the magic pill right now to tell you. We're going to be working this one very hard.
Okay, understood. The last one I had is just on the commentary around cap rates versus interest rates. And you noted there is somewhat of a mismatch there, so maybe first, to what extent is there a mismatch? And then secondly, if we do see that correct itself, what does that imply for any sort of valuation trench for commercial real estate and whether or not things are overvalued here. So is that a looming credit issue?
Our opinion Matt is that, it could certainly possibly be a looming credit issue, which is why we're treading lightly. And in terms of where the metrics are today, cap rates haven't moved. There are projects that are sub-5% cap rates and projects that are not high quality projects that are at 5% or talking about one example, the board yesterday, as a matter of fact and those levels just don’t line up with what’s happened with the 10 year treasury as of late and if the 10 year treasury continues to move that situation will get worse. There’s obviously -- that’s all happening in a backdrop of very strong local economy and still presumably a lot of liquidity looking for investments, so it may take some time for that to play out and maybe it’ll be a bit softer reversal that it has been historically, especially if the increase in the 10 year is gradual, but we’re being cautious for sure.
I want to point out to remind you this management team has or members about five or six or seven and you may recall that we performed very well going into that, and throughout the recession and it may look little frothy now where we’re not stretching, we’re applying our same conservative underwriting now as we did during the -- throughout. So that's constant, so I think we’re being very methodic on discipline here.
And ladies and gentlemen this concludes the question-and-answer session. I’d like to turn the conference back over to Mr. Oddleifson and the rest of the team for any final remarks.
Okay, thank you very much Rocco, thank you everybody, we look forward to reporting full year results in January. Have a good rest of the day.
Thank you.
And thank you sir, today’s conference has now concluded and we thank you all for attending today’s presentation. You may now disconnect your lines and have a wonderful day.