Independent Bank Corporation (IBCP) Q3 2015 Earnings Report, Transcript and Summary

Good morning and welcome to the IBCP Independent Bank Corp Third Quarter 2015 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator instructions] Please note this event is being recorded. I would now like to turn the conference over to Brad Kessel, President and CEO. Please go ahead, sir.

Good morning. Thank you for joining Independent Bank Corporation's conference call and webcast to discuss the Company's 2015 third 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 two in our presentation. If anyone does not already have a copy of the press release issued by Independent today, you can access it at our 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 four, we are reporting for the third quarter of 2015 net income of $5 million, or $0.22 per diluted share, versus net income of $4.9 million, or $0.21 per diluted share, in the prior year period. For the nine months ended September 30th, 2015, the Company reported net income of $14.4 million, or $0.62 per diluted share, compared to net income of $14.1 million, or $0.60 per diluted share, in the prior year period. Turning to the 2015 third quarter financial highlights slide, page five, this quarter's results were positively impacted by growth in net interest income of $700,000, or 3.6%, on a year-over-year basis, reductions in non-interest expenses of $205,000, and continued improvement in asset quality metrics, with net recoveries for the third quarter of $260,000, which led to a $244,000 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 higher quality -- into quality higher yielding loans. This past quarter our portfolio loans grew by $18 million, or 4.9% annualized. I am very encouraged by these results, particularly as this represents the sixth consecutive quarter of growth for our portfolio loans. In addition, average earning assets are up $91.5 million, or 4.5%, over the same period one year ago. I am very pleased to report total deposits increased to $2.1 billion as compared to $1.9 billion for the same year quarter one year ago. This represents a $165 million increase, or 8.7% increase, while consolidating six branches and selling a seventh branch in conjunction with our branch optimization strategy. During the third quarter, we repurchased 381,747 shares of our stock under our previously announced 5% share repurchase program. Thus far in 2015, the Company has repurchased 659,162 shares, or approximately 2.9% of our outstanding common stock, at an average price of $13.69. The Company paid a $0.06 per share cash dividend on August 15th, 2015. I am pleased to report a 33% increase in our dividend with today's earlier announcement of an $0.08 per share cash dividend payable on November 16th, 2015. As of September 30th, our tangible book value per share now stands at $11.11 per share as compared to $10.65 per share at September 30th, 2014. Our footprint is shown on the core banking market slide, page six. Today Independent Bank is the fifth largest bank headquartered in Michigan, and operates 63 branch locations in 21 counties and 11 metropolitan statistical areas. These 21 counties contain 6.5 million of Michigan's 9.9 million residents. According to the FDIC's most recent report on bank and branch deposits, Independent improved or maintained its market share position in 18 of its 21 markets this past year. We believe that, while we have significant market presence today in many of our markets, we have the opportunity to gain market share going forward. For the third quarter of 2015, Michigan market conditions continue to show improvement. This is evidenced by a reduced state unemployment rate, now at 5%. Not seasonally adjusted, the unemployment rate by MSA for Grand Rapids was 3.4%, Lansing 4.0%, and Detroit 5.7% respectively. Michigan payrolls added 84,000 net new jobs as compared to one year ago. And Michigan housing conditions also continued to be upward trending, as evidenced by total housing sales, housing starts, and the median sales price of single family homes. Commercial real estate vacancy rates in Grand Rapids, Lansing, and Detroit continued to be flat or improving. The table at the bottom of this slide provides a snapshot of our loan and deposit balances by market for the quarter ended September 30th, 2015 in comparison to one year ago. As you can see, our west region has shown the largest dollar loan and deposit growth, with a good mix across all our regions. Moving to the deposit franchise slide, page seven, for the third quarter of 2015 we increased deposits by $136.7 million, or 7.1%, over year-end 2014. This is substantially all core funding with $1.64 billion, or 80%, in transaction accounts. In addition to this growth, we have been able to maintain a low cost on our deposits, now at 20 basis points. We have made significant changes to streamline and optimize our branch delivery network, going from 106 branches in 2011 to our current 63 branches as of September 30th, 2015. During the third quarter, we closed on the sale of our Midland, Michigan branch. This transaction resulted in a one-time pre-tax gain of approximately $1.2 million. Since the end of 2011, we have improved the average profitability per branch and increased the average deposits per branch from $20.2 million to over $32.7 million per branch. Revenue growth through cross selling our existing customers and the acquisition of new customers continues to be the focal point of all sales associates. At the same time, we continue to look to drive down costs and increase productivity in all our delivery channels. Our lending highlights, loan composition, and loan yield are shown on slide eight. Total loans grew by $18 million, or 4.9% annualized. This represents our sixth consecutive quarter of loan growth and brings our total outstandings to $1.49 billion as of September 30th, 2015. Our commercial banking team grew balances by $15.3 million, or 8.6% annualized loan growth for the third quarter. This was accomplished through $75.4 million in originations, of which $43.9 million was new money and $31.5 million were in renewals. Much of the new money was not funded until late in the quarter. This past quarter, 64% of this production was floating and 36% was fixed. Year-to-date, the commercial team has originated nearly $157 million in new commitments. The current pipeline on new loans, while down from the second quarter, is still strong. Our consumer lenders grew balances by $6.9 million, or 11.9% annualized, while mortgage balances were essentially flat for the quarter. We continue to sell our 15 year and 30 year fixed rate production. During the third quarter, we originated $80 million of mortgages, sold $71 million, with net gains of $1.8 million. This compares to the second quarter, in which we originated $101 million, sold $82 million, and had net gains also of $1.8 million. In addition to a strong quarter of mortgage originations, our team successfully converted to a new origination platform, which we believe will improve our overall mortgage origination productivity. 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.

