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Edited Transcript of INDB earnings conference call or presentation 19-Jul-19 2:00pm GMT

Q2 2019 Independent Bank Corp (Massachusetts) Earnings Call

Rockland Jul 23, 2019 (Thomson StreetEvents) -- Edited Transcript of Independent Bank Corp (Massachusetts) earnings conference call or presentation Friday, July 19, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher Oddleifson

Independent Bank Corp. - CEO, President & Director

* Mark J. Ruggiero

Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer

* Robert D. Cozzone

Independent Bank Corp. - Executive VP & COO

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Conference Call Participants

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* Collyn Bement Gilbert

Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst

* David Jason Bishop

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* Laurie Katherine Havener Hunsicker

Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst

* Matthew M. Breese

Piper Jaffray Companies, Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Good morning and welcome to the Independent Bank Corp. Second Quarter 2019 Earnings Conference Call. (Operator Instructions)

Before proceeding, let me mention that 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 may include those identified in our annual report on Form 10-K and on 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.

Please note that, during this call, we will also discuss certain non-GAAP financial measures as we review Independent Bank Corp.'s performance. These non-GAAP financial measures should not be considered replacements for and should be read together with GAAP results. Please refer to the Investor Relations section of our website to obtain a copy of our earnings press release, which contains reconciliations of these non-GAAP measures to the most directly comparable GAAP measure and additional information regarding our non-GAAP measures. Please note that today's event is being recorded.

At this time, I would like to turn the conference over to Chris Oddleifson, President and CEO. Please proceed.

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Christopher Oddleifson, Independent Bank Corp. - CEO, President & Director [2]

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Thank you. Good morning, everyone, and thank you for joining us today. I'm accompanied today by Rob Cozzone, our Chief Operating Officer; and Mark Ruggiero, our Chief Financial Officer.

We continued our earnings momentum with yet another record quarterly financial performance. Excluding M&A-related charges, operating net income rose to $48.8 million or $1.42 per share, significantly above both prior quarter and prior year's results. On a year-to-date basis, operating EPS is up 28% over the prior year.

Our core fundamentals remain strong with organic loan and core deposit generation, solid fee income, continued growth in assets under management, benign credit trends, improved operating efficiency and healthy returns. Most notably, tangible book value per share grew 8% in the last quarter alone and now sits just about 20% above its level of a year ago.

The major milestone in the second quarter, of course, was the bringing of Blue Hills into the fold as of April 1, which vaulted us to a bank with over $11 billion in assets. Rob will take you through some of the integration details and progress points while Mark will cover the impact on key financial categories, but suffice it to say, we're very happy with how things have gone thus far.

The talent of Blue Hills' colleagues who joined our ranks have settled in nicely and already contributing to our overall success. Our 3 new Board members who came over from Blue Hills have been very helpful in providing continuity and achieving a smooth assimilation. Very noteworthy is that during a quarter when we were focused on the successful integration of Blue Hills, our organic growth engines are running very well.

During the second quarter, we had record new investment management volume. Our assets under management now stand just a tad below $4.25 billion. We had record commercial loan originations, record residential loan originations and record new core consumer account sales. All this tells me our brand recognition, our standing as a top place to work among all employers and our reputation as having the highest customer satisfaction in Massachusetts continues to serve us well in building our business.

Our footprint continues to extend in a contiguous fashion by both de novo expansion and opportunistic acquisitions, providing us a real opportunity to capitalize on the strength of the Rockland Trust brand. We now reach westward to Worcester, to the northern suburbs of Boston, southward to Cape Cod and the islands, and throughout Greater Boston. These markets encompass the strongest economic activity in New England along with the most attractive demographics.

But as I've said before, size alone or becoming the biggest local bank is not our ultimate goal. Rather we seek to sustain our track career as a high-performing company and the preferred financial institution to customers in all our markets. In order to do so, we must continue to balance and need to remain nimble, maintain intimate relationships while possessing significant sufficient size and scale to continue investing in critical areas, especially technology.

We devote considerable resources to the Blue Hills integration efforts, and our deep talent pool allows us to move forward on other key initiatives. Foremost among them are the significant strides we continue to make in the digital space. Our implementation of online account opening technology that allows a customer to open an account in 5 minutes or less is proving quite successful. Deposit accounts opened online increased 18% over a similar period last year.

We've introduced new services, such as video tellers, card swap and Apple Watch access to enhance the customer experience. We've also begun to use robotics for such things as processing address change requests with a goal to free up our colleagues from handling routine or repetitive tasks. And we continue to strengthen our cybersecurity capabilities to protect against that growing risk.

