Independent Bank Corporation (IBCP) Q4 2015 Earnings Report, Transcript and Summary

Good day, and welcome to the IBCP Independent Bank Corp. Fourth 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 Mr. Brad Kessel, President and Chief Executive Officer. Please go ahead, sir. William “Brad” Kessel: Good morning. Thank you for joining Independent Bank Corporation's conference call and webcast to discuss the company's 2015 fourth quarter and full year results. I am Brad Kessel, President and Chief Executive Officer 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 Bank today, you can access it at our company's Web site, 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, we are reporting for the fourth quarter of 2015 net income of $5.6 million, or $0.25 per diluted share, versus net income of $3.9 million, or $0.17 per diluted share, in the prior-year period. For the year ended December 31, 2015, the company reported net income of $20 million, or $0.86 per diluted share, compared to net income of $18 million, or $0.77 per diluted share, in 2014. This represents a 11.1% and a 11.7% increase in net income and diluted earnings per share, respectively, over the prior year. Turning to the fourth quarter financial highlights slide, Page 5, this quarter's results were highlighted by a 42.7% and 47.1% increase in net income and diluted earnings per share, respectively, over the year ago quarter; growth in portfolio loans, which increased $47.1 million, or 12.7% annualized; growth in total deposit balances, which increased $25 million representing a 4.8% annualized rate in the fourth quarter of '15. Continued progress in improving asset quality, with non-performing assets down 1.8 million, or 9.2%, since September 30, 2015. Share repurchases of 308,037 at a weighted average price of $14.52 per share and a payment of an $0.08 per share dividend on November 16, 2015. One of our key strategies for long-term sustained profitability and growth continues to be centered on changing our earning asset mix from lower yielding short duration investments into higher yielding quality loans. This past quarter, we supplemented our organic loan growth with a $32.6 million bulk purchase of fixed rate jumbo mortgage loans with all of the collateral located here in Michigan. For the year, our average earning assets are up $96.5 million, or 4.8%, over the same period one year ago. Turning to the 2015 annual financial highlights side, Page 6, the company’s full year 2015 results were highlighted by an increase in net interest income of $1.7 million and a reduction in non-interest expenses of $1.5 million. Total assets were $2.41 billion as of year end '15, an increase of $160.3 million from December 31, 2014. Total net portfolio loan growth of $105.1 million, or 7.5%, adjusted to 5.2% when excluding the bulk mortgage loan purchase; a $161.7 million or 8.4% increase in total deposits; a $3.8 million or 17.6% decrease in non-performing assets and a $2.5 million or 78% decline in loan net charge-offs; share repurchases of 967,199 shares at a weighted average price of $13.96 per share; and an increase of 3.6% intangible book value per share to $11.18 as of year end 2015. As we look back on 2015, we are proud of many significant achievements including increased loan and deposit balances, growth in revenues and earnings, a reduction in non-performing assets and the implementation of several new technology-driven initiatives to better service our customers. As we move into 2016, we recognize the importance of continuing our improved performance. We continue to evaluate and implement initiatives to grow loans and core deposits as well as to improve our operating efficiencies. We believe our balance sheet is well positioned to benefit from higher interest rates in 2016. In addition, we are announcing the continuation of our share repurchase program. Our 2015 share repurchase plan expired on December 31, 2015. On January 21, 2016, the Board of Directors of the company authorized a 2016 share repurchase plan. Under the terms of the share repurchase plan, the company is authorized to buy back up to 5% of its outstanding common stock. The plan is authorized to last through the end of 2016. Also on January 21, 2016, the Board of Directors of the company declared a quarterly cash dividend on our common stock of $0.08 per share payable on February 16 to shareholders of record on February 5. Our footprint is shown on the Michigan market slide, Page 7, of our deck. Today, Independent Bank is the fifth largest bank headquartered in Michigan and operates 63 branch locations in 21 counties and 11 MSAs. 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, particularly in the more densely populated urban markets where we believe we can compete well against the large bank competitors and in markets exhibiting disruption as a result of recent M&A activities. For the fourth quarter of 2015, Michigan markets continue to improve or to be stable. This is evidenced by its reduced state unemployment rate now at 5.1% versus the national rate of 5.0%. That seasonally adjusted the unemployment rate by MSA for November 2015 in Grand Rapids was 3%, in Lansing 3.4% and in Detroit 5.2%, respectively. Michigan payrolls added 72,000 net new jobs as compared to one year ago. Michigan housing conditions also continued to be upward trending, as measured 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. Page 8 contains a summary of our loans and deposits by region. Moving to the deposit franchise slide, Page 9, deposits totaled $2.09 billion as of December 31, 2015, an increase of $161.7 million from December 31, 2014. The increase in deposits was due to growth in checking, savings and time or certificates of deposits. The company’s deposit base is substantially all core funding with $1.66 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 2012 to our current 63 branches as of December 31, 2015. Since the end of 2011, we have improved the average profitability per branch and increased the average deposits per branch from $20 million per branch to just over $33 million per branch. Revenue growth through cross selling new services to our existing customers and the acquisition of new customers continues to be a 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 are shown on Slide 10. Loans, excluding loans held for sale, were $1.52 billion as of December 31, 2015 compared to $1.41 billion at December 31, 2014, an increase of 7.5%. We believe we have strong momentum in generating high-quality loans from our commercial team, our in-house mortgage team, our branch lenders and our indirect channels. On the commercial front for the year, the portfolio grew by $57 million or 8.3%. The group booked 250 million in new commitments with 209 million in new outstandings. There is a good balance of new business by region with the East region our strongest followed by the West region and then our Central region. Our commercial pipeline continues to be very strong. On the mortgage front, for the year our team originated $337 million in loans compared to $265 million in 2014. In addition, the portfolio grew by 5.9%, which included a bulk purchase transaction late in the fourth quarter of $32.6 million of single-family residential fixed rate jumbo mortgage loans from another Michigan-based financial institution. These mortgage loans were all on properties located in Michigan, had a weighted average interest rate after a quarter point servicing fee of 3.94% and a weighted average remaining contractual maturity of 344 months. The weighted average FICO was 771 and the weighted average original LTV was under 74%. In addition to a strong quarter of mortgage originations, our team has now successfully converted to a new origination platform and has effectively integrated the new truth and lending disclosure regulatory requirements. On the consumer front, for the year our team grew the portfolio by $25 million or 12.2%. These results include almost $70 million of indirect recreational vehicle and marine financing. 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 for 2016. Rob?

