Independent Bank Corp (Michigan) (IBCP) 2019 Q4 法說會逐字稿

Good day, and welcome to the Independent Bank Corporation Fourth Quarter 2019 Earnings Conference Call and Webcast. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Mr. Brad Kessel, President and CEO. Please go ahead.

Good morning. Thank you for joining Independent Bank Corporation's conference call and webcast to discuss the company's 2019 fourth quarter and full year results. I am Brad Kessel, President and Chief Executive Officer; and joining me is Rob Shuster, Executive Vice President and retiring Chief Financial Officer. Also joining is Steve Erickson, Executive Vice President and incoming Chief Financial Officer.

Before we begin today's call, it is my responsibility to direct you to the important information on Page 2, the cautionary note regarding forward-looking statements. 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, independentbank.com.

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

Before we begin reviewing our financial results, as previously announced, Steve Erickson is the incoming Chief Financial Officer for IBC following Rob's retirement on January 31, 2020. As this is Rob's last earnings call, I want to take a moment and thank Rob for his service to IBC over the last 25 years. His contributions to the organization have been instrumental to our success, and I want to wish Rob well as he embarks on his well-deserved retirement. Rob, do you have any comments that you'd like to make before we begin today's session?

Yes. First, I would like to thank the Board of Directors, the executive management team and all of my fellow associates at Independent Bank Corporation for their support. Being the CFO of IBCP has truly been a labor of love for me. In particular, I want to thank Jim Twarozynski, our controller and the entire accounting team; Dean Morse, our Head of Finance and his team; and Amy Anderson, our Head of Secondary Marketing and her team. Their hard work and professionalism over all these years is very much appreciated.

There are countless external business associates who have made my job better and who have been of great assistance over the years, and I wish that I could recognize them all. However, two in particular, Mike Wooldridge and Kim Baber from our outside law firm, Varnum, have been with me nearly every step of the way during my journey at IBCP. Finally, since this is an earnings conference call, I thank our analysts, our investment bankers and our shareholders for their support. I would like to recognize some institutional investors who I have known, in some cases, for nearly 30 years, and who has taught me so much. First, Rich Lashley and John Palmer from PL Capital who I have known since their days at KPMG. Next, Joe Hall and Terry Maltese from Maltese Capital Management, who I have known since my days back to Mutual Savings Bank. And finally, Joe Steven from Steven Capital Advisers who I have known for a very long time and who taught me how much time it takes to sun to set once it touches the horizon. Steve, I wish you much success; and Brad, I appreciate the opportunity to make a few remarks and my special thanks to you for all of your support, but especially for your friendship.

Thank you, Rob. And best wishes to you and Diane.

At a high level, I am very pleased with our fourth quarter and full year 2019 results. For all of 2019, we continued to execute on our operating plan, delivering strong growth in earnings, growth in loans, while maintaining excellent asset quality, growth in core deposits and effectively managing our capital. Our fourth quarter growth in net income and earnings per share was fueled by an increase in net gains on mortgage loans and a credit loan loss provision, primarily as a result of net recoveries on previously charged-off loans. On the balance sheet side, growth in our mortgage loan portfolio more than offset the higher-than-usual payoffs we experienced in our commercial loan portfolio. To yield net overall growth for the 23rd consecutive quarter. Mortgage loan originations surpassed $1 billion in production. For only the second time in our company's history.

Turning to Slide 5 of our presentation, with a little more detail on the quarter. We are reporting fourth quarter 2019 net income of $13.9 million or $0.61 per diluted share versus net income of $9.9 million or $0.41 per diluted share in the prior year period. This represents year-over-year increases in net income and diluted earnings per share of 39.7% and 48.8%, respectively.

