Independent Bank Corp (Michigan) (IBCP) 2014 Q2 法說會逐字稿

Good morning and welcome to the Independent Bank Corporation's second-quarter earnings conference call. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Brad Kessel, President and CEO. Please go ahead, sir.

Good morning. Thank you for joining Independent Bank Corporation's conference call and webcast to discuss the Company's financial results for the second 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 two in our presentation. If anyone does not already have a copy of the press release issued by Independent today, you can access it at the Company's website.

We will begin today's call with our prepared remarks and then open the call up to questions.

Beginning with the financial summary slide, page 4, we're pleased to report for the second quarter of 2014 net income of $6.1 million or $0.26 per diluted share. On an income before tax basis, we are reporting $7.9 million as compared to $6.9 million for the same quarter last year.

This represents $1 million or 14.5% year-over-year increase. For the six months ended June 30, the Company is reporting net income applicable to common stock of $9.2 million or $0.39 per diluted share compared to $66.9 million or $2.90 per diluted share in the prior year period. Recall the second quarter and year to date results -- 2013 results, included income tax benefit of $57.6 million associated with the reversal of substantially all of the Company's deferred tax asset valuation allowance in June of 2013.

Turning to the financial highlights slide, page 5. We remain optimistic about the Company's prospects for long-term earnings growth. This past year, we saw net interest income up slightly on a linked quarter basis. Non-interest expenses also on a quarterly basis had been reduced by $5.2 million or 18.7% as compared to the same quarter one year ago.

Our balance sheet continues to be strong with net loan growth for the quarter. Our growth is being driven by a commercial loan growth of $12.2 million or 7.6% annualized and consumer installment loan growth of $12.9 million or 27.4% annualized. Our tangible common equity ratio increased to 10.68% and our tangible book value per share increased to $10.47.

On July 22, 2014, our Board of Directors declared a $0.06 per dividend payable on August 15 to shareholders of record as of August 5. Our footprint, shown on the core banking market side, page 6, includes significant market presence and opportunity to gain market share in attractive Michigan markets. For the second 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, both residential and commercial. Commercial vacancy rates continued to improve for industrial, retail, and office space.

Moving to the deposit franchise slide, page 7, we continued to emphasize growth in our core deposit base. We have $1.9 billion in total deposits as of June 30, 2014, up $92 million or 5.1% since June 30, 2013. $1.5 million or 79% of our $1.9 billion in deposits are transaction accounts. For the second quarter of 2014, our cost of deposits was 26 basis points, down 2 basis points for the quarter.

Consistent with industry trends, we are seeing increased transaction volume to our electronic channels and decreased foot traffic in our branches. Accordingly, we continue to review our staffing models and branch profitability model. 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 now demanding.

Our loan composition in historical yield on the loan portfolio is shown on slide eight. Total portfolio loans grew to $1.4 billion as of June 30, 2014. For the second quarter, in addition to the commercial and consumer portfolio growth, we originated $65.4 million of residential mortgages and sold $47 million in mortgages generating $1.5 million in net gains. The 8 basis point decline in yield from the first quarter to the second quarter was evidence of the continued low rate environment and competitive pricing for loans that we see in our markets.

Our associates continue to execute on our strategies to grow our loan portfolios, targeting the commercial small business and consumer markets. We also continue to be well-positioned in our markets with a very experienced team of residential mortgage originators to support in-market purchase mortgage needs, both salable and non-salable product.

As you can see on the overview slide, page nine, we outlined what we believe to be the keys in executing to improve our efficiency ratio and grow earnings. While there does exist improvement opportunity on the cost side, a majority of the improvement now needs to come from revenue growth. And while our balance sheet is set up very defensively for a rise in interest rates, our revenue growth strategies continue to be led by our commercial line of business.

For the first half of the year, we had new commercial commitments of $94 million, with $73 million in funded new loans. Of this new business, C&I lending accounted for the largest portion for $55 million. In terms of where the growth is taking place, we had very good balance between our East Michigan and our West Michigan regions followed by our Central region.

The quality of our portfolio continues to improve and is now very strong with watch credits under 10%, early-stage delinquencies at $0.7 million or 11 basis points, and commercial non-accruals at $5.1 million or 78 basis points. Our commercial pipeline is solid and we feel good about achieving our targeted growth rate.

Our retail banking business continues to gather momentum. This past quarter, we saw across-the-board improvement in branch network originations and very strong originations by our indirect lending group. The indirect group is very seasoned and has been with the bank for some time.

This past quarter, the group generated $18.5 million in new bookings, principally a combination of recreational vehicle and marine lending. Our mortgage business for the first six months of 2014 was challenging as this unit worked through an extremely difficult winter, generally higher interest rates compared to the first half of last year, competitive pressures, and a significant number of new regulations.

That said, we expect improvement in this division having increased the number of originators, the addition of two new loan production offices, an increase in demand for construction loans, and finally having received approval for [JMA] securitization.

This will assist in an improved net margin on a portion of our loan sales while allowing us to retain the servicing for this customer base.

Finally, as mentioned, we continue to work on reducing our expenses, our delivery channel optimization efforts. This includes investment in new technologies, further branch rationalization, and workflow process improvement enterprise [flag].

I would now like to turn the presentation over to Rob Schuster 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 second quarter of 2014, a decrease of $1 million from the year ago period, but an increase of $0.1 million on a linked quarter basis. Our net interest margin was 3.74% during the second quarter of 2014, compared to 4.16% in the year ago period and 3.79% in the first quarter of 2014.

The year-over-year decrease in the net interest margin primarily reflects a change in asset mix as higher-yielding loans decrease and lower yielding investment securities increase. The linked quarter increase in net interest income is primarily due to growth in average interest earning assets, including loans. Average interest earning assets were $2.01 billion in the second quarter of 2014, compared to $1.9 billion in the year ago quarter and $1.99 billion in the first quarter of 2014. We will comment more specifically on our outlook for net interest income for the remainder of 2014 later in this presentation.

Moving on to page 11, non-interest income totaled $10.1 million in the second quarter of 2014 as compared to $13 million in the year-ago quarter and $9 million in the first quarter of 2014. The most significant change was the $1.7 million year-over-year quarterly decline in gains on mortgage loans. In addition, mortgage loan servicing was $1.5 million lower, as the second quarter of 2014 included a $0.2 million impairment charge on capitalized mortgage servicing rights compared to a $1.7 million recovery in the year ago quarter.

However, overall total non-interest income in the second quarter was within our expected range, albeit at the lower end. As we previously reported, we did sign a new debit card brand agreement in January of 2014. We expect this to add about $1 million of net interchange revenues annually, and we substantially completed the conversion of our debit card base in June and July.

As detailed on page 12, our non-interest expense declined to $22.6 million in the second quarter of 2014 as compared to $27.7 million in the year ago quarter. Many expense categories were lower in 2014, primarily reflecting our cost reduction initiatives. In particular, year-over-year quarterly credit related expenses declined by $4 million.

Investment securities available for sale increased by approximately $56 million since the beginning of 2014, reflecting in part funds provided from the year-to-date increase in deposits. However, during the second quarter of 2014, investment securities available for sales declined by $5 million, due primarily to the combination of loan growth in a seasonal decline in total deposits during the second quarter.

Page 13 provides an overview of our investments at June 30, 2014. 50% of the portfolio is variable-rate and much of the fixed rate portion of the portfolio is in maturities of five years or less. The estimated average duration of the portfolio is about two years.

Page 14 provides data on non-performing loans, other real estate non-performing assets and early-stage delinquencies. We continue to make progress on improving asset quality. Non-performing loans declined by $3.5 million or 17% during the second quarter of 2014.

ORE was relatively unchanged at $18.1 million as of June 30, 2014. However, subsequent to quarter end in July 2014, we sold our single largest ORE property, which had a book balance of about $5.5 million for nearly 1/3 of our total ORE balance. We recorded a gain on this sale of $405,000 in July of 2014.

In addition, total 30 to 89 day delinquencies declined to $9.9 million or 0.7% of portfolio loans at June 30, which is the lowest level in several years.

Moving on to page 15, we recorded a credit provision for loan losses of $1.8 million in the second quarter of 2014, compared to a credit provision of $2.1 million in the year ago quarter. Low net charge-offs declined to $0.4 million in the second quarter of 2014, or just .12% annualized of average portfolio loans, and were $1.9 million or 0.54% of average portfolio loans in the year ago quarter.

Other credit related costs, such as loan in collection, in net gain or loss on ORE were significantly better in the second quarter of 2014 as compared to the year ago quarter.

Finally, the allowance for loan losses totaled $28.2 million or 2.05% of portfolio loans at June 30.

Page 16 provides some additional asset quality data including information on new loan defaults and on classified assets, which declined by approximately $3 million in the second quarter of 2014. Page 17 provides information on our TDR portfolio that totaled $118.4 million at June 30, 2014, a decline of about 9.5% on an annualized basis since the end of 2013.

Specific reserves allocated to the TDR portfolio were $13.1 million or about 11.1% of the total balances at June 30. Importantly, nearly 89% of the TDR portfolio was current as of June 30.

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. Second-quarter 2014 actual results were somewhat better than our expectations.

As we outlined in our April 2014 call, we expected a seasonal pickup in consumer lending 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. Both of these occurred, leading to growth in net total portfolio loans of $17 million or 5% annualized in the second quarter of 2014 and we're now up about $3 million since the end of 2013.

We indicated in our April 2014 earnings conference call that we were optimistic that we could hold net interest income steady or increase it from the first quarter of 2014. This, in fact, did occur in the second quarter. We also believe that the extended period of net interest margin compression caused by near zero borrowing short-term interest rates is likely nearing an end.

We continue to 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 our watch credit levels will be the primary factors impacting our 2014 provision levels for the last half of the year.

Moving on to non-interest income, we anticipate for the last half of 2014 that total quarterly levels will remain between $10 million to $11 million. In January 2014, we forecast non-interest expenses to be in a range of $22.5 million, $23.5 million per quarter during the year. Actual second-quarter 2014 non-interest expenses of $22.6 million were just above the low end of the range. We continue to expect non-interest expenses to be at or near the low end of the aforementioned range through the last half of 2014.

Finally, we expect income taxes to equal 31% to 32% of pretax income during the last half of 2014, with the primary permanent differences being interest income on tax-exempt securities and earnings on our bank-owned life insurance. As mentioned in our earnings release, we did record $0.7 million in income tax credits in the second quarter of 2014, which reduced our effective tax rate below that expected range.

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

Very good. Thank you, Rob. As we look ahead, we will continue to execute on strategies and initiatives to improve earnings and increase long-term shareholder total return. Our focus areas continue to be on organic growth, increasing revenue through retaining and cross selling existing customers and acquiring new customers, controlling costs, utilizing enterprisewide risk management best practices, retaining, developing and attracting an engaged workforce, and providing our customers legendary and exceptional service.

At this point in time, we would now like to open it up for questions.

(Operator Instructions) Rick D'Auteuil, Columbia Management.

Just -- so one thing we had talked about when you visited and I think as you did the offering last year were some thoughts and targets on efficiency ratio. Can you talk about your progress toward your targets and -- without the non-interest expense coming down in a more material way, I would like to hear your thoughts on your expectation to achieve those targets.

Well, we are at about 70%, maybe just below in the second quarter and -- so that's moving in the right direction. Longer term, we want to move it towards 75% as we move through the balance of this year with our long-term goal of moving it toward the 65% level. I think as Brad referenced in his comments, we do feel -- we need a little bit more balance coming from the revenue side and I think there's a couple of things there.

The primary driver there would be loan growth in starting to build net interest income. Certainly, if we had a bump up in interest rates, that could accelerate that progress. The loan growth piece given our outlook for low single digit loan growth is likely to take a little bit more time without the bump in interest rates.

We do feel there's a couple of categories in the non-interest income, mainly gains on loan sales and interchange where we could get some modest increases. And in addition, we did have -- not that it's a huge number, but $0.2 million of impairment charges on mortgage servicing rights and we feel a more -- I guess normalized number for that would be $500,000 to $600,000 positive income per quarter, so we can get some boost there.

And then we think longer term, there's still progress to be made on the expense side, but we feel to get to the 65% long-term goal from where we're at today, more of it is going to have to come from the revenue side. We went from $3.5 billion in assets some time ago to $2.2 billion. Some of that was due to the branch sale that we had at the end of 2012, but a lot of it was due to the deleveraging of the balance sheet.

We do feel we have the infrastructure to support a larger balance sheet. Certainly, the capital as well, and that's what our longer term targets are.

So you don't have -- I guess you're saying short term, expect the non-interest expense to be slightly below the $22.5 million a quarter, but on the longer term, you don't expect that needle to move very much -- on the downside, anyway?

Well, I guess -- Rick, I would jump in there. On the expense side, I think the two categories, as Rob mentioned, that still have room are loan and collection, and we've made a lot of progress there. I think the other category, obviously, is our largest expense. And that's salaries and benefits and today, we have a -- continue to have a large number of FTEs for an institution our size, including our service portfolio.

So, I think as -- I think that's the area that will -- it does have some opportunity. I think in terms of capitalizing on the opportunity, we have a couple of things in the works. Number one is we are -- we have contracts, including the third party that's helping us with what I call workflow for process flow throughout the organization and essentially trying to minimize the number of handoffs, eliminate paper.

And as we flow chart today, the way work runs through our system and then flow chart a more optimized process of it running through our system, I think out of that, we're going to find some work today that we are doing just as (inaudible) itself.

So I think there's some pretty good upside there. I also think that today we have 70 branches and at our peak we had 106. We sold all 21 and consolidated another 15, and we probably have some room for further branch consolidations and/or sales. So we are not, I guess, just set or comfortable with the $22.5 million run rate. We're going to continue to whittle away at it.

Okay, thank you very much, appreciate the answers.

(Operator Instructions) Damon DelMonte, KBW.

Just wondering if you could talk a little bit about on the loan growth, maybe some of the -- go into a little bit more detail on some of the initiatives on the commercial side that's going to be the biggest drivers of growth in the coming quarters.

Sure. So I think we have now the right team in place. We have 21 business bankers spread across our markets -- and I outline them as East Michigan, West Michigan, and Central Michigan. And in overseeing those business bankers, we have three growth managers and two of them have been with us for some time and then the third is an add here in West Michigan within the last 18 months.

And I think what we've seen here over the last six months in particular is finally starting to ramp it up here in the West Michigan region. I think before that, there was probably untapped demand, simply because of we were still coming out of our prior period of healing the balance sheet and we didn't necessarily have all the people in place. So now that the people have been in place for, I think, enough time to make a difference and we are getting a lot of looks in all our markets.

And it's a nice mix. What I like is that it's a mix in product, it's a mix in geography, and it's very granular. As an example, this past quarter I think our largest on boarding was probably just around the $10 million mark and after that, there's probably another 35 credits that -- over the $500,000 mark -- so a lot of solid good-sized credits.

And then within the new business, we are seeing this past quarter -- it was probably more slanted to new customers as opposed to new to existing customer. But -- so that's some of the facts behind what we're seeing and I guess I will leave it at that.

Okay, that's helpful, thank you. And then just with respect to the margin, I take from the commentary you'll probably see a little bit more pressure on the margin, but can you quantify your estimate for maybe on a quarterly basis? Are we talking just a couple basis points similar to kind of what we saw this last quarter? Or are we looking at something a little bit greater than that?

No, I think that's fair, Damon. I said in my comments that we believe we are coming likely to an end of compression caused by the near zero short-term interest rate environment. So absent an unexpected adverse shift in loan mix, our modeling seems to -- or indicates that we really have pretty much come to the end of the downward margin compression. So perhaps we get a basis point or 2 additional, but we really feel it's flattening out at that point.

Okay, that's helpful. That's all that I have for now, thank you very much.

Having no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Brad Kessel for any closing remarks.

In closing, 2014 is a very special year for us at Independent Bank as we mark 150 years of serving our Michigan communities. I'm very proud of our associates and to be part of a company that has such a long history. On behalf of Independent Bank, I would like to thank you for joining us on today's call. Have a great day.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.