Independent Bank Corp.

Good morning, and welcome to the Independent Bancorp Second Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. Should you need any assistance today, please signal a conference specialist by pressing the star key followed by zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your telephone keypad. To withdraw a question, please press star, and then two. 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 their 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 Chris Odlifson, President and CEO. Please go ahead, sir.

Good morning, everyone, and thank you for joining us today. I'm once again accompanied by Mark Ruggiero, our Chief Financial Officer, and Rob Cuzzone, our Chief Operating Officer. Our second quarter performance is a strong one, which is driven by the business fundamentals of our franchise. Net income for this past quarter came in at $61.8 million, or $1.32 per share, nicely above both prior quarter and prior year results. Mark will be covering the quarter in greater detail, but highlights include Underlying loan activity remains encouraging, with net growth of 5% on an annualized basis, exclusive of PPP loan runoff. My colleagues are quite active in meeting the credit needs of our customers. In fact, loan closings in the second quarter grew by 35% over the first quarter volumes to nearly $1 billion, and loan pipelines stand at healthiest levels as well. Core deposits have now reached 87% of total deposits and remain a source of great strength and economic value, higher-cost CDs continue to retreat, allowing us to maintain a very low five basis points total deposit costs. Our balance sheet management has enabled us to clearly benefit from rising rates as evidenced by the notable increase in net interest margin this quarter. And we are positioned to continue to benefit from further rate increases that are widely expected, and Mark will comment on this in a moment. The revenues were strong this quarter across a range of sources. Our investment management business continues to excel and we're encouraged by the volume of new inflows along with the ongoing success of our internal referrals. Expense levels remain well managed as our operating efficiency measured declined to 52% this quarter. Credit quality continues to be benign with minimal net losses and stable non-performing levels experienced in the second quarter and capital levels remain in fine shape which gave us the confidence to proceed with a modest share buyback in the second quarter. We continue to make progress in several important fronts. The assimilation of East Boston Savings Banks continues to proceed very smoothly. My new branch colleagues have adapted quite well to our processes and platforms. All major systems have been fully integrated, and we are actively pursuing new business opportunities we've identified in our expanded markets and acquired customer bases, all of which we're very excited about. We successfully opened our new branch at Westboro in May, bringing our total retail presence to eight in Worcester County. Our expansion into this market and the broader Metro West area is an important part of our growth strategy. Customer reception to our brand and offerings has been very encouraging thus far. We remain hard at work enhancing our digital banking capabilities with respect to account access and openings, payment networks, and our Your Banker platform to ensure we remain responsive to customer preferences. We're also in the process of streamlining our front-end processes, especially related to our lending platforms, and continue more fully leveraged sales force throughout the company. Turning to the economic picture, now the labor market, as we all know, is showing continuous strength, and the focus remains heavily on inflation. Inflation surged again in June, and the Fed has reiterated their commitment to combat increased price and rate hikes. The Fed is expected to continue with rate increases, but market uncertainty is on the rise. The bright spot here is that each increase will provide a tailwind to income, as Mark will discuss in a moment. We feel we've positioned ourselves in a flexible manner to deal with a highly uncertain operating environment, and should we enter a period of pronounced slowdown or begin to witness unfavorable competitive practices, especially on the lending side, we'll react with as much discipline as we have in the past, which has served us well over the long term. In the meantime, I remain highly focused on serving our loyal and growing customer base. We build strong relationships with our customers and provide them with our award-winning level of service for our highly motivated Rockland Trust colleagues. In fact, a point that is well worth mentioning again is that during the first quarter, we received the number one ranking in New England and a J.D. Power 2022 U.S. Retail Banking Customer Satisfaction Study. Before signing off and handing it over to Mark, I'd like to acknowledge our director, Frederick Taw, who has reached retirement age. I have valued his insight and support during his tenure on our board, and we wish him well. And with that, I'll hand it over to Mark.

