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Edited Transcript of INDB earnings conference call or presentation 17-Jan-20 3:00pm GMT

Q4 2019 Independent Bank Corp (Massachusetts) Earnings Call

Rockland Jan 23, 2020 (Thomson StreetEvents) -- Edited Transcript of Independent Bank Corp (Massachusetts) earnings conference call or presentation Friday, January 17, 2020 at 3:00:00pm 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. - CAO & CFO

* Robert D. Cozzone

Independent Bank Corp. - Executive VP & COO

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Conference Call Participants

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* Bernard Robert Horn

Polaris Capital Management, LLC - President, CIO, Treasurer & Portfolio Manager

* 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

* Mark Thomas Fitzgibbon

Piper Sandler & Co., Research Division - MD & Head of FSG Research

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Presentation

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Operator [1]

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Good day, and welcome to the Independent Bank Corp. Fourth Quarter 2019 Earnings Call and Webcast. (Operator Instructions)

Before proceeding, let me mention that this call may contain forward-looking statements with respect to financial conditions, 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 any unduly relying any forward-looking statements and disclaim any intent to update publicly and forward-looking statements whether in response to new information, future events or otherwise.

Please note that during the call, we will also discuss certain non-GAAP financial measures as we view 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 press release, which contains reconciliations of these non-GAAP measures to the most directly comparable GAAP measures and additional information regarding non-GAAP measures. Also please note that this event is being recorded.

I'd now like to turn the conference over to Mr. Chris Oddleifson, President and CEO. Please go ahead.

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

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Thank you, Nick, and good morning, and happy new year to everyone and thank you for joining us. I am accompanied today by Rob Cozzone, our Chief Operating Officer; and Mark Ruggiero, our Chief Financial Officer.

We produced another solid financial performance in the fourth quarter with earnings of $47.5 million or $1.38 per share. Mark will cover the quarter in more detail shortly. I'd like to focus my comments today on a full year just completed.

Financially, we had a terrific year in 2019. We generated record earnings for the seventh consecutive year. Highlights included operating EPS of $5.62, which represents growth of 20% over the prior year. Strong returns with operating ROA and ROE of 1.7% and 12.1%, respectively. Robust organic loan volumes was about $1.5 billion in commercial originations, along with healthy pipelines. This is matched by higher levels of pay downs and runoff, especially related to the acquired Blue Hills portfolios. Similarly, organic growth -- organic core deposit generation remained strong while also being offset by anticipated runoff in the higher cost acquired deposits as well as cash flow volatility within some larger commercial deposits. Our investment management group had another banner year with 10% revenue growth. And assets under management and administration, rising 26% to $4.6 billion. Credit quality remains stellar, with fairly stable nonperforming asset levels and a loss rate of a mere 3 basis points for the year. Our efficiency ratio was in the low 50% range. Tangible book value per share rose another 19% last year. We are quite proud of the fact that this key measure has grown at a compounded rate of 12% over the last 5 years despite numerous acquisitions.

And finally, we rewarded our many loyal shareholders with another healthy double-digit increase in our dividend last year. So all in all, our performance in 2019 was a very good one.

As we turn the calendar page over to 2020, we do face several headwinds. Like others in the industry, we head into the new year with lower interest margins that puts pressure on revenue levels. In addition, having crossed the $10 billion asset threshold, we will begin to incur the impact of the Durbin Amendment related to the interchange fees commencing the second half of 2020. Also some of our tax credits related to community lending are expiring this year, which will result in an increase to our effective tax rates. Notwithstanding these weights on earnings and related growth rates, we expect to post solid returns. Color -- Mark will give us -- will give you more color on this in a moment.

Beyond the numbers, the Rockland Trust franchise continued to progress over the past year in many ways. First and foremost, our acquisition and successful deleveraging and assimilation of Blue Hills Bank has significantly advanced our strategic path. It has bolted us into the #1 deposit share position in the state of any Massachusetts-based bank and meaningfully expanded our presence in the coveted greater Boston market. It has also brought us a powerful mortgage origination platform and an excellent mortgage team. And of course, we had a great talent in commercial banking and retail banking and other areas.

Other progress points include our continued expansion in the Worcester market, good growth in our new downtown Boston branch, new household formation above the population growth rate of the state, new products and features such as a credit card offering, premier banking products, streamlined online account opening, expanded use of video tellers and multiple mobile banking enhancements. We further strengthened our enterprise risk management, cybersecurity programs, and we continue to receive recognitions of excellence by reputable publications such as J.D. Power, Forbes, Global Finance and The Boston Globe and we position ourselves for future success while preserving our culture by strengthening our executive leadership ranks by internal promotions of highly talented and qualified individuals, such as Rob and Mark, who have joined me today.

