Independent Bank Corp (Michigan) (IBCP) 2022 Q1 法說會逐字稿

Hello, ladies and gentlemen. Thank you for joining and being present at the Independent Bank Corporation Q1 2022 Earnings Conference Call. My name is Irene, and I will be coordinating today's call.

(Operator Instructions) I will now hand you over to your host, Brad Kessel, President and CEO, to begin. Brad, 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 first quarter 2022 results. I am Brad Kessel, President and Chief Executive Officer; and joining me is Gavin Mohr, EVP and Chief Financial Officer; and Joel Rahn, Executive Vice President, 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 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.

Slide 4 provides a good summary of our historical results. I am very pleased with our team's continued execution of our operating plan. In doing so, our first quarter 2022 performance generated strong core results, with good growth in net interest income, stabilization of our net interest margin and net growth in each category of loans and total deposits. We were also able to make progress in reducing our noninterest expenses.

During the first quarter, inflation was reported at near 4-year highs, and we witnessed a very dramatic increase in rates on the middle and long end of the yield curve, with the expectation now for multiple Fed hikes through 2022 and into 2023. This recent increase in rates has slowed our mortgage refinance origination volume and decreased this quarter's net gains on mortgage loan sales. However, we have also structured our mortgage business to have an emphasis on supporting home purchase requests, and these volumes continue to be at solid levels.

Additionally, the increase in rates also significantly increased the value of our capitalized mortgage servicing rates, somewhat of a natural hedge, providing a benefit with higher rates. Over the years, we have shared our intentions and success in generating a diversified revenue stream through 3 lines of business: commercial banking, mortgage banking and consumer banking. During 2021, we made significant investments both in talent and technology, primarily in our commercial and consumer banking lines of business. We are seeing some of the early paybacks for these investments with a very strong commercial pipeline and some increased efficiencies in our consumer banking business.

Turning to Page 5. Independent Bank Corporation reported first quarter 2022 net income of $18 million or $0.84 per diluted share versus net income of $22 million or $1 per diluted share in the prior year period. The decrease in the 2022 first quarter earnings as compared to the first quarter of 2021 primarily reflects a decrease in noninterest income and an increase in noninterest expense that were partially offset by an increase in net interest income and a decrease in the provision for credit losses.

The first quarter 2022 highlights include an increase in net interest income of 9% over the first quarter of 2021, loan growth of $99 million or 13.8% annualized, and deposit growth of $88.4 million or 8.7% annualized, a return on average assets of 1.54% and a return on average equity of 19.38%. In addition, our asset quality continues to be very good with very low net charge-offs in the first quarter as well as commercial watch credits at just 2.44% of the portfolio and a continued very low level of past-due loans. These favorable asset quality metrics, combined with reduced reserves related to COVID-19, allowed us to record a negative provision for the first quarter.

Page 6 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 are off to a strong start. In 2020, we closed 8 branch locations as part of our ongoing branch optimization reviews. During the second quarter of 2022, we will be closing an additional 4 locations, 1 each in Kent, Oakland, Lapeer and Saginaw Counties. Annual expected cost savings from the combined closings is expected to be $1.5 million. These closings will reduce our branch network to 58 locations in total.

Turning to Page 7. We displayed several key economic statistics for the state of Michigan. Overall, we are seeing continued improvement in the unemployment rate for Michigan, now at 4.7%, slightly above the national average of 3.8%. However, the state of Michigan has 110,000 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 also continued to constrain many businesses in our markets. Regional average home prices continue to climb, as inventory levels in many of our markets continue at record lows and negatively impact the overall volume of home sales.

On Page 8, 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.

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

Thanks, Brad. On Page 10, I'll provide -- we've provided an update on our $3 billion loan portfolio that I'll provide some insight on. For the first quarter, the commercial segment of the portfolio grew by $54 million. However, when you exclude PPP activity, our commercial balances increased by $74.5 million. This follows on a strong fourth quarter of 2021 where we experienced commercial loan growth of $45 million, also excluding PPP activity. Our annualized commercial growth rate over the past 6 months is 21%, and based on a strong pipeline, we expect strong commercial growth in the second quarter of 2022 as well.

