Earnings Call Transcript - INDB Q3 2023

Operator, Operator

Good morning, and welcome to the Independent Bank Corp. Third Quarter 2023 Earnings Conference 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 in the Investor Relations section of our website. Finally, please note that this event is being recorded. I would now like to turn the conference over to Jeff Tengel, CEO. Please go ahead.

Jeff Tengel, CEO

Thanks, Anthony, and good morning, and thanks for joining us today. I'm accompanied this morning by CFO and Head of Consumer Lending, Mark Ruggiero. Our third-quarter performance was a solid one given the macro environment and included stable deposit flows, modest margin pressure, benign credit, higher fee income, and disciplined loan growth. Mark will take you through the details in a minute but I thought I'd offer a few observations prior to. Needless to say, there are many near-term challenges confronting the banking industry. I feel we've weathered them quite well thus far. We continue to focus on our distinct strengths and expertise. It's this operational resiliency that has served us well through the years during a variety of credit and economic cycles. Rockland Trust competes in the areas where we can bring unique value, resources, and acumen. Our goal is to achieve top quartile performance while delivering a differentiated customer experience where each relationship matters. Equally important is knowing where we cannot offer a unique client experience and steering resources elsewhere. As we manage through this unprecedented rising rate environment and the lingering issues brought on by the pandemic, we also keep an eye towards the future. Trust me, there's no grand strategic vision being undertaken here. We're simply looking at the best way to capitalize on our inherent strength in a rapidly changing competitive playing field focusing on long-term value creation. We remain committed to our disciplined approach to building profitable relationships and executing our community banking model that has served Rockland Trust so well over its 100-plus years. In some respects, it's getting back to basics, organic growth in the absence of M&A and focusing on being efficient and effective at $20 billion in assets. While M&A has been a significant value driver in the past and will again in the future, we are not sitting around waiting for the next deal. With that in mind, we do see near-term growth opportunities to exploit our proven operating model in a variety of ways, including leveraging the Rockland Trust business model in our newer markets like the North Shore and Worcester, continued investment in technology and data analytics to deliver actionable insights for our bankers, ongoing focus on organic loan and deposit growth in our legacy markets, and opportunistically attracting high-performing talent who can drive revenue. Although the M&A activity continues to be somewhat muted, we will continue to be disciplined on the M&A front when conditions improve. Points to take advantage of opportunities that fit our historical acquisition strategy and pricing parameters. To summarize, we have everything in place to deliver the results the market has been accustomed to over the years including a talented and deep management team, ample capital, highly attractive markets, good expense management, disciplined credit underwriting, strong brand recognition, operating scale, and an energized workforce. Before turning the call over to Mark, I'd like to note the $100 million share repurchase program we just announced. In this environment, we obviously take our capital position very seriously. At the same time, we recognize that perceived industry concerns can cause our stock's valuation to reach levels that we feel warrant repurchasing stock. With that in mind, this share buyback program allows us the flexibility to create long-term value over time. And on that note, I'll turn it over to Mark.