Thanks, Brad, and good morning, everyone. I am starting at page nine of our presentation. Our net interest income totaled $18.8 million during the third quarter of 2015, an increase of $0.7 million from the year ago period and an increase of $.1 million on a linked quarter basis. Our tax equivalent net interest margin was 3.58% during the third quarter of 2015 compared to 3.61% in the year ago period and 3.62% in the second quarter of 2015. Two factors, in addition to the prolonged low interest rate environment, contributed to the slight decline in the net interest margin in the third quarter. First, the yields on new loan volumes remained below the weighted average yield on the total loan portfolio. Second, we had significant deposit growth, some of which occurred late in the third quarter. And thus, some of these funds could not be deployed by quarter end, which resulted in an increase in cash and cash equivalents. Average interest earning assets were $2.11 billion in the third quarter of 2015 compared to $2.02 billion in the year ago quarter and $2.08 billion in the second 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 that was partially offset by an increase in interest expense on deposits and borrowings. A little more color on the new loan production and yields is as follows. Portfolio loan production, excluding mortgage loans originated for sale, in the third quarter totaled $137 million, of which 56% had variable or adjustable rates and 44% had fixed interest rates. The overall yield on this portfolio new loan production was approximately 3.87%. This compares to a total portfolio yield of approximately 4.83% during the third quarter. We will comment more specifically on our outlook for net interest income for the remainder of 2015 and into 2016 later in the presentation. Moving on to page 11, non-interest income totaled $10.1 million in the third quarter of 2015 as compared to $10.5 million in the year-ago quarter and $11 million in the second quarter of 2015. Our mortgage banking operations caused most of the quarterly comparative year-over-year variability in noninterest income. In the third quarter of 2015, gains on mortgage loans increased by $0.3 million due to increased mortgage loan originations and sales. However, more than offsetting the increase in gains on mortgage loans was a $1.5 million decline in mortgage servicing, due primarily to a $900,000 impairment charge on capitalized mortgage servicing rights in the third quarter of 2015 compared to a $0.5 million recovery in the third quarter of 2014. As we previously announced, we did record a $1.2 million gain on a branch sale in the third quarter of 2015. Total deposits at this branch at the time of sale were $8.7 million. As detailed on page 12, our non-interest expense totaled $21.9 million in the third quarter of 2015 as compared to $22.1 million in the year ago quarter. Several expense categories were lower in 2015, which reflects our cost reduction initiatives. However, non-interest expenses did increase by about $300,000 on a linked quarter basis due principally to an increase in compensation caused in part by one additional workday in the third quarter and staffing increases and overtime in our mortgage lending operations, reflecting the implementation of a new mortgage loan origination system in preparation for the new TILA-RESPA integrated disclosure rules. In addition, the third quarter non-interest expenses were elevated by several smaller nonrecurring items that individually were not significant, but collectively added approximately $200,000 to $300,000 of expenses scattered over data processing, communications, and other non-interest expense. Investment securities available for sale increased by approximately $71.5 million in the first nine months of 2015, primarily 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 September 30, 2015. Approximately 34% of the portfolio is variable rate, and much of the fixed rate portion of the portfolio is in maturities of five years or less. The estimated average duration of the portfolio is about two years. Page 14 provides data on non-performing loans, other real estate, non-performing assets, and earl stage delinquencies. Non-performing loans did tick up about $3.5 million in the third quarter compared to our June 30, 2015 total. This increase was primarily due to a $4.2 million commercial relationship moving into nonaccrual. Previously, this relationship was an accruing