Independent Bank Corp (Michigan) (IBCP) 2020 Q2 法說會逐字稿

Good morning and welcome to Independent Bank Corp.'s Second Quarter 2020 Earnings Conference Call. (Operator Instructions) Please note that this event is being recorded.

I'd 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 2020 second quarter results.

I am Brad Kessel, President and Chief Executive Officer; and joining me is Rob Shuster, who rejoined Independent Bank Corporation as Chief Financial Officer last month. We are very appreciative to have Rob rejoin our team as we work to permanently fill the position vacated with the resignation of Steve Erickson. Also joining us today is Jim Mack, Executive Vice President and Head of Commercial Banking for our company.

Before we begin today's call, it is my responsibility to direct you to the important information on Page 2 for the cautionary note regarding forward-looking statements. If anyone does not already have a copy of the press release issued by our attendant 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, I'd like to take a moment to pause and recognize the very difficult period of time this past quarter has been for our country, our communities, and our associates. Too many lives have been lost or negatively impacted by the coronavirus as have too many lives have been lost or negatively impacted by racism and social and inequity. This period of crisis does hold opportunity for positive change.

We are thankful to our customers, employees and our Board of Directors. The hope, patience and perseverance that all of you as the Independent Bank Corporation community have demonstrated is simply amazing. To all of them and to you, our investors and analysts, I hope that you and your families are and remain safe and healthy during these difficult times.

Our efforts to keep our customers and employees safe in this environment began on March 3, 2020, when we enacted our business continuity plan to help prevent the spread of the coronavirus.

On March 10, 2020, the Michigan Department of Health and Human Services identified the first 2 positive cases of COVID-19 in Michigan. Since then as of July 27, the U.S. CDC reports Michigan with 71,019 cases and 6,151 deaths due to the coronavirus, while Ohio reports 84,073 positive cases and 3,307 deaths.

Page 4 of our slide presentation was some of the actions that we have taken since the start of COVID-19 to protect our employees, clients, vendors and the communities we serve.

Turning to the financial highlights on Page 6. I am extremely pleased to report a very strong financial performance in the second quarter of 2020 despite the many challenges brought on by the COVID-19 pandemic. In my opinion, our associates did an amazing job during this quarter. We closed nearly $0.5 billion of mortgage loans, helping our customers to buy new homes or refinance existing mortgage loans. We closed over $250 million of PPP loans, helping our customers to keep their employees on the payroll and their businesses operating. We actively administered over 1,700 forbearance plans to help our business and retail customers who have been adversely impacted by the COVID-19 pandemic. We continue to effectively operate our business continuity plan to safely serve our customers and protect our employees.

Finally, we maintained the solid asset quality metrics during the second quarter of 2020 and, in fact, continued to build loan loss reserves. Excluding PPP loans and the remaining Traverse City State Bank acquired loan balances, the allowance for loan losses was equal to 1.38% of portfolio loans at June 30, 2020.

Net income was $14.8 million or $0.67 per diluted share in the second quarter of 2020 versus $10.7 million or $0.46 per diluted share for the year ago quarter. For the 6 months ended June 30, 2020, the company earned $19.6 million or $0.88 per diluted share compared to net income of $20.1 million or $0.85 per diluted share in the prior year period.

On the balance sheet side, total assets grew to $4.04 billion at June 30, an increase of $478.6 million from December 31, 2019. For the second quarter of 2020, our loan portfolio increased by $148.5 million while our securities available for sale increased by $262 million.

Total deposits grew $401.6 million during the second quarter of 2020. Excluding brokered CDs, this deposit growth increases to $424.8 million. Also important for us during the second quarter was our issuance of $40 million of subordinated notes qualifying Tier 2 capital with a 10-year maturity, a 5-year call option and an initial coupon interest rate of 5.95%. The purpose of this issuance was for general corporate purposes and provides additional liquidity at the bank holding company level.