Heading into the new year, our priority initiatives include: continuing to build out our Worcester presence with new branches, ATMs and marketing campaigns; continuing to satisfy the Blue Hills customer base with our more extensive product offerings; capitalizing on investment management opportunities, especially in recently acquired markets such as Martha's Vineyard and Nantucket; augmenting customer online access to offerings such as credit card, home equity and investment management; further streamlining our underwriting processes; and keeping pace with the growing customer preferences for mobile banking.

So it's another busy year in store for us. With the added scale and operating leverage provided by the Blue Hills acquisitions, we'll be making incremental investments in our infrastructure, especially risk management, technology and analytics to ensure we're fully equipped to pursue the concrete growth opportunities we envision arising from our increased scale. While these investments will add to our expense base, some long-term benefits will be well worth it.

Nationally, we continue to monitor the increasing risks associated with foreign tensions, global economic struggles and tighter labor markets. The 10-year expansion has continued on the back of a strong labor market, with unemployment remaining unchanged at 3.5%, a 50-year low. Locally, the Massachusetts unemployment rate has held steady at an incredible 2.9% for October, with an estimated state -- gross state GDP of about 1.4% in Q3. So despite the headwinds I just mentioned, we continue to see a rather healthy economy around us.

And wrapping up, I want to reiterate that while we enter 2020 a much different company in terms of size and scale, we remain the same in many important ways. Specifically, we retained the look and feel of a local bank, totally focused on our customers. We're committed to continue providing top-tier products and services while building even stronger customer relationships. Our ongoing success serving our customers is validated by a consistently high customer satisfaction and service rankings we receive.

We also remain committed to a path of discipline and focus, which has served us well and will continue to be a cornerstone of our success. We will devote our resources to leverage our core competitive advantages while, at the same time, avoiding being distracted by pursuits that detract from it.

Once again, I wish to salute my Rockland Trust colleagues for the incredible energy, innovation and creativity they bring to work each and every day. We invest heavily in their potential with an integrated learning and coaching culture that provides us with the next-generation of leaders. For the 11th year in a row, we earned a very high ranking in The Boston Globe's top places to work survey of employees, which reflects this commitment to our colleagues.

And lastly, before I hand it over to Mark, I'd like to acknowledge Brian Tedeschi, our longest-serving director, who made a decision to voluntarily step down earlier this month. I greatly appreciate Brian's support and guidance over these many years. He will be missed. Mark?

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [3]

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Thank you, Chris. I will now cover the fourth quarter results in more detail. GAAP net income of $47.5 million and diluted EPS of $1.38 in the fourth quarter of 2019 reflect decreases of 8.4% and 8.6%, respectively from the prior quarter's results, driven primarily by margin pressure imposed by the macro-level interest rate environment and timing over net charge-off and recovery activity and related provisioning.

In addition, the third quarter results included a gain associated with the deleveraged sale of residential loans as well as merger and acquisition expenses and their related tax impacts. When excluding items deemed to be noncore, the net income and diluted EPS results for the fourth quarter reflect decreases of 8.1% and 8%, respectively, when compared to the prior quarter and reflect increases of 32.3% and 7%, respectively when compared to 2018 fourth quarter results. Despite the quarter-over-quarter decrease in earnings, the results were in line with expectations and reflect strong, consistent business momentum across a number of key areas that I will cover in more detail. In addition, the fourth quarter return on average assets of 1.64% anchored an additional increase in tangible book value of $0.75 in the quarter, bringing the December 31, 2019, tangible book value per share to $34.11. Inclusive of the full impact of the Blue Hills acquisition and cost save initiatives absorbed in 2019, this year end tangible book value per share represents a 19% increase over the prior year level. In addition, return on average tangible common equity was a healthy 16.14% for the quarter.

Included in the Q4 results, net loans decreased slightly in the fourth quarter as the total outstanding balances continue to reflect strong loan closing activity being offset by accelerated payoffs and pay downs. Included in the payoff and paydown activity for the fourth quarter was approximately $100 million associated with acquired Blue Hills commercial loans and another $60 million in the Blue Hills residential portfolio.

Similar to prior quarters, the majority of payoff activity in the commercial book is occurring in the commercial and industrial and commercial real estate portfolios as borrowers continue to take advantage of favorable conditions to pursue refinance or exit event opportunities. Countering the payoff activity and resulting decline in these portfolios, the strong Northeast economy continues to spur solid business investment as reflected in the 5% increase in construction loan balances as well as strong closing volumes in the commercial real estate category. In addition, the approved commercial pipeline was $261 million as of December 31, 2019, which bodes well for continued strong closing volumes heading into 2020.

On the consumer real estate side, the overall reduction in balances continues to primarily reflect the fact that the majority of the company's robust mortgage production is being sold to the secondary market, resulting in strong mortgage banking income results, offsetting the decrease in residential loan balances. And as noted last quarter, the yield curve shape continued to favor cash-out refinance mortgage opportunities, causing a temporary strain over home equity demand and balanced growth.