The stakes to remain competitive in the digital space are unrelenting, and we intend to keep pace in an intelligent, cost-effective fashion by prioritizing efforts in areas that improve the customer experience. We've also enhanced and broadened the scope of our enterprise risk management program in tandem with becoming a much larger institution. This included forming a Board risk committee for advising the membership and other Board committees, refining risk appetites and thresholds, expanding dashboard reporting on key metrics, strengthening our internal risk department, and obtaining independent third-party reviews. These are just a few of the things we're working on. Needless to say, we're not sitting still, and we are optimistic about the future despite the clouds of trade disputes, weak global economies and the Fed appearing to signal that the economy is about to weaken unless they cut rates. All this contributes to uncertainty, but the local economic conditions here in Massachusetts remain favorable with state unemployment of only 3% at the end of May and real GDP growth of 4.6% on an annual basis at the end of Q1.

So looking ahead, as now a bigger bank, we believe we are creating the foundation needed for a sustainable future that at the same time preserves our all-important culture of Rockland Trust, one that sets us on a path of constant improvement and superior performance. The expression where each relationship matters is well known to all my colleagues, and that expression is a living, breathing call to action that recognizes our need to work hard to gain our customers' trust and added business. It's a seemingly simple idea, but it is complex to put into action and deliver on a continual basis.

My Rockland colleagues have taken this to heart and exhibit the passion and dedication to continue to exceed expectations, which has led to recognition of our service excellence by reputable third parties. We remain disciplined and have an unwavering focus on our competitive advantages. We continue to take nothing for granted and expect the competitive challenge and external uncertainty will persist, yet we feel confident in our ability to sustain our track record of growth and performance. That's it for me.

Rob?

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Robert D. Cozzone, Independent Bank Corp. - Executive VP & COO [3]

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Thank you, Chris. Good morning. I'll provide some additional color on the Blue Hills front before turning it over to Mark.

Following the closing of the acquisition on April 1, we converted all systems and facilities over the weekend of June 7. I can't say enough about the combined efforts of the conversion teams on both the Rockland and Blue Hills sides. Despite the stress associated with learning all new systems and transitioning approximately 30,000 households, our new Rockland colleagues continue to serve their customers with care, further solidifying already strong relationships.

As part of the combination, we closed 3 overlapping branches in West Roxbury, Norwood and Westwood, and uniquely, we decided to maintain the Nantucket Bank brand on the island of Nantucket, a brand that dates back to the mid-1800s. Even with 10 successful acquisitions under our belt, I never cease to be amazed by the talented colleagues we had working on our integrations, and I can't thank them enough.

With the Blue Hills acquisition, we added $2.1 billion of loans, $1.9 billion of deposits, $197 million of securities and $125 million of borrowings. As previously discussed, some balance sheet delevering had been performed prior to the closing with more anticipated afterwards.

Since closing, we have sold $47 million of securities and have identified an additional $86 million of residential loans to be sold in the third quarter, loans which have been reclassified to help the sale. In addition, we've allowed for accelerated loan runoff for segments of the Blue Hills portfolio that don't line up well with ours. While we do not anticipate further loan or security sales, we will continue to allow certain loan portfolios to run down.

On the business side, onboarded Blue Hills commercial loan officers began producing out of the gate, and our desire to leverage the Blue Hills mortgage operation has already proven fruitful with record closings during the second quarter. Notably, we have exceeded our initial financial expectations for the transaction. Tangible book value accretion was north of 2.5%. We have extracted more than 50% in cost saves as of 6/30. Mortgage banking income was well ahead of expectations for the second quarter and partially due to accelerated purchase accounting, net interest margin dilution was much less than anticipated. We know that there is more work to be done to fully assimilate former Blue Hills Bank colleagues and customers, but we are confident that we are off on the right foot.

Mark?

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Mark J. Ruggiero, Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer [4]

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Thank you, Rob. I will now cover the second quarter results in more detail.

GAAP net income of $30.6 million and diluted earnings per share of $0.89 in the second quarter of 2019 reflect decreases of 13% and 29%, respectively, from the prior quarter's results, driven primarily by $24.7 million of pretax merger and acquisition expenses associated with the Blue Hills acquisition. Excluding these merger and acquisition expenses and their related tax impact, net income and diluted EPS were $48.8 million and $1.42, respectively, new records for the company and generating increases of 33% and 9%, respectively, when compared to Q1. This strong earnings performance resulted in a sustained 1.69% operating return on average assets.

In addition, tangible book value per share increased a remarkable $2.36 in the quarter, a direct result of the acquisition impact, strong operating earnings and a $0.41 lift attributable to other comprehensive income. And return on average tangible common equity on an operating basis remained strong at 18.1% for the quarter.

Organic loan activity, inclusive of the delevering actions taken, was essentially flat for the quarter across all categories. Within the commercial portfolio, strong construction loan growth was offset by decreases in both the commercial real estate and C&I categories. However, as Rob alluded to in his comments, a certain level of loan runoff on the Blue Hills acquired commercial loans was anticipated and offset strong closing volumes in the second quarter. On the consumer side, the majority of mortgage production continues to be sold in the secondary market, while overall demand for home equity loans remains a challenge across the industry, both leading to flat organic movement for the quarter. Prospectively, the expanded footprint continues to provide a significant flow of potential opportunity to our lenders and is evidenced by an approved commercial pipeline at June 30 of approximately $170 million.

On the deposit side, although runoffs in the acquired core deposits was slightly elevated during the quarter, the company experienced a strong rebound in demand deposits with 4.6% or 18.5% annualized organic growth in the category for the second quarter. And within the time deposit category, new broker deposits were obtained to replace the liquidity needed from increased levels of maturing CDs included in the Blue Hills deposit base.

As a result of the movement in balances noted, despite the absorption of the higher costing deposit base of Blue Hills, we were able to mitigate the negative impact on our funding cost. The overall cost of deposits for the second quarter was still a relatively low 49 basis points, reflecting only a 10 basis point increase from the prior quarter.

The company's borrowings profile in the second quarter reflected a number of moving pieces, including an approximate $250 million increase in Federal Home Loan bank borrowings, the majority of which consist of overnight borrowings. In addition, the company fully paid off the $50 million line of credit that was secured in the first quarter for funding the Blue Hills acquisition and redeemed approximately $10.3 million of higher cost callable trust preferred debt.

Amidst a lot of moving pieces for the quarter, the net interest margin of 4.09% for the second quarter came in higher than expected and was boosted by approximately $4.3 million of loan accretion on acquired balances. Although accretion income can be difficult to predict due to the potential volatility associated with payoff activity, a more normalized level of accretion income would have pegged the margin right around 4%, which reflects a decrease from the prior quarter due to the full quarter absorption of Blue Hills' lower margin balance sheet.

And as an update over implications associated with the growing expectations of potential Federal Reserve rate cuts, the company has entered into an additional $150 million of hedges during the quarter, protecting against downward rate movements, bringing the total hedge position against lower rates to $750 million as of June 30, 2019. As a reminder, layering on additional protection against reduced rates remains challenging as market pricing has already factored in the significant rate cuts expected throughout 2019. Currently, we would expect a 25 basis point Fed cut near the end of July to result in a decrease in net interest income of approximately $700,000 to $800,000 in the third quarter and a decrease of approximately $1.4 million to $1.6 million in the fourth quarter.

Shifting gears to noninterest items. The noninterest income of $28.6 million for the quarter reflects an increase of approximately $7.1 million or 33% when compared to the first quarter as every major category experienced an increase from the prior quarter. Some key highlights to note include the following: Enhanced postacquisition mortgage production capabilities and increasing refinance wave due to the current interest-rate environment and natural seasonality have resulted in an over 300% increase in mortgage banking income for the quarter. An increase in assets under administration to $4.2 billion combined with seasonal tax preparation fees have driven strong investment management results for the quarter. The increased customer accounts in core households resulting from the acquisition have generated higher levels of deposit interchange in ATM fee income. And lastly, other noninterest income includes approximately $750,000 of income associated with the sale of the small business credit card portfolio as well as increased income from equity method investments and FHLB dividend income.

Total noninterest expense of $93 million for the quarter represents a $36.7 million or 65% increase from the prior quarter. Included in this number is $24.7 million of merger-related expenses, the majority of which include severance and contract termination cost. When excluding merger-related expenses, noninterest expense increased approximately $13 million from the prior quarter with the major drivers being a salaries and benefits increase of $5.7 million, including the new combined higher workforce base, increased incentive expense as well as some transitionary costs through the acquisition core conversion date of June 7.

Occupancy and equipment expense increased $1.3 million, reflecting primarily the enhanced branch network from the Blue Hills acquisition. A net loss of approximately $1.5 million was realized on the $47 million deleveraged security sale previously mentioned by Rob, which is included in other noninterest expense. Other drivers of that category increase from the prior quarter include increased amortization of intangible assets acquired in the acquisition, increased consulting expenses, director's fees tied to immediately vested awards customarily granted in the second quarter and provision for unfunded commitments.

Despite the increases in absolute dollars noted, the successful achievement of expected cost saves from the Blue Hills acquisition that Rob covered has led to a further reduction in the operating efficiency ratio to 50.7% for the quarter.