Mark Ruggiero, CFO

Thanks, 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. Starting on Slide 3 of the deck, 2023's third quarter GAAP net income was $60.8 million, and diluted EPS was $1.38, which reflected another quarter of solid overall business activity amidst a very challenging environment. As Jeff alluded to in his comments, we grew total loans in a disciplined manner, maintained a stable funding profile, while growing household accounts generated strong fee income, experienced credit quality trends in line with expectations, maintained lower efficiency ratios, and authorized a new $100 million share repurchase program. In summary, these results produced a strong 1.25% return on assets, an 8.4% return on average common equity, and a 12.8% return on average tangible common equity. In addition, tangible book value per share grew $0.72 or 1.7% in the third quarter and is up almost 8% from the prior year period. Continuing to focus on a number of topics that are certainly top of mind, Slide 4 summarizes our deposit activity for the quarter. Although total deposits declined by $189 million or 1.2% to $15.1 billion for the quarter, average deposits remained relatively flat quarter-over-quarter. Approximately $240 million of the period-end decline is attributable to municipal deposits, which is typically impacted by seasonal declines in the third quarter. In addition, the remixing of deposits was modest with total non-interest-bearing deposits comprising 32% of total deposits at quarter end, representing no real change from the prior quarter. Reflecting a cumulative 20% deposit beta, the cost of deposits increased to a well-contained 1.07% for the third quarter, highlighting the differentiating value of our overall deposit franchise. In addition, new account opening activity remained strong on both the consumer and business front with an increase in total households for the quarter of 0.9% or 3.7% annualized. Though balance sheet growth is muted given the overall macroeconomic challenges, we firmly believe that this steady and consistent quarterly growth in households throughout 2023 provides the impetus for our long-term relationship banking model that has served us well for decades. Slide 5 provides updated information regarding uninsured deposit and overall liquidity information with no meaningful changes in overall risk posture quarter-over-quarter. Moving to Slide 6. We summarized key information related to our securities portfolio including updated information regarding book and fair values on both the available for sale and held to maturity portfolios. This further supports the share buyback decision. We note that the tangible capital ratio remains at a strong 9.5% even when factoring in the HTM unrealized loss position net of tax. Turning to Slide 7. Total loans increased 0.6% or 2.4% annualized to $14.2 billion for the quarter. The increase was fueled primarily by adjustable-rate residential loans while total commercial loans experienced a slight decline within this challenging environment. Having said that, new commercial closing activity has been solid and we remain optimistic and open for business in our markets as we continue to see market disruption drive a steady flow of new relationship opportunities across both our commercial and small business segments. And while Slide 8 provides an overall snapshot of the makeup of the various loan portfolios, we will take a deeper dive into overall asset quality, and in particular, an update on non-owner-occupied commercial office exposure. So regarding office commercial real estate exposure, we recognize this remains an area of deep interest. As we have noted in many conversations over the last couple of quarters, the ultimate credit performance will likely play out over time. As such, our goal is to be transparent to the investor community around the insights we gain as we continue to monitor and manage the portfolio. Slides 9 and 10 provide various updates and risk viewpoints on a number of factors. To highlight a few, I'll start with the current status update, which is positive. The one non-performing loan within the Office CRE portfolio from last quarter has been fully resolved with a $5 million charge-off taken during the quarter and the remaining $9 million paid in full subsequent to quarter-end. As a reminder, this loan was largely reserved for last quarter. Total criticized and classified balances within the office portfolio are currently comprised of only 11 loans and are monitored closely by an experienced credit and workout team. In addition, we continue to closely monitor and provide insight on our top 20 office exposures which make up approximately $504 million in balances or 48% of the entire office portfolio. Within these top 20, we note zero non-performers, $56 million in a criticized status and $28 million classified with every one of these loans recently reviewed for appropriate risk rating adjustments. The bigger credit picture across the broader loan portfolio is reflected in the graphs noted on Slide 10. While we certainly aren't immune from the inevitable bumps and bruises in our industry through this cycle, we remain vigilant and confident in our approach to managing credit risk as evidenced by the decrease in total non-performing assets and contained net charge-off and provision expense results in the quarter. Turning to Slide 11. As anticipated, the continued pressure on cost of deposits outpaced asset yield repricing benefit resulting in a 3.47% margin for the quarter, which reflects a 7 basis point drop from the prior quarter or only 5 basis points when excluding non-core items. I'll include specific margin guidance here in a couple of minutes, but some key items regarding the margin that are worth noting are highlighted on this slide. In summary, we will experience margin benefit resulting from general asset repricing in the higher rate environment from both loans and securities as well as the maturities of certain one-month SOFR macro level hedges. Assuming a more stabilized rate environment in the first half of 2024, we would anticipate this benefit will outweigh the increases in overall deposit costs which will continue to be impacted by time deposit maturities. Moving to Slide 12. Fee income was up nicely for the quarter as overall deposit and ATM activity remains strong, and wealth management income experienced increased insurance and retail commission income to help offset the drop from seasonal tax preparation fee recognized in the second quarter. The quarter also reflected approximately $2.7 million of combined benefit from gains on bank-owned life insurance and loan-related fees. Turning to Slide 13. Total expenses increased $2.2 million or 2.3% when compared to the prior quarter, reflecting increased commissions, retirement benefits, and consulting expenses. Also included in the quarter was $750,000 of outsized expense related to one-time severance costs and volatile unrealized losses on a trading securities portfolio. Lastly, as summarized on Slide 14, we provide an updated set of guidance focused primarily on Q4 expectations. We expect low single-digit loan growth in the fourth quarter to be funded primarily from securities runoff. We anticipate flat to modest declines in total deposit balances, reflecting our typical Q4 seasonality impact. Using the current forward curve assumptions, we expect the margin to stabilize in the 335 to 340 range during the fourth quarter. Though ongoing uncertainty challenges, credit quality assumptions across all loan portfolios, we anticipate provision for loan loss will continue to be driven primarily by the near-term performance of our investment commercial real estate portfolio. Regarding fee income, we anticipate Q4 results largely in line with Q3 when excluding the non-recurring items I just referenced, and for non-interest expense, we expect relatively flat to slightly increased levels as compared to Q3. That concludes my comments, and we will now open it up for questions.

