Good morning and welcome to the Independent Bank Corp Second Quarter 2013 Earnings Call. [Operator Instructions] This call may contain forward-looking statements with respect to the financial condition, results of operations and business of Independent Bank Corp. Actual results may be different. Independent Bank Corp. cautions you against unduly relying upon any forward-looking statements and disclaims any intent to update publicly any forward-looking statements, whether in response to new information, future events or otherwise. Please note this event is being recorded. I would now like to turn the conference to Christopher Oddleifson. Please go ahead.

Good morning, everyone, and thank you for joining us today. Unfortunately, our CFO, Denis Sheahan could not be with us today, as he had to travel unexpectedly to Ireland to attend to a family illness. Filling in capably for Denis, is our Treasurer, Rob Cozzone. It was business as usual for us in the second quarter, and that is a good thing. Our welcome to the [indiscernible] story continues to be marked by strong origination volumes, a deepening of customer relationships, growing recognition of our brand and adherence to discipline, as the competitive environment heats up. Core earnings in the second quarter totaled $13.2 million, or $0.58 per share. Once again, fundamentals led the way. Commercial lending remains a pillar of strength for us, with the portfolio growing at a double digit annualized rate again in the second quarter. The C&I sector has been especially strong for us. Deal flow in the commercial real estate side, the CRE side has been good as well, and the commercial pipeline continues to build nicely. Competition for credits is steadily ratcheting up, especially for the small credits by smaller banks anxiously seeking growth. We have been able to counter this pretty successfully thus far, but we'll keep a watchful eye on trends here. As before, total loan growth was muted by heavy refinancing volumes that persist in the resi-mortgage space, combined with a known practice of selling a high percentage of originations into secondary markets. Deposits grew sharply in Q2 and continue to serve as a low cost funding source. Core deposits have now risen to 85% of total deposits. The cost of total deposits declined further, helping us to mitigate the strong pressure on earning asset yields from the low rate environment. Fee revenues were up nicely in Q2, as strength in…

Thank you, Chris, and good morning. I'll now review our earnings release in more details. Independent Bank Corp. reported net income of $12.8 million, and GAAP diluted earnings per share of $0.56 in the second quarter of 2013. This compared to net income of $12.3 million, and diluted earnings per share of $0.54 in the first quarter. Both quarters included M&A charges, and the first quarter included severance, associated with the outsourcing of the bank's mortgage operations, as previously discussed. Excluding these items, diluted earnings per share on an operating basis was $0.58 in both quarters. Year-over-year, diluted earnings per share on an operating basis improved by 35%, as the prior year quarter was negatively impacted by an isolated loan fraud. I'll now speak to some key items for the quarter. As anticipated, with healthier pipelines, strong commercial loan growth resumed in the second quarter. The C&I category was up almost 23% annualized during the quarter, and total commercial, including C&I increased at an 11.2% annualized rate during the quarter. Also, the approved pipeline ended the quarter at a year-to-date high of $260 million. However, aggressive competitive pricing, especially from smaller institutions went unabated during the quarter. The seemingly irrational pricing at times, and our strict discipline, is resulting in lower pull through rates and higher payouts. In addition, our consumer real estate portfolios continued to experience declines in the second quarter, as refinancing activity lingered. With the recent and significant increase in mortgage rates, this refinancing activity should diminish, as we head into the second half of the year. The combined result of these loan portfolios changes is just under 1% growth in total loans for the quarter. As Chris mentioned, core deposit growth was particularly strong in the quarter. Demand deposits increased 7% on annualized, and savings and…

Thank you, Rob. Chad, we're ready for some questions.

[Operator Instructions] Our first question today comes from Mark Fitzgibbon, with Sandler O'Neill.

I wondered if you could share with us the size of your loan pipelines at present?

Yes, Mark. The commercial loan pipeline, the approved pipeline that is, is at $260 million, which is the highest it's been year-to-date. Our residential pipeline is at about $70 million, which was actually pretty close to where it ended last quarter.

Okay, great. And then secondly, your efficiency ratio is around 68%, and I know you've got some noise in there from acquisitions and somewhat higher costs related to your fee-based businesses, but do you have a target that you're driving toward over time?