In the first quarter, our residential mortgage balances have increased by $30.4 million, and our consumer installment loan portfolio grew by $14.6 million. We remain optimistic about our ability to continue the earning asset rotation from lower-yielding investments to higher-yielding loans and believe we're on track to grow loans at a low double-digit pace throughout 2022.

On Page 11, we display the concentrations of our $1.3 billion commercial loan portfolio. C&I lending continues to be our primary focus, representing 65% of the portfolio. Manufacturing is the largest single concentration within the C&I segment, comprising approximately 11% or $136 million. The remaining 35% of the portfolio is comprised of commercial real estate, with the largest concentrations being retail at $112 million or 9% and industrial at $91 million or 7%. By design, this portfolio is very granular in nature, and our credit metrics, which Gavin will cover in a moment, reinforce that this portfolio has held up very well through the pandemic and the resulting supply chain pressures.

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

Thanks, Joel, and good morning, everyone. I'm starting on Page 12 of our presentation. Page 12 contains details on our investment securities portfolio. Net unrealized losses increased in the second quarter of '22 from year-end '21 to $61.5 million net of swaps. The increase in rates in the first quarter of '22 is primarily responsible for the increase in unrealized losses. These unrealized losses do not impact regulatory capital levels. The investment securities portfolio has a very strong credit profile, making credit losses unlikely. Excluding any credit impairment, the investment securities will recapture the current unrealized losses as they mature. Approximately 30% of the portfolio has a variable rate structure, including swaps.

Page 13 highlights our strong regulatory capital position. The reduction in the CET1 ratio and the total risk-based capital ratio is due to an increase in risk-weighted assets of $161.2 million in the first quarter of '22. Net interest income increased $2.7 million from the year ago period. Our tax-equivalent net interest margin was 3% during the first quarter of 2022, which is down 5 basis points from the year ago period and down 13 basis points from the fourth quarter of 2021. I will have some more detailed comments on this topic in a moment.

Average interest-earning assets were $4.49 billion in the first quarter of 2022 compared to $4.05 billion in the year ago quarter and $4.43 billion in the fourth quarter of 2021.

Page 15 contains more detailed analysis of the linked quarter decrease in net interest income and net interest margin. Our first quarter 2022 net interest margin was negatively impacted by 2 factors: A decline in PPP loan balances had a negative 13 basis point impact; and change in loan yield and mix, excluding PPP, decreased margin by 1 basis point. That was partially offset by an increase in investment yield of 2 basis points in the quarter. We will comment more specifically on our outlook for net interest income and the net interest margin for 2022 later in the presentation.

On Page 16, we provide details on the institution's interest rate risk position. The comparative simulation analysis for the first quarter 2022 and fourth quarter 2021 calculates the change in net interest income over the next 12 months. The base rate scenario assumes a static balance sheet and applies the spot yield curve from valuation date. The increase in the base rate forecasted net interest income in the first quarter of '22 compared to the fourth quarter of '21 is primarily due to an increase in rates, which resulted in higher forecasted earning asset and yields as well as higher forecasted earning asset balances.

Most of the increase in the interest income was on term earning assets, those pricing of the 2- to 7-year part of the curve. The majority of the bank's funding basis consists of nonmaturing deposits, which price off overnight Fed funds rate. Management did not change a nonmaturity deposit rates after the first Fed hike, thus the spread between term-earning assets and the bank's nonmaturity funding widened notably, resulting in the expansion of the forecasted net interest income.

Currently, 17% of assets reprice in 1 month and 31.8% reprice in the next 12 months. The institution maintains an asset-sensitive position, primarily due to a favorable funding base and we'll continue to evaluate strategies to manage net interest income through hedging, as well as product pricing and structure.

