Earnings Call Transcript - INDB Q2 2023

Operator, Operator

Good morning, and welcome to the INDB Independent Bank Corporation's Second Quarter 2023 Earnings Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Before proceeding, please note that during this call, we will be making forward-looking statements. Actual results may differ materially from these statements due to a number of factors, including those described in our earnings release and other SEC filings. We undertake no obligation to publicly update any such statements. In addition, some of our discussion today may include references to certain non-GAAP financial measures. Information about these non-GAAP measures including reconciliation to GAAP measures may be found in our earnings release and other SEC filings. These SEC filings can be accessed via the Investor Relations section of our website. Finally, please also note that this event is being recorded. I would now like to turn the conference over to Jeff Tengel, CEO. Please go ahead.

Jeffery Tengel, CEO

Good morning, and thanks for joining us today. I'm joined this morning by Mark Ruggiero, CFO and Head of Consumer Lending. Our second quarter performance was a solid one marked by healthy new loan volumes with moderating attrition, stable deposit levels, higher fee income, contained expenses and ample liquidity and capital. While the current rate environment continues to pressure earnings in the banking industry, we are continuing to act on our long-standing strategies and are well-positioned when things begin to turn. Mark will take you through the quarter, but I'd first like to offer some observations following my first full quarter as CEO. Beyond addressing the current industry dynamics, my efforts have been focused on continuing to personally engage with all of my Rockland Trust colleagues, deepening my understanding of individual business units and sizing up additional growth opportunities for future consideration. In a nutshell, I came away even more impressed and excited about our franchise and the opportunities in front of us. Rockland Trust has a solid foundation and a number of attributes that position us for future success. We operate in markets with highly attractive demographics that has guided our thoughtful acquisition and organic growth initiatives over the years. It's a market with household income levels and projected growth that are above national averages with multiple growth industries and a deep labor pool arising out of the many universities in the region. We have a business mix and a full suite of commercial and consumer product offerings, which meets the increasingly sophisticated needs of our client base that is complemented by a large and scalable investment management business and an extensive retail branch network. Our footprint now extends from Greater Boston, West Worcester and down through Cape Cod and the islands with the number one share in key local markets, while the number of households served continues to reach record levels. I've been very impressed by the caliber of both customer-facing and support staff and the depth and quality of the senior management ranks, many of whom have decades of experience at Rockland Trust. We have a passion for service excellence and have the highest net promoter score in our market evidencing our culture where each relationship matters. We have a disciplined operating philosophy that has guided Rockland Trust over its 100 plus years. Our risk management culture is deeply embedded throughout all levels of the company. This discipline has allowed us to emphasize those businesses where we have a competitive advantage and to avoid pursuing activities where we can add value. When you put all that together, Rockland Trust has consistently demonstrated solid profitability with an EPS compound annual growth rate of 10% over the past 10 years. We have a track record of strong performance on ROA, ROTC, efficiency ratio, credit costs and cost of deposits. This has led to a consistent growth in tangible book value per share through multiple cycles and despite multiple acquisitions. At the same time, we've been investing in our technology. We leverage best-in-class applications like Salesforce and Encino. We're rolling out a new online account opening application. We've invested in other customer experience-driven technologies, including applications geared towards guiding our customers through their financial journey with personalized insights, advice and automated money management. We are continuing to use RPA to help increase our productivity with repetitive tasks. And finally, we're upgrading our core platform that will modernize and improve the front-end user experience and advance day-to-day operational efficiencies. Before turning it over to Mark, I want to publicly thank Chris Oddleifson, our now-retired CEO, who has provided invaluable advice and insights during my onboarding. Chris has been extremely helpful in accelerating my learning curve and he is a ready source of ongoing counsel should the need arise. And on that note, I'll turn it over to Mark.