Yes, Mark, this is Chris. I think we'd like to be, over time, and this is not any sort of forecast, sort of in the lower 60s. We don't anticipate ever getting into the 50s given the nature of our branch network. But Rob has been sort of managing to an efficiency ratio per se here, sort of managing to overall shareholder value creation, and we're sort of balancing sort of explicit expenses, and are not providing a return immediately, but will provide a return in the future. For example, this Boston office we're opening up, and the additional expense we're incurring in business development. So yes, we are doing -- we have done in the past, a lot of consolidation and efficiency work, and we continue to do that throughout the company. But to give you say, we will achieve X percent by X date, I don't want to put a number like that out there.

Okay. And then, Rob, just to clarify on your point about the loan-loss provision in the second half of the year. I think your provision in the first half of the year was $4.4 million, should we assume that it's going to be lower than that in the second half for the year, based on your comments on asset quality?

No, I wouldn't assume that it would be lower, Mark. It's going to be lower than our original guidance, which was $10 million to $14 million, but should be fairly consistent with this quarter.

Okay. And then the last question. Chris, I wondered if you could just share with us what you're seeing out there on the M&A front? You've been successful recently in doing a few small bank acquisitions. Do you sense that there are a lot of other transactions out there, and are you optimistic on your ability to do more in coming quarters?

Mark, you know how I can and cannot answer that question. But I will say, the -- I will make this observation that a number of publicly traded firms in our area over the last decade has diminished pretty dramatically, so now there's just a handful of independent kind of stock traded banks, making now the sort of M&A sort of more of a -- what I'd call a random event. It ain't any sort of trend. So we could see some or we could not, I mean, it sort of depends. Sort of what -- it depends on the mood of the board, their boards. I guess the important thing is that, we're a proven, successful acquirer, integrator. We deliver what we say we deliver to the acquiree shareholders, and we hope that when board has decided they'd like to look at the strategic auctions, that we'll be a -- on the short consideration list.

Our next question comes from Matthew Kelley with Sterne Agee.

I was wondering if you can just talk about how much you've seen commercial loan yields improve, particularly with the pipeline yields for commercial real estate? I think that's the area that most have been anticipating, obviously a pretty significant improvement in yields, given the uptick in rates. What have you seen?

Well, Matt, we typically don't get into specific pricing, as we think that can cause a threat competitively. I will tell you that, as we mentioned, we're not seeing the smaller institutions in our footprint react to the increase in rates yet, especially in regard to commercial loans, which is why we're finding it more difficult to get some of these loans to closing, the smaller institutions are extremely competitive and they seem to be less inclined to adjust their rates when market rates increase.

And the 5 year has gone from what, 60 …

The 5 year's gone from just over 60 points to 160 basis points, which -- and the swap has done the same, which is where many of those medium-term commercial real estate deals you would expect to price off of. However, we do expect our new volume yields to gradually increase in commercial.

Okay. Got you. Then on your securities portfolio, if the intermediate- and longer-term parts of the yield curve, the treasury yield curves hold where they are right now, do you think you can kind of put a bottom here in the securities yield at 2.60, 2.75?

Yes I think that's fair to say. Might be a couple more basis points of decline. But should these yields hold, that should be true.

Okay. Got you. And then in your mortgage banking business, you said you outsource that, so there'll be a commensurate decline in any type of expenses there you can kind of -- you don't have any issues with negative operating leverages, as revenues come down in that business?

That's right.

We now have minimal fixed expense associated with that operation.

Got you. And where did the pipelines end there for loans originated for sale? What's the outlook, and what you've seen just the last couple of weeks?

Obviously it's down, certainly nationally it's down meaningfully. But just keep in mind, the mortgage production operation contributes very little to our bottom line, so we are fairly insensitive to what happens with mortgage production, especially now with the outsourcing.

Okay. And last question, just looked through your 10-Q, and a parallel shift up 200 basis points results in NII up 3.5% is what you displayed in the March 31, 10-Q. What about kind of the type of bear steepening that was seen with the long end moving higher, so a steepening of the yield curve. How does that impact projected NII? What magnitude of improvement beyond the 3.5% would you expect?