watch credit. The relationship was originated more than 10 years ago, and the collateral primarily consists of income producing properties. We believe that we have provided adequate reserves for the resolution of this credit. Other real estate declined by about $600,000 during the third quarter of 2015. Total non-performing assets were $19.7 million, or 0.82% of total assets, at September 30, 2015. Total 30 to 89 day delinquencies were $9.7 million, or 0.7% of portfolio loans, at September 30, 2015. Included in this figure was a $1.6 million matured commercial credit that paid off in full subsequent to quarter end. Moving on to page 15, we recorded a credit provision for loan losses of $0.2 million in the third quarter of 2015 compared to a credit provision of $0.6 million in the year ago quarter. We had net recoveries of about $260,000 in the third quarter of 2015. The allowance for loan losses totaled $24.6 million, or 1.68% of portfolio loans, at September 30, 2015. Page 16 provides some additional asset quality data, including information on new loan defaults and on classified assets. Page 17 provides information on our TDR portfolio. That totaled $97.4 million at September 30, 2015, a decline of 11.6% since the end of 2014. This portfolio continues to perform very well, with 92% of these loans being current at September 30, 2015. On page 18, we provide a summary of our actual 2015 performance as compared to our original outlook. Overall we believe our performance in the third quarter of 2015 was generally in line with our original outlook. Net portfolio loan growth in the third quarter of 2015 was $18 million, or 4.9% annualized. We continue to target mid single digit percentage loan growth as we move through the balance of 2015 and into 2016. We indicated an expectation for modestly higher net interest income for 2015, and we believe that we remain on track to achieve this. We are targeting mid single digit growth in net interest income in 2016, due primarily to the aforementioned loan growth. We recorded a small credit provision for loan losses in the third quarter of 2015 that I discussed previously. As we look ahead to the remainder of this year and into 2016, 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 generally continue to be stable to improving. Non-interest income of $10.1 million in the third quarter of 2015 was just above the high end of our expected range of $9.5 million to $10 million. A branch sale gain largely was offset by an impairment charge on capitalized mortgage loan servicing rights, as I discussed previously. We expect mortgage loan origination volumes and sales to remain relatively strong over the next two months and then decline a bit due to seasonal factors as we move into the first quarter of 2016. Non-interest expense, at $21.9 million in the third quarter of 2015, was in line with the higher end of our forecasted range of $21 million to $22 million, but was not where we wanted to be. Our goal is to move down to a quarterly average of $21 million in 2016. Finally, our effective income tax rate of 31.1% in the third 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 solid overall results for the third quarter of 2015. We reported revenue growth, continued reductions in non-interest expense as compared to the same quarter one year ago, continued strong asset quality metrics. Our quarterly return on assets was 86 basis points, and our return on average common shareholders' equity was 7.84%. 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. As previously shared, our target or roadmap to this level of performance is built in improving net interest income to $20 million or better per quarter, non-interest income of $10 million or better per quarter, non-interest expense of less than $21 million per quarter, and 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; first, generating revenue growth through the migration of our earning assets from lower yielding securities portfolio to a higher yielding loan portfolio; second, 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 to increase long term shareholder total return is through the prudent management of our capital. As it relates to our 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 a consistent dividend payout plan and share repurchase plan. We believe 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, sir. [Operator instructions] Our first question comes today from Damon DelMonte with KBW.