Mark Ruggiero, CFO

Thank you, Jeff. I will now take us through the earnings presentation deck that was included in our 8-K filing and is available on our website in today's Investor portal. As Jeff touched on many of the themes noted on Slide 2, I will move to Slide 3 of the deck which summarizes our second quarter results and key drivers. 2023 second quarter GAAP net income grew to $62.6 million and diluted EPS of $1.42, which reflected modestly higher loan balances, stable deposit levels, competitively higher funding costs and higher fee income along with the full quarter benefit of our first quarter buyback activity. These results produced a 1.29% return on assets and an 8.78% return on average common equity and a 13.54% return on tangible common equity. And despite additional other comprehensive losses, tangible book value grew $0.57 or 1.4% in the second quarter. I'll now discuss the primary drivers behind the second quarter results as highlighted on this slide. As we move to Slide 4, we will focus first on deposit activity which remains top of mind. Total deposits declined minimally by $24.1 million or 0.2% to $15.25 billion when compared to last quarter. While the cost of deposits increased from 59 basis points in Q1 to 85 basis points in Q2, driven primarily by a continued shift to a more normalized overall funding profile. The modest balance change for the quarter reflects a meaningful stabilization of our overall deposit balances. Our longstanding focus on core relationship accounts drove a healthy 1.1% increase or 4.4% annualized in total households for the quarter, as we are really starting to see our award-winning customer service and market reputation resonate with both existing and new customers amidst the market disruption in our footprint. Continuing to focus on the strength of our deposit base, Slide 5 provides updated information regarding uninsured deposit balances, also reflecting stable levels when compared to the prior quarter. Turning now to Slide 6, we provide additional information regarding the company's overall liquidity position, including details around the measuring and monitoring of both on and off-balance sheet metrics. The Q2 activity reflected in our interest-earning cash position includes a couple of items worth highlighting. First, in response to the stabilizing deposit environment, we just talked about, we reduced the amount of proactive borrowings from $300 million to $100 million during the quarter. In addition, you can see the rest of the quarterly cash activity is primarily a function of our core operating business and balance sheet changes for the quarter. Regarding our off-balance sheet borrowing capacity, we pledged additional securities during the second quarter to increase our overall borrowing capacity at the Federal Home Loan Bank of Boston and we continue to track and monitor deposit activity to ensure appropriate risk mitigation as evidenced by our strong uninsured coverage metrics noted on this slide. Another important element of both our interest rate and capital risk management, Slide 7 summarizes key information related to our securities portfolio, which totaled $3 billion at quarter-end with an unrealized loss position on the AFS portfolio of $160 million or 10.4% of the portfolio. Not included in the reported balances is another $180 million of unrealized losses on the held-to-maturity portfolio or 11.1% of those balances. The average life of the entire portfolio was approximately 4.5 years with details of expected principal repayments over the next three years included on this slide. In terms of the portfolio impact on capital, we highlight that the tangible capital ratio remains very strong at 9.4% even when factoring in the held-to-maturity portfolio unrealized losses, net of tax. Moving to Slide 8. Total loans increased 1.4% or 5.5% annualized to $14.1 billion for the quarter, driven primarily by disciplined growth in our residential real estate and overall commercial portfolios, which are also benefiting from lower attrition levels. While we remain cautious in our approach to new loan opportunities, we are optimistic over second half deal flow. Our approved commercial pipeline at quarter end sits at a healthy $239 million and is anchored in our core relationship-based lending that has served us well over many years. And on the consumer portfolios, we are prioritizing salable or variable rate portfolio products on the residential lending side in addition to a stable home equity pipeline. And