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INDB > SEC Filings for INDB > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for INDEPENDENT BANK CORP

Form 10-K for INDEPENDENT BANK CORP


28-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANAYLISIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company is a state chartered, federally registered bank holding company, incorporated in 1985. The Company is the sole stockholder of Rockland Trust, a Massachusetts trust company chartered in 1907. For a full list of corporate entities see Item 1 "Business - General." All material intercompany balances and transactions have been eliminated in consolidation. When necessary, certain amounts in prior year financial statements have been reclassified to conform to the current year's presentation. The following should be read in conjunction with the Consolidated Financial Statements and related notes.

Executive Level Overview

Management evaluates the Company's operating results and financial condition using measures that include net income, earnings per share, return on assets and equity, return on tangible common equity, net interest margin, tangible book value per share, asset quality indicators, and many others. These metrics help management make key decisions regarding the Bank's balance sheet, liquidity, interest rate sensitivity, and capital resources and assist with identifying areas to improve. The Company is focused on organic growth, but will consider acquisition opportunities that provide a satisfactory financial return. During the fourth quarter of 2013 the Company acquired Mayflower Bancorp, Inc. and its bank subsidiary.

The following information should be considered in connection with the Company's results for the year ended December 31, 2013:

Loans and Asset Quality

Management's balance sheet strategy emphasizes commercial and home equity lending. The results depicted in the following table reflect the focus on those asset classes:

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Commercial lending drove 2013 organic loan growth, with year-end commercial lending balances up 6.9% from the prior year (exclusive of the Mayflower acquisition).

Management strives to be disciplined about loan pricing and generates loan assets with interest rate sensitivity in mind. The Company has gradually and intentionally shifted its balance sheet composition so that its interest-rate risk position is fundamentally asset-sensitive.

Management takes a disciplined approach to credit underwriting seeking to avoid undue credit risk and loan losses. For 2013, net charge-offs were 0.19% of average loans. Nonperforming loans totaled $34.7 million, or 0.73% of total loans, at December 31, 2013 due to management's proactive approach to loan workouts.


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Funding and the Net Interest Margin

Management emphasizes core deposit growth to fund loans, as depicted by the following chart:

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Core deposits grew by 11.9% during 2013 and, at year end, represented 84.9% of total deposits.

The net interest margin decreased to 3.51% for the year ended December 31, 2013 as the prolonged low rate environment continued to pressure asset yields. The Company has countered net interest margin pressure with robust loan growth which, when combined with asset and liability pricing discipline, has led to net interest income growth. Management expects the net interest margin to stabilize in coming quarters.

Noninterest Income

Management continues to focus on growing noninterest income which grew by 9.7% in 2013 and now represents 27.1% of total revenue, or 26.8% of total revenue on an operating basis. This growth was primarily due to increases in deposit account fees, interchange and ATM revenues, and fees paid for investment management services. The following chart depicts the steady increase in noninterest income as a percentage of revenue, on an operating basis, (net interest income plus noninterest income) over the last few years:

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Expense Control

Management takes a balanced approach to noninterest expense control by paying close attention to the management of ongoing operating expenses while making needed capital expenditures and prudently investing in growth initiatives. The Company's primary expenses arise from Rockland Trust's employee salaries and benefits and expenses associated with buildings and equipment. During 2013, noninterest expense was well contained. Noninterest expense increased by 8.9% from the prior year, largely due to the full year impact of the Central acquisition. The Company's 2013 efficiency ratio (on an operating basis) was relatively consistent with prior years.

The following chart shows the trend in the Company's efficiency ratio, on an operating basis (calculated by dividing noninterest expense by the sum of net interest income and noninterest income), over the past five years:

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Tax Effectiveness

The Company participates in federal and state tax credit programs designed to promote economic development, affordable housing, and job creation. During 2013, the Company participated in the federal New Markets Tax Credit program and the federal low-income housing tax credit program. The Company has also established security corporation subsidiaries and, through its subsidiaries, purchased tax-exempt bonds. Federal and state tax credit program participation and other tax strategies permit the Company to operate in a tax effective manner and sometimes also creates a competitive advantage for Rockland Trust and its community development subsidiaries. During 2013, the Company achieved an effective tax rate of 24.7%.