Impacting our fourth quarter results for both 2019 and 2018 are the changes in the fair value due to price of our capitalized mortgage loan servicing rights. For the 3 months ended December 31, 2019, an increase in the fair value of our capitalized mortgage loan servicing rights due to price, increased noninterest income by approximately $600,000 or $0.02 per diluted share after tax. This compares to a $2.4 million decrease in fair value due to price or $0.08 per diluted share after tax for the 3 months ended December 31, 2018. Also positively impacting the fourth quarter of 2019 was a reduction of noninterest expense of approximately $400,000 or $0.01 per diluted share after tax related to the company's use of its FDIC small bank assessment credit, the company does not have any assessment credit remaining to offset 2020 expense.

For the fourth quarter of 2019, our return on average assets and return on average equity were 1.56% and 15.92%, respectively. These ratios decreased to 1.47% and 14.97%, respectively, when excluding the after-tax impact of the MSR change and the assessment credit. For 2019, the company reported net income of $46.4 million, or $2 per diluted share compared to net income of $39.8 million or $1.68 per diluted share in the prior-year period. This represents an increase of $6.6 million or 16.6% in net income, and $0.32 or 19% increase in diluted earnings per share. Our return on average assets and return on average equity for the year ended December 31, 2019 improved to 1.35% and 13.63% respectively.

We're optimistic about our future and recently announced an 11% increase in our quarterly common stock cash dividend to $0.20 per share to be paid on February 14, 2020. This annualized dividend rate is equal to a 40% payout on our 2019 earnings and a dividend yield of approximately 3.6%.

Slide 7 of our presentation provides a good view of our footprint. You will note that we're opening a new loan production office in Toledo, Ohio in Q1 2020. We were pleased to be able to attract an experienced and high caliber residential mortgage lending team in this market.

Turning to Slide 8. Michigan business conditions continue to be generally favorable with low unemployment, some job growth, affordable housing and continued good demand for commercial real estate.

Our regional portfolios are shown on Page 9. Our 2 strongest growth regions are the West or Grand Rapids region, up $69 million in loan balances, and our Southeast Michigan region, up $40 million in loan balances. The introduction of a reciprocal cash suite product has continued to generate significant deposit growth for our franchise. Some of the regional declines in deposits reflect the migration of larger deposit customers into the reciprocal deposits.

The next couple of slides cover our balance sheet. Turning to Page 10, we provide a couple of charts, reflecting the attractive composition of our deposit base as well as the continued growth in this portfolio while working to effectively manage our overall cost of funds. Independent has $3.04 billion in total deposits, of which $2.43 billion or about 80% are non-maturity deposit accounts. When comparing fourth quarter 2019 to the same quarter 1 year ago, we increased total deposits by $204.3 million or 7.7%. This excludes brokered deposits. Our total cost of funds decreased 10 basis points on a linked-quarter basis and is up 3 basis points when comparing to the same quarter 1 year ago. Our success in growing deposits, while managing the overall cost, has been primarily through growth in our commercial deposits and the sale of the insured cash suite product to public fund entities.

Details of our loan portfolio are found on Page 11, we continue to target a diversified loan mix with the largest portfolio being our commercial book of business. At December 31, 2019, and our loan mix included 42% commercial, 39% mortgage, 16% installment and 3% held for sale. Total mortgage originations for the quarter were $302.5 million, reflecting a $27 million decrease from the third quarter's very strong $329.5 million and up from the fourth quarter 1 year ago of $190.3 million. Portfolio mortgage loans increased by $28.9 million for the quarter, and we are up $56 million or 5.4% for the year for that category. The commercial portfolio declined by $22.3 million during the quarter. But was up $22.2 million or 2% for all of 2019. The decline in balances during the fourth quarter was primarily due to $16 million in payoffs and/or pay downs of watch credits. For the year, we booked new commitments of $326 million with new outstandings of $265 million. At year-end, our pipeline was stable.

Consumer installment loans declined by $4 million during the quarter due primarily to seasonal factors as these loans are sourced primarily through our indirect lending line of business which targets Michigan Marine, powersports and RV dealers. For the year, our consumer installment portfolio increased by $64.3 million or 16%. Total loans outstanding now aggregate $2.8 billion, including $69.8 million of loans held for sale. Excluding loans held for sale, our loan portfolio grew $2.6 million in the fourth quarter, bringing total loan growth for 2019 to $142.5 million or 5.5%. Excluding portfolio loan sales and securitizations of $76.4 million, total loan growth for all of 2019 would have been $218.9 million or 8.5%.