Thank you, Chris. And similar to last quarter, my comments will refer to the information contained within the earnings presentation deck that was included in our 8K filing last night and is also available on our website in today's investor portal. So jump into slide four of that deck. 2022 second quarter gap net income was $61.8 million and diluted EPS was $1.32, both reflecting notable increases from the prior quarter operating results. Worth noting, there were no non-GAAP related items within the second quarter. Key drivers for the quarter include 4.9% annualized net loan growth when excluding PPP loans driven by strong consumer loan activity. In addition to overall reductions in cash balances, we continued modest cash deployment into the securities portfolio, continuing to remix the balance sheet for enhanced profitability. The core net interest margin, which excludes purchase accounting and PPP-related impact, increased to 3.23% for the quarter, up from 3% in the prior quarter, and the reported margin was up nicely as well. And I'll provide some more detail into the impact and benefit of the rising rate environment here in a little bit. New core deposit account activity remained strong, with the overall reduction in deposit balances being driven primarily by lower time deposit balances. Provision for the quarter was zero, reflecting continued strong asset quality metrics. In addition, the quarter included higher fee income and a modest increase in operating expenses, both of which I will provide more detail on shortly. And lastly, the company bought back 1.3 million shares under its share repurchase program during the quarter. So in summary, we certainly view the quarter's results as a great reminder of our strong core fundamentals and evidence of a balance sheet positioned to increase profitability and shareholder value moving forward. On both a gap and operating basis, the results reflect a 1.24% return on assets, an 8.49% return on average common equity, and a 13.01% return on tangible common equity for the quarter. And similar to last quarter, in addition to the aforementioned share repurchase activity, tangible book value was also negatively impacted by other comprehensive losses attributable to the available for sale, security unrealized losses, and hedge fair valuation declines net of tax. These factors drove an 84-cent decrease in tangible book value to $40.31 as of June 30th. As we move to slide five, we'll dive into some key components of the quarter results. And as shown here, inclusive of PPP, the loan portfolio increased slightly to $13.7 billion. Excluding PPP, as I mentioned, total loans grew at a healthy 4.9 percent annualized rate for the quarter. As you can also see on the slide, the consumer portfolios were the primary drivers of the overall increase, as the vast majority of residential production was retained on balance sheet, while demand for home equity offerings and line utilization increased meaningfully in the quarter. Also excluding PPP loans, strong growth occurred in the CNI category, as well as construction, with both categories also benefiting from increased line utilization. Commercial real estate balances dropped $106 million or 1.3% in the quarter as payoff activity on both the East Boston portfolio and legacy portfolios remains elevated. Slide six provides some additional details around loan activity for the quarter. As noted on the left side of this slide, commercial loan origination activity was exceptionally strong for the quarter with total closed commitments of $557 million. With much of that production coming from construction and other line of credit-type fundings, total upstandings did not reflect the same level of increase in the second quarter, but bode well for increased utilization going forward. In addition, the approved commercial pipeline at June 30th was $372 million, up notably from the prior quarter level of $307 million. As for opportunities in our market, we continue to see the majority of commercial real estate and construction activity centered around one to four family, condo, and apartment asset classes. While on the CNI side, the retail trade industry continues to provide solid deal flow. Also noted on the slide, you can see the PPP balances paid down to $31 million as of June 30th, generating $1.8 million of net fees recognized this quarter, compared to $3.5 million in the prior quarter, with remaining unearned net fees now only totaling $600,000. On the right side of the slide, we reflect some key metrics around the strong consumer book activity for the quarter. Given the company's balance sheet position and secondary market pricing dynamics during the quarter, approximately 92% of the quarter's mortgage activity was retained in the portfolio. And as history has proven out in prior cycles, as the refinance market slows down amidst the rising rate environment, we see the natural hedge in our strong home equity product set really show its value as well. Along those lines, after a prolonged period of challenging growth, the second quarter saw real solid closing activity, which along with increased line utilization, led to the home equity balance growth I just previously mentioned. As we move to slide seven, deposit activity for the quarter was in line with expectations, with decreases in time deposits and money markets driving an overall decline in deposits for the quarter. And as we enter into a rise in rate environment, the long-standing focus on core deposit relationships will likely lead to some level of rate-sensitive money exiting the bank over the remainder of 2022 and allow for adequate levels of funding while effectively managing our overall cost of deposits. With core deposits comprising 86.8% of total deposits as of June 30th, the cost of deposits for the quarter remained low at only five basis points for the fourth consecutive quarter. This serves, I think, as a nice segue as we move to slide eight and focus on the net interest margin results for the quarter. And as we presented in prior quarters, this slide provides some details over the reported margin as well as a breakdown of volatile or non-recurring items to reconcile back to a core net interest margin. And as you can see here, both the reported and core net interest results increased nicely over the prior quarter. In particular, we highlight the core net interest margin results, which, when excluding the PPP fees and purchase accounting impact, increased 23 basis points as compared to the prior quarter margin, core margin. This increase is a reflection of the company's asset-sensitive positioning as well as a favorable remixing of its excess liquidity. As an update on the margin guidance provided last quarter, the bottom right