Slide 7 provides a view of our Michigan markets. Despite the unexpected challenges brought on by the pandemic, we continued to execute on our longer-term strategic objectives, including ongoing branch optimization and a digital transformation. As it pertains to branch optimization, we closed 2 branch locations on June 26, 2020, and an additional 6 locations are closing July 31. During the second quarter and for the 6 months of 2020, we recognized branch closure costs of $417,000, primarily due to the write-down of fixed assets and lease assets. As a result of these 8 branch closures, we anticipate annual pretax savings of approximately $1.3 million, respectively. This brings our total branch count to an even 60 locations.

Turning to Page 8. We displayed several key economic statistics, reflecting the literal shutdown of the Michigan economy during the second quarter of 2020. The Governor of Michigan issued her first Stay Home, Stay Safe executive order effective March 24. In general, that order and subsequent modifications required individuals of Michigan to stay at home or their place of residence, except for certain specified activities that were deemed necessary to sustain or protect life.

That original executive order was amended several times and has since been rescinded and replaced entirely by a series of safer at home executive orders, which generally extended certain social distancing restrictions that lifted the requirement that individuals remain in their homes. Under the current order, certain retail operations, restaurants and bars and other businesses are committed to resume in-person operations, subject to capacity limitations and other workplace safety requirements. In addition, for both the State of Michigan and the State of Ohio, protective masks are required to be worn in public facilities and for larger gatherings outside.

The degree to which business may resume operations varies based on the region of the state in which they are located, pursuant to the governor's Michigan Safe Start Plan. Arguably, Michigan's shutdown was broader and longer than many other states. As a result, Michigan's unemployment rate is currently reported much higher than the U.S. unemployment rate. At this time, it is unclear as to how long Michigan's unemployment rate will be elevated as well as the pandemic's overall impact on the Michigan economy.

On Page 9, 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. Since December 31, 2019, our deposits, excluding brokered CDs, have increased by $506.6 million, with $425 million of this increase taking place during the second quarter. The largest category increasing on a linked-quarter basis was our noninterest-bearing business deposits, followed by savings and interest-bearing checking within the retail portfolio. Some of the second quarter increase is related to the deposit of PPP-related funds. However, it is very difficult to determine how much of the overall deposit increase will stay in the bank and for how long.

Accordingly, we have invested these balances in very liquid, relatively short duration assets generating high levels of cash payments. Our total cost to deposits decreased by 33 basis points on a linked-quarter basis and is down 53 basis points when comparing to the same quarter 1 year ago.

On Page 10, we provide an update on our loan portfolio. Total loans increased by $148.5 million for the quarter, and now aggregate to $2.87 billion at June 30, 2020. This excludes loans held for sale of $84 million. The increase was entirely related to PPP loans within our commercial portfolio, offset by declines in our mortgage and installment portfolios. The commercial portfolio grew by $181.4 million during the quarter. Again, this increase was primarily PPP-related that was offset by significant paydowns, payoffs and a reduction in line utilization.

Backed line utilization decreased to 30.9% at June 30 from 40.2% the prior quarter end. Total mortgage originations for the quarter were $470.6 million compared to $241.4 million in the second quarter of 2019, reflecting the impact that lower rates have had on the refinancing market. Portfolio mortgage loans decreased by $28.3 million for the quarter due to portfolio paydowns and a higher salable mix for new loan origination volume.

On Page 11, we have an update on our modification and forbearance activities and our participation in the Paycheck Protection Program. We take pride in being supportive of our customers and communities and are actively assisting those experiencing financial difficulty. At June 30, 2020, we have payment deferrals to 259 commercial customers and $210.5 million in loans or 15.4% of our portfolio.

Commercial forbearances are generally for principal payment only with interest payments continuing to be made. On the retail side, we have forbearance agreements with 388 portfolio mortgage loan customers with $81.2 million in balances or 7.8% of the mortgage loan portfolio and 280 installment loan customers with $7.4 million in balances or 1.6% of the installment loan portfolio.

Retail forbearance plans are primarily for both principal and interest payments for up to 90 days. Updating these metrics for the retail side as of this week, we now are down to 506 portfolio forbearances aggregating to a little under $69 million.

With regards to the Paycheck Protection Program, we built an effective process to manage the high volume of applications for loans as well as the applications for loan forgiveness. As of June 30, we had 2012 PPP loans for $259 million outstanding and there was approximately $7.7 million of remaining unaccreted net fees related to PPP loans. We expect these fees to be accretive into interest income over the next 20 months.