Operator, Operator

We will now begin the question-and-answer session. Our first question will come from Mark Fitzgibbon with Piper Sandler. You may now go ahead.

Mark Fitzgibbon, Analyst

Hey, guys. Good morning. And happy Friday.

Mark Ruggiero, CFO

Hi, Mark. Happy Friday, Mark.

Mark Fitzgibbon, Analyst

Mark, I was curious, what gives you so much confidence that deposit costs won't remain under pressure for a while, especially given that your cost of deposits is low relative to your peers?

Mark Ruggiero, CFO

Yeah. We certainly expect the cost of deposits to continue to increase, Mark. I'd say the benefit is really on the asset side, where we believe we'll continue to see repricing benefit that will mitigate the majority of those costs continuing to rise. So I highlighted a couple of key items in my comments. But if you look out over the next 12 months, we have a number of levers that will drive outsized asset yield benefit compared to what you've seen over the last couple of quarters. So in particular, not only loan and securities runoff, but the hedges will continue to mature. And every one of those factors give some meaningful lift to the margin. So I think it's really that dynamic, we believe, will start to outpace what we still expect to be continued increases on the deposit side such that the margin stabilizes heading into 2024.

Mark Fitzgibbon, Analyst

Okay. And then on the buyback program, historically, you guys have sort of just used it opportunistically if the price got really cheap. But it seemed like in the past, you were more focused on using excess capital to support acquisitions with it harder to do M&A right now. Is this kind of a strategic shift in your thinking with respect to buybacks? Or should we expect more of a kind of a pedal to the metal approach than maybe that opportunistic sort of a little less often with the buybacks that we saw in the past?

Jeff Tengel, CEO

Yeah, Mark, it's Jeff. I'll take a shot at that. I don't think this is a kind of a strategic shift in our mindset. I think honestly, we just thought at the levels our stock is trading and with the amount of capital we had, it really was prudent for us to take advantage of a buyback in the environment we're in today. And I think importantly, even if you assumed we did the entire buyback today, we're still going to be very well capitalized and feel like our currency will enable us to continue to pursue acquisitions down the road should they present themselves. So not really much of a strategic change. I would characterize it more as very opportunistic.

Mark Fitzgibbon, Analyst

Okay. Lastly, regarding office, your slide indicates that about a third of your office portfolio will mature or reprice over the next two years. What do those renewals look like? Do you reappraise all of them, and how much does your value decrease when you do so? Additionally, what are the loan-to-value and debt service coverage ratios for the new loans?

