Independent Bank Corp Q4 FY2020 Earnings Call

Good morning and welcome to the Fourth Quarter 2020 Earnings Call. All participants will be in a listen-only mode. 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 Corporation. 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 Corporation 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.

Good morning and Happy New Year to everyone. Thank you for joining us today. With me, as usual, is Mark Ruggiero, our Chief Financial Officer. We will again be joined by Rob Cozzone, our Chief Operating Officer; and Gerry Nadeau, President of Rockland Trust and our Chief Commercial Banking Officer. They'll be available to answer your questions, post Mark and my comments. As always we extend our hopes for continued well-being to all of you and your families. We ended the year with another solid performance with fourth quarter net income coming in at $34.6 million or $1.05 per share. Mark will take you through the details shortly, but I'd like to focus my comments on the full year just completed. And what a year it was, the pandemic stressed every corner of our economy and society, creating enormous demand, supply and financial shocks to our systems, and banks in particular had to quickly pivot and adapt to these challenges. We've responded to the challenge to serve our customers in times of need while continuing to move our franchise forward. Financially, we performed well in 2020 when considering all the economic headwinds. Highlights include operating earnings of $121.7 million or $3.66 per share. Robust core deposit growth of 30%, which further reduced our very low funding cost. While loan growth was tempered by elevated levels of pay downs and refinancing, loan closings remained strong. Origination volumes across the combined commercial and consumer sectors reached nearly $3 billion. This excludes PPP, some 11% above prior year levels. Investment management levels grew 9% to nearly $5 billion, driven by net new money and market appreciation. We had significant growth in our residential mortgage activities and revenues. We extended about $800 million in loans to stressed companies under the SBA's PPP program. Business households grew by 5% and consumer households grew by 1.5%.

Thank you, Chris. I will now cover the fourth quarter results in more detail. GAAP net income of $34.6 million and diluted EPS of $1.05 in the fourth quarter of 2020 reflect decreases of 0.7% and 0.9% respectively from the prior quarter's results. Fourth quarter results were negatively impacted by a number of decisions that led to approximately $5.2 million of one-time costs incurred during the quarter, including a $4.2 million associated with two branch closure decisions and $1 million related to a loss on sale of non-core small business fund investments acquired in the Blue Hills merger in 2019. Although negatively impacting current quarter earnings, these strategic decisions were made primarily to improve future profitability. To provide further context into the core business drivers of the fourth quarter results, I would highlight the following factors, all of which I will shortly provide further additional color into. As Chris highlighted in his comments, we experienced another quarter of solid core business volumes, including strong closing activity in both the loan and deposit franchises. In addition, the combination of our hedging positions, loan pricing and funding cost management led to consistent core margin results. Effective work-out of certain non-performing assets and no significant change to assumptions of credit risk led to significantly decreased NPAs, minimal charge-offs and zero provision expense for the quarter. Also, the level of loan deferrals notably declined as well. Fee income results were in line with expectations and expenses increased due primarily to the large one-time items noted above combined with select incremental costs associated with multiple strategic initiatives. The combination of this activity drove a return on assets and return on tangible common equity of 1.04% and 11.77% respectively for the fourth quarter. In addition, the tangible book value per share of $35.59 at December 31, 2020 reflects another solid $0.42 increase in the current quarter. I will now provide further insight into each of the summary points just discussed. Total loans decreased $12.3 million or 0.5% on an annualized basis continuing the narrative that we have been discussing for much of the year. With ongoing commercial loan growth and robust closing activity throughout the total portfolio being offset by pay off and attrition. Focusing first on the commercial side, we continue to find pockets of opportunity, despite the challenging environment with notable increases in the quarter in both C&I and commercial real estate balances.

The first question comes from Mark Fitzgibbon with Piper Sandler. Please go ahead.

Chris, I'm curious, you touched on a little bit of your plans with respect to the branch network and I saw that you had closed a few locations this quarter. But given what we've seen from some other banks in your market with fairly large branch closure announcements, I'm curious how you're thinking about your roughly 100 branch franchise. Could that number come down dramatically in the years ahead as customers migrate to more of your digital approaches to interacting with you all?

