Earnings Call Transcript - IBCP Q1 2024

Brad Kessel, President and CEO

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 first quarter 2024 results. I am Brad Kessel, President and Chief Executive Officer; and joining me is Gavin Mohr, Executive Vice President and Chief Financial Officer; and Joel Rahn, Executive Vice President of 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 today, 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. Independent Bank Corporation reported first quarter 2024 net income of $16 million or $0.76 per diluted share versus net income of $13 million or $0.61 per diluted share in the prior year period. I am very pleased with our first quarter 2024 results, driving organic growth on both sides of the balance sheet with loans up 5.3% and core deposits up 9%. We're able to generate net interest margin expansion, increasing to 3.30% from 3.26% on a linked-quarter basis and net interest income growth on both a linked-quarter basis and a year-over-year quarterly basis. Expenses continue to be well managed. Our credit metrics continue to be very good with watch credits and nonperforming assets near historic lows. These fundamentals drove good growth in both our earnings per share, a 23% increase, and tangible book value per share, a 16% increase compared to the prior year quarter. Our performance ratios for the quarter included a return on average assets of 1.24% and return on average equity of 15.95%. Leveraging our team's proven success in the integration of dynamic new professionals, we are optimistic about continuing these positive growth trends for the balance of this year and into 2025. Total deposits as of March 31, 2024, were $4.58 billion. Overall, core deposits increased $95.7 million or 9% annualized during the first quarter of 2024. On a linked-quarter basis, retail deposits increased by $23.5 million, business deposits increased by $25.4 million, and municipal deposits also increased by $46.9 million. Our existing customer base continues to exhibit a remix out of non-interest-bearing and/or lower-yielding deposit products into higher-yielding product offerings, but the remix pace has slowed. Additionally, our sales team continues to bring in new relationships well below our wholesale cost of funds. We have included in our presentation a historical view of our cost of funds as compared to the Fed fund spot rate and the Fed effective rate. For the quarter, our total cost of funds increased by 2 basis points to 2.01%. Through the first quarter of 2024, the cumulative cycle beta for our cost of funds is 37.3%. At this time, I'd like to turn the presentation over to Joel Rahn to share a few comments on the success we're having in growing our loan portfolios and provide an update on our credit metrics.

Joel Rahn, Executive Vice President of Commercial Banking

Thanks, Brad, and good morning, everyone. On Page 7, we share an update on our $3.8 billion loan portfolio and quarterly activity. Total loans increased by $49 million in the first quarter, representing 5.3% annualized growth. The strongest segment continues to be commercial lending, which grew by $55 million. We also realized growth in our mortgage business with that portfolio growing by $4.6 million for the quarter. Our installment portfolio decreased by $11.1 million with softness in demand but also as a result of a strategic decision to pull back in that segment. As noted in the material, in each portfolio, the yield on new production is significantly higher than the respective portfolio yield. The commercial portfolio continues to be our highest yielding portfolio with a yield of 6.83%. We continue to see a return on our strategic expansion of our commercial banking team. The experienced talent that we continue to add has been a strong contributor to our commercial growth, which on an annualized basis was 13% in the first quarter, consistent with the pace of growth experienced in 2023. Based upon a solid commercial pipeline, we see continued growth opportunity while maintaining our disciplined credit standards. Page 8 provides additional detail on our commercial loan portfolio. As I've pointed out in prior quarters, C&I lending continues to be our primary focus, representing 68% of the portfolio. Manufacturing continues to be the largest concentration within the C&I segment comprising approximately 10% or $174 million. The remaining 32% of the portfolio is comprised of investment in real estate with the largest concentration being industrial at 7.9% or $140 million. It's worth noting that our exposure to the office segment stands at $89 million or 5% of our commercial portfolio at quarter end. Our office exposure consists primarily of suburban, low-rise office space with medical comprising 25% of our overall office exposure. The average loan size is $1.2 million, which points to the granularity of this segment of our portfolio. For additional insight into our office exposure, I refer you to Page 25 of the appendix to this presentation. Key credit quality metrics and trends are outlined on Page 9. Overall, credit quality continues to be excellent. Total nonperforming loans were $3.7 million or approximately 10 basis points of total loans at quarter end which is a slight decrease from 12/31/23. Past due loans totaled $7.1 million or 19 basis points, up slightly from year-end '23. At this time, I would like to turn the presentation over to Gavin for his comments including the outlook for the remainder of the year.

