Earnings Call Transcript - IBCP Q3 2021

Brad Kessel, 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 third quarter 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 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. Slide 4 provides a good summary of our historical results. I continue to be very pleased with the high level of performance by our team, generating strong core results for yet another quarter. We continue to execute on our strategies of investing in people and technology. During the third 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. Fueling some of this growth was the opening of two new commercial loan production offices, one in Ottawa County and the second in Macomb County. Deposit gathering continues to be robust, both via existing customers as well as through the addition of new customers. In addition, mortgage gains continue to be solid, and our card strategies are generating good growth in interchange revenue. On the asset quality front, I could not be more pleased with net recoveries for the quarter. Commercial watch credit's at 2.4% of the portfolio and a very low level of past dues and non-earning assets. While there are many uncertainties and challenges ahead, we are excited about the momentum we have in our markets and look forward to continuing these trends through the end of 2021 and into 2022. Turning to Page 5. Independent Bank Corporation reported third quarter 2021 net income of $16 million or $0.73 per diluted share versus net income of $19.6 million or $0.89 per diluted share in the prior year period. The highlights included annualized return on assets and average equity of 1.4% and 15.9%, respectively, an increase in net interest income of 5.7% over the third quarter of 2020. Net gains on mortgage loans of $8.4 million and total mortgage loan origination volume of $453.8 million. Net growth in portfolio loans of $69.4 million or 9.8% annualized; continued strong asset quality metrics, as evidenced by $1.5 million in net loan recoveries during the quarter; as well as a low level of non-performing loans and non-performing assets; and finally, the payment of the $0.21 per share dividend on common stock on August 16, 2021. For the nine months ended September 30, 2021, the Company reported net income of $50.4 million or $2.30 per diluted share compared to net income of $39.2 million or $1.76 per diluted share in the prior year period. Highlights for the first nine months of 2021 include: increases in net income and diluted earnings per share of 28.6% and 30.7%, respectively. Annualized return on average assets and average equity of 1.53% and 17.32%, respectively. Net gains on mortgage loans of $30.3 million and total mortgage loan origination volume of $1.44 billion. Net growth in portfolio loans of $150.3 million or 7.4% annualized; and net growth in deposits of $374.7 million or 13.8% annualized. Page 7 provides a good snapshot of our loan and deposit metrics for our Michigan markets. 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 4.6%, slightly below the national average of 4.8%. However, we have 180,000 fewer workers employed today as compared to pre-COVID. Labor shortages are having a noticeable impact in 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 constraining many businesses in our markets. Regional average home sale prices continue to climb as inventory levels in many of our markets are at record lows and negatively impacting the overall volume of home sales. On Page 9, we provide a couple of charts reflecting the composition of our deposit base as well as the continued growth in this portfolio. We're 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 to Page 10, we have a few highlights relating to Independent Bank's digital transformation. Following our second quarter whole bank conversion, we are seeing good utilization and growth rates of our ONE Wallet and Treasury ONE platforms. At this time, I would like to turn the presentation over to Joel Rahn to share a few comments on our loan portfolio.

Joel Rahn, EVP, Commercial Banking

Thanks, Brad. On Page 11, we provide an update of our $2.9 billion loan portfolio. For the third quarter, commercial balances decreased by $21.7 million. However, excluding PPP activity, our commercial balances increased by $60 million for the quarter. We're seeing a gradual increase in commercial working capital line usage, which was 36% in the third quarter. While it's up from prior quarters, this continues to lag the historical average. Our commercial pipeline is very strong, and we expect solid commercial loan growth in the fourth quarter. Our residential mortgage balances increased by $55.9 million, and installment balances increased by $35.3 million. Our mortgage pipeline, while down from peak levels, continues to display strength, and we remain optimistic about our ability to accelerate the earning asset rotation from lower-yielding investments to higher-yielding loans and continue to believe we are on track to grow loans, net of PPP, at the higher end of our original forecast. On Page 12, we have an update of our loan modifications, which declined to $6 million or 0.2% of total loans at September 30, 2021. Moving to Page 13, we provide an update on the bank's administration of the SBA's Paycheck Protection Program. As of September 30, 2021, we had $90.2 million in balances outstanding and $3.2 million in net unaccreted fees. We expect most of these fees to be accreted in interest income in the next three to six months. Moving to Page 14, we displayed the concentrations of our $1.2 billion commercial loan portfolio. You'll note that 63% of the portfolio is comprised of a variety of C&I categories, the largest of which is manufacturing at $132 million or 10.8%. The largest concentrations, or excuse me, the remaining 37% of the portfolio is comprised of commercial real estate, with the largest concentration being retail at $108 million or 8.8%; and office, the majority of which is medical, at $74 million or 6%. Our portfolio is very granular in nature. Our credit metrics indicate this portfolio has held up very well through the pandemic. And 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 outlook for 2021.

