Independent Bank Corp (Michigan) (IBCP) 2004 Q1 法說會逐字稿

Please stand by for realtime text. Good afternoon, ladies and gentlemen. And welcome to the Independent Bank Corporation's first quarter earnings conference call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone key pad. As a reminder, this conference is being recorded. This webcast may contain forward-looking statements, as defined in section 27-A, I-1 of the Securities Act of 1933 as amended, including statements regarding, among other things, the company's business strategy, and growth strategy. Expressions which identify forward-looking statements speak only as of the date the statement is made. These forward-looking statements are based largely on this company's expectations and are subject to a number of risks and uncertainties, some of which cannot be predicted or quantified, and are beyond their control. Future developments and actual results could differ materially from those set forth in, contemplated by or underlying the forward-looking statements. In light of these risks and uncertainties, there can be no assurance that the forward-looking information will prove to be accurate. This webcast does not constitute an offer to purchase any securities, nor a solicitation of a proxy, consent, authorization or agent designation with respect to a meeting of company stockholders. It is now a pleasure to introduce your host, Charles Van Loan, President and Chief Executive Officer of Independent Bank Corporation. Thank you. You may begin.

Thank you, Diego. Good afternoon. We are pleased you could join us for our conference call to discuss first quarter 2004 results. You may recall from our January 2004 conference call that we commented on our expectations that full-year 2004 earnings per share would be relatively flat compared to 2003. And that the first quarter of 2004 would be especially difficult because of a comparatively lower level of gains on loan sales. Our first quarter 2004 net income of 8.4 million, or 42 cents per diluted share, was slightly lower than our comparative 2003 net income, of 8.8 million, or 44 cents per diluted share. Our results were also lower than the consensus market expectation of 45 cents per share. This is the first time since the opening quarter of 1994 that we have reported a decline in comparative quarterly earnings per share. Although we are disappointed to report this decline, the results, when excluding the impairment charge on capitalized mortgage loan servicing rights, we're actually ahead of our internal expectations.

Although down from the first quarter of 2003, our measures of profitability remain strong. With our return on average assets, at 1.44%, and our return on average equity at 20.34%. Highlights for the quarter included increases in net interest income and fee income from deposits. However, as expected, gains on mortgage loan sales declined sharply. In addition, we recorded an additional $1 million impairment charge on our capitalized mortgage loan servicing rights. Rob will go into greater detail on these items later in the call. Loans, excluding loans held for sale were up 36.6 million, or nearly 9% on an annualized basis, with about three quarters of this growth in finance receivables at Mepco. Our level of nonperforming assets declined from year-end 2003. Loan quality remained solid, with nonperforming loans at 10.7 million, or .63% of total portfolio loans compared to 12.7 million or .76% of total portfolio loans at December 31, 2003. Our two recently-announced acquisitions, Midwest Guarantee Bank Corp, and North Bank Corp are moving forward nicely.

We expect to close the Midwest acquisition on May 31 and the North Bank Corp acquisition on July 1. Our expected cost saves are on track and while these transactions will not have a significant impact on earnings per share accretion in 2004, because of their size and the timing of the closings, we are confident that they will positively impact 2005 earnings per share. We are also confident that our management model will improve the growth and level of revenues at both of these entities, after they have become part of IBC. Before I turn the call over to Rob Shuster our CFO to provide greater detail on our first quarter results, I just want to summarize a few points. First, excluding the million dollar pre-tax impairment charge on capitalized mortgage loan servicing rights, our diluted earnings per share would have been right on the consensus estimate of 45 cents. Second, we nearly overcame the impact of $3 million -- of a $3 million decline in gains on loan sales through growth in net interest income, partially offset by higher noninterest expense.

As a result, we believe that our current level of earnings is much less susceptible to cyclical changes such as those which impacted our mortgage banking-related revenues. Finally, we remain confident regarding our earlier guidance of relatively flat earnings for all of 2004 compared to 2003. And I want to add that given the current level of mortgage loan interest rates, we would expect to recover in the second quarter the impairment charge on capitalized mortgage loan servicing rights that we recorded in the first quarter of 2004. I will now turn the call over to Rob.

Thanks, Chuck. And good afternoon, everyone. Chuck's already given a very good overview of the first quarter so I'm going to just provide some additional details. First quarter 2004 tax equivalent net interest income was up 4.7 million, or about 21.5% on a comparable quarterly basis, and down slightly, about 350,000, on a linked quarter basis. The comparable quarterly increase was primarily due to the Mepco acquisition, which added $165 million in average loans at a yield of about 10.5% during the first quarter of '04. Growth in commercial loans, real estate mortgage loans, and investment securities also contributed to the total increase of 326 million in average interest earning assets. Finally, our net yield was also up 14 basis points to 4.89%, for the first three months of '04, compared to 4.75% for the first three months of '03.

On a linked quarter basis, as I stated earlier, tax equivalent net interest income was down about 350,000, due primarily to an 11 basis points drop in net yield, from 5% in the last quarter of '03, to 4.89% for the first quarter of '04. The decline in net yield was partially offset by a $38 million increase in average interest earning assets, about 60% of this growth was in Mepco's average loans. About two-thirds of the $350,000 linked quarter decline in tax equivalent net interest income, was due to a lower level of certain loan fees, which are included in interest income, including late fees, and the accretion of discounts on loans. The lower level of discount accretion primarily reflects a lower level of prepayment activity in the portfolio during the first quarter of 2004. Looking ahead, we would anticipate linked quarter net interest income to increase as projected growth and average interest earning assets is expected to more than offset any modest declines in the net yield.

Service charges on deposits were up just slightly over 11% on a comparable quarterly basis and down 5.8% on a linked quarter basis. The linked quarter decline is a recurring seasonal pattern, reflecting a decline in checks written in the first quarter of a year, compared to the fourth quarter of a year. Our linked quarter in-clearing check volume was down approximately 5.4%. Of course, the explanation for this is more checks are written in the fourth quarter of a year, primarily because of the holiday season. As Chuck mentioned, the most significant factor impacting the first quarter 2004 results on a comparative quarterly basis, was the drop in gains on loan sales of $3 million. We sold $69 million of mortgage loans in the first quarter of '04, compared to 230 million in the first quarter of '03. When factoring out FASB 133-related adjustments our net profit margin on loan sales was right around 1.5% for both quarters. We originated 159 million of mortgage loans in the first quarter of 2004, about 60% of which were refinances. This compares to 262 million in the first quarter of 2003, of which about 85% were refinances. Actually, our purchase and new construction mortgage volume was up over 60% in 2004, compared to the first quarter of 2003. At March 31, 2004, we had $54 million of loans held for sale, as well as another $59 million of locked mortgage loan commitments, for a total pipeline of approximately 113 million.

This compares to a total pipeline at December 31, 2003, of just 51 million, and would indicate an expected stronger level of gains on loan sales in the second quarter of '04, compared to the first quarter. Title insurance fees declined $200,000 on a comparative quarterly basis, or about 27%, again generally reflecting the downturn in mortgage refinance volume. Real estate mortgage loan servicing fees declined to an expense of $700,000 in the first quarter of '04, due primarily, and as Chuck referenced, to a $1 million impairment charge on capitalized mortgage servicing rights, reflecting higher expected prepayment rates, at the end of the quarter. Since quarter-end, long-term mortgage loan interest rates have increased by about one-half of a percent, and if these higher rates were to persist through the end of the second quarter, we would expect to recover most or all of this impairment charge. Noninterest expenses totaled 20.7 million in the first quarter of '04, an increase of 2.6 million on a comparative quarterly basis.

The acquisition of Mepco accounted for over three quarters of this increase. The balance of the increase was mainly concentrated in compensation and employee benefits, reflecting July 1, 2004, merit increases, and some staffing additions. On a linked quarter basis, noninterest expenses declined by just shy of a $1million, or about 4%, due primarily to declines in compensation and benefits, and also in advertising. The provision for loan losses was down slightly due primarily to a decline in nonperforming and other adversely-related -- or other adversely rated loans. Nonperforming loans dropped by $2 million during the first quarter to 10.7 million or approximately .63% of total portfolio loans. This decline is due principally to a $1.5 million initial claim payment received from the United States department of agriculture, on a federally guaranteed commercial real estate loan that is currently in foreclosure.

Our effective income tax rate fell to about 25.6% during the first quarter of '04, due primarily to tax exempt income growing slightly in representing a higher percentage of pre-tax earnings, and also due to a change in our employee stock ownership plan which now allows us to deduct dividend payments we make on these shares for federal income tax purposes. I would now like to turn the call back over to Chuck for some closing remarks.

Well, again, while we were disappointed that our earnings were not higher than last year at this time, we still feel fairly good about the quarter. We were at a fairly large number -- had a fairly large number to overcome, over $3 million in real estate sales and for the most part we were able to do that, so we're still very confident that 2004 will be a year that is somewhat flat, relatively flat, compared to 2003. But still very high performing year for Independent Bank Corporation. With that we are available to take questions.

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone key pad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment it may be necessary to pick up your hand set before pressing the star keys. One moment, please, while we poll for questions.

Our first question comes with Joe Stievens with Stifel Nicolaus. Please state your question.

Good afternoon, guys. This is John Rotus [sp]. How are you doing.

Hi, John.

Hey Rob, I actually had a question just kind of relating to Mepco, since you guys have gotten into this business, it looks like things are going very well but have you started to see an increase in competition in their business? Or I mean are things pretty much going as you had planned?

I would say yes to both those questions. We are seeing an increase in competition in the business, but I think as many are aware, there has been a couple commercial bank acquisitions of premium finance companies, MBNA also bought a premium finance company in Great Britain, so there is some increase in competition. On the larger transactions, we're seeing a little bit more price competition.

You'll see that Mepco's -- if you go back over the last several quarters, you'll see that Mepco's gross yield on their portfolio has drifted down some, and I think what that reflects is two things, one is we're moving what I would call upstream in the industry in that because of the backing of the bank, Mepco is able to bid on larger transactions, and those transactions tend to have a little bit lower pricing, so that's a part of it, and also, there is some increased competition, I think over time, what's happened is the very low interest rate environment has continually sort of crept in, and pushed pricing down on the transactions, but still at 10.5%, it it's an extremely healthy spread, I think if short-term rates do begin to rise, we will be able to push the yield up, commensurately.

Typically what you do is, you don't do it, you know, basis point by basis points, but as you get, you know, more significant climb in short-term interest rates, you would eventually push those through on the premium finance side. In general, though, it's has gone very well. Their receivables continue to grow at a good pace. Their net charge-offs are been very good. Their -- for example, their first quarter total net charge-offs were about $81,000. That's a very low percentage of their total outstanding receivables.

And we continue to see good growth opportunities, even with the increased competition in the industry, if you go back to when we first acquired Mepco, they only had a sales force totaling three and most of their business was concentrated in California and in Illinois, and what they've been able to do over time, given our greater financial backing, and access to capital and borrowings, is added sales force in a number of other geographic regions, so we've been able to start to grow, and it takes time to develop relationships with agencies, get your software and other programs in place, but we're really starting to see some acceleration on that front, and in addition, we're seeing some good opportunities for growth in the auto warranty financing side, and continue to add some important customers in that front. So we continue to see good things ahead for that business unit.

Okay. One follow-up question to you, Rob, regarding net interest income. I think you said earlier that you expected the dollars to actually increase quarter by quarter. Despite whatever would happen to the margin. And I was just wondering if you could give a little bit more guidance relating to the margin.?

Well, in terms of the margin, I think we were down 11 points -- or 11 basis points linked quarter. Some of that, as I explained, was due to just some changes, and some discount accretion, and loan fees that are included as part of interest income, but in the low rate environment, we're still seeing, you know, a little bit of a quicker pace in decline in yields on loans than what we're seeing in cost to funds. If you look for example in our core deposit area, savings and checking accounts, we went from something like 58 basis points total cost of funds, down to 54 basis points. There is just not a lot more room to push those core deposit rates down. So as long as the fed funds rate stays really low, we might see very modest declines in the margin, and by modest, I mean, you know, probably under five, 10 basis points, maybe even less than that. Again, really depending on the mix of what we're able to generate on the asset side, and what's going on in terms of our deposit mix, and that type of thing, which is a little bit difficult to predict. If rates start to climb, as many are projecting, I think longer term, that will have some benefit for us. Shorter term, it is probably going to be relatively neutral, for a couple reasons. One is we're positioned largely from an asset liability management standpoint where we're relatively balanced. We're not going to see, you know, any real huge climbs in our net interest margin but over time, I think we will be able to hold down our core deposit rates, and lag them and yet bring our earning asset rates up more quickly. The other reason why I think we'll not have a real big jump if rates start to move up and our margin, is because we've got a fair amount of commercial loans with floors in them, where they're down at their floor levels, and so you may see a rise in the fed funds rate and the prime rate, and yet, we won't see a bump up in some of those commercial loans with floors because they're not going to start to climb until they get above that floor level. But again, I think any changes are going to be relatively modest, and what will really be driving our net interest income dollar-wise forward will be growth in average interest earning assets.

Okay. Thanks, Rob.

I would add one thing on Mepco, and that is while the business has performed at least as well as we've expected, we've also been very pleased that the management that has been very good with Independent Bank Corporation.

Okay. Thanks, Chuck.

Our next question comes from Terry Mcevoy with Oppenheimer. Please state your question.

Good afternoon.

Hi, Terry.

A couple of questions, if I could. It looks like you had some real good deposit growth in the quarter especially in the noninterest bearing and savings accounts. Could you talk a little bit about what happened in the first quarter? Also could you provide maybe some guidance on where you think the tax rate will be going forward? And the third question, maybe a little bit more difficult to answer, but if I annualize the first quarter, I come up with a $1.68 and I was wondering if you could give me a little bit more clarity on how we can get closer to that $1.87 that was reported in 2003 especially just listening to Rob's last comment about the balance sheet not being as asset sensitive as I might have thought earlier on.

All right. A couple of things or there are three questions there. The first, on the effective tax rate, Terry, the point I would make there is, you know, it was about 25.6%. My thought would be the range is going to be somewhere between there and about maybe on the high end 27.5%. And what that is going to depend on is the level of tax exempt earnings relative to total pre-tax income, and what I'm trying to drive at there, is if -- as we grow pretax earnings, it is more likely to be in categories that are going to be taxed at 35% at the federal level, so for example, if net interest income continues to rise, and it is coming from loans in general, and taxable securities, more than tax exempt, and as gains on loan sales maybe recover, and as we have positive real estate mortgage loans servicing fee income, that is all going to be taxed at 35%.

So that is going to drive that rate up a little bit. So I would tell you, I think the 25.6 we were at this quarter is going to be sort of a low end of that. And it is going to be drift up, as the earnings drift up. So I can't give you an exact number but those are kind of going to be the components that make it up. In terms of your annualization, I guess what I would first argue on your annualization is taking 42 cents times four is not really a -- I think a good way of doing it, because if I take out, for example, the impairment reserve piece, that would be -- we would have been at about 45.5 cents. Removing that item. So if I take 45.5 times four, that is $1.82. And so you're not really very far away if you take 45.5 cents times four, you're not very far away from 1.87.

And I would point out a few additional items there, is one, I commented that we do expect good growth in dollars of net interest income as we move forward this year, largely coming from strong loan growth across the board, particularly in a non-refi environment, we think we'll get good growth in a number of sector, and the real estate mortgage loan portfolio, when it is a non-refi environment, we get more portfolio lending. We think we're going to have good growth in the commercial loan area. We we've got a good pipeline developing on that front. And we feel that we will get good growth there, as the year ensues. We think Mepco will continue to grow at a good rate.

So all of those factors, plus the addition of some acquisitions, we think is going to give us some great opportunities for stronger loan growth, and then the final comment I would make on that front is the million dollars of gains on loan sales this quarter, and this has been true historically in non-refi environments. Now, if you go back to the first quarter of '03, the 4 million we made was an anomaly because it had a lot of refinancing activity. 85%. But we think the million dollars is kind of a low -- a low point for the year. And so that number is likely to be higher as the rest of the year ensues. So that's kind of my math on how we get there. And I certainly, you know, would be happy to enter -- or talk about any follow-up on that front. You had one more question that I don't think I answered.

Just the deposit growth.

Oh, the deposit growth.

In the quarter.

I guess I don't have any, you know, real specific items I could tell you there. You know, we just continue to really execute on our programs at all of our banks relative to our checking programs, and you know, I don't -- Chuck, I don't know if you could add anything. There is nothing specific that I can tell you, except that we've just on an ongoing basis continue to do the kind of things we've been doing on a, on you know, every quarter, and --

I would say in addition that we have put more of an emphasis on treasury management lately as well. And we have some full-time 100% effort people out calling on municipalities and other high balance customers that are getting results.

Thank you very much.

Our next question comes from John Bergquist with Sandler O'Neill. Please state your question.

Yes, could you go into the outlook for continued reduction of nonperforming loans? Obviously some progress was made this quarter.

Well, I mean I think, you know, you saw, other than in commercial, you saw sort of reductions across the board. The bump in commercial, and there is about a million dollar bump there, there was no single large credits in that increase, or it was just a bunch of little small credits that comprised that change. So the only item really left in the commercial side in that 4.9 million of any size is a commercial real estate loan that's secured. It is about $1.1 million. It is secured by a number of different properties. And that is in the process of a purchaser coming in to a new borrower and purchaser coming in on that property. So we're hopeful that that particular credit may come out of nonperforming in the second quarter. The balance in there is just a lot of small loans. Nothing of any significance.

So you know, I don't -- other than the 1.1 million, I would guess barring any large addition, that number is going to kind of hover in the three to four -- to $4.5 million range. The one item for about 900,000 that is titled commercial guaranteed under a federal program is what I was referencing on the USDA guaranteed loan. And we've received the initial claim, so the 900,000 isn't going to go away until we actually liquidate the collateral. We don't expect that probably to occur until 2005 because of the redemption period related to that piece of property. And then consumer and mortgage took nice downturns. You know, just on the size of our portfolios, I don't think you're going to get a whole heck of a lot lower than those numbers that were at just under a $1 million on consumer, and under about -- under -- a little under $3 million on mortgage.

And then finally the comment I'd maybe make with Mepco's finance receivables that are at 1.2 million is while they're categorized as nonperforming, what those really represent is loans where we've cancelled the insurance policy and we're awaiting a return premium from the carrier. So the vast majority of those finance receivables, the 1.2 million, are secured by returned premiums from carriers, so it is really just a matter of a timing issue, related to the receipt of those funds. In fact, I think Mepco had total unsecured balances for loans, 120 days or more past due, it was just a little over $100,000 in unsecured balances, so the vast majority of that number is secured. And that number is going to bounce around a little bit.

But as I said really it is just a timing matter of the collection of the return premiums from the carriers. So John, I guess to answer your question, I don't see -- think you're going to see any significant declines in that number, but maybe we're going to bounce around between, you know, say 9 million to 11 or 12 million.

I would add that the overall business climate in Michigan is still somewhat sluggish. I'd call it stable and somewhat sluggish, but there does seem to be some positives on the horizon. But it is going to take a while for the economy in Michigan to really start to strongly positive recovery.

That's helpful, thank you.

Our next question comes from Brad Milsap with FTN securities. Please state your question.

Good afternoon.

Hi, Brad.

Hi, Brad.

Just one quick question. You had some securities gains in the quarter that provided some offset for the MSR impairment, Rob I was wondering if you could just give me an idea if there was a gain in the portfolio at March 31 if any and what kind the livelyhood would be of you taking that gain over the next few quarters?

Well, first there is a gain in that portfolio. It is well north of 10 million. I'm just -- our total accumulated other comprehensive income is a positive 9.8 million, Brad. And that number is comprised of two things. It's -- there's a negative number on our six-pay interest rate swaps, and that negative number is -- it's somewhere between three and four million. So based on that, there is probably about $13 million of, you know, market appreciation in the securities portfolio, and we don't have any intention of necessarily selling to take gains or anything else. In fact, I would add relative to the first quarter gains, what those largely represented was some sales of just a couple of corporate -- corporate fixed income securities, and the main reason for that, it wasn't driven to offset anything. The reason we did is the credit spreads on those particular corporates had narrowed down to their -- their lowest level, almost in history, and we just felt given that, that it was -- it made sense to take advantage of that just significant spread tightening. And typically, when we do securities sales, it is driven for economic reasons. It is not driven for any earnings management reasons. We're doing it because there is some opportunity we see that we're taking advantage of, and those transactions have to have an internal rate of return that is attractive to us, because of course, every time you sell a security, you have to make some determination of how to reinvest those funds, and so that's really what drives our decisions, is the economics of the transaction.

Okay. Thank you.

I would also note that we did have some other offsetting negatives during the quarter that were -- none of them in particular were particular, but when you put them all together, they pretty well offset any gains we had.

Just a reminder, if you would like to ask a question, please press star one on your telephone key pad.

Our next question comes from Danielle Randall with Merger Market. Please state your question.

Hello, can you hear me?

Yes, we can.

Hi. Thank you very much for your in-detail report. I do appreciate it. Of course, I'm interested in learning about your M&A growth strategy going forward. I understand you guys just recently did a deal. Can we expect you to do one or two more before the year is out?

Well, we have announced two deals that will close in the next several months.

I know.

And we will continue to look, but I guess normally, we try not to answer whether there is anything on the horizon, because you can't announce it until it is something that is pretty definitive and if you say there isn't, and there is, that's not anything we want to do, either. I would say that we continue to look for the kinds of companies, both banks and other financial entities, that can add immediate value to our shareholders. We, for very obvious reasons now, like the Mepco transaction, it has added a lot of value to our company, we think our two bank acquisitions that will close within the next three months will also add good value, but we -- we are very, very firm on our attitude towards acquisition, that they must be accretive. And they must be accretive immediately for them to have interest for us. I hope that answers your question, Danielle.

I think it does. Because there's been some speculation that you wouldn't embark on a transaction for the following months of this year, because you do have your hands tied at this point with the two deals, and going ahead and integrating them. When can we expect them to be integrated?

Well, that's a good question. We have a fairly long history of very quick integration. In these two cases, we should have them fully integrated operationally by the middle of September.

We actually will have conversion dates on both within three or four weeks of the closing dates. So in case of Midwest Guarantee, it is the latter part of June, and in the case of First National Bank of Gaylord or North Bank Corp, it is in the latter part of July, and the integration of personnel and other operations beyond core deposits or core deposit and loan systems is also going to occur very quickly after closing. So as Chuck mentioned, you know, by the end of the summer, those are going to be fully integrated.

Great. Thank you both for answering my questions.

Gentlemen, there are no further questions at this time.

Well, again thank you very much for attending our conference call. Very good questions. We appreciate it. Thank you.

This concludes today's teleconference. Thank you all for your participation. All parties may disconnect now.