Independent Bank Corp (Michigan) (IBCP) 2003 Q3 法說會逐字稿

Good afternoon and welcome, ladies and gentlemen to the Independent Bank Corporation third quarter earnings 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 question-and-answers after the presentation.

This presentation may contain certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include expressions such as; expects, intends, believes and should, which are not necessarily statements of beliefs as to expected outcomes of future events. Actual results could materially differ from those contained in or applied 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.

I will now turn the conference over to Mr. Charles Van Loan, please go ahead, sir.

Thank you, good afternoon. We're glad you could join us to discuss third quarter results. I will apologize in advance for my voice and, hopefully it won't be too bad, I've had a nasty cold.

We're very pleased to be able to report record earnings of $10.3 million or 51 cents per diluted share when is a 46% increase over third quarter 2002 earnings per share of 35 cents. Other measures of profitability were also exceptional. Our return on average assets was 1.75 and our return on average equity was 26.8%. Driving our record earnings were increased in net interest income, service charges on deposits, net gains from real estate and mortgage loan sales, title insurance fees and real estate mortgage loan servicing revenues.

Rob will get into greater detail in the call but the combination of our mortgage banking operations, Mepco acquisition and balance sheet growth were big pluses. These outstanding quarterly results also provided us with the opportunity to take some securities losses and prepay some higher rate borrowings. On an after-tax basis, these losses totaled $1.5 million or 7 cents per share. We expect these transactions to pay off in future periods through enhanced net interest income.

Over the course of years, you've heard me comment on our retail "totally free checking" program and the positive impact it's had on growing our checking account balances and revenues. During the third quarter of 2003, we launched "totally free checking" for business. We hope, over the long-term, that the same kind of success with this program that we've had with our retail product.

On the lending side, we are actively seeking to add mortgage loan originators to attempt to counteract some of the impact of the decline in mortgage loan refinance volume on our future results. Once again, Rob will get into more detail on our outlook in this area.

We've also added and will continue to add new high-quality commercial lenders in our better lending markets. We expect this to further enhance our loan portfolio of growth. Loan quality remains strong in the third quarter. Non-performing loans were .55% of total portfolio loans and net loan charge offs were just 15 basis points on an annualized basis.

I would now like to turn the call over to Rob Shuster, our CFO, to provide greater detail on our third quarter results. Rob?

Thanks, Chuck. Good afternoon, everyone. I will just jump right into some of the details on our third quarter results.

Tax equivalent net interest income was up $4.5 million, to just over 20% on a comparative quarterly basis and up $1.9 million or 7.7% on a linked quarter basis. The comparative quarterly increase was primarily due to the Mepco acquisition which added about $3.6 million in net interest income during the third quarter of 2003, with the balance of the increase driven largely by growth in interest-earning assets, notably, real estate mortgage loans, commercial loans and investment securities. On a linked quarter basis, Mepco accounted for about 32% of the increase in tax equivalent net interest income with the balance of the increase largely coming, again, from loan growth.

We were very pleased with third-quarter portfolio loan growth of $81 million which equates to an annualized rate of about 21%. Mepco's annualized loan growth rate was 62% in the third quarter. Our net interest margin also held up very nicely at 4.9% in the third quarter of '03, compared to 4.82% in the third quarter of '02 and 4.85% in the second quarter of '03. Much of our success in this area is actually attributable to our downward push on cost of funds.

Several factors were essential to this success. First, we had solid growth and lower cost core deposits; checking, savings and money market accounts. These average balances were up $106 million on a comparative quarterly basis and $42 million on a linked quarter basis. Second, we were able to further push down our average costs on core deposits despite the already low interest rate environment. Third, due to maturities of some higher costing time deposits and other borrowings, the new borrowings at lower costs, we saw nice reductions in our cost of funds in these categories.

Factoring out Mepco on a linked quarter basis, our net interest margin actually grew from 4.46%, to 4.45%. Again, primarily reflecting our success in pushing down our cost of funds at a faster pace than the drop in yield on our interest-earning assets during the third quarter; however, the growth in our net interest income was also due in part to the high level of mortgage loans held for sale on which we can earn long-term yields but yet are able to fund the short-term borrowings.

As you can see in our balance sheet, loans held for sale dropped to about $70 million at September 30th and our expected lower average balance in the fourth quarter will adversely impact our net interest income; however, we are optimistic that we can overcome this impact through future loan portfolio growth. Gains on real estate mortgage loan sales were a big part of our third quarter results and totaled $5.7 million which is up 342% from '02 and 31% on a linked quarter basis.

We did actually have a reduction in net third quarter gains of about $500,000 related to FASB 133. This is a timing difference that will reverse when the applicable commitments to sell loans in the secondary market are fulfilled during the fourth quarter. Loan sales volume was $300 million during the quarter, and mortgage loan origination volume was $345 million, a new quarterly record.

Our purchased refinance mix improved during the third quarter, with 32% of originations being purchased or new construction and 68% refinanced. This compares to a purchased refi mix of about 25/75 earlier in 2003. Like everyone in the mortgage industry, we did see a drop in application volumes in the third quarter which were down 40% compared to the second quarter of '03.

I'm going to take a stab at walking you through the impact of the high volume of mortgage loan refinancing on third quarter results in our mortgage banking outlook for 2004. As you know, our actual level of loan sales gains were $5.7 million in the third quarter. Given our sales platform and interest rate outlook for 2004, we see a more normalized quarterly run rate of about $2 million for these gains. This would suggest a per share impact of 12 cents for the quarter from the high level of gains. That 12 cents is computed by taking the $5.7 million of actual, less, what we consider, would be a more normalized run rate of $2 million and then multiplying it by 65% to get an after-tax number and dividing it by about $20 million or 20 million shares.

Offsetting that 12 cent impact are our securities losses, losses on prepayment of borrowings and a somewhat lower level of real estate mortgage loans servicing income due to the high level of amortization of originated mortgage servicing rights. Collectively, these items adversely impacted third quarter results by approximately 8 cents per share.

So, sorting everything out, the plus 12% and the minus 8 cents, or the plus 12 cents and the minus 8 cents leaves us net plus impact of about 4 cents per share which would suggest a current quarterly run rate at about 47 cents per share. Chuck mentioned our losses on securities and pre payments of borrowings in his opening comments. As described in our press release, our securities losses included a write off of $750,000 which represents our remaining book balance on a North Country Trust Preferred Securities.

As I think most of you know, North Country is a Northern Michigan-based bank holding company. We also incurred $800,000 in losses on municipal securities. This loss is comprised of just over $500,000 from the sale of $10.7 million of municipal securities and a $300,000 loss on $6.3 million of municipal securities that we identified at quarter end as not having the intent to hold the maturity. The proceeds from the sales of the municipal securities was reinvested into higher yielding securities which is expected to improve future tax equivalent net interest income by about $120,000 annually.

We also prepaid $5 million of Federal Home Loan Bank advances and incurred a loss of $1 million. The new borrowings, which replaced those that we prepaid, had a 3.8% lower weighted average interest rate resulting in an expected annual reduction in cost of funds of about $$180,000. Real estate mortgage loans servicing income ended up at a positive $200,000 for the quarter. There has been a lot of volatility in this number, due to mortgage loan pre payments.

In the third quarter of '03 we did record a $600,000 recovery of valuation allowances from previously recorded impairment charges. However, our level of amortization of originated mortgage servicing rates was quite high due to actual mortgage pre payments during the quarter. We still had an impairment reserve of $1.2 million at September 30, 2003.

Looking ahead, given the size of our servicing portfolio and more normalized levels of amortization, we would expect a quarterly run rate of about $400,000 for real estate mortgage loan servicing income.

With regard to operating expenses, I want to focus on the link quarter, since with the addition of Mepco in 2003, it is more difficult to compare to 2002. If you adjust our third quarter expenses of $22.3 million, to remove the $1 million in losses on pre payments of borrowings and consider that Mepco was included for all of the third quarter but for only two and a half months in the second quarter, the linked quarter increase in non-interest expense was approximately .8% or 3.2% annualized and much of this increase was in advertising, in particular, related to our launch of "totally free business checking".

In conclusion, we have covered some of the more significant factors influencing our third quarter and also hopefully provided some information to help you assess our prospects for 2004. I would now like to turn the call back over to Chuck.

Well, we will accept questions, if you are ready and again, thank you for attending.

Thank you, sir, the question-and-answer session will begin at this time. If you are using a speaker phone, please pick up the handset before pressing any numbers. Should you have a question, please press star one on your push button telephone. If you wish to withdraw your question, please press star two. Your questions will be taken in the order they are received. Please stand by for your first question. Our first question comes from Joe Stieven from Stifel Nicolaus.

Hi, guys. First of all, great quarter.

Thank you, Joe.

Can you help me out a little bit? Your loan growth, excluding Mepco was easily better than expected. So can you talk, I mean, did it exceed your expectations too and what is helping you drive that? That's question number one.

And then question number two is regarding Mepco. If we sort of look out from here, you know, give us some thoughts on where Mepco could be 12 or, you know, let's say the end of next year, it would be five quarters from now, as far as balances on your balance sheet? Thanks, guys. Great quarter.

Thank you, Joe. Well, the commercial loan area was the real highlight on the loan growth but also mortgage because we have more portfolio product going in. Rob, do you want to add to that answer?