Asset quality metrics remain strong. Net charge-offs for the quarter remained at only 1 basis point of loans on an annualized basis, and the uptick in nonperforming assets are primarily attributable to approximately $5.2 million of combined nonperforming loans and other real estate owned balances obtained in the Blue Hills acquisition. The provision level of $1 million for the quarter was needed primarily to accommodate growth in nonacquired loan balances.

For a quick update on the company's current expected credit loss, or CECL, preparation, the company is finalizing its initial forecast assumptions in economic scenarios to layer into the model on top of the loan level's historical loss factors. This step will lead to a more refined process of generating parallel runs to the current loss model, which will then lead to outputs needed to fine-tune assumptions over the second half of the year.

I'll now provide an update on guidance for the rest of the year. Given the significant change in the overall composition of the company as a result of the Blue Hills acquisition, our guidance will be primarily focused on the second half of the year. With a continued focus on company liquidity along with pricing competition and additional expected runoff on certain acquired portfolios, overall loan growth is anticipated to be flat to low single-digit growth for the rest of the year. Deposits are expected to grow in the low single-digit range for the rest of the year. Assuming no changes to rates from the Fed, the net interest margin is anticipated to be in the high 3.9% range as previously guided, assuming normalized loan accretion levels. However, a reminder that impact of loan payoff activity can provide for upside potential in any given quarter.

Noninterest income in the third quarter is expected to remain relatively consistent with Q2 results as demand over mortgage banking is anticipated to remain strong into early fall, combined with decreases from nonrecurring items realized in the second quarter being offset by an anticipated gain on the pending deleverage residential sale. With no anticipated nonrecurring gains and mortgage demand expected to wane in the fourth quarter, noninterest income is anticipated to decrease at a mid-single-digit percentage in Q4 when compared to Q3 -- Q2 and Q3 estimates.

With no further transitionary costs and full Blue Hills Bank cost save expectations to be realized in Q3, quarterly noninterest expense is expected to decrease at a low- to mid-single digit percentage compared to operating Q2 results.

And as we have been saying, although no credit concerns are noted for the near term, eventual deterioration is likely inevitable. And lastly, the tax rate for the rest of the year is expected to remain around 25%.

That concludes my comments. Chris?

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Christopher Oddleifson, Independent Bank Corp. - CEO, President & Director [5]

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Thank you very much. We are ready for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Today's first question comes from David Bishop of D.A. Davidson.

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David Jason Bishop, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [2]

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A question for you. In terms of -- you saw the uptick in deposit cost. I think that was sort of a telegraph of some of the pressure of some of these, the wholesale side of Blue Hills, but what are you seeing in terms of the marketplace? And what are your estimates in terms of the -- maybe the pace of growth and funding cost on the deposit side in the second half? Or you think maybe those can plateau just given some of the remix on strong demand you've had on the noninterest-bearing side. Just curious how you are thinking about the deposit cost as we head into the back half of the year?

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Mark J. Ruggiero, Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer [3]

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Sure, David. Thank you. You hit upon certainly a concept that we're looking at closely, and that's essentially the mix of deposits. As you can look at the second quarter results, we had very strong growth in demand deposits at 4.6%. Although we would love to see that growth continue into the third quarter, that may be a bit outsized. So certainly the mix of deposits could put a little bit of strain on the cost of deposits. On the positive side, we are seeing pricing pressures subside. The competition certainly on the CD pricing is starting to come in, and I think the industry expectations over potential rate cuts is certainly starting to resonate amongst our competitors. So with all that being said, I think we are -- we feel pretty comfortable that we should be able to remain deposit cost in check, but I would expect maybe 1 basis point or 2 increase into the third quarter probably solely primarily due to the mix of deposits.

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David Jason Bishop, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [4]

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Got it. Have you all started lowering, I guess, some of your legacy rates on terms of savings and any CDs across the board?

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Robert D. Cozzone, Independent Bank Corp. - Executive VP & COO [5]

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We have not, David. We have lagged as you probably recognize on the way up. We are certainly positioning ourselves to reduce rates should we actually get a cut from the Fed and use that as the impetus to do so, but as of now, we have not reduced any of our rates on deposits.

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David Jason Bishop, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [6]

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Got it. And then, sounds like a pretty strong quarter on the origination fronts. I'm just curious that it sounds like clearly there was some runoff in some of the legacy Blue Hills sectors. Maybe talk about sort of the pace, the volume of commercial and residential originations, and I'll be curious just to hear what was sort of planned attrition on the legacy Blue Hills side versus maybe what was sort of legacy or organic runoff that may have caught you by surprise. That math, it sounded like pretty strong organic loan growth?

