Independent Bank Corp. (NASDAQ:INDB) Q4 2022 Earnings Call Transcript

Independent Bank Corp. (NASDAQ:INDB) Q4 2022 Earnings Call Transcript January 20, 2023

Operator: Good day, and welcome to the INDB Independent Bank Corp. Fourth Quarter 2022 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 include 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. Please also note that this event is being recorded. I would now like to turn the conference over to Christopher Oddleifson, President and CEO. Please go ahead.

Chris Oddleifson: Good morning, everyone, and Happy New Year. Thank you for joining us today. I am once again joined by Mark Ruggiero, our Chief Financial Officer; and Rob Cozzone, our Chief Operating Officer. As I’m sure most of you know by now, we recently announced my decision to retire as CEO after 20 years at the helm of our terrific bank. There really is no mystery here, just customary thoughtful succession planning overseen by our independent directors. The decision to retire was mine. I am healthy and well. And after two decades just felt it was time to pass the baton to someone else to lead the next phase of our growth and long-term success. The Board has made a great choice in Jeff Tengel to lead that effort. Jeff will formally assume as CEO role on Monday, February 6.

I’ll remain an Executive — in an Executive Advisory role until the end of this year. I will also continue to serve as a Director until my term expires in May 2023. The CEO transition does not reflect the change in our strategic direction whatsoever. Also after many years of succession planning, we recently elevated two long-term commercial colleagues, Jim Rizzo, Catherine O’Malley to our executive leadership team, both will continue to report to our President, Gerry Nadeau. On the earnings front, we capped the year with another strong and fundamentally sound performance. Net income in the fourth quarter rose to $77 million or $1.69 per share. Mark will take you through the quarter shortly, while I’ll be focusing my comments on the full year just concluded.

Financially, it was another — in a string of strong annual performances in a difficult economy, our operating EPS grew by 8% in 2022. Loan activity remained robust with commercial loan closings rising 14% to $2.1 billion of combined residential mortgage and home equity originations totaled $1.2 billion. We continue to generate record level of consumer checking account openings and core deposits comprised 88% of total deposits. Astute balance sheet management drove a 44 basis point improvement in the full year net interest margin. The strength of our investment management business was on full display this year, as strong new inflows totaled $1.2 billion, way above previous levels. Our assets under administration or management increased versus a year ago to $5.8 billion despite the sharp decline in market valuations.

Now one fun footnote or historic footnote I’d like to share with you is, that the $1.2 billion of new money in 2022 is almost 3 times the total assets of our management we had when I arrived in 2003. This business has come a long way. Credit quality continued in excellent shape with a total loss rate of a mere 1 basis point for the full year. Capital remains at Apple levels, which accommodated ongoing share repurchases and healthy dividend increases and expense levels are being well managed, bringing our operating efficiency measure to nearly 50%. We also made significant strides in advancing our franchise on a number of fronts. Most significant has been the seamless integration of East Boston Savings Bank, our largest acquisition to-date, which has materially strengthened our presence in the coveted Boston market, while being both accretive to both earnings and tangible book value.

We continue our expansion in and around Worcester, the second largest city in Massachusetts Customer reception to our brand has been excellent. We continue to make critical enhancements to our digital banking offerings, covering a full range of account access and openings, payment networks and front-end loan processing. And our ability to attract experienced senior talent into our company continued throughout the year, including the hiring of a Chief Risk Officer successor, and this will enable us to capitalize on the new business opportunities arising out of our larger size and expanded footprint. Now looking ahead, our near term priorities lie in the following areas: talent, a real focus there to accomplish our long-term goals and capitalize on opportunities, building our businesses in areas where we enjoy competitive advantages, streamlining and modernizing to remain competitive and nimble while keeping pace with the rapid technology advances.

Our branch network optimization continues, finding the right balance between the physical presence and satisfying the widely varying preferences of different generational consumer groups. Of course, ERM, Enterprise Risk Management continues to evolve, ensuring that our risk management infrastructure and skill sets keep pace with our growth and of course, continued integration of new businesses and new colleagues. We must continue to develop and motivate our colleagues to meet the challenges both organic and acquired growth. These priorities are all supported by detailed plans, which will prove a great help to Jeff as he comes on board. A few quick observations on the economic front. The job market continues to be a bright spot for e-comm (ph) activity with consistent and strong payroll cranes, but retail sales printed back-to-back monthly declines and points to a cooling in the overall ECA (ph) activity, which may be consistent with the recent inflationary reports showing signs of easing with broad-based declines in prices.