Yes, I mentioned in my comments, Matt, that for this year, we wouldn't expect significant improvement as a result of the shift, because obviously, it takes time for those cash flows to reprice. But next year, on a static balance sheet, we would anticipate 2% to 2.5% improvement in net interest income, as a result of the shift that has already taken place.

Our next question comes from David Darst with Guggenheim Securities.

Chris, could you may be talk about a few more items that are on your list to invest in and kind of how that might impact the cost structure? I mean I guess marketing was up this quarter, you've talked about the Boston wealth management office. Is there anything else, or should we think about these as…

Yes, I think the – we've added – we're adding seasoned commercial lenders. We've added business development and the folks at the smaller business level. We have a full complement of very large, relatively speaking, business development group in our investment management group, I think there are about 14 of them altogether, which is significant, which has really yielded some great results. We've taken that business from losing money to making meaningful contribution to the bottom line. We have -- contemplating, and we'll talk to the Boston office and we are evaluating how to think about our branch network, both on the trimming side and the expansion side, and sort of how do we want to optimize that. There are a few more examples.

Okay. Then, Rob, as you were discussing the margin in the steeper curve, you're thinking about just maybe one more quarter of compression before you begin to see the stabilization and improvement?

I think we'll continue to compress the remainder of this year, but it should be fairly limited. As you know, a high proportion of our loans tied to the shorter end, however our investment portfolio, our fixed commercial real estate portfolio, our residential real estate portfolio will benefit from this increase in the middle part of the curve.

Okay. What percentage of loans are tied to the short end of the curve?

Might take me a minute to get that, David, if you have another question you can ask?

No, I think that's it, I think we've covered everything.

Yes, I might have to get back to you on that, David.

We'll continue to sort of look forward, as we try and answer some other questions, we may answer it later in the call or we may get back to you.

Our next question comes from Collyn Gilbert with KBW.

First question I guess, Rob, maybe you could address it. It's just the jump in cash this quarter, sort of what facilitated that, and what you anticipate the uses of that cash to be, maybe in the next quarter? And I guess my thought would be that, that would be a positive impact to the NIM going forward, but perhaps not. So if you could just give a little bit more color around that.

No, Collyn, this should be a positive impact to the NIM. However, a large portion of that increase in cash comes from our municipal business, where we get influxes of deposits at the end of the quarter. So some of that will not be maintained, but certainly a portion of it will, and a portion of it, we will likely deploy into investments.

Okay. And then, what percent of your sort of investment and trust revenues are tied to market values?

On our investment management business?

Yes, yes.

I would say the vast majority of the revenues in our investment management group are a function of the fees associated with the level of assets in our customer accounts. I mean, we do have some tax prep fees, especially in the second quarter and a few other fees. But that's it. We're looking at the – I'm going to get the details right here. I think -- so that – yes. The vast majority. So if we were to – if the market were to chop up 25%, you'd see a material increase in our revenue and likewise account side.

Okay. Is there a bit of a lag in terms of when those…

Those fees are charged on a monthly – gosh is it monthly or quarterly? I believe it's a monthly basis to the account, based on the asset levels at the end of the month. So it would be pretty – there would not be a lag.

Pretty immediate. Okay, got it. That's helpful. Okay. Then you may -- I don't know if you guys addressed it and I apologize, the drop in compensation expense this quarter, what was driving that?

That's due to the…

Just a seasonal change in payroll? Okay.

Payroll tax associated with the incentive payouts in the first quarter.

There's also a shift, we outsourced our mortgage operations, so we had a decline there as well.

Okay, that's helpful. And Rob, I know you said that for competitive purposes, you generally don't offer what the pricing you're seeing on your loan segments is, but what is, of all your lending buckets, where are you seeing the best pricing, and what's giving you kind of the best yield at this point?

Yes, it's funny, and you probably wouldn't expect it, but it's actually on the larger deals, where the larger institutions are adhering to pricing discipline. It's really the deals that are $5 million and less where the small banks compete, where we're seeing irrational pricing. But as you go upmarket, the larger banks seem to be pricing off of market rates, and so we're seeing better pricing there.

