Independent Bank Corp (Michigan) (IBCP) 2021 Q4 法說會逐字稿

Good morning, and welcome to the Independent Bank Corporation Reports 2021 Fourth Quarter and Full Year Results 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.

Good morning, and welcome to today's call. Thank you for joining us for Independent Bank Corporation's conference call and webcast to discuss the company's fourth quarter and full year 2021 results. I am Brad Kessel, President and Chief Executive Officer, and joining me is Gavin Mohr, EVP and Chief Financial Officer; and Joel Rahn, EVP, Commercial Banking.

Before we begin today's call, I would like to direct you to the important information on Page 2 of our presentation, specifically the cautionary note regarding forward-looking statements. If anyone does not already have a copy of the press release issued by us this morning, 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.

Slide 4 provides a good summary of our historical results. I am very pleased with the high level of performance by our team generating strong core results for yet another quarter and now for the full year 2021. We continue to execute on our strategies of investing in people and technology.

During the fourth quarter, we saw a good growth in net interest income, stabilization of our net interest margin and across-the-board loan growth net of PPP.

Our commercial pipeline is at its highest level in many quarters. Deposit gathering continues to be robust, both by existing customers as well as the addition of new customers. In addition, while mortgage gains have tapered down, they continue to be solid and our card strategies continue to generate positive growth in interchange revenue.

On the asset quality front, I could not be more pleased with our net recoveries for the full year as well as commercial watch credits at just 3.1% of the portfolio and a very low level of past due loans. We are excited about the momentum we have in our markets, and we look forward to continuing these trends into 2022.

Turning to Page 5. Independent Bank Corporation reported fourth quarter 2021 net income of $12.5 million or $0.58 per diluted share versus net income of $17 million or $0.77 per diluted share in the prior year period. The highlights included an increase in net interest income of 10.6% over the fourth quarter of 2020.

Net gains on mortgage loans of $5.6 million in total mortgage loan origination volume of $424.6 million. Net growth in portfolio loans of $21 million or 2.9% annualized, excluding PP loans increased by $84.9 million or 11.8% annualized; continued strong asset quality metrics as evidenced by lower net charge-offs during the quarter as well as low level of nonperforming loans and nonperforming assets; and our payment of a $0.21 per share dividend and common stock on November 15, 2021.

Turning to Page 7. For the full year ended December 31, 2021, the company reported net income of $62.9 million or $2.88 per diluted share compared to net income of $56.2 million or $2.53 per diluted share in 2020. The increase in full year 2021 net income as compared to 2020, primarily reflects an increase in net interest income and a decrease in provision for credit losses that were partially offset by a decrease in noninterest income and an increase in noninterest expense and income tax expense.

Highlights for the full year of 2021 include increases in net income and diluted earnings per share of 12% and 13.8%, respectively; annualized return on average assets and average equity of 1.41% and 16.1%, respectively; net gains on mortgage loans of $35.9 million and record total mortgage origination volume of $1.9 billion; net growth in portfolio loans of $171.4 million or 6.3% annualized; net growth in deposits of $479.7 million or 13.2% annualized. We paid $0.84 in dividends, which was a 5% increase compared to 2020, and tangible common equity per share increased by 6.1% to $17.33 per share.

Page 8 provides a good snapshot of our loan and deposit metrics for our Michigan markets. I would point out that our 2 loan production offices opened in Ottawa County and Macomb County during the third quarter of 2021 and are off to a strong start. As a result, we do plan to open a new full-service office in Ottawa County during the first half of 2022.

Turning to Page 8, we display several key economic statistics for the state of Michigan. Overall, we are seeing continued improvement in the unemployment rate for Michigan now at 5.9%, above the national average of 3.9%.

However, the state of Michigan has 282,000 fewer workers employed today as compared to pre-COVID. Labor shortages are having a noticeable impact on many segments of our economy, including an increase in wages in our markets and reductions in business operating hours.

In addition, supply chain shortages are also constraining many businesses in our markets. Regional average home sale prices continue to climb as inventory levels in many of our markets continue to be at record lows and negatively impacting the overall volume of home sales. That said, we continue to have very strong applications levels for new home purchases.