The Fed remains hawkish, and as indicated, there is more room for rate hikes in 2023. So as a final economic prognostication as CEO, I’ll say that while the risk of overtightening shouldn’t be overlooked, the window for a soft landing remains a possibility. So before signing off, my last of 80 earnings calls, I’d like to say that it has been an honor and a privilege to serve as CEO of INDB and Rockland Trust for the last 20 years. I’ve seen our company grow from $2.3 billion in assets to nearly $20 billion from annual operating income of $24 million to $269 million. Our market cap is going from $339 million to $3.9 billion. Our investment management grew — asset investment management from $334 million to $5.8 billion. Now from my precise February 24, 2003, CEO start date, share price has increased 305% versus a KBW Bank Index increase of 42% and NASDAQ Bank Index increased of 84%.

Tangible book value per share has grown from $8.64 to $41.12, an increase of 376%. We’ve accomplished a great deal by nurturing and building a relationship-oriented culture of care and respect. And we believe that a great place to work in retaining excellent colleagues is the essential foundation of a high performing bank over the long term. We’ve been recognized by the Boston Globe Top Places to Work employee survey for 14 consecutive years. And we’ve earned high rankings across a range of customer satisfaction, service and loyalty categories, as surveyed by J.D. Power, Greenwich Associates and Forbes, among others. J.D. Power currently ranks as number one in retail customer satisfaction in New England. I’m extremely proud of all my colleagues.

Now while culture may start at the top, our entire team deserves credit for the culture of the bank and the success and momentum of INDB. I am so grateful that I’ve been able to work alongside my amazing colleagues to build INDB into what it is today. I can’t thank them enough. They’ve been extraordinarily engaged and resilient over the years and bring so much enthusiasm and passion to excel day-in, day-out. My successor, Jeff Tengel will benefit from a deep an accomplished executive management team, including Rob and Mark, who are here on this call with me, and I’m deeply indebted to all my fellow executives. Together, we have been focused, discipline and unwaveringly committed to nurturing a culture of the banks and have produced consistently solid results over a long period of time.

I will truly miss leading the bank with them. I’m also grateful to our Board of Directors for giving me this opportunity in 2003 for their unflagging support of me over the last two decades through good times and occasional difficulties. And finally, I wish to thank you the investment and analyst community for your support. We’ve always maintained an open and honest dialogue. I have learned a lot from you, and I thank you for your interest and insights. I’ll now turn it over to Mark.

Mark Ruggiero: Thank you, Chris. Certainly, a tough act to follow, but 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. Jumping to Slide 4 of that deck. To summarize results, 2022 fourth quarter GAAP net income was a company record $77 million and diluted EPS was $1.69, reflecting 7.2% and 7.6% increases, respectively, from prior quarter results. In addition, the fourth quarter results produced a 1.56% return on assets, a 10.70% return on average common equity and a 16.57% return on tangible common equity, all up significantly over prior quarter results. Regarding tangible equity, the tangible book value per share increased an impressive $1.56 to $41.12 as of December 31, reflecting strong earnings and stabilized other comprehensive income.

There were no share repurchases during the fourth quarter. As we move our way through the deck, we will hit on the additional details behind the quarterly performance key drivers noted here on the slide. Turning now to Slide 5. We provide a high level summary of our loan portfolios for the quarter. And as noted here, reported balances for the quarter increased 1.7% or 6.6% on an annualized basis. As anticipated, with the rising rate environment, payoff and refinance activity decreased when compared to prior quarters, which, along with the strong closing activity. Chris noted, fueled solid commercial loan growth across both C&I and commercial real estate. Residential balances also increased nicely but at a slower pace than prior quarters. Slide 6 provides some additional details around the loan activity for the quarter.

As I just alluded to, new commercial commitments for the quarter were strong at $636 million, up over 20% from the prior quarter. This naturally drove a decrease in the approved pipeline from $383 million last quarter to $317 million at year end. However, the current balance should still bode well for good closing activity heading into 2023. And as noted on this slide, you can see the majority of activity is in the asset classes and industries we’ve been referencing for most of the year. On the right side of the slide, consumer portfolio closings were down compared to the prior quarter as expected with the vast majority of Q4 residential volume once again placed into the portfolio, driving the solid balance sheet growth. Moving now to Slide 7, the combination of inflationary pressures impacting customer liquidity and competitive pricing led to a 2.8% decrease in overall deposit balances.