On the deposit side, the balance sheet narrative is similar as healthy new core deposit sales are being offset by various sources of deposit outflow, including customer cash flow volatility in commercial checking and municipal deposits as well as a subsiding, but notable runoff of higher cost Blue Hills Bank deposits. The remix of deposit products and use of broker deposits to replace higher costing CD maturities has stabilized the overall cost of deposits with a fourth quarter cost of 48 basis points, reflecting a 2 basis point decrease from the prior quarter.

In addition to the favorable deposit remix, the fourth quarter also reflected a full quarter of minimal wholesale borrowing balances as well as the retirement of $35 million in subordinated debentures, further improving the company's overall funding cost. As such, the decline in the net interest margin for the fourth quarter to 3.90% was also in line with expectations and it is inclusive of a full quarter impact from both the July and September federal reserve rate cuts as well as an additional cut at the end of October. Offsetting the rate cut compression, loan accretion income for the acquired loans remains at an elevated level and was approximately $3.4 million for the fourth quarter.

Shifting gears to noninterest items. Fourth quarter noninterest income was $33.3 million and represents an operating 7.9% increase from the third quarter when excluding a $1 million gain attributable to the residential deleverage sale in the prior quarter.

Key item -- key items to highlight for the quarter include the following: regarding investment management income, the outflow of a large temporary $200 million custody account that we noted last quarter was mitigated by another quarter of strong new asset generation, increase in the overall assets under administration to $4.6 billion as of December 31, 2019. This shift in asset holdings, along with increased retail commissions drove overall increases in fee revenues when compared to the third quarter. While down from exceptional third quarter levels, both mortgage banking income and loan level derivative income remained elevated as strong demand for both reflect a natural hedge against declines in longer-term rates. Interchange in ATM fee income were down compared to the prior quarter due to seasonality. And lastly, recognition of a $3.1 million insurance recovery is included in the other category, which I will speak to in a bit more detail as part of my update on asset quality metrics.

Total noninterest expense of $67.4 million for the fourth quarter of 2019 represents a slightly elevated level from the prior quarter when excluding approximately $700,000 of merger-related expenses in the third quarter. Some key items to highlight for the quarter include salaries and benefits decreased due primarily to the timing of incentive-related accruals that correspond to each quarter's earnings levels. And similar to the third quarter, the FDIC assessment expense was 0 in the fourth quarter due to credit utilization with an additional $1.2 million in credits available to be offset against future quarterly FDIC assessments assuming the fund reserve level stays stabilized.

And as Chris alluded to in his earlier comments, the company continues to invest prudently in its overall infrastructure. This prioritization on strategic initiative spending is focused on building scale while optimizing efficiency and includes incremental costs associated with risk management, primarily in the areas of technology risk and credit administration as well as new market expansion. Along those lines, included in the fourth quarter results were $440,000 of onetime costs associated with lease exits and restructures as well as increases in technology and consulting to further build scale while maintaining infrastructure efficiency. Despite the modest level of increased spending, the efficiency ratio for the fourth quarter remained low at 50.6%.

Asset quality metrics remained strong despite a couple of one-off items during the fourth quarter. Similar to prior experience with acquisitions, except this quarter on a larger scale, a couple of acquired relationships experienced exit events, resulting in offsetting nonrecurring net income results. In particular, the $2.5 million charge-off on an acquired commercial real estate loan was offset by the previously alluded to $3.1 million insurance claim payout associated with the prior charged-off Blue Hills loan. Because of the time line of events and business combination purchase accounting implications, the charge-off impact is reflected in the company's increase in provision for loan loss, whereas the insurance recovery is included in noninterest income. As these items are considered to be isolated events, they are not deemed to be indicative of any other general credit characteristics within the portfolio as nonperforming assets remained consistent with the prior quarter at approximately $48.2 million or only 0.4% of total assets. The provision for loan loss of $4 million provides coverage for the large charge-off as well as general allocation for organic loan growth, essentially replacing the runoff of acquired balances that come over with 0 reserve allocation.

And with the long-awaited arrival of CECL implementation heading into 2020, the company is complete with its model build out and is finalizing documentation of model validation and its associated processes and controls. As such, we feel it is premature to disclose a specific result at this point. However, we are comfortable indicating that the day-1 impact on the reserve is expected to be immaterial.

Lastly, the tax rate for the fourth quarter declined to 23.2%, which reflects the benefit of a revised state tax filing position. As such, the company amended previously filed tax returns, which resulted in a $632,000 discrete tax benefit recorded in the fourth quarter as well as additional benefit for adjusting the year-to-date 2019 tax expense to the newly determined, lower effective tax rate. In conjunction with this amended position, the company incurred approximately $370,000 of consulting expense, which also contributed to the increase noted in other expenses this quarter.

