Independent Bank Corp (Michigan) (IBCP) 2015 Q1 法說會逐字稿

Good day and welcome to the Independent Bank Corporation first-quarter 2015 earnings conference call. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to President and CEO Brad Kessel. Please go ahead.

Good morning. Thank you for joining Independent Bank Corporation's conference call and webcast to discuss the Company's 2015 first-quarter results. 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 Bank today, you can access it at the Company's website, www.Independent Bank.com.

The agenda for today's call will include prepared remarks followed by a question-and-answer session and then closing remarks.

Beginning with the financial summary slide, page 4, we are reporting for the first quarter of 2015 net income of $3.8 million or $0.16 per diluted share. This is a $0.6 million or 20.5% increase over the same quarter one year ago. I am very encouraged by these results, particularly as this represents the fourth consecutive quarter of growth for our portfolio loans.

Turning to the 2015 first-quarter financial highlights slide, page 5, this quarter's results were positively impacted by improved asset quality metrics, which led to a $0.7 million credit provision as compared to the prior year's $400,000 expense provision, a $1 million or 87% increase in gain on mortgage sales, continued reduction in noninterest expense, and a stabilization of net interest income. These were offset by a $700,000 impairment charge on mortgage servicing rights and a $200,000 in severance costs related to the branch consolidation initiative.

Our strategies for long-term profitability and growth continue to be centered on changing our earning asset mix from lower yielding short-term investments into quality higher yielding loans. This past quarter, our commercial portfolio continued to lead the way with $19.4 million or 11.4% annualized growth.

Also this quarter, we repurchased 70,643 shares at an average price of $12.77 under our previously announced 5% share repurchase program. 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. We have made significant changes to streamline and optimize our branch delivery network, going from 106 branches in 2012 to our planned 64 branches as of April 30, 2015.

During the same time period, we have increased the average deposits per branch from $19.7 million to over $30 million on a pro forma basis.

For the first quarter of 2015, 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 of real estate values. Commercial occupancy rates continue to improve for industrial, retail, and office space. The table at the bottom of this slide provides a snapshot of our loan balances by market for the quarter ended March 31, 2015 in comparison to one year ago.

As you can see, our West region has shown the largest dollar growth followed by our Southeast region and then our East/Thumb region.

Moving to the deposit franchise slide, page 7, for the first quarter of 2015, we increased deposits by $76.2 million or 4% over year-end 2014 and ended the quarter at the $2 billion mark. This is substantially all core funding with $1.63 billion, or 81%, in transaction accounts. In addition to this growth we were able to improve the cost on our deposits by another 3 basis points with our total costs now down to 21 basis points.

Our loan composition, yield, and lending highlights are shown on slide 8. Total loans grew for the fourth consecutive quarter to $1.45 billion as of March 31, 2014. As mentioned earlier, our commercial team continued to lead the way with net growth of $19.4 million for the quarter.

Our commercial line usage increased to 48% as of quarter end from 46% a year earlier and our pipelines continue to be strong. The commercial team continues to target businesses with $1 million to $50 million in annual sales, and our new commitments continue to be very granular as is our whole portfolio. Our consumer direct and indirect channels also reported net growth of $1.6 million or 3.1% in what typically is a soft time of year, due to seasonality.

In addition we originated $79.8 million of residential mortgages and sold $68.7 million, generating $2.1 million in net gains. I would now like to turn the presentation over to Rob Shuster to share a few comments on our financials, credit quality, and management's outlook.

Thanks, Brad, and good morning, everyone. I'm starting at page 9 of our presentation. Our net interest income totaled $18.1 million during the first quarter of 2015, a decrease of $0.4 million from the year-ago quarter and an increase of $34,000 on a linked quarter basis. Our tax equivalent net interest margin was 3.57% during the first quarter of 2015 compared to 3.79% in the year ago period and 3.56% in the fourth quarter of 2014.

Although the net interest margin remains under some pressure due to the prolonged low interest rate environment that has resulted in declining average yields on the Company's loan portfolio we did achieve an increase in the margin on a linked quarter basis for the first time since the start of 2013. Thus, we are optimistic that the downward trajectory of the net interest margin has generally come to an end. Average interest-earning assets were $2.06 billion in the first quarter of 2015 compared to $1.99 billion in the year ago quarter and $2.03 billion in the fourth quarter of 2014.

Page 10 contains a more detailed analysis of the linked quarter increase in net interest income. This increase was primarily due to an increase in interest income on securities and investments and a decrease in interest expense on deposits and borrowings that was partially offset by a decrease in interest and fees on loans. In addition, two less days in the first quarter of 2015 as compared to the fourth quarter of 2014 reduced net interest income by about $0.2 million on a linked comparative quarterly basis.

We will comment more specifically on our outlook for net interest income for the remainder of 2015 later in the presentation.

Moving on to page 11, noninterest income totaled $9 million in the first quarter of 2015 as compared to $9 million in the year-ago quarter and $9.2 million in the fourth quarter of 2014. Our mortgage banking operations positive caused most of the quarterly comparative variability in noninterest income.

In the first quarter of 2015, gains on mortgage loans increased to $2.1 million due to increased mortgage loan originations and sales. The decline in longer term interest rates during the first quarter of 2015 resulted in an increase in refinance activity.

However, this same decline in interest rates also resulted in a $0.7 million impairment charge on capitalized mortgage loans servicing rights in the first quarter of 2015. Also recall that the fourth quarter of 2014 included a $500,000 gain on the extinguishment of debt.

As detailed on page 12, our noninterest expense totaled $22.2 million in the first quarter of 2015 compared to $22.4 million in the year ago quarter. Many expense categories were lower in 2015, primarily reflecting our cost reduction initiatives. First-quarter 2015 compensation and benefits expense does include a $0.2 million of severance expense related to our branch consolidation and other staffing reductions.

As we have previously discussed, we expect the branch consolidation to reduce noninterest expenses by approximately $1.6 million annually. Investment securities available for sale increased by approximately $38.6 million in the first quarter of 2015, primarily reflecting the deployment of a portion of the funds provided from the year-to-date increase in deposits.

Page 13 provides an overview of our investments at March 31, 2015. 40% 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 1.9 years.

Page 14 provides data on nonperforming loans, other real estate, nonperforming assets and early-stage delinquencies. We made further progress on improving asset quality during the first quarter of 2015. Nonperforming assets declined by 5.7% during the first quarter of 2015, and were down to 0.88% of total assets.

In addition, total 30- to 89-day delinquencies fell to $7.3 million or 0.5% of portfolio loans at March 31, 2015.

Moving on to page 15, we recorded a credit provision for loan losses of $0.7 million in the first quarter of 2015 compared to a provision expense of $400,000 in the year ago quarter. Loan net charge-offs declined to $0.7 million or 0.19% of average portfolio loans in the first quarter of 2015. The allowance for loan losses totaled $24.7 million or 1.73% of portfolio loans at March 31, 2015.

Page 16 provides some additional asset quality data including information on new loan defaults and on classified assets. New loan defaults totaled just $2.4 million in the first quarter of 2015.

Page 17 provides information on our TDR portfolio that totaled $106.5 million at March 31, 2015, a decline of 3.3% since the end of 2014. This portfolio continues to perform very well with 90% of these loans being current at March 31, 2015.

On page 18 we provide a summary of our actual 2015 performance as compared to our original outlook. Overall, we believe our performance in the first quarter of 2015 was generally in line with our original outlook. Although the first quarter is typically somewhat challenging for loan growth, because of seasonal factors, we got off to an excellent start in 2015 with strong commercial loan growth. We continue to target mid-single digit percentage growth for loans as we move forward in 2015.

We indicated an expectation for modestly higher net interest income for 2015 and we believe we remain on track to achieve this through a stabilization of our net interest margin and the aforementioned loan growth. Asset quality metrics improved across the board in the first quarter of 2015 which led to a credit provision that I discussed previously.

As we look ahead to the remainder of 2015, the level of loan net charge-offs, loan defaults, watch credits, and the performance of the TDR portfolio will be the key factors influencing our provision levels. We are optimistic that our asset quality metrics will continue to improve.

Noninterest income of $9 million in the first quarter of 2015 was somewhat below our expected range of $9.5 million to $10 million. Although the first quarter of 2015 was adversely impacted by a $0.7 million impairment charge on capitalized mortgage loan servicing rights, we also enjoyed strong gains on mortgage loans that somewhat offset the impairment charge.

We expect mortgage loan origination volumes and sales to remain relatively strong over the next several months. And, consequently, in the absence of additional MSR impairment charges we believe we can move noninterest income up to the lower end of the forecasted range.

Noninterest expense at $22.2 million in the first quarter of 2015 was generally in line with the higher end of our forecasted range. With the completion of the branch consolidation on April 30, 2015, and the resulting expected decreases in noninterest expenses along with other cost reduction initiatives, we believe that total noninterest expenses will move downward over the remainder of 2015, into our $21 million to $22 million forecasted range.

Finally, our effective income tax rate of 32% in the first quarter of 2015 was in line with our forecasted range.

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

Thanks, Rob. The first quarter of 2015 was a solid start to the year for our Company with $3.8 million in net income. However, our management team recognizes we need to continue to grow revenue and improve our overall earnings as we work towards a performance of 1% return on assets and 9% to 10% return on equity by 2016.

Our target or roadmap to this level of performance is built on improving net interest income to $20 million, noninterest income of [$10] million or better and noninterest expense of $21 million or less.

As we look ahead, we will continue to execute on strategies and initiatives to increase long-term shareholder total return. These strategies include the following. Revenue growth through asset migration from a lower yielding securities portfolio to a higher yielding loan portfolio. This strategy includes originations of high credit quality, diverse mix by segment, diverse by geography, and a very granular makeup of credits.

Secondly, we will continue to focus on and invest our resources in higher growth Michigan markets. Third, we will continue to leverage our low-cost core deposit base which will, at some point, provide greater upside in a rising rate environment. Fourth, we will continue to improve the bank's efficiency ratio, primarily through revenue increases but also continuing to aggressively attack our cost structure.

And finally, the fifth strategy is to increase long-term shareholder total return through the prudent management of our capital. As it relates to our capital, our near-term target for tangible common equity is 10.5% and a longer term target is 9.5%.

Our plan is to retain capital for organic loan growth and return capital through a consistent dividend payout plan and share repurchase plan. We believe sound execution on these strategies will generate solid total shareholder returns over the long run.

Before opening the call for questions, I would like to touch on one more subject which is the decision to relocate Independent Bank's principal office from the current 230 West Main in Ionia, Michigan to the branch office at 4200 East Beltline Avenue in Grand Rapids, Michigan.

This change is not expected to have a material effect on our presence in the city of Ionia or in Ionia County, for that matter. Rather, this change will officially align our headquarters with how we have been operating from a practical standpoint for several years. Presently, quite a few of our departments -- auditing, collections, finance, mortgage origination, and independent title services as well as four of our six executive team members operate from the Grand Rapids East Beltline location.

I'm excited to share this news as the Grand Rapids market is one of the leading markets in the state of Michigan from a population growth, a job growth, and a new business growth perspective. I believe being headquartered in the larger market will mean, while difficult to quantify, new business opportunities for us.

What is not changing is our commitment to the Ionia market or any of our markets as each one is very important to our success.

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

(Operator Instructions) Matthew Forgotson, Sandler O'Neill.

Just a question on your margin guidance. This quarter, you put on some securities and now I believe the guidance is that you are going to drive and -- hold the margin flat or drive some modest accretion by rotating securities into higher yielding loans. Am I seeing the dynamic clearly there?

Yes. The object is to achieve mid-single digit growth in the loan portfolio, kind of the wild card with the securities is going to be the deposit growth side. So, to the extent we do have deposit growth that exceeds that mid single-digit growth on loans, you could still see securities rise but the real key from our perspective is bringing the mix of earning assets higher on the loan side and ultimately lower on the securities aside.

Okay.

So again, the driver on the margin or on net interest income would be the combination of earnings, some earning asset growth along with margin stabilization or even growth because of that rotation out of the lower yielding securities and into higher yielding loans.

Maybe I'm reading too much into it but, in the release and then again on the call, you referenced that you are seeking further reductions in the expense base.

Are you pointing to cost savings that are going to flow out from the branch consolidation or are you kind of speaking a bit more broadly and potentially teeing up the potential for a more broad-based initiative?

Matthew, so I would say if you actually look at you know the expense categories on our income statement there's, I believe, 16 categories and 12 of the 16 are down from a year ago. And so in essence, it's a continuation of turning over every rock, and we still think there's some opportunity.

We've tackled, I think, a lot of the low hanging fruit. But I think there is still opportunity there.

As an example, we have a further large investment in some processing software which will completely be depreciated later in 2016. And so that -- while there's some additional investment there that could be likely, we think there will be a huge savings there and what's really hard to quantify is -- and I've mentioned this on some previous calls, we renegotiated our core processing contract with FIS a year ago this quarter. And since that point in time we've been in a streamlining of processes endeavor and we continue -- that will be going on throughout 2015, where essentially we are having better integration through all our applications. We are having fewer vendors to deal with on all our applications. We are getting rid of a lot of the paper that's in our Company and that we believe sort of bogs us down.

So it's difficult to say, hey, the additional cost savings will be this as a result of those workflow streamlining efforts. But I do believe that they will be material.

And Matthew, just to put some dollars on the comment Brad mentioned, we had some internally developed software that becomes fully depreciated in March of 2016 and that level of amortization is close to $1 million a year. So, we expect to see data processing costs go down further, once that becomes fully amortized.

Okay and then lastly and then I will hop out, as far as share repurchases, just a quick note, can you remind us number one how much cash there is at the holding company level? And then number two, what we should expect as far as the pace of those repurchases is concerned.

Well, the cash of holding company is about $32 million-ish. So there's a fair amount of cash available. The 5% would be roughly on 23 million shares somewhere around $1.15 million. So, there's plenty of cash available at the current company to accomplish the share repurchase and the pace, I would say we would prefer to do it sooner rather than later but at least at the start we were doing open market transactions, so there's limits on how much we can buy in a particular day.

We'd also be interested if there's blocks that come available. But we are -- I guess the bottom line is we want to be able to be able to consistently be in the market through the course of 2015 and looking at opportunities on where we might be able to accelerate it or where there may be opportunities to buy on weakness. So we don't have anything in particular on pace, but we want to certainly accomplish the 5% over the course of the year.

Thank you very much.

John Rodis, FIG Partners.

Maybe just a quick question on the loan growth. You put up some pretty good commercial growth in the quarter. Was the growth this quarter -- was it fairly granular or where there a couple of bigger credits that drove the quarter?

It is the latter in terms of being very granular in origination. And it was also, I think, a very good mix from geography from a geographic standpoint. The West region led us this past quarter, followed closely by our Southeast Michigan region, and then even the Saginaw-based City/Thumb market also had some very good growth.

And it was also, I think, a good mix. We now have more -- a greater allocation towards C&I as opposed to investor real estate, and so, that continues to be a positive trend for us.

Okay, makes sense. Just one other question, on the, I guess the mortgage results this quarter, the gain on sale spread was up, I think, about around 3% or 3.1%. What sort of break do you think you sort of expect going forward there? And I know it can be volatile but what do you guys expect?

We do have, in the table, a chunk of that is due to the fair value adjustment in the fair value adjustment is basically -- we -- because of the derivative accounting we mark to market every quarter, not just loans held for sale but commitments to originate loans that we don't take 100 and assume a certain fallout ratio. And then, we also take into account commitments to sell loans.

So we are marking three different items on a fair value basis at the end of each quarter. So, in a quarter where we get growth in what we call the pipeline, commitments to originate loans, that's going to push the margin higher because of fair value adjustments.

So, what we see in the second quarter, for example, will be sensitive to the size of that pipeline to originate the loans at the end of June. Now typically, we see seasonal pick-up there so to the extent the pipeline stays relatively the same, we wouldn't have large fair value adjustments.

So, we might see the margin come down but we'd also see the volume of actual loan sales move up. So, the bottom line is, we might see the margin -- I would say a more normal margin would be more around 2.5% where you're not having those fair value adjustments and then you are going to have obviously, dependent on the volume of originations.

But, as we move through the next couple of quarters, we would typically see the seasonal increase in purchase volumes. So, even if refinances come off a little bit, we'd still expect to have good solid results in terms of gains on loan sales. Whether we get $2.1 million, we may be a little shy of that but we still expect good gains on loan sales and what we hope we won't see is an impairment charge on MSR.

So, the net between loan sales gains and MSRs or mortgage servicing income or expense would be better in the second and third quarters versus the net in the first quarter. That's what we hope for. And then that would move us more in that $9.5 million to $10 million range for noninterest income.

Okay. That makes sense, Rob. All right, thanks guys.

(Operator Instructions) Damon DelMonte, KBW.

First question is, how to deal with the outlook for the provision. I know you mentioned there's obviously a lot of moving parts that go into how that shakes out each quarter but just kind of maybe you could help us frame it out a little bit. What are you expecting for full-year net charge-offs?