while Slide 9 provides an overall snapshot of the makeup of the various loan portfolios, we will dive a bit deeper into overall asset quality and non-owner occupied commercial real estate exposure. Regarding the latter, we move to Slide 10, which provides several details over that portfolio. As indicated, while we disclose owner-occupied and mixed-use balances in the top chart, our enhanced disclosure and credit risk monitoring is primarily focused on the approximately $1.07 billion of non-owner occupied office portfolio. Big picture, the current quarter migration of $14.2 million loan into nonperforming is driving the majority of the additional reserve allocation provided for in the quarter. While we continue to closely monitor the remaining exposure for any further degradation, as we work through that enhanced monitoring, we remain cautious yet confident in the current status, noting that within our top 20 largest office balances, there are zero nonperforming and zero delinquent loans within that group. And noted on Slide 11, the story embedded in the graphs presented here is fairly straightforward. As I mentioned during the second quarter, we fully charged off the $23 million C&I loan that had already been fully reserved for as of last quarter, accounting for the vast majority of charge-offs in the quarter. Regarding that loan, we are still working through remediation efforts and any possible loss recovery is unknown at this point. As I noted on the previous slide, the provision for loan losses in the quarter was driven primarily by one office CRE loan that moved to nonperforming status and all other asset quality metrics remained stable. Turning to Slide 12, the net interest margin, the full quarter of increased wholesale borrowings and higher deposit costs resulted in a 25 basis point reduction in the reported net interest margin to 3.54% for the quarter. When excluding non-core items, the core net interest margin decreased 26 basis points for the quarter. And as noted in the charts below, we now peg the cumulative beta impact on both the loan and deposit portfolios at 28% and 16%, respectively. Though deposit rate pressures will persist, on a positive note, the relative stability of the deposit balances experienced in the second quarter along with asset repricing and hedge maturities benefit should provide a path to future margin stability in the second half of the year. Noted on Slide 13, fee income increased nicely in the quarter, fueled by increased wealth management fees, loan level derivative swap income and other miscellaneous items, and another solid quarter of new money inflows in our wealth business along with market appreciation drove an overall increase in assets under administration to a record $6.3 billion at June 30, a $159 million or 2.6% increase over the prior quarter. As evidenced, this is further evidence of our focus on operating leverage. Total expenses noted on Slide 14 decreased by $3.1 million or 3.1% when compared to the prior quarter as we continue to ensure there is an appropriate balance of near-term expense discipline while not sacrificing investments in the company's future value initiatives. Lastly, as summarized on Slide 15, we provide an updated set of guidance focused primarily on general trends over near-term expectations. As noted, we now expect relatively flat loan balances for the second half of the year. Though deposit balances are stabilizing, we further expect remixing of noninterest-bearing deposits into term deposits, which will continue to pressure the net interest margin in the near future. Using the forward curve, assumptions we expect the margin to stabilize in the $335 million to $340 million range during the second half of the year, likely in the fourth quarter. Similar to the first half of the year, we expect changes in our borrowing levels will primarily be a direct reflection of loan and deposit changes. With the level of uncertainty still impacting all loan portfolios, we anticipate the provision for loan losses will be driven primarily by the near-term performance of our investment commercial real estate portfolio and the office exposure, in particular. Regarding fee income, we anticipate flat to low single-digit percentage increases when compared to Q2 results. And for non-interest expense, we also expect relatively flat to slightly increasing levels as compared to Q2. That concludes my comments, and I'll now turn it back to Jeff. I'm sorry, we're actually going to take questions.