Thanks, Brad, and good morning, everyone. I am starting at Page 11 of our presentation. Our net interest income totaled $19.4 million during the fourth quarter of 2015, an increase of $1.3 million or 7.2% from the year-ago period and an increase of $0.5 million on a linked quarter basis. Our tax equivalent net interest margin was 3.56% during the fourth quarter of 2015, which is unchanged from the year-ago period and down slightly by 2 basis points from the third quarter of 2015. At this point, we believe the net interest margin has pretty much stabilized and I will comment more on this topic when we discuss our outlook for 2016. Average interest earning assets were $2.18 billion in the fourth quarter of 2015 compared to $2.03 billion in the year-ago quarter and $2.11 billion in the third quarter of '15. As Brad mentioned, for all of 2015, net interest income totaled $75 million, an increase of $1.7 million or 2.4% over 2014. Page 12 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 new loan production and yields is as follows. Portfolio loan production, excluding mortgage loans originated for sale, in the fourth quarter totaled $131 million, of which 56% had variable or adjustable interest rates and 44% had fixed interest rates. The overall yield on this portfolio new loan production was approximately 4.11%. This compares to a total loan portfolio yield of approximately 4.82% during the fourth quarter. We will comment more specifically on our outlook for net interest income for 2016 later in the presentation. Moving on to Page 13, non-interest income totaled $10.1 million in the fourth quarter as compared to $9.2 million in the year-ago quarter and $10.1 million in the third quarter of 2015. Our mortgage banking operations caused most of the quarterly comparative year-over-year variability in non-interest income. We had a $0.8 million recovery of previously recorded impairment charges on capitalized mortgage servicing rights in the fourth quarter of 2015 compared to $1 million impairment charge in the fourth quarter of 2014. For all of 2015, non-interest income totaled $40.1 million compared to $38.8 million in 2014. As detailed on Page 14, our non-interest expense totaled $22.8 million in the fourth quarter of 2015 compared to $22.9 million in the year-ago quarter. However, non-interest expenses did increase by just under $1 million on a linked quarter basis due principally to $0.6 million increase in performance-based compensation due to our final 2015 performance metrics relative to targets and $0.4 million increase in advertising expenses related primarily to a new checking account acquisition program and increased outdoor advertising. For all of 2015, non-interest expenses totaled $88.5 million, which was $1.5 million or 1.7% lower than 2014. A couple of final comments on non-interest expense. I do not believe that you can view the bump in the linked quarter total expenses in isolation from the overall results for the quarter in one’s assessment of the quality of earnings. The credit loan loss provision and the resulting impact on net income as well as improved asset quality metrics were important factors in driving up incentive compensation. Thus, a move to a more normalized provision for loan losses that would reduce one’s measurement of core earnings for the fourth quarter would also significantly reduce incentive compensation. Finally, as to advertising expense, clearly many components of this area are discretionary. Two focal points for our 2016 advertising are a direct mail checking account acquisition program and a debit card incentive designed to increase card usage. Long term, we believe these initiatives will drive up non-interest income. For 2016, we would expect an average quarterly run rate between $400,000 and $500,000 for advertising expense, which is about $350,000 lower than our fourth quarter 2015 expenses. Taking into account all of these various factors, I believe it is also necessary to adjust non-interest expenses lower by approximately $1 million on assessing the overall results for the fourth quarter. Page 15 includes our investment securities available for sale, which increased by approximately $52.3 million during 2015, primarily reflecting the deployment of a portion of the funds provided from the increase in deposits. Approximately 33% 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 16 provides data on non-performing loans, other real estate, non-performing assets and early stage delinquencies. Total non-performing assets were $17.9 million or 0.74% of total assets at December 31, 2015. MPAs declined by $1.8 million or 