Earnings Call Transcript - IBCP Q2 2025

Operator, Operator

Hello, everyone, and welcome to the Independent Bank Corporation Reports 2025 Second Quarter Results. My name is Ezra, and I will be your coordinator for today. I will now hand over to our host, Brad Kessel, President and CEO, to begin. Please go ahead.

William Bradford 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 second quarter 2025 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, 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. I am pleased to report our solid second quarter results as we advance our mission of inspiring financial independence. Our vision is a future where people approach their finances with confidence, clarity and determination. Our core values of courage, drive, integrity, people-focused and teamwork are the blueprint our employees live by. We strive to be Michigan's most people-focused bank. Today, Independent Bank Corporation reported second quarter 2025 net income of $16.9 million or $0.81 per diluted share compared to net income of $18.5 million or $0.88 per diluted share in the prior year period. Significant items impacting comparable second quarter results include changes in the fair value of capitalized mortgage loan servicing rights, which resulted in a loss of $0.2 million or $0.01 per diluted share after tax for the three