Welcome to the Independent Bank Corp. Second Quarter 2017 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. 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. Factors that may cause actual results to differ include those identified in our annual report on Form 10-K and our earnings press release. 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. I would now like to turn the conference over to Christopher Oddleifson, CFO. Please go ahead.

Thank you, Brendan. Our CFO, Rob Cozzone, is with us today and he will be speaking with us later. Good morning. We continued our long term record of consistent financial performance with our solid quarter in Q2. Inclusive of M&A expenses, EPS on a GAAP basis came in at $0.75 per diluted share in second quarter. Excluding these costs, net income rose to $22.4 million or $0.82 per diluted share which is comfortably ahead of both prior quarter and prior year results. Rob will provide added color on our results following my comments. The strength of our underlying fundamentals was again on full display this quarter. Overall consumer and business household growth remained strong. Organic growth in our commercial loan portfolio was sustained, as we continue to maintain healthy pipelines and actively participate in deal flow activity. Small business lending has been strong for us, with balances up 19% in the past year. On the consumer side, both our home equity and residential portfolios continued their upward ascent as customers responded to our attractive offerings. Core deposits have more than kept pace with our loan growth and have now reached 91% of total deposits. Our investment management business continues to be real bellwether for us with strong revenue growth in Q2 and assets managed under administration climbing to $3.2 billion. Astute balance sheet management by a treasured group is really paying off, as demonstrated by a rising net interest margin. Credit quality remains in good shape, as we have not wavered from our disciplined underwriting practices. Tightly -- we're tightly managing our expenses and that has a result in a further improvement of our operating efficiency ratio. And capital levels continue to grow nicely. Tangible book value per share continues at steady -- to steadily rise even while absorbing the…

Thank you, Chris and good morning. As Chris just described, things came together especially well for us in the second quarter. GAAP net income of $20.6 million was relatively consistent with both the prior quarter and the same quarter of last year. Conversely though, operating net income which is adjusted for merger charges, at $22.4 million was up over 6% versus the first quarter and over 9% versus the prior year. In addition, operating earnings per share increased 5% over both prior periods to $0.82 in the second quarter. Strong earnings results translated into enhanced profitability. On an operating basis, second quarter return on assets, return on equity and return on tangible equity improved to 1.15%, 10% and 13.5%, respectively. These results are a byproduct of maintaining our focus on strategic and financial priorities, many of which are highly evident in second quarter results, namely consistently maintaining asset sensitivity, growing fee income businesses and realizing operating leverage. I'll discuss each of those further following in my balance sheet comments. Total assets grew to $8 billion as of June 30, primarily as a result of the Island Bancorp acquisition and continued steady loan growth. The Island acquisition which was closed and converted over the May 12 weekend, added $156 million in loans and $160 million in primarily core deposits. A complete schedule of the acquired assets and liabilities can be found in the press release. As Chris stated, customer response have been simply terrific and deposit retention has exceeded all expectations thus far. As anticipated, the transaction was neutral to tangible book value per share and earnings accretion expectations remain intact. Our strategic regulatory and operational acquisition expertise has become a core competency that reduces integration and financial risk. Consistent with expectations, total organic loan growth was almost 1% for the…

Thanks, Rob. Brendan, we're ready for Q&A.

[Operator Instructions]. The first question comes from Mark Fitzgibbon with Sandler O'Neill Partners.

We've seen a number of other banks your size that have recently announced plans to kind of move into your markets, so your core markets of Boston that's offshore. Are you seeing any impact from that yet on loan deposit pricing?

No, nothing imminent yet, Mark, especially relative to the more recent entrants. As you could imagine, the Boston market has been extremely competitive with all of the large players that we have to compete against in addition to many smaller players trying to get a foothold. But our pricing held up nicely actually in the second quarter and we expect that to continue.

Okay. And then secondly, I wondered if you could update us, if I'm not mistaken, you guys were sort of systematically going through your branches and trying to upgrade and reduce the footprint size of those, improved technology, et cetera. How is that going? How many have you been able to convert and how many remain?