Yes, Mark. I'll give a minute on this topic then I'd really like to turn it over to Rob, who is really leading that effort. I think if I were to - so if you look out, let's say 20 or 30 years, clearly, there is going to be a shift over time. But it's not going to be in our opinion rapid. I mean, there are a lot of customers who we have established relationships with through these branches. We receive extraordinary referrals from other business units from the branches and we view them as very critical. Rob, as he'll explain, we have a very comprehensive and focused evaluation of branch performance, and that's why you see over time that we have made a number of branch closures or consolidations. But we think in the short to medium term that branches are going to remain very key to our success. Rob, what would you add to that?

Well, you covered a lot there, Chris, but certainly, your direct question, Mark about significant decreases in our branch network over the next several years. We're just not forecasting that as an appropriate strategy for us. Although our level of account openings coming from digital sources has improved, our new online account opening system allows consumers to open an account in just 4 minutes, which was a wonderful technology and we continue to educate our customers and our prospects about that alternative and we've doubled our volume of account opening through that channel. However, it is still less than 10% of our total account openings, and the number of accounts that we're opening in our branches has accelerated. Our fourth quarter, and you've heard me say this during prior quarters, had record openings of deposit accounts, primarily checking accounts and savings accounts in the fourth quarter versus any other fourth quarter. And as Chris referenced, the volume of referral activity still coming from our branches is significant. At the moment, we don't have a clear line of sight as to how that referral activity can shift to a digital alternative. Those referrals come from in-depth conversations between our bankers and customers referring them to our other relationship managers in wealth management and mortgage areas. We are still receiving lots of home equity applications, the vast majority of them coming through the branch network as they explore needs with our customers. That said, as you noted, we did close two locations, one of which was certainly accelerated by the pandemic. Both the branch and the associated office space at that location were underutilized, so it made sense to accelerate that decision. I don't see significant acceleration among the rest of our network, but we will continue to look for opportunities to pare back branches. And when we do close a branch like many other banks, we see very high retention rates as long as there is another location relatively nearby. I suspect that we'll continue to be in the single-digit range for opportunities to consolidate locations, but keep in mind, our expansion into Worcester is a physical expansion. We believe that to be successful in a new geography, we need branch locations with highly trained local staff who know the communities. The two branches that we opened in Worcester during 2020 in the midst of a pandemic are doing exceptionally well, and we hope to open at least two more in the Greater Worcester area in 2021.

2021.

Super helpful. And then, Mark, I'm curious - I apologize for this, but did you give any guidance on expenses for 2021?

Yes. Basically, Mark, that the guidance as we look at really the last couple of quarters is really a strong baseline for expectations into 2021. The fourth quarter should be viewed with the caveat of the large one-time items we took in the quarter. We've made some incremental investments; we've discussed some expense increases in software and technology to continue to build out that digital customer experience. We've mentioned some areas around our risk infrastructure build-out. So there have been some really key hires in terms of talent and personnel in those areas. This creates a bit of an increase in the run rate from those perspectives, but we are being very thoughtful in holding the line on other discretionary spending. We think that the combination of that approach should keep expenses relatively flat with that run rate we've shown over the last couple of quarters.

And then lastly, if you aren't able to find acquisitions and capital continues to pile up, I guess I'm curious, would you contemplate a special dividend or maybe bumping up the quarterly dividend rate?

Yes. Certainly, capital management is top of mind, and I think you mentioned a couple of alternatives that we continue to keep in the tool belt and continue to assess. We saw a successful buyback program earlier in 2020. It's certainly an approach that we would be comfortable deploying with these levels of capital despite some uncertainty in the environment. But with the positive increase we've had in the stock price from an economic perspective, it does not make sense at this point. So I would say from a ranking perspective, that would certainly be the most logical deployment of capital if the economics made sense. From a dividend management perspective, we typically review our dividend rate in the first quarter of each calendar year. Again, there is certainly an overall comfort level with absolute levels of capital from an ongoing dividend perspective. We continue to be very cognizant of payout ratios and want to make sure we're considering that when managing against the short-term environment and understanding dividend rates given our current profitability levels—this will certainly shape our mindset as we think about any changes in 2021. In terms of a special dividend, it's a strategy that we honestly haven't deployed in the past, but we understand there are pros and cons regarding what that truly accomplishes. But again, I think nothing is completely off the table, and we will be looking at all of those alternatives as we finalize the 2021 capital plan.

