INDB - NASDAQ

Good morning, and welcome to the Independent Bank Corp., Third Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation there will be an opportunity to ask questions. [Operator Instructions]. 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 also note that this event is being recorded. I would now like to turn the conference over to Jeff Tengel, CEO. Please go ahead.

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 deal 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 time on 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 stocks 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 overtime. And on that note, I'll turn it over to Mark.

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 3rd 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, maintain 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 grew per share grew $0.72 per share 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. That's further support for 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 the 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 overtime. 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 is 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 noncore 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 onetime 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.

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

Hey, guys. Good morning. And happy Friday.

Hi, Mark. Happy Friday, Mark.

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?

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 run off, 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 increase on the deposit side such that the margin stabilizes heading into 2024.

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?

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.

Okay. And then lastly, on office. I think in your slide, you suggest that you have about a third of your office book maturing or repricing over the next two years. What are -- I guess, I'm curious, what do those renewals look like? Do you reappraise all of those? And how much your value is coming down when you do that? And also, what are the loan-to-value and debt service coverage ratios look like on the new loans?

Yeah, it's a great question. And unfortunately, the answer is still largely -- it depends. I think what we're learning is each situation has a little bit of a unique facts and circumstances. But in general, when you look at that population that's set to mature or reprice it breaks down pretty consistently over the next 24 months. We have about $100 million maturing I guess, a little bit more elevated in the next three months and then there's about $80 million in 2024 and $175 million in 2025. What's interesting is when you look at even just in the very near term, the $100 million coming due in Q4, $70 million of that is comprised in just three relationships, three loans. So each one of those three loans, we have good visibility into. In fact, one of those already renewed here in October. It's performing based upon reappraised valuations, debt service is 1.2 and loan-to-value is 60%. So that's an example of one where we expect the maturities to be somewhat of a non-event and we still see valuation and debt service at the hurdles we'd like them to be. But we're not suggesting that's going to be the case for every loan. There are a couple where maybe occupancy isn't as strong that we'll work through. But in general, it's a very manageable number. The population, as we look at it today, continues to have essentially the 60% to 65% LTV and debt service around 150-160. How much stress we'll see as those mature is a little bit of, like I said, kind of depending on each unique facts and circumstances. But when we look at out the near term, we feel really good about the individual credits coming due.

Thank you.

Sure.

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

Good morning, guys.

Good morning.

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?

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.

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?

Yeah. Well, I mean, honestly, just because I'm still relatively new, I'm trying to meet people for no other reason just to continue to familiarize myself with the banking landscape here in Massachusetts. So that is ongoing. And in part, those are very -- what I would characterize as very benign conversations. But I think in the current environment, when you pencil out some of the deal dynamics, it just makes it difficult to do, I think, from either side, right? I mean if you're the seller, you're thinking I can increase the value of the franchise, why would I sell now? And if you're a buyer, the marks that you would have to take become challenging in a tangible book value earnback type scenario. So we're going to continue to have as many conversations as we can so that when there is the opportunity diversed, some of the banks that I'm meeting decide that they want to maybe pursue a different alternative than continuing to stay independent that will be their first call. But that's -- so there's both of those things kind of going on at the same time, I guess, sort of the challenging environment that we're working through. And again, just myself hinting out and meeting a number of the bank executives across our landscape.

Okay, that's helpful. And then on the credit that was -- you had the $5 million charge-off. Was that resolution through a note sale? Or just kind of curious if you could give any color on that.

Yeah. That actually went to auction, believe it or not, Stephen, which we -- there was a lot of discussion here internally around the appropriate resolution for that credit. This isn't necessarily the optimal environment for an office loan to be sold at auction. So we could have potentially looked for a different alternative route and held on to that and maybe look for a slightly better resolution. But at the end of the day, we felt it was appropriate and prudent to go to auction, get the resolution we did and just get that loan behind us. So it did go out a foreclosure sale.

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.

Okay, that's helpful. And then in terms of just the -- maybe just going back to the margin here. With the dynamic of margin stabilizing here in the fourth quarter, what are you guys assuming for a deposit beta -- a cumulative cycle we hold steady at 5.25-5.50 funds rate?

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.

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

Thank you.

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

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

That was a Class B.

That was a Class B. Okay. And so it was -- if I'm doing the math right, that was a 35.7 on the dollar haircut.

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

Okay. And then as far as the breakdown of your maturity, I mean, I think you guys were sort of put in the penalty backs 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?

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 result in a 175, 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.

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

That was about $18 million.

$18 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. I just wanted to know what was the difference there.

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. And that's more of the focus now going forward.

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?

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 nonowner-occupied.

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

You're welcome.

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

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?

I mean obviously, that's something that we're paying very, very close attention to and have our bankers all very focused on near-term rate resets and maturities. And as Mark said a little while ago, every loan is unique. And so the story difficult to paint the story with the same broad brush. So we're being very diligent and trying to be very thorough in our analysis. So I think we're going to have some continued ins and outs in that criticized and classified category. Yes. I mean, of course, we will. But as we sit here today, we've gone through all of that -- all of the loans that have that near-term risk to it and feel very comfortable with our current classification.

Okay, got it. On the ---

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.

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.

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.

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?

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.

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?

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 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.

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 as 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.

Absolutely, thanks. Appreciate taking my questions.

Thank you.

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

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.