Gavin Mohr, Executive Vice President and CFO

Thanks, Joel, and good morning, everyone. I am starting at Page 10 of our presentation. Page 10 highlights our strong regulatory capital position, while capital ratios increased from a linked-quarter basis. Net interest income increased $1.8 million from the year-ago period. Our tax-equivalent net interest margin was 3.3% during the first quarter of '24 compared to 3.32% in the first quarter of 2023 and up 4 basis points from the fourth quarter of 2023. Average interest-earning assets were $4.91 billion in the first quarter of 2024 compared to $4.7 billion in the year-ago quarter and $4.93 billion in the fourth quarter of 2023. Page 12 contains a more detailed analysis of the linked-quarter increase in net interest income and the net interest margin. On a linked-quarter basis, our first quarter '24 net interest margin was positively impacted by 3 factors: an increase in yield on loans and investments of 2 basis points, a change in earning asset mix of 3 basis points, and a change in funding mix of 4 basis points. These increases were partially offset by an increase in funding cost of 5 basis points. On Page 13, we provide details on the institution's interest rate risk position. The comparative simulation analysis for the first quarter of '24 and the fourth quarter of '23 calculates a change in net interest income over the next 12 months under 5 rate scenarios. All scenarios assume a static balance sheet. The base rate scenario applies to the spot yield curve from the valuation date. The shock scenarios consider immediate permanent and parallel rate changes. The increase in the base rate forecasted net interest income in the first quarter of '24 compared to the fourth quarter of '23 is primarily due to a shift in the asset mix with an increase in loans and a decline in securities. The loan growth was centered in variable rate commercial loans. Additionally, a modest increase in term rates during the quarter increased modeled asset yields related to fixed-rate lending products. Sensitivity is largely unchanged during the quarter with the exposure to rising rates decreasing modestly for larger rate increases. Currently, 33% of assets repriced in 1 month and 43.8% repriced in the next 12 months. Moving on to Page 14. Noninterest income totaled $12.6 million in the first quarter of 2024 as compared to $10.6 million in the year-ago quarter and $9.1 million in the fourth quarter of 2023. First quarter '24 net gains on mortgage loans were $1.4 million compared to $1.3 million in the first quarter of '23. The increase is primarily due to increased profit margins that were partially offset by a lower volume of loan sales. Positively impacting noninterest income was a $2.7 million gain on mortgage loan servicing net. This is comprised of $2.2 million of revenue, a $1.3 million or $0.05 per diluted share after-tax gain due to change in price that was partially offset by a $0.8 million decrease due to paydowns of catalyzed mortgage loan servicing rights in the first quarter of 2024. As detailed on Page 15, our noninterest expense totaled $32.2 million in the first quarter of 2024 as compared to $31 million in the year-ago quarter and $31.9 million in the fourth quarter of 2023. Performance-based compensation increased $1.2 million due primarily to higher expected incentive compensation payout for salary and hourly employees and salary increases effective at the beginning of the year. Data processing costs increased by $0.3 million from the prior year period, primarily due to core data processor annual asset growth and CPI-related cost increases as well as the purchase of a new lending solutions software. Page 16 is our update on our 2024 outlook to see how our actual performance during the first quarter compared to the original outlook that was provided in January of 2024. Our outlook estimated loan growth in the middle-single digits. Loans increased $49.1 million in the first quarter of 2024, 5.3% annualized, which is below our forecasted range. Commercial and mortgage had positive growth while installment loans decreased in the first quarter. First quarter 2024 net interest income increased by 4.6% over 2023, which is lower than our forecast of mid-single-digit growth. The net interest margin was 3.3% for the current quarter and 3.32% for the prior year quarter, but was up 4 basis points from the linked quarter. The first quarter 2024 provision for credit losses was an expense of $0.7 million and below our forecasted range. The first quarter '24 provision expense was primarily a result of provision expenses on loans that were partially offset by a credit provision on securities held to maturity. Moving on to Page 17. Noninterest income totaled $12.6 million in the first quarter of '24, which was within our forecasted range of $11.5 million to $13 million. First quarter 2024 loan originations, sales and gains totaled $94 million, $80.8 million and $1.4 million, respectively. Mortgage loan servicing net generated a gain of $2.7 million in the first quarter of 2024. Noninterest expense was $32.2 million in the first quarter, below our forecasted range of $32.5 million to $33.5 million. Our effective income tax rate of 19.3% for the first quarter of 2024 was lower than our original forecast. Lastly, there were no shares repurchased in the first quarter of 2024. That concludes my prepared remarks. I would like to now turn the call back over to Brad.

