Independent Bank Corporation (IBCP) Q4 2021 Earnings Report, Transcript and Summary

Good morning, and welcome to the Independent Bank Corporation Reports 2021 Fourth Quarter and Full Year Result Conference Call. All participants will be in a 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.

Good morning, and welcome to today's call. Thank you for joining us for Independent Bank Corporation's conference call and webcast to discuss the Company's fourth quarter and full year 2021 results. I am Brad Kessel, President and Chief Executive Officer. And joining me is Gavin Mohr, EVP and Chief Financial Officer; and Joel Rahn, EVP, Commercial Banking. Before we begin today's call, I would like to direct you to the important information on Page 2 of our presentation, specifically the cautionary note regarding forward-looking statements. If anyone does not already have a copy of the press release issued by us this morning, you can access it at the Company's website, independentbank.com. The agenda for today's call will include prepared remarks, followed by a question-and-answer session and then closing remarks. Slide 4 provides a good summary of our historical results. I am very pleased with the high level of performance by our team, generating strong core results for yet another quarter and now for the full year 2021. We continue to execute on our strategies of investing in people and technology. During the fourth quarter, we saw good growth in net interest income, stabilization of our net interest margin and across-the-board loan growth, net of PPP. Our commercial pipeline is at its highest level in many quarters deposits gathering, continues to be robust - by existing customers as well as the addition of new customers. In addition while mortgage gains have tapered down it continue to be solid in our current strategies continue to generate positive growth in interchange revenue. On the asset quality front, I could not be more pleased with our net recoveries for the full year as well as commercial watch credits at just 3.1% of the portfolio and a very low level of past dues loans. We excited about the moment we have in our markets and we look forward to continuing these trends into 2022. Turning to Page 5 Independent Bank Corporation reported fourth quarter 2021 net income of $12.5 million or $0.58 per diluted share versus net income of $17 million or $0.77 per diluted share in the prior year period. The highlights included an increase in net interest income of 10.6% over the fourth quarter for 2020. Net gains on mortgage loans of $5.6 million and total mortgage loan origination volume of $424.6 million. Net growth in portfolio loans of $21 million or 2.9% annualized; excluding PPP loans increased by $84.9 million or 11.8% annualized. Continued strong asset quality metrics as evidenced by loan and charge-offs during the quarter; as well as a low level of nonperforming loans and nonperforming assets; and our payment of a $0.21 per share dividend on common stock on November 15, 2021. Turning to Page 7 for the year ended - full year ended December 31, 2021 the company reported net income of $62.9 million or $2.88 per diluted share, compared to net income of $56.2 million or $2.53 per diluted share in 2020. The increase in full year 2021 net income as compared to 2020 primarily reflects an increase in net interest income and a decrease in provision for credit losses that were partially offset by a decrease in non-interest income an increase in non-interest expense and income tax expense. Highlights for the full year of 2021 include increases in net income and diluted earnings per share of 12% and 13.8% respectively. Annualized return on average assets and average equity of 1.41% and 16.1% respectively, net gains on mortgage loans of $35.9 million and record total mortgage origination volume of $1.9 billion. Net growth in portfolio loans of $171.4 million or 6.3% annualized. Net growth in deposits of $479.7 million or 13.2% annualized. We paid $0.84 in dividends which is a 5% increase compared to 2020 and tangible common equity per share increased by 6.1% to $17.33 per share. Page 8 provides a good snapshot of our loan and deposit metrics for our Michigan markets. I would point out that our two loan production offices opened in Ottawa County in Macomb County during the third quarter of 2021, and are off to a strong start. As a result, we do plan to open a new full service office in Ottawa County during the first half of 2022. Turning to Page 8, we display several key economic statistics for the state of Michigan. Overall, we are seeing continued improvement in the unemployment rate for Michigan, now at 5.9% above the national average of 3.9%. However, the state of Michigan has 282,000 fewer workers employed today as compared to pre-COVID. Labor shortages are having a noticeable impact on many segments of our economy, including an increase in wages in our markets and reductions in business operating hours. In addition, supply chain shortages are also constrained in many businesses in our markets. Regional average home sale prices continue to climb as inventory levels in many of our markets continue to be at record lows, and negatively impacting the overall volume of home sales. That said, we continue to have very strong applications levels for new home purchases. On Page 10, we provide a couple of charts reflecting the composition of our deposit base, as well as the continued growth in this portfolio while working to effectively manage our overall cost of funds. Extensive government stimulus continues to result in increased deposit levels for many of our customers. Turning into Page 11, we have a few highlights relating to Independent Bank’s digital transformation. Following our second quarter whole bank conversion, we continue to see good utilization and growth rates in our ONE Wallet, ONE Wallet+, one wallet plus the Treasury ONE platform. At this time, I would like to turn the presentation over to Joel Rahn to share a few comments on our loan portfolio.

