Independent Bank Corp (Michigan) (IBCP) 2016 Q1 法說會逐字稿

Good morning, and welcome to the IBCP Independent Bank Corp first-quarter 2016 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 2016 first-quarter results. I am Brad Kessel, President and Chief Executive Officer. 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 today, you can access it at the Company's website, www.independentbank.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 in our deck. We are reporting for the first quarter 2016 net income of $4.1 million, or $0.19 per diluted share, versus net income of $3.8 million, or $0.16 per diluted share in the prior-year period. This represents 8.4% and 18.8% increases in net income and diluted earnings per share respectively over the prior-year period.

Turning to Slide 5. This quarter's results were highlighted by a year-over-year and sequential increase in net interest income of $1.7 million and $0.4 million respectively; growth in portfolio loans, which increased $23.9 million, or 6.4% annualized; growth in total deposit balances, which increased $68.7 million, or 13.3% annualized; continued progress in improving asset quality, with non-performing assets down $0.6 million or 3.5% since December 31, 2015 and NPAs have declined by $3.2 million, or 15.7% since March 31, 2015. Non-performing assets to total assets are now at 69 basis points. This compares to 74 basis points at December 31, 2015 and 88 basis points at March 31, 2015.

During the first quarter of 2016 we repurchased 1,059,865 shares of our stock at a weighted average price of $14.63 per share, representing 4.8% of outstanding shares at December 31, 2015. Since the beginning of 2015 the Company has repurchased a total of 2,027,064 shares at an average price of $14.31 per share. Also this first quarter the Company paid an $0.08 per share dividend.

Our footprint is shown on the Michigan market slide, page 6. Today Independent Bank is the fifth largest bank headquartered in Michigan and operates 63 branch locations in 21 counties and 11 MSAs.

For the first quarter of 2016, Michigan market conditions continue to be good. This is evidenced by a reduced State unemployment rate now at 4.8% versus the national rate of 4.9%. Michigan payrolls added 97,000 net new jobs as compared to one year ago.

Michigan housing conditions also continued to exhibit positive trends as measured by total housing sales, housing starts, and median sales price of single family homes. Commercial real estate occupancy rates for office, light industrial and retail continue to trend positively.

Page 7 contains a summary of loans and deposits by region.

Moving to the deposit franchise slide, Page 8. Deposits totaled $2.15 billion at December 31, 2015, an increase of $68.7 million from December 31, 2015 and $154.2 million, or 7.7% since March 31, 2015. The increase in deposits is due to growth in checking, savings and time account balances.

The Company's deposit base is substantially all core funding, with $1.7 billion, or 79% in transaction accounts. In addition to this growth, we continue to have a low cost honor deposits, now at 21 basis points.

We have made significant changes to streamline and optimize our branch delivery network, going from 106 branches at the start of 2012 compared to our current 63 branches as of March 31, 2015. Since the end of 2011 we have improved the average profitability per branch and increased the average deposits per branch from $20 million per branch to just over $34 million per branch.

During the fourth quarter of 2015 and the first quarter of 2016 we have reissued over 100,000 new EMV chip cards to our customer base. We are hopeful the chip technology will significantly reduce debit card fraud on a go-forward basis.

Revenue growth through cross-selling new services to our existing customers and the acquisition of new customers continues to be a focal point of all our sales associates. At the same time we continue to look to drive down costs and increase productivity in all our delivery channels.

Our lending highlights are shown on slide 9. Loans including loans held for sale were $1.57 billion at March 31, 2016. For the quarter portfolio loans were up $23.9 million, or 6.4% annualized.

Our commercial team lead the way, with $72 million in new commitments, generating net growth of $22.5 million, or 12.1% annualized. By category, $5 million was commercial real estate related and $17.5 million was C&I related.

For the quarter almost all the net growth occurred in our West region. Our commercial pipeline continues to be very strong for all three regions. The commercial portfolio metrics continue to display good quality, with just 5% in the watch category, and good granularity with a nice mix of balances less than $500,000, $500,000 to $2.5 million, and $2.5 million and up. Line usage did decline to 43.8% during the quarter from 45.6% in the fourth quarter of 2015.

Our mortgage team originated $73.5 million during the quarter, down from $79.8 million the same quarter one year ago. While most of our originations continue to be saleable 15- and 30-year fixed rate, which we continue to sell, we did have $3.6 million, or 2.9% growth in the mortgage portfolio for the quarter. The pipeline was up over last quarter end. Consumer balances, as expected due to seasonality, were flat for the quarter.

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 for 2016. Thanks, Rob.