Moving on to Page 17. Noninterest income totaled $18.9 million in the first quarter of 2022 as compared to $26.4 million in the year ago quarter, $15.8 million in the fourth quarter of 2021. First quarter 2022 net gains on mortgage loans totaled $0.8 million compared to $12.8 million in the first quarter of '21. The decrease in gains was due to a decrease in mortgage loan sales volume and in the mortgage loan pipeline, as well as lower loan sale profit margins. Margins were negatively impacted by approximately $3.8 million in a fair value adjustment on portfolio of saleable construction loans.

Mortgage loan applications remained solid, although refinancing applications have slowed and the mortgage production mix has rotated to a lower percentage of saleable loans. Positively impacting noninterest income was a $9.6 million gain on mortgage loan servicing due to an $8.5 million or $0.31 per diluted share after tax increase in the fair value due to price and a $0.9 million decrease due to paydowns of capitalized mortgage loan servicing rights in the first quarter of 2022.

As detailed on Page 18, our noninterest expense totaled $31.5 million in the first quarter of 2022 as compared to $30 million in the year ago quarter and $33 million in the fourth quarter of 2021. Compensation increased $2.3 million compared to the prior year quarter due to raises that were effective at the start of the year, a decreased level of compensation that was deferred in the first quarter of 2022 as direct origination costs on lower mortgage loan origination volume, an increase in lending personnel and higher healthcare insurance costs.

Performance-based compensation decreased $0.6 million due primarily to a decrease in mortgage lending volume compared to the first quarter of '21. The first quarter of 2022 included $0.4 million recoveries related to a reserve for unfunded lending commitments due to a decrease in the unfunded lending commitments. We will have more comments on the outlook for noninterest expense later in the presentation.

Page 19 provides data on nonperforming loans, other real estate, nonperforming assets and early-stage delinquencies. Total nonperforming assets were $5.4 million or 0.11% of total assets at March 31, 2022. Loans, 30- to 89-day delinquent totaled $2.7 million at March 31, 2022, compared to $2.3 million at December 31, 2021.

Page 20 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 the first quarter of 2022.

Page 21 provides information on our TDR portfolio that totaled $36 million at March 31, 2022. This portfolio continues to perform well, with 96.5% of these loans being current at March 31, 2022.

Moving onto Page 22. We recorded a provision for credit losses credit of $1.6 million in the first quarter of '22 compared to provision credit of $0.5 million in the year ago quarter and a provision expense of $0.6 million in the fourth quarter of 2021. The allowance for loan losses totaled $45.6 million or 1.52% of the portfolio loans at March 31, 2022.

Page 23 is our update for our 2022 outlook to see how our actual performance during the first quarter compared to the original outlook that we provided in January 2022. Our outlook estimated loan growth in the low single digits. Loans increased $99 million in the first quarter of 2022 or 13.8% annualized. Commercial mortgage and installment loans all experienced growth in the first quarter of 2022. Excluding PPP loans, total loan portfolio grew at 16.7% annualized rate during the first quarter of 2022, above our forecasted range.

First quarter 2022 net interest income increased by 9% over 2021, which is higher than our forecast. However, the net interest margin for the first quarter of 2022 was 5 basis points lower than the first quarter of 2021. Net interest margin of 3.05%, which is less than our original forecast. The first quarter 2022 provision for credit was $1.6 million. This is below our forecasted 2022 full year provision range of 0.15% to 0.2% of average total portfolio loans. The primary drivers of the decrease in the provision for credit losses were a decrease in adjustment to allocations based on subjective factors due in part to the expected reduction in risk related to COVID-19.

Noninterest income totaled $18.9 million in the first quarter of 2022, which is higher than our forecasted range of $13 million to $17 million. First quarter 2022 mortgage loan originations, sales and gains totaled $270.2 million, $221.7 million and $0.8 million, respectively. The decrease in net gains on mortgage loans sold were primarily due to lower sales volume, decreased profit margin on mortgage loan sales and a decrease in fair value adjustments on the mortgage loan pipeline.

Mortgage loan servicing generated a gain of $9.6 million in the first quarter of 2022, due primarily to a positive $8.5 million fair adjustment -- a value adjustment due to price.