Thank you, Brad. On Page 12, we provide an update of our $2.9 billion portfolio. For the fourth quarter commercial balances decreased $19.2 million. However, if you exclude PPP activity, our commercial balances increased by $45 million for the quarter and for the year excluding PPP loans, our commercial portfolio grew by 9.4%. Looking more closely at the growth of the third and fourth quarters is annualized the commercial portfolio increased at an annualized pace of nearly 19%. As Brad said, our commercial pipeline is very strong, and we expect solid commercial loan growth in the first quarter of 2022. In the fourth quarter, our residential mortgage balances increased by $38.7 million and installment balances increased by $1.6 million. Our mortgage pipeline while down from peak levels continues to display strength. We remain optimistic about our ability to accelerate, the earning asset rotation from lower yielding investments to higher yielding loans. And we continue to believe we're on track to grow loans at a low double-digit pace in 2022. We turn to Page 13, we provide an update on our loan COVID-related modifications, which declined to $2.3 million or 0.1% of total loans in December 31. Of the one of these modifications are in our residential mortgage portfolio. Moving to page 14, we provide an update on the banks administration of the SBA Paycheck Protection Program. As of December 31, 2021, we had $26.2 million in balances outstanding and $806,000 in net unaccreted fees. We expect fees remaining loans to be forgiven and fees to be accreted into interest income during the first quarter of 2022. On Page 15, we display the concentrations of our $1.2 billion commercial loan portfolio. Consistent with prior quarters, you'll note that 63% of the portfolio is comprised of a variety of C&I categories, the largest of which is manufacturing at $114 million or 9.5%. The remaining 37% of the portfolio is comprised of commercial real estate, the largest concentration is being retail at $109 million or 9% an office, the majority of which is medical related, and $72 million or 6%. The portfolio is very granular in nature. And our credit metrics indicates that this portfolio was held up very well through the pandemic and the resulting supply chain pressures. So at this time, I'd like to turn the presentation over to Gavin to share a few comments on our investments, capital, financials, credit quality, and our outlook for 2022.