Right. So we have about 85 branches right now, Mark. And our -- we -- it's been a continuous process over the really last 10, 15 years which on average are probably close, relocate sort of 1, 2, 3 branches a year. Currently, that pace over the last 3, 4 years has accelerated. During 2016, I think we had 4 branches that we closed. And in 2017, we have branch relocation from Burlington into a much better location where we're building a brand new branch in a new location. We have a de novo branch that we're kind of building in Newton. We have a branch in Hyannis where we're moving down the street to a much sort of bigger and more accessible building that will have not only a branch but all our other lines of businesses. And in terms of transformations, our most recent transformation, we moved from a traditional branch to a sort of a teller pod concept as Mashpee down in the Cape. So far we've transformed about 8 or 9 branches into this new concept. We -- this is sort of the story that's never going to end, Mark. I mean, we're going to be continuing asking ourselves, how -- what -- where do we trend, where do we add, where do we combine, the -- and sort of what is the priority of the new markets we wanted to now move in. So I expect -- you can expect over the next number of years that we'll continue that. And we're also sort of asking ourselves, what additional sort of branch technology do we want to introduce. In fact, there is a lot out there, as you've probably read and seen. We have to be careful and very judicious about what we can test, but we're on that path as well.

Okay. And then lastly on the margin, Rob, you had mentioned that the NIM guidance that you had given previously is too conservative. How are you thinking about the margin for the third quarter in terms of the magnitude of improvement?

Well, my guidance for the full year was 15 to 20 basis points of expansion versus full year 2016 on the core margin. I would expect the margin to expand into the third quarter because of the June increase. I -- based upon I think we're all seeing out there, there likely won't be another increase, at least in Fed funds until the end of the year, probably December which means we would likely see the Q4 net interest margin be flat to slightly down versus Q3, because I expect more deposit pricing sensitivity to take some hold as these rate increases become evident to folks and has competition for deposits which is already happening to some extent, intensifies. So we have about $3 billion of assets that are tied to LIBOR or Fed funds or prime. And then we have about another $400 million in change that is indexed to kind of a 1-year home loan bank or 1-year LIBOR rate.

Our next question comes from Matthew Breese with Piper Jaffray.

I just wanted to make sure I had the core margin right this quarter. What was -- and I'm sorry if I missed it, what was the accretable yield in there?

The accretable yield for the quarter was about $300,000. And that's been pretty consistent, Matt, over the last couple of quarters prior to that and was averaging about $400,000 a quarter.

Okay. And so the updated guidance from 16 to 17 to 15 to 20 basis points of expansion, that's off the core margin?

That's off the core margin, but that will be pretty close on both core and absolute actually.

Okay. And then just going to your deposit competition commentary that perhaps could drive the margin actually down in 4Q, in what areas of your market is it most intense and in what product categories is it most intense?

Yes. So pretty consistently what I have said the last couple of quarters is the government banking business has been very competitive. And so we've seen pricing go up on that portfolio to the tune of about 5 or 6 basis points. And that began early on really in the fourth quarter of last year. But our absolute cost of funds in that book of business is still fairly very attractive. Then we saw competition intensify and customers take notice in the larger commercial categories. All those customers that were maintaining some excess funds in their business checking accounts, they have been more sensitive to pricing and are seeing alternative pricing levels at other financial institutions. Just recently, we've started to see a little bit more sensitivity in the kind of broader base deposit products on the business and consumer side. So we have made some minor adjustments to a couple of product categories which we think will likely increase our cost of deposits in the third quarter by the tune of about 2 basis points.

Okay, very helpful. And then thinking about the Island Bancorp acquisition, just curious, could you remind us of what your outlook for cost saves was and how far along in the process of achieving those cost saves we're at this point?

Yes. So in terms of achievement, they've all been achieved. And our cost save estimates which are typically conservative for us out of the gate, were around 35%. One thing that is slightly different with Edgartown this kind of early on, as Chris mentioned, is that we've been successful in recruiting some new business folks from other local institutions. So some of that expense, including a commercial banker and some wealth management folks, so that expense is not included in our original assumptions, but neither is the benefit on the revenue side.

Okay. And then lastly, each quarter, we march a little bit closer to the $10 billion threshold. And I just wanted to get a sense for how far along in the expense process you are. How much of the DFAST expenses are currently baked in? How much more do you think you have to go? And then could you just remind us of what the interchange risk is?

