Independent Bank Corporation (IBCP) Q2 2015 Earnings Report, Transcript and Summary

Good morning and welcome to the Independent Bank Corp. Second Quarter 2015 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Brad Kessel, President and Chief Executive Officer. Please go ahead, sir.

Good morning. Thank you for joining Independent Bank Corporation’s conference call and webcast to discuss the company’s 2015 second quarter results. I am Brad Kessel, President and Chief Executive Officer of Independent Bank and joining me is Rob Shuster, Executive Vice President and Chief Financial Officer. Before we begin today’s call, it is my responsibility to direct you to the cautionary note regarding forward-looking statements. This is Slide 2 in our presentation. If anyone does not already have a copy of the press release issued by Independent today, you can access it at the company’s website www.independentbank.com. The agenda for today’s call will include prepared remarks followed by a question-and-answer session and then closing remarks. Beginning with the financial summary slide, Page 4 in our presentation, we are reporting for the second quarter of 2015 net income of $5.6 million or $0.24 per diluted share versus net income of $6.1 million or $0.26 per diluted share in the prior year period. On a pre-tax basis, this is a $300,000 or 4.4% year-over-year increase. For the six months ended June 30, 2015, the company reported net income of $9.4 million or $0.40 per diluted share compared to net income of $9.2 million or $0.39 per diluted share in the prior year period. Turning to the 2015 second quarter financial highlights slide, Page 5, this quarter’s results were positively impacted by growth in net interest income and non-interest income on both a linked quarter basis as well as compared to same quarter last year, reductions in non-interest expenses of $1 million or 4.3% on a year-over-year basis, and improved asset quality metrics which led to a $100,000 credit provision as compared to the prior year’s $1.8 million credit provision. One of our key strategies for long-term profitability and growth continues to be centered on changing our earning asset mix from lower yielding short duration investments into quality higher yielding loans. This past quarter our portfolio loans grew by $27 million or 7.6% annualized. I am very encouraged by these results, particularly as this represents the fifth consecutive quarter of growth from portfolio loans. In addition, total deposits increased to $1.961 billion as compared to $1.908 billion for the same quarter one year ago. This represents a $53 million increase or 2.8% increase, while we completed another phase of branch consolidations this past quarter. Our loan-to-deposit ratio increased to 73.9% from 73.3% at year end 2014. During the second quarter, we repurchased 206,772 shares of our stock at an average price of $13.38 under our previously announced 5% share repurchase program. Thus far in 2015, the company has repurchased 277,415 shares for approximately 1.2% of our outstanding common stock. The company paid a $0.06 per share cash dividend on May 15, 2015. And as of June 30, 2015, our book value per share now stands at $11.06 per share as compared to $10.94 per share at March 31, 2015 and $10.47 to one year ago. Our footprint shown on the core banking market slide, Page 6, includes significant market presence and opportunity to gain market share in attractive Michigan markets. We have made significant changes to streamline and optimize our branch delivery network going from 106 branches in 2012 to our current 64 branches as of June 30, 2015. During the same period, we have increased the average deposits per branch from $19.7 million to over $30 million per branch. Looking ahead, we expect to close on the sale of our Midland, Michigan branch in August 28, 2015. We anticipate this transaction will result in a one-time pre-tax gain approximately $1.5 million in the third quarter 2015. For the second quarter of 2015, Michigan market conditions continued to improve as compared to the same period one year ago. This is evidenced by a reduced unemployment rate now at 5.5%, an increase in Michigan payrolls, 107,000 net new jobs as compared to one year ago, and continued appreciation in real estate values. The table at the bottom of the slide provides a snapshot of our loan balances by market for the quarter ended June 30, 2015 in comparison to one year ago. As you can see, our West region has shown the largest dollar growth, followed by our Southeast region and then our East Thumb region. Moving to the deposit franchise slide, Page 7, for the second quarter of 2015, we increased deposits by $37.1 million, or 1.9% over year end 2014. This is substantially all core funding with $1.59 billion or 81% in transaction accounts. In addition to this growth, we were able to reduce the cost on our deposits by another basis point with our total cost deposits now at 20 basis points. Revenue growth through cross-selling our existing customers and the acquisition of new customers continues to be a focal point for all sales associates. At the same time, we continue to look to drive down cost at increased productivity in all our delivered channels. Our loan composition yield and lending highlights are shown on Slide 8. Total loans grew for the fifth consecutive quarter to $1.48 billion as of June 30, 2015. On a very positive note, for the first time in many quarters, we saw an uptick in the overall yield on loans improving to 4.90% for the second quarter 2015 as compared to 4.89% for the first quarter of ‘15. All of our lending units are extremely active. This past quarter, our mortgage business team led the way with $100 to $1.3 million in originations, with loan sales of $82.2 million generating gains of $1.8 million. In addition to a strong quarter of originations, our team is in process of converting to a new origination platform, which we believe will improve our overall mortgage origination productivity. The mortgage pipeline continues to be strong with a good mix of purchase volume to total volume. Also during the quarter, our consumer installment portfolio grew by $20.8 million, or 40.1% annualized. A large portion of this growth came from our indirect business, which has a specialty focus in both marine and recreational vehicle lending. We view the activity in our indirect period to be a good indicator of the overall economy as these purchases are often larger ticket items and discretionary in nature. At the same time, these purchases are very seasonal in nature too. We expect good volume of originations through the third quarter before slowing down in the fall. Finally, while our commercial loan portfolio was slowed for the second quarter as a result of fewer than expected new money bookings and higher than expected pay offs, we are still very pleased with this group’s performance and remain optimistic about our future growth prospects. Year-to-date new commitments booked are over $91.8 million, new outstandings year-to-date, are $79.4 million and the pipeline remains at a very good level. I would now like to turn the presentation over to Rob Shuster to share a few comments on our financials, credit quality and management’s outlook. Rob?