Thanks, Joel, and good morning, everyone. I'm starting at Page 18 of our presentation. Net interest income increased $3.3 million from the year ago period. Our tax equivalent net interest margin was 3.13% during the fourth quarter of 2021, which is up one basis point from the year ago period, and downside five basis points from the third quarter of 2021. I'll have some more detailed comments on this topic in a moment. Average interest-earning assets were $4.3 billion in the fourth quarter of 2021 compared to $3.98 billion in the year ago quarter, and $4.3 billion in the third quarter of 2021. Page 19 contains a more detailed analysis of the linked quarter increase in net interest income and a decrease in the net interest margin. Our fourth quarter 2021, net interest margin was negatively impacted by three factors decrease in yield on securities available for sale had an impact over a negative one basis point. Growth in liquid assets had a impact of negative four basis points and the change in the loan mix, loan yield and mix had a impact of a negative three basis points. We will comment more specifically on our outlook for net interest income and the net interest margin for 2022 later in the presentation. Moving on to Page 20, non-interest income totaled $15.8 million in the fourth quarter of 2021 as compared to $22.4 million in the year ago quarter and $19.7 million in the third quarter of 2021. Fourth quarter 2021, net gains on mortgage loans totaled $5.6 million, compared to $15.9 million in the fourth quarter of 2020. The decrease in these gains was due - a decrease in the mortgage loan sales volume and in the mortgage loan pipeline as well as lower loan sales profit margins. Mortgage loan applications remained strong although refinancing application slowed in the fourth quarter of 2021. Our purchase mortgage volumes continued to be strong, positively impacting non-interest income was a $1.3 million gain on mortgage loan servicing due to a $0.6 million or $0.02 per diluted share after tax increase in the value due to price and a $1.3 million decrease due to pay downs of capitalized mortgage loan servicing rights in the fourth quarter of 2021. As detailed on Page 21, our non-interest expense totaled $34 million in the fourth quarter of 2021 as compared to $32.7 million in the year ago quarter and $34.5 million in the third quarter of 2021. Compensation increase $0.6 million compared to the prior year quarter due to raises that were affected at the start of the year. The hiring of new lenders and increased overtime related to data processing conversion. Performance-based compensation decreased $1 million due to a higher accrual catch-up in the fourth quarter of 2020. The fourth quarter of 2021 included $0.9 million of costs related to the reserve for unfunded lending commitments due to an increase in unfunded lending commitment balances. We will have more commitments on our outlook for non-interest expense later in the presentation. Page 22 provides data on non-performing loans, other real estate, non-performing assets and early-stage delinquencies. Total non-performing assets were $5.3 million or 4.11% of total assets at December 31, 2021. Loans 30 to 89 days delinquent decreased to $2.3 million at December 31, 2021, compared to $2.4 million at September 30, 2021. Page 23 provides some additional asset quality data including information on new loan defaults, and on classified assets. I would highlight there were no new commercial loan defaults for full year 2021. Page 24 provides information on our TDR portfolio that totaled $37 million at December 31, 2021. This portfolio continues to perform well with 96.4% of these loans being current at December 31, 2021. Moving on to Page 25, we recorded a provision for credit losses expense of $0.6 million in the fourth quarter of 2021 compared to a provision credit of $0.4 million in the year ago quarter, and a provision credit $0.7 million in the third quarter of 2021. The allowance for loan losses totaled $47.3 million, or 1.63% of portfolio loans on December 31, 2021. This ratio increases to 1.64% when excluding the PPP loans and the remaining Traverse City State Bank acquired loans. Page 26 is our update for 2021 outlook to see how our actual performance during the year compared to the original outlook that we provided in January of 2021. Our outlook estimated loan growth in the low single-digits loans increased $21.1 million in the fourth quarter of 2021 or 2.9% annualized. Growth in mortgage and installment loans were offset by a decline in commercial loans due to a $63.8 million decrease in PPP loan balances in the fourth quarter of 2021. Excluding PPP loans, total portfolio loans grew at 11.5% annualized rate during the full year of 2021 above our forecasted range. For full year 2021, net interest income increased by 5% over 2020, which is higher than our forecast. However, the net interest margins for the full year of 2021 were 24 basis points lower than the full year of 2020 net interest margin of 3.34%, which is a steeper decline than our forecast higher than anticipated deposit growth that that has largely been deployed into lower yielding investment securities is the primary reason for these variances. The fourth quarter 2021 provision for credit losses was an expense of $0.6 million. This is below our forecasted 2021 full year provision range of 0.25 to 0.35 of average total portfolio loans. The primary drivers of this decrease in provision for credit losses were a decrease in the adjustment to the allocations based on subjective factors and an increase in recoveries of loans previously charged off. Non-interest income totaled $15.8 million in the fourth quarter of 2021, which is within our forecasted range of $13 million to $16 million. The mortgage loan pipeline continues to be solid, although refinance activity slowed down in the fourth quarter of 2021. Non-interest expense was $34 million in the fourth quarter outside our $28.5 million to $29.5 million targeted quarterly range. Increases in compensation and employee benefits, data processing and expense related to the reserve for unfunded lending commitments for the primary categories that caused non-interest expense to exceed the target range. Our effective income tax rate of 19.2% to 18.6% for the fourth quarter of full year 2021 respectively, was a bit lower than our forecast. This is due in part to a higher than expected levels of tax-exempt interest income. Lastly, the company purchased 814,910 shares at an average cost of $21.19 for the full year 2021. Turning to Page 27, this will summarize our initial outlook for 2022. The first section is loan growth. We anticipate loan growth in the low double-digit range and are targeting a full year growth rate of 10%. We expect to see growth across all three loan categories. This outlook assumes in improving Michigan economy. Next is net interest income, where we are forecasting a low single-digit growth of 1% to 3% over full year 2022. We expect the net interest margin to trend lower compared to the full year 2021 by 10 to 15 basis points primarily due to declining yields on earning assets. This forecast assumes a 25% increase in June and September and target federal funds rate to 2022 with long-term rates up slightly by year end. Full year 2022 provision expense for the allowance for credit losses of approximately 0.15% to 0.2% of average loans would not be unreasonable. Related to non-interest income, we estimate a quarterly range of $13 million to $17 million. We expect mortgage loan origination volumes to decline by approximately 21% in 2022 combined with the declining margins on sold loans. Our outlook for non-interest expense is a quarterly range at $30.5 million to $32.5 million for the total, for the year, 3% to 5% below 2021 actuals. We expect total compensation and employee benefits and conversion-related expenses to be lower in 2022 compared to 2021. Our outlook for income tax at an effective rate of approximately 18.5% assuming the statutory federal corporate income tax rate it does not change during 2022. Lastly, we believe the share repurchases will be at the midpoint of our authorization of approximately 5% of outstanding shares. That concludes my prepared remarks. I would now like to turn the call back over to Brad.