Brad Kessel, President and CEO

Thanks, Gavin. I'm very pleased with how we started 2024 and it is very much in line with the strong results that our company has been delivering quarter over quarter, year after year for some time. This success is directly attributable to our talented team, their focus on connecting with customers, investing in our communities and making banking easy. We've built a strong community bank franchise which positions us well to effectively manage through a variety of economic environments and continue delivering strong and consistent results for our shareholders. As we move forward in 2024, our 160th year of serving the communities in Michigan, our focus will be on continuing to invest in our team, leveraging our technology, and supporting our communities. In doing so, we will continue the rotation of our earning assets out of lower-yielding investments into higher-yielding loans. With the strong value proposition offered as a large community commercial bank, we believe we can continue to grow our customer base while managing our cost of funds and controlling our noninterest expenses. Accordingly, we are excited about our future. At this point, we would now like to open up the call for questions.

Brendan Nosal, Analyst

Maybe to start off here. There was a pretty meaningful transaction announcement last week. I know that it's early days, but any preliminary thoughts on how Independent might be impacted and where you might like to capitalize on a talent dislocation if those opportunities arise.

Brad Kessel, President and CEO

Brendan, that's a great question. Our competitor has always performed well in our market, and we see their sale as a chance for us in Kent County and Ottawa County and related areas. We believe this presents opportunities for both acquiring new customers and attracting talent. This is really part of the ongoing M&A disruption in the Independent Bank markets. Therefore, we view this event as a very positive development for our franchise.

Brendan Nosal, Analyst

All right. That's helpful color. Maybe turning over to the margin, it continues to move in the right direction for another quarter. Just curious if you have any updates to the guidance or the margin you laid out early in the year, but you're still on track there or performing better or worse based on what you say.

Gavin Mohr, Executive Vice President and CFO

Yes, Brendan, this is Gavin. I think we're right on track from what we've forecasted. Yes. I just leave it at that.

Damon DelMonte, Analyst

Just a quick follow-up on the margin. Should there be some rate cuts in the back half of the year, and given some of the more asset-sensitive portions of your balance sheet, how would you expect the margin to react? Do you feel you have some leverage on the funding side that could reprice kind of in step with the asset side and keep the margin stabilized? Or what are your thoughts on that?

Gavin Mohr, Executive Vice President and CFO

Yes, Damon, I would come back to our January guidance that we gave. We do have some rate cuts built into that. So within that back half, I don't know how much pricing—repricing leverage we'll have on the deposit side. I think that's a big question mark. But the forecast we gave with the increase in NIM of 10 to 15 did have Fed rate cuts in May and June, August and October.

Damon DelMonte, Analyst

Okay. So that's 3 cuts. Great. And then regarding the loan growth on the first quarter, growth was on the low end of the kind of the full-year guide. If you look out over the next few quarters, do you still feel good for that 6% to 8% growth for the year? And is that being primarily driven by the C&I side as well?