Sure. I think a couple of things on the loan growth, Joe, and I would like to say that it exceeded our expectations but I think Chuck has pretty high expectations so I've never going to necessarily make that comment. The things that helped outside of Mepco on the loan growth side were, first of all, Chuck mentioned we have been adding some commercial lenders so that continues to help us a little bit, we think, on the commercial side.

And on the mortgage side, we started to see a little bit better mix between purchase and refinances, as I indicated and as we gravitate more to a purchase market, we see better opportunities for portfolio loan growth, you know, it sort of skews a little bit of the production away from so much predominantly being 15 and 30 or fixed rate, which we're selling. So that helps some.

And then I think lastly, you know, we've been having very good loan originations but we've had so much in the way of refinancing that that's, you know, taken away a little bit from the net growth and I think we finally started to see towards the end of the third quarter a little bit of slowdown in refinance volume.

With regards to Mepco, they were up to about $125 million or so at the end of the third quarter and, as I said, annualized their third quarter growth, you are looking at about a 62% rate. Of course, as that number gets bigger, it's harder on a percentage basis to keep up that kind of pace but based on where we see their origination volume next year and based on the quick turnover of their portfolio, we do think they could get up somewhere in the 220, to $230 million range in finance receivables by the end of '04 and then, hopefully longer term, we continue to, you know, be able to grow at a pretty good clip.

I do think that their prior size was constrained dramatically by their capital and lending opportunities. The borrowing opportunities, I mean and so there was some pent-up demands that they were able to do with their sales force and so we've had some very strong growth and we expect it to continue but perhaps, not at that 60% range.

Okay. Thanks, guys. Great quarter.

Thank you, Joe.

Thank you. Our next question comes from Brad Milsaps from Midwest Research, excuse me.

Good afternoon.

Hi, Brad.

Just a couple of questions in relation to mortgage. I wonder if you could give me an idea of the number of loans that you have locked and ready to close kind of at the end of the third quarter and secondly, will we see any reduction in personnel expense as your mortgage continues to tail off? I know you mentioned hiring more lenders to try to make up some of the reduction in volume, in order to make up some of the volume that way but didn't know if there would be any other incremental reductions in expenses? Thanks.

Well, we would expect to see our back room expense decrease, as we do so. Our always preferred method of dealing with it is to find ways to build the growth instead and most of the originators we're speaking about commission based, so they don't cost us anything if they don't deliver. The natural tendency then, you know, in the environment that we're looking at now is there is some fairly strong marginal costs that go down with the lower volumes.

And, Brad, in terms of the question on what is locked and ready to close, we had about $70 million of loans held for sale that, obviously, are going to spill into the fourth quarter, so that's kind of what was there on the books and are going to be sold fairly quickly and then, obviously, whatever we originate in the quarter, plus what we had in the pipeline in terms of applications at the end of the third quarter.

On the cost side, one thing to take into account when you look at our operating results and this should be true of all mortgage bankers is, we're required to defer direct loan origination costs and those are actually netted against the gains. So, and what we mean by direct loan origination costs, probably the easiest one would be the commissions we paid the loan originators, so those are not down in personnel expense, they get deferred and then to be extended to sold loans, they get netted against the gains. So you may have some degree of indirect expenses down in operating costs that are higher because of the volume of our mortgage banking activities but those are going to generally be much more difficult to trim back than direct origination costs.

So, I don't think you're going to see a big decline in operating costs because the mortgage banking operations have not really generated huge jumps in our operating costs, although we have big jumps in cost, again those are deferred and netted against the gains.

Right. Okay. That's what I was getting at, kind of a backroom operating cost but it sounds like those are going to remain pretty static.

Well, I mean, I don't think they we're in a long-term cycle of much lower production. I think Chuck's suggestion that it is a lot better to try to find ways to keep your revenue up is the right way, because, you know, a lot of the people you have in that business are people with good training whether they are underwriters or closers or processors and it's sometimes hard to find them when you need them.

So, we would rather, you know, other things we would prefer to do is maybe to cut back their workweek from 40 hours to 35 hours or something. There's other ways to skin the cat rather than getting rid of your highly trained people who you need when your volumes are higher.

Well, this environment does give us an opportunity that we haven't had for nearly two years now. Some of the less robust players in the mortgage market, who tend to be the smaller mortgage companies, they have a much more difficult time dealing with the environment that we're going into right now. As a result, we tend and have had in the past the opportunity to hire some of the better producers from some of the other players around us. So, even though we are anticipating considerably less volume we think we can do a good job of holding it up to reasonable levels.

Okay. Good thank you and great quarter.

Our next question comes from John Bergquist from Sandler O'Neill, please go ahead with your question.