The year-over-year decrease in noninterest income could be outside of our original forecast due to lower gain on sales mortgages in the coming quarter.

Noninterest expense was $31.5 million in the first quarter, in the middle of our $30.5 million to $32.5 million targeted quarterly range. Our effective income tax rate of 18.6% for the first quarter of 2022 was at the lower end of our forecast.

Lastly, the company purchased 59,002 shares at an average cost of $23.46 for the first quarter of 2022. That concludes my prepared remarks. I would like to turn the call back over to Brad.

Slide 24 displays a high-level view of our key strategic initiatives. In 2021, we made significant investments to our overall technology platform to improve the customer experience and increased productivity amongst other goals. We have already seen some very positive results with this investment. And I believe, we will see continued growth and improve productivity in 2022.

While the current operating environment contains numerous challenges and much uncertainty, it also provides many opportunities. We are excited about the momentum we have in our markets and look forward to continuing these growth trends for the remainder of 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 from Piper Sandler.

Just to start off here, maybe, on the mortgage piece. I was hoping you can offer a little bit more color on the dynamics that kind of drove the compression quarter-over-quarter, particularly that fair value mark and then kind of tie in your thoughts on mortgage for the rest of the year as it feeds into the overall updated fee guidance.

Maybe, I'll start, Brendan. This is Gavin with the mark and then let Brad talk maybe about the more high-level mortgage operation for the rest of the year. So Brendan, the biggest impact to the fair value mark for the quarter was a saleable construction portfolio. As you're aware, the construction timelines are longer than they have historically been for completion. As these loans are brought on, they are mark-to-market each quarter from the day that the loan closes to the end -- to the ultimate to the end mortgage. And so what we've seen was that we had an existing portfolio from 2021 origination with lower coupons in the current market.

So we -- as rates increased, the value -- the market value of that portfolio that was unhedged decreased because it's difficult to hedge a 12-month construction loan. So that $3.8 million or the fair value mark, the majority of it is related to that $3.8 million mark-to-market adjustment.

And I would just point out, we have taken additional risk off the table of that portfolio, so there won't be any material mark-to-market adjustments regarding that going forward.

All right. That's certainly helpful. And maybe, kind of turning to the expense side of things. Certainly, nice to see the run rate improved so much quarter-over-quarter. And then there's the additional savings from the closed branch locations later on in the year. Just kind of curious about the way that you're accruing for comp at the start of the year. I mean are you accruing at a level that reflects the potential revenue benefits of a higher short-term interest rate environment later on in the year?

Yes.

Our next question comes from Damon DelMonte from KBW.

This is Matt Renck filling in for Damon DelMonte. I hope everybody is doing well today. First question, just as you remix the earning assets, do you have a targeted range of -- or a targeted percentage or proportion of securities to average earning assets?

I don't have a -- I would say that the securities -- I anticipate the security balances declined through 2022. So as we can redeploy those cash flows into loans, you will see dollar for dollar that move out of the securities portfolio. So obviously, Matt, the current allocation is much higher than we would historically have targeted. So we'd like to see it come down.

Okay. Got it. Got it. And then just one last question, if I could get your updated thoughts on share repurchases for the year.

Sure, Matt. Good question. This is Brad. You could see from our report that we were in the market during the first quarter on a small scale. And I think prospectively, our decision to continue to be in the market as a function of where we're trading, how the -- where our growth is, our capital needs for growth, both organically and potentially, acquisitively and also, overall capital levels. So I think probably see a continuation of what our historical pattern has been.

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

This is Manuel Navas on for Russell. I'm looking at your loan growth performance and outlook for the whole year, are you starting to get a sense for perhaps, stronger growth in the first half of the year and a little bit more cautious in the second half? Or you're just seeing how loan growth comes in?

Joel, why don't you...

I'll attempt to answer that one. I wish I had a crystal ball to tell you. Right now, we're seeing very strong growth, and it's a good mix of new customers to the bank, as well as organic growth that would label it to existing customers. And there was a very nice split in our first quarter growth. We're seeing that based on our pipeline into the second quarter. Certainly, not naive to what -- if the economy starts to slow later in the year, it's hard to predict that. But at this point, all I can tell you is based on our pipeline, we're seeing good demand.