section of this slide provides the key aspects of the company's asset sensitivity. So in summary, with any movement in short-term interest rates, primarily Fed funds, one-month LIBOR, term SOFR, or prime, we would see immediate repricing benefit in our federal cash balances, federal reserve cash balances, of $1.3 billion. and approximately 34% of our loan book that is tied to these indices. During the quarter, in an effort to balance its interest rate risk positioning and current earnings, we closed on another $300 million of macro-level loan hedges, with $150 million of that being straight variable to fixed rate instruments and $150 million of interest rate caller hedges. This strategy partially offsets the loan benefit of rising rates in the long run, while still providing some level of immediate earnings improvement in the near term. So, regarding the longer-term impact, the total macro hedge portfolio of $1.2 billion combined with a small subset of loans with index floors that are currently in the money would offset a portion of the asset repricing benefit I just described. So, in summary, approximately 20 to 25 percent of total loans on a net basis would immediately benefit from rising rates. And as we have noted previously, market pressures will certainly heavily influence the pace of deposit rate increases through this rate cycle. Moving to asset quality, slide 9 provides some key metrics that are worth highlighting. Non-performing loans stayed relatively consistent at $55.9 million as of June 30th. Net charge-offs were a mere $200,000 or one basis point on an annualized basis. Total delinquencies ticked up slightly to 0.4% of the portfolio, and total loan deferrals at June 30th decreased another 108 million to 197 million, or 1.4% of the total portfolio, with the majority of that set to mature prior to 2023. So in conjunction with these stable metrics and modest loan growth, zero provision for loan loss was recognized, maintaining the allowance for credit loss as a percentage of loans at 1.06%. Shifting gears now to non-interest items, slide 10 provides details on non-interest income results for the quarter, a few of which I will quickly highlight. Deposit account interchange and ATM fees all increased nicely from the prior quarter, driven primarily by seasonal increases in activity. And despite a market-driven reduction in assets under administration from $5.7 billion last quarter, to $5.2 billion as of June 30th. Overall investment management fee income increased nicely in the quarter, driven by strong retail and insurance commission income, as well as seasonal tax prep fees. Also on a positive note, despite the challenge in market conditions, we have experienced strong inflows of new money in 2022. As seasoned sales reps combined with new hires have really seen success, in our legacy markets, as well as increased momentum in the newly acquired markets and geographies. And lastly, as mentioned earlier, the company's capacity to absorb straight fixed rate lending products has challenged both mortgage banking and loan level swap income during the second quarter. Turning to the next slide, total operating expenses, $90.6 million, reflect a 2.4% increase from the prior quarter when excluding last quarter's $7.1 million of merger-related expenses. Some notable items in the second quarter expenses when compared to last quarter include increased incentive compensation within salaries and benefits, decreased snow removal costs within occupancy and equipment, and within the other non-interest expenses, the increase was driven primarily by increased consulting costs associated with certain operational initiatives, increased unrealized losses on equity securities and annual director equity awards. Lastly, the tax rate for the quarter increased slightly to 24.8% due to the increase in projected earnings. So finishing up on slide 12, I'll provide a few updates with regards to 2022 guidance. Regarding commercial loan growth inclusive of PPP and small business, total commercial loans are down approximately 1.8% on a year-to-date basis. And as we've described, that's been driven mostly by PPP and East Boston acquired commercial real estate runoff, as we expected. We do anticipate flat to low single-digit growth in the second half of 2022, which would result in a relatively flat to low single-digit percentage decrease in balances for the full year. Regarding residential loan growth, despite reduced demand expected in the second half, we anticipate additional growth in the mid single digit rate range, which would peg 2022 full year growth at around 20%. As for home equity, we anticipate the Q2 positive momentum to continue into the second half of 2022 with low to mid single digit percentage growth for that six month window resulting in full-year 2022 growth in the mid- to high-single-digit percentage range. As for deposit growth, we are extremely pleased with our success of generating new core operating accounts in both our legacy and acquired markets. Having said that, the likely rising rate environment and excess levels of liquidity allow us to be strategic in letting some level of time deposits and rate-sensitive balances to it right out. resulting in relatively flat to modest decreases in total deposits expected in the second half of 2022. Also, with the June rate increase in future rate hike expectations at virtually near certain levels, the guidance we provided earlier regarding the immediate asset repricing impact and strong deposit franchise will continue to drive core net interest margin and benefit going forward. In terms of provision levels, though overall asset quality remains strong, looming recessionary fears are real. Though it's certainly tough to predict the impact with so many moving pieces, based on today's environment, we anticipate current allowance levels to hold steady for the foreseeable future, with current charge-offs serving as the proxy for provisioning levels going forward. Regarding non-interest items, total non-interest income could experience modest decreases driven primarily by decreased investment management income and continued pressure on mortgage banking income. In addition, as we talked about last quarter, we are also assessing likely changes to our overdraft program. Though the final impact is not fully determined at this point, and timing of any changes would likely be later in the calendar year. And finally, non-interest expenses are expected to increase in the second half at a low to mid-single-digit percentage rate, driven mostly by wage and other inflationary factors. And lastly, the tax rate for the second half of the year will likely approximate 25%. That concludes my comments, and we'll now open it up to questions.