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Mark J. Ruggiero, Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer [7]

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Yes. And we had very, very strong commercial closings in the quarter, and the pipeline numbers that I referenced in my prepared comments suggest we have really strong momentum going into the third quarter. So in terms of opportunities, we continue to have very good success in our corporate banking initiative, which is sort of the upper middle market customer base. As you know, we've opened a commercial lending office in Worcester, and we're really starting to see some opportunities, especially in the C&I and ABL portfolios there. And we think there is some market disruption in that space that we can take advantage of.

So we feel that in terms of new originations going into the third quarter, we should continue to see very strong originations. And to your point, offsetting that, there is some level of the acquired portfolio from Blue Hills that we do anticipate will continue to attrite, in particular, there were some leverage lending loans that, once they become due, we would likely not renew or look to continue on. So there's still an element of that portfolio still expected to run through.

And then other deals that did pay off in the second quarter is a combination of essentially nonrelationship commercial real estate loans where the pricing just didn't really fit what we think made sense, or C&I relationships that again just didn't really fit into our typical profile. So nothing unusual as we said. That runoff was expected, but I think it will still be a combination of that runoff offsetting what should be another strong closing quarter going forward.

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Robert D. Cozzone, Independent Bank Corp. - Executive VP & COO [8]

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And then on the residential side, David, as I stated in my comments, we had record closing volumes, about $240 million in the quarter, a combination of combining the sales force of Blue Hills with Rockland. We now have about 40 originators in total, and we expect that and, obviously, the rate decrease driving some refinance volume. But we expect that to increase to the tune of 20% to 25% in the third quarter given the pipeline that we had at the end of June. So obviously, that will subside as we head into the fourth quarter, but we expect the third quarter to be quite strong in the residential front.

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David Jason Bishop, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [9]

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Got it. That is cool color. And then I guess, Chris, from a holistic basis, you guys were over the $10 billion mark, closing in on $12 billion. Obviously, your relationship banking model has produced strong ROA. Do you look at it from an asset size. Do you worry about getting away from the relationship-driven model to a more transactional basis as you get bigger and have to do sort of bigger credits. Is that sort of a holistic concern as you move forward in terms of just growing bigger?

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Christopher Oddleifson, Independent Bank Corp. - CEO, President & Director [10]

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Yes. I think you have to be very, very focused and diligent to mitigate the natural tendency to -- for when you get bigger to sort of think about the numbers instead of the people. I think that's exactly sort of what happens to sort of very large organizations is people who are really making the business work day-to-day don't feel valued and respected. And we are absolutely focused in on that, and we are -- we have a staff culture that naturally mitigates that tendency, and certainly in our acquisition strategy, we spend a lot of time on the people side. The numbers and the technical stuff, that yields to a lot of hard work. The people stuff, you really have to focus on and be thoughtful on how to really include everybody in the ongoing entity. So that definitely is a risk that we understand exists, and we're-- our continued high performance depends on our ability to really maintain that relationship orientation. And I have a lot of confidence that we have a lot of runway to go before I have to start thinking about my colleagues as serial -- as employee numbers rather than people.

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Operator [11]

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Our next question comes from Laurie Hunsicker of Compass Point.

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Laurie Katherine Havener Hunsicker, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [12]

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Just wondered, on your other, other expense, that $18.2 million, I know that it included a $1.5 million loss from sale of securities. You mentioned that there was some other higher consulting fees. Can you tell us what else noncore was in that figure?

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Mark J. Ruggiero, Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer [13]

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Sure, Laurie. So in terms of noncore items, I wouldn't say there is significant items that would not recur into the third quarter. Certainly, some of the consulting expense was a bit outsized, but a lot of that was delays of some of the initiatives that we had intended through the first quarter. And with a lot of the strategic priorities we have -- crossing $10 billion, preparing for CECL and a number of other factors -- the consulting expense sort of run rate has certainly ticked up a bit in 2019 and is expected to sort of stay there.

There is Director fees in the second quarter associated with the equity awards. That all expense in the quarter that will not recur, that's $0.5 million. So I think when you look at the loss on the sale of securities and the Director's fees, there's $2 million there within that category that we can assuredly say would not occur again in the third quarter. I'd say those are the 2 biggest components within that category.

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Laurie Katherine Havener Hunsicker, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [14]

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Okay. And then just so that I heard you right, the outsize consultant fees, they'll continue to run elevated just simply as you've crossed $10 billion?

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Mark J. Ruggiero, Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer [15]

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Correct. And in terms of -- they won't be elevated in terms of what we anticipated. I think it was just from Q1 to Q2, there was a timing difference there that suggested a bigger increase.

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Laurie Katherine Havener Hunsicker, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [16]

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Okay. Perfect. That makes sense. And then also can you just give a little bit more color specifically on the accretion income dollar-wise that you're looking at for the back half of this year and also into next year as we think about the net interest income line?

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Mark J. Ruggiero, Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer [17]

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Sure. As my comment suggested, it obviously can be a bit volatile depending on any individual loan payoff, but I'd say a good target in terms of a normalized run rate would be half of what we saw in the second quarter. So I mentioned or alluded to $4.3 million of total loan accretion. I think half of that is a good gauge of what a normal run rate would be.

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Laurie Katherine Havener Hunsicker, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [18]

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Okay. That's helpful. Great. And then Chris, last question for you. Go ahead, I'm sorry.

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Mark J. Ruggiero, Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer [19]

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I was just going to say, Laurie, that would peg the margin to be right in line with the 4%, high 3s that we've been talking about.

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Laurie Katherine Havener Hunsicker, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [20]

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Okay. Great. So I guess, yes, right, if we're looking at that then the accretion income, which was 16 basis points on your NIM, will jump down to 10, 9, 8, that type of thing as we go forward?

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Mark J. Ruggiero, Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer [21]

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Exactly.

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Laurie Katherine Havener Hunsicker, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [22]

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Okay, cool. And then Chris, you've got one of the strongest currencies in New England. Can you just update us now that you've closed Blue Hills, what is your M&A appetite at this point? What are you looking for, even what you're avoiding. Any color you could give would be helpful.

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Christopher Oddleifson, Independent Bank Corp. - CEO, President & Director [23]

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It wouldn't be a complete call without this question from you, Laurie, so thank you. The -- our sort of orientation continues to be a strong sort of regional franchise. We've seen examples of banks who get a little bit too far afield, and what I call kind of a gangly franchise, and it's really difficult to manage. We think our strength is really our tight geographical focus.

And this is our 10th acquisition since I've been here and they've all been sort of within or very contiguous to our franchise and it's worked out very well. If I were to paint a perfect picture, I mean, we'd have a bank in the $15 billion to $20 billion, $25 billion range that's from -- includes Worcester and then arcs to the Atlantic Ocean, both North and South. That is where the real sort of concentration of economic activity is. I mean, if there is a franchise that's sort of a little bit out of that, that comes available, we certainly would have a conversation. And we love to be in conversations. I mean -- you know better than I that banks are sold not bought, and any Board that wants to have a conversation, I'd love to engage and see whether something makes sense.

We are disciplined or discipline is this whole thing. So we don't do strategic acquisitions. We do acquisitions that make sense from a strategic point of view but also are fiscally super responsible.

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Operator [24]

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(Operator Instructions) Our next question comes from Matthew Breese of Piper Jaffray.

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Matthew M. Breese, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [25]

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Just wanted to round out the NIM discussion to make sure I have kind of everything right. So all else equal, no Fed cuts, just given your comments that the -- that top line NIM could be in the high 3-kind-of-90 range. Did that imply that all else equal, the core NIM at this point is going to face compression of a couple basis points a quarter? Is that accurate?

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Mark J. Ruggiero, Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer [26]

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Yes. I think certainly the implications would be on the deposit side. So as I alluded to earlier, to the extent we have a little remixing of the deposit, I think that could put a little bit of pressure there and would attribute to the overall potential NIM compression. So 1 to 2 basis points is a pretty good estimate.

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Matthew M. Breese, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [27]

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And if you layer in a Fed cut, I think your comments suggest that perhaps per Fed cut, at least on a quarterly basis, it's maybe 3 basis points of additional pressure on the core NIM?

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Mark J. Ruggiero, Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer [28]

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On a -- for a full quarter, it'd be more like about 5 bps. So I mentioned $1.5 million.

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Matthew M. Breese, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [29]

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Understood. Okay.

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Mark J. Ruggiero, Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer [30]

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For the third quarter, it would be about 3 basis points because it would be essentially halfway through the quarter.

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Matthew M. Breese, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [31]

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Got it. Okay. Okay. And then just thinking about the hedges you have in place, the $750 million at this point, what is the protection it provides? If that wasn't there, for instance, what would be the full quarter impact from a Fed cut?

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Mark J. Ruggiero, Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer [32]

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Sure. So of that $750 million portfolio, right now, approximately $550 million of that portfolio is what we call in the money. We're already providing protection, so any rate cut from where we are today, that $550 million would protect approximately $1.5 million of that. So on a quarterly basis, that's essentially $375,000, $400,000 in terms of interest income protection. The additional $200 million that we're not speaking to, as you can expect because of the market conditions, pricing had already factored in at least a couple of rate cuts. So those hedges provide protection but not until we get 2 or maybe even 3 cuts in as either the fixed rate or the floor that we have on those hedges is in the 1 70 to 1 90 range.

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Matthew M. Breese, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [33]

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Understood. Okay. Okay. And then, just thinking about the franchise holistically with Blue Hills, certainly some more seasonal island presences. Can you just give us an update on how that seasonality will impact things on a go-forward basis? The quarters, do you expect to be really strong, the categories you expect to be different and how we should be factoring that into the model.

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Robert D. Cozzone, Independent Bank Corp. - Executive VP & COO [34]

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Yes. In terms of the deposit side of the equation, the deposit balances actually don't fluctuate as much as you might expect, Matt, not to an extent that you would see an impact on the company's overall deposit book. On the lending side, certainly, our ability to produce loans on the islands does slow in the late fall and winter months. That would be somewhat noticeable within our mortgage production now. And then also, on the commercial side, again, it's a small piece of our entire commercial production at the moment. So we're not noticeably impacted. You're talking single digit kind of percentage decreases in production as a result of that seasonality.

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Matthew M. Breese, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [35]

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Okay. All right. And just a final one from me going back to the accretable yield. If we cut it in half for next quarter, we get to $2.1 million. At what point do we get to something sub-$1 million in quarterly accretable yield? I know it's tough to model but just trying to gauge the ramp-down cadence on that over the next 18 months?

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Mark J. Ruggiero, Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer [36]

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Yes. I guess, the nuance-y part of this is essentially a large credit assumption included in that fair value mark and essentially the accounting rules because of how you bifurcate the loan books, that entire mark is getting accreted in just based upon sort of normal paydown activity. So full payoffs of loans would create volatility, but you can think about the 1% credit mark on that Blue Hills book are $24 million. That in theory should be a consistent accretable number over the duration of that portfolio. So you shouldn't expect to see sort of a significant dip in any quarter. After a period of time, that should result in sort of a level interest-earning accretion, but the nuance of loan payoffs in any quarter would create the volatility.

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Operator [37]

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The next question comes from Collyn Gilbert of KBW.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [38]

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I apologize. I just got kicked off for a quick second when Matt was asking his questions, so I hope I'm not repeating what he already asked. But just curious on the runoff of the BHBK portfolio, can you just remind us again of where the balances are, what you intend to run off?

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Mark J. Ruggiero, Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer [39]

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Yes. So it's a combination of a few portfolios, in particular. On the commercial side, it's primarily isolated to C&I and commercial real estate. There was a significant construction portfolio that came over in the acquisition, and we're seeing good outstandings associated with that, and that category will naturally either pay off or move into a permanent CRE loan over time. But the bulk of what we've been seeing for payoff activities to-date have been in the C&I and CRE portfolio, and I think we'll continue to see that going into the third quarter as some of the highly leveraged C&I book is still expected to attrite. And then, given the residential portfolio being much higher than what we have had, this is natural runoff of that portfolio anticipated as well. So that in the second quarter, there was around $40 million of runoff on the resi book. Some of that was due to full payoffs, though.

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Robert D. Cozzone, Independent Bank Corp. - Executive VP & COO [40]

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So of the $2.1 billion we acquired, Collyn, we're down to about $2 billion.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [41]

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Okay. Sorry and that was what I was going to ask is just the balances of what -- I mean, is the anticipation of runoff that full $2.2 billion?

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Mark J. Ruggiero, Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer [42]

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No, no.

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Robert D. Cozzone, Independent Bank Corp. - Executive VP & COO [43]

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Of course not. That's a small fraction. It was a -- call it a couple hundred million within that book that doesn't line up with the categories of commercial lending that we're comfortable with, and so we'll let those attrite over time. So now a little less than $100 million with the second quarter looking at probably a similar amount as we head into the third quarter and then should start to slow thereafter.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [44]

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Got it. Okay. Okay. That's helpful. And then just in terms of the dynamic between the originations and paydowns that you're seeing, what's the rate differential that you're seeing on some of these loans, the credits that are paying down and then versus what the origination rates are?

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Mark J. Ruggiero, Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer [45]

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There hasn't been, I'd say, a sizable differential between them. As you know, part of the tradeoff of our somewhat modest organic growth is that we continue to stay very disciplined over pricing. Certainly, in the market, we're continuing to see spreads come in, but those are the deals that we don't actively go after. So we're continuing to see volume and getting deals with spreads in sort of our price range. On the fixed rate side, certainly, pricing has come in a bit, and that is anticipated obviously with what's expected from the Fed. But in terms of the delta between the runoff and new originations, we don't see much of a significant impact as a result of that.