Yes, I have just a kind of follow-up to Joe's question. Do you think the yield on the Mepco receivables will stay at a higher rate? You know, it's at 13% now, is that a sustainable yield?

There's really two questions there, in a way. The yield on the asset tends to be fairly stable but we're funding this with very short-term money because of the short-term nature of the asset itself and this short-term interest rates increase, we don't necessarily think we'll keep our net margins.

The gross margins did come down a little bit from, I mean, the yield on the assets came down a little bit from the second quarter and some of that depends on their mix. We're getting more growth right now on the premium finance business than the extended automobile warranty business. That's been a little bit more sluggish, primarily because auto sales haven't been as robust and that portfolio has the higher yield. That portfolio probably has a yield closer to about 18% or so, whereas the premium finance business is a somewhat lower, so if market growth comes in the premium finance business, you might get somewhat of a reduction in that overall net yield. So, I think it might come off a little bit but I think it will be more than offset by the overall growth in their portfolio.

So you might, you know, it might be wise to trim it off a little bit but I don't think it would be real material, John.

Good. Also on the, I was pleasantly surprised as well, with the commercial loan growth. I was wondering, is that sustainable on a quarter-by-quarter basis or is that something that also surprised you and where is that growth coming, are you stealing market share from other competitors or is there actually some organic growth in your markets which would surprise me because it would seem to be hard to find in other places.

I would say that primarily it is taking it from others and that's largely as a result of what I said earlier, our ability to hire some real quality commercial lenders in the Northern Oakland County areas has been a plus for us. We're also adding in the greater Grand Rapids market, which has had its challenges but at the same time, some of our larger competitors have provided some opportunities for banks like ours by changing their criteria for various loans or the total dollar amount that they are willing to loan to one customer.

Okay. Also --

And as long as things stay the way they are, we do think we'll continue to grow that.

Good. That's excellent. Also, nobody has asked about the margin expectations. Obviously the Mepco, the growth of the Mepco portfolio will help margins. What do you think see as far as other things going on in terms of expected changes in your funding structure or changes in your asset structure as far as margin expectations?

Let me have Rob go into a little bit more detail but in general, we have been, at least for the last six months, looking at ways to position our balance sheet for rising rates. It's not gone up as fast as we predicted they would but we're still are anticipating rising rates and we are doing what we can to provide some ability within our balance sheet for that to improve our margins or at least keep it the same.

John, I think probably the most direct answer is, we feel that we can continue to grow our net interest income but the vast majority of that growth is going to come from expansion of our interest-earning assets rather than a rise in our margin. You know, we're up to 4.9% and to the extent Mepco so continue to be a big factor in that growth, it might surprise me what happens with that margin, but, you know, I think that's, you know, I'm not going to, I never will say it's as good as it will get but it's pretty good, so we don't really anticipate, you know, the bumps going forward to come from being able to expand that. We consider most of it to be coming from portfolio loan growth where we do see good opportunities.

Yeah. Yeah. I'm coming from the other side. I mean it looks pretty darn good and I just, you know, I just was, it's not going to fall off the cliff, I would hope, but is it, you know, is it sustainable where it is, given the potential for additional securities or loans or liabilities to, you know, roll off? Some of that stuff is kind of a black box from our side, so.

Yeah, I don't see anything right now that, you know, that really concerns us regarding, you know, the sustainability of the margin. I mean, with Mepco, in some of their receivables, they can't really push the rate a lot higher. That's mostly on the auto warranty stuff. They are about as high as they can get and on the premium finance, the short-term rates start to rise, they will be able to push those rates up some but not in the auto warranty. So Mepco could, if short term rates went up, experience a little bit of compression in their margin, which, you know, may affect us a little bit but I still think overall, if we continue to grow the portfolio that's going to, you know, much more make up any little margin compression but, you know, that would be the one kind of phenomenon that you could see.

Other than that, you know, we don't see anything in the near term that would cause us any real significant issues on where the margin is right now.

Okay. Thanks, guys Good quarter.

I should say one other thing. I had mentioned quite a bit that it had been pushed up by the growth in core deposits. I mean, if that were to trend the other way, that could also have an influence. We don't see anything there but, obviously, some of our gain has been by growing those real core deposits which are at very low rates right now.

Okay. Thank you.

Thank you. Just as a reminder, ladies and gentlemen, if you do have a question, please press star one on your push button telephone at this time. Thank you. There are no further questions. I will turn the call back to Mr. Van Loan.

Thank you all for attending, for listening if you didn't ask a question and I'm glad you could be with us today. Have a great day and a great weekend.

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 a pass code i.d. number of 307740. This concludes our conference for today, thank you all for participating and have a nice day. All parties may now disconnect.