Gavin Mohr, CFO

Thanks, Joel, and good morning, everyone. I'm starting at Page 17 of our presentation. Net interest income increased $2.4 million from the year-ago period. Our tax-equivalent net interest margin was 3.18% during the third quarter of 2021, which was down 13 basis points from the prior year period and up 16 basis points from the second quarter of 2021. I will have some more detailed comments on this topic in a moment. Average interest-earning assets were $4.3 billion in the third quarter of 2021 compared to $3.89 billion in the year-ago quarter and $4.22 billion in the second quarter of 2021. Page 18 contains a deeper analysis of the linked-quarter increase in net interest income and the net interest margin. Our third quarter '21 net interest margin was positively impacted by three factors: an increase in yield on securities available for sale of 1 basis point, an increase in PPP accretion of 15 basis points, and a decline in funding costs of 1 basis point. We will comment more specifically on our outlook for net interest income and the net interest margin for the remainder of '21 later in the presentation. Moving on to Page 19. Non-interest income totaled $19.7 million in the third quarter of 2021 as compared to $27 million in the year-ago quarter and $14.8 million in the second quarter of 2021. Third quarter '21 net gains on mortgage loans totaled $8.4 million compared to $20.2 million in the third quarter of '20. The decrease in these gains was due to decreases in mortgage loan sales volume and in the mortgage loan pipeline as well as lower loan sale profit margins. Mortgage loan applications remain solid, although refinancing applications slowed in the third quarter of '21. Our purchase market volume continues 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 fair value due to price and a $1.4 million decrease due to paydowns of capitalized mortgage loan servicing rights in the third quarter '21. As detailed on Page 20, our non-interest expense totaled $34.5 million in the third quarter of 2021 as compared to $33.6 million in the year-ago quarter and $32.5 million in the second quarter of 2021. Compensation increased $1.2 million compared to the prior year quarter due to raises that were effective at the start of the year, the hiring of new lenders, and increased overtime related to the data processing conversion. Performance-based compensation decreased $2.1 million due to a higher accrual catch-up in the third quarter of '20. The third quarter of 2021 included $0.3 million of conversion-related expenses. We have more comments on our outlook for non-interest expenses later in the presentation.

Matt Rank, Analyst

This is Matt Rank pinch-hitting for Damon. My first question, just with regards to the buyback, you have a little less than 500,000 shares left in the authorization. Just wanted to get your thoughts going forward on that?

Brad Kessel, CEO

At the beginning of the year, our Board approved approximately 1.1 million total shares. We had indicated that we expected to buy about half of that for the year. So far this year, we are exceeding that pace. This is influenced by factors such as our capital levels, the current share price, and other potential uses of funds. I believe we will continue our current approach unless an unexpected situation arises.

Joel Rahn, EVP, Commercial Banking

Yes, I agree with the overview you provided regarding our strategy for the two new loan production offices, which we aim to develop into full-service locations, initially focusing on commercial and residential mortgages. It's important to note that this initiative is heavily driven by talent as we expand. These locations were ones we had long wanted to enter, and our ability to attract top talent in those areas was a key factor in making that happen. Regarding new production, without going into excessive detail, we've seen a rapid contribution from our new team members, which is encouraging. However, we need to keep in mind that this is a long-term investment. This growth has also contributed to the expense pressures mentioned earlier. Overall, in the third quarter, I estimate that our new loan production offices collectively added about $30 million, which is excellent.

Russell Gunther, Analyst

I'm on for Russell Gunther. I just want to ask a little bit more about the LPOs and how they're already helping the loan growth. Can you add any color there? And kind of what are our expectations about possible further LPOs in the future?

Brad Kessel, CEO

We've been expanding our team since the first quarter and into the early second quarter. Since Joel Rahn is here, I’ll let him discuss our successes. I believe we are well-established with our current offices. At some point, I could see us transitioning to full-service branch locations in these two markets. However, we want to increase our earning assets and deposit levels a bit before making that move. Joel, would you like to share some insights about the team, its success, and how much they have contributed to our production this year?

Gavin Mohr, CFO

This is Gavin. I'll go first, and then Brad can share too. So the margin, I feel really good today about where it came, so net of PPP, around 3%. That was up three basis points from the prior quarter. So we've seen a little bit of lift in the securities portfolio. So we've seen rates back up a little bit. So I think that favors us if we continue to have to deploy cash there, Brendan. But ultimately, we're going to get a nice pickup if we can just continue to rotate or attempt to rotate the liquidity into loans. So yes, I think we're in a pretty good place today. And I think the margin is expected to be pretty stable for the year-end.

Brad Kessel, CEO

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 each of 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 toward 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.