In terms of capital management, earning assets are up 6% year-to-date, reflecting all organic growth. Our capital levels continue to be strong with tangible common equity to tangible assets of 8.96% at December 31, 2019, which represents an increase of 25 basis points from September 30, 2019. This level is near the midpoint of our targeted TCE range of 8.5% to 9.5%. We paid a quarterly cash dividend of $0.18 per share on November 15, 2019. There were no share repurchases during the fourth quarter. In total 2019 -- during 2019, the company completed the repurchase of 1,204,688 shares at a weighted average purchase price of $21.82 per share. In addition, we recently announced a 2020 share repurchase plan for up to 1,120,000 shares or approximately 5% of our current outstanding shares.

At this time, I'd like to turn the presentation over to Steve to share a few comments on our financials, credit quality, CECL and our outlook for 2020.

Thanks, Brad, and good morning, everyone. I'm starting on Page 13 of our presentation. Fourth quarter 2019 net interest income declined by approximately $160,000 or 0.5% compared to the third quarter of 2019, due primarily to a decline in our net interest margin. The decline in margin was partially offset by a $35.7 million increase in average earning assets. Our tax equivalent net interest margin was 3.7% during the fourth quarter of 2019, which is down 6 basis points from the third quarter of 2019 and down 23 basis points from the year-ago quarter. Average interest-earning assets were $3.32 billion in the fourth quarter of 2019 compared to $3.29 billion in the third quarter of 2019 and $3.12 billion in the year-ago quarter.

On Page 14, we see a more detailed analysis of the linked quarter decline in net interest income. There's a lot of data on this slide, but to summarize a couple of key points. The linked quarter tax equivalent yield on loans declined 14 basis points, and the tax equivalent yield on investments declined 11 basis points, leading to a decrease in our yield on average earning assets of 16 basis points to 4.44%. This primarily reflects lower market interest rates, particularly short-term rates, partially offsetting the decline in yields. Our average cost of funds decreased by 10 basis points to 0.74% in the fourth quarter. We will comment more specifically on our outlook for the net interest margin and net interest income for 2020, later in the presentation.

Moving on to Page 15, and noninterest income totaled $15.6 million in the fourth quarter of 2019 as compared to $9 million in the year-ago quarter and $12.3 million in the third quarter of 2019. The increase was driven primarily by mortgage banking-related activity, namely changes in net gain on mortgage loans and mortgage loan servicing income caused most of the quarterly comparative year-over-year variability in noninterest income.

Fourth quarter 2019 net gains on mortgage loans increased to $6.4 million compared to $2 million in the fourth quarter of 2018. The increase in these gains was due to increases in mortgage loan sales volume, the mortgage loan pipeline and our profit margin. Mortgage loan application volume was very strong in the fourth quarter. We do expect to see a normal seasonal slowdown in the first quarter of 2020. Brad already discussed the changes in the fair value due to price of capitalized mortgage loan servicing rights. Our capitalized mortgage loan servicing rights asset of $19.2 million at December 31, 2019 represented a value of just 74 basis points on our $2.58 billion of mortgage loan servicing.

As detailed on Page 16, our noninterest expense totaled $29.3 million in the fourth quarter of 2019 as compared to $26.8 million in the year-ago quarter, and $27.8 million in the third quarter of 2019. Actual fourth quarter noninterest expenses were above the high end of our projected range of $27 million to $27.5 million, due primarily to an increase in performance-based compensation driven by the company's financial performance in the fourth quarter. We'll have more comments on our outlook for noninterest expenses later in the presentation. Investment securities available for sale increased $78.7 million during the fourth quarter of 2019.