The next question comes from Christopher Keith with D.A. Davidson. Please go ahead.

So I'd like to just dig in a little bit to your loan growth. Starting with PPP relative to the 2020 activity, how large do you expect the participation to be in this newer iteration of the program?

Yes, it's a great question, Keith, and one that's very relevant this week. Just as a reminder, we did a little over 6,000 PPP loans in the first round. You could think of it as sort of two different waves in 2020, but we did do a little over 6,000. This new program, when you look at the rules and requirements around first draw, second draw loans, our experience towards the end of that first round suggests that we think most borrowers that truly needed to get a PPP round did in fact get one during 2020. So we anticipate and believe the majority of our demand in this new wave will likely be second draw requests. In other words, existing PPP borrowers coming back looking for a second draw. Heading into this round, we anticipated probably somewhere between 50% and 75% of that first round population to likely qualify and return. In the first 24 to 48 hours, it felt like we were going to meet those expectations, but it has come down in the last day or two. It's still early in the program, so we are not sure if we need to read into that too much yet, but where we sit here today suggests we may not reach those types of levels. However, we already have well over 1,000 applications in the queue today, but whether we get to the 3,000 to 4,000 range is still a bit early to determine.

And then I guess looking at traditional commercial and industrial, assuming you do get to that 3,000 or 4,000 level, do you anticipate that having a negative impact on the demand for more traditional commercial and industrial products?

We don't. I'll share my thoughts and then Gerry Nadeau will share his thoughts as well. Leveraging our experience through the first round, it seemed like the two were mutually exclusive. We certainly had some overlap in certain industries that could secure a PPP loan, but we saw our industries continue to have demand from normal lending needs. So we did not experience one or the other truly impacting demand. They were quite honestly mutually exclusive, and we think there continue to be good pockets of opportunity both from a C&I and a commercial real estate perspective. To give a few examples, we've continued to see apartments and our construction projects, particularly outside of the Boston proper market neighborhoods. We have nice growth within our asset-based lending and C&I portfolios, especially in warehousing and flex space. We're seeing some uptick there, especially from borrowers that may be looking for lab space. There have been opportunities on our end there as well. All of this means typically borrowing relationships that honestly may or may not qualify for PPP, but we haven't seen that constraint demand. I don't know if Gerry, you have other thoughts along those lines?

Perhaps the only thing to add to that is the only category I think is still to be determined would be for contractors. If you remember back in the spring of 2020, Massachusetts shut down a lot of construction for an extended period. Many contractors can show 25% quarterly revenue decline, even though they may have had a good overall year. So with that in mind, there is a possibility. If they indeed end up getting the PPP loan, it could potentially lead to pay downs on lines of credit. So it may not negate new loan demand as much as perhaps decrease utilization rates on lines of credit in some industries.

And then I guess just lastly, looking at deposits and specifically time deposits, is there more room to move on both a balance level for time deposits or a cost perspective for time deposits to move down?

There is. In both areas, certainly, our new time deposit offerings are at rates significantly lower than the weighted average cost of those deposit products on the books. We’ve noted that a lot of our success in account generation over the last couple of quarters has primarily focused on core deposit generation. In the last couple of quarters, we’ve experienced a rundown in the time deposit portfolio. Another good portion of that product is set to mature over the next six months. In fact, over the next three months, the weighted average of what will run-off is well over 1% on that product. Thus, a natural maturity schedule of those deposits will continue to benefit us on the cost of deposits front, and any new CD pricing coming on the books is at a much lower rate, which has contributed significantly to our ability to reduce deposit costs.

The next question comes from Laurie Hunsicker with Compass Point. Please go ahead.