9.2% during the fourth quarter of 2015. Total 30 to 89-day delinquencies were $7.2 million or 0.5% of portfolio loans at December 31, 2015. Moving on to Page 17, we recorded a credit provision for loan losses of $1.7 million in the fourth quarter of 2015 compared to a credit provision of $1 million in the year-ago quarter. For all of 2015, we recorded a credit provision for loan losses of $2.7 million compared to a credit provision of $3.1 million in 2014. Loan net charge-offs declined to $0.7 million or just 0.05% of average portfolio loans during 2015. The allowance for loan losses totaled $22.6 million or 1.49% of portfolio loans at December 31, 2015. Page 18 provides some additional asset quality data including information on new loan defaults and on classified assets. Page 19 provides information on our TDR portfolio that totaled $88.3 million at December 31, 2015, a decline of 19.8% since the end of 2014. This portfolio continues to perform very well with 92% of these loans performing and 89% of these loans being current at December 31, 2015. On Page 20, we provide a summary of our outlook for 2016. We are targeting high single digit overall loan growth in 2016. We expect this growth to be supported by increases in commercial and consumer installment loans as well as a planned bulk mortgage loan purchase. This forecast assumes a stable Michigan economy. We expect mid single digit growth in net interest income in 2016 due primarily to the aforementioned loan growth. This forecast also assumes two 25% bumps in the federal funds rate, which we expect to occur in May 2016 and October 2016. We recorded a credit provision for loan losses in 2015 that I discussed previously. As we look ahead to 2016, the level of 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 credit quality metrics will generally be stable to slightly improving. We expect total non-interest income for 2016 to be generally comparable to 2015. Due to seasonal factors, non-interest income is typically somewhat lower in the first quarter of the year. We expect total non-interest expense to range between $21 million and $22 million on a quarterly basis during 2016 and for the full year expect a low single digit decline compared with 2015. We anticipate the reductions in 2016 versus 2015 to primarily occur in the following areas; compensation and benefits due principally to somewhat lower incentive compensation, occupancy, data processing, loan and collections, advertising and legal and professional. Finally, we expect an effective income tax rate of approximately 32% in 2016, which is comparable to our 2015 rate of 31.9%. That concludes my prepared remarks, and I would now like to turn the call back over to Brad. William “Brad” Kessel: Thanks, Rob. Moving on Page 21, we are pleased to report continued improved results for the fourth quarter and full year 2015. We reported revenue growth, continued reductions in non-interest expense and continued strong asset quality metrics. Our quarterly return on average assets was 93 basis points compared to 69 basis points for the same quarter one year ago. For the full year, our return on average assets was 86 basis points in '15 versus 80 basis points in 2014. Our quarterly return on average common shareholders’ equity was 8.8% compared to 6.19% for the same quarter one year ago. For the full year, return on average equity was 7.89% in 2015, up from 7.43% in 2014. Our management team recognizes we need to continue to grow revenue and improve our overall earnings as we work toward our next performance milestones of 1% or better return on assets and 9% to 10% or better return on equity in 2016 and beyond. As previously shared, our target or roadmap to this level of performance is built on improving net interest income to $20 million 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 our existing strategy as well as several new initiatives to increase long-term shareholder total return. These strategies include the following. First, revenue growth through the migration of our earning assets from lower yielding securities portfolio to higher yielding loan portfolio; second, to improve the Bank’s efficiency ratio primarily through revenue increases but also continuing to attack our cost structure; third, a focus on investing our resources in higher growth Michigan markets; fourth, to leverage our low cost core deposit base, which will at some point provide greater upside in a rising or higher rate environment. 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 9.5% to 10.5% and the longer-term target is 8.5% to 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.

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

Hi. Good morning, gentlemen. William “Brad” Kessel: Good morning.

How much of the high single digit loan growth you’re expecting in 2016, on how much of that should we expect to be resi bulk loan purchases? William “Brad” Kessel: We are anticipating not more than 50 million of bulk purchases, so the balance would be organic growth.

Okay. And in your NIM forecast you’re assuming two rate hikes that’s slightly more aggressive than the forward curve is currently implying. Just as a but exercise, if you strip out these rate hikes, Rob, how much pressure would you expect on the stabilized margin?

I still think the margin would be stable, we would actually anticipate a little upward drift in the margin if we get those two rate hikes. So we would still even, absent those, expect the margin to be stable.

Okay. William “Brad” Kessel: Rob, just part of that is just it’s a combination – one, we did get a 25% increase in mid December, which really essentially had no impact on 2015 and then second would be the continued migration into higher yielding loans from the lower yielding investment portfolio. So even in the absence of additional increases in Fed funds, we would expect the margin to be stable to maybe a tiny upward drift. But with the two bumps, we would expect a little more upward drift.

Okay. And next on expenses, just I hear what you’re saying about the fourth quarter run rate, the $1 million of non-run rate spend that you identified. Is it fair to say that we should expect that $1 million to fall out in the first quarter of '16 or is that too aggressive an assumption to make? William “Brad” Kessel: No, I don’t think that would be aggressive at all. What we do with incentive comp is every quarter we’re – the goals we set are disclosed in the proxy statement. Those goals are based on net income, which is measured by earnings per share, which is 32% of the overall, asset quality is 16%, deposit growth 16%, efficiency ratio 16% and individual goals for the particular person is 20%. Those are all laid out in our proxy statement. So we move through the year we’re measuring not just our actual performance but our forecasted performance for the balance of the year vis-à-vis those disclosed incentive targets in adjusting incentive comp. And I could just tell you in the fourth quarter as you can probably appreciate that we’re not budgeting or forecasting large credit provisions or there may be certain other factors as well. So what that impacts is when you have a quarter, like we did in the fourth quarter where we had a lot of things going on a positive basis that bumped up that incentive accrual and it sort of got moved more disproportionately into the fourth quarter.

Okay. And then lastly and then I will hop out. I know there are a lot of moving parts in the provision, Rob, but assuming stable asset quality, is it fair to think that you’d run a zero provision across '16 or should we expect it to swing into the positive such that you’re providing for loan growth?

Well, it’s so difficult to project because there’s all those factors that go into it. I would just say this. That 1.49 we look across the landscape, we’re still a little bit higher than peer group. We see peer group is low for some institutions down toward that 1% area, but I think peer last I looked was in the 1.30-ish handle. I’m not suggesting we’re moving down to that. What I would say is where we probably have a bit more of allowance relative to peers is in our TDR portfolio, which as you know we put a slide in every quarter to the extent that that portfolio continues to perform well. In decline, we could see releases of specific reserves there. In addition, if we run low new default rates and relatively low charge-offs and have relatively strong recoveries, I mean that would be sort of the factors that would get you into the range where maybe it’s zero to a small credit. It’s hard and I think you pointed it out in your comments this morning, it’s hard to envision that. You’re going to see a continuation of credits but certainly I could envision factors that would have the provision very low in 2016 even with some loan growth.

Thank you very much.

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

Good morning, guys. William “Brad” Kessel: Good morning, John.

I guess most of my questions were asked and answered but maybe just a question for either for Brad or Rob just on the – I guess just the trends in the loan portfolio during the quarter. I mean if you look at commercial loans, they were down a little bit and then commercial real estate was up. Could you just maybe – I’m assuming pay downs were probably up on the commercial side. And then on the commercial real estate side was the growth fairly granular or did you see a couple bigger loans in the quarter that sort of drove the increase?

