INDEPENDENT BANK CORP quarterly report, Q1 FY2018

Independent Bank Corp. — Q1 2018 Form 10-Q

Business context and reporting period: Independent Bank Corp. is the bank holding company for Rockland Trust Company. This unaudited report covers the three months ended March 31, 2018; balance-sheet comparisons are with December 31, 2017. Unless otherwise noted, amounts below are in millions of dollars.

Financial results and condition

Balance sheet and liquidity: Total assets were $8.09 billion, loans $6.36 billion, deposits $6.75 billion and borrowings $298.9 million at quarter-end. Since year-end, loans increased $6.5 million, deposits increased $22.3 million and borrowings fell $24.8 million. Cash and cash equivalents ended at $165.5 million, down $47.6 million from the start of the year. Operating cash flow was $33.9 million, versus $37.4 million in Q1 2017; investing activities used $69.4 million and financing activities used $12.0 million. Management reported $2.06 billion of additional borrowing capacity across listed liquidity sources.

Credit quality and capital: Nonperforming assets were $48.1 million, or 0.59% of assets, compared with $50.3 million and 0.62% at year-end and $58.5 million and 0.76% a year earlier. Nonperforming loans were 0.75% of gross loans. The allowance for loan losses was $60.9 million, or 0.96% of loans; quarterly net charge-offs were $0.3 million. Regulatory capital ratios remained above applicable minimums: consolidated total risk-based capital was 14.08%, common equity tier 1 was 11.47%, and Tier 1 leverage was 10.32%. Stockholders’ equity was $956.1 million.

Material changes versus prior periods

• Earnings growth reflected higher net interest income and a lower effective tax rate; Q1 2018 effective tax rate was 19.86%, versus 30.31% in Q1 2017, principally due to the Tax Act and tax benefits. Management cited $1.2 million of excess stock-compensation tax benefits and other discrete items.
• Net interest margin improved, supported by the company’s asset-sensitive position and reinvestment of excess liquidity. Core deposits were 90.1% of deposits; the quarterly cost of deposits was 0.24%.
• Noninterest expense rose 9.6%, including higher salaries and benefits, occupancy/equipment costs, and other expenses. The company attributed some expense increases to the 2017 Island Bancorp acquisition, equipment leasing activity, and accounting changes. No merger and acquisition expense was recorded in Q1 2018, compared with $0.5 million in Q1 2017.
• Available-for-sale securities had $22.5 million of gross unrealized losses at March 31, versus $10.4 million at year-end. The decline in securities values contributed to a $5.1 million after-tax comprehensive loss for the quarter and accumulated other comprehensive loss of $8.2 million. Management attributed most securities impairments to interest rates, not credit quality, and recorded no other-than-temporary impairment.
• Accounting updates adopted in 2018 included new equity-security measurement and revenue-recognition guidance; management reported no material impact from adopting either standard. The expected-credit-loss standard was still under assessment and is effective for the company in 2020.

Outlook, commentary, and risks

Management’s 2018 outlook, compared with 2017, was for low-single-digit loan and deposit growth; 15–20 basis points of full-year net interest margin expansion assuming no further Federal Funds rate increases; low- to mid-single-digit growth in both noninterest income and noninterest expense; and an approximately 23% effective tax rate for the remainder of the year, excluding discrete items. Management described New England economic conditions as generally positive and stable, while noting potential pressure on commercial real estate valuations from rising longer-term yields and tight housing supply.

Key exposures include credit deterioration, particularly in larger commercial relationships; real estate market weakness in Massachusetts and Rhode Island; changes in interest rates and deposit pricing; securities-market declines; competition; cyber and operational threats; and regulatory, tax, and technology changes. The company’s interest-rate simulations showed estimated first-year net interest income decreases of 7.6% under an immediate 100-basis-point decline and increases of 4.9% and 9.2% under 100- and 200-basis-point increases, respectively; results depend on assumptions about rates, customer behavior, and prepayments. Off-balance-sheet commitments to extend credit totaled $2.50 billion, with $16.0 million of standby letters of credit. Ordinary-course lawsuits were not expected by management to have a material adverse effect. The filing states there were no material changes in contractual obligations or off-balance-sheet arrangements during the quarter.

Important facts for investors to verify

• Whether loan and deposit growth, margin expansion, and expense trends develop in line with management’s 2018 outlook, particularly if Federal Reserve rate changes differ from the stated assumption.
• Credit performance in commercial and real estate lending: the filing identifies $78.9 million of potential problem loans, though these were performing at quarter-end.
• Whether the increase in unrealized securities losses remains interest-rate-driven and whether it affects capital, liquidity, or future earnings.
• The sustainability of the lower effective tax rate, including the effect of tax credits and discrete stock-compensation benefits.
• Liquidity and funding trends, including core deposit retention, deposit-cost increases, and availability of pledged-asset borrowing capacity.
• Expense growth and the contribution of acquisition-related staffing, equipment leasing, and other initiatives to future operating results.