New account opening activity remains strong, but it’s no secret, we are in a different deposit environment than we were just a few quarters ago. As such, we remain focused on core relationships and operating accounts while addressing pricing pressures where needed. As noted on this slide, the majority of outflow occurred in our business savings and money market balances with consumer balances experienced and some net flow as well while the CD product set served as a compelling alternative to retain some level of higher rate sensitive customers. As expected, these dynamics resulted in an increase in the cost of deposits to a still low 35 basis points for the quarter, up from the prior quarter level of 15 basis points, reflecting the inherent value of our deposit franchise, based on the effective date of the Federal Reserve rate hikes, the total deposit beta for the quarter was 14%, with the cumulative beta on all deposits at only 8.4% or 13% when isolated to only interest-bearing deposits.

However, we do not deny that pricing pressure has increased, and we will touch upon deposit cost outlook in our forward guidance. Slide 8 reflects our customary snapshot of the reported margin as well as a breakdown of volatile or non-recurring items to reconcile back to a core net interest margin. The 21 basis point increase in margin and 23 basis point increase on a core basis is right in line with previous quarter guidance and a reflection of the asset sensitivity positioning noted in the bottom right of the slide. With absolute levels of cash significantly reduced, our overall asset sensitivity has also been reduced with the balance sheet well positioned to manage interest rate risk heading into 2023. Moving on to asset quality. Slide 9 provides some key metrics worth highlighting.

Addressing the key notable development referenced in the earnings release first, the C&I credit making up the majority of that category’s non-performing balances in both Q3 and Q4 is still in workout. Though still very fluid, a specific reserve allocation of $14 million has been built over the last two quarters and is reflected in the provision levels already recorded with actual charge-off amount in the 2023 timing still being assessed. Not surprisingly, the now delinquent status of this loan is the main driver of the fourth quarter increase in the overall delinquency rate. Aside from that one loan, no other pervasive credit concerns are noted with non-performing assets staying relatively consistent at $54.9 million and negligible charge-offs of only $394,000 for the quarter or 1 basis point annualized.

Shifting gears to non-interest items. Slide 10 provides details on the strong net interest income results for the quarter, a few of which I will highlight. Decreases in deposit account interchange and ATM fees reflect typical seasonality. Regarding investment management income, the significant increase in revenue reflects continued very strong new money inflows, as Chris noted, solid market performance, strong retail commission income and a one-time non-recurring earned incentive of $650,000. Though a portion of the growth is tied to a meaningful increase in customer demand for shorter-term cash strategies, the increase of assets under administration from $5.1 billion last quarter to $5.8 billion at year end is a testament to investment performance as well as the inflows generated from the relationship synergies developed over many years between wealth and bank colleagues.

Loan level derivative income increased nicely as customers have become more comfortable with expectations over the pace of future rate changes. And lastly, other non-interest income includes a $900,000 gain on the sale of a previously closed branch building. Turning to the next slide. Total operating expenses of $94.9 million reflect a 2.3% increase from the prior quarter. While the quarter contains some specific notable variations to the prior quarter results, such as changes in the fair value of split dollar insurance obligations and increased technology spend, the overall increase is in line with expectations. And lastly, the tax rate for the quarter dropped to 23.2% as the fourth quarter typically reflects some level of discrete adjustments related to the filing of the corporate tax returns.

We’ll now shift gears to Slide 12 and cover 2023 forward guidance, which will obviously remain fluid throughout the year. With the level of overall economic uncertainty still at play, we expect overall loan growth in the low-single digit percentage range. And with the payoff activity in commercial real estate decreasing from 2022 levels, we should see more balanced growth across both the commercial and consumer books. As deposit pressures continue, we anticipate additional decreases in balances in the first quarter of 2023 in the low-single digit percentage range. Though, we will remain focused on customer acquisition efforts, insight into deposit balance volatility for the rest of the year is difficult to predict at this time, and we will certainly provide quarterly updates on deposit balance expectations throughout the year.

Given the current balance sheet profile at year end, we anticipate securities will attrite modestly over the course of the year, while cash and/or some level of wholesale borrowings will be a function of actual loan and deposit activity throughout the year. Regarding net interest income, we currently expect loan yield betas to stay in the range of 20% to 25%, reflecting the overall composition of portfolios tied to short-term rates, combined with the $1.45 million current macro hedge portfolio. Deposit betas are expected to continue to increase from prior quarters with the cumulative total deposit beta to reach approximately 15% through the cycle. In terms of shorter-term guidance, assuming an early February 2023 Fed reserve rate increase of 25 basis points, we expect the net interest margin to expand in the first quarter by 3 basis points to 5 basis points with a reminder that fewer days during the first quarter will drive lower net interest income results on a relative basis.