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Capital

The Company's disciplined approach with respect to revenue, expense, and tax effectiveness is designed to promote long-term shareholder value. The Company's consistent profitability has steadily increased tangible book value per share and helped create the Company's strong capital position. The following chart shows the trend of the Company's tangible book value per share over the past five years:

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This strong growth in capital has led to a consistent cash dividend which increased from $0.72 per share in 2009 to $0.88 per share in 2013, a 22.2% increase.

2013 Results

Implementation of the disciplined approach and strategies described above led the Company to 2013 net operating earnings of $55.2 million, or $2.39 on a diluted earnings per share basis, a record high, and an increase of 17.2% and 10.7%, respectively, when compared to net operating earnings of $47.1 million, or $2.16 per diluted share for 2012. Net income for 2013 computed in accordance with generally accepted accounting principles was $50.3 million, or $2.18 on a diluted earnings per share basis, as compared to $42.6 million, or $1.95 for the prior year.

2014 Earnings Outlook

The Company anticipates 2014 diluted earnings per share performance to be in a range between $2.42 and $2.52.

Key assumptions in the 2014 outlook include:

Total loan growth of 4-5%;

Total deposit growth of 2-3%;

A net interest margin in the mid to low 3.40% range;

Stable asset quality outlook, with a provision for loan loss in the range of $11-$14 million and net charge-offs in the range of $9-$12 million;

Noninterest income growing by 3-4%;

Noninterest expense increasing by 3-4%;

An effective tax rate of 30%; and,

Unadjusted Tangible Common Equity ratio increasing to a range of 7.25% to 7.50% by the end of 2014.


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Non-GAAP Measures

When management assesses the Company's financial performance for purposes of making day-to-day and strategic decisions, it does so based upon the performance of its core banking business, which is primarily derived from the combination of net interest income and noninterest or fee income, reduced by operating expenses, the provision for loan losses, and the impact of income taxes. The Company's financial performance is determined in accordance with Generally Accepted Accounting Principles ("GAAP") which sometimes includes gains or losses due to items that management believes are unrelated to its core banking business and will not have a material financial impact on operating results in future periods, such as gains or losses on the sales of securities, merger and acquisition expenses, and other items. Management, therefore, also computes the Company's non-GAAP operating earnings, which excludes these items, to measure the strength of the Company's core banking business and to identify trends that may to some extent be obscured by such gains or losses.

Management's computation of the Company's non-GAAP operating earnings information is set forth because management believes it may be useful for investors to have access to the same analytical tool used by management to evaluate the Company's core operational performance so that investors may assess the Company's overall financial health and identify business and performance trends that may be more difficult to identify and evaluate when noncore items are included. Management also believes that the computation of non-GAAP operating earnings may facilitate the comparison of the Company to other companies in the financial services industry.

Non-GAAP operating earnings should not be considered a substitute for GAAP results. An item which management deems to be noncore and excludes when computing non-GAAP operating earnings can be of substantial importance to the Company's results for any particular quarter or year. The Company's non-GAAP operating earning information set forth is not necessarily comparable to non-GAAP information which may be presented by other companies.

The following tables summarizes the impact of noncore items recorded for the time periods indicated below and reconciles them in accordance with GAAP:

                                                                   Years Ended December 31
                                                                                              Diluted
                                                         Net Income                      Earnings Per Share
                                               2013         2012         2011        2013       2012       2011
                                                        (Dollars in thousands, except per share data)
As reported (GAAP)
Net income                                  $ 50,254     $ 42,627     $ 45,436     $ 2.18     $ 1.95     $ 2.12
Non-GAAP measures
Noninterest income components
Net gain on sale of securities, net of tax      (153 )         (3 )       (428 )    (0.01 )        -      (0.02 )
Gain on life insurance benefits, tax exempt     (227 )     (1,307 )          -      (0.01 )    (0.06 )        -
Gain on extinguishment of debt, net of tax      (451 )                              (0.02 )
Noninterest expense components
Prepayment fees on borrowings, net of tax          -            4          448          -          -       0.02
Severance, net of tax                            192            -            -       0.01          -          -
Merger and acquisition expenses, net of tax    5,564        4,459            -       0.24       0.21          -
 Goodwill impairment, net of tax                   -        1,317            -          -       0.06          -
Total impact of noncore items                  4,925        4,470           20       0.21       0.21          -
    As adjusted (non-GAAP)                  $ 55,179     $ 47,097     $ 45,456     $ 2.39     $ 2.16     $ 2.12


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The following table summarizes the impact of noncore items on the calculation of the Company's efficiency ratio for the periods indicated:

                                                   Years Ended December 31
                                2013          2012          2011          2010          2009
                                                   (Dollars in thousands)
Net interest income          $ 182,578     $ 172,799     $ 167,079     $ 163,961     $ 150,694   (a)

Noninterest income (GAAP)    $  68,009     $  62,016     $  52,700     $  46,906     $  38,192   (b)
Net gain on sale of
securities                        (258 )          (5 )        (723 )        (458 )      (1,354 )
Gain on life insurance
benefits                          (227 )      (1,307 )           -             -             -
Gain on extinguishment of
debt                              (763 )           -             -             -             -
Gain on terminated hedge             -             -             -             -        (3,778 )
Noninterest income on an
operating basis              $  66,761     $  60,704     $  51,977     $  46,448     $  33,060   (c)

Noninterest expense (GAAP)   $ 173,649     $ 159,459     $ 145,713     $ 139,745     $ 141,815   (d)
Merger & acquisition            (8,685 )      (6,741 )           -             -       (12,423 )
Severance                         (325 )           -             -             -             -
Goodwill impairment                  -        (2,227 )           -             -             -
Prepayment fees on
borrowings                           -            (7 )        (757 )           -             -
Loss on terminated hedge             -             -             -          (554 )           -
Noninterest expense on an
operating basis              $ 164,639     $ 150,484     $ 144,956     $ 139,191     $ 129,392   (e)

Total revenue (GAAP)         $ 250,587     $ 234,815     $ 219,779     $ 210,867     $ 188,886   (a+b)
Total operating revenue      $ 249,339     $ 233,503     $ 219,056     $ 210,409     $ 183,754   (a+c)

Ratios
 Efficiency ratio (GAAP)         69.30 %       67.91 %       66.30 %       66.27 %       75.08 % (d/(a+b))
 Operating efficiency ratio      66.03 %       64.45 %       66.17 %       66.15 %       70.42 % (e/(a+c))

Noninterest income as a % of
revenue                          27.14 %       26.41 %       23.98 %       22.24 %       20.22 % (b/(a+b))
Noninterest income as a % of
revenue on an operating
basis                            26.78 %       26.00 %       23.73 %       22.08 %       17.99 % (c/(a+c))

Financial Position
Securities Portfolio The Company's securities portfolio may consist of trading securities, securities available for sale, and securities which management intends to hold until maturity. Securities increased by $199.9 million, or 39.4%, at December 31, 2013 as compared to December 31, 2012. The ratio of securities to total assets as of December 31, 2013 was 11.6%, compared to 8.8% at December 31, 2012.
The Company continually reviews investment securities for the presence of other-than-temporary impairment ("OTTI"). For debt securities, the primary consideration in determining whether impairment is OTTI is whether or not the Bank expects to collect all contractual cash flows. The Bank also evaluated its investment securities held as of December 31, 2013 to identify those that meet the definition of a Covered Fund as set forth in the final rules issued on December 10, 2013 to implement section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (commonly referred to as the "Volcker Rule"). In that regard, the Bank considered the impact of the related interim final rule issued by its primary banking regulators on January 14, 2014 to address the treatment of certain collateralized debt obligations backed primarily by trust preferred securities ("TruPS CDOs"), including the non-exclusive list of TruPS CDOs that are exempt from the Covered Fund provisions under the interim


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final rule. The Bank identified no investments held as of December 31, 2013 that meet the definition of a Covered Fund which are required to be divested by July 21, 2015 (or before recovery of their individual amortized cost basis) under the foregoing rules. Further analysis of the Company's OTTI can be found in Note 3, "Securities" within Notes to Consolidated Financial Statements included in Item 8 hereof.