Thanks Brad, and good morning everyone. I am starting at page 10 of our presentation.

Our net interest income totaled $19.8 million during the first quarter of 2016, an increase of $1.7 million, or 9.2% from the year-ago period, and an increase of $0.4 million, or 2.1% on a linked quarter basis. Our tax equivalent net interest margin was 3.61% during the first quarter of 2016 compared to 3.57% in the year-ago period and 3.56% in the fourth quarter of 2015.

Although the net interest margin remains under some stress due to the prolonged low interest rate environment that has pressured yields on the Company's loan portfolio, we remain optimistic that we can offset this stress by a remix of our earning asset base, largely through loan growth. Average interest earning assets were $2.21 billion in the first quarter of 2016 compared to $2.06 billion in the year-ago quarter and $2.18 billion in the fourth quarter of 2015.

Page 11 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 loans that was partially offset by an increase in interest expense on deposits and borrowings. Net recoveries of interest on charged-off or non-accrual loans increased by $365,000 in the first quarter of 2016.

Going in the other direction, one less day in the first quarter of 2016 as compared to the fourth quarter of 2015 reduced net interest income by about $116,000. We'll comment more specifically on our outlook for net interest income for the remainder of 2016 later in this presentation.

Moving on to page 12. Non-interest income totaled $7.8 million in the first quarter of 2016 as compared to $9 million in the year-ago quarter and $10.1 million in the fourth quarter of 2015. Our mortgage banking operations caused much of the quarterly comparative variability in non-interest income.

In the first quarter of 2016, gains on mortgage loans fell to $1.6 million due to decreases in mortgage loan originations and sales. Although purchase money mortgage origination volume increased by $19.1 million, this was more than offset by a decline in refinance mortgage origination volume of $25.4 million on a year-over-year basis. A decline in mortgage loan interest rates resulted in an impairment charge of $1.45 million, or $0.043 per diluted share after taxes on our capitalized mortgage loan servicing rights in the first quarter of 2016.

Interchange income also declined on a year-over-year basis for the first time in several years. Although we experienced a 2.7% increase in transaction volume, this was more than offset by a 7.5% decline in interchange revenue per transaction. We are seeing merchants direct more transactions through as pin-based, which has a lower level of revenue than signature-based transactions.

In addition the first quarter of 2015 had $170,000 of volume-based incentive revenue. We moved from a quarterly to an annual volume-based incentive calculation in 2016 under our debit card brand agreement. We elected not to record any accrual for volume-based incentive revenue in the first quarter of 2016 due to uncertainty as where the year will end up.

As detailed on page 13 our non-interest expense totaled $22 million in the first quarter of 2016 as compared to $22.2 million in the year-ago quarter. Looking ahead in 2016, we estimate about $750,000 of reduced quarterly non-interest expenses broken down as follows; $250,000 reduction in data processing expenses due to primarily lower software amortization expense at our payment plan processing subsidiary Mepco;$250,000 reduction in occupancy costs due primarily to seasonal factors such as lower or no snow removal costs; $100,000 reduction in legal costs due to the resolution of a collection-related matter at Mepco; $100,000 reduction in communications expenses as the first quarter of 2016 included some one-time elevated mailing costs, the primary example being the distribution of chip-enabled debit cards to our customer base; and $50,000 in various other categories, payroll taxes being one example.

Page 14 provides an overview of our investments at March 31, 2016. 33% of the portfolio was variable rate, and much of the fixed rate portion of the portfolio was in maturities of five years or less. The estimated average duration of the portfolio is about two years.

In the first quarter of 2016 we initiated the use of Pimco to manage a $150 million segment of our investment portfolio. We anticipate achieving about $500,000 of additional annual interest income after management fees on this portion of our investment portfolio. Although this sector of our investment portfolio will have a similar risk weighting and duration as our remaining portfolio, the additional earnings are expected to be generated through rebalancing into other sectors and better trade execution. We anticipate seeing the tangible benefits of this relationship beginning in the second quarter of 2016.

Page 15 provides data on non-performing loans, other real estate, non-performing assets and early stage delinquencies. We made further progress on improving asset quality to start 2016. Non-performing assets declined by 3.5% during the first quarter of 2016 and were down to 0.69% of total assets at quarter end.

Moving onto page 16. We recorded a credit provision for loan losses of about $500,000 in the first quarter of 2016 compared to a credit of $0.7 million in the year-ago quarter. We actually recorded net recoveries on loans of about $0.5 million, or 0.12% of average portfolio loans in the first quarter of 2016. The allowance for loan losses totaled $22.5 million, or 1.46% of portfolio loans at March 31, 2016.

