Independent Bank Corporation
Q2 2017 Earnings Call Transcript

Published: 29 Jul 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to the Independent Bank Corporation Second Quarter 2017 Earnings Call and Webcast. [Operator Instructions] Please also note that this event is being recorded. I would now like to turn the conference over to the President and CEO, Mr. Brad Kessel. Please go ahead, sir.

[Brad Kessel:]

Good morning. Thank you for joining the Independent Bank Corporation’s conference call and webcast to discuss the company’s 2017 second quarter results. I am Brad Kessel, President and Chief Executive Officer, and joining me is Rob Shuster, Executive Vice President and Chief Financial Officer. Before we begin today’s call, it is my responsibility to direct you to the cautionary note regarding forward-looking statements. This is Slide 2 in our presentation. If anyone does not already have a copy of the press release issued by Independent today, you can access it at the company’s website, www.independentbank.com. The agenda for today’s call will include prepared remarks followed by a question-and-answer session and then closing remarks. To follow along, I will begin with Slide 5 of our presentation. Overall, I am very pleased with the improved quality of our earnings this past quarter, as we grew revenue on a linked quarter and year-over-year basis while completing the divestiture of our high-yield payment plan business and recording a more normalized provision as a result of strong organic loan growth. As it relates to earnings for the second quarter of 2017, we are reporting net income of $5.9 million or $0.27 per diluted share versus net income of $6.4 million or $0.30 per diluted share in the prior year period. The second quarter’s results were driven by net interest income of $21.5 million, up $1.9 million or 9.5% from the year ago. Non-interest income also improved to $10.5 million, up $866,000 or 9%, primarily as a result of gains on mortgage loans of $3.3 million, up $815,000 or 32% from the year ago. In addition, we also saw year-over-year increases in both service charges on deposits and interchange income. These increases in revenue were offset by a $600,000 loan loss provision as compared to a credit of $700,000 in the year ago quarter. Also offsetting the revenue increases was a $1.9 million increase in non-interest expense, primarily due to increases in compensation and employee benefits directly related to our mortgage banking expansion. Rob will cover this in more detail in his part of the presentation. As it relates to our balance sheet, total portfolio loans grew by $140.9 million or 33.8% annualized with organic growth in each loan category. Asset quality continues to be strong with nonperforming assets down $3.4 million or 23.6% during the second quarter. In addition to growth in our loan portfolios, we also continued to see growth in deposits, now at $2.25 billion, up from $2.13 billion one year ago. Our loan-to-deposit ratio at quarter end of 80.65%, we believe, provides us continued net interest income expansion opportunity. In addition, we also believe our capital level, with tangible common equity to tangible assets at 9.79%, provides further upside in growth of our earning asset base. At June 30, 2017, our tangible book value per share grew to $12.22 per share, up from $11.89 per share at March 31, 2017. For the six months ended June 30, 2017, we are reporting net income of $11.9 million or $0.55 per diluted share compared to net income of $10.5 million or $0.48 per diluted share in the prior year period. This represents a $1.4 million or 13% increase in net income and a $0.07 or 14.6% increase in our diluted earnings per share. Slide 6 of our presentation provides additional highlights on significant performance categories for the first six months of each of the last four years. Today Independent Bank is the 4th largest bank headquartered in Michigan. Our branch network is in a combination of rural, suburban and urban markets. The conditions in these markets continue to be generally favorable as measured by the labor, housing and commercial real estate metrics. Our balance sheet growth continues to come from more urban and suburban markets. At a high level, I would say the west Michigan market and the southeast Michigan market are the strongest. A common theme in many of our markets is that of a shortage of housing supply. Accordingly, we are witnessing historically record low home listing times, rising residential real estate values and an increase in new construction. Our new loan production offices in Ann Arbor, Brighton, Troy and Traverse City, Michigan, as well as Columbus and Fairlawn, Ohio, are performing very well. For these markets I would characterize the Ann Arbor, Brighton and Columbus markets as being very strong. In addition, we have new loan production offices that were recently opened in Dearborn and Grosse Point, Michigan. The favorable economic conditions as seen in our loan origination and deposit-gathering results, Page 8 contains a good summary of our loans and deposits by region. We have seen year-over-year loan and deposit growth in each of our four Michigan markets with the exception of our Lansing market, where we have seen a slight decrease in total deposits. Total deposits as seen on Page 9 were $2.25 billion at June 30, 2017. Excluding broker deposits, this represents an increase of $84.6 million or 4% since June 30 of 2016. The company’s deposit base is substantially all core funding with $1.77 billion or 79% in transaction accounts. Our cost of deposits continues to be relatively low at 26 basis points and was flat when comparing to the prior quarter. We are seeing some pressure in our markets on the deposit pricing front, particularly in the public funds sector. We are monitoring closely and actively managing so as to retain core while also limiting the effects of rising rates on our deposit base. As seen on Page 10 of our slide deck, loans including loans held for sale increased to $1.86 billion at June 30, 2017. This represents the 13th consecutive quarter of net loan growth for our company. For the second quarter of 2017, total portfolio loans grew by $140.9 million or 33.8% annualized with organic growth in each loan category. The commercial team generated net growth of $13.3 million or 6.5% annualized during the quarter. Our new commercial originations continue to be very granular in size, diverse in industry and a good mix between commercial and industrial and commercial real estate. The pipeline is good when comparing to last quarter end and the same quarter one year ago. The consumer lenders in the indirect desk generated consumer installment loan net growth of $34.2 million or 50% annualized. We continue to see very good demand for marine and RV financing from our indirect team. Our mortgage team originated $235 million and we sold $105 million during the second quarter of 2017. Year-to-date in 2017 we have originated $393 million and sold $184 million as compared to 2016, when we originated $165 million and sold $126 million for the first six months of last year. For all of the second quarter we grew our mortgage portfolio by $93.5 million or 64.5% annualized. As mentioned last quarter, we continue to portfolio a higher percentage of our total mortgage originations than we budgeted for, for several reasons. Originally we anticipated selling two-third of our production and one-third going into portfolio. Our actual mix is closer to 50% salable and 50% non-salable. While we did plan for a shift to more purchase money versus refinances, we are also capturing a larger share of the jumbo mortgage market. This was the goal with the expansion. In addition, we are seeing a higher demand for construction loans and non-warrantable condo loans. All three of these product types we currently place into our portfolio. Some statistics on the loans placed into the mortgage portfolio for the quarter include the following