Just to get back to David Darst's question regarding short loading assets, we have approximately $1.8 million of our loan portfolio, primarily made up of commercial loans and home equity lines that are tied to either LIBOR or prime.

That was $1.8 billion.

Correct, billion, sorry.

$1.8 billion, right, okay. Chad, are there any more questions?

[Operator Instructions]. Our next question comes from Bernard Horn with Polaris Capital.

Just a quick question again on loan growth. So I know in response to Mark's question, looks like the pipeline is reasonably flat, and I think in Matt's question, you talked about commercial being somewhat competitive from the small banks, but probably not seeing a lot of reductions. So I think that in terms of the guidance going forward being a little bit lower, it looks like the residential loan portfolio is where you're seeing most of the prepayments coming through, and I'm wondering if you can just give us some sense for the -- like the term structure or the yield structure of your in-house portfolio? Is it consisting a lot of variable rate, fixed rate, and kind of what sort of exposure do you have to a lot more prepayments?

Yes, just Rob can answer that, but Bernard I wanted -- the pipeline is actually quite strong in commercial, relatively speaking. I think you characterized it as flat.

Well, I thought it was flat quarter-to-quarter?

No, it's actually up 60% or so.

The commercial pipeline. The residential pipeline is flat, quarter-to-quarter.

So 260 and 70 respectively I think it was?

That's right. Commercial was about 180 last quarter, so up meaningfully.

Yes. So that would -- so my sense would be that maybe you're -- either you're being modest, or that there's a lot of prepayment exposure on the residential, in order for your guidance to be 1% to 2% loan growth?

Yes, actually -- it's actually not the case that we expect the prepayments in the residential portfolio to continue to increase, it's in the commercial portfolio where we're seeing stiff competition as it relates to commercial credit, and again, it's especially from smaller institutions. And last year, we looked at about $1.9 billion in credits in commercial, and we closed to $900 million. Year-to-date, we've looked at, I think almost $1 billion and have only closed about $300 million. So our pull through on commercial has declined and we're also seeing both pay outs and pay downs. Some of the pay downs are lines that are remaining open, but it's companies that have excess cash, and are choosing to use that cash to pay down their lines of credit.

Okay. But are you seeing – so the -- even though the pipeline is up strongly, then it sounds like you're still expecting to be -- to see a fair amount of essentially offsetting pay offs and pay downs for total loans to be up 1% to 2% for the second half, if I'm getting that right?

That's correct.

One of the advantages we have with such a substantial commercial relationship and bankers out in the field is that we're able to look at a lot of the deals and we have a lot of looks. And we're able to then work and take the deals that fit our pricing expectations, and hope – let the rest go to the folks who don't have the pricing discipline we have right now. We expect that the smaller banks over time are going to catch up. I mean, this is not a permanent phenomenon. Rates have sort of rocketed up, and they don't have the sort of sophistication I think that the bigger banks do like us. So hopefully, we're not going to be looking at this for too long.

Right. And then just on capital, with the new guidance from FDIC and so forth, are you -- obviously you've got some balance sheet growth through the acquisitions. Any other thoughts on capital or where that's going or how you might deploy that going forward?

Yes, well it was all positive news for us. As you know, being under $15 billion, the areas that we were concerned about is that the trust preferred, that being eliminated over time. The other comprehensive income on the mark-to-market, on your available for sale, on your cash flow hedges having to flow through regulatory capital. We have the opportunity to opt out of that. And risk weighting of residential loans was positive as well. So we're feeling even more comfortable than we already did about our capital position, and don't have any plans at the moment to change anything structurally.

Okay. So with 9 plus percent of leverage ratio, you should either be able to do stock buybacks, which I'm not saying you should do, I'm just asking that or the tradeoff between just continuing to grow the balance sheet through M&A or -- because loan growth doesn't sound like it's going to be able to grow the balance sheet enough to drop the capital ratio/

Yes certainly, we prefer the latter, continue to grow.

There appears to be no further questions at this time. So I'd like to turn the conference back over to management for any closing remarks.

Great. Thank you, Chad, and thank you, everybody, for joining us this quarter. We look forward to giving you another update in 3 months. Have a good summer. Bye.

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