Earnings Labs

Independent Bank Corporation (IBCP)

Q2 2016 Earnings Call· Mon, Aug 1, 2016

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Transcript

Operator

Operator

Good morning and welcome to the Independent Bank Corp. Second Quarter 2016 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 CEO. Please go ahead.

Brad Kessel

Analyst · KBW. Please go ahead

Good morning. Thank you for joining Independent Bank Corporation’s conference call and webcast to discuss the Company’s 2016 second quarter 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 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 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. We are very pleased to report strong overall results for the second quarter of 2016. Solid loan growth, continued improvement in asset quality, a rise in net gains in mortgage loans, as well as our continuing efforts to reduce non-interest expenses contributed to a 14.6% increase in net income. Diluted earnings per share rose by 25%, reflecting both the increase in net income and the benefit from our share repurchase activity. Further, despite continued pressure from the low interest rate environment, we did achieve net growth in net interest income on a quarterly and year-to-date basis compared to 2015. Turning to page five. This quarter, we are reporting net income of $6.4 million or $0.30 per diluted share versus net income of $5.6 million or $0.24 per diluted share in the prior year period. For the six months ended June 30, 2016 the Company is reporting net income of $10.5 million or $0.48 per diluted share compared to net income of $9.4 million or $0.40 per diluted share in the prior year period. The second quarter’s results were driven by net interest income of $19.6 million, up $900,000…

Rob Shuster

Analyst · KBW. Please go ahead

Thanks, Brad and good morning, everyone. I’m starting at page 11 of our presentation. Our net interest income totaled $19.6 million during the second quarter of 2016, an increase of $900,000 or 5% from the year ago period and a decrease of $133,000 or 0.7% on a linked quarter basis. Our tax equivalent net interest margin was 3.52% during the second quarter of 2016 compared to 3.62% in the year ago period and 3.61% in the first quarter of 2016. The decline in the linked quarter and net interest income was due to $0.4 million decline in net interest recoveries on previously charged-off or non-accrual loans. Although the net interest margin remains under some stress due to the prolonged low interest rate environment that has pressured yields on the company’s loan portfolio, we remain optimistic that we can offset this stress by a remix of our earning asset base, largely through loan growth. Average interest earning assets were $2.26 billion in the second quarter of 2016 compared to $2.08 billion in the year ago quarter and $2.21 billion in the first quarter of 2016. Page 12 contains a more detailed analysis of the linked quarter decrease in net interest income. This decrease was primarily due to a decrease in interest income on loans, and a slight increase in interest expense on deposits and borrowings that was partially offset by an increase in interest and dividends on investment securities. If you adjust the first quarter 2016 net interest margin to normalize net recoveries of interest and charged-off or non-accrual loans, the 3.61% would adjust down to 3.54%. So over the last four quarters, the net interest margin has been 3.58% in the third quarter of 2015, 3.56% in the fourth quarter of 2015, 3.54% as adjusted in the first quarter of…

Brad Kessel

Analyst · KBW. Please go ahead

Thanks, Rob. As we look ahead to the remainder of 2016 and beyond, we are focused on building on the momentum generated in the first half of this year. We are pleased to report solid first half results in 2016 with growth in earnings and earnings per share as compared to last year. The improvement is directly related to the successful execution of our strategy to migrate earning assets from lower-yielding investments to higher-yielding loans in order to grow net interest income. Similarly, improvement was seen with reductions in non-interest expense on both a sequential and year-over-year quarterly basis. Our quarterly return on average assets was 1.06% compared to 0.98% for the same quarter one year ago and our four-quarter moving average return on assets improved to 0.88% from 0.80% one year ago. Our quarterly return on average common shareholders’ equity was 10.66% compared to 8.86% for the same quarter one year ago and our four-quarter moving average return on equity improved to 8.50% from 7.26% one year ago. Our management team recognizes we need to continue to grow revenue and improve our overall earnings, as we work toward sustained performance milestones of 1% or better return on assets, 10% or better return on equity in 2016 and beyond. As previously stated, our target or roadmap to this level is built on improving net interest income to $20 million per quarter, non-interest income of $10 million per quarter, non-interest expense of less than $21 million per quarter and a normalized provision. 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.