On Page 12, we are displaying the concentrations or makeup of our entire commercial loan portfolio. The chart on the left, segmented by industry category reflects our C&I portfolio, including owner-occupied commercial real estate loans. The chart on the right, segmented by collateral type, reflects our investor real estate loans. The percentage is shown on both of these charts aggregate to 100% of the entire $1.36 billion commercial portfolio.

The portfolio is very granular in nature, with the largest concentrations in C&I being manufacturing at 11%, construction at 9% and retail at 7%. Within the CRE portfolio, the largest concentration is retail at 6%. We believe this portfolio is holding up very well, including loans in those industry sectors whose business has been more negatively impacted by the COVID-19 pandemic.

Page 13 provides an overview of our investments at June 30, 2020, and activity within the portfolio during the quarter. Investment securities available for sale increased $262 million during the quarter. The portfolio's a very high quality, with 85% of the portfolio rated AA or better. Additionally, the portfolio is generally shorter term in nature, with an estimated average duration of 2.47 years and weighted average yield of 2.32%.

In terms of capital management, our capital levels continue to be strong with tangible common equity to tangible assets of 8.03% at June 30, 2020. This is a bit below the bottom of our targeted range of 8.5% to 9.5%, primarily as a result of larger than previously planned growth in total assets during the first half of 2020. We do anticipate moving back into our targeted TCE range by the end of 2020 due to a decrease in total assets, in part because of anticipated PPP loan payoffs as well as an increase in overall tangible capital through earnings.

We paid a quarterly cash dividend of $0.20 per share on May 15, 2020, and recently declared a $0.20 dividend on July 21, payable on August 14, as we believe that our capital levels currently support the continuation of our dividend program.

During the first quarter of 2020, we repurchased 678,929 shares through March 16 before suspending the buyback in response to certain -- uncertain economic environment.

At this time, I would like to turn the presentation over to Rob to share a few comments on our financials, credit quality, CECL and our outlook for the second half of 2020.

Thanks, Brad, and good morning, everyone. I am starting at Page 15 of our presentation.

Brad discussed the year-over-year slight decrease in our net interest income during his remarks, so I will focus on our net interest margin. Our tax equivalent net interest margin was 3.36% during the second quarter of 2020, which is down 51 basis points from the year ago period and down 27 basis points from the first quarter of 2020. I will have some more detailed comments on this topic in a moment. Average interest-earning assets were $3.66 billion in the second quarter of 2020 compared to $3.19 billion in the year ago quarter and $3.35 billion in the first quarter of 2020.

Page 16 contains a more detailed analysis of the linked-quarter increase in net interest income and the decline in the net interest margin. Like many other banks, our second quarter 2020 net interest margin was adversely impacted primarily by 3 factors: the significant decrease in market interest rates, a surge in deposits and liquidity and low relative yields on the PPP loan portfolio. We will comment more specifically on our outlook for net interest income and the net interest margin for the balance of 2020 later in the presentation.

Moving on to Page 17. Noninterest income totaled $20.4 million in the second quarter of 2020 as compared to $9.9 million in the year ago quarter and $11 million in the first quarter of 2020. Of course, the story here is our exceptionally strong mortgage banking revenues. 2Q '20 net gains on mortgage loans increased to $17.6 million compared to $4.3 million in 2Q '19. The increase in these gains was due to increases in mortgage loan sales volume and in the mortgage loan pipeline as well as stronger loan sale profit margins. Mortgage loan application volume was very strong in 2Q '20 and continues to be strong at the start of the third quarter as we have both a solid purchase market in Michigan and Ohio, and refinance volumes have been exceptionally strong due to lower interest rates.

Partially offsetting these strong gains on mortgage loans was a $3 million loss on mortgage loan servicing due primarily to a $2.9 million or $0.10 per diluted share after tax decrease as a fair value due to price of capitalized mortgage loan servicing rights in 2Q '20.