Page 17 provides some additional asset quality data, including information on new loan defaults and on classified assets. New loan defaults totaled just $2.2 million in the first quarter of 2016 and we achieved a 22% decline in classified assets.

Page 18 provides information on our TDR portfolio that totaled $87.1 million at March 31, 2016. This portfolio continues to perform very well, with 90% of these loans being current at quarter end.

On Page 19 we provide a summary of our actual year-to-date 2016 performance as compared to our original outlook. Overall we believe our performance in the first quarter of 2016 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 2016 with strong commercial loan growth. We continue to target high single digit percentage growth for loans as we move forward in 2016.

We indicated an expectation for mid-single digit growth in net interest income for 2016, and we believe we remain on track to achieve this through general stability in our net interest margin and the aforementioned loan growth. Asset quality metrics generally improved across the board in the first quarter of 2016, which lead to a credit provision that I discussed previously.

As we look ahead to the remainder of 2016, the level of net -- 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 be stable or improve. Non-interest income of $7.8 million in the first quarter of 2016 was well below our expected range of $9.5 million to $10 million.

The first quarter of 2016 was adversely impacted by a $1.4 million impairment charge on capitalized mortgage loan servicing rights. Assuming the absence of the MSR impairment charges and the historical seasonal increases in service charges on deposits, interchange income, and gains on mortgage loans, we believe we can move non-interest income up at least to the lower end of our forecasted range.

Non-interest expenses at $22 million in the first quarter of 2016 was generally in line with the higher end of our forecasted range. Earlier I outlined several expense reductions that we believe will reduce total non-interest expenses to about $21.3 million per quarter over the remainder of 2016. Our effective income tax rate of 32.3% in the first quarter of 2016 was in line with our forecasted range.

If you summarize all of these items, it might look something like this in the second quarter of 2016; net interest income of $19.8 million, this was unchanged sequentially, as the increase from projected net loan growth is largely offset by interest recoveries moving to more normal levels, if you'll recall from my earlier remarks, interest recoveries were up $365,000 in the first quarter of 2016; non-interest income of $9.5 million, non-interest expense of $21.3 million Assuming no provision for loan losses, you'll wind up with $8 million of pretax earnings and $5.4 million of after-tax earnings using a 32.5% effective income tax rate. Using a 21.5 million diluted share count results in $0.25 of earnings per diluted share.

This was not intended to be a forecast of our second-quarter results, and we regularly indicate the difficulty in trying to project the provision for loan losses. Rather this is simply an illustration of how some of the various changes that I outlined in my remarks might line up when overlaid over our actual first-quarter 2016 results.

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

Thanks, Rob. Moving to page 20 in our deck. We are pleased to provide -- we are pleased to report a solid start to 2016, with growth in earnings and earnings per share as compared to the same quarter one year ago. The improvement is directly related to the successful execution of our strategy to migrate earning assets from lower yielding investments to higher yielding loans, which then grew net interest income on both a quarter-over-quarter basis and on a same quarter year-ago basis. Similarly improvement was seen with reductions in non-interest expense on a quarter-over-quarter basis as well as on a same quarter one year ago basis.

Additionally Rob outlined our plans for further reductions in non-interest expense beginning in the second quarter. Our quarterly return on average assets was 0.68% compared to 0.67% for the same quarter one year ago. Our quarterly return on average common shareholders equity was 6.7% compared to 6.05% for the same quarter one year ago.

Our management team recognizes we need to continue to grow revenue and improve our overall earnings as we work toward our next performance milestones of 1% or better return on assets and 9% to 10% better return on equity in 2016 and beyond. As previously shared, our target or road map to this level of performance is built on improving net interest income to $20 million per quarter, non-interest income of $10 million or better per quarter, and non-interest expense of $21 million or less per quarter and a normalized provision. As we look ahead we will continue to execute on our strategies outlined on slide 20 to increase long-term shareholder total return.

As it relates to our capital our near-term target for tangible common equity is 9.5% to 10.5% and the longer-term target is 8.5% to 9.5%. At quarter end we now stand at 9.55%, very close to the top end of our long-range target.

Our plan is to retain capital for organic loan growth and return capital through both a consistent dividend payout plan and share repurchase plan. As we now have 52,703 shares remaining in our current authorized share repurchase plan, our Board will be revisiting this topic in the very near future and a public announcement will be made shortly thereafter. We believe sound execution on our strategies will generate solid total shareholder returns over the long run.