Operator

Operator

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

Matthew Forgotson

Analyst

Just wondering if you can talk to us a little bit about the remixing capacity that you have to rotate cash flows from the securities portfolio into loans, how do you think about that here?

Brad Kessel

Analyst · KBW. Please go ahead

I guess, I would start with our loan to deposit ratio at 70-odd percent. And so we think that there is quite a bit of upside running that to 85%, 90% and really, it’s a function of market’s loan demand and our execution on new loans. So we think there is a significant upside to improve the net interest income. On top of that, I think as you heard in Rob’s comments, we’ve had nice improvement in the overall yield of the investment security portfolio was really not taking on additional extension risk and/or significant credit risk.

Matthew Forgotson

Analyst

Can you give us a sense of kind of where new loans are coming on relative to the portfolio yield? I guess it was for 4.64% in the second quarter?

Rob Shuster

Analyst · KBW. Please go ahead

Yes, for the commercial side, for the fixed rate component, we’ve been in that mid-4 range, so we’re really not seeing much pressure on the portfolio yields from the fixed rate commercial loan component. The variable rate is coming on at about 3.75%, so to extent we’re getting, in the last quarter, it was about two-thirds variable rate and one-third fixed rate, so that of course puts a little bit of downward pressure on, although those are also assets that are going to reprice immediately, if we get our upward movement in the prime rate. On the retail side, it’s coming in at around 4% give or take and so that’s having a little bit of pressure, as well. I think where we still are feeling that eventually we’re going to get some either slow down or stopping of the downward drift is by that remix, so that even though the loan portfolio yield may drop a little bit, because that represents a greater share of our earning assets versus the investment securities that we still would get the margin stabilized or perhaps even slightly improving. Now it hasn’t quite happened yet, but if you go through my comments, we’ve been going down about two basis points a quarter over the last four quarters, but again, we’re hoping that we’re kind of coming to the end of that to at least get to a more stable NIM at around 3.5%.

Matthew Forgotson

Analyst

Okay. I guess on mortgage, good production volume and the gain on sale margin was quite thick this quarter, I guess, around 350. Can you talk about your expectations for sustaining the gain on sale margin at that level?

Rob Shuster

Analyst · KBW. Please go ahead

Well, I think that we can sustain it at that level, at least looking out through the third quarter and looking at today’s pipeline. And then I would imagine we probably see that come down a little bit, as we trail to the end of the year and due to seasonality and so on, but at least for the next quarter, I would envision that we would be at that level.

Matthew Forgotson

Analyst

Okay. And I guess lastly and then I’ll hop out, in terms of the credit provisions that we’ve seen, I know it’s a challenging area to forecast, but I guess I could ask the question by saying, is there anything large or lumpy in the recovery pipeline that we ought to be taking into consideration as we model that going forward?

Brad Kessel

Analyst · KBW. Please go ahead

Well, so, Matt, you asked a question. We have tracked all the charge-offs, obviously over the years. And today what’s nice is that we really look at our recoveries in two categories. There’s the sort of just reoccurring payment stream that we have built in today through retail as well as the commercial base. We had a pretty good feel for that and then there is the lumpy ones, if you will and those predominantly are more on the commercial side. This past quarter, I think we had, Rob probably, I don’t know, was there 200,000, 250,000 in that number in terms of lumpy.

Rob Shuster

Analyst · KBW. Please go ahead

Yes, maybe a bit more, but a good half of what we’re seeing right now is more along the lines of the consistent recurring recovery. So there is always a few outliers here and there, but I think we don’t see any real pressure from new defaults for a couple of reasons. One is, the level is quite low and two the loss content is much subdued, because of the collateral position, so that’s helpful. So that means hopefully that new charge-offs are fairly low and so those recoveries that we’re just talking about sort of gets us to either a net recovery position like we’ve had in the last couple of quarters or certainly a very low charge-off position. And if you combine that with the TDR portfolio continuing to pay down, where we have fairly high specific reserves, you could certainly paint a picture where your provision levels are either close to zero or perhaps a credit like we’ve had in the first couple of quarters.