On Page 10, we provide a couple of charts reflecting the composition of our deposit base as well as the continued growth in this portfolio while working to effectively manage our overall cost of funds. Extensive government stimulus continues to result in increased deposit levels for many of our customers.

Turning to Page 11. We have a few highlights relating to Independent Bank's digital transformation. Following our second quarter whole bank conversion, we continue to see good utilization and growth rates in our ONE Wallet, ONE Wallet+ and Treasury ONE platforms.

At this time, I would like to turn the presentation over to Joel Rahn to share a few comments on our loan portfolio.

Thank you, Brad. On Page 12, we provide an update on our $2.9 billion portfolio. For the fourth quarter, commercial balances decreased $19.2 million. However, if you exclude PPP activity, our commercial balances increased by $45 million for the quarter, and for the year, excluding PPP loans, our commercial portfolio grew by 9.4%. Looking more closely, if the growth of the third and fourth quarters is annualized, the commercial portfolio increased at an annualized pace of nearly 19%. As Brad said, our commercial pipeline is very strong, and we expect solid commercial loan growth in the first quarter of 2022.

In the fourth quarter, our residential mortgage balances increased by $38.7 million and installment balances increased by $1.6 million. Our mortgage pipeline while down from peak levels continues to display strength. We remain optimistic about our ability to accelerate the earning asset rotation from lower-yielding investments to higher-yielding loans, and we continue to believe we're on track to grow loans at a low double-digit pace in 2022.

If you turn to Page 13, we provide an update on our loan COVID-related modifications, which declined to $2.3 million or 0.1% of total loans at December 31, although one of these modifications are in our residential mortgage portfolio.

Moving to Page 14. We provide an update on the bank's administration of the SBA's Paycheck Protection Program. As of December 31, 2021, we had $26.2 million in balances outstanding and $806,000 in net unaccreted fees. We expect these remaining loans to be forgiven and fees to be accreted into interest income during the first quarter of 2022.

On Page 15, we display the concentrations of our $1.2 billion commercial loan portfolio. Consistent with prior quarters, you'll note that 63% of the portfolio is comprised of the variety of C&I categories, the largest of which is manufacturing at $114 million or 9.5%. The remaining 37% of the portfolio is comprised of commercial real estate, the largest concentrations being retail at $109 million or 9%, and of office the majority of which is medical- related at $72 million or 6%. The portfolio is very granular in nature, and our credit metrics indicate that this portfolio has held up very well through the pandemic and resulting supply chain pressures.

So at this time, I'd like to turn the presentation over to Gavin to share a few comments on our investments, capital, financials, credit quality, and our outlook for 2022.

Thanks, Joel, and good morning, everyone. I'm starting at Page 18 of our presentation. Net interest income increased $3.3 million from the year ago period. Our tax equivalent net interest margin was 3.13% during the fourth quarter of 2021, which is up 1 basis point from the year-ago period and down 5 basis points from the third quarter of 2021. I'll have some more detailed comments on this topic in a moment.

Average interest-earning assets were $4.3 billion in the fourth quarter of 2021 compared to $3.98 billion in the year ago quarter and $4.3 billion in the third quarter of 2021.

Page 19 contains a more detailed analysis of the linked quarter increase in net interest income and a decrease in the net interest margin. Our fourth quarter '21 net interest margin was mainly impacted by 3 factors. Decrease in yield on securities available for sale had an impact of negative 1 basis point. Growth in liquid assets had an impact of negative 4 basis points and the change in the loan yield and mix had an impact of a negative 3 basis points. We will comment more specifically on our outlook for net interest income and the net interest margin for 2022 later in the presentation.

Moving on to Page 20. Noninterest income totaled $15.8 million in the fourth quarter of 2021 as compared to $22.4 million in the year ago quarter and $19.7 million in the third quarter of 2021. Fourth quarter '21 net gains on mortgage loans totaled $5.6 million compared to $15.9 million in the fourth quarter of '20. The decrease in these gains was due to a decrease in the mortgage loan sales volume and in the mortgage loan pipeline as well as lower loan sale profit margins.