Thanks, Gavin. Slide 28 displays a high level view of our key strategic initiatives. During this past year, we have harvested the fruit of seeds planted in prior years. This included our investments in the mortgage banking business in prior years when others were exiting the business. As a result, over the last few years, we have produced record origination volumes, strong fee income and a material increase in our overall servicing customer base with over 11% increase in balances service for others. With the heightened probability of moving to a higher rate environment, we have seen a decline in refinance activity in our home finance purchase volume continues to be strong. In 2022, we made significant investments to our overall technology platform to improve the customer experience and increase productivity amongst other goals. We have already seen some very positive results in this investment. I believe we will see continued growth and improve productivity in 2022 very significant investments were made in human capital in 2021 specifically the recruitment and expansion of our commercial banking team by over 25%. These investments and people are already showing results with this very strong commercial pipeline as we begin fiscal year 2022. We have increased our earnings per share and dividends for eight consecutive years. I believe we are well positioned for 2022 and beyond. At this point, we would now like to open up the call for questions.

[Operator Instructions] Our first question comes from Brendan Nosal with Piper Sandler. You may go ahead.

Maybe just digging into the cost outlook a little more to start off here, I mean expenses down 3% to 5% feels fairly optimistic given the inflationary environment. So maybe help us breakdown that improvement between the three areas that you call out in the guidance slide and then tied into you know how you can drive a declining comp expense this year despite wage pressure?

Yes, thanks Brendan. Yes so, referencing the slide is - as we talk about the incentive compensation, that based on the current budget this year again, we had as you are aware how the compensation is structured, we did outperform. So the accrual was higher. We believe next year, it will be - that will not be the case. So, it's really coming through reduction in the incentive piece. We have lower anticipate lower mortgage production. Those incentives that were tied to that production as well, beyond just the broad company goals, reduction in overtime, relating to the conversion in all greatly reduced, if not fully reduced conversion related expenses this year. As we've seen, those you can see, this quarter declined significantly. And then the other thing that we had pointed out here we saw an increase in the unfunded lending commitments in 2021 as we've seen the growth and the outstandings not necessarily balanced outstandings, but just the availability of credit through that asset class.

Got it all right, that's helpful color. Maybe one more for me turning to kind of provisioning needs and reserve coverage mean ratio of kind of 1.65ish percent strikes me is very healthy. So the outlook for 15 to 20 bps of loans in terms of provisioning was probably a bit heftier then I was thinking, given that strong coverage ratio. So can you maybe offer a little bit of insight into how much you have left in COVID factors in the reserve today and how that might allow you to flex that reserve ratio lower as we move through the year? Thanks.

