Independent Bank Corp (Michigan) (IBCP) 2014 Q1 法說會逐字稿

Good morning and welcome to the Independent Bank Corporation's first-quarter 2014 earnings conference call. (Operator Instructions) Please note, this event is being recorded.

I would like to turn the conference over to Mr. Brad Kessel. Please go ahead.

Good morning. Thank you for joining Independent Bank Corporation's conference call and webcast to discuss the Company's financial results for the first quarter of 2014. I am Brad Kessel, President and CEO of Independent Bank, 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 Bank this morning, you can access it at our Company's website, www.independentbank.com.

We will begin today's call with our prepared remarks and then open up the call to questions. Beginning with the financial highlights slide -- page 5 in our presentation -- we are pleased to report first-quarter net income of $3.1 million, or $0.13 per diluted share. This is our ninth consecutive quarter of profitability.

Although our earnings declined compared to the year-ago quarter, they were generally in line with our expectations, given the sharp drop in gains on mortgage loans that we anticipated due primarily to the decrease in mortgage refinance volumes and the seasonality of the purchase money business in Michigan. We were able to partially offset declines in net interest income and non-interest income by a significant reduction in noninterest expenses.

We remain optimistic about the Company's prospects for improved earnings for the balance of 2014 as compared to the first quarter. Near term, we expect an increase in mortgage loan gains as we move into spring and summer home sales season in Michigan.

Further, new contracts related to our debit card program and core processing systems are expected to increase interchange revenue and reduce data processing costs in the future as compared to the first-quarter 2014 levels.

Our business strategies of emphasis on commercial lending and core deposits is reflected in the quarterly change in our balance sheet, with commercial loan growth of $6.8 million and deposit growth of $53.9 million. Our capital position continues to be strong, with our tangible common equity ratio at 10.35%. We also increased our book value per share to $10.19 at March 31, 2014, from $10.01 at December 31, 2013.

Finally, we are very pleased with the recently announced restoration of a common stock cash dividend of $0.06 per share, payable on May 15 to record holders on April 30. Our footprint, shown on the core banking market slide, page 6, includes significant market presence and opportunity to gain market share in attractive Michigan markets.

For the first quarter of 2014, Michigan market conditions continued to improve as compared to the same period one year ago, evidenced by a reduced unemployment rate, net job growth, and appreciation in real estate values. That said, it was a particularly tough winter in the state, which negatively impacted mortgage and consumer financing levels for our bank as well as increased our occupancy expenses.

While still down from the highs in the early 2000s, building permits are gathering momentum. Michigan building permits for new houses are up 24.5% from a year ago, based on an annualized 12-month moving average.

Moving to the deposit franchise slide, page 7, we continue to grow our core deposit base and at the same time squeeze out another basis point or two in cost. This past quarter, our cost of deposits was 28 basis points. Consistent with industry trends, we are seeing increased transaction volume through our electronic channels and decreased foot traffic in our branches.

Accordingly, we regularly review staffing models and branch profitability. We continue to invest in our associates to position them as trusted financial advisors inside and outside the branch. And we continue to invest in the self-service channels, as that is what many of our clients and prospective clients are demanding.

Our loan composition and historical yield on the loan portfolio is shown on slide 8. The change in yield from the fourth quarter to the first quarter was impacted by a significant level of interest recoveries recorded in the fourth quarter that were not repeated in the first quarter. That said, we continue to see pricing pressure in our markets.

Our associates continue to execute on our strategies to grow our loan portfolios, targeting the commercial small business and consumer markets. And while we have seen a significant drop in residential mortgage refinance volume, we are well positioned in our markets with a very experienced team of originators to support in-market purchase mortgage needs with both salable and non-salable product.

As you can see on the commercial lending slide, page 9, we had net growth of $7 million in first quarter and $30 million, or 4.9%, since the first quarter one year ago. Our commercial bankers originated $41 million in new commitments in the first quarter, led by our East Michigan lenders with $21 million, followed by our West Michigan lenders with $12 million.

We continue to make progress on credit quality; however, nonperforming loans increased by $2.9 million in the first quarter of 2014, primarily due to two commercial loan relationships moving into nonaccrual status. Both of these relationships had been classified as substandard accruing watch credits at year end 2013. Thus the migration to nonaccrual represents our ongoing collection and resolution efforts, rather than a newly developed problem credit situation.

Our commercial early-stage delinquency is at $2.3 million, or 36 basis points of total commercial loans. Total commercial watch credits are down to $59.5 million, having declined almost 34% over the last year.

I would now like to turn the presentation over to Mr. Rob Shuster to share a few comments on our financials, credit quality, and management's outlook. Rob?

