Earnings Call: Q3 2021

Oct 22, 2021

Good day, and welcome to the Independent Bank Corporation Third Quarter 2021 Earnings Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Before proceeding, let me mention that this call may contain forward looking statements. With respect to financial condition, results of operations and business of Independent Bank Corporation, actual results may be different. Factors that may cause actual results to differ include those identified in our annual report on our Form 10 ks and our earnings press release. Independent Bank Corporation cautions you against unduly ruling relying upon any forward looking statements and disclaims of any intent to update or publicly any forward looking statements, whether in response to new information, future events or otherwise. Also, please note that during this call, we will also discuss certain non GAAP financial measures as we review Independent Bank Corporation'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 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. Finally, please also note this event is being recorded. I would now like to turn the conference over to Chris Oglivson, President and CEO. Please go ahead. Thank you, Seth, and good morning, everyone. Thank you for joining us today. With me as usual is Mark Ruggiero, our Chief Financial Officer. We are joined by Rob Cazone, our Chief Operating Officer and Jerry Nadeau, President of Lawson Trust and our Chief Commercial Banking Officer. We remain encouraged by our ability to consistently perform throughout this uncertain environment as demonstrated by solid third quarter results. Excluding M and A charges, operating net income for the quarter totaled $41,100,000 or $1.25 per share, well ahead of both prior quarter and prior year results. Mark will be covering the details shortly, but highlights include the following points. While loan levels were essentially flat due to stubbornly high pay down activity, our closing volumes and pipelines are quite robust as our lenders remain very much in the deal flow. Total loan originations for the 1st 9 months grew to $2,400,000,000 a healthy 17% of our prior year volumes for the comparable period. Deposit generation remains quite strong across both the commercial and consumer sectors. Demand deposits alone rose by 5% this quarter as we continue to generate record levels of new account openings. While this influx continues to add to excess liquidity levels and puts pressure on the interest margin, we believe strong deposit generation will pay dividends in the long run. Fee revenues were a particular strength this quarter with every core fee category experiencing growth. Mortgage banking has become a real source of strength for us and our investment management group continues to excel as we maintain our record assets under management level. Credit quality remains in great shape with another quarter of lower non performing loans and negligible net charge offs. Operating expense levels were actually slightly down in the 3rd quarter as we carefully balanced investing in our growth with a disciplined management of costs. Returns remained at attractive levels with an operating return on assets of nearly 1.2%. What we take great pride in is the steady growth in tangible book value per share, which rose again this past quarter. This marks the 31st consecutive quarter of growth in this key measure. Keep in mind that this has been achieved despite completing 5 separate acquisitions over this period. This is a clear indication of the priority we place on protecting and growing shareholder value. As to current priorities, the highest of course relates to the closing and integration of Meridian Bancorp and its flagship Greater Boston Area Bank subsidiary, East Boston Savings Bank. Much progress is being made towards completion. All required shareholder approvals were received in August. Approvals have been received from the 2 federal banking regulators as we await final approval from the state regulator, which typically follows the federal approvals. We have reached agreements to sell 8 of the overlapping branches targeted for closure to a combination of a local community bank and a credit union. These agreements only include the physical branch facilities as we intend to maintain the existing customer More importantly, all employees in the involved branches are to be retained, which was a very important consideration for us. Internally, we continue to conduct in-depth training of our soon to be new colleagues, including a focus on Roth and Trust's deeper product set in both the commercial and consumer areas. And over 300 East Boston Savings Bank employees have indicated they will continue their careers with us, which we are thrilled about. These new colleagues will be a great addition to Rockland Trust and importantly, they bring with them excellent relationships with their customers and communities they've worked hard over the years to cultivate. Richard Gaviano, who is Chairman and CEO of Meridian, orchestrated and led East Boston's growth. He's been a pleasure to work with as we collaborate and engage in the critical work of planning a successful integration. We expect to close in mid November. We also continue to move forward on other important initiatives. We recently opened our 3rd retail branch within the City of Worcester. This brings our total branch footprint to 7 in the broader Worcester County as part of a carefully planned expansion in this targeted market. Our reach is further strengthened by a robust commercial banking and investment management presence. Establishing new relationships and expanding existing relationships remains central to our growth mission. To assist us in these endeavors, we continue to deploy sales force technology and capability throughout our bank. We are engaged in a project to further streamline our commercial loan origination process, designed to enhance the overall customer experience with us. And we continue to develop our risk management and technology infrastructure to align with our growing size and sophistication as a company. Despite the unique challenges presented by the pandemic, the economic recovery continues to push forward and show its robustness. The challenges are well known. Supply chain issues still provide uncertainty. Labor market constraints are still a drag on growth. Although month over month trends are going in the right direction, inflation remains a concern too. Nevertheless, nationally, consumer spending continues to improve with a strong increase in September and that will likely provide a healthy tailwind heading into Q4. Locally, the Massachusetts economic recovery remains on track with Q2 GDP growth of 8% compared to a 6.7% figure nationally. In addition, the labor market in Massachusetts has continued to outpace the nation with interesting leisure and hospitality providing the strongest rebound. Needless to say, the current operating environment continues to be impacted by the ongoing overall certainty regarding the pace of the economic recovery and the prolonged political gridlock. Yet we feel we have the necessary franchise and business mix to continue to persevere and perform in the short term while remaining confident about our long term potential. Now I wish to commend our hardworking Rockland Trust colleagues and our East Boston Savings Banks partners for their dedication and commitment to ensuring a smooth integration effort of our 2 banks, while continuing to maintain superior service levels to our customers. Thank you. And before closing, I'd like to also take a moment to welcome Susan Perry O'Day as the newest member of our Board of Directors. Susan's experience in multiple service industries and her deep knowledge of information systems and technology will be invaluable to our Board's oversight role. We very much look forward to working with her. And with that, I'll turn it over to Mark. Mark? Thank you, Chris. 3rd quarter GAAP net income of $40,000,000 and diluted EPS of $1.21 represent increases of approximately 6.5 percent and 6.1 percent respectively from prior quarter results. The increase was driven primarily by further negative provision levels and higher non interest income offset by a decrease in PPP fee income. Both the 3rd and second quarter results included merger related expenses associated with the pending Meridian Bancorp merger. Excluding merger and acquisition expenses, operating net income and diluted EPS were $41,400,000 and $1.25 for the 3rd quarter, reflecting a 6.7% and 6.8% increase respectively from last quarter's non GAAP operating results. On a GAAP basis, the results reflect a 1.11% return on assets and 9.04% return on average common equity, while the operating results excluding M and A were 1.15% and 9.35% respectively. The GAAP based return on average tangible common equity for the quarter was 13.21%, while the operating result was 13.51%, and the tangible book value per share rose another $0.46 to $37.24 as of September 30, 2021. I'll now summarize the major drivers behind the quarterly results. Changes in loan balances continue to be skewed by PPP loan activity, but to a much lesser degree than in the prior quarters. Total loan balances decreased by $131,000,000 or 1.5 percent for the quarter with $99,000,000 of the decrease attributable to PPP loans. The drivers behind the relatively flat loan growth across the entire portfolio when excluding PPP continue to reflect the dynamics we have described on prior calls. Strong pipelines and close in activity being negated by elevated payoffs and low line utilization. Excluding PPP loans, total commercial loans stayed flat yet included another healthy quarter of $470,000,000 in total close commitments. Delving further into commercial loan funding activity in the Q3, for commercial real estate, we continue to see the majority of our activity centered around residential property assets, including both single and multifamily developments, as well as pockets of opportunity in industrial and non owner occupied office space. Construction balances increased nicely in the quarter as 1 to 4 family apartment and condo development activity remains strong. Regarding C and I, fundings were driven by activity across a diverse set of industries that continue to be challenged by low utilization rates within the portfolio. In fact, total C and I line utilization rates are down about 8% to 10% from pre COVID levels on total current aggregate exposure of approximately $1,900,000,000 We do envision loan growth here to pick up when these rates invariably return to more normalized levels. And the small business portfolio continued its modest growth, which is encouraging. On the consumer side, residential balances decreased by $17,400,000 or 1.4 percent, reflecting a solid quarter of $250,000,000 in loan closings, yet due to continued competitive rate pressures, only 26% of the current quarter closings were retained in the portfolio and 74% sold in the secondary market versus a 45%, 55% split in the prior quarter. And home equity balances continue to be impacted by payoffs and similar challenges over low line utilization rates. Reinforcing expectations around strong closing activity through the rest of 2021, the approved commercial loan pipeline as of September is approximately $292,000,000 while the low rate environment continues to drive solid residential and home equity application volume. And as a quick update on the PPP portfolio, over 98% of our 2020 originated PPP loans have been successfully forgiven and the associated fees have been recognized in earnings. As expected, the fee income recognized in the 3rd quarter dropped to approximately $2,200,000 compared to $7,200,000 in the prior quarter, driving the decrease noted in interest income for the current quarter. As of September 30, 2021, and inclusive of the 2021 PPP originations, we now have approximately $384,000,000 of outstandings and $16,300,000 of deferred fees remaining to be recognized, the majority of which should be recognized in 2022 assuming successful forgiveness and repayment outcomes. Total deposits increased by 2.3 percent or $273,000,000 reflecting increases across all core deposit products and both personal and business deposit categories. As Chris alluded to, core households are up another 1% in the quarter and 3.6% on a year to date basis. With time deposits continuing to run off, core deposits now comprise 92% of total deposits and the cost of deposits for the 3rd quarter dropped another 2 basis points to a mere 5 basis points. It's been no secret that our successful core deposit generation has generated significant excess liquidity that remains challenging to deploy in this environment. Yet we do feel the expanded customer base and low cost funding provided represents a real long term benefit. While maintaining enough dry powder for more profitable deployment in the future, we did accelerate our securities purchasing activity, investing an additional $733,000,000 during the quarter. All security purchases in the quarter were comprised of treasury and government agency securities with a weighted average expected life of 4 years. And we believe this approach continues to be prudent. While our crystal ball is no better than others, we do anticipate some level of short term rate increases in the not too distant future. And therefore, the strategy has been to deploy excess liquidity at a level that balances some measure of increased short term profitability, while maintaining an asset sensitive profile poised to benefit from future rate increases. Shifting gears to the income statement. Net interest income of $90,100,000 decreased by $3,300,000 or 3.5 percent compared to the prior quarter, while the reported margin decreased 21 basis points to 2.78 percent for the 3rd quarter. The decreases are almost entirely related to the already noted $5,000,000 reduction in PPP fees and increases in lower yielding short term assets, with the increased level of cash and securities continued to suppress the margin in the near term, but to a lesser degree. On a positive note, when excluding the impact of PPP fees, the core loan yields held up nicely during the quarter with modest compression mitigated by the decrease in funding costs. The asset quality picture remains quite benign. Non performing loans decreased further by $2,000,000 to a modest $45,800,000 or 0.52 percent of the total portfolio as of September 30th. Net charge offs for the quarter were negligible. Total delinquencies increased due primarily to 1 modest sized commercial credit, but remained low at only 21 basis points of the portfolio. And total loan deferrals stayed consistent at approximately $223,000,000 or 2.5 percent of the total portfolio and remains concentrated in the accommodation industry. Given all of these strong factors noted in improving economic forecasts, a negative $10,000,000 provision for bad debts was recognized in the 3rd quarter, lowering the allowance for credit loss as a percentage of loans from 1.15% to 1.05% as of September 30th. We experienced broad based improvement in non interest income, which increased nicely by $1,500,000 or 6%, driven by stronger deposit accounts deposit account fees, mortgage banking, wealth management and swap income. The mortgage banking income results reflect strong closing and pipeline activity with further pressure on margins as expected, while the wealth management income results included increased insurance related income and increased fees from assets under administration. Total assets under administration at September 30th were $5,400,000,000 and reflect approximately $50,000,000 of net asset inflows for the quarter, offset by modest market depreciation. On the expense side, total reported expenses were basically flat when compared to the prior quarter, inclusive of $1,900,000 in merger related expenses versus $1,700,000 in the prior quarter. All other expenses reflected various quarter over quarter swings, but remained relatively consistent in total. Lastly, the tax rate increased to 26.1 percent for the 3rd quarter, reflecting the improved profitability. As we look out into the 4th quarter and to serve as a big picture update on the pending East Boston Savings acquisition, we provide the following near term guidance, which we'll update following the year end. As Chris noted, we anticipate the Meridian Bancorp East Boston Savings Bank merger to close in mid November, Though various components of the earnings stream attributable to the deal continue to be fine tuned, in general, we reaffirm our big picture deal metrics as announced regarding initial tangible book value and earnings accretion. With that being said, one particular item to note as an update from guidance provided last quarter, with the continued flow of excess liquidity over the last 6 months, the net interest margin on a pro form a basis may see some modest tick down. Regarding standalone Rock and Trust guidance, loan growth is expected to mirror Q3 results such that continued payoffs will mitigate strong anticipated closing activity resulting in relatively flat balances. As noted before, any increase in line utilization could serve as a catalyst to stronger loan growth. Deposit growth is expected to be in the low single digits. Near term deployment of excess liquidity will likely continue to be in the form of increased securities balances. Similar to prior quarter's guidance, assuming an anticipated trend of improving general economic factors and no major surprises from overall asset quality, the provision for credit loss will likely continue to track at levels below net charge offs. Non interest income will likely decrease slightly due to seasonal declines from deposit fees, reduced mortgage banking income attributable to compressed gain on sale margins and a likely increase in production retained in the portfolio, as well as reduced equity investment gains, which benefited both Q2 and Q3 results of approximately $1,000,000 in each quarter. And non interest expense is expected to increase slightly. That concludes my comments. We will now open it up to questions. We will now begin the question and answer session. Our first question will come from Mark Fitzgibbon from Piper Sandler. Please go ahead. Just to clarify, Mark, your guidance for the Q4 is independent standalone, it doesn't incorporate the impact to Meridian? That's right. The components over sort of loan deposit and fee and expense is all standalone guidance. That's right. Got you. Okay. And then, I guess I was curious, I heard what you said about provisions being less than charge offs. But, do you think we're getting close to the end of reserve releases for the company standalone ex the impact of Meridian? It's a great question, Mark. I think to put the numbers in perspective, if you look back at 2020, for the full year, we had $52,000,000 in provision. And through 2021, we pulled back about $17,000,000 of that. So there's certainly some headroom there in terms of where we were comfortable with the allowance as a percentage of loans at CECL adoption. I'm certainly not suggesting there's $25,000,000 to $30,000,000 of additional release. But I do think we're being cautious. We're continuing to understand the environment and the risk associated with it. But I do think there is another couple of quarters here where additional releases may be appropriate if the picture stays positive. Okay. And then, I was curious, Chris, it sounded like you were really optimistic that you'd be able to close this transaction mid November, but it feels like the regulators have been dragging their heels a little bit on deals generally. I guess I'm curious what gives you so much confidence that you'll be able to get it done in mid November? Mark, we're sort of in constant contact with the regulators and understanding, so we're there in the process and they're tracking right along with past acquisitions. There's no yellow flags or anomalies and things are clicking along, I mean, just per usual. Our sense is that the what we're hearing in the marketplace about deals being sort of approvals being dragged out are really for larger institutions at this point and are not impacting transactions of our size. So we feel like we have a clear road ahead per path of our experience and our current conversations with them. And to be clear, Mark, we do have we do already have approval from the 2 federal regulators, both the Fed Reserve and FDIC have already approved. It's just the division of banks that is pending right now. Okay. And then I wondered if you could share with us what the maturity schedule of the $223,000,000 of loans on deferral looks like. I think last quarter you said most of it was in 2022, those deferrals mature. But I wonder if you could just give us an update on that? Sure. So about $40,000,000 of that is set to mature here in the Q4 of 2021. And then as you stated, the rest of that, a very small amount, it actually triples into 2023, about $8,000,000 But the rest of it will mature in 2022, the bulk of that being in the back half of the year. And just one final question, if I could. I was curious if you could give us an update on the Worcester expansion sort of progress to date, maybe loans and deposit balances would be great. Thank you. Sure. I know Rob is on the phone and is always eager to talk about all the great things that are happening in Worcester. So maybe Rob, if you want to share that. Sure. Good morning, Mark. As you probably heard Chris mention in his opening comments, Mark, we just opened our 3rd City of Worcester branch. So in addition to the City of Worcester, we also opened a branch last year in Shrewsbury. In total, our deposits are at about $65,000,000 across those branches. That is not our Worcester County deposit. In total, our in excess of that, if you include the Milford acquisition. And we're lining up another branch in that expansion hopefully for the Q1 of 2022. I don't have loan portfolio information. Jerry, I don't know if you do. Yes, Rob. Just on the commercial side, now this is just in the Worcester lending team. So this is not necessarily all of our commercial loans in Worcester and Worcester County. Just out of the new team that we put in Worcester at the end of September, the outstandings were about 75 $1,000,000 Our next question will come from David Bishop from Seaport Research Partners. Please go ahead. Yes. Good morning, gentlemen. Good morning. Good morning, Dave. Just remind us maybe what the interest rate risk positioning looks like or will look like post Meridian? I know there's some balance sheet restructuring here and there's been some moving parts obviously with the deployment of securities. But just curious if there's been a material change in the interest rate positioning intra quarter? Yes. They are slightly liability sensitive. So matching up with our balance sheet, it will moderate our asset sensitivity to a degree. But we will still continue to be fairly asset sensitive on a pro form a basis. And I think to give it some perspective, we historically talk a lot about our 1 month LIBOR and prime based loans, which currently make up about 45% of our loan portfolio today. On a pro form a basis, that would drop to probably around 30%, 35%. So those are the loans that would reprice immediately with any sort of Fed rate increase. So we still will be an asset sensitive bank just to a slightly lesser degree. Got it. And then, any sense in terms of floors in place, how much you have to see from a Fed rate move to penetrate those floors? Yes. We have done a nice job of putting floors in place on a lot of our recent commercial activity. And if you're asking the question in this direction, we think in a 25 basis point rate increase, approximately $650,000,000 of that 1 month LIBOR book will not get the benefit because they are already in the money with the floors we've put on. Our next question will come from Kelly Myler from KBW. Please go ahead. Hey, good morning. Thanks for the question, guys. I just wanted to turn back to loan growth. And in your prepared remarks, you mentioned that utilization rates could potentially be a catalyst for growth going forward if they tick up. Can you remind us where utilization is right now and how that compares to where you have historically been before now? Thank you. Sure. So, as I noted in the comments, especially on C and I in particular, our general C and I utilization rates right now are about 35%, and that's about 8 or 10 basis points lower from where we were pre COVID. The other big line pool is on the home equity side, which has a similar situation. Home equity line of credit utilization is also around 35% today. And historically, pre COVID, those levels were more in the low 40% range. So those are also down, call it 7%, 8% from where we were. So both of those carry aggregate exposure of $1,700,000,000 each. So there's certainly some level of increased loan outstandings to the extent any of that line utilization picks up. Our next question will come from Laurie Hunsicker from Compass Point. Please go ahead. Just touching on a couple of things here. The 8 branch sale to a credit union and to Harper 1, Is there an expected gain or loss on that? And what is the timing? And is there a change in terms of how we should be thinking about expenses? Or was that initially part of the plan in terms of your expense guide with the merger? Yes, that's all initially part of the plan, Laurie. From a timing standpoint, it'll be we're looking to structure it effectively right after the legal close. But these were branches that we had already modeled and anticipated would be closing as part of the merger and we had modeled one time costs associated with exiting those branches. The numbers are still being fine tuned a bit, but it should not materially change any of the assumptions that we considered when we thought about cost saves or one time costs in exiting those branches. Got it. Okay. And then just back to your comments on margin. Obviously, you all asked PPP, you were $271,000,000 this quarter. It looks like EBSD was $305,000,000 So kind of putting that combined, can you just help us think about how the asset reduction is playing into that? And if we're looking at this coming up with somewhere between 2, call it, 275, 2.78 core margin as we sort of fast forward 2 quarters out. Is that sort of a right starting point? Or how should we be thinking about this? Sorry, Laurie, just confirming that number you just referenced is that were you referring that on a combined basis a couple of quarters out? Yes, correct, pro form a. Just you have a lot going on, It's not your typical merger just because of the asset reductions. I just want to make sure that I'm thinking about it the right way in terms of a starting point. Yes. No, there is a lot of moving pieces, you're right. And if you look at our starting point, I reaffirm what you're suggesting is that we're currently at about 2.7%. I think heading out into 2022, depending on the timing of the PPP, we may see a little bit of a lift there, but we'll likely have some other modest compression mitigating that. So I think you stay in that range of where we are now. As you mentioned, East Boston has experienced some attrition in their commercial book, so their margin has come down. They've done a really nice job moving on the funding side to mitigate that. But I think you'll see some modest compression if you think about their book as a standalone basis as well. Where we'll get some lift is in our ability to restructure the balance sheet even after we close. So a lot of the loan runoff is part of what we modeled. So we've seen that accelerate and we'll be looking to spend a lot of time and effort making sure that we can mitigate the attrition and look for opportunities for growth post close. So we don't input anticipate we'll see the level of runoff that we thought post close because it's already happened to some degree. But what we will be able to do is pay down their FHLB borrowings immediately and allow for some higher cost time deposit runoff as well. So that on a net basis will give us a lift in the margin. So that I think you get closer back to 3% all things being equal in that scenario. Okay. And they had about, I don't know, dollars 600,000,000 or something in borrowings, is that 560,000,000. Yes, you're right. Okay, great. And then how should we be thinking about tax rate next year? Yes. We continue to guide that to about 25%, Laurie. This quarter ticked up a bit because we had at the time through the 1st couple of quarters, the tax rate forecast didn't anticipate the level of loan loss recovery or provision recovery. So we had a little bit of a modest uptick to sort of right size the year to date tax rate for that improvement in profitability. But I think you'll see it tend to trend back to 25%. Okay, great. And then Chris, just last question for you. Now that we're right here, almost at the last inning, how are you thinking about forward looking M and A? Would you be ready if an opportunity presented or how are you thinking about that? Thanks. Generally, of course, we're going to be ready and sort of going to be interested in continuing what appears to be sort of a track record every year or 2 doing an acquisition. I think in an ideal world, Laurie, I'd like to get through this acquisition and give everybody a really nice holiday, because they work really hard. And maybe something will surface next year. That would be my sort of preference in terms of timing. But in terms of sort of our trend, I think nationally M and A is going to continue. It's been continuing since 1985 and it's going to continue here. The number of banks that are eligible certainly have been diminished over the years. But there are some really, really nice banks. There'd be a great combination with Rockland Trust and maybe someday they'll raise their hand and we'd love to have a conversation. I always can count on you for that question, Laurie. I look forward to it each quarter. This concludes our question and answer session. I'd like to turn the conference back over to Chris for any closing remarks. Thank you everybody for joining us today. And we will talk to you in January and have a great Q4. Goodbye. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.