Page 17 provides an overview of our investments at December 31, 2019. Approximately 28% of the portfolio is variable rate and much of the fixed rate portion of the portfolio is in maturities or average lives of 5 years or less. The estimated average duration of the portfolio is about 2.64 years with a weighted average tax equivalent yield of 2.84%, which is down 16 basis points from September 30, 2019.

Page 18 provides data on nonperforming loans, other real estate, nonperforming assets and early stage delinquencies. Total nonperforming assets were $11.4 million or 0.32% of total assets at December 31, 2019. Nonperforming loans increased by $2.9 million during the fourth quarter of 2019, driven primarily by the residential mortgage loan portfolio. At December 31, 2019, 30 to 89 day commercial loan delinquencies were 0.02% and mortgage and consumer delinquencies were 0.45%.

Moving on to Page 19, we recorded a credit provision for loan losses of $221,000 and an expense of $591,000 in the fourth quarters of 2019 and 2018, respectively. In addition, we recorded net loan recoveries of $221,000 and loan net charge-offs of $104,000 in the fourth quarters of 2019 and 2018, respectively. The allowance for loan loss totaled $26.1 million or 0.96% of portfolio loans at December 31, 2019.

Page 20 provides some additional asset quality data, including information on new loan defaults and on classified assets. New loan defaults were only $7.9 million during 2019.

Page 21 provides information on our TDR portfolio that totaled $50.7 million at December 31, 2019, an increase of $0.5 million during the fourth quarter. This portfolio continues to perform very well, with 93.8% of these loans performing and 92.2% of these loans being current at December 31, 2019.

Page 22, provides a detailed timeline for implementation of the CECL accounting standard. We will discuss our current CECL estimate shortly in the 2020 initial outlook slide on Page 24.

Page 23 is our final update for our 2019 outlook to see how our actual performance during the year compared to the original outlook that we provided back in January of 2019. Our initial loan growth outlook estimated loan growth in the 8% to 9% range. We achieved actual annualized loan growth of 0.4% and 5.5% for the fourth quarter and full year of 2019, respectively. If you recall from Brad's earlier comments, we sold and/or securitized $76.4 million in portfolio mortgage loans during 2019. The portfolio mortgage loan sales and securitizations were done for asset liability management purposes, including balancing the mix of our overall loan portfolio. Without those transactions, loan growth would have been 8.5%. Our original forecasted growth rate of 10% to 11% for 2019 net interest income was based on a forecast that included a single 25-basis-point federal fund rate increase in June of last year. Instead, the Federal Reserve cut their target rate by 75 basis points in 2019.

In our Q2 update, we brought our expected range down to 8% to 9%. It's under those changing conditions that fourth quarter 2019 and full year 2019 actual net interest income increased 0.1% and 8.2% from comparable respective periods in 2018. As for the loan loss provision, we expected generally stable asset quality metrics during 2019, so our outlook suggested that 20 basis points of average total portfolio loans would not be unreasonable for the year. During 2019, our actual provision was $824,000, well under the expected 20 basis points as we experienced net loan recoveries for the year, and asset quality remained healthy and stable. We'll provide the 2020 outlook under CECL in a few moments.

Moving on to the noninterest income, our actual total for 2019 was $47.7 million, which was at the high end of our initial outlook. This was driven primarily by net gains on mortgage loans. It's worth noting and included in our noninterest income for 2019 were $6.4 million of reductions to the fair value of our capitalized mortgage servicing rights due to price. With respect to noninterest expense, we ended 2019 at $111.7 million in total, which was above the high end of our 2019 outlook of just under $109 million. While we remain very focused on managing expenses, our strong performance for the year increased our performance-based compensation expense relative to the initial forecast. Finally, our effective income tax rate was in line with our 2019 outlook.

Turning to Page 24. This will summarize our initial outlook for 2020. The first section is loan growth. We anticipate loan growth in the mid-single-digit range and are targeting a full year growth rate of approximately 7% to 8%. We expect to see growth across all 3 of our loan portfolios and expect most of the growth to occur during the last 3 quarters of the year due to a seasonally slower first quarter. This outlook assumes a stable Michigan economy for 2020.