I'll now switch gears to provide full year 2020 guidance. Assuming no significant changes to the current competitive and economic landscape, net loan growth is expected to be in the low single-digit range. To provide a bit more insight, new loan closing commitments are expected to remain strong into 2020 while the challenge for net growth will likely continue to be impacted by the recent increase in payoff activity from both the acquired Blue Hills portfolio as well as the current rate environment. Changes in either assumption could result in loan growth volatility or results outside of this range. Consistent with loan growth guidance, net deposit growth is also expected to be in the low single-digit range. Assuming a static rate environment and with an expectation of continuing to shift balances from maturing time deposits to core deposits, the overall cost of deposits is expected to improve slightly over the course of the upcoming year.

Regarding the net interest margin, we anticipate the full year 2020 margin to be in the mid- to high 3.80% range, which represents a decline from total 2019 levels of approximately 15 to 20 basis points. This 2020 guidance includes the following assumptions: no changes to interest rates from the Fed reserve, loan yield stabilizing with some nominal level of compression resulting from portfolio turnover, overall funding costs to improve slightly, and a normalized level of loan accretion of $2 million to $2.5 million per quarter. Operating fee income should remain essentially flat as compared to adjusted 2019 results, with that baseline number excluding $5 million recognized in 2019 for the aforementioned insurance recovery and other large onetime gains on asset sales. One of the factors weighing on revenue levels is an assumed reduction in interchange income from the Durbin Amendment of $5 million to $5.5 million over the last 6 months of the year.

Operating expenses, excluding merger-related and other non-core expenses incurred in 2019, are anticipated to be well contained with a year-over-year increase in the low to mid-single-digit range despite continued investment in digital capabilities, internal infrastructure and new market expansion.

Similar to the impact on the reserve, provisioning for bad debt under the CECL model should not materially change from previous levels and will be driven primarily by net charge-off experience and general economic and credit conditions, both of which do not pose any known significant concern over the long-term horizon at this point.

And lastly, with the 2019 final expiration of new market tax credit benefit, the tax rate is expected to increase to approximately 26% for the year with some level of discrete benefit in the first quarter due to vesting of equity compensation awards. That concludes my comments. Chris?

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Christopher Oddleifson, Independent Bank Corp. - CEO, President & Director [4]

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Great. Thanks, Mark. And Nick, we're ready for some questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) First question comes from Mark Fitzgibbon, Piper Sandler.

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Mark Thomas Fitzgibbon, Piper Sandler & Co., Research Division - MD & Head of FSG Research [2]

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I wanted to, first, if you could just clarify a comment you made about the interchange fees. Is that in that $5 million to $5.5 million of lost interchange fees in the second half of the year? Did you say that was including that or excluding that? I apologize, I missed it.

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [3]

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The guidance includes that reduction, Mark.

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Mark Thomas Fitzgibbon, Piper Sandler & Co., Research Division - MD & Head of FSG Research [4]

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Got you. Okay. And then secondly, can you help us think about the purchase accounting accretion as we sort of go into the first quarter, does that move a touch lower?

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [5]

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It does. Yes. We've been experiencing, over the last couple of quarters, if you recall, the Q3 accretion income was about $3.9 million. Q4 was about $3.4 million. Our expectations on a normalized level, included in the margin guidance I gave is about $2 million to $2.5 million a quarter. So we do anticipate that to come down. But again, always somewhat contingent on individual credits and what we may have from marks on those. But on a whole basis, we do anticipate to come down to a degree, yes.

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Mark Thomas Fitzgibbon, Piper Sandler & Co., Research Division - MD & Head of FSG Research [6]

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Okay. And then how much more runoff do you think is likely from the Blue Hills portfolio? Are we getting to the end of that?

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [7]

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Yes. I'd say, big picture, when we close on the deal and looked at the portfolio, there were a handful of credits that we certainly anticipated when they came up for renewal that we would not extend or that would, just because of their transactional nature, refinance out here in the near term. So I would say the majority of that has exited through the fourth quarter. So I -- we do anticipate that the level of payoffs and pay downs should subside. I wouldn't say it's all behind us by any means, but we should -- certainly should see that come down compared to the levels we've been seeing.

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Mark Thomas Fitzgibbon, Piper Sandler & Co., Research Division - MD & Head of FSG Research [8]

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Okay. And then lastly, I know the couple of credit things you had this quarter were idiosyncratic. But the -- from a credit perspective, what are the kinds of things that you're worried about out there that you're maybe dialing back a little bit or avoiding?