Well, we really don't give specific guidance but I guess we would hope that the kind of run rate we are at down in that 20 basis points would be similar to what we see or [badder]. I guess it seems there our one -- we are seeing less lost content on defaults.

In other words, collateral values are improved versus where we were a few years ago. So, that helps in terms of just the new charge-off rate and then secondarily, if we continue to see decent recoveries like we did in the first quarter, I would be optimistic that we could be still at that 20 basis points or better as we move through the balance of the year. Hopefully, even better.

Okay. And then if you look back over the last few quarters you've had a credit to the provision for the last four quarters in a row and absent first-quarter 2014 a bunch more quarters before that. So how should we look at, I guess, the provision line going forward? Your reserve is at $173 million. Should we continue to model in a negative provision expense?

It's difficult. I mean, it's not something we necessarily go into a quarter and expect a negative provision. We go through, we have a very what I would say rigorous process of how we do the modeling. You know, what has helped and you know if we look at peer group, you are more around the 1.5 give or take a few basis points level.

I think where we get some of the elevation is, we still have $106 million of TDRs. A lot of our specific reserves are in that category.

So, what's helping us move this down is a couple of things. One is, you know, what the level of new defaults is. And that's been declining. What the level of net charge-offs in -- within net charge-offs, recoveries are. That's been helping us as that has moved down.

And in addition in those homogenous portfolios, what helps those charge-offs come down is that level of charge-offs is what influences the reserve calculations within those portfolios. So, within the homogenous portfolios, we are looking at refreshed FICA scores. Those refreshed FICA scores give us a probability of default level as we do our migration analysis and then, within the probability of default, sort of a historical charge-off rates give us that final loss given default level, which sort of feeds into the provision.

We then have a subjective portion that's influenced a lot by economic data and the economic data has been improving. So that's allowed us to have some release from the subjective in -- and so those are kind of the primary influencing factors.

It would be hard for me to see a scenario where we go well below or below that sort of pure range of that $1.5 million and change. So my thought is, you can't stay with negative provisions. But if we have very good credit metrics we might get a quarter or two more but then I think at some point we're going to move 20 more normalized provision level which, I would think, would be more in that 20 to 25 basis point range, depending on loan growth and other factors.

So, maybe we squeeze out a couple more quarters bottom line. But I think at some point it comes to an end. So I don't know if you want to add anything.

I think that was very good, Rob.

That's very helpful. Thank you very much for that color. I guess just one other question. I think you had mentioned that you were -- you are hopeful that deposit growth would, you know, potentially exceed that of loan growth this coming year.

What are some of the initiatives that you have going on or some of the programs you have in place that give you confidence that you could get strong deposit growth throughout the year?

I don't know that I said we expected that. I said if deposit growth exceeds the mid-single digit loan growth, then that might cause us to have to grow the investment portfolio. I think our more sort of normal range on an annualized basis for deposit growth, and if you look at our proxy statement this is in the incentive plan would be more in the 2.5% to 5% range, and we would expect loan growth to hopefully be somewhat above that.

So, we saw strong deposit growth in the first quarter but some of that is seasonal in nature. We see -- particularly with our municipalities -- tax collections accrue a lot in February so there is some boost in deposits. So we would, I guess on a overall basis, not expect deposit growth to be quite as great as loan growth.

Now, the one other factor to consider is your base of percentage growth on deposits is coming off $1.9 billion. Your base of growth on loans is coming more off $1.4 billion. So, dollarwise they still may be in sync.

And Brad, I don't know if you want to comment on some of the factors but a lot of it is just efforts whether it's treasury management, commercial, etc.

Yes, Rob, I think you are right on with that. I would add that we view the deposit base as being a huge value for our franchise. So deposits have always been, are, and will continue to be an emphasis for our people. And the fact again, for 2015, it is one of the annual incentive plan category targets that we have for our people in their -- this is outlined in their proxy.

We have a threshold goal of 2.5% growth target level of 5% growth and then a maximum level of 10%. So, that's what our people are striving for and there's not a -- there's not a quick fix to get there.

It's essentially blocking and tackling. It's our structure, it's our people, our community bankers knocking on doors. It's our commercial lenders continuing to emphasize the C&I portfolio that does generate greater deposit balances and again, continuing to take very good care of our municipal customer base.

Okay. That's helpful. Thank you for those points. That's all that I have for now. Thanks.

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.

Very good. I would like to thank each of you for your interest in Independent Bank Corporation today and for joining us on today's call. I wish everyone a great day.

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