Hey. Good morning, guys. How are you doing?

Good.

Good. So, my first question just relates to the buyback. Thanks for the color on the repurchase activity this quarter. Could you talk a little bit about maybe pricing sensitivity? I know the shares have been strong lately, and the average price at which you've bought back the stock year-to-date has been significantly lower than where the shares are today. How do you factor that into the equation, given where the stock price is?

Well, we have an internal model that we utilize with a target in terms of tangible book dilution recovery in the two to three year range. So, obviously some of the inputs there are earnings and where the stock will trade on a P/E basis. But, that's sort of what we're using. And as we reflect on where we feel earnings are moving towards, it gives us sort of roadway of where we think it's wise to repurchase the shares at. So, certainly there's been some times where we weren't buying. But, I would say most of this year we have been buying, including into October.

Okay, that's helpful. Thanks. And then, I appreciated the commentary on the margin. And from a modeling perspective, it sounds like you're probably going to feel a little bit more pressure, just given where the new production was this quarter versus what the portfolio yield is. Is that a fair assessment?

What was a little unusual this quarter was we got quite a bit of deposit growth that was late in the quarter that we just couldn't get all out to work. And then, some of the loan growth, just the timing of the closings sort of fell later in the quarter on the commercial side. So, I mean, even with the gap between the new production, and I had given you the numbers with the average yield at 3.87%, and recognize about 60% of the new production was variable or adjustable rate. So, that tended to push a little bit there, and that compares to an overall yield of 4.83%. So, that gap is still roughly, if this is representative, about 100 basis points. But, the rotation, if we're growing those loans and the money is coming out of the investment portfolio, we still feel like that migration can keep the margin relatively steady. Now, again, some of the push this quarter was just from a timing perspective and not being able to get all those dollars out. But, I do think there is still, with that gap, a little bit of downward pressure. But, we're hopeful we could sort of make that up on the margin through the transition of dollars out of lower yielding securities and into higher yielding loans, even if that loan yield is more around 4%. And then, certainly we feel like we could continue to push the dollars up toward that $20 million a quarter that Brad mentioned. And I don't know if you want to add anything, Brad.

That was very good, Rob.

Okay, great. That's all that I had for now. Thanks.

Thanks, Damon.

Our next question comes from Matthew Forgotson with Sandler O'Neill & Partners.

Hi. Good morning, gentlemen.

Morning, Matthew.

Good morning, Matthew.

I'm sorry if I missed this, but would you mind just giving us a little bit of color about what exactly drove the quarter-to-quarter increase in deposits? Was it a new campaign? Was it municipal inflows? Just looking for a little granularity there.

Very good, Matthew. So, actually I'm very pleased with the deposit growth, and I think it's a reflection of a continued emphasis within our company to grow the core deposit base. And we've had people out in our markets regularly knocking on doors and asking for the business. So, it's great to see it come in. This quarter I'd say there was quite a bit of pick up in our municipal or Pub Fund client base, and really across the board, across our markets. And a lot of that's seasonal in terms of tax revenues coming in and then being shifted back out into their respective markets. But, I think it reflects continued confidence in Independent Bank by our customer base. On top of that, I would say that we continue to work real hard at growing our checking account base. We do direct mail and a series of activities at growing that client base too. So, we feel really good about the growth this third quarter there.

Okay. Can you give us a sense about kind of the trajectory to $21 million non-interest expense run rates? I know we've been talking about this being a level that you want to achieve as we move into 2016. But, is it -- how are you seeing it? Is it reasonable to expect you to get there for the fourth quarter, or is this really pushing now into the first quarter of next year?

Go ahead, Rob.

Yes. I think we'll be down in the fourth quarter. I don't think we'll be down to the $21 million level. I commented we had a handful of what I would classify as nonrecurring items that were $200,000 to $300,000. That was kind of the quarter-to-quarter linked quarter jump that were spread between communications, data processing, and other. And then, on the comp side, we had some bump because one just -- we had an additional workday in the quarter. That's $130,000 or so, but plus we had a lot going on in our mortgage operations with the conversion to a new origination system and getting ready for TRID, which came into play in the first week of October. Some of that may bleed into the fourth quarter, but we think longer term that trajectory, once we get TRID behind us and once we're I think more used to this new system, it's going to improve the productivity there and ultimately lead to better efficiency. And then, there are certain things we talked about I think in the past. In 2016, with some roll off of some software costs and other things that are pretty significant, and some occupancy costs that collectively are probably getting upward toward $1.5 million annually, that's going to sort of fold in between November of this year and about April of next year for that to be kind of fully achieved. So, I think to sort of summarize, lower in the fourth quarter versus where we were this quarter is what we believe. And then, moving progressively toward that $21 million or better, certainly we feel by the second half of next year we'll be there. And our goal is to get to $84 million for the full year.

Okay. And then, I'll just finish up with another point on buyback. Let's just assume the current market price. Is it reasonable to expect that, if the stock holds in the current range, that you're going to work through the balance of the authorization by the end of the year?

I would say that is reasonable, yes.

Okay. Thank you very much.

You're welcome.

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

I would like to thank each of you for your interest in Independent Bank Corporation and for taking the time to join us on today's call. I wish everyone a great day.

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