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [9]

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Yes. I'd say, certainly, when you look at the growth in our construction portfolio, I think that's a portfolio that inherently may seem to be more risky, but we feel very, very good about that portfolio and the opportunities we've been seeing. And I think, in particular, an interesting dynamic there is we're really getting a lot of those construction deals that are looking to have a very local banker familiar with construction lending and underwriting. And as a result, we're seeing less competition for those types of deals, such that they meet our underwriting standards, the pricing is very well, we have good spreads there. We typically see borrowers putting more equity into those deals. And when those deals get to a permanent stage and are looking to get permanent refinancing, that's when we often may see other competitors coming into the market. The underwriting gets a little bit more loose. We may not see the level of equity coming in from the borrower, and that's where we are willing to step away from those relationships on the permanent side.

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

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When we look around the market, I mean, the things that concern us are things that we're staying away from. I mean like the large multifamily high-end housing developments or all the cranes you see in Boston. I mean that's -- that raises our eyebrows. And that's something we historically have not been involved in. And we sort of -- we avoid -- continue to avoid it. Yes. So Mark, that's sort of a -- we don't really have a lot of worries right now. I mean we just -- we -- as you know, over time, we're just super -- we're very disciplined and fairly conservative lenders. And we feel we're well secured and they're in good shape.

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Operator [11]

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Our next question comes from David Bishop, D.A. Davidson.

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David Jason Bishop, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [12]

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Appreciate the [merger] and the guidance. A quick question. You mentioned in terms of operating expense outlook, some new market initiatives and infrastructure investment. Any details you can provide there, just a little bit more color in terms of what you're thinking in terms of specifics?

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Christopher Oddleifson, Independent Bank Corp. - CEO, President & Director [13]

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So I'll start. I mean one of the markets that we've been wanting to really sort of enter for a long time is Worcester. And over the last 18 months, we've begun doing just that. It took us a while to sort of figure out sort of who we could build the team around. As we have announced a while ago, Mike Crawford joined us. And he's leading a team there, and we're building out with investment management, commercial folks, treasury services. And we will be opening our first branch in Worcester in a month or so. Is that right?

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [14]

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Yes.

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Christopher Oddleifson, Independent Bank Corp. - CEO, President & Director [15]

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That's right. So that is a market we believe would really be very suitable for our Rockland Trust and our operating approach. That's 1 big thing. There's a lot of work in our technology and operations area, on cyber, on risk management related activities. We are more fully fleshing out first, second and third lines of defense. We have formed a risk committee at the Board and we've always had a good risk management approach, I think, across the $10 billion places higher expectations on us, even higher expectations on us. And we were -- we are making a lot of headway there. We've added some headcount in our technology and our risk areas to help us meet those.

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [16]

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And I would just add to that front. I think a lot of those spend is really looking to build scale so that we can leverage that framework as we continue to grow. I think incremental spends in the near term is still the prudent thing to do and we feel creates longer-term value as we continue to build out that infrastructure. So doing it right and then spending a level of incremental money at this point to really get us to scale for future growth, it's -- is the right thing and the right opportunity at this point. So that's where we're seeing a little bit more of the elevated expense that we talked about in the fourth quarter and that will transition a bit into 2020.

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David Jason Bishop, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [17]

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Got it. And then Chris, you mentioned the Worcester effort there. Any sense or is it too early just to bring fence how you're thinking in terms of the growth potential in terms of maybe the low end of deposit growth potential from a dollar perspective. Any targets or any numbers you can share there at this point or is it still a bit too early?

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Robert D. Cozzone, Independent Bank Corp. - Executive VP & COO [18]

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Yes. Probably too -- Dave, it's Rob. It's probably a little too early to share any specific targets. And in terms of the development plan, Chris mentioned, we expect to open 1 branch in early February, and we're hoping we can have another branch by mid-year and maybe even a third location before the end of 2020, and that's what we've contemplated in the expense numbers that Mark shared with you. I will tell you, the Worcester market has about $4 billion of deposits in just the city of Worcester and that is primarily owned by BofA and Berkshire and then People's United, who just acquired United. So there's some disruption there with the acquisition of Commerce Bank by Berkshire a few years ago, and then more recently, People's United acquisition of United. So we -- and we think there's a decent opportunity for a commercial bank of our scale to make a difference in that market. It's also a nicely growing market. It's been revitalized. There are a number of meaningful initiatives in the city itself that we expect to drive additional growth in addition to what they've already seen in the last couple of years. So we're really excited about this opportunity. And the key there is finding the right people, and we've been fortunate to find a number of Worcester-based individuals with a long history of being successful in that market.

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David Jason Bishop, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [19]

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Got it. And then maybe just one follow-up in terms of credit. Noted there was a little bit of an uptick in additions to nonaccrual. Any color in terms of what flowed in, the [nature] of the increase and additions to nonaccrual?