Mark Ruggiero, CFO

That's a great question. Unfortunately, the answer is still largely uncertain. We're finding that each situation has unique facts and circumstances. Generally, when we examine the group set to mature or reprice, it appears to break down consistently over the next 24 months. We have about $100 million maturing soon, with a slightly higher concentration in the next three months, and then approximately $80 million in 2024 and $175 million in 2025. Notably, for the $100 million due in Q4, $70 million is related to just three loans. We have good visibility into each of those loans, and one has already been renewed in October. It's performing according to reappraised valuations, with a debt service of 1.2 and a loan-to-value ratio of 60%. This is an example of a situation where we expect the maturities to be relatively smooth, and we still see valuation and debt service at desirable levels. However, this may not be the case for every loan, as there are a few with weaker occupancy that we will manage. Overall, it's a manageable scenario. The current population maintains an LTV of around 60% to 65% and debt service of approximately 150-160. The amount of stress we might encounter as these loans mature depends on their specific circumstances. Nonetheless, we feel optimistic about the individual credits coming due in the near term.

Mark Fitzgibbon, Analyst

Thank you.

Mark Ruggiero, CFO

Sure.

Operator, Operator

Our next question will come from Steve Moss with Raymond James. You may now go ahead.

Steve Moss, Analyst

Good morning, guys.

Mark Ruggiero, CFO

Good morning.

Steve Moss, Analyst

Mark, just on your comment with regard to the margins stabilizing. If you could remind us the amount of fixed rate hedges maturing in 2024?

Mark Ruggiero, CFO

Yeah, I have. So the next 12 months is $300 million of hedges that will mature with an average strike rate of about 2.8%. So those in the current rate environment, we just reverted back to essentially a floating rate impact, which is well north of 5% today. So you're talking about a 225 basis point increase on that $300 million of notional.

Steve Moss, Analyst

Okay. Awesome. That's helpful. And then Jeff, on M&A, it sounds like M&A discussions are not active as kind of like how I'm thinking about it. Maybe just for interpreted. Just kind of curious are you having any discussions with anyone? Is it just seller resistance at current pricing? Any color you could share there?

Jeff Tengel, CEO

I'm still relatively new and trying to meet people to get familiar with the banking landscape in Massachusetts. This effort is ongoing, and many of those conversations are quite straightforward. However, in the current environment, the dynamics of deals make things challenging for both buyers and sellers. Sellers may think about increasing their franchise value and question why they would sell now. On the other hand, buyers face obstacles with the marks they would have to take in terms of tangible book value earnback scenarios. We will continue to have as many conversations as possible so that when the opportunity arises, some of the banks I meet may consider alternatives to staying independent and will reach out to us first. Both these factors are happening simultaneously, reflecting the challenging environment we are navigating while I continue to meet various bank executives in our area.

Steve Moss, Analyst

Okay, that's helpful. Regarding the $5 million charge-off, can you clarify if that resolution was achieved through a note sale, or provide any additional details on that?

Mark Ruggiero, CFO

That actually went to auction, believe it or not, Stephen. There was a lot of internal discussion about the appropriate resolution for that credit. This isn't necessarily the ideal environment for an office loan to be sold at auction. We could have considered different options and potentially held onto it for a slightly better outcome. However, we ultimately decided it was appropriate and prudent to go to auction, achieve the resolution we did, and move past that loan. It did go out at a foreclosure sale.

Jeff Tengel, CEO

I would just add to that, just to put words to Mark's comments, we could have kicked the can down the road. That was an option for us. And we just made the decision that we didn't see the level of commitment on the part of the sponsor that we felt was going to be appropriate. And so instead of kicking the can down the road, we decided to take our medicine now.

Steve Moss, Analyst

Okay, that's helpful. In terms of the margin, with the stabilization anticipated in the fourth quarter, what are you assuming for a deposit beta with a cumulative cycle holding steady at a 5.25-5.50 funds rate?

Mark Ruggiero, CFO

Yeah. No, we're at 20% cumulatively today. When I look out into 2024, I'd say the biggest driver is going to be primarily the level of CDs maturing. And if you play out essentially the entire CD book, if you just assume that matures at current rates, I think this the potential for anywhere of 10 to 15 basis points impact on the margin. I haven't done the math on what that does to the beta in particular, but I'd suggest that it certainly goes a bit north from where we are today. So I think if I were to do the math in my head, it feels like it probably stays in that mid-20s range.

Steve Moss, Analyst

Okay, great. Thanks for all the color. Appreciate it.

Mark Ruggiero, CFO

Thank you.