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

Thank you.

(Operator Instructions)

The first question comes today from Matthew Forgotson with Sandler O'Neill and Partners. Please go ahead.

Hi. Good morning, gentlemen.

Good morning.

Lots of dislocation in your markets. Can you give us a sense of the opportunities you're seeing to gain market share and attract talent as a result of this dislocation?

Sure, Matthew.

So I would say that the disruption through M&A today is present in almost every one of our markets. And it has been going on now for a period of time, and we are seeing that in our numbers. It's in the pipelines that we have in terms of opportunity to look at loans that we might otherwise not have had. And it's also been fruitful for us in terms of talent acquisition. And I'll leave it at that.

Okay. Rob, a couple questions on margin.

First, can you give us a sense of how much interest recoveries have been contributing to margin on an average basis relative to the $550,000 you booked this quarter?

Yes. I mean the previous quarter, the fourth quarter of 2015 we were about $148,000. I would say somewhere around $100,000 would be a normal run rate, plus or minus a little bit from there. So clearly the $550,000 was an exceptional quarter. And I think you in your notes hit the impact of that, which was about that the margin would have been down about, you said 2 basis points. It's about 1.5 basis points. So you're very close there.

The one other item I would say that was unique to the first quarter, and I commented briefly about it, and I can't sitting here give you an exact basis point number of the impact. But we did also liquidate quite a few investment securities, almost $50 million. And you'll see in our cash and cash equivalents. Now those produced the gains, which most people would take out.

But the other impact is we are sitting on a lot more low yielding cash in the first quarter as we were transitioning $150 million of our investment portfolio to Pimco to act as our investment advisor there. And they didn't really have an opportunity during most of the first quarter to reinvest those monies. But as we got toward the end of the quarter, more and more of that occurred. And it's largely now been completed and they've added about 44 basis points of book yield on that portfolio. So that's where after costs I come up with that $500,000 annualized improvement that I talked about in my comments.

So I do feel that we'll start seeing is some benefit from that in the second quarter. And that weighed down the first quarter, but whether it would offset that entire 1.5 basis points that we saw if you take out or normalize the interest recoveries. It would probably have some impact there. So maybe we would have been more close to flat on the margin rather than down 1.5 basis points, if you would normalize the interest recoveries. On that basis I think that $355,000-ish level is probably reasonable when you take all of the factors into account.

Right, okay. And going one step further on that, I know that you outlined that you have two Fed fund rate hikes baked into your margin expectations. If the guidance calls for -- or your commentary, I should say, calls for holding it at or around this $355,000, what would the impact be if we don't get those two Fed funds hikes?

Well, we would have expected our margin to gradually increase with those two hikes. So what I would say is that we might see a tiny bit of erosion, but we feel that the combination of continuing to remix the earning asset base with more loans and fewer investment securities along with having Pimco assist on a portion of our investment portfolio to move the book yield up, that even absent the -- any rate increases, we'd still see a reasonably steady margin.

Thanks very much.

Our next question is from John Rodis with FIG Partners. Please go ahead.

Good morning.

Hi, John.

Rob maybe a question for you. Just I think last quarter you talked about maybe doing a bulk loan purchase again this year. Can you just talk about where you're at in that process?

Yes. We, as you're aware, we did about a $32 million run rate last year. I would tell you right now, and we did in our plan anticipate doing something midyear, but we may elect not to do that. With where the 10-year Treasury has fallen, we're seeing a couple things on the whole loan mortgage fund. One is absolute yields are lower.

Two is at least with where the production is, you're having to pay a relatively high premium on what we're seeing out in the market. So what I'd say is, we're going to be patient there. We don't feel we really have to press that. And we feel at least with the start we've had in 2016, the organic loan growth has been solid enough where we don't feel pressure to supplement with the whole loan purchase. So we're going to be cautious in what we do on that front.

Okay. So the goal of high single digit growth in 2016 is -- assumes no bulk purchase, is that correct?

No. It did assume a bulk purchase, but we've also started the year much stronger than what we anticipated. So, I guess I'd say it would be within the range of when you say high single digit, high is 9-plus. But you could also argue that 6.5 is -- or 7 is there, too. So I feel like we're still going to get good mid-single digit without a bulk purchase, solid mid-single digit.

To get it up into the very high end of that without a purchase might be a bit challenging, but I don't feel like we also think we need to do that to get the operating results we're looking for. And we're reluctant to either pay a high premium or end up with book yields that we just feel we'll look back and think maybe we just pressed too hard there.