Mark and Gerry, this is a question for you. Just regarding credit, I noted two out of your three credits here this quarter. I'm just wondering which ones they were, the hotel, the restaurant or the entertainment?

Yes, first two, Laurie. The hotel paid off and the restaurant relationship paid off as well.

Okay. Great.

So just a reminder, the hotel was the relationship that we took the charge-off in the third quarter down too at the time and expected payoff level and that did pay off as we planned. The restaurant relationship we had - as you mentioned sort of the interest benefit associated with that. That was a very positive workout solution.

That’s the 900. Okay, right. And so the - and the hotel was $20 million and the restaurant loan was $20 million, is that correct?

Yes. The hotel we had charged down to, I believe, a little over $18 million in the all-in-restaurant relationship was a little over $20 million. I think it was more like $22 million.

$22 million. Okay, cool. And then just looking at the charge-offs this quarter, looks like $1.9 million was C&I; was any of it from those two loans?

No, the C&I is primarily driven by one charge-off on an acquired loan from the Blue Hills acquisition. We had an - and then some other just much smaller charge-offs. So one of - one loan equates to about $1.8 million, $1.9 million of that Q4 activity, but they are completely separate from those. Those are the three that we put on non-performing. So that was actually a new non-performer in the quarter, which offsets the reduction of those work-out loans that we were just discussing.

Okay. And so, and then to your point on provisions, obviously, loan growth is going to be nominal. I think that's true across the board. I mean 84%, 85% of your charge-offs then were related to this one loan. So as we think about your loan loss provision, it could be very, very light compared and obviously, there are a lot of question marks around COVID, but it could...

Okay.

I mean, could it be light from the standpoint of thinking about what things looked like in 2019 or how do you see that?

Yes. No, I think that's a fair way to look at it. I'm sure you're monitoring as much as we are, and we don't necessarily always need to compare ourselves to industry trends, but I think the obvious takeaway is what the CECL methodology has done in driving significant loan loss reserves, and quite frankly, what should have happened with CECL is to build up that reserve when future risk is evident. We've experienced in the fourth quarter, and our approach to what you've seen in terms of the zero provisioning level, leading us to feel comfortable that barring any major changes to macroeconomic environment, we believe we have a good handle on what we've already provided for future credit risk. We should be in a position to continue thinking about either reducing reserves or matching charge-off activity with provisioning, but I think we demonstrated this in the fourth quarter. It's a concept we’d be comfortable taking into 2021, with the understanding that we don’t necessarily need to continue to replenish reserves at this level unless we are taking losses on reserves that we've already had in place.

Got it. Okay, that's helpful. And then I guess jumping over to deferrals here. Your overall deferral is down nicely; commercial deferral is now at 2.4%. It looks like every category improved except one other category, small business services of $151 million with a deferral right now of $24 million or 16% up from last quarter. Can you talk a little bit about that book and how you're seeing it?

I'm sorry, Laurie. Which category were you referencing?

So it's the other business services book; then you have the highlighted categories of hotel, food, retail, parks and rec, and then the other services book of $151 million. It looks like that's the only category that didn't increase. I could follow up offline if that's easier, but I just wondered if there was anything concerning about the other services, aside from public administration, so it's your non-profit, religious, social services and that type of thing.

Right. Yeah. I think this is an interesting dynamic I wanted to continue providing some transparency into. Although we've continued to highlight that industry and give some color to it, I would point to the level of deferrals we've experienced to date and there is a very low correlation of active deferrals to that industry. So we feel a lot better about that category, and as you can see a lot of the current deferrals continue to be primarily associated with hotels, restaurants, etc. We are not seeing much stress in that category. We continue to provide insight and monitor it, but we aren't feeling overly concerned about it.

Just a couple more questions. On the other non-interest income line up: $4.8 million out of the $27.5 million of total non-interest income, what were the one-time non-recurring year-end items? What did they total?

The securities, the equity securities portfolio is one we— I wouldn't necessarily categorize as being non-recurring. It can just be very volatile. The market involves unrealized gains or losses on that securities book. If you allow me a moment, I'll get you the exact number that increased quarter-over-quarter by about $300,000. We typically have year-end realized gains or capital gain distributions on that book as well and that was about $150,000. So, all in, about $0.5 million on the equity securities portfolio, some of which could certainly occur over time, depending on continued appreciation or evaluation.