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Robert D. Cozzone, Independent Bank Corp. - Executive VP & COO [46]

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Yes. And the new volume yields are pretty close to our current book yields now, Collyn. So it feels to us like the loan yield is stabilizing if you strip out the volatility with purchase accounting.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [47]

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Okay. Okay. That's helpful. And then just lastly on mortgage banking. You guys offered great color there, and that seems to be obviously coming in really strong. How do you -- beyond what you're going to -- what you're anticipate seeing in kind of the third and fourth quarter, just longer term kind of broadly, how do you see that business contributing to you guys in 2020 and beyond? I mean, just given the infrastructure that you've cited, you've got 40 kind of originators on staff now. How should we think about that business contribution a little bit longer term?

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Robert D. Cozzone, Independent Bank Corp. - Executive VP & COO [48]

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Yes. Historically, we've struggled with the mortgage business, Collyn, and had to some extent deemphasize it and favored the offering as a supplement to our banking relationships. The majority of our volume purely by necessity was coming from our existing customer base and making the connection between our LOs and our branch personnel and commercial lenders and the like. But that was largely because we were not successful in recruiting LOs that had relationships with local COIs. Blue Hills, on the other hand, has had lots of success recruiting those individuals. And so they were able to bring the bank new customers via the mortgage channel, giving us the ability to cross-sell -- hopefully, cross-sell bank services to those mortgage customers.

And then, the other piece of the equation is the ability to leverage the infrastructure and have an infrastructure that delivers a very good customer experience. In the past, with a team of 20 LOs, it's difficult to support an internal mortgage operation. Now with 40 good-producing LOs, we can efficiently support an internal mortgage operation but especially an internal mortgage operation that delivers a great customer experience because Blue Hills made the right investments in customer-facing as well as LO-facing technology.

So we don't anticipate that it will be a significant contributor to the bottom line. On a run-rate basis, it will be a good contributor and will be able to enhance our offerings to both customers and prospects, but certainly, if these -- this quarter or next quarter are any indication, we're feeling very good about what we've done on the mortgage side.

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Christopher Oddleifson, Independent Bank Corp. - CEO, President & Director [49]

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I think we could probably add that our aspirations in the mortgage business are consistent with our branch footprint in our franchise.

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Mark J. Ruggiero, Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer [50]

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That's right.

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Christopher Oddleifson, Independent Bank Corp. - CEO, President & Director [51]

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I mean we don't have aspirations to go super regional or national.

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Mark J. Ruggiero, Independent Bank Corp. - Senior VP, CFO, Controller & Principal Accounting Officer [52]

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That's exactly right. No aspirations for that at all.

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Operator [53]

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The next question comes from David Bishop of D.A. Davidson.

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David Jason Bishop, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [54]

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Just one quick follow-up. Chris, you mentioned the health of the regional economy there, and I think there is discussion about loan pricing. That being said, any loan segments or maybe especially on the CRE side where you guys are pulling back from just seeing pricing and structure just getting too frothy where you're just putting the breaks on and stepping aside?

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Robert D. Cozzone, Independent Bank Corp. - Executive VP & COO [55]

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I can answer that, David. You've seen the decline in the CRE portfolio over the last several quarters, flat to down in the CRE book, and that is purely due to the competition that we're seeing on the CRE front. We're seeing both credit terms as well as pricing continue to come in, and we continue to see anecdotal evidence of spreads being narrower than the prior quarter. So we expect modest declines in the CRE book to continue.

Where we have been seeing opportunities is, obviously, on the construction side, on some of the smaller deals and the expertise we have in the construction space has allowed us to capitalize on those. And with those transactions, we're able to get healthy pricing as well as very good credit terms and loan terms overall.

I would also say, just finally, we are bumping up against internal limits on the hospitality side, so we are only allowing really new production to existing customers there while that portfolio runs down to free up some headroom.

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David Jason Bishop, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [56]

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How big is that portfolio?

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Robert D. Cozzone, Independent Bank Corp. - Executive VP & COO [57]

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You had to ask me that, David. I don't think I have it at my fingertips. 350 issues, what I remember, but I could be wrong.

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Operator [58]

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This concludes the question-and-answer session. I would now like to turn the conference back over to Chris Oddleifson for any closing remarks.

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Christopher Oddleifson, Independent Bank Corp. - CEO, President & Director [59]

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Thank you, everybody, for all your good questions. We appreciate your interest. We'll talk to you again in 3 months, and be careful this weekend with this heatwave. Stay cool. Goodbye.

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Operator [60]

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