The following table sets forth the fair value of available for sale securities and the amortized cost of held to maturity securities along with the percentage distribution:
Table 1 - Securities Portfolio Composition

                                                             December 31
                                      2013                      2012                      2011
                               Amount       Percent      Amount       Percent      Amount       Percent
                                                       (Dollars in thousands)
Fair value of securities
available for sale
U.S. government agency
securities                   $  40,449        11.3 %   $  20,822         6.3 %   $       -           - %
Agency mortgage-backed
securities                     234,591        65.8 %     221,425        67.2 %     238,391        78.1 %
Agency collateralized
mortgage obligations            58,153        16.3 %      68,376        20.8 %      53,801        17.6 %
Private mortgage-backed
securities                           -           - %       3,532         1.1 %       6,110         2.0 %
State, county and municipal
securities                       5,412         1.5 %           -           - %           -           - %
Single issuer trust
preferred securities issued
by banks                         2,952         0.8 %       2,240         0.7 %       4,210         1.4 %
Pooled trust preferred
securities issued by banks
and insurers                     3,841         1.1 %       2,981         0.9 %       2,820         0.9 %
Marketable securities           11,464         3.2 %       9,910         3.0 %           -           - %
Total fair value of
securities available for
sale                         $ 356,862       100.0 %   $ 329,286       100.0 %   $ 305,332       100.0 %
Amortized Cost of Securities
Held to Maturity
U.S. treasury securities     $   1,011         0.3 %   $   1,013         0.6 %   $   1,014         0.5 %
Agency mortgage-backed
securities                     155,067        44.2 %      72,360        40.6 %     109,553        53.5 %
Agency collateralized
mortgage obligations           187,388        53.5 %      97,507        54.6 %      77,804        38.0 %
State, county and municipal
securities                         678         0.2 %         915         0.5 %       3,576         1.7 %
Single issuer trust
preferred securities issued
by banks                         1,503         0.4 %       1,516         0.9 %       8,000         3.9 %
Corporate debt securities        5,005         1.4 %       5,007         2.8 %       5,009         2.4 %
Total amortized cost of
securities held to maturity  $ 350,652       100.0 %   $ 178,318       100.0 %   $ 204,956       100.0 %
Total                        $ 707,514                 $ 507,604                 $ 510,288

The Company's available for sale securities are carried at fair value and are categorized within the fair value hierarchy based on the observability of model inputs. Securities which require inputs that are both significant to the fair value measurement and unobservable are classified as Level 3. As of December 31, 2013 and 2012, the Company had $3.8 million and $6.5 million of securities categorized as Level 3.


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The following tables set forth contractual maturities of the Bank's securities portfolio at December 31, 2013. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Table 2 - Securities Portfolio, Amounts Maturing