Next is net interest income, where we are targeting a full year 2020 increase of approximately 1% to 2% over 2019. This is driven by net interest margin that is generally stable relative to our fourth quarter net interest margin of 3.7%, but is lower than the full year 2019 NIM. This outlook assumes no changes in the target federal funds rate in 2020 as well as a slight increase in the long-term rates relative to year-end 2019 levels. For provision, our outlook is based on the new CECL standard. This is a very difficult area to forecast as per division levels under CECL will be particularly sensitive to loan growth and mix, projected economic conditions, watch credit levels and loan default volumes. As we continue to refine our CECL modeling and related assumptions, the estimated range of our initial CECL adjustment was changed from when we first disclosed an estimate in the second quarter of 2019's 10-Q. We now estimate our initial CECL adjustment, effective 1/1/2020, to be approximately $7 million to $8 million. This estimate is still subject to certain final review procedures that will be completed in the first quarter of 2020.

After the initial adjustment, we believe that a full year 2020 provision for loan losses in the range of 15 to 20 basis points of average total portfolio loans would not be unreasonable. Related to noninterest income, we estimate a quarterly range of $11 million to $13.5 million. We expect mortgage loans origination volumes to decline by approximately 15% due to lower refinance activity. We also expect that we will not experience a comparable level of fair value write-downs on our capitalized mortgage servicing asset due to price in 2020.

Our outlook for noninterest expense is a quarterly range of approximately $27.5 million to $28.5 million. We expect compensation and employee benefits to be slightly lower in 2020 compared to 2019 due to lower incentive compensation expense. Our outlook for income taxes remains the same in 2020 as it was for 2019 at an effective rate of approximately 20%, assuming the statutory federal corporate income tax rate does not change during 2020. And lastly, we believe that share repurchases will be just above the midpoint of our authorization of approximately 5% of outstanding shares.

That concludes my remarks for today, and I'll turn the call back over to Brad.

Thanks, Steve. 2019 was another very successful year for us as we had solid organic growth in both loans and deposits. This growth enabled us to improve our operating leverage. We exceeded our company's targets of 1.3% return on assets and 13% return on equity. We pride ourselves on investing in our communities in providing exceptional customer service. During 2019, we committed over $1.7 billion in financing in our markets, we invested nearly $750,000 in sponsorships and donations and our associates volunteered nearly 20,000 hours of time. Our customer base is growing as is our brand. During 2019, we were recognized by Forbes for the second consecutive year as having the highest customer satisfaction for banks in Michigan.

As we move forward into 2020, our plan is a continuation of those initiatives we have shared in the past, they are shown on Slide 25 of our deck. We believe the successful execution on these initiatives will continue to drive strong returns. As a community bank at the center of all our strategies is staying focused on serving our customers and investing in our markets and in our people. Our vision for the future is clear, 2020, actually, at Independent Bank, we know that our customers want to be independent, with personalized, convenient and safe financial solutions from someone they can trust. Picking a financial partner can feel overwhelming when there are so many choices, yet we understand our customers' time is valuable. Banking just shouldn't be that hard.

Here's how we simplify the experience. First, we collaborate with each customer, defining their needs and wants for the future. Next, we customize a plan that meets their goals. Then we empower each of them to be independent.

At this point in time, we'd like to open up the call for questions.

(Operator Instructions) Our first question comes from Brendan Nosal with Piper Sandler.

I just want to start off on the net interest margin here. I appreciate the guide for being flat with the fourth quarter throughout most of the year. Just kind of curious as to the puts and takes that would allow you to hold the margin flat? I mean, I'd imagine if the Fed does not cut rates further, it's certainly one of the things that could help out, but I'm curious what else underlies that expectation?