Mortgage loan applications remain solid, although refinance applications slowed in the fourth quarter of '21. Our purchase market volumes continue to be strong. Positively impacting noninterest income was a $1.3 million gain on mortgage loan servicing due to a $0.6 million or $0.02 per diluted share after tax increased in the value due to price and a $1.3 million decrease due to paydowns of capitalized mortgage loan servicing rights in the fourth quarter of '21.

As detailed on Page 21, our noninterest expense totaled $34 million in the fourth quarter of 2021 as compared to $32.7 million in the year ago quarter and $34.5 million in the third quarter of 2021. Compensation increased $0.6 million compared to the prior year quarter due to raises that were effective at the start of the year. The hiring of new lenders and increased overtime related to data processing conversion.

Performance-based compensation decreased $1 million due to a higher full catch up in the fourth quarter of '20. The fourth quarter of '21 included $0.9 million of costs related to the reserve for unfunded lending commitments due to an increase in unfunded lending commitment balances. We will have more commitments on our outlook for noninterest expense later in the presentation.

Page 22 provides data on nonperforming loans, other real estate, nonperforming assets and early-stage delinquencies. Total nonperforming assets were $5.3 million or 0.11% of total assets at December 31, 2021. The loans 30 to 89 days delinquent decreased to $2.3 million at December 31, 2021, compared to $2.4 million at September 30, 2021.

Page 23 provides some additional asset quality data, including information on new loan defaults and on classified assets. I would highlight, there were no new commercial loan defaults for full year 2021.

Page 24 provides information on our TDR portfolio that totaled $37 million as of December 31, 2021. This portfolio continues to perform well with 96.4% of these loans being current at December 31, 2021.

Moving on to Page 25. We recorded a provision for credit losses expense of $0.6 million in the fourth quarter of '21 compared to a provision credit of $0.4 million in the year ago quarter and a provision credit of $0.7 million in the third quarter of 2021. The allowance for loan losses totaled $47.3 million or 1.63% of portfolio loans at December 31, 2021. This ratio increases to 1.64% when excluding the PPP loans and the remaining Traverse City State Bank acquired loans.

Page 26 is our update for our 2021 outlook to see how our actual performance during the year compared to the original outlook that we provided in January of 2021. Our outlook estimated loan growth in the low single digits. Loans increased $21.1 million in the fourth quarter of 2021 or 2.9% annualized. Growth in mortgage and installment loans were offset by a decline in commercial loans due to a $63.8 million decrease in PPP loan balances in the fourth quarter of '21. Excluding PPP loans, total portfolio loans grew at 11.5% annualized rate during the full year of 2021, above our forecasted range.

For full year 2021, net interest income increased by 5% over 2020, which is higher than our forecast. However, the net interest margin for the full year of 2021 was 24 basis points lower than the full year of 2020 net interest margin of 3.34%, which is a steeper decline than our forecast. Higher-than-anticipated deposit growth that has largely been deployed into lower-yielding investment securities are the primary reason for these variances.

The fourth quarter '21 provision for credit losses was an expense of $0.6 million. This is below our forecasted 2021 full year provision range of 0.25% to 0.35% of average total portfolio loans. The primary drivers of the decrease in provision for credit losses were a decrease in the adjustment to the allocations based on subjective factors and an increase in recoveries of loans previously charged off.

Noninterest income totaled $15.8 million in the fourth quarter of '21, which is within our forecasted range of $13 million to $16 million. The mortgage loan pipeline continues to be solid, although refinance activity slowed down in the fourth quarter of 2021.

Noninterest expense was $34 million in the fourth quarter, outside our $28.5 million to $29.5 million targeted quarterly range. Increases in compensation and employee benefits, data processing and expense related to the reserve for unfunded lending commitments were the primary categories that caused noninterest expense to exceed the target range. Our effective income tax rate of 19.2% and 18.6% for the fourth quarter and full year 2021, respectively, was a bit lower than our forecast. This is due in part to a higher-than-expected levels of tax-exempt interest income. Lastly, the company purchased 814,910 shares at an average cost of $21.19 for the full year of 2021.

Turning to Page 27. This will summarize our initial outlook for 2022. The first section is loan growth. We anticipate loan growth in the low double-digit range and are targeting a full year growth rate of 10%. We expect to see growth across all 3 loan categories. This outlook assumes an improving Michigan economy. Next is net interest income where we are forecasting a low single-digit growth of 1% to 3% over full year 2022. We expect the net interest margin to trend lower compared to the full year 2021 by 10 to 15 basis points, primarily due to declining yields on earning assets. This forecast assumes a 25% increase in June and September and target federal funds rate in 2022, with long-term rates up slightly by year-end. Full year 2022 provision expense for the allowance for credit losses of approximately 0.15% to 0.20% of average loans would not be unreasonable.

Related to noninterest income, we estimate a quarterly range of $13 million to $17 million. We expect mortgage loan origination volumes to decline by approximately 21% in 2022, combined with declining margins on sold loans. Our outlook for noninterest expense is a quarterly range of $30.5 million to $32.5 million with the total for the year, 3% to 5% below 2021 actuals. We expect total compensation and employee benefits, the conversion-related expenses to be lower in 2022 compared to 2021. Our outlook for income tax is an effective rate of approximately 18.5%, assuming the statutory federal corporate income tax rate does not change during 2022. Lastly, we believe the share repurchases will be at the midpoint of our authorization of approximately 5% of outstanding shares.

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

Thanks, Gavin. Slide 28 displays a high-level view of our key strategic initiatives. During this past year, we have harvested the fruit of seeds planted in prior years. This included our investments in the mortgage banking business in prior years when others were exiting the business. As a result, over the last few years, we have produced record origination volumes, strong fee income and a material increase in our overall servicing customer base with over 11% increase in balances serviced for others.

With the heightened probability of moving to a higher rate environment, we are seeing a decline in refinance activity yet our home finance purchase volume continues to be strong. In 2022, we made significant investments to our overall technology platform to improve the customer experience and increase productivity amongst other goals. We have already seen some very positive results. In this investment, I believe we will see continued growth and improved productivity in 2022.

Very significant investments were made in human capital in 2021, specifically the recruitment and expansion of our commercial banking team by over 25%. These investments in people are already showing results with this very strong commercial pipeline as we begin fiscal year 2022. We have increased our earnings per share and dividends for 8 consecutive years. I believe we are well positioned for 2022 and beyond.

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

(Operator Instructions)

Our first question comes from Brendan Nosal with Piper Sandler.

Maybe just digging into the cost outlook a little more to start off here. I mean expenses down 3% to 5% feels fairly optimistic given the inflationary environment. So maybe help us break down that improvement between the 3 areas that you call out in the guidance slide and then tie it into how you can drive a decline in comp expense this year, despite wage pressure.

Yes, so referencing the slide as we talk about the incentive compensation, that based on the current budget this year, again, we had -- as you are aware how the compensation is structured, we did outperform. So the accrual was higher. We believe next year, it will be -- that will not be the case. So it's really coming through a reduction in the incentive piece. We have lower -- anticipate lower mortgage production. There were incentives that were tied to that production as well beyond just the broad company goals. Reduction in overtime related to the conversion, it all greatly reduced, if not fully reduced conversion-related expenses this year.

As we've seen those, as you can see, this quarter declined significantly. And then the other thing that we had pointed out here, we saw an increase in the unfunded lending commitments in 2021 as we've seen the growth in the outstandings, not necessarily balance outstandings, but just the availability of credit through that asset class.

Got it. All right. That's helpful color. Maybe one more for me, turning to kind of provisioning needs and reserve coverage. I mean a ratio of kind of 1.65-ish percent strikes me as very healthy. So the outlook for 15 to 20 bps of loans in terms of provisioning is probably a bit heftier than I was thinking, given that strong coverage ratio.

So can you maybe offer a little bit of insight into how much you have left in COVID factors in the reserve today? And how that might allow you to flex the reserve ratio lower as we move through the year?

Yes. Another great question. So subjectively, there is currently $12.7 million within the reserve that we would define as objective. There are 12 basis points within the reserve to total loans that is COVID-related in some form or factor. And so to your point, I guess, there could be some potential there, but what we're really seeing, Brendan, is the growth in the pooled factor. So as our loans are growing, we've seen strong growth in the mortgage portfolio, and that is one of the most costly in terms of booking assets because of the length of the cash flows to reserve pool and the allowance for credit losses. So that's the offset. So actually, quarter-over-quarter, this objective did come down $1 million, but it was just offset by the loan growth.

Our next question comes from Damon DelMonte with KBW.

So first question regarding the margin guidance. I think you mentioned it to be down a bit from where it was this past quarter. Is that guidance taking into account the core margin? Or is that the -- like the reported margin, which included the PPP impact during 2021?

Great question. So that is the reported margin. We -- the core we think will be very, very stable through 2022.

Okay. All right. Great. That's helpful. And then could you just elaborate a little bit more on the revenue outlook? I mean -- sorry, the noninterest income outlook when you consider the decline expected in mortgage banking, what are some of the other positive drivers that we could look for?

So one of the factors there, a couple, right? So one, we are factoring into rate increases in -- I guess, are you talking about noninterest income? I apologize.

Yes, I'm sorry. Yes, noninterest income.

Yes. Okay. So yes, as we are saying, it will be down. We continue to see very good growth in the interchange income. It's approximately 5% year-over-year as well as service charges on deposits. We are forecasting a decline in NSF fees, as I think the industry is anticipating. But we think that the treasury management-related service charges can offset that to seeing growth in the treasury management area fees as well. So does that give you a little more context?

Yes, it does. That's helpful. And then I guess just lastly on the loan growth outlook. When you talk about the strong commercial outlook, how do you see that breaking out between C&I and CRE loans? Is one area kind of set up better for growth over the other one or is it pretty equally split?

Yes. This is Joel. We, by design, are going to keep that very evenly split. We've been running roughly 60-40 on C&I versus investment real estate and we like that balance. We want to maintain it. So we're forecasting growth on -- in both of those buckets, and yes, that's important to us that we want to maintain that discipline.

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

Just a quick follow-up on the loan growth discussion. I appreciate the color on the 10% double digits and what you just remarked on CRE versus C&I. Just wondering within the mix of that 10% growth, do you expect it to be similar to '21? Would there be less of an appetite to portfolio single-family resi today, given the commercial outlook? Just want to get a sense for how you think that 10% breaks down across asset classes.

Yes. Great question. So to indicate, we are sensitive to the mix. I think this year is going to be a good representation of what we will look like going forward. The growth rate is pretty level across the 3 loan categories next year.

That's very helpful. And then you guys mentioned the 2 LPOs in the -- came online in the third quarter opening a full-service in 2022. Do you consider LPOs an adjacent or expansion market? It sounds like that's not included in your 10% guide, but bigger picture, is that something strategically you would look to do?

I guess I'm not clear, Russell, in terms of your question because the -- those loan growth forecast are a function of the 2 LPOs that are online. So...

Yes. No, understood. I'm sorry if I wasn't clear. I was asking if kind of bigger picture strategically, you would think about additional LPOs in adjacent markets or even a bit further afield than what you typically do in footprint, is that something you guys would look to do?

Yes. Okay. Yes. So I would say right now, we're always open to growing our talented team and we continue to have ongoing dialogues. And so additional LPOs are probably a function of our desire to and success in adding new recruits. Having said that, I do think, as Joel mentioned, we've grown the team by a substantial amount in the last year. And so there is, I think, an important effort to blend them into our culture and with the existing team. So I'd say, it can happen, but we're not -- as we forecast 2022, it's not a huge part of what we're trying to accomplish.

Understood. I appreciate the thoughts there, Brad. And then switching gears to the margin. So I appreciate your thoughts, guys, in terms of the NII expectations and your rate assumptions. Could you isolate though for your thoughts around what the 25-basis point move in Fed funds means to your margin? And what deposit betas you would be assuming in that analysis?