                                   Within One Year            One year to Five Years      Five Years to Ten Years        Over Ten Years                 Total
                                               Weighted                       Weighted                  Weighted                   Weighted                  Weighted
                                                Average                        Average                   Average                    Average                   Average
                                 Amount          Yield          Amount          Yield       Amount        Yield        Amount        Yield       Amount        Yield
                                                                                      (Dollars in thousands)
Fair value of securities
available for sale
U.S. government agency
securities                   $      -               -      $       20,163        1.3 %    $  20,286        2.1 %    $        -          -      $  40,449        1.7 %
Agency mortgage-backed
securities                          -               -               8,707        4.5 %       56,524        3.0 %       169,360        3.2 %      234,591        3.2 %
Agency collateralized
mortgage obligations                -               -               2,026        4.1 %          199        1.4 %        55,928        1.8 %       58,153        1.9 %
State, county and municipal
securities                          -               -                 259        1.2 %        3,655        2.1 %         1,498        2.4 %        5,412        2.1 %
Single issuer trust
preferred securities issued
by banks                            -               -                   -          -              -          -           2,952        5.6 %        2,952        5.6 %
Pooled trust preferred
securities issued by banks
and insurers                        -               -                   -          -              -          -           3,841        0.9 %        3,841        0.9 %
Marketable securities(1)            -               -                   -          -              -          -          11,464          -         11,464          -
Total fair value of
securities available for
sale                         $      -               - %    $       31,155        2.4 %    $  80,664        2.7 %    $  245,043        2.9 %    $ 356,862        2.8 %
Amortized cost of securities
held to maturity
U.S. Treasury securities     $      -               -      $            -          -      $   1,011        3.0 %    $        -          -      $   1,011        3.0 %
Agency mortgage-backed
securities                          -               -                 455        5.5 %       16,679        2.3 %       137,933        3.1 %      155,067        3.0 %
Agency collateralized
mortgage obligations                -               -                   -          -              -          -         187,388        2.3 %      187,388        2.3 %
State, county and municipal
securities                        255             4.7 %               423        4.8 %            -          -               -          -            678        4.8 %
Single issuer trust
preferred securities issued
by banks                            -               -                   -          -              -          -           1,503        7.4 %        1,503        7.4 %
Corporate debt securities           -               -               5,005        3.4 %            -          -               -          -          5,005        3.4 %
Total amortized cost of
securities held to maturity  $    255             4.7 %    $        5,883        3.7 %    $  17,690        2.3 %    $  326,824        2.6 %    $ 350,652        2.6 %
Total                        $    255             3.7 %    $       37,038        2.6 %    $  98,354        2.7 %    $  571,867        2.7 %    $ 707,514        2.7 %

(1) Marketable securities have no contractual maturity and are excluded from the weighted average yield and amounts maturing. As of December 31, 2013, the weighted average life of the securities portfolio was 5.1 years and the modified duration was 4.4 years.

Residential Mortgage Loan Sales The Company's primary loan sale activity arises from the sale of government sponsored enterprise eligible residential mortgage loans to other financial institutions. During 2013 and 2012, the Bank originated residential loans with the intention of primarily selling them in the secondary market. The following table shows the total residential loans that were closed and the amounts which were held in the portfolio, sold or held for sale in the secondary market during the periods indicated:
Table 3 - Closed Residential Real Estate Loans

                                                    Years Ended December 31
                                                 2013         2012         2011
                                                     (Dollars in thousands)
Held in portfolio                             $  31,839    $  47,205    $  63,824
Sold or held for sale in the secondary market   260,950      373,063      270,427
Total closed loans                            $ 292,789    $ 420,268    $ 334,251


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The table below reflects the loans which were sold during the periods indicated:

Table 4 - Residential Mortgage Loan Sales

                                              December 31
                                           2013              2012
                                         (Dollars in thousands)
Sold with servicing rights released $     210,073         $ 313,329
Sold with servicing rights retained        87,229            33,393
Total loans sold                    $     297,302         $ 346,722

Loans may be sold with servicing rights released or with servicing rights retained. The principal balance of loans serviced by the Bank on behalf of investors amounted to $331.4 million at December 31, 2013, inclusive of an $80.4 million acquired portfolio related to the Mayflower acquisition, and $198.8 million at December 31, 2012. Upon sale, the mortgage servicing asset is established, which represents the then current estimated fair value based on market prices for comparable mortgage servicing contracts, when available, or alternatively is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. Servicing rights are recorded in other assets in the consolidated balance sheets, are amortized in proportion to and over the period of estimated net servicing income, and are assessed for impairment based on fair value at each reporting date. Impairment is determined by stratifying the rights based on predominant characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance, to the extent that fair value is less than the capitalized amount. If the Company later determines that all or a portion of the impairment no longer exists, a reduction of the allowance may be recorded as an increase to income. The following table shows the adjusted cost of the servicing rights associated with these loans and the changes for the periods indicated:
. . .

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