As detailed on Page 18, our noninterest expenses totaled $27.3 million in the second quarter of 2020. This compared to $26.6 million in the year ago quarter and $28.7 million in the first quarter of 2020. The second quarter of 2020 included about $420,000 of branch closure costs and about $350,000 of conversion-related expenses. We'll have more comments on our outlook for noninterest expenses later in the presentation.

Page 19 provides data on nonperforming loans, other real estate, nonperforming assets and early-stage delinquencies. Total nonperforming assets were $13.9 million or 0.34% of total assets at June 30, 2020. Nonperforming loans decreased by $4.4 million during the second quarter of 2020, due primarily to a $4 million charge-off on one commercial credit that then had a remaining balance after this charge-off of $2.9 million at June 30, 2020. We received a $2.6 million paydown on this credit on July 21, 2020. The last $300,000 on this credit was fully reserved at June 30, but we are optimistic of collecting this remaining amount prior to the end of the year.

Page 20 provides some additional asset quality data including information on new loan defaults and unclassified assets.

Page 21 provides information on our TDR portfolio that totaled $55.8 million at June 30, 2020. This portfolio continues to perform very well with 94.2% of these loans performing and nearly 93% of these loans being current at June 30, 2020.

Moving on to Page 22, we recorded a provision for loan losses expense of $5.2 million in the second quarter of 2020 compared to $652,000 in the year ago quarter and $6.7 million in the first quarter of 2020. The single most significant factor driving the higher year-to-date provision for loan losses in 2020 was an $8.7 million or 98.2% increase in the qualitative subjective portion of the allowance for loan losses. This increase principally reflects the unique challenges and economic uncertainty resulted from the COVID-19 pandemic and the potential impact on our loan portfolio.

The allowance for loan losses was $34.5 million or 1.2% total portfolio loans at June 30, 2020. And as Brad mentioned, this ratio increases to 1.38% when excluding PPP loans and the remaining Traverse City State Bank acquired loans.

Page 23 provides an analysis of our allowance for loan losses under the incurred loss methodology and the CECL methodology at June 30, 2020. Our calculated as if CECL allowance at June 30, 2020, was approximately $43.2 million. This indicates that given the midpoint of our as if Day 1 CECL impact of $9 million that the provision for loan losses in the first 6 months of 2020 under CECL would have been similar to what we have recorded under the incurred loss methodology.

Page 24 provides an update on our implementation of the CECL accounting standard. As we stated last quarter, we will implement CECL at the earlier of 12/31/2020, or the end of the COVID-related national emergency.

Page 25 is our update for the remainder of 2020 as well as a comparison of our actual performance during the year to the original outlook that we provided back in January 2020. And as you can appreciate, many of the factors that shaped our original outlook have changed dramatically given the economic upheaval from the COVID-19 pandemic.

We now expect total portfolio loans to decline by approximately 1% to 2% for all of 2020. This is due primarily to paydowns, including forgiveness that we anticipate the PPP loan portfolio over the last half of 2020 and more muted commercial loan demand as well as continued low overall commercial line of credit usage.

Despite the aforementioned overall decline in portfolio loans, we expect the net interest margin to be steady to slightly higher over the last half of 2020 due primarily to the following factors: an increase in the overall average yield of the PPP loan portfolio due to paydowns, resulting in an acceleration in the accretion of net fees in the third and fourth quarters.

The deployment of excess liquidity from the deposit surge into securities available for sale, which largely took place during the last month of the second quarter. And finally, we expect relatively steady interest rates in the last half of 2020 as compared to the second quarter of 2020. The provision for loan losses is very difficult to forecast given the economic uncertainty that we are facing. However, as Brad mentioned, we have seen a decline in the level of forbearance agreements in our mortgage and installment loan portfolios during July.

In addition, asset quality metrics presently remain solid. We are currently modeling the provision for loan losses of about 0.55% to 0.60% annualized of portfolio loans for the last 6 months of 2020. This equates to about $8 million to $8.5 million in total for the last half of 2020. We expect noninterest income to average a bit above the high end of the original forecasted range in the last 2 quarters, excluding any volatility associated with changes to the price in the fair values of MSRs. Mortgage loan origination activity and application volumes have remained very strong in July, but we do anticipate a seasonal slowdown in purchase activity and some cooling of refinance activity as we move towards the end of the year.