[Rob Shuster:]

Thanks, Brad, and good morning, everyone. I am starting at Page 12 of our presentation. Brad discussed the increase in our net interest income during his remarks, so I will focus on our net interest margin. Our tax equivalent net interest margin was 3.60% during the second quarter of 2017, which is up 8 basis points from the year ago period and down 9 basis points from the first quarter of 2017. I will have some more detailed comments on this topic in a moment. Average interest-earning assets were $2.42 billion in the second quarter of 2017 compared to $2.26 billion in the year ago quarter and $2.37 billion in the first quarter of 2017. Page 13 contains a more detailed analysis of the linked quarter increase in net interest income. There is a lack of data on this slide, but to summarize a few key points

[Brad Kessel:]

Thanks, Rob. In summary, we are pleased to report a very good first half of 2017, both in earnings and earnings per share. The improvement is directly related to the successful execution of our strategy to migrate earning assets from lower-yielding investments to higher-yielding loans in order to grow net interest income. As we look ahead, we continue to be focused on driving high performance with balance sheet growth and strength, quality earnings, per-share value and strong profitability levels. We continue to build on the momentum generated over the last several years. At this point we’d like to turn the presentation and open it up for questions.

[Operator:]

Thank you very much, sir. [Operator Instructions] Our first question is from Matthew Forgotson of Sandler O’Neill & Partners. Please go ahead.

[Brendan Nosol:]

Good morning, guys. This is actually Brendan on the line from Matt’s team. A few quick questions from me. Starting off on the margin, I was hoping to get a sense of the NIM trajectory going forward as you guys absorbed the full quarter’s drag from the Mepco sale.

[Brad Kessel:]

I would anticipate that there would not be much drag on a go-forward basis. The Mepco net interest income in the second quarter was down to $338,000. So it wasn’t that significant in the second quarter. It was down $650,000 from the first quarter. So I think that, by and large, the sale of the payment plan receivables is already reflected in the margin, and the continued migration of loans at higher yields vis-à-vis investments at lower yields should support, certainly, a stable if not slightly growing margin.