Thanks, Brad and good morning everyone. I am starting at Page 9 of our presentation. Our net interest income totaled $18.7 million during the second quarter of 2015, an increase of $0.2 million from the year ago period and an increase of $0.6 million on a linked quarter basis. Our tax equivalent net interest margin was 3.62% during the second quarter of 2015 compared to 3.74% in the year ago period and 3.57% from the first quarter of 2015. Although the net interest margin remains under some pressure due to the prolonged low interest rate environment, we did achieve an increase in the margin on a linked quarter basis for the first time since the start of 2013. As I mentioned last quarter, we are optimistic that the downward trajectory of the net interest margin has generally come to an end. Average interest earning assets were $2.08 billion in the second quarter of 2015 compared to $2.01 billion in the year ago quarter and $2.06 billion in the first quarter of 2015. Page 10 contains a more detailed analysis of the linked quarter increase in net interest income. This increase was primarily due to increases in interest income on loans and on securities and investments and a decrease in interest expense on deposits and borrowings. In addition one more day in the second quarter of 2015 as compared to the first quarter increased net interest income by about $100,000 on a linked comparative quarterly basis. We will comment more specifically on our outlook for net interest income for the remainder of 2015 later in this presentation. Moving on to Page 11, non-interest income totaled $11 million in the second quarter of 2015 as compared to $10.1 million in the year ago quarter and $9 million in the first quarter of 2014 or I am sorry of 2015. Our mortgage banking operations caused most of the quarterly comparative year-over-year variability in non-interest income. In the second quarter of 2015, gains on mortgage loans increased to $1.8 million due to increased mortgage loan originations and sales. Further mortgage servicing generated $1.5 million on income compared to $0.2 million of income in the year ago quarter due primarily to $1.2 million recovery of previously recorded impairment charges on capitalized mortgage servicing rates in the second quarter of 2015. As detailed on Page 12, our non-interest expense totaled $21.6 million in the second quarter of 2015 as compared to $22.6 million in the year ago quarter. Many expense categories were lower in 2015 primarily reflecting our cost reduction initiatives. As we have previously discussed, we expect the branch consolidation that was completed on April 30, 2015 to reduce non-interest expenses by approximately $1.6 million annually. Investment securities available for sale increased by approximately $24.5 million in the first half of 2015 reflecting the deployment of a portion of the funds provided from the year-to-date increase in deposits. Page 13 provides an overview of our investments at June 30, 2015. Approximately 38% of the portfolio was variable rate and much of the fixed rate portion of the portfolio is in maturities of 5 years or less. The estimated average duration of the portfolio was about 1.8 years. Page 14 provides data on non-performing loans, other real estate, non-performing assets and early stage delinquencies. We made further progress on improving asset quality during the second quarter of 2015. Non-performing assets declined by 17.8% during the second quarter of 2015 and were down to 0.73% of total assets at June 30, 2015. In addition, total 30-day to 89-day delinquencies fell to $6.1 million or 0.4% of portfolio loans at June 30, 2015. Moving on to Page 15, we recorded a credit provision for loan losses of $0.1 million in the second quarter of 2015 compared to a credit provision of $1.8 million in the year ago quarter. We actually achieved loan net recoveries of about $40,000 or 0.01% of average portfolio loans in the second quarter of 2015. The allowance for loan losses totaled $24.6 million or 1.70% of portfolio loans at June 30, 2015. Page 16 provides some additional asset quality data including information on new loan defaults and on classified assets. New loan defaults totaled just $1.2 million in the second quarter of 2015. Page 17 provides information on our TDR portfolio that totaled $104.3 million at June 30, 2015, a decline of 5.3% since the end of 2014. This portfolio continues to perform very well with 93% of these loans being current at June 30, 2015. On Page 18, we provide a summary of our original 2015 – of our actual 2015 performance as compared to our original outlook. Overall, we believe our performance in the second quarter of 2015 was generally better than our original outlook. We had solid overall loan growth and we continue to target mid single-digit percentage growth for the loans as we move forward during the balance of the year. We indicated an expectation for modestly higher net interest income for 2015 and we believe we remain on track to achieve this through a stabilization of our net interest margin in the aforementioned loan growth. Asset quality metrics generally improved across the board in the second quarter of 2015, which led to a small credit provision that I discussed previously. As we look ahead to the remainder of 2015, the level of loan net charge-offs, loan defaults, watch credits and the performance of the TDR portfolio will be the key factors influencing our provision levels. We are optimistic that our asset quality metrics will continue to be stable or improve. Actual non-interest income of $11 million in the second quarter of 2015 was above our expected range of $9.5 million to $10 million. The second quarter of 2015 was positively impacted by $1.2 million recovery of previously recorded impairment charges on capitalized mortgage servicing rights and we also enjoyed relatively strong gains on mortgage loans. We expect mortgage loan origination volumes and sales to remain reasonably strong in the third quarter of 2015 and consequently in the absence of any significant MSR impairment charges or recoveries, we believe that non-interest income will be within our forecasted range. Non-interest expense at $21.6 million in the second quarter of 2015 was generally in line with the midpoint of our forecasted range. With the completion of the branch consolidation on April 30, 2015 and the resulting expected decreases in non-interest expenses, along with other cost reduction initiatives, we believe that total non-interest expenses will continue to be within our $21 million to $22 million forecasted range for each of the last two quarters of 2015. Finally, our effective income tax rate of 31.8% in the second quarter of 2015 was in line with our forecasted range. That concludes my prepared remarks. And I would now like to turn the call back over to Brad.