We expect noninterest expenses to generally be within our forecasted range in the last half of 2020. Our effective income tax rate was 19.3% in the second quarter of '20, which was generally in line with our forecast, and thus, we reaffirm our guidance for approximately a 20% effective income tax rate.

Finally, we anticipate share repurchases to remain on hold until there is more certainty with respect to the economic fallout from the COVID-19 pandemic.

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

Thanks, Rob. The first half of 2020 has been an extraordinary period of time for all of us. Our team continues to execute on the initiatives reflected on Slide 26 of our presentation, in addition to new initiatives as a result of the pandemic.

We will continue to move forward both these planned and unplanned initiatives, while continuing to protect the health and well-being of our employees, our customers and our community.

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

(Operator Instructions) First question comes from Brendan Nosal, Piper Sandler.

I just want to start off here on the net interest margin. So your guidance calls for flat to up modestly for the rest of the year. And it sounds like that includes some acceleration of PPP fees as those loans are forgiven.

Can you just give us a sense of what you expect the NIM to do for the remainder of the year outside of those accelerated fees?

Yes. I think outside of that, it would be relatively flat from the third -- or from the second quarter. And I think the other 2 factors that are influencing that, that I mentioned was one, we did deploy much of that deposit surge in the month of June. So we're getting a full impact from having done that, whereas during the second quarter, that for a period of time, was just an overnight funds at the fab earning very little. So I think that will be a boost that will tend to offset some of the compression from some shrink in the loan portfolio that we anticipate taking aside the PPP loans.

So where we see the boost is really from the acceleration in -- the accretion of those fees. And then the other comment that I made is we anticipate that rates will be relatively flat. Short-term rates really can't come down much anymore unless we get into the negative territory and long rates seem to sort of be at a steady point. So we feel like much of the impact of the dramatic decline in rates occurred during the second quarter, and it's not going to continue to have a negative impact. In fact, I say, I think we do have a little more room on the funding side as we move through the last 2 quarters. Not a lot, but a bit.

Brad, I don't know if you wanted to add anything.

No. That's good.

All right. Perfect. That's very helpful. And then one more for me. Just on the charge-off this quarter, if I recall correctly, that was the loan that moved from watch list to nonaccrual last quarter. And just in relation to that, just as you look at the broader portfolio, are there any other credits, whether they're on deferral right now or nonaccrual that you see having enough issues because of COVID that you think could move to a loss position over the next 3 or 6 months?

I guess, I'll take first shot at that and then let Jim jump in there.

So you did see an increase in the TDRs for the quarter of about $5 million. That was a commercial real estate relationship. And while it bumped up TDRs, we do have that borrower has a purchasing agreement for the sale of that property. And so I guess that was probably one that would have been on my radar as I'm a little concerned about. And we still want to see that come to fruition the eventual sale. But beyond that, Jim, I'm not really -- anything is popping off outside of the one you mentioned, there are no other large ones that I see on the fence like that.

And in the one that did go sideways, there was in the movie theater business. So that was in an asset category that we just decided to move as opposed to hold them. And we don't have any more -- and we do not have any more in that industry.

And the other thing I'd add is we've taken a pretty in-depth look at our top 50 credits within the commercial loan portfolio. So we really try to evaluate all of those credits in relation to the kind of economic climate we're dealing with, and we really find that, that group of loans is still doing quite well.

Our next question comes from John Rodis with Janney.

Rob, welcome back.

Thanks. Good to be back. Glad to hear your voice.

It's been a long time.

Yes.

No, not really, but a lot has changed. And I guess, Rob or Brad, one of you, just your comment about the loan outlook, looking for loans to be down. I think you said 1% to 2% year-over-year.

What are you sort of assuming, though, for the PPP loans, the level of forgiveness? And then how much in the second half of this year versus next year?

Why don't you take first shot on the PPP.

With all the changes that went on with the PPP forgiveness piece so far, which we're waiting for that to fully be finalized. But with the 24-week time frame now, we look to have a much higher percent forgiven than I initially thought. So I think it will be up in the 90% to 95% range for the forgiveness piece. And we had modeled out about 2/3 of the forgiveness process to be collected by the end of this year.