[Brendan Nosol:]

And then turning on to the gain on sale, one, could you remind us of what the purchase-refi split was in the second quarter? And then two, on the gain on sale margin itself, it held in pretty nicely around 3.20%. Are you guys feeling any pressure here as refi players push into their purchase base?

[Brad Kessel:]

I’d say a couple of things. Our split was about 85% purchase money mortgages and 15% refis. I think there’s been a consistent pressure in the markets, but I still think we’ve been able to maintain a pretty good margin here. It’s down a bit from where we were a year ago when you had more of a refi market. You typically see this when you gravitate to more of a purchase money market, but I still think margins are holding in reasonably well.

[Brendan Nosol:]

All right, great. Just regarding asset sensitivity and some of the complexion changes in your balance sheet, I believe in the K you guys offered that you’re roughly 3.5% asset sensitive under a 100-basis-point shock scenario. Just given some of the complexion changes in the balance sheet, how do you see that number as you stand today?

[Rob Shuster:]

Well, actually, and just to give you some specifics, at December 31, 2016, with 100-basis-points rise in interest rates, net interest income increased by 4.04%. That same measure at June 30 in 100-basis-point rise, the percent change is plus 3.62%. So the sensitivity has not changed dramatically, plus the base has gone up substantially versus the year ago period because of the loan growth. And just to give you some stats on the mortgage portfolio itself, 65% of the portfolio is adjustable rate or variable rate. 47.3% of the portfolio have adjustable or variable rates that will adjust in one year or less. 17.5% have adjustable rates that will adjust in over one year. The two of those combined equal that 65% of the portfolio. About 28.8% of the portfolio was fixed rate. About 3.3% is salable construction loans. 3% – or 2% are term home equity loans, and 1% of the portfolio is in the non-accrual bucket. So that kind of gives you a much more detailed look at the portfolio. So it’s still pretty rate sensitive as it stood at June 30. The other nice thing with portfolio mortgage loans is we’re able to pledge them to the Federal Home Loan Bank and borrow against them. And the one nice thing with Federal Home Loan Bank borrowings is you could do long-term borrowings and you could create kind of a ladder to absorb some of the fixed rate originations that are coming onto the portfolio.

[Brendan Nosol:]

All right. That’s fantastic color there, very helpful. Thanks for taking my questions.

[Operator:]

Thank you. The next question is from Kevin Reevey of D.A. Davidson. Please go ahead.

[Kevin Reevey:]

Good morning.

[Brad Kessel:]

Good morning, Kevin.

[Kevin Reevey:]

So Brad, earlier you talked about your loan-to-deposit ratio was roughly about 80.65% at the end of the quarter. As you look out towards the end of the year, do you have any specific internal goals that you’d like to get to on that ratio?

[Brad Kessel:]

Well, Kevin, that’s a great question. We’re having a lot of discussions internally as the growth rate has been a little faster than the – projected at the start of the year. Our latest forecast have us at that 90% level or plus or minus. So quite a bit of change from where we were one year ago, and even from where we’re at today.

[Kevin Reevey:]

And then moving along on your mortgage banking, are you pretty much done as far as adding to staffing there?

[Brad Kessel:]

Yes, I feel like the team we have today – Rob mentioned 69 new associates on the team, the bulk of which are related to the mortgage expansion. And we’re now at a period of digestion and just getting people comfortable in processes. And so for the near term, I’d say for 2017, I think we’ve got the team we want to have generally.

[Kevin Reevey:]

And then on the C&I side, do you see any pricing competition in your markets for those types of loans?

[Brad Kessel:]

Absolutely. I mean, it’s very competitive and we feel like we work really hard to deliver competitive pricing and structures ourselves, quick turnaround times. But there’s no doubt we can spend significant time on requests and still not get the deals. So it’s competitive, and that’s just part of the market. But I feel very good about the team that we have today. I feel like we’re getting at least our fair share. And again, our niche is that $1 million to $5 million commercial relationship. And I’m very pleased, actually, the progress we’ve made over the last several years in actually raising the average commercial loan size for our company, which has translated into improved efficiencies for us.

[Kevin Reevey:]

Great. Thanks for taking my question.

[Brad Kessel:]

Thank you.

[Operator:]

Thank you. The next question is from John Rodis of FIG Partners. Please go ahead.

[John Rodis:]

Good morning guys.

[Brad Kessel:]

Good morning, John.