Joel Rahn, Executive Vice President of Commercial Banking

Yes, this is Joel. I think we're right on track, right where we plan to be. As I said in my comments, our pipeline is looking solid, very comparable to how we were positioned last year. Yes, we're still seeing opportunity on the C&I side as well as we're still making some real estate loans where obviously we're cautious there in certain segments, office being the most notable. But yes, I feel like we're positioned well to hit our plan. Part of that is also we continue to add talent. We added some commercial bankers in the first quarter, capitalizing on some disruption in the marketplace throughout the state in all our footprint, and it positions us really well.

Damon DelMonte, Analyst

Okay. Great. And then lastly, the credit trends remain very strong. Looking at the prospects for loan growth and where the loan loss reserve is now, I think it's 147 basis points. Do you feel that you need to maintain that level? Or do you feel that there's enough cushion where you could let that drift down a little bit?

Brad Kessel, President and CEO

That's a great question. If we do experience the soft landing that it seems we are moving towards, we might see that level decrease somewhat. Currently, a portion of our total reserve is related to this matter, and some of that could potentially be released with a soft landing. So that's the direction we are considering, Damon. Future provisioning will depend on loan growth.

Damon DelMonte, Analyst

Got it. Okay. Great. That's all that I have for now.

Brendan Nosal, Analyst

Just one more for me, not to beat a dead horse on the margin, especially considering how it's performing over the past few quarters. Let's say we don't get any of the 4 rate cuts that you baked into the guide at the start of the year. Just curious how that might impact that margin outlook. I know you're fairly rate neutral at this point, but curious how that impacts the margin?

Gavin Mohr, Executive Vice President and CFO

It'd be beneficial moderately. But again, I just keep coming back to the— the question mark is the deposit remixing. So if that trend continues, what we're currently seeing and rates stay flat, we would be a little better off in margin.

John Rodis, Analyst

Question, and maybe for Gavin on the securities portfolio. How should—I assume it's going to continue to trend down. But can you just talk about just as far as cash flows and whether you decide to reinvest any going forward?

Gavin Mohr, Executive Vice President and CFO

Yes. So this quarter, we—so we start from the top, cash flow projection for the year is $140 million, $145 million of amortization, assuming no repurchases or reinvestment into the securities book. We were able to pull some of that forward. We sold $28 million in the first quarter; we see a small loss of about $300,000; that earn-back will be—by year-end will be a breakeven on that loss. So that being said, I think—I don't think we're targeting for a portfolio to total asset is around 12%. So when you look at the current cash flows and the current size, it will be some time before we anticipate reallocating capital into the securities portfolio.

John Rodis, Analyst

Okay. And Gavin, you said some cash flows this year, $140 million and then you pulled forward $28 million in the first quarter with the sale. Do you have what cash flows are next year, roughly?

Gavin Mohr, Executive Vice President and CFO

Yes, it's around $130 million.

John Rodis, Analyst

Pretty similar.

Gavin Mohr, Executive Vice President and CFO

Yes, it's similar for the 24-month period.

Joel Rahn, Executive Vice President of Commercial Banking

Okay. So to get down to that 12% area, I mean, it will take you a couple of years or a few years without reinvesting, correct?

Gavin Mohr, Executive Vice President and CFO

That's correct, John. Yes.

John Rodis, Analyst

And I assume if deposit growth would remain pretty solid if loan growth were to slow, then you decide to reinvest a little bit in the securities portfolio at higher rates? Does that—does that make sense?

Gavin Mohr, Executive Vice President and CFO

Yes, absolutely. I mean we have liquidity and loan—greater than our loan growth. That would be an excellent option for capital.

Brad Kessel, President and CEO

In closing, we would like to thank our Board of Directors and our senior management for their support and leadership. We would also like to thank all our associates. I 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 towards our common goal of guiding our customers to be independent. Finally, I'd 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.

Operator, Operator

Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines.