Independent Bank Corp (Michigan) (IBCP) 2003 Q2 法說會逐字稿

Good afternoon, and welcome, ladies and gentlemen, to the Independent Bank Corporation second quarter conference call. At this time I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode. At the request of the company, we will open the conference up for questions and answers after the presentation.

This presentation may contain certain forward-looking statements within the meaning of the Private Securities Reform Act of 1995. Forward-looking statements include expressions such as expects, intends, believes and should which are necessarily statements of belief as to expected outcomes of future events.

Actual results could materially differ from those contained in or implied by such statements. Independent Bank Corporation undertakes no obligation to release revisions to these forward-looking statements or reflect events or circumstances after the date of this presentation.

At this time, I would like to turn the conference over to Mr. Charles Van Loan, please go ahead, sir.

Thank you. Welcome and thank you for calling in this afternoon.

Overall, we are very pleased with the results of our second quarter. Earnings per share at 50 cents was a 28% increase over last year. ROE was 24.37, ROA was at 166%. Very strong numbers for us.

Net interest margin was up 5 basis points in the quarter. Rob will go into some detail in a moment, but I should note that the Mepco transaction completed in April had a significant impact on our margin. Without Mepco, our margin would have declined instead of increasing.

Mepco increased our assets by $125 million with $108 million in finance receivables and $92 million in average loan balances. Mepco also had net income of $700,000 for the two and a half months we've owned them.

We had significant improvement in non-performing loans and non-performing assets during the quarter. As a result, our provisions loan losses decreased by $450,000, compared to second quarter '02. Non-performing loans ended the quarter at .53%, versus .72% at year end.

Real estate lending was very strong, as the refi boom continues. Gains on sales real estate loans were $4.3 million, but were somewhat offset by a decrease in loan servicing fees.

Overall, the second quarter was another very strong performance at IBC. Looking a little further forward, we do expect the refi market to soften over the next several months. Our pipeline of applications remains strong and we are seeing increasing numbers of new construction and purchase money applications.

With that, I will turn it over to Rob, to go into some detail on the numbers.

Thank you. Good afternoon.

As Chuck outlined, we had a strong second quarter with record earnings $9.1 million, up 28%, from Q2. I will cover some of the details of our second quarter.

Tax equivalent net interest income was up $3.3 million or nearly 16% on a comparative quarterly basis, and up $2.7 million or just over 12% on a linked quarter basis. These increases were largely due to our Mepco acquisition, which added approximately $3 million to our net interest income in the second quarter of '03.

Total averaged interest earning assets grew $261 million in the second quarter of '03, compared to '02 with Mepco contributing 35% of this growth. The balance of the growth was due to increases in loans held for sale, commercial loans, and investment securities.

Our tax equivalent net interest margin was 4.85% in the second quarter of '03, compared to 4.80% in the second quarter of '02, and 4.75% in the linked quarter. The growth in the margin was entirely due to Mepco, which added $92 million in loans for the quarter, at an average yield of over 14%.

Absent the addition of Mepco, the margin would have been 4.46%, down 34 basis points from 2002 and down 29 basis points on a linked quarter basis.

This margin contraction, that is absent Mepco, is primarily due to our March 2003 issuance of $50.6 million in 8.25% Trust Preferred Securities, our having $17.25 million of old 9.25% Trust Preferred Securities still outstanding through April 21st, growth in lower spread earning assets, such as investment securities, as we've leveraged some of the proceeds of the new Trust Preferred Securities, and finally, the impact of the low interest rate environment.

We plan to purchase approximately $100 million in investment securities to partially leverage our Trust Preferred Security issuance, and at June 30, 2003, had completed $60 million in purchases although the average balance during the entire quarter was quite a bit lower.

Looking ahead, we continue to see some modest margin pressure due to low interest rates. However, depending on the growth rate at Mepco, we may be able to entirely offset the margin pressure at the banks.

Further, we did achieve stronger loan growth in the second quarter of '03. Excluding loans held for sale in the Mepco acquisition, loan balances were up $35.8 million in the quarter, which equates to just over a 10% annualized growth rate, with this growth, mainly concentrated in commercial loans.

Our commercial loan growth reflects a number of factors, including still some residual fallout from bank mergers, changes in lending focus at some larger banks, increased activity by IBC in the Oakland and the Macomb County markets near Detroit and finally we believe our high level of service.

Moving on to non-interest income, fee income on deposits was up 13.5% on a comparative quarterly basis and up 12.4% on a linked quarter basis, primarily due to continued checking account growth.

As Chuck mentioned, gains on mortgage loan sales were very strong at $4.3 million, compared to $1.2 million in the second quarter of '02. Mortgage loan sales reached $242.5 million, and originations $363.5 million in the second quarter of '03. Obviously, a result of the strong refinance market.

Refis made up about 74% of our total second quarter 2003 origination volume. At June 30, 2003, we had $131.2 million in loans held for sale, and slightly over $200 million of locked but unclosed loans in the pipeline, which would suggest strong mortgage banking activity in the third quarter of 2003 as well.

We are often asked about the bottom line impact of the increased mortgage banking revenues due to the high refinance volume. I would estimate the impact in the second quarter at about 4 to 5 cents per share, based on the following: we would project a normalized, meaning lower refinance level of gains on mortgage loan sales at about 1.5 to $1.6 million in the quarter, or about $2.7 million lower than our actual level.

Offsetting this would be a $1.4 million increase in mortgage loan service fees. Thus resulting in a pretax reduction of income in the 1.3 to $1.4 million range or about 850,000 to $900,000 after tax, resulting in about 4 to 5 cents per diluted share.

This analysis, of course, assumes no reduction in non-direct mortgage loan origination costs, which we would, in fact, expect to be able to reduce in a lower volume environment.

Mortgage loan service fees were actually an expense of $1 million in the second quarter of '03, compared to income of $300,000 in the second quarter of '02. This large swing was due to increased amortization of capitalized mortgage loan servicing, as well as an additional impairment charge of $600,000.

The increased amortization and impairment charge reflect actual higher and expected prepayment rates as a result of the refinance environment.

Non-interest expense increased by $4.1 million on a comparative quarterly basis, with about half, $1.9 million of the increase due to the Mepco acquisition. The balance of the increase relates primarily to compensation in benefits, which increased due to January 1 merit pay increases, additional staff levels, and increased healthcare costs.

Other categories of expenses that were up were primarily due to the opening of four new branch offices in the last seven months of 2002, and two new loan production offices in the first quarter of 2003.

On a linked quarter basis, total non-interest expenses were up $2.6 million, or about $700,000, if you exclude Mepco. This increase was concentrated in compensation, employee benefits, advertising, and several categories of other expenses such as legal and professional, Michigan single business tax, and freight and postage.

Turning now to asset quality.

As Chuck mentioned non-performing loans declined during the quarter with improvement across the board in commercial, mortgage, and consumer loans. You can see from the table in the press release that Mepco added $1.3 million of finance receivables to total non-performing loans. The vast majority of these receivables are collateralized by return insurance insurance premiums from insurance carriers and there is little unsecured exposure.

With respect to our interest rates sensitivity position, we remain relatively neutral and would only expect very modest improvement in our net interest margin if interest rates rise.

During the second quarter of 2003, we repurchased 332,000 shares of our common stock at an average price of $22.62 per share. We have about 453,000 shares remaining under our current share repurchase plan, and expect to continue to be active in this area during the balance of 2003.

I would now like to turn the call back over to Chuck for some closing remarks.

Well, as I said earlier, we are very happy with our second quarter results. We are expecting the rest of the year to be strong, though the mortgage market will be more challenging in the second half of the year than it has been in the first half of the year. I think with that, we're ready for questions.

Thank you, gentlemen. The question and answer session will begin at this time. If you are using a speaker phone, please pick up the hand set before pressing any numbers. Should you have a question, please press star one on your push button telephone. If you wish to withdrawal your question, please press star two. Your question will be taken in the order it is received. Please stand by for your first of question. The first question comes from Joe Stieven with Stifel Nicolaus, please state your question.

Hi, Chuck, hi Rob. First of all, good quarter.

Thank you.

Two things. I guess a clarification. Number one, you started to talk about the mortgage banking operations but I just want to clarify, didn't you say that your pipeline are actually at record levels right now, Rob?

Yes. The pipeline was at over $200 million and by pipeline, what I'm referring to is locked loans where the borrower has locked in a rate with us but they haven't closed yet, so they don't show up on our balance sheet. And when they are locked in, we normally get a pull through rate of better than 90% and with rates having gone up since quarter end, there's probably a lot less risk of fallout than if rates had gone in the other direction.

So we would expect to pull through a lot of those to closed loans. And then on top of that, we had another $131 million of loans held for sale that had closed on the balance sheet, but hadn't been sold yet. So right there, you're without taking another application you're at $331 million.

So, I mean, in a lot of respects, without making any predictions, you know the third quarter mortgage -- or mortgage banking should be, again, another very, very strong quarter for you guys?

That is our expectation.

Okay. Then, I liked your analysis when you talked about mortgage banking slowing down, but I didn't hear your first premise, or your first assumption that you made. Can you sort of run through that again?

Yeah, what I did, Joe, is I -- and this is an estimate, but given the growth in our mortgage banking platform we bought Saginaw Bay Mortgage last year and we've added some loan production offices. We think there is some volume in the purchase and construction market, as well as some more modest level of refinance volume that even in a non-refinance market, we would be generating, it would be our estimate somewhere in the range of $1.5 million to $1.6 million of gains on loan sales and what I would call a more normalized environment.

Okay.

I mean, part of the way get to that number is assuming our gain margin is equivalent on purchase and construction as refis and generally there's not much difference, 26% of our volume in the second quarter was purchase and new construction. So if you take the $4.3 million, and multiply it by 26%, you're already at $1.1 million, with no refi volume.

Right. Okay.

Even in the non-refi market, we'll run, you know, a decent level of refis that are not rate driven. They're driven by other factors. So we don't think it is a stretch to move up another 4 to $500,000 in gains from refis even in a non-refi market. [INAUDIBLE] get to that figure. And that's about $2.7 million lower than what we actually had in the second quarter.

And then the other big swing item is in a non-refinance market, we're going to get back to a period of time where we actually have revenue from mortgage servicing rather than expense and given where our portfolio currently stands, we'd expect that revenue in a normal environment, where we're just amortizing based on more normal prepayment rates to see a positive 3 to $400,000 instead of a negative million.

Instead of a negative million.

Million to $1.1 million.

That's what I was trying to get.

When you kind of put those numbers together that's after tax how you get to the 4 to 5 cents per share. And my concluding comment was I assumed no reduction in non-direct origination costs. Direct origination costs under current accounting rules get deferred and netted against gains. So to the extent, for example, we have higher commissions, we're paying the loan originators, that's effectively getting netted against gains. But there's a fair amount of non-direct origination costs that do flow through expenses and that's the challenge is to root out those expenses and cut them when our volume drops.

But that also doesn't take into -- okay. I was going to say to the extent you've got MSR impairments.

Well, the MSR impairments are kind of accounted for in that $1.4 million.

The 1.4 million, okay. Good. I just wanted to understand the assumption. That makes, that's very clear now. Okay, thanks, guys. Good quarter.

Thank you, Joe.

The next question comes from John Bergquist with Sandler O'Neill, please state your question.

Hi, guys. Good quarter. I just wanted to get a little bit more information on your assumptions for Mepco going down the road. Obviously, you've had good success with that so far. Also I wanted a description of, if possible, of the integration experience with that. But more looking at, you know, now that you guys actually own the business, have had some experience with it, where do you expect that business to go?

I'll give you the broad view, and Rob can get into some detail, perhaps. As we said in two and a half months, they earned $700,000 after tax. They are growing nicely at this stage. They've been able to expand and are adding salespeople to the business as we go forward. So we do expect them to continue to go nicely over the next couple of years, at least.

The integration, I think has gone very well. We did not try to swallow them up within the bank, so to speak. They are a stand alone company. Run by the same management that we acquired, the people who have been running it for -- the family operation for 40 years.

There are some cost saves that we're working on. Some of the more obvious ones are their cost of funds but generally speaking, we're very pleased with where they've gotten to in the first two and a half of months.

John, just a couple more details. You know, we've seen them grow from maybe just slightly less than $100 million in finance receivables when we started to about $110. So we've he seen some reasonably good growth.

I think there is a little differentiation between their two primary businesses. We're seeing very solid, strong growth on the premium finance side, and I think it revolves around three different areas.

One is they've been able to add salespeople, as Chuck mentioned, because now they have the wherewithal to fund a lot higher volume of loans. So they are not constrained by their access to debt. So I think long term, that's going to be a big benefit.

Our cost of funds allows them to be more competitive in bidding on the higher dollar premium finance loans, as well. So I think that also is a very positive factor there.

The other end of their business, the automobile warranty finance area, that's really been staying at about level, right around the 44 to $45 million area. And there, I think, the outlook is a little less robust. The auto market has slowed a bit, so the volumes there aren't growing at the same rate as they are on the premium finance side. But we certainly continue to see good opportunities on the premium finance side.

We pretty much taken advantage of the lower cost funds because we paid out all of their bank debt right at the day of closing and replaced it with our cost of funds. There's probably some more modest expense saves over time, but those would probably largely be offset by continuing to grow their business and add salespeople.

Good. One other question, and then a follow-up question to Joe's question about the mortgage banking business. Do you guys think about it in terms of a profit margin business? Do you guys have a profit margin in mind with that, as far as the overall cost to generate loans for sale?

Well, the individual banks have very set profit margins and it can vary to some degree, depending on the environment. For instance, over the last nine months now, because of the volumes that are out there, our profit margins have expanded to 2% or higher on a closed loan.

John, we don't treat it as a legal segment for reporting purposes, but we do look at the performance on an overall basis of the operation, including what they generate for portfolio loans and the spread income associated with it. And over the last couple of years, it's been very profitable, because of the refi business, even taking into account the servicing incurment.

But even in environments, if we go back to 2001, which wasn't a big refi volume, it was still profitable and it doesn't tie up a lot of capital, which is the other benefit. That's one of the reasons I think for our ROEs are very high because the mortgage banking business doesn't tie up a lot of capital.

The real art to mortgage banking is being able to get your fixed costs down when the volume drops. And that's what is the real challenge, because you obviously get the big swings in volume.

Okay. Good.

The next question comes from Jon Arfstrom with RBC Capital Markets. Please state your question.

Good afternoon, guys.

Hi, Jon.

A couple more follow-ups on Mepco. How high are you willing to take this business as far as a percentage of loans? That you would keep on your balance sheet?

Well, we have -- we've looked at that and said probably the 200, 250 on our balance sheet is a comfort level to begin with. When I say to begin with, we expect that to take several years to get there. And then after that, we would be looking at some securitization issues. Do you want to expand on that, Rob?

Yeah, I think Chuck hit it absolutely on the head. We would certainly feel comfortable at $250 million, and I think if we got to that volume, it would also make the potential of securitization a lot more viable from an expense standpoint, because there is a fairly high cost, fixed cost of going through a securitization, bit the securitization process could do a number of things.

We could still maintain a fairly significant yield differential, we think, and we could, depending on the structure of the securitization get some capital relief, and it would give us some opportunities to continue to grow and expand the business. But, you know, if we're otherwise growing the bank, I could see the 250 getting higher.

And the other issue with funding the business, obviously, is what's the most efficient means of funding it? We could get to a point where securitization represents the most economical and efficient way of funding that business. So that's something we continue to explore on an ongoing basis.

Okay. Okay. So somewhere under 20% of loans is probably a good assumption.

That's probably a good assumption.

Okay. And then the average life on these loans, is this the typical 9 to 12 months type paper?

Yeah, the premium finance loans are 9 or 10 months and the auto warranty finance receivables are 12 or 24 months. The average life of the portfolio is about 7 months, 6 to 7 months. So it turns over very quickly. I mean, it's great from an asset liability management standpoint, but the challenges you have to keep originating an awful lot of new loans to feed that engine, because it's burning a lot of gas.

Okay. That makes sense. A couple more things. On the -- you talked about the investment securities purchases. Can you talk a little bit about what you're buying and if you are concerned at all about the ratio risk and then maybe talk about what your thoughts are there.

Well, we're buying a mix. A lot of municipal securities. And we like the munis in particular because they don't have the negative convexity problems of mortgage-backs.

We've also bought some CMOs that usually -- or not usually. What we are buying are backed by shorter term paper, and we're buying traunchs that don't have a lot of risk either in terms of extension or rates were to go down for some reason, you know, real high, you know, prepayment potential problems. However, I will say in doing that, we're giving up spread at the outset to get the much tighter kind of traunchs.

And then we bought a little bit of a ten-year mortgage backed paper and the reason again, we like the 10-year mortgage-backed paper is, if you look historically even in a refi environment, it stands up better than the 30 or 15-year because the customer is not getting as much of a payment reduction, given a declining rate. And if it rates go up, it doesn't extend nearly like what a -- you know a longer term mortgage back would. So, again, we're giving up some spread to get, you know a much tighter kind of performance level on it.

So overall, what we think we did was we -- you know, we gave up a lot of, you know, maybe current income to end up with a leverage strategy that entails a lot less risk.

Okay. And then one other question on real estate owned. It looks like, if I'm reading the release correctly, you had, I think it's the infamous Bad Axe credit that rolled off and you had a few other things come in.

Yeah, we had the hotel in Bad Axe rolled off. We sold that hotel, and that transaction closed in June. And so I think we were down over all on ROE and repos by about $500,000 or so. So we had $1.2 million coming off, but the offset was we had a rise in one to four family homes in ROE. So that was kind of the offset.

The nice thing about that is the one to four family you tend up with very minor losses when we do sell them.

Okay. This looks good. Thanks, guys.

Once again, ladies and gentlemen, if you do have a question, please press star one on your push button telephone at this time. The next question comes from David Duzenbury with Janus Capital. Please state your question.

Good afternoon. You guys were real good about talking about the mortgage banking income, trying to normalize that. What about the title insurance? It looks like if you normalize that it should be another two pennies off the current run rate to make it about like 7 cents off the current run rate.

That's a good point. Obviously, our title agency business has contributed to our revenue for the first half, in particular. Running way ahead of plan. I think our revenue is up to about $900,000 in the --

I mean, I think the 2002, the 464, that certainly is a more normalized run rate. The other thing, with the title insurance is, we still think we have a ways to go to capture business on the east side of the state. The title insurance is still largely skewed to the west part of the state. We just haven't had the closers to really cover the east side of the state as well. So I think we would have some opportunity to offset the refi decline with some increased capture of our business on the east side of the state.

And beyond that, the other thing I think you'd see maybe make a comeback is, we're off about $100,000 on mobile home loan origination fees and that part of the business is just getting really hammered with the low mortgage rate environment, because what you are finding is someone could buy a $100,000 home, given the low mortgage interest rates for about the same monthly payment as a $60,000 mobile home. So when mortgage rates rise, we think that will help in the manufactured home area. So we think we will get some pickup there.