Thanks, Brad, and good morning, everyone. I am starting at page 10 of our presentation. Our net interest income totaled $18.5 million during the first quarter of 2014, a decrease of $1.1 million from the year-ago period and a decrease of $900,000 on a linked quarter basis. Our net interest margin was 3.79% during the first quarter of 2014 compared to 4.25% in the year-ago period and 3.96% in the fourth quarter of 2013.

The year-over-year decrease in the net interest margin primarily reflects a change in asset mix as higher yielding loans decreased and lower yielding investment securities increased. Analyzing the $900,000 linked quarter decline in net interest income in more detail is as follows.

Approximately $400,000, or 45% of the decline, is due to the fourth quarter of 2013, including that amount of net interest recoveries on nonaccrual loans as compared to virtually none in the first quarter of 2014. This change in net interest recoveries impacted the comparative average yield on loans by about 12 basis points.

About $200,000, or 22% of the decline, is due to two less days in the first quarter of 2014 versus the fourth quarter of 2013. And the remaining $300,000, or 33% of the decline, was due to the change in asset mix that I just discussed, which was partially offset by an increase in average interest earning assets.

Average interest earning assets were $1.99 billion in the first quarter of 2014 compared to $1.87 billion in the year-ago quarter and $1.96 billion in the fourth quarter of 2013. We will comment more specifically on our outlook for net interest income for the remainder of 2014 later in the presentation.

Moving on to page 11, noninterest income totaled $9 million in the first quarter of 2014 as compared to $11.1 million in the year-ago quarter. The big story here, of course, is the decline in gains on mortgage loans. In addition, service charges on deposits were lower due to a decline in NSF occurrences.

Mortgage loan servicing was lower, as the first quarter of 2014 included $300,000 impairment charge on mortgage servicing rights. And title insurance fees were lower due to the decline in mortgage loan origination volume.

The first quarter of 2013 did include a $1 million charge related to the increase in the fair value of the warrant issued to the US Treasury, which was retired in August 2013. As we previously reported, we did sign a new debit card brand agreement in January 2014. We expect this to add about $1 million of net interchange revenues annually, beginning late in the second quarter of 2014, as we complete the conversion of our debit card base.

As detailed on page 12, our net interest expense declined to $22.4 million in the first quarter of 2014 as compared to $25.5 million in the year-ago quarter. Most expense categories were lower in 2014, primarily reflecting our cost reduction initiatives.

Investment securities increased by approximately $60 million during the first quarter of 2014, reflecting funds provided from the increase in deposits and from the decline in total loans. Page 13 provides an overview of our investments at March 31, 2014. 51% of the portfolio was variable rate and much of the fixed-rate portion of the portfolio is in maturities of five years or less.

Page 14 provides data on nonperforming loans, other real estate, nonperforming assets, and early-stage delinquencies. Overall, we continue to make progress on improving asset quality. Nonperforming loans did increase by $2.9 million during the first quarter of 2014, and Brad explained that increase in his earlier remarks.

Other real estate declined $18 million during the first quarter. In addition, total 30- to 89-day delinquencies declined to $11.3 million, or 0.8% of portfolio loans, at March 31, 2014, which is the lowest level in several years.

Moving on to page 15, we recorded a provision for loan losses of about $400,000 in the first quarter of 2014 compared to a credit provision of about $700,000 in the year-ago quarter. Loan charge-offs were $2.3 million in the first quarter of 2014, or 0.69% annualized of average portfolio loans, and were $2.8 million, or 0.82% annualized of average portfolio loans, in the year-ago quarter.

Other credit related costs, such as loan and collection costs and net gain or loss on ORE, were significantly better in the first quarter of 2014 compared to the year-ago quarter. The allowance for loan losses total $30.4 million, or 2.4% of portfolio loans at March 31, 2014. Page 16 provides some additional asset quality data, including information on new loan defaults and on classified assets, which were relatively unchanged in the first quarter of 2014.

Page 17 provides information on our TDR portfolio that totaled $121.5 million March 31, 2014, a decline of about 9% on an annualized basis since the end of 2013. Specific reserves allocated to the TDR portfolio were $14.5 million, or about 12% of the total balances at March 31, 2014. Importantly, 87% of the seasoned portfolio was current as of March 31, 2014.

Finally, on page 18, we provide some details on our outlook for the remainder of 2014. In January 2014, we outlined our expectation for low single-digit overall loan growth during the year. First-quarter 2014 actual results were generally in line with our expectations.

As we move through the balance of the year, we expect a seasonal pickup in consumer spending volume and continued growth in commercial lending, thus leading to our forecast of low single-digit overall loan growth by the end of the year.