Yes. So I'll take the latter first. As our interchange revenue grows, obviously, we have more at risk. So now we're kind of approaching the $7 million mark in terms of a modest interchange that is potentially at risk and that will likely continue to grow. But what we're doing as an aside here is aggressively looking at our credit card offerings to see -- first of all, we don't have a consumer credit card offering right now, but we intend to get one. And we're hopeful that we can migrate some of that debit card activity, not a substantial amount likely, but some of that debit card activity to credit card offering. In terms of the expense, we continue to incrementally add. For example, this quarter, we added a consumer risk specialist in our portfolio -- credit portfolio analytics group. That is a position that we probably wouldn't have added if we didn't think we were going to cross the $10 billion threshold. And we have been doing that for last couple of years now. So I wouldn't expect, as I've said in the past, to see a significant incremental increase in expense as we cross $10 billion. But we'd probably still have another $1 million to $2 million in annual spend that we'll be gradually incorporating as we approach $10 billion.

I was mentioning our progress in DFAST.

Yes, we're making significant progress in preparing for a DFAST submission. Our hope is that before the end of the year that we're in a position to have kind of a test run.

So that gives some indication on the infrastructure we have already in place?

Right, I mean, that sounds like if you're ready for test run, you're most of the way there.

That's right.

Our next question comes from Laurie Hunsicker with Compass Point.

Just a follow-up on Matt's question. So without acquisition, where do you think about the $10 billion cross being in terms of when you would actually run across that line?

Well, if you think about our organic growth rate being in the 6% to 8% range, we probably are looking 2.5 years out. If you throw an acquisition in there, well, it could be a lot sooner.

Okay. And I guess, just going back to margin here, I just want to make sure that I have this right. So with $300-or-so million of accretable income, that's roughly 2 basis points, so your core NIM is already at 3.58% versus you are at 3.38% for 2016. Again, that's core distrophing at accretion income. So you're already sitting at your very top of your upper guidance at potentially 20 basis points up?

Well, that's this current quarter. We were lower than that last quarter. So if you average the 2, we would be lower than 20 basis points. And I expect to expand in the third quarter, but fourth quarter is a little bit difficult to predict because of potential for deposit pricing sensitivity. But I would not expect borrowing an additional Fed funds increase, a margin to expand further in the fourth quarter.

Got it. Okay. That's helpful. Okay. And then just lastly, looking at your income statement, the other expense line of $13.2 million, is there anything nonrecurring in that?

Well, we've mentioned the consulting fees associated with some projects and all those particular expenses will not be repeated. We will have likely additional consulting associated with other products as we continue to invest in strategic initiatives. But consulting as a whole I would expect to decline. Some of the recruitment expense and we have been very successful in recruiting some senior folks in the commercial banking side. We also just added our Head of Retail, Pam Frey, that Chris mentioned. So those are expenses I would not expect to continue at the same level. And then we have some other expenses which will decline into the third quarter, more operating type expenses. So as I said, we do expect the efficiency ratio to improve throughout the remainder of the year.

Okay. And so then just to be clear, something like a signing bonus is falling into that other, other?

That's right.

Okay. And then as we think about the salary...

Relocation expenses.

And relocation, okay, got it. And so if you look at the salary and benefits line, because obviously, the hiring was in this quarter, how should we been thinking about that just as we head into next quarter with the fully baked run rate on the salaries and benefits line with your new hires?

It will actually decline a little bit because of payroll taxes. But obviously, some of the hires will add that. So I don't have a detailed number that I'd like to provide you, but I would expect the whole thing, salaries and benefits combined, to decline for the remainder of the year.

[Operator Instructions]. Our next question comes from Collyn Gilbert with KBW.

Just a few housekeeping questions. Rob, what's the split between your -- of your deposits? How much is split between retail and commercial?

The way we categorize business deposits which includes small business, we have about $2 billion in total business deposits and then $4 billion in total consumer deposits and then about $600 million in municipal deposits. And then we have some small other deposits like the 1031 exchange business.

Okay. Okay, right, that's helpful. And then on your fee outlook, maybe can you just talk in broader terms about what you're sort of seeing on -- within the derivative activity and then mortgage banking? I knew you gave specific fee guidance. But just trying to understand some of the trends that you're seeing in each of those businesses as you look out for the next 6 to 12 months or so.