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [20]

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Nothing I'd say indicative of any portfolio as a whole concern. There was a little bit of increase on our residential side. And some additional inflow on the commercial book as well. But both of them were fairly nominal compared to overall portfolios, and I wanted to say, at this point represents any sort of more broader concern in terms of credit characteristics. These were, again, what we would consider to be sort of isolated events associated with individual credits.

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Operator [21]

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Our next question comes from Collyn Gilbert, KBW.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [22]

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Mark, if we could just start with the NIM. And I appreciate your guidance for 2020, indicating kind of the mid- to high 3.80% range. Could you just talk a little bit about how you sort of see that trajectory going? And I know you indicated that, that assumes no more fed cuts. But just some of the dynamics you expect kind of in the next quarter or so? And then how you see that playing out for the remainder of the year?

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [23]

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Sure, Collyn. So I'd say it really stems from where we would peg the fourth quarter margin on a normalized basis. So as you know, we reported a 3.9% margin for the quarter with $3.4 million of purchase accounting accretion. If we scale that back to sort of the normalized level that I -- in the range that I provided in my guidance and essentially, assuming the rate environment remains benign and static, that would sort of peg our margin to the -- in the 3 -- mid-3.80% range. Going throughout the rest of the year in 2020, we do think there's opportunity to continue to just naturally [attrite] our higher cost and time deposits down, replace those with lower cost core deposits. There may also be some opportunities on the funding side as well. So we do think we can make incremental headway on our overall cost of funding, which should add a bit of an increase to the margin. So I think that combination of stabilized loan yields being pegged to what I'd say is a normalized run rate through the fourth quarter with some level of increasing on the funding side, should put us in that mid- to high 3.80% range.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [24]

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Okay. Okay, that's very helpful. And then just on mortgage banking, can you just talk about sort of where -- what some of the trends are you're seeing there and where you're kind of expecting incremental demand to be? I mean I know it's baked into your fee guidance, but just trying to think about that business, if -- kind of, in total, how you're thinking about the growth there?

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Robert D. Cozzone, Independent Bank Corp. - Executive VP & COO [25]

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Collyn, this is Rob. It's been a very successful 2019 with the mortgage business and the combination with Blue Hills. We now have almost 40 LOs producing for us, produced over $800 million in production. And if you annualize the last 3 quarters of the year, it would be $1 billion annually. So we're very excited about the opportunity there. The momentum has continued into 2020. Application volume continues to be strong with a healthy mix of purchase and refinance. And we think that, that has made a meaningful difference to the potential stability of the combined entity having a high percentage in purchase. And there's a fair amount of refi still, about 55% of our production is purchase volume. And I think as long as the local real estate market remains healthy and the yield curve is stable where it is, we continue to expect refinance volume and purchase volume to be healthy. 75% of that volume is being sold into the secondary market and there's -- continues to be strong demand there and we're getting healthy pricing. So in the next couple of quarters, we expect the momentum to be good. It has certainly surprised us the level of production that we've been able to generate as a combined team, but there are no signs that, that is slowing to any meaningful extent at this point.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [26]

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Okay. That's very helpful. That's great. Okay. And then just on the paydown dynamics that you guys are seeing. You had indicated in your opening comments, I think, that like it was $100 million, if I took this down correctly. $100 million of Blue Hills on the commercial side and then $60 million of Blue Hills on the resi side. Just curious how that compares to what you saw in just kind of stand-alone Rockland.

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [27]

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Yes. To be honest, we actually had even more payoff and paydown activity on the legacy Rockland portfolio. So in addition to the numbers you mentioned for Blue Hills, we also saw over $200 million of commercial payoff activity associated with our legacy portfolio and also another $100 million on the retail side. So just to bring that back up to sort of the bigger picture, just in that fourth quarter, we're talking about almost $0.5 billion in overall paydown and payoff activity. And when you look at that translating to flat loan growth, we had just as strong a success on fundings and new origination. So close to $0.5 billion of increased lending to existing customers or funding on new relationships. So there's a lot of volume and a lot of activity going through the book that is essentially washing to the net balances over the last couple of quarters. So that's why to the extent some of this runoff activity does subside, we feel very good about the closing volumes in the pipelines heading into 2020.

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Christopher Oddleifson, Independent Bank Corp. - CEO, President & Director [28]

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And a couple of things that probably are worth noting that the $1.5 billion of commercial originations for 2019, like 40%, 50% sort of above our sort of previous highs, so a lot of strong. And also, what bodes well is that the Blue Hills lending team was a significant contributor in the fourth quarter. I mean they're really coming online and producing for us.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [29]

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That's great. Okay. Okay. That's helpful. And then just wanted to clarify on the credit side. So the net charge-off that you guys saw this quarter, you indicated recent acquisition, can we assume that, that was Blue Hills?