And then on expenses, just going back, and I appreciate your color around thinking about non-interest expenses being flat. I just want to know on a core basis, obviously, we're stripping out the loss on the sale of the equity investment. I’m sorry, the lease impairment of $4.2 million and then the BHBK loss on sale of equity investment of $1 million. It looks like there were other non-recurring expenses as well, and I’m just trying to understand the delta. So when you talk about core expenses, are you talking about a base of $16.5 million? Or are you looking at that and saying to your point, you have some commentary in the press release that there was $1.07 million or so of linked quarter increase. I just didn't know how much of that sort of miscellaneous non-recurring could we strip out in the core base. Is it closer to $66.8 million? Any color you can provide to help us think through core expenses?

Sure. I thought I heard - Certainly, in the fourth quarter, some of that increase was driven by salary and employee benefits, incentive compensation, and commissions. I think you've recognized that and it sounds like you're also looking for some more insight into that other non-interest number. A couple of items we spoke about were accelerated in the fourth quarter, which represents some elevated level of expenses. This had to do with some consulting arrangements or agreements we incurred in the fourth quarter. A couple of examples are associated with the PPP program. We obviously continue working through the closings on the first round of up, but there is still significant work to do on the forgiveness side. Thus, we had to bring in some additional help on that process, leading to related expenses that will continue until the completion of the PPP program. That should drop off. We’ve had increased expenses to continue building our risk framework. There is a bit of elevated expense in that front. However, we also made key hires to continue improving the business infrastructure. We think it is critical to continue investing in this company's infrastructure while maintaining our focus on strategic priorities without sacrificing long-term value. Recognizing all that may lead to some incremental increase in the expense side. We've had some consulting work, as we continue to expand, we believe that investing in our infrastructure is important for growth, which will cause some volatility in any given quarter when looking at these expenses.

And I guess, Chris, one last question for you. Can you give us very high level your thoughts on M&A? You're sitting here with a very strong stock currency at Q2 of tangible book—how do you see the world right now on that?

Yes. On a high level, I would say that the secular trend will continue, and there will be bank consolidations and M&A nationally and over time locally. The number of banks existing here in Massachusetts is greatly reduced. It's much more random rather than predictable, and I would also point out that the interest rate environment will add to the performance considerations of many banks.

The next question comes from Dave Bishop with Seaport Global. Please go ahead.

A quick question; it sounded like the retention of mortgage production on the residential side jumped about 10% in the fourth quarter. Just curious how you're thinking about that heading into 2021 if you think that overall retention rates should continue to remain elevated relative to 2020?

Yes. I think it's appropriate to be a bit more aggressive in putting that production onto our portfolio. Certainly, we have encountered challenges growing that overall book while maintaining balance on our balance sheet. In this environment, the refinancing activity creates a good deal of outflow. We want to be cautious in protecting the long-term health of our balance sheet. Thus, we will continue to look to be a bit more aggressive in putting production on the balance sheet. I will say that in the last couple of weeks, with the 10-year treasury showing some life and tick up a bit, this is contingent on the overall economic environment and certainly what will transpire with mortgage rates. If we start to see a bit of lift on the long end of the curve, without an immediate reaction on mortgage pricing, we wouldn't continue to feel comfortable putting that lower price at that duration on the books, but all things considered, I think the levels we did in the fourth quarter created a good baseline for what we would be comfortable going forward into 2021.

And then popping back to credit, thanks again for the added disclosures in the back there. Relating to the deferrals in some of the areas you're looking at, but going perhaps a layer deeper. We're still waiting on what's happening with substandard loans and special mentions. Do you think you have the areas identified fairly well? I guess my question is, are you observing any bleed-through to other segments or sectors that perhaps didn't make these tables but could be considered indicators of potential concern heading into 2021?