The $18.5 million of net increase income in the first quarter of 2014 was below our expectations. The change in loan mix, with somewhat lower levels of loans held for sale and prepayment receivables, were less than we expected, as well as somewhat lower yields on investment securities were the significant contributing factors. As we look ahead, we are optimistic that we can hold net interest income steady or increase it from the first-quarter 2014 level.

We expect generally steady improvement in asset quality during the remainder of 2014. The performance of the TDR portfolio, where we have a significant amount of allocated specific reserves as well as loan net charge-offs, loan default volumes, and watch credit levels, will be the primary factors impacting our remaining 2014 provision levels.

Moving on to noninterest income, we anticipate for the remainder of 2014 that total quarterly levels will return to $10 million to $11 million. Primary drivers are expected to be increases in gains on mortgage loans and interchange income. Over the last six weeks, we have seen about a 50% to 60% pick up in mortgage loan application volume from earlier in the year.

In January 2014, we forecast non-interest expenses to be in a range of $22.5 million to $23.5 million per quarter. Actual first-quarter 2014 noninterest expenses of $22.4 million were slightly below the low end of the range. We continue to expect noninterest expenses could be at or near the low end of the aforementioned range.

We anticipate data processing expenses to move lower due to our new core contract that we executed in March 2014 and we expect a seasonal decline in occupancy expense. As an example, first-quarter 2014 snow removal costs were approximately $500,000, which was about $200,000 higher than the year-ago quarter.

Finally, we continue to expect income taxes to equal 31% to 32% of pre-tax income, with the primary permanent differences being interest income on tax-exempt securities and earnings on our bank-owned life insurance.

That concludes my prepared remarks and I would now like to turn to call back over to Brad.

Thanks, Rob. As we look ahead, we continue to execute on strategies and initiatives to improve earnings and increase long-term shareholder and total return. Our focus areas continue to be on increasing revenue through retaining and cross-selling existing customers and the acquisition of new customers. Also controlling costs; utilizing enterprise-wide risk management best practices; retaining, developing, and attracting an engaged workforce; and providing our customers legendary and exceptional service.

In closing, 2014 is a very special year for us at Independent Bank, as we mark 150 years of serving our Michigan communities. I am very proud to be a part of a Company that has such a long history. I would like to acknowledge the commitment and ongoing effort of our Board of Directors, our bank officers, and all our bank associates.

Their dedication and service is outstanding and each of them is truly making a positive difference in the lives of our shareholders, customers, and the communities we serve.

At this point, we would like to open up the call for questions.

(Operator Instructions) Michael Pareto, KBW.

Hi, good morning, guys. I appreciate the color on the margin and the updated outlook on slide 18. I was wondering if I could circle back to the margin, though, for a second.

In terms of -- so it sounds -- correct me if I'm wrong, but it sounds like there is still some expected compression going forward here -- at least in the next couple of quarters. I was wondering if you guys could maybe just give a little more color on what you guys are expecting for the rate of that compression. I'm assuming it's not going to be another 15, 17 basis points like this past quarter. Any guidance there would be helpful.

Yes, part of the compression is that the fourth quarter of 2013 -- and I mentioned this -- we had some interest recoveries on nonaccrual loans that weren't repeated in the first quarter that impacted the comparative yields on loans about 12 basis points and the comparative yield overall on the net interest margin by about 8 or 9 basis points. So that somewhat sort of masks the change between quarters.

Having said that, we do feel that the compression in the margin we can offset through growth and average interest earning assets and try and keep that interest income dollar stable, but growing. You know, it's difficult to project the exact change, but I would expect it to level out a bit from -- we're down to about 3.79%.

I don't think we're going to be able to pick up a lot on the cost of fund side. We moved down a bit, but there's not a lot of room on the deposit side. And at least where we're seeing new origination volumes on the commercial side, I don't envision quite as much compression as we've seen when we were coming off of higher average yields in the portfolio.

And on the consumer side, probably a little bit more potential for compression there, just based on where we are seeing new origination volumes at versus the existing portfolio rates. And on the investment side, I don't see much, if any, compression on that side, because we're already at a pretty low weighted average rate.

So, you know, where we see some potential for pickup is the continued investment of the monies we have at the Fed. We were still at about $80 million of money at the Fed, so we're continuing to work to get that out. So we'll get some pickup off the 25 basis points we're earning over there that we hope will offset a little bit of the compression on the loan side.

So when you throw that all into the mix, we would anticipate the pressure on the margin to be a little bit gradual over the next couple of quarters. Hopefully, five basis points or less, and then make that up with average interest earnings growth to try to get that -- the dollars moving up from the $18.5 million in the first quarter. That's a long answer -- I don't know --

No, thanks, Rob. That was extremely helpful. Thank you. And, Brad, maybe just a bigger picture question on the efficiency progress. Just the expenses were good this quarter, but maybe just an update on what initiatives you guys maybe have left to accomplish over the next couple of quarters and when we -- if that should be a continued steady decline?

Do you expect any choppiness in that going forward for the rest of the year? The efficiency ratio, that is? Or any color there would be helpful.

Sure, Michael. So we are at the end of this first quarter here with an efficiency ratio of about 81% and obviously, that is well off of our long-term target of being in the low to mid 60%s.

That said, I am very pleased with much of the progress we've made to date, particularly in reducing the expense side to that equation and we have additional levers, I think, to pull. We've got, I think, a -- with the renewal of our core processing contract here in March, which was a very time-consuming and important initiative, but having now completed that, and with that new contract, we have quite a few new services with our core provider, FIS.

But we expect and we'll achieve with that new contract in excess of $1 million in annual cost saved, just on data processing alone. We have -- ultimately, though, it's going to be a game of growing revenue. And our team knows that, and I like what I'm hearing in terms of the sale side, as we mentioned in our prepared remarks.

It was soft first quarter, but Rob commented on our mortgage pipeline being up substantially over the last six weeks. We have been adding mortgage originators, contrary to what we're seeing from some of our competitors' doing. We also see our commercial pipeline is probably up about 20% from where it was at year end.

So in addition, we have some new products that we're rolling out that I think are going to produce some nice levels of noninterest income. Rob mentioned the debit card -- changing brand to MasterCard, which will be significant for us.

We also are rolling out a new swap program for our commercial customers so they can lock in long-term fixed rates that will be a fee income contributor to our Company. So, Michael, in the end, it's going to be -- hey, we are going to continue to whittle away at the expense side. I think we've still got some room there, but this infrastructure's set up to be a larger bank.

Okay. Great. Thanks. That was really helpful. One final one for me -- it was good to see the dividend reinstated. Maybe just an update on your capital priorities as they stand today. Thanks.

Sure. Obviously, the dividend was a central point for us to get that initiated again. We feel the $0.06 quarterly level is a good starting point. We still feel from an overall capital standpoint at 10.35% tangible, but that's long term, a bit higher than the target range that we would envision at about 9% to 10%.

First priority is to try and organically grow the balance sheet through quality lending to try and drive that a bit lower. The other comment that I'll make is we did gain regulatory approval for a return of capital from our bank to our parent company of $15 million. So now the parent company as of today is sitting with about $26 million in cash.

So not only are the capital levels better, but the cash levels at the parent company are better as well. That gives us a little bit more flexibility from a capital management perspective.

So in terms of priorities, again, I think first is organic high quality growth. Second is maintaining a consistent healthy dividend. And the third would be, I guess, depending on opportunities, either on the M&A side. At this point, I don't think the share repurchase is something we would look at near term, but certainly with the increase in cash at the parent company, it gives us a little bit more flexibility.

Okay. Great. Thanks for taking my questions, guys. Appreciate it.

(Operator Instructions) Louis Feldman, Wells Capital Management.

I was looking for a little bit more color. Mr. Kessel, you just made the comment that pipeline -- you felt the pipeline was about 20% above where it was at year end. Can you discuss what your average closing rate is on that?

And then Mr. Schuster, can you touch -- in terms of your commentary -- on your hope to deploy building earning assets in terms of a volume versus rate basis. Are you just actually looking for more loans outstanding? Or simply moving it from the Fed at the 25 bps on a great basis to higher-yielding assets in the loans?

Well, I'll take your latter question first. I think it's both.

Okay.

So we are -- we have not, for a long period of time, grown total average loans. We have had growth in commercial lending over the past year, but the other categories of loans -- and installment last year increased a little bit, but I think what we are looking for as we move through 2014 is to start to get on a sequential quarterly basis some growth in average loans.

And then in addition to that continue to redeploy some of the interest bearing deposits at the Fed into securities. So the combination of those two things as well as hopefully some continued growth in overall assets would lead to -- I think what we're looking for is more than an offset to some of the margin pressures so that the dollars of net interest income are growing off the $18.5 million that we reported in the first quarter.

So it would be both of those items. Brad, if you could comment on the commercial piece.

Sure, Louis. So in regard to the pipeline and closing rates, I'll just share some numbers with you. So at year end, our pipeline was roughly about $95 million and at quarter end, we were up to about $120 million. Within those numbers, we measure apps in process -- those are loans that are approved and then those that are approved and are expected to close here in the very near future.