Operator, Operator

Our next question will come from Laurie Hunsicker with Compass Point. You may now go ahead.

Laurie Hunsicker, Analyst

Yeah, hi. Thanks. Good morning. Just going back to office here, and I really appreciate all your details. So the $14.2 million on performer that's sold, was that a Class A or Class B.

Mark Ruggiero, CFO

That was a Class B.

Laurie Hunsicker, Analyst

If I'm doing the math right, that was a 35.7 percent reduction in value.

Mark Ruggiero, CFO

Yeah, compared to what we added on the books at, I think that's right.

Laurie Hunsicker, Analyst

Okay. And then as far as the breakdown of your maturity, I mean, I think you guys were sort of put in the penalty box because you had so much debt to mature and reprice over the next two years compared to your peers that we've already walked back from in June, it was 41%. Now you're 33%. You've got this huge chunk that's coming in the fourth quarter, this $100 million, that's 9% right there of your whole balance. And Mark, thank you for the update on the one loan, but could you help us think about the other two loans? How do we get comfortable that, that $100 million is going to renew? How should we be thinking about that?

Mark Ruggiero, CFO

Sure. I mean the biggest of those three, just to give some facts to it, it's 85% occupied. It's currently at a 5% rate. So if we were to likely just renew and continue to price at the five-year part of the curve, you'd suggest pricing maybe only resulting in a 175 to 200 basis point increase in their rate. And when you look at debt service under that scenario, I think we continue to feel very good about that. So that's another one where I think our expectation is that renewal at current rates does not create undue risk or concern. And then the other is, again, pretty well occupied. There's a little bit of tenant rollover that they're looking for replacements on but based on the cash flow and sort of what we'd expect the LTVs at reappraisal, we think there's a pretty good story there. They've been very communicative with us through the process. We have really good direct relationships with most of these borrowers. So again, those three loans in the very near term, I'd say all three of them, we feel pretty good about.

Laurie Hunsicker, Analyst

Okay. And then the one that you already renewed, how much of the $100 million does that comprise?

Mark Ruggiero, CFO

That was about $18 million.

Laurie Hunsicker, Analyst

Eighteen million, okay. Great. Thanks for the color on that. And then just one more question on office. It looks like maybe you did a bit of a restatement, and I realize you gave a whole lot more details in so many of the other banks, but I'm just trying to make sure that I'm comparing apples-to-apples here. So your premixed use that was primarily office had it last quarter at $401 million, it looks like it's restated to $269 million. I just wanted to know what was the difference there.

Mark Ruggiero, CFO

Yeah. So hopefully, you can appreciate, Laurie, as we continue to mine the data and really do deeper dives into a lot of the portfolio. We thought it was appropriate to just continue to further clarify last quarter was mixed-use regardless of how much office was in that relationship. And what we want to do now is really start to highlight those loans that have primarily office exposure, so i.e., greater than 50% of it is office. So when you look through that same lens at the last quarter, that $400 million gets reduced down to $269 million. And that's more of the focus now going forward.

Laurie Hunsicker, Analyst

Okay, perfect. Okay. And then just one quick question on your owner occupied, and I realize owner-occupied is much lower risk, but is there anything that's concerning you in the owner-occupied book? Any trends that you're starting to see percolate from higher rates? Or how are you thinking about that?

Jeff Tengel, CEO

Yeah. I don't think we've seen anything in the owner-occupied that we're concerned about. And often, there's certainly nothing compared to the office, the non-owner-occupied.

Laurie Hunsicker, Analyst

Okay, great. I'll leave it there. Thanks for taking my questions.

Jeff Tengel, CEO

You're welcome.

Operator, Operator

Our next question will come from Chris O'Connell with KBW. You may now go ahead.

Chris O'Connell, Analyst

Hey, good morning. Hate to keep being a horse on the office side. But just wanted to see if you guys had any color specifically on what look to be some migration or perhaps just new loans moved into the Class A classified category from criticized?

Jeff Tengel, CEO

We are closely monitoring the situation and have our bankers focused on upcoming rate resets and maturities. As Mark mentioned earlier, each loan is unique, making it challenging to generalize. We are being thorough in our analysis, so we expect some fluctuations in the criticized and classified category. As of now, we have reviewed all loans with near-term risks and are confident in our current classification.