The short answer is no, David. I mean, we frequently discuss our strategy and the value of knowing our markets, staying geographically centralized and the diversification across industries and product levels. Managing our size and loan exposure gives us significant comfort that we know our borrowers well and understand where the risk lies, allowing us to identify where we believe there continues to be risk accurately. We can't sugar coat the fact that there is still a lot of uncertainty in our geography here in Massachusetts. There are still many businesses with limitations on being able to stay open, occupancy rates, etc. So we are very cautious to suggest we're past all major concerns, but we think we have a solid understanding of where that risk lies, and we believe we've captured it appropriately in our reserving and provisioning. We're not seeing any delinquency metrics or significant changes in our classified levels that cause additional concern outside of what we have reserved for.

And one final question; I’m not sure if I missed or heard you here. It sounds like you see some opportunities within the commercial real estate subset. Just curious where you see those opportunities, and did I hear you correctly that you're becoming increasingly constructive about Boston or are you remaining cautious in terms of that market?

No. We're still being cautious, but let me turn it over to Gerry for a bit more insight into the commercial real estate market.

Yes. What I think we've observed are opportunities in suburban apartments. The demand for housing seems to be increasing daily; stories are surfacing about the lack of availability of homes to purchase. This has been driving increases in apartments. Individuals are opting for suburban locations, at least for now, whether that’s permanent or not. We’re also noticing opportunities with mixed-use as well as flex and warehouse industrial spaces. I think it's still too early to determine how strong the demand will be for lab and light space in Massachusetts, but I think it will be strong. Additionally, I see a general re-establishment of bringing back a lot of capacity to the United States from overseas—this bodes well for Massachusetts in the near future, but it is early to feel completely confident. So, to summarize, where we see the most opportunity is in warehouse industrial, flex space, and mixed-use.

Is the ongoing situation—many universities here in the Mid-Atlantic are still virtual—affecting the commercial real estate market concerning student housing? I’m curious if you have much exposure there, but is there any macro impact in the market?

Yes. In Boston proper, where many students typically reside, certainly the apartment buildings around colleges have more vacancies than they did previously. Just to provide some context, in September, which typically peaks for occupancy in Boston due to students, there were about a thousand empty apartments compared to the usual three or four. However, this situation has since improved; many students who don’t want to stay at home during remote learning are now opting for independent living in apartments with friends. It's actually leading to better occupancy rates. So while they may be in school virtually, they're still choosing to be in the apartments, which is part of growing. Nevertheless, we are cautious regarding new credit in Boston until we clearly understand the consequences of this pandemic.

The next question comes from Chris O'Connell with KBW. Please go ahead.

Just a couple of questions. First off, how do you guys expect the PPP forgiveness schedule to play out over the course of 2021?

Yes, certainly we think that should start to accelerate now in the first quarter. There has been a lot of waiting around for that simplified form for borrowers under $150,000, which was just released this week. We anticipate this to serve as a catalyst for significant forgiveness activity early in 2021. I would expect that we should see most of that forgiveness processed in the first six months.

Great. And finally, regarding excess liquidity. Overall loan growth seems likely to remain modest for 2021; you have between $900 million and $1 billion in excess cash on the balance sheet. At what point do you consider putting that into securities, even if the yields aren't highly attractive, just to achieve better yield than simply keeping it in cash?

Yes, it's a great question and one we discuss weekly. The positive development is we are gaining more comfort, as I mentioned, with the 10-year yield increasing a bit. This provides us room to be more aggressive than we have been in a while, as evidenced by us putting meaningful net growth into the securities book just this first quarter. It is the most obvious lever we’ll pull and one that we plan to be more aggressive in throughout 2021. I think on the margins, we will continue investing more of that cash into securities. There are some smaller fringe investments we need to keep an eye on as well, such as BOLI investments and low-income housing tax credit investments, for which we see merit. We’ll proceed where possible, keeping in mind that there isn't a single strategy that will dramatically address this situation, but we are optimistic about opportunities to make some improvements.

This concludes our question-and-answer session. I would like to turn the conference back over to Chris Oddleifson for any closing remarks.

Great. Well, thank you very much, everybody. Appreciate all your good questions. We look forward to talking to you in three months and between now and then stay safe. Bye.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.