Well, this is Brad. I guess, first off, for the fourth quarter we're at 3.7%. As we look into 2020, we've got some pretty respectable loan growth expectations there. And -- but I think we're -- maybe some of the lever for the bank is still the opportunity on the cost of funds side. And over the years, we have structured the funding side with a lot of detailed segmentation of our customer base and really looking at the customers' usage of the bank services, the balances that they carry and so on. So I think, prospectively, one of the levers is on the funding side. Thereafter, we're going to continue to push on the production side, but not at the sacrifice of credit quality.

Steve, I don't know if you have anything to add here.

Yes. No, the pricing structure on the asset side are going to remain important to us. And we're not going to give the credit quality. We're not going to change what our targeted structure or price range is, I mean, on the asset side.

All right, great. That's helpful. And then if I can sneak another one in there. Moving on to the provision. The outlook for 15 to 20 basis points, that's obviously a big step-up from this year, of course, in 2019, you had nice net recoveries. I'm just curious, how much of that higher provisioning level is driven by CECL? So I guess, kind of what would you think it would be absent the new capital guidance?

Absent CECL would be basically flat. If you look at where our ALLL is going into this transition into CECL, we're at 96 basis points of loans. CECL, with the adjustment, will get us up, let's call it, approximately 1.25% of loans. So that provision guidance, going forward, allows for additional loan growth at and around that new CECL expected ALLL rate as well as allowing for some level of charge-offs.

Okay, got it. So basically, just kind of allows for you to hold the reserve at the new post CECL level?

That is correct. We don't anticipate 2020 having near the same level of recoveries as we've seen in the last couple of years. So we're allowing for both in that number.

No, I mean we have had 3 consecutive years for that to recover. So it would be nice to understand that. Yes, that would be good.

Our next question comes from Russell Gunther with D.A. Davidson.

Thanks so much for all of the detail on the loan growth outlook, you had 7% to 8%. I hear that the expectation is for contribution across your lending verticals. I would just be curious if there is -- I thought that, that would be pretty evenly spread if one particular vertical might have better strength than another? And then, from a geographic perspective, submarkets within the Michigan footprint that might be or continue to be bigger drivers of growth?

Right, right. Yes. So Russell, that's a good question. Again, I think we believe that we are positioned to give a balanced growth in all 3. One of the intentions of our company in committing resources to the multiple categories is you just don't know. Well, one may be stronger at one-time and then another portfolio maybe getting a little stronger, and we saw evidence of that here in Q4 with the mortgage originations being very, very strong. But I hope that it'd be coming out of all 3. I think, on the commercial front, when I look at the number of origination staff that we have starting the year versus where we started the -- a year ago, we're up. We've been, I think, solidly moved forward in terms of adding talent to our team and then there, obviously, continues to be disruption in our marketplace. So I think it's the addition of staff and the disruption in the marketplace that creates the opportunity for us on the commercial side.

On the mortgage side, I'm pleased to report, knock on wood here, we've had a very little turnover in this team now for an extended period of time and actually while we're down a little bit in the pipeline here at year-end versus the third quarter, we're better than -- higher than we were a year ago at this time. And so I think we're approaching 2020, even though the Mortgage Bankers Association believes that overall mortgage volume should be down principally because of lower refinances, I'm still very optimistic on the mortgage side. And then as we move over to the consumer side that really comes out of our branch network and I'm so pleased with the development of that team, the stability of that team and they continue to, I think, grow in their efforts to originate consumer installment loans. And then, of course, the indirect, which has been the horst for us for multiple years. It's the same small group of teams that are out knocking in on our dealers and getting sort of first look at the best paper and I applauded them this morning on an all-employee call, as I said, what are records meant for, they are meant to be broken. And this team continues to break their annual production volumes year after year.

So that's sort of how we're looking at growth in 2020. And Steve, I don't know if you got anything to add there?

No, nothing to add there at all.

I appreciate that, guys and the detailed response. Last question would be, and in consideration of the guidance you laid out on the noninterest expense side. How do you tie all this together and think about a core efficiency ratio for 2020 and how that fits into your kind of near and long-term targets for that guidepost?