Yes. Great question. The 25 basis points is 1 to 2 basis points of margin and that's with a very low beta. We think the first couple will be able to really hold back on increasing deposit rates. So low beta assumption there.

Got it. Okay. Very helpful. And then the last one for me is, within your NII guide, what are you guys thinking in terms of the investment portfolio, overall size in terms of growth or potential contraction in '22?

Yes. So there is an asset rotation that we'll have -- we are optimistic that it will take place -- start to take place in 2022. I don't anticipate the size of the portfolio drastically shrinking, but also maintaining current level to slightly declining would be reasonable through the year just depending on when we experienced the loan growth.

Our next question comes from Daniel Cardenas with Boenning and Scattergood.

Quick question on the lending side. Could you give us a little bit of color as to the competitive factors that are out there, specifically as it relates to pricing in your various markets? Do you kind of see that as a headwind to the loan growth in 2022?

Let's break that down. Let's go with commercial first and Joel maybe talk a little bit about that.

Yes. I mean pricing is always a factor. And when the whole industry is looking for earning assets, there's been a lot of competition and squeeze on the pricing. We don't see that being -- that environment being dramatically different in 2022 than it was, frankly, in 2021. The little bit of increase in -- or the forecast increase, the rate hikes will help a little bit and the bond markets already do. So I mean, we're seeing pricing yield on the fixed rate loans are increasing following the treasury market, but then we've got some smaller community banks around the state that always kind of seem to lag that. So it keeps pressure on our margins a little bit as the rates are rising because the industry doesn't move in tandem, obviously. Everyone's got a slightly different philosophy. So yes, there's going to be continued pressure there, but we're finding a way to win business at fair returns, and with a focus on really good credit quality.

And I think to add then over on the mortgage side, it is very, very competitive, both the salable and nonsalable. There's pressure on the margins there. We've seen -- as an example, I think the jumbo pricing, which historically you'd have some type of premium to the conforming and then it was riding for a lot of last year right on top, we've seen that go through and be less than some of the conforming pricing. And so we -- we've considered that in our forecast, and we're fighting real hard and Independent believes being in the business for the long haul. It may be a little more challenging in the early part of the year here as we -- Q1 and whatnot, but yes, the mortgage side is definitely heightened in terms of its overall competitiveness.

Okay. Excellent. And then how should I think about deposit growth going forward? Is that -- I don't think it's going to keep lockstep with loan growth, but what's kind of the outlook on the deposit side in '22?

I can take first shot. We have now for a couple of years seeing deposit growth outpaced loan growth significantly. We think that's going to flip this coming year. Very difficult to forecast the surge in deposits, if you will, and how long they'll stick. I think it's directly -- it will be directly related to how fast rates move and whatnot. But we are, in our forecast, keeping deposits pretty flat.

So back to a much more historical run rate to that 2-ish percent levels, nothing what we've seen in the last few years.

Okay. Excellent. And then last question for me. As your digital platform continues to gain traction, how do you guys think about your branch franchise? Is that something that would begin to contract as your digital platform grows? Or is that not necessarily the case?

Well, Daniel, that's a great question. And over the last 8 to 10 years, the branch footprint that Independent, as feels it has significantly changed. We had over 100 locations at -- in the early 2010, '11 time frame, and over the years, we really pared it back. At the same time, we more than doubled the average -- well more than double the average deposits per branch.

In 2010 -- I'm sorry, in 2020, we consolidated another 8 locations. In 2021, we did do the whole bank conversion and really the -- moving forward with the digital transformation. That really, I think, is going to help us as we go forward. We likely will have some additional, what we call, branch optimization. We're constantly looking at profitability per location. We're looking at the average number of transactions per FTE, and that has -- that continues to decline. So I think it would be reasonable to see us scaling back some additional in the coming quarters.

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

In closing, I would like to thank our Board of Directors and our senior management for their support and leadership. I also want to thank all our associates. I continue to be so proud of the job being done by each member of our team. Each team member, in his or her own way, continues to do their part towards our common goal of guiding our customers to be Independent.

Finally, I 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.