Okay, fair enough. And then Brad, just one question for you. I think you said the Board would be, I guess, reevaluating a new buyback. Is that correct? And sounds like we'll hear something relatively soon?

Yes, that's correct.

Okay. Thanks.

The next question is from Damon DelMonte with KBW. Please go ahead. Mr. DelMonte, the floor is yours; perhaps your line is muted?

We'll go to the next question. And that question is Louis Feldman with Wells Capital Management. Please go ahead.

Thank you. Good morning, gentlemen.

Good morning, Louis.

Question for you, Rob.

I wanted clarification of something I thought I heard you say during your prepared remarks. In terms of margin improvement by remix, how much price elasticity is there in the rates that you're able to ask that you would be able to remix and improve the earning yield on the portfolio? To what extent are you able to move prices versus competition?

Well, it's really -- for us, it's not as much based on the competition and getting rates higher than what our competitors might be able to get. I think like most banks we have to be very competitive in term of our offering.

Where we're seeing the benefit is we have, relatively speaking, a low loans to asset and loans to deposit ratio. So the remix I'm talking about is really getting loan growth that actually if I look at where the average yield is coming on our new origination volume, it's still lower than our average portfolio yield. But what we're doing is we're driving dollars out of our investment portfolio and picking up 250 to 300 basis points of additional yield by having less investments in more loans.

So that's sort of the remix that I'm referring to. So, that remix is helping us keep that margin stable, or hopefully we get even maybe some expansion there. But it's still with loan yields on new production being a little bit lower than our average portfolio yield sitting here today. But it's moving dollars out of lower yielding investments and into higher yielding loans.

Okay. That's the clarification I was looking for. Thank you much.

Yes.

(Operator Instructions)

Next question is from Damon DelMonte with KBW. Please go ahead.

Hey, good morning. Sorry about that. I guess I had trouble unmuting myself before.

I just wanted to follow-up on the loan growth outlook. Brad, could you talk a little bit about where across your footprint you think the best opportunity is to achieve this growth?

Well, so for the first quarter, the bulk of our growth was in the West Michigan market. The pipeline today is strong on the commercial side, really in all three markets, but I'd say particularly West Michigan and Southeast Michigan. And it's a very good mix between both commercial real estate and C&I. And then I'd say on the consumer loan side, typically the first quarter is soft for us. And it was, I think, continued to be, but it actually wasn't bad. We had pretty good originations out of the branch network and pretty good originations out of our indirect desk. And I think we're going to see that pick up here in second quarter and third quarter. So we expect the consumer portfolio to pick up.

And then if we can continue forward with the growth that we saw in the mortgage portfolio like we did this past quarter, that would be great. Because really this is one of the, outside of the bulk purchases, this is one of the first quarters we've actually grown in the mortgage portfolio. And one of the reasons behind that was -- well, two reasons behind it are that we sell predominantly all 15- and 30-year fixed rate mortgages. But we had a line of business, our resort line of business that we discontinued years ago, that's been in run-off. And there's not much left in that portfolio. So it would be great to see some growth in the mortgage book.

Does that help answer, Damon?

Yes it does. Thank you.

And then on the topic of capital, I know you laid out 9.5% to $10.5% as your near-term TCE target. And you're getting to that 9.5% level. So just given the outlook for the good organic loan growth opportunities, and you're going to revisit the buyback. Should we expect you guys to take it to the next level sooner rather than later?

I don't necessarily think so, because I think the loan growth can get supported by bringing investments down a bit. So I don't necessarily see assets growing a lot. I will say also, and you might have seen it in accrued expenses and other liabilities, in the first quarter we had about $20 million of unsettled investment trades. So there we increased investments and we increased other liabilities, but those settled in early April. And so that's actually going to reduce assets $20 million, because cash comes down as we settle on those investment transactions, and that we get rid of that accrued liability.

So I don't necessarily see asset, overall asset growth, pushing our capital ratio down. And I think with good earnings and where our dividend level is, I still think we have good room for additional share repurchases that will not pressure the tangible assets -- or tangible equity/tangible assets ratio. Rather, maybe it gets spread out a little bit more over the last three quarters. We just had a lot of opportunities for share repurchases in the first quarter, I think in part driven because the stock market was so poor. But I think as we move forward, maybe it spread out a little bit more. But I think the earnings less the dividend still gives us enough additional ammunition to continue to do share repurchases.

Got you. Okay, that's helpful. Thank you very much.

Ladies and gentlemen, that concludes our question-and-answer session. I would like to turn the conference back over to Brad Kessel for any closing remarks.

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

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