So as far as the noninterest expense side and our growth of just under 1% for the year, we anticipate, based on the budget, a lower incentive compensation expense for next year. However, we do also have merit increases that went into effect towards the end of the year and the beginning of 2020. And so the 2 of those will rather offset each other to keep those expenses about flat at under just 1% increase.

If you look at the efficiency ratio, that is something that we intend to keep focusing on expenses. We intend to keep downward pressure on those expenses and so that being said, our plan and our target is to keep those going down towards our long-range target of 60% in the next few years.

As far as specific strategies, it's really going to be across the Board, whether it'd be large contracts, management of headcount, that type of thing.

I don't know, Brad, if you have other questions?

Yes, I think that covers it. I think one thing that's in our deck, on Slide 16, we have a nice trend line that shows year-over-year, continued improvement in the efficiency ratio. That said, we still feel like it's higher than we would like it, and there's a continued emphasis on dropping it. I think our accounting finance area recently shared that probably 100 -- a 1% drop there is about a $1.7 million reduction in cost is what's needed. And so that's our goal is to keep whittling away at that.

I think -- and sorry to tag team back and forth between Brad and myself. If you look at that trend, that downward trend of the efficiency ratio, our associates here, the staff here has done a fabulous job of doing much more with less, and we anticipate that we will continue to do that. The staff here really, really responsible also the challenge of continuing to bring that ratio down.

Our next question comes from Kevin Swanson with Hovde Group.

Just a follow-up on the provision question. With ex-CECL provisioning relatively flat. It sounds like there's no real credit concerns on the horizon. But just interested on your perspective if there's any areas you see heating up or areas you're kind of shying away from?

So I am very pleased with our company's -- where we're at today with overall asset quality. During '19, we did have, through the third quarter, some elevation in the watch credits. I think we were up at 7.2% of the commercial book. And in that year at fourth quarter, we were able to bring that down to, I think, 6.7%. And I would just say that as we look through our top 50 relationships, and as our team meets on a quarterly basis looking at the entire portfolio, there are not any one segment that necessarily stands out. We don't have tremendous concentrations to begin with, that's intentional. So I feel very, very pleased with where we're at. At year-end, we had a slight uptick in the retail past dues. And I think it was -- there was one loan, it was $1.1 million where there was a problem with the incoming ACH, not on our end, but of the sending banks and it and so that came current right after year-end.

So I feel really good. I think the challenge has been, and we referenced this a little bit earlier, over the last X number of years, we've had this very strong stream of recoveries in both the commercial portfolio and retail portfolio. And I think we're still going to have some recoveries. I think they'll be lumpy, but we just -- we're not expecting them to be necessarily at the same level.

And as far as credit trends are concerned, I mean, we don't see anything in any particular area or geography that leads us to think that there's any kind of systemic or widespread issue going on. Any of the items we talk about are -- have just been one-off kind of situational items. So in our book, we don't see any danger there at this point.

Great. And then adding the production office in Toledo, is that kind of the most likely form of footprint expansion? And maybe just kind of comment on how M&A plays into the thought process there?

Yes. So historically, and prospectively, our growth in the market is just going to be talent driven. Several years back, we opened a number of LPOs, including our interest in Ohio, the Akron market and the Columbus market, here with the latest one in Toledo. And so it was following up on the positive image that the company has in the marketplace with our mortgage, particularly, in this case, the mortgage banking side. We're looking at where can we find talent. These recruiting efforts don't happen overnight. They're over a period of time. What I like about this, obviously, it sort of connects the dots a little bit with the other two Ohio locations, gets a little closer back to the core deposit franchise here in Michigan. And I am hopeful that, at some point, we can start converting some of these LPOs into full-service locations at a certain point.

Great. And then maybe just one final one. I appreciate the updated guidance for 2020. Maybe if we're on the call a year from now, you guys have a better-than-expected year. Are there certain areas you think would stand out leading to better results? Or are there certain areas that you're particularly excited about?

I think that, that's a great question. And I think 2020 is going to have things that we expect to happen and things that we don't expect. And as I tell our team, ultimately, it's about how we respond to those unexpected challenges. And so I think we have a solid game plan for 2020. We've also put together a refresh of our 5-year forecast. As we've mentioned earlier in the call, I think, we believe the efficiency ratio is an area that we need to continue to work on. So I'm hopeful that we can continue to chip away on the expense side. And I'm cautiously optimistic that we can continue to have the exceptional credit levels and then maybe resulting lower provision levels. But I mean, it's just been so benign here for multiple years, it's hard to say. So I don't know if that doesn't tip my hand too much or maybe too much. But Steve, anything to add?

I'm not adding to any of that as far as 2020.

You our next question comes from Scott Beury with Boenning and Scattergood.

Congratulations, Rob.

Thank you, Scott.

So just kind of tying a couple of pieces in your guidance here together with to 7% loan growth and kind of mid-single-digit deposit growth. I'm just curious, does that imply that overall balance sheet growth is going to be a little bit slower than the loan portfolio, i.e., like do you see remixing out of securities into loans being kind of a part of that forecast?

Yes, I think that's fair to say that we'll see some reduction. On the security side, we're actually up quite a bit at year-end. So that's fair to say.

Yes. And I guess, just a follow-up on that. Do you have any sort of target range, whether it be in dollar figures or as a percent of assets of -- trying to where you'd like the securities book to be? And kind of how low you'd be comfortable with?

From a comfortable perspective, we generally look at kind of that 10% to 12% range as being where we want to be at the lowest.

So 10% to 12% of securities to total assets.

Correct.

Yes. There's a lot of metrics that we watch and monitor there in terms of liquidity. And I think that's a lot of what we're talking about here. But we, consistently, over the last few years, have said, hey, we get to about 10% or 12%. That's about our comfort level.

Well, that's very helpful. And most of my other questions have been answered. But I guess, just 1 follow-up. As it pertains to capital management and potential M&A opportunities. Can you just give a refresher on kind of what your geographic target area would be for M&A? As well as maybe like size of target?

Sure. If we talk about M&A, I think it's sort of put a little further down the capital usage priority list. Again, we -- organic growth would be the first priority. But an acquisition would assist us in getting improved scale, of course. And so when we think about target metrics, I'd say markets, first, would be our home market here in Michigan. And I'd say, generally, filling in within the holes of the existing footprint. And I'd say there's a preference probably for some of the stronger growth markets, albeit you then also comes through oftentimes in more competitive pricing. But -- so that's sort of the -- on a markets standpoint. And then I think there's a size where maybe -- because an acquisition involves a lot of resources and time that maybe has to be a certain size. And I think we've felt like the Traverse City acquisition that we closed on in 2018 at a little over $300 million that was a nice size for us. So I'd say sort of that size, and we could go larger. It could be up to that $750 million, maybe a little bit more, but that's probably the sweet spot. Having said that, I -- hey, there's always exceptions, but that's sort of the target range.

Excellent. No, that's very helpful. And then just as we've seen kind of across the industry, they're starting to become a trend of more and more MOE type transactions. Then I guess, just on a higher level, what are your thoughts on a potential opportunity of that nature? And just kind of any high-level views on that?

Well, I think that MOEs can make a lot of sense. And there's a lot of considerations and it -- the financial metrics need to be easier. And so that would be a starter. And there's just some combinations when you drill out of the financials, they don't make sense. But if it does make sense, then it's about maybe culture and how are the cultures going to blend. And I agree, we have seen, in recent history, some where the cultures -- where the metrics made sense and the cultures didn't mesh and there was a lot of unexpected change. We've also seen MOEs where metrics made sense, the cultures meshed, and they look really good. So from our standpoint, we would consider that in the same context that our Board, and they do this on a regular basis, the entire upstream, downstream, i.e., MOE review -- opportunity review. So that's sort of a high-level on the MOE side.

Steve or Rob, I don't know if you guys have anything to add there?

No.

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

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

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