Operator

Operator

Our next question comes from Damon DelMonte with KBW. Please go ahead.

Damon DelMonte

Analyst · KBW. Please go ahead

I just wondered, when you look at your outlook for the loan growth, where in the footprint are you seeing the best opportunities for the growth?

Rob Shuster

Analyst · KBW. Please go ahead

Okay, we had a slide in our deck that sort of give us the breakdown by market. And at the slide seven in our deck and year-to-date, the largest loan growth has come from our West Michigan market and I would expect that we’d continue to see that. It’s also been very strong in Southeast Michigan market. I think that a difference between those two markets, there are probably four competitors in the West Michigan market similar to us in size in the community banking profile then say maybe in the Southeast Michigan market. So we continue to look for both those regions being strong and then also, sort of filling in the gaps with our team in the lending market, they are in the Lansing market as well as in the Bay City, Saginaw and Thumb region.

Damon DelMonte

Analyst · KBW. Please go ahead

Got you. Okay. And then the installment portfolio, that had pretty good growth this quarter. I think you touched on that briefly, but could you just kind of go through that again as to what types of loans are coming on?

Brad Kessel

Analyst · KBW. Please go ahead

We referenced that probably half of the consumer originations were through the branch network and then half were through our indirect desk. The indirect desk is really two-fold. RV, which is two-thirds of that and then, or actually power sport and then the other third would be RV. And those are long-term relationships that we’ve had with dealers throughout the State of Michigan. And it’s interesting with that assured internally with our team today, but we actually have a very nice book-to-look ratio, if you will, on the indirect desk, 50% matter of fact. So they’re only sending us the higher quality deals. And so that’s, and Rob referenced roughly in the 4% yield range. And then over the branch side, it’s a mixture of, to our customers that are home improvement loans and maybe vehicle loans and a sundry of smaller dollar installment purchases.

Damon DelMonte

Analyst · KBW. Please go ahead

And then there’s been a couple of larger M&A transactions across your marketplace. Are you guys seeing any disruption that’s creating opportunity for you to either A, win over new lending and depository relationships or B, hire talent from other organizations?

Brad Kessel

Analyst · KBW. Please go ahead

There is a lot of disruption in the Michigan market today and it does create both of the opportunities, which you mentioned, opportunities to bring in new customers as well as opportunities to speak with talented staff that may be interested in a change. I’d say that we believe there is benefits for an Independent Bank on both those fronts and I think that will enable us to hit some of these projections and/or exceed these projections possibly.

Operator

Operator

Our next question comes from Scott Beury of Boenning & Scattergood. Please go ahead.

Scott Beury

Analyst · Boenning & Scattergood. Please go ahead

Just had a quick question, looking specifically at the loan growth, it looks like you had really strong production in the installment book, as you had mentioned. And I’m just wondering in terms the back half of the year, to what degree do you think that’s impacted by seasonality, imagine a lot of the assets being financed with those relationships are kind of more in demand in the warmer months, if you will. And just wondering how you are thinking about that?

Brad Kessel

Analyst · Boenning & Scattergood. Please go ahead

I’ll let Rob jump in here too, when I look at our loan portfolio, I would say the most consistent, year around, we’d probably going to, we’re going to see on the commercial side. And I’m hopeful that we see more of the same there. On the mortgage side, we had a nice second quarter, I would see that that will continue into the third quarter and probably slowdown in Q4 and then back into Q1. I do look for us to hopefully actually get some more portfolio loans in the mortgage side and we’re working on initiatives to accomplish that. On the installment portfolio, particularly the indirect desk, second quarter, third quarter, those are the higher peaks for that demand. And then Q4 and Q1, we should see that settle back down.

Scott Beury

Analyst · Boenning & Scattergood. Please go ahead

Okay, thank you. That’s very helpful. All my other questions have been answered. So, I am going to hop off now. Thanks.

Operator

Operator

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

Brad Kessel

Analyst · KBW. Please go ahead

Very good. I thank each of you for your interest in Independent Bank Corporation and for joining us on today’s call. We wish everyone a great day.

Operator

Operator

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