Operator, Operator

We will now begin the question-and-answer session. The first question comes from Mark Fitzgibbon with Piper Sandler. Please go ahead.

Mark Fitzgibbon, Analyst

Hey, guys, good morning.

Jeffery Tengel, CEO

Good morning, Mark.

Mark Fitzgibbon, Analyst

First question I had for you is on that $14 million credit that went non-accrual this quarter. I'm curious, is it a loan in Boston? And I was also curious what the LTV looks like on it and whether you have had it reappraised yet?

Mark Ruggiero, CFO

It's not located in downtown Boston, which is why it's not part of our Financial District or Back Bay exposure. Instead, it's in a suburb of Boston and has a unique situation. We are currently negotiating with the borrower. The loan was supposed to mature back in May, so it's about 60 days past due. We decided to put it on discretionary non-accrual since we don't have any formal forbearance or modification in place yet. There is some vacancy in the facility affecting cash flows, but we are still working with the borrower to stabilize the situation. For now, we felt it was prudent to adopt a conservative approach and classify it as non-accrual while we continue discussions with the borrower.

Mark Fitzgibbon, Analyst

And do you have a sense for what the rough LTV on that is, Mark?

Mark Ruggiero, CFO

Yeah. Our most recent appraisal also helped us to make that decision that we felt there was a deficit in terms of the appraised value compared to what it is on the books. We've actually set up a specific reserve to the tune of about $4 million at the end of the second quarter based upon the recent appraisal.

Mark Fitzgibbon, Analyst

Okay, great. And then secondly, on Page 10 of your Slide deck, which was super helpful. Thank you. Am I reading it right that about 40% of the office book will mature or reprice within the next two years?

Mark Ruggiero, CFO

Yeah. We have about 22% of that will actually mature within the next two years. And then we have adjustable rate loans that we're looking at that will come up for a new rate reset within the next two years, and that's another 19% or so.

Mark Fitzgibbon, Analyst

Okay. Any thoughts about maybe trying to sell some office loans given where we are in the cycle with this stuff?

Jeffery Tengel, CEO

I don't think so. Not at this point. We still feel pretty good actually about our underlying portfolio and the underwriting historically that we've done on that. So I think we're going to hang in there. I think a lot of our customers are going to work with us. We've seen some of that already as we've been proactively reaching out to them. And there is a practical reality that I don't think there's a lot of buyers, at least not at the levels that we'd be comfortable with.

Mark Fitzgibbon, Analyst

Okay. And then I saw your comments on provisioning being somewhat dependent on office portfolio trends. Should we take that to mean that there could be some more sort of swings in the provision, larger swings than maybe we're accustomed to seeing on provisioning levels?

Mark Ruggiero, CFO

Not necessarily, Mark. What I was trying to convey is, I think what you've seen over the last few quarters for us. The provision there has really been tied to the movement of one or two large credits. But as we sit here today with the one loan we were just talking about that moved into nonperforming, right now we have no other nonperforming or delinquencies within that office pool, which is where we see the most risk. So, I think we're feeling good about credit. We're continuing to monitor, obviously, the subset of the portfolio. You referenced in terms of what's coming due is where we're spending a lot of our efforts, but right now looking out on the horizon, things are looking pretty good. So I think, barring any movement into non-performing, we should see some stabilization on provision.

Mark Fitzgibbon, Analyst

Okay. And then lastly, what do you think the cumulative deposit beta looks like when we sort of fully get through the cycle, the rising rate cycle? I think to date, the cumulative deposit beta is like 16%. Where do you think that settles out?

Mark Ruggiero, CFO

Yes, it's a great question and how I think about it, embedded in that margin guidance we've provided in terms of how we're thinking about where the level would stabilize. That would suggest our cumulative deposit beta probably gets to about 20% or so, maybe slightly higher than that. But I think that's, as I said, all through the cycle, that's right in the range that we've always talked about and think about the performance of our deposit franchise. It's consistent with how we do a lot of our ALCO modeling. So it's been comforting to see that through the cycle beta as we'll probably get to the point that we've always thought about.

Mark Fitzgibbon, Analyst

Thank you.

Mark Ruggiero, CFO

Thank you.

Operator, Operator

Our next question comes from Steve Moss with Raymond James. Please go ahead.

Steve Moss, Analyst

Hi. Good morning.

Mark Ruggiero, CFO

Hi, Steve.

Steve Moss, Analyst

Maybe just following up on the deposit beta there. You mentioned total deposit beta, Mark. Just curious, in terms of the level of remixing you're assuming there is maybe just a little bit more noninterest-bearing to interest-bearing remix. Is that a fair assessment?

Mark Ruggiero, CFO

It's difficult to provide an exact number, but I believe the migration we've observed over the past few quarters will continue. There is still some room for improvement. Historically, our noninterest-bearing demand deposits were around 29% of total deposits pre-COVID, and we are currently at about 32%. I hope to maintain that 30% range, and it's possible we could drop to the low 20%. Overall, I see a positive trajectory moving forward.

Steve Moss, Analyst

Okay. Appreciate that color. And then in terms of just on loan pricing here, curious to see where new loans are coming on the books. And you mentioned you had a pretty healthy pipeline, just kind of what you're expecting to come on later this year for yields?