In terms of our closing ratio, probably half of this pipeline is with existing relationships and the closing rate for those loans is very, very high. Obviously, we have good relationships and have been doing business. For new money transactions and new customers, we're probably closer to half, as it's very competitive.

And in fact, I just was sitting in on a regional commercial group meeting this morning. And where it's a new relationship, we are trying to [being] -- it's very, very difficult, because what you find is the incumbent oftentimes, even if they've upset the customer, will get the last look. So it oftentimes can be frustrating to do a lot of work and then get to the finish line and not get the deal. But that's just a little bit of color on our pipeline.

Do you gentlemen feel that -- can you describe what the pricing environment is like for you guys at this point in time? Is a rational, is it irrational? Are you seeing deals out there that you say, man, I wouldn't touch that with a 10 foot pole?

Well, I think it's -- well, we are rational and everybody else is irrational, right?

Everyone states that, sir. The sane man in an insane society would appear insane.

Yes. You know, I think for the very good [clients] that us and our competitors are chasing, it's very, very competitive. And we are seeing the selection of some fixed-rate pricing, hence my sharing of our loaning out a swap program and allowing our customers to go longer with fixed rates.

At the same time, we are also having maybe of our customers still stay with variable rate pricing. In the end, I think we as a Company -- we have a pricing model. We know what we can and can't do and we are willing to walk.

In fact, we have walked on a number of occasions here in the last quarter. But I think, all in, it's -- I think, as you're seeing everywhere else, Louis, it's sort of a competitive environment. Rob, I don't know if you had --

Yes. I'd just conclude by saying I think on both fronts -- on pricing, I think it's very competitive but not irrational, generally speaking. So you can see the one-off here and there, but on balance, extremely competitive but not irrational.

And I'd say the same thing holds true, maybe even a little bit more so, on the underwriting side, where the terms are, in some cases, maybe getting a little bit more competitive, but not irrational. So I think in general -- I think the bigger difficulty is there is just a lot of people chasing a fixed amount of business.

So while everyone, I think, is trying to be sensible, customers are getting provided a lot of different proposals, I guess is the one thing I'd say.

Okay. And I apologize; I had to step off the call for a couple of moments. In terms of new loan defaults, do you feel your run rate this year is a little bit different, because it looks as though -- just on a one quarter basis, the run rate seems fairly similar to where 2013 was.

What has changed that is encouraging you at this point in time? In terms of total.

I would say on the commercial side -- I mean, the defaults we saw really were with a couple of credits that were already in the substandard nonaccrual bucket. So they weren't what I would call the development of new credit issues. And the early-stage delinquencies, they were at about the lowest level we've seen since well before the adverse credit cycle, at $2.3 million or 0.36%. So that encourages us on the commercial side.

And then in addition, watch credits continue to fall. So I guess kind of the feeder area keeps shrinking, which leads us to believe new defaults will be lower. And on the residential side, you know, we continue to see some here and there that would be items coming out of the TDR portfolio in general.

But overall, we have not done a lot of new lending, new portfolio one to four family lending. Most of what we've done over the last several years of originations we've sold, so that the portfolio has got seasoning and these people have already gone through sort of a long cycle of tough times.

So we feel like -- and with home prices in many of our markets moving upward, we just feel that new default levels should be stable to lower on the retail side. So the combination of those two things, as we move through 2014, we'd expect default levels, when all the dust settles, to continue to move downward.

So for example, on the mortgage line on page 2 of your press release, mortgage defaults went up a little bit. To what extent were people say, two days late, three days late, and have come current again? Are you encountering that? Just -- I was out of town, I missed my payments. And they are resolving themselves?

No, not as much there. I mean, we had a couple of just -- I don't want to get into granular details, but on the residential side, there were just a couple of items that were sort of credits that had been hanging on that sort of tipped over into the 90-day plus.

It wasn't -- and again, the early-stage delinquencies there were lower. So not dissimilar to the commercial side. It was more a couple of credits tipping over into the 90-day plus area. That's what we constitute as a default, when they move into nonaccrual or into the 90-day plus category.

So again, it wasn't anything we saw widespread, it was just a couple of credits that kind of pushed it above -- or pushed it a little bit higher in the first quarter.

Okay. Thank you very much for the information.

You're welcome.

And this concludes our question and answer session. I would like to turn the conference back over to Mr. Brad Kessel for any closing remarks.

Again, we'd just like to thank the audience for taking the time to listen to our release. We are very excited. Obviously this past week about announcing our dividend and very optimistic for the balance of 2014. And I wish everybody a great day. Thank you.

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.