Chris O'Connell, Analyst

Okay, got it. On the current classification, we've gone through all the loans that have near-term risk and feel very comfortable with it.

Mark Ruggiero, CFO

And again, there's only a handful of loans, too, just and I don't think we gave the unit count, but that increase dollar-wise is primarily like two loans.

Chris O'Connell, Analyst

Okay. Great. Thanks. And can you just remind us kind of $240 million of the seasonal muni outflows this quarter, when those should come back in and if you think that you'll recapture the full amount of the seasonal outflows.

Mark Ruggiero, CFO

Yes, it's a good question. Certainly, we expect to recapture a good portion of that. There is some money in the third quarter, municipal related that was, I'd say, kind of coined as temporarily pocked here that did outflow in the third quarter that we wouldn't expect and that was about $80 million or so. But I do think the rest of that is consistent with where we saw municipal levels through most of the first half of 2023. So I would expect the majority of that to come back in at some point in the fourth quarter. But typically, we see a little bit of seasonality affecting our deposit balances in the fourth quarter, primarily on the consumer side and some of the holiday spending towards the tail end of the year, we may see a little bit of a dip on that front.

Chris O'Connell, Analyst

Got it. And excluding the seasonal factors in Q4 that you're referring to, on the overall kind of non-interest bearing deposit mix shift, I mean, it's kind of consistently declined in order of magnitude over the course of 2023. Do you think that there's still a little bit of mix shift left? Has it been slowing down over the course of the quarter and into the fourth quarter? What's your view on how much might be kind of remaining over the next couple of quarters?

Mark Ruggiero, CFO

Yeah. It certainly feels as if the shifting is slowing down. I think what we're seeing mostly drive the dynamic today is just the continuing repricing into the higher rate environment. So those CDs that were promotionally priced six-seven months ago, that is starting to mature. We'll obviously likely renew into now a higher promotional product. So I think it feels to me like the mix is starting to slow. I'm going to say it's 100% behind, but I don't think that's as big of an impact. But those deposit relationships where rate is important. I think you'll continue to see those same customers likely getting additional exception pricing higher or on the CD book maturing into a higher rate CD. So I think the population of deposits that we've priced up will continue to be a bit pressured.

Chris O'Connell, Analyst

Got it. That's helpful. And on the expense side, I appreciate the guide into Q4, and I know it's early for 2024. But I guess just in general, I mean, do you guys you started looking at 2024 in terms of expenses. I know there's opportunities to add hires here. But is there also some opportunities that you guys are exploring on the efficiency side or ways to kind of limit expense growth given the overall rate environment?

Mark Ruggiero, CFO

Absolutely. Certainly, as we head into our budgeting process for next year and strategic planning and thinking about some key initiatives that to your point, we want to obviously continue to invest in. There are areas in the bank where we're taking hard looks and we recognize there needs to be a very focused short-term view on expenses as well. So there will be less of an appetite to really look for any meaningful expense creep and we'll look at that very closely heading into 2024. And I do think there's very practical areas where we can hold the line and/or decrease.

Jeff Tengel, CEO

Yeah, that was a bit of my comments about kind of getting back to basics and being more efficient and effective is looking at some of the areas that Mark just spoke about. We've almost doubled in size in the last three years or so. And we're really taking a hard look at how we're organized and are we being as efficient and effective as we can be and making sure that we're being really focused on that. I would also mention that to the extent that we do have some opportunistic hires that we think can drive revenue, we would expect that to be incremental revenue over and above what we would be normally planning on in any sort of planning environment, whether it be 2024 or beyond. So they'll bring revenue with them.

Chris O'Connell, Analyst

Absolutely, thanks. Appreciate taking my questions.

Jeff Tengel, CEO

Thank you.

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.

Jeff Tengel, CEO

Thanks, Anthony, and thank you all for your continued interest in Independent Bank Corp. and we will look forward to talking to you at the end of the fourth quarter.

Operator, Operator

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