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [30]

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That's correct.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [31]

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Okay. And then is that directly tied to the insurance claim gain...

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [32]

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No. Those are...

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [33]

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That you saw or those are 2 separate issues?

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [34]

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Those are 2 separate events.

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Christopher Oddleifson, Independent Bank Corp. - CEO, President & Director [35]

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That happened in the same quarter, very conveniently.

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [36]

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Right.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [37]

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Okay. Okay. So just curious what if -- a little bit of color on the credit that you charged off. The obvious question is the fact that you kind of did a good deep dive in diligence, I would assume, when you acquired Blue Hills. So just what -- why this sort of came as a surprise or maybe a little bit of background as to what happened with this specific credit?

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [38]

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Yes. This was an individual commercial real estate deal that, at the time of the acquisition, was actually performing and indicated no evidence of credit deterioration. The borrower went bankrupt since the time of acquisition. It was a single tenant...

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Robert D. Cozzone, Independent Bank Corp. - Executive VP & COO [39]

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The tenant went bankrupt.

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [40]

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The tenant went bankrupt. Sorry. The tenant went bankrupt and it was a large facility with just 1 single tenant in that facility. So as a result, the property was no longer as marketable. We've actually exited that relationship in full. It has been paid off in full and resulted in the associated charge-off that we did take in the fourth quarter. But it was really a function of a single tenant, large facility which is not indicative of what we typically see in our portfolio.

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Christopher Oddleifson, Independent Bank Corp. - CEO, President & Director [41]

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And as I understand, we had a special -- I mean somewhat special-purpose outfit underwriting. So it would require a bit of -- we have to get it up to standard.

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [42]

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And that was the reason for sort of the depressed market pricing or the value of the property at the time we -- it was trying to be sold.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [43]

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Okay. Just curious, the geography of that credit? Where was that?

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Christopher Oddleifson, Independent Bank Corp. - CEO, President & Director [44]

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It was in our market area.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [45]

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Okay. Okay. And...

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Christopher Oddleifson, Independent Bank Corp. - CEO, President & Director [46]

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Adjacent. Just adjacent to it. So within our commercial market area.

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

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Okay. Okay, very good. And then just lastly, I mean, I guess, it's a question is for both Chris and Mark, but you guys continue to build a light capital. You did not buy back any shares this quarter. Can you just talk about sort of capital deployment plans, whether appetite for buyback, capital goals, targets? And then, Chris, if you could just kind of give an update on how you're seeing the M&A landscape?

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Christopher Oddleifson, Independent Bank Corp. - CEO, President & Director [48]

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I'd be happy to, after Mark because -- as you -- it couldn't just be any different than what I've said in the past, but I'd be happy to talk about it.

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [49]

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So from a capital management perspective, certainly, in the first quarter, we'll -- as we customarily do it, we'll take a look at our dividend and revisit. And again, as you noted, we had very healthy capital levels, which would bode for a sizable nominal increase in what we expect to pay out for dividends. But the exact number, we obviously haven't determined yet, but I think it's safe to say that we'll look to make the right change in that quarterly rate going forward. And from a stock buyback perspective, it certainly continues to be on our radar. And when we look at really the levels of capital that we have been able to generate over the last couple of quarters and the corresponding increase in our tangible book value, we continue to look at that. That authorization is one that we really want to make that an economic decision over what the right level is to buyback at as a multiple of our tangible book. So as we continue to grow that capital over 2020, there may be an opportunity to execute on that buyback. But again, we still feel it's prudent to do that only when it makes economic sense. And that'll be something we'll certainly monitor closely throughout the year.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [50]

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Okay.

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

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And -- yes. M&A. Oh, go ahead, if I missed that on...

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [52]

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No. I was just going to say, Mark, could I push you a little bit harder on that in terms of the economic sense? Do you look at it similar to the way you would look at an acquisition in terms of buyback on the dilution that you would take or...

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [53]

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Yes. Earn back on tangible book dilution and the corresponding benefit on the multiple on the return on tangible. So it's similar to how we think about pricing deals, right? Just understanding the dynamics of that earn back.

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Collyn Bement Gilbert, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [54]

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Got it. Okay. Very good. Okay. Go ahead, Chris. You're going to dive right through the whole new M&A strategy and...