So I'm not quite sure, you know, even if you look at where we're at, the 900 versus the 450, you know, on an after-tax basis it's probably a couple cents a share, but we think we can get some pickups in some other areas.

Okay. And just out of curiosity, the normalizing the mortgage bank operations, I've assumed will work off of Fannie, Freddie-type mortgage origination market of $2 trillion, half of it is refi and it looks and feels a little bit like 2001. What happens to your gain on sale margins on the loans you sell because that's a benefit greatly over the past couple of years.

Well, as a said earlier, our gain on sale margins have expanded to a very limited degree because everybody's been so busy handling refis. I think everybody built in a little extra so that they could at least get paid for the overtime involved.

Right. Does it come down to like 130 basis points or --

Well, oh no, we wouldn't look at that. I think, what do we normally average, Rob, around 150 to 180 basis points?

That would be normally what -- I mean, we actually price the margin even higher than that but then when you're deferring your expenses against it, it comes down some, but we would still envision an environment where we'd be north of say, 1.5, even after netting expenses when you take into account capitalized servicing. A lot of it just depends on what the competitive environment is, you know, what everyone is doing in the market when you are trying to capture that purchase and the refi volume.

We actually find often in a purchase and construction market where refis have abated we can compete more effectively because we have a variety of portfolio loan programs. Now, again, that's not flowing through gain on sale. Those would be loans we're actually booking and earning the spread income on.

But in addition to that, we have a lot of very good construction loan programs, and actually, our refi volume, in our refi volume is included permanent loans that are refinances of our construction loans. We count those as refis because they're rebuying an existing loan but it's really purchase and new construction activity. So we still think we fair fairly good in a market that we saw some decline in the refis.

Another factor that affects the mortgage business for us. In the state of Michigan, over the last three or four years, they've gone from about 200 mortgage companies to over 2,000 mortgage companies. A lot of that is driven by the refi market. Right. Very easy to do. Very much a commodity. When you get into more of the purchase money situation, now you're dealing more with relationships with realtors in particular, builders, and we have advantages there that most mortgage companies don't, for instance, our product line is much more flexible. We can work with them.

One of the reasons that's a very strong advantage for us is that right now, it's higher -- the top quality mortgage originators is very, very difficult because they have a pipeline that they give up if they move from mortgage company or another bank to us. When that starts slowing down and those pipelines reach more normal levels, it's not as costly for them to jump ship and join us. And that's been our past experience over the years, that that does happen more.

I just want to go back and make sure we're talking about the same issue when it comes to gains as a percent of real estate mortgage loans sold. If I look at your K, those gains have ranged from 135 to 153 basis points. You're saying in a non-refi environment, you would still be able to maintain that at the higher end of that range.

Well, I mean, if you look at the three months ended the '02 figure, the 135, that was driven down by some FASB 133 adjustments. We show that the 22 basis points so that brings it up more around 157. I think we had said we feel we could, depending on the competitive pressures in the market, certainly stay above the 150 mark, absent these FASB 133 adjustments.

Okay. So absent the FASB 133 adjustments, assuming a similar level of competition and pricing flexibility to the current refi environment, you could do 150.

We think we can probably do a little better than 150. You had said in the current environment.

No, I'm looking for a normalized environment.

Well, I think that's probably a reasonably fair guesstimate is right around that mark.

Okay. Thank you.

If there are no further questions I will turn the conference back to Charles Van Loan to conclude.

Thank you very much for calling in this afternoon. Excellent questions. We appreciate that. As always, if we can be helpful in answering questions, we'd be happy to. With that, thank you, and we'll be talking to you.

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 1-800-428-6051 or 973-709-2089 with an ID number of 299881. This concludes our conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.