Yes. Certainly, so for low-level derivative income, it's a combination of our new business activity and then obviously customer demand for fixed rate. I would suggest that our fee income going forward will be more -- in that category will be more reflective of the absolute amount of loan closings that we do in a particular quarter. So in the second quarter, we had very high commercial closings, one of our highest quarters ever. And so the derivative income increased as a result. I would not say that we've seen any change in business customers' perspective regarding interest rates. And so it doesn't seem like the rate environment is influencing their decision to swap or not swap. It's just new business coming in the door that wants a 7- or 10-year fixed rate and they can get a better rate if they chose to swap. So that's derivative income. In terms of mortgage banking income, we have actually seen in the last few quarters a higher percentage of our production go into portfolio and therefore benefit our mortgage banking income line item. But you see that our growth in the residential book, our organic growth is more than it has been historically. There is significant demand, probably not surprisingly, in the Greater Boston market for jumbo product and jumbo product that there is not really an active competitive secondary market for. And based upon our pipelines, we expect that business to continue in the short term which means we're selling a little bit less production than we have historically, closer to probably 60% versus 75% or 80% in the past. Should that change, should there be a more competitive market for jumbo or should we see more conforming production, then I would expect, obviously, mortgage banking income to increase. But I think the number for the second quarter is a pretty good number going forward. We have built out our mortgage operation from an operational perspective quite nicely and we're getting very favorable customer feedback. And we have a nice complement of mortgage officers on staff right now.

Okay, that's helpful. And then what -- do you have the breakout on what would be considered retail-related CRE within your CRE book?

Yes. We put a pie chart together for the Q which shows commercial buildings in total at 18%. And then we have hotels and motels at about 9%, strip malls at about 4%. So within that commercial building category, there is a portion of that which is retail related, the majority of which is non -- the vast, vast majority, non-big-box retailers. We have a pretty meaningful portfolio of stopping shop. I mean, a grocery store, sorry and it's -- and convenient stores, but not many other retail, certainly not big-box retailers.

Okay. Okay, that's helpful. And then, I guess, just one final question for -- no, actually another sort of detailed question. Rob, thoughts on the provision kind of going forward, it's jumped a little bit, just given some of the emergence of credits in the last two quarters. But how do you see that trending as you look out for the rest of the year?

Yes, I mean, credit quality aside from that, one commercial credit that we've discussed the last couple of quarters has been exceptional. All the trends look favorable from, if you strip that one out again, from a delinquency nonperforming asset perspective. Everything is trending favorably. So we don't see anything on the horizon that would suggest anything other than maybe a periodic charge-off of any meaningful size. So we're feeling very good about credit quality.

Okay. Okay, that's helpful. And then finally, Chris, just if you could comment on what you're seeing out there in terms of M&A in the market and just sort of what your appetite is. And I mean, if -- I'm sure it probably hasn't changed, but maybe more of what the landscape looks like here in the last few months or so.

Well, I can't talk about sort of detail, but I will say that there was a large enhancement in our marketplace that I'm sure we're having. We're always desirous to be at the table. Our currency is strong. And as in the past, I'll just emphasize that we're really sort of disciplined and focused probably on some of these things. I mean, the -- we need to be sort of thinking about the long term. In terms of the other sort of banks that may raise their hands, there not as many of these in the past, but there's certainly a number that I imagine that the trend is not going to come to a abrupt halt, but over time that some of these banks are going to raise their hand. They want to talk about a potential merger. And we're ready, willing and able to have that conversation. Our strategy for M&A is tightly focused, I mean, historically. I mean, we really believe in just being opportunistic, but also that we believe a major sort of economic center of New England is right here where we're, so emanating in a semicircle around Boston. And we'd like to sort of put our primary focus on that. Not that if there's an interesting bank that comes up a little bit further way, we wouldn't take a look at it or think about it. But we would -- I mean, ideally, we'd like to sort of continue our march which is fill on our market and move out in the directions of Northwest and -- or Southeast.

[Operator Instructions]. This concludes our question-and-answer session. I would like to turn the conference back over to Christopher Oddleifson for any closing remarks.

Okay. Thank you, Brendan and thank you, everybody, for joining us. And we look forward to talking with you again in 3 months. Have a good rest of the summer. Bye.

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