[John Rodis:]

Hey, Rob, just a follow-up for you on net interest income. I just wanted to make sure I heard you right. So you’re looking for high-single-digit growth in the second half. That’s relative to the second half of 2016?

[Rob Shuster:]

Yes, that’s correct. I said at least high digit, high-single-digit loan growth. Correct.

[John Rodis:]

High-single-digit growth, okay. And then, Rob, just a question on expenses. As we look to next year, 2018, do you sort of expect to keep operating expenses in this current range or do you think there will be modest growth off of that level? Or do you think there’s some room for some savings, just as you look at things right now?

[Rob Shuster:]

We’re always trying to find opportunities to gain efficiency. I think we had been sort of in a period of time where over the last two years or three years, where our non-interest expenses were trending lower. And then we had the opportunity to undertake this expansion of our mortgage banking operations. Really, that started in the last quarter or so of 2016. As Brad commented, I think we’re where we want to be with that expansion now and with the addition of the loan production offices. So I don’t really see a lot of drivers of areas where that would be growing next year other than what I would call sort of normalized things like merit increases and the like. But hopefully, we could find areas of efficiency where we could keep the non-interest expenses at reasonably the same kind of run rates we’re currently at or only slightly higher. But I think the more powerful thing is that our anticipation now is for revenue growth at a much higher pace than what we otherwise would have been thinking, say, a year ago.

[John Rodis:]

Great. That makes sense. Okay. Thanks, Rob.

[Rob Shuster:]

Yes.

[Operator:]

Thank you. Our next question is from Damon DelMonte of KBW. Please go ahead.

[Damon DelMonte:]

Hey, good morning guys. How are we doing today?

[Brad Kessel:]

Good, Damon.

[Damon DelMonte:]

My first question is could you give us a little perspective as to how big you will have the residential mortgage portfolio that’s being held on balance sheet yet as a percentage of total loans?

[Rob Shuster:]

So, Damon, that’s a great question and we’re, again, that’s a subject that’s getting a lot of discussion internally. And today we’ve talked about sort of where one portfolio sits relative to the other portfolios that we have. And I’m probably not in a position today to say, hey, this is the limit, or, this is the max. What we’re trying to do as a company is build a balance sheet where we have a nice diverse mix of loans by category. And so our intent is not to have one portfolio necessarily dwarf all the others.

[Brad Kessel:]

And one other thing – Damon, one other thing just on the mortgage portfolio, there is a segment of that portfolio, the resort lending piece of $96 million, that’s really in runoff. And we would expect, as those loans continue to age, the runoff pace will pick up a little bit. So at least there’s one area of the portfolio that’s sort of moving in the other direction that I think will support the ability to continue to originate and grow as we’ve been doing so far the first half of this year.

[Damon DelMonte:]

And then on the consumer installment loan portfolio, could you just remind us of some of the kind of underwriting dynamics of those loans

[Rob Shuster:]

Well, yes, off the top of my head, you’re probably looking in the $15,000 to $25,000 average loan size, very strong FICOs, 700 and above, got the income of in that probably $30,000 to $35,000 range, good LTVs. Duration’s a little longer, particularly on the RV and the marine, probably a duration closer to four, four-plus years. And...

[Brad Kessel:]

Just a little more color on the consumer installment loan portfolio. About $22 million are real estate secured first or second liens. $126 million, roughly, are marine-related loans. About $90 million are recreational vehicle-related loans, and about $71 million is in other categories. And the vast majority of the portfolio has FICO scores. And if you recall in our Qs, we break out those portfolios by FICO. And the vast majority have FICOs at 700 or higher, with the biggest portion of the portfolio at 750 or higher. And the final comment I’d make is when we went through the great recession, that portfolio was our best performing. So I think the underwriting, at least based on our historical results, is very strong.

[Damon DelMonte:]

All right. Great. That’s an excellent color. That’s all I had, I’m out of questions, where has been answered. Thank you.

[Brad Kessel:]

Thanks Damon.

[Operator:]

Thank you very much. That concludes today’s question-and-answer session, and I would now like to turn the conference back to Mr. Kessel for any closing remarks.

[Brad Kessel:]

I would like to thank each of you for your interest in the Independent Bank Corporation and for joining us on today’s call. We wish everybody a great day.

[Operator:]

Thank you very much, sir. Ladies and gentlemen, that concludes this conference call, and you may now disconnect your lines.