John, I'm looking at it going from about $250 million down to a bit over $100 million, I think, by the end of the year.

That assumes that everything is moving along with the SBA and processing forgiveness applications you don't run into big delays there.

And obviously, Rob, that would be more heavily weighted in the fourth quarter versus the third quarter? Just...

Yes. I mean we're assuming that we get a bit of a chunk in September once the portal opens up. So there is a chunk in September as well, but the bigger paydown is in the fourth quarter, too.

Okay. And then, just one other question on the securities portfolio, so it's roughly 21% of assets today. And given you still have some excess liquidity and so forth. And then, I guess, depending on what happens on the deposit side, how high would you take that, I guess, in the current environment as a percent of assets from the current 21%?

I don't really think there's a ratio there. I think what we'll look -- one is, it's going to be driven by what's going on in the deposit portfolio. And then kind of the rate of paydown in the PPP portfolio. I don't think we're going to see big changes in the installment loan portfolio or the mortgage portfolio. Mortgage portfolio may drift down a little bit because of refinancing activity, but I don't think that's going to change. But I think outside of PPP, commercial loans will be reasonably steady.

So given that, I think a lot of it is just going to depend on the deposit surge, and we do have potentially another wave of moneys going to consumers with the federal government aid package that is being discussed. So it's hard to tell the length of time that those deposits will remain here. And as a result, we've sort of taken an approach to investing in, really, either relatively short duration assets that throw off a lot of cash, or investments that could easily be liquidated or a variable rate. So sort of a combination of those 3 things.

But I think if it moves up, relative to total assets, it's largely going to be because of what's going on with the deposit base. Again, I don't think we're going to set some kind of limit there.

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

I appreciate the commentary on deferral activity, especially within the migration in retail. Is there any incremental color you could provide on the commercial deferrals of roughly 15%? I know you mentioned things were heading lower in July, but just kind of a point-to-point update there, if it's at all possible?

Sure. This is Jim Mack. So as shown in the presentation, we had 259 loans and $210 million of deferrals that were done. Right now, we're getting close to the end of that time frame. A lot of those were done in mid- to late April, some even in May. So August will be the first period where those payments will resume to the normal schedule. Also, keep in mind that over 90% of what we did were simply principal deferrals. Interest payments continued on the bulk of that portfolio.

And then we've seen very few for second round additional requests. There have been 5 so far to ask us for another 3 months. And that remains to be seen how many more. It's been low activity at the moment.

Okay. And then so would your expectation then be for the originals as they roll off? The overwhelming majority, it sounds like, would -- when we speak next quarter we would not be talking about much in the way of deferrals.

That's the expectation. But again, it remains to be seen.

Yes. Understood. Okay. I appreciate the clarification there. And then another minor one. In terms of the provision guidance, the -- what is this, the 55 to 60 basis points of average total loans. Does that include PPP loans on the balance sheet? Or should we adjust for that?

I just took the total average loans. So I didn't really adjust for that in coming up with that number. That's why I kind of gave you a dollar amount to $8 million to $8.5 million in total for the last 6 months. So that just sort of clarifies what that ratio range means.

Perfect. I appreciate the clarification there. And then a bigger picture and this maybe a few quarters out. But in terms of PPPs off the books as you think about what '21 might hold from a budgeting perspective around organic loan growth. Obviously, a lot can change from now to then, but do you have a view as to where independent might shake out from an organic loan growth perspective into '21?

Russell, that's a good question. So you're asking me to see 12 months when I'm having a hard time seeing 3 months.

I would say this, we continue to position the company to be competitive within our markets. And we're still knocking on doors. We're recruiting, we're adding talented staff, even this past quarter as there continues to be remnant disruption from past announced MOEs. And so we will -- our loan activity in 2021 will be very much driven by what's happening with the overall economy, but we will feel the team that will be very, very competitive in our markets.

Sorry, that -- sorry, that doesn't give you a percentage for the model.

No, not at all. Well, I would think there's a lot of market share up for grabs. So I appreciate your thoughts there.

This concludes our question-and-answer session. Now I'd like to turn the conference back over to Mr. Brad Kessel. Please go ahead.

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

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