Yes, another great question. So subjectively, there is currently $12.7 million within the reserve, as we would define as subjective. There are 12 basis points within the reserve to total loans that is COVID related in some form or factor. And so to your point I guess, you know, there could be some potential there, but what we're really seeing Bren is - the growth in the pooled factor, so is our, is our loans are growing, we've seen strong growth in the mortgage portfolio And that is one of the most costly in terms of that - booking assets, because of the length of the cash flows to reserve for and the allowance for credit losses. So that's the offset. So actually quarter-over-quarter this objective did come down $1 million, but if it was just offset by the loan growth.

Our next question comes from Damon DelMonte with KBW. You may now go ahead.

So first question regarding the margin guidance, I think you mentioned you know you mentioned it to be down a bit from where it was this past quarter. Is that guidance taking into account the core margin or is, that the like the reported margin, which included the PPP impact during 2021?

Great question, so that is the reported margin. The core we think will be very, very stable through 2022.

Okay, all right great that's helpful. And then - could you elaborate a little bit more on the revenue outlook I mean, sorry the non-interest income outlook, when you consider the decline expected in mortgage banking. What are some of the other positive drivers that we could look for?

So one of the factors there a couple right. So one, we are factoring into rate increases. I guess are you talking about non-interest income I apologize yes let me reschedule.

Yes non-interest income?

Yes okay. So yes, as we are saying it will be down, we continue to see very good growth in the interchange income it's approximately 5% year-over-year as well as service charges on deposits. We all forecasted decline in SFBS is I think the industry is anticipating. But we think that the treasury management related service charges can offset that to seeing growth in Treasury Management area fees as well. So that gives you a little more context.

Yes, it does that's helpful, thank you. And then I guess just lastly, on the loan growth outlook, when you talk about this strong commercial outlook. How do you see that breaking out between C&I and CRE loans is one area kind of set up better for growth over the other one or it is pretty equally split?

Yes, this is Joel, by design are going to keep that very evenly split. We've been running roughly 60/40 on C&I versus investment real estate. And we like that balance we want to maintain it. So we're forecasting growth in both of those buckets. And yes that's important to us that we want to maintain that discipline.

Our next question comes from Russell Gunther with D.A. Davidson. You may now go ahead.

Just a quick follow up on the loan growth discussion. Appreciate the color on the 10% double-digits and what you just remarked on CRE versus C&I. Just wondering within the mix of that 10% growth, do you expected to be similar to 2021 would there be less of an appetite to portfolio single family resi today, given a commercial outlook, just want to get a sense for how you think that 10% breaks down across asset classes?

Yes, great question. So to indicate we are sensitive to the mix. I think this year is going to be a good representation of what we'll like going forward. The growth rates, is pretty level across the three loan categories next year.

Okay - that's very helpful. And then you guys mentioned the two LPOs - that came on line in the third quarter opening of full service in 2022. Do you consider LPOs in adjacent or expansion markets it sounds like that's not included in your 10% guide. But bigger picture is that something strategically you would look to do?

I guess I'm not clear Russell, in terms of your question, because - those loan growth forecasts are a function of the two LPOs that are online so.

Yes, no understood. I'm sorry if I wasn't clear. I was asking if kind of bigger picture strategically, you would think about additional LPOs in adjacent markets are even a bit further afield than what you typically do in footprint. Is that something you guys would look to do?

Yes, okay yes. So I would say right now, we're always open to growing our talented team. And we continue to have ongoing dialogues and so additional LPOs are probably a function of our desire to and success in adding new recruits. Having said that, I do think as Joel mentioned, we've grown the team by a substantial amount in the last year and you know so there is a. I think an important effort to blend them into our culture and with the existing team. So I'd say it can't happen, but we're not as we forecast 2022 it's not, it's not a huge part of what we're trying to accomplish.

Understood, and I appreciate your thoughts there Brad. And then switching gears to the margin. So I appreciate your thoughts, guys in terms of the NII expectations and your rate assumptions. Could you isolate Brad for your thoughts around what a 25 basis point move in Fed Funds means to your margin and what deposit basis you would be assuming in that analysis?