Well, actually John, so commercial was up pretty good as a whole for the quarter and for the year. And what we liked there is that it’s a good mix between the C&I originations and the commercial real estate originations. It’s a good mix between each of our free markets, again, with our Southeast market being the strongest followed by our West Michigan market and then Central market. And it is very granular in originations. And in fact we target sort of that $1 million to $5 million commercial financing asset side and I think we had about 61 deals there last year. And in fact through all this growth, we did not have any originations over the $10 million mark. We had some larger ones when we sold off beyond the 10 million, so it was very granular in nature. And then finally, the pipeline continues to be real strong. So I think we’ve – in many of the bookings actually here in the fourth quarter on the commercial side, we’re late in the quarter in the month of December. William “Brad” Kessel: John, I’ll add one thing on the C&I side. We did have one relatively large payoff on an automotive-related credit in Southeast Michigan. So your comment regarding that sort of change in mix between September 30 and December 31 balance is influenced by that factor.

Okay. Okay, guys, fair enough. Thank you.

Thanks, John.

Our next question will come from Damon DelMonte from KBW. Please go ahead with your question.

Hi. Good morning, guys. How are you doing? William “Brad” Kessel: Hi, Damon.

My first question just regarding the provision, I know there’s a lot of moving parts there and it is difficult to provide great clarity as to what a quarterly run rate would be. But as you put on new loans, what’s the typical level of reserve you’re taking for the loans you’re putting on currently? William “Brad” Kessel: Well, it depends on a lot of factors. For example, on the commercial side it’s driven to a large degree on the grade of the loan. So with that you’re going to see more variation on commercial credits. But I would say you could see a range of under 0.5% to say 1.5%. So it’s a relatively wide range there. If we look on the retail side, you’re on an overall basis down more towards 50 basis points, which includes a historical allocation and then there is a portion of subjective allocations. So when you blend those altogether you would generally be probably down toward the 1% mark. And again, that driven to some degree by where on homogeneous pools like consumer and mortgage where incurred losses have been and on the commercial side it would be driven by a loss given default and probability of default rate, which is a direct factor of the loan rating and then migration factors. And I should add on the retail, we also do a migration that’s based on FICO score. So, I would just say as an overall comment that when you mix all that together it would generally be less than the current allowance of 1.49%.

Got you. That’s great color, thank you. And then with respect to the securities as a percentage of earning assets, what’s your targeted level over time? William “Brad” Kessel: I would say the targeted level would be more toward a 15% or so, so that would be more in the 300 to 350 range, so it would be down a couple hundred million from where we’re at.

Okay. William “Brad” Kessel: And that would be influenced too – it would be reflective of still a deposit base that’s predominately core and not a lot of wholesale funding, which we expect the balance sheet to be like that.

Right, okay. And then just with respect to the bulk purchases of the mortgage loans. Could you just talk a little bit about the thought process behind adding longer term fixed rate assets on the books at this point in time? William “Brad” Kessel: Sure, Damon. So I think we have shared consistently that sort of the profile of our balance sheet be very asset sensitive with both short duration on the securities portfolio as well as very short on the loan portfolio. And again, this overall strategy of working to migrate out of the securities into higher yielding loans and then within that a higher loans to deposit ratio. So, we in '15 made a decision that if we can find quality paper we would look to take on some interest rate risk while also managing appropriately the credit risk. So we booked just under 33 million, it’s in-market collateral, very good FICOs, very reasonable LTV, some seasoning. And our team went through a high percentage due diligence effort and I think we feel very good about the overall process. And as a result have gone back and said, hey, if we can find that paper again, we would continue with that strategy. And I think Rob on an earlier comment said maybe up to another $50 million.

Yes, I’d just add one – it’s a relatively modest amount relative to our balance sheet, which is as Brad covered quite asset sensitive. And then too and I mean hey, it’s not like we’re trying to forecast where the market is but even with some movement in the Fed funds rate, we still feel like longer-term rates are probably not as likely to move up as much. And in fact if you look at what’s happened with the 10-year thus far this year, that’s certainly been the case. So we kind of feel if we could get near that 4% level on a longer duration asset that it still makes some sense given the entirety of our balance sheet profile.

Got you, okay. That’s helpful. All of my other questions have been answered. So thank you very much.

Ladies and gentlemen, this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Kessel for any closing remarks. William “Brad” Kessel: I would like to thank each of you for your interest in the Independent Bank Corporation and for joining us on today’s call. We wish everyone a great day.

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