Regarding asset quality and provision levels, we think it’s prudent to keep our guidance anchored more in the near term than a full year outlook. As the previously mentioned large C&I loss estimate has already been provided for future provision levels will continue to be driven by loan growth, any future migration of asset quality metrics or changes in the overall economic outlook. Regarding noninterest income, despite an anticipated late Q1 change in our overdraft program anticipated to reduce 2023 fees by approximately $3.5 million, total fee income is anticipated to grow by a low-single digit percentage compared to 2022 totals. Key drivers of the growth are expected in deposit account interchange in ATM given the focused growth on core operating accounts, continued growth momentum in wealth management, though likely not to the degree experienced in Q4 and a continued demand over loan level derivative product driving fee income similar to the levels noted in Q4.

Given the reduction in mortgage refinance opportunities and decreased pipelines, mortgage banking income will continue to be challenged for much of 2023. Regarding more immediate guidance, given the increased level of non-recurring fee income noted in the fourth quarter and reduced level of days in Q1, Q1 fee income is expected to be down a high-single digit percentage when compared to Q4 levels. Regarding non-interest expenses, inflationary pressures increased investment in continuously improving the customer experience and some one-time items associated with the recently announced CEO transition are expected to drive increases in total expenses in the mid to high-single digit range for the full year as compared to 2022 operating levels, which exclude M&A.

In terms of more immediate guidance, Q1 2023 expenses are expected to increase at a low to mid-single digit percentage over 2022 Q4 levels. And lastly, the tax rate is expected to be in the 24% to 25% range for the full year. That concludes my comments, and we will now open it up to questions.

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Q&A Session

Operator: We will now begin the question-and-answer session. Our first question comes from Mark Fitzgibbon with Sandler O’Neill. Please go ahead with your question.

Mark Fitzgibbon: Hey, guys. Good morning.

Chris Oddleifson: Good morning.

Mark Fitzgibbon: I just wanted to start by saying, Chris, congratulations on your retirement. You’ve done an absolutely amazing job at the helm. Congrats.

Chris Oddleifson: Well, thank you very much, Mark. It’s been a pleasure to know you for these 20 years.

Mark Fitzgibbon: First question I had for you. You referenced in your early comments about the investment management business. You had about $470 million of net flows this quarter. Did that come from existing clients or did you bring in some new teams that really drove that?

Mark Ruggiero: Yeah. A little bit of both, Mark. We had a couple of hires in 2022, one of which really was very successful in tapping into his connections and networking and brought in about $80 million of gross money during the year. I also mentioned we really found a good opportunity given the rate environment to work with both existing customers and some new customers who are looking for more shorter-term treasury security cash strategies and that equated to about $240 million of new money in the year. So that’s a little bit of a different kind of product set from our typical wealth management business, but I think a good reflection of really leveraging the retail bank and being creative to look for opportunities, given the interest rate environment.

So those are really the two drivers. But the team still finds really good opportunity in our typical larger wealth products. We talk a lot about the long standing relationships that our wealth advisers and commercial lenders have created over the many years, and you’re really seeing that on display lately.

Chris Oddleifson: Yeah. Just Mark, one thing that I want to add to this is that the code that we cracked a number of years ago is the — completely eliminated any reluctance from the vast majority of our commercial lenders and the branches to working with wealth and providing referrals to wealth. So a stumbling block that exists in many other financial institutions.

Mark Fitzgibbon: Okay. And then what was that $650,000 one-time incentive in the wealth business?

Mark Ruggiero: Yeah. Just in — we actually switched a couple of our wealth products to a different platform. And the third-party we’re using for the new platform, incentivized us to make that switch. So there’s a one-time fee associated with the transfer of that money from a platform perspective.

Chris Oddleifson: Something there was also a win-win for sort of our customer service and access and so on.

Mark Fitzgibbon: Okay. And then I know credit is not really an issue, but a couple of quick credit questions if I could. That one C&I loan that you’ve already provided for, I think you said you had a $14 million reserve against it. Do you think that’s sufficient to be able to cover the charge that you’re expecting to take? And when will you — do you anticipate taking that charge?