Yes, great question the 25 basis points is one to two basis points of margin. And then that's what the very low beta, we think that the first couple will be able to really hold back on increasing deposit rates so low beta assumption there on it.

Okay, very helpful. And then the last one for me is within your NII guide, what do you guys thinking in terms of the investment portfolio overall size in terms of growth or potential contraction in 2022?

Yes so, there is an asset rotation that will have - we are optimistic it will take or to take place in 2022. I don't anticipate the size of the portfolio drastically shrinking, but also, maintaining current level to slightly declining would be reasonable through the year just depending on when we experienced the loan growth.

Our next question comes from Daniel Cardenas with Boenning & Scattergood. You may now go ahead.

Quick question on the lending side, could you give us a little bit of color as to the competitive factors that are out there, specifically as it relates to pricing in your various markets? Do you kind of see that as a headwind to loan growth in 2022?

Let's break that down. Let's go with commercial first and Joel, maybe talk a little bit about that.

Yes, I mean you know, the pricing is always a factor. And when the whole industry is looking for any assets, you know, there's been a lot of competition in squeeze on the pricing. We don't see that being, you know, that environment being dramatically different in 2022, than it was, frankly in 2021. Yes, there is a little bit of increase in - the forecast increase the rate hikes will help a little bit. And in the bond market already do, so I mean, we're seeing pricing, you know, yield on the fixed rate loans are increasing following the Treasury market, but then we've got some, some smaller community banks around the state that always kind of seemed to lag that. So it keeps pressure on our margins a little bit as the rates are rising, because, the industry doesn't move in tandem, obviously. Everyone's got a slightly different philosophy. So yes, there's going to be continued pressure there, but we're finding a way to win business at fair returns and with a focus on really good product quality.

And I think to add that over on the mortgage side, it is very, very competitive. You know, both the saleable and non-saleable there's pressure on the margins there. We've seen as an example, I think that jumbo pricing, which historically you'd have some type of premium to the conforming and then it was writing for a lot last year, right on top. We've seen that go through and be less than some of the conforming pricing. And so, we've considered that in our forecast and we're fighting real hard and Independent believes being in the business for the long haul. It may be a little more challenging in the early part of the year here, as we you know Q1 and whatnot, but yes, the mortgage side is definitely heightened in terms of its overall competitiveness.

Okay excellent. And then how should I think about deposit growth going forward? Is that I don't think it's going to keep lockstep with loan growth. But what's kind of the outlook on the deposit side in 2022?

I can take first shot, Gavin you know we have now for a couple of years seeing deposit growth outpace loan growth significantly. We think that's going to flip this coming year, very difficult to forecast, the surge in deposits, if you will and how long they'll stick. I think it's direct - it will be directly related to how fast rates move, and what not, but we are in our forecast, keeping deposits pretty flat so.

Back to a much more historical run rate to that 2ish percent levels, nothing what we've seen in the last few years.

Okay, excellent. And then last question from me as your digital platform continues to gain traction. How do you guys think about your branch franchise? Is that something that would begin to contract as your digital platform grows or is that not necessarily the case?

Daniel, that's a great question. And over the last eight, eight to 10 years, the branch footprint that Independent has fielded has significantly changed. We had over 100 locations at the - in the early 2010/2011 timeframe and over the years, we've really paired it back. At the same time, we more than doubled the average, well more than doubled the average deposits per branch. In 2010 I am sorry, 2020, we consolidated another eight locations. And 2021, we did do the whole bank conversion and really the moving forward the digital transformation that really, I think is going to help us as we go forward. We likely will have some additional what we call branch optimization. We're constantly looking at profitability for location. We're looking at the average number of transactions per FTE and that has that continues to decline. So I think it would be reasonable to see us scaling back some additional in the coming quarters.

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

In closing, I would like to thank our Board of Directors and our senior management for their support and leadership. I also want to thank all our associates that continue to be so proud of the job being done by each member of our team, each team member in his or her own way, continues to do their part to our common goal of guiding our customers to be independent. Finally, I would like to thank each of you for your interest in Independent Bank Corporation, and for joining us on today's call. Have a great day.

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