We're seeing businesses expand or not seeing signs of pullback yet. But certainly, we're following the economic conditions closely. It's difficult to say what the second half of the year will look like. Right now, we don't see it slowing up, but the world is changing rapidly with the economic news.

Definitely understandable. What are you seeing right now in terms of pricing competition, both on the lending side? Like, what are you seeing on new loans here in April? And on the deposit side as well, is anyone stepping up deposit competition yet?

Well, this is Joel again. I'll answer the loan side. We've seen a lot of pricing pressure, yield pressure, really starting in the second half of last year is -- all banks were hungry to grow earning assets, and that has changed. So there's still a lot of pressure on yields. And I expect that, that's going to continue here throughout this year. And I'll turn it over to Brad or Gavin on thoughts on deposit rates.

Well, I think we're not seeing a lot of pressure on the deposit side at this point, and that's going to be very interesting to watch here with each Fed rate hike.

And on the mortgage side, I would say, it just feels like the market is slow to adjust to what's happening with the yield curve. And so it's, I think, been in a lot of discussion internally about being disciplined in our pricing, but it is very aggressive on all the loan fronts today.

(Operator Instructions) Our next question comes from Bryce Rowe from Hovde Group.

I wanted to kind of follow up on that last comment about loan competition. I'm curious, where you're seeing new loans pricing in this environment relative to the portfolio yield for the first quarter?

Yes. I'm proud of our group in terms of the discipline that we've shown to hit our projected our pro forma yields on the commercial side. It has been very difficult because as rates were rising, especially fixed rates -- conventional fixed rates. As the yield curve was rising rapidly, not all of our competitors seem to be, as Brad just alluded to a second ago, seemed to be on top of that or passing that along in terms of their quoted rates. And so I think we were more proactive. And at times, it means we lost business, and yes, we're still able to show the growth that we showed.

That's the best answer I can give you. I don't know if Gavin, you have anything to add to that?

Well, I would -- I guess Joel can obviously highlight the spread aspect of it and the consistent pressure. I do think you are seeing a rotation into a higher allocation of variable loans, which obviously, is carrying a lower yield as well, if you're just looking at the consolidated portfolio yield.

Yes. Yes. Okay. And the asset sensitivity interest rate risk management slide you have in the deck obviously highlights an asset-sensitive position. Curious, what deposit beta you are assuming in that analysis?

Yes. So we took a look back, Bryce, at the current early last rate hike, and we have very low betas through the first, say, plus 75 hikes, and then they come back to a more long-term, historical, I guess, what we would call adjustment. So in the -- up another 50 to 75, the beta assumption is low. Yes.

Okay. Okay. Let's see, the last one for me. We've seen pressure on tangible common equity from the fair value mark on the securities portfolio is really across the industry here this quarter. Does that compression in tangible common equity ratio, does that change your outlook from a repurchase perspective? Just trying to gauge how I do you all see that compression and just any views around that would be helpful.

Yes. Great question. And we've had a lot of discussion about it, internally. We have run multiple stress scenarios in terms of further depreciation with additional rate hikes. Of course, where we've seen the bulk of the move today in the curve has been right in that belly portion, which is rate where our asset or security duration is. So we're hopeful that we're sort of past the worst part of it, but you don't know. And so we're watching it closely. We continue to have conversations with all the stakeholders, of course, from the investment community to regulators, which, of course, are focused on regulatory capital. This does not impact regulatory capital and so on.

So it's a consideration, but it's not necessarily going to be the ultimate yes or no. We're out of the market or we're just going to keep doing what we're doing.

Currently, we have no further questions. Therefore, I will hand back to Brad Kessel, President and CEO, 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 the Independent Bank Corporation and for joining us on today's call. Have a great day.

Ladies and gentlemen, this concludes today's conference call. Thank you for being with us today. Have a lovely day ahead. You may disconnect your lines now.