Thanks, Rob. We are pleased to report strong overall results for the second quarter of 2015. We reported revenue growth, continued reductions in non-interest expense, improved asset quality and a quarterly return on assets of 0.98% and return on average common shareholders’ equity of 8.86%. However, our management team recognizes we need to continue to grow revenue and improve our overall earnings as we work toward a sustained performance of 1% or better return on assets and 9% to 10% or better return on equity by 2016. Our target or roadmap to this level of performance is built on improving net interest income to $20 million, non-interest income of $10 million or better, non-interest expense of less than $21 million in a normalized provision. As we look ahead, we will continue to execute on strategies and initiatives to increase long-term shareholder total return. These strategies include the following: revenue growth through the migration of our earning assets from a lower yielding securities portfolio to higher yielding loan portfolio. This strategy includes the originations of a high credit quality, diverse mix by segment, diverse by geography and a very granular makeup of credits. Secondly, we will continue to focus on and invest our resources in higher growth Michigan markets. Third, we will continue to leverage our low cost core deposit base, which will at some point provide greater upside in a rising rate market. Fourth, we will continue to improve the bank’s efficiency ratio, primarily through revenue increases, but also continuing to aggressively attack our cost structure. And finally, the fifth strategy is to increase long-term shareholder total return through the prudent management of our capital. As it relates to capital, our near-term target for tangible common equity is 10.5% and the longer term target is near 9.5%. Our plan is to retain capital for organic loan growth and return capital through consistent dividend payout plan and share repurchase plan. We believe the sound execution on these strategies will generate solid total shareholder returns over the long run. At this point, we would now like to open up the call for questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question will come from Matthew Forgotson of Sandler O'Neill & Partners. Please go ahead.

Hi, good morning gentlemen.

Good morning.

Can you give us a sense of the loan pipeline, the balance is complexion weighted average coupon and remind us also where it was last quarter?

Sure. Sure, Matthew, this is Brad. I start with the mortgage pipeline and our mortgage pipeline is a little bit under where we were at the start of the second quarter, what it’s still at a lofty level. And we see closings continue to be strong through the third quarter. On the commercial side, our pipeline is very strong. It is higher than it was at the start of the second quarter. And I think the yields continue to be probably on a weighted average basis in that 4.5% range. And it’s a very good mix of C&I and commercial real estate, very granular in nature and very diverse in terms of geography.

Okay. In terms of the balance sheet remixing, I should say the loan portfolio remixing, as you look at your securities to assets ratio kind of what should we expect that to be on a stabilized basis? I am trying to get at how much incremental margin expansion we could see from this level barring a material shift in rates say over the next 12 months?

I think longer term we like to see loans assuming total assets of roughly the same level as that we have today at about $2.3 billion, another couple of $100 million in loans and $200 million less in securities. So, that would add roughly 9% to where we are at today in terms of loans to assets and we think that would be a very comfortable level in terms of still maintaining good liquidity within the balance sheet, but having fuel to really boost net interest income.

Okay. Just moving over to expenses, if you are at $21.6 million today, where would you ultimately expect this to flush out saying the third quarter, once the branch sale takes effect and if I recall correctly you also have some amortization expense that’s rolling off as well. So, where do you see that trending?

Well, I think we will keep working on our way down toward $21 million as we moved through this year. And then as we move into the following year getting that pushed below the $21 million level, but amortization you are referring to is some software amortization that runs out after the first quarter of 2016. So, by the second quarter that sort of kicks in, and that’s about $900,000 annually that software amortization. So, we will get the benefit of that. And then as you mentioned, we do have – we will start to see the full benefit of the branch consolidation that took place on April 30 in these last two quarters of this year and then moving into next year, we didn’t really get that much of the benefit in this second quarter. So, the combination of those two items will help start to push us below that $21 million figure, that’s our target as we move into 2016.

Thank you very much.

You are welcome.

Our next question will come from John Rodis of FIG Partners. Please go ahead.

Good morning, guys.

Good morning, John.

Rob, I guess one question on the loan portfolio, I noticed METCO loans were up slightly this quarter and I know it was only like $2 million, but that was the first quarter they have actually not gone down in quite a while. Could you just maybe just talk to that real quick?

Well, yes, we are just at sort of a volume level. Presently, that portfolio was stabilized at this juncture. We are still working on some initiatives to try and shift that business, where the volume will become more through auto dealerships as opposed to direct marketers of service contracts. So, if that push is ultimately successful, we think we could get some growth there. It certainly would not be significant growth, but it would sort of stop the trend of that portfolio of heavy move down, but right now, we are sort of at this juncture, where the incoming volume and the run-off of the portfolio are sort of a sequence now, so the portfolio is somewhat stabilized.

Okay. I also noticed on the mortgage side, I guess the gain on sales spread was down from the first to second quarter, can you just talk about what we should expect and I know what’s sort of a volatile number, but what you see going forward?

Yes. A couple of things, one is I think we will see that the margin pump up a bit as we move into the third quarter. The second quarter couple of things affected it, one is there was just the competitive landscape was such that we just saw some compression what we call primary and secondary spread. So I think that was part of it. The other piece was the actual close ratio was a bit above where our hedge ratio was. And if you recall during the second quarter the 10-year treasury was up quite a bit, that’s what triggered the MSR recovery. So some of the margin compression on the gains on sales, were just because we were selling some additional loans that had not been hedged because of the closing ratio being a bit higher and the pricing was coming down during the quarter, so that we had a modest impact as well. But based on where we are seeing volumes coming and where the pricing is done in the pipeline right now, we expect to see a bit of a bounce back on that margin in the third quarter.

Okay. And then maybe just one final question for me on the buyback, I think you guys said you bought back like 206,000 shares in the quarter, would you sort of expect that to be the quarterly pace going forward or how would you characterize I guess the pace of activity going forward?

Well, our ultimate goal is to try and fulfill the 5% by the end of the year which we are at 1.2%, so we probably have to pickup that pace a bit. What we are really focused on there is increasing value for our shareholders. So we are cognizant of what the tangible book dilution recovery timeframe is. And we are looking obviously for opportunities to buyback the stock. Secondly I think we certainly don’t want to be the price driver in the market, so we are careful about that. But having said all those things, we would like to see if we can get to that 5% by the end of the year. So we are 3.8% shy which would mean bumping that level up the next two quarters to get there.

Okay, it makes sense. Thanks guys.

And at this time we will conclude the question-and-answer session. I would like to hand the conference back over to Brad Kessel for his closing remarks.

Very good. I would like to thank each of you for your interest in Independent Bank Corporation and for joining us on today’s call. And wish you all great day.

Thank you. Ladies and gentlemen, the conference has now concluded. We thank you for attending today’s presentation. You may now disconnect your lines.