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Christopher Oddleifson, Independent Bank Corp. - CEO, President & Director [55]

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Yes. Exactly, Collyn. We'll [douse] you with the first -- for 35 years since 1985, we have a pretty steady trend of about 3%, 3.5% of the banks being acquired or merged per year. And we've taken that from 18,500 banks down to about 5,000 banks today. And I'm going to make the bold prediction that that's going to -- and that the -- the -- and actually, it's -- that we're not -- I mean we're not going to see sort of -- any sort of significant acceleration of de novo banks in the country, given the heightened regulatory scrutiny that we've sort of entered into over the -- since The Dodd-Frank in the last 10 years. Locally, the great hay day of acquisitions or an acquisition was announced every month or 2 with Sovereign Bank North and Citizens, sort of mopping up the marketplace. Those days are over. You have a handful of publicly-traded banks that really are, even could be sold if they wanted to. That pool is additive from time to time with the mutual conversions. And then there's a 3-year wait period and we've been the beneficiary that among our 10 acquisitions we've done in the last 15 years. And we'd like to continue to be a buyer. I mean we -- but we know we really can't control that, right? We can't go out and do a bank store and buy banks. We need to wait until Board of Directors decide to maybe moving up to our currency is a good idea. And so what we view our charge doing is to really maintain that high multiple on our currency. So we need -- so we continue to be an attractive buyer. And be it -- also we have developed the reputation of being a good acquirer, one that would say what we're going to do and we do what we say and we treat people well and we're going to have a great culture and we just want to endeavor to maintain that. I will say, interestingly, when we sort of started our acquisition in the last -- sort of back in '03, '04, we looked at acquisitions as an opportunistic thing. And I would say that, look in your rearview mirror that it's really been pretty important to add scale and get to the scale we need today with the -- all the fixed overhead you need now to run a bank in a risk-appropriate way. And I would hope that would continue and I imagine it will. But in terms of predictions, it's really hard to say. So that's a long way of saying nothing. So...

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Operator [56]

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(Operator Instructions) Our next question comes from Bernard Horn, Polaris Capital.

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Bernard Robert Horn, Polaris Capital Management, LLC - President, CIO, Treasurer & Portfolio Manager [57]

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Two questions. On the press release, it talks about another noninterest expense. It was up mostly because of an increased provision on unfunded commitments. I didn't -- I just don't understand why you'd have a provision on an unfunded commitment or maybe you could -- maybe I missed something there.

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [58]

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Yes. That is a prescriptive requirement in accounting guidance that speaks similar to the reserve for the allowance, it doesn't roll into that balance. But to the extent you've legally committed to extend credit in the anticipation of actually extending that credit and applying a nominal default loss rate to that. So that number can be volatile depending on what stage of the pipeline certain loans are. So I mentioned our approved pipeline was pretty consistent with where we were at the -- at the end of the third quarter, it just happened to shift a bit in terms of the stage of that pipeline, which really resulted in the level of increase that we added to book in the fourth quarter.

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Bernard Robert Horn, Polaris Capital Management, LLC - President, CIO, Treasurer & Portfolio Manager [59]

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Okay. All right. The other question I had is just on the ALCO positioning. I know I hear the guidance on the net interest margin for next year and the puts and takes on kind of deposits, but is there anything that you anticipate to change much on your ALCO position. And it looks like you must be a bit asset-sensitive. But you talked a little bit about shifting around deposit and borrowings and -- but are we expecting to see the same kind of ALCO positioning for 2020?

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [60]

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Yes. We continued to be asset-sensitive, but we have made great strides throughout 2019 of reducing that exposure. And just to reiterate, we now have $850 million of hedges in place against our loan portfolio to protect against rates going down. Of that $850 million, $750 million of that is already in the money. So that has already provided protection based on where we are today in rates. $50 million of that is neutral. It was a caller where current market rates are right in the middle of that range. And then the last $50 million will give us additional protection to the extent we have 1 more cut. So that's a program that we continue to look at. Ideally, we would like to probably put some more hedge [at rate] to give us a bit more protection on the down rate environment risk. The challenge there has really just been convincing ourselves to actually lock in at rate that the market is pricing in order to execute those hedges. So essentially taking the loss now for future protection. We've all sort of seen over the last couple of months, the outlook has certainly improved. It's comforting to see in the last round of the Fed reserve meetings, there seems to be at least consensus that rates should relatively hold flat here for a while and specific risks over any future cuts have really diminished. So it may provide the right pricing opportunities to put a little more protection on, but we have -- we feel very good about the level we've been able to execute during '19, and a strategy we'll continue to implement through 2020.

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Bernard Robert Horn, Polaris Capital Management, LLC - President, CIO, Treasurer & Portfolio Manager [61]

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Okay. And I'm assuming that the net interest margin guidance is -- those hedges are built into that guidance?

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Mark J. Ruggiero, Independent Bank Corp. - CAO & CFO [62]

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They are correct. Sure.

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Operator [63]

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

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Christopher Oddleifson, Independent Bank Corp. - CEO, President & Director [64]

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Right. Thank you very much, Nick, and thank you, everybody, for joining us today, and we look forward to talking to you in 3 months' time about our first quarter 2020 results. Have a good rest of winter. Bye.

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Operator [65]

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Conference has now concluded. Thank you for attending today's presentation, you may now disconnect.