Mark Ruggiero, CFO

Sure. New originations are currently showcasing a contrast between fixed and variable rates. In the second quarter, much of our activity was in the residential portfolio for fixed-rate, which remains competitive, particularly in the middle range. Most of our new fixed-rate loans were around 6%, and that is now shifting to the mid-6% range. Conversely, for variable pricing, whether based on SOFR or prime lending, we closed deals in the mid to high sevens, which is expected to trend upwards towards the high sevens and even reach 8% on several loans. The mix appears to be fairly balanced, with a focus on increasing variable rate lending going forward, leading to an expected all-in rate on new originations of around 7%.

Steve Moss, Analyst

That's helpful. Regarding the pipeline, your guidance suggests it will be relatively stable for the second half of the year. However, you seem optimistic about potential growth due to your pipeline. I'm interested in exploring that further.

Jeffery Tengel, CEO

Yeah. So the flatness that we're thinking about over the second half of the year really comes about because of the ongoing amortization in the portfolio and then a little bit of attrition, but we do feel good about the value proposition that we have in the marketplace and the stability of the franchise. So, we've continued to support our existing customers and are actively prospecting for new customers and some of that prospecting is starting to pay off in the form of new business. So we feel like we have a pretty engaged and active sales force and expect to be able to take a little bit of market share in the second half.

Steve Moss, Analyst

Okay, great. Appreciate all the color. Thank you very much.

Jeffery Tengel, CEO

Thank you.

Operator, Operator

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

Chris O’Connell, Analyst

Good morning. Just wanted to circle back on the office portfolio and see if you guys had a total reserve for the entirety of the portfolio, not just the one credit that migrated this quarter?

Mark Ruggiero, CFO

Yes. It's pretty consistent with the total overall allowance, Chris, in terms of specific allocation to that portfolio.

Chris O’Connell, Analyst

Okay. Got it. And then, just wanted to get a sense of, from a strategic standpoint, there's been a lot of disruption in your markets. Have you guys been looking at a lot more hiring opportunities? If so, what types of teams or personnel are you guys most looking to add on a go-forward basis?

Jeffery Tengel, CEO

We continue to look for opportunities in that area. I have always believed that having the best people is key to success. When talented individuals become available, we tend to act quickly and effectively. We have a strong narrative to attract great talent. We've noticed that we are most successful in recruiting individuals from larger banks in the region, as they find the prospect of working for Rockland Trust appealing. We offer many of the same capabilities as larger banks, but with greater agility, allowing us to respond more quickly. One advantage of hiring from that pool is that these candidates usually possess strong credit skills and are well-versed bankers, making them a good fit for our objectives. We have seen some success in the first half of the year and have brought on four to five new team members from that talent pool, and I expect we will remain proactive in recruiting in the second half of the year.

Chris O’Connell, Analyst

Great. Do those hiring opportunities create any pressure on the overall expense base as we approach 2024? Or do you have the ability to offset in other areas? Could you also provide more detail on the core platform enhancement you mentioned in your prepared comments?

Mark Ruggiero, CFO

To address your first question, Chris, I don't expect this to significantly affect our expense run rate moving forward. As you pointed out, we are focused on identifying areas where we can offset expenses while continuing to invest wisely in the future. We're effectively finding a balance that keeps any expense increases manageable. We should be able to maintain that even as we look to expand our hiring in the areas Jeff mentioned that make sense. Regarding technology spending, we are currently upgrading our core provider, which will enhance efficiency internally. The new user interface will improve usability for our team, along with better risk and governance settings. There is a one-time expenditure as we engage consultants to help optimize this technology and our processes. Overall, we anticipate the technology spending to be around $1 million to $1.5 million, and this won't have a substantial impact on our expenses in any given quarter or overall run rate.

Chris O’Connell, Analyst

Okay. Got it. And I know that after the big slug of repurchases in the first quarter, you guys were looking to take a little bit of a pause just given the overall economic environment that we've had since then. But obviously, I mean, capital levels are really strong all around TCs now at 10% and the guidance does imply pretty minimal balance sheet growth here for the next couple of quarters. Have you guys thought about whether there will be additional repurchases at some point in the back half of the year or into 2024? And I guess, if not, what would trigger that decision?

Mark Ruggiero, CFO

Yes, I think your question hit on a lot of the things that we're constantly talking about and considering in that decision, Chris. Certainly, absolute levels of capital remain very strong. And we certainly think there's an opportunity to look to deploy capital in that sense and rightsize capital a bit. But we will obviously and continue to be very cautious around just ensuring the stability of the franchise as a whole. And a couple of things that are certainly pointing in the right direction. We talked about the deposit stabilization in the second quarter. And I think that's a really strong indication of things getting back to normal heading into the second half. And then certainly from a credit standpoint, we're monitoring some of these individual credits that we've been highlighting in the materials, but all in all, we still feel very good about credit. So I think a lot of the things we've been weighing and thinking about in terms of that decision are becoming more clear. I'd like to think there's a stronger opportunity for buyback here in the second half. We haven't made a final decision on that yet, but I do think it's certainly reasonable for us to get to a point where we think that makes sense and we'd be comfortable with it.

Chris O’Connell, Analyst

Okay. Got it. And just last one for me. Outside of the office portfolio here, I mean, obviously, you kind of talked about general CRE, but is there any other pockets of stress that you're seeing either within your portfolio or in your markets? Or areas where competitors are being aggressive on either pricing or structure where you might just be kind of pulling back on or having additional caution on at this point in the cycle?

Jeffery Tengel, CEO

In response to your first question, we are not observing any significant stress in other areas of the portfolio, nor do we feel that there are any indicators causing us to be cautious or to pull back. We have a strong confidence in the historical underwriting practices of our company. As for the second question, we have consistently maintained a disciplined approach regarding both loan pricing and credit quality, and that remains unchanged. We generally do not chase opportunities when the market becomes competitive. In some sectors, it appears that competitors are becoming more conservative and aligning with our long-standing approach. We are confident in our market messaging and our capacity to compete effectively. Historically, we have not focused on competing based on rates and structures, and we do not intend to do so now. This reflects our historical credit quality and operational performance along with the type of customers we have engaged with over the years.

Chris O’Connell, Analyst

I appreciate the insights you've shared. That's all I have for now. Thank you.

Jeffery Tengel, CEO

Thank you.

Operator, Operator

Our next question will be a follow-up from Mark Fitzgibbon with Piper Sandler. Please go ahead.

Mark Fitzgibbon, Analyst

Hey, guys. Just to clarify one of the responses to Chris' questions. Did I hear correctly, Mark, you said the reserve on the office book is consistent with the rest of the portfolio. And so I think the office book is $1.1 billion, so roughly 1% reserve on total loans. So you have about $11 million of reserves against the office book. Is that correct?

Mark Ruggiero, CFO

Yeah. I don't have the exact number, but we don't have necessarily a meaningfully noted elevated reserve against it. We have qualitative factors that look at commercial real estate as a whole. We've certainly ticked up a bit there because of the office exposure. And just keep in mind, we have the specific reserve on the one that is nonperforming. So we have a general, call it, one maybe slightly higher than that allocation over and above that specific reserve as well.

Mark Fitzgibbon, Analyst

Got you. Thank you very much.

Operator, Operator

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

Jeffery Tengel, CEO

Thank you. We are fully cognizant that there is no shortage of uncertainty regarding the current macro environment and its impact on near-term earnings. In that context, I would close by underscoring that we are well situated to absorb its challenges while positioning ourselves to take advantage of opportunities when the environment shifts. That confidence emanates from our excess capital position, combined with strong internal capital generation, scalability of our franchise, stable core deposit base, attractiveness of our brand and community banking model, a track record as a proven operator and acquirer, and a conservative balance sheet providing downside protection. Thank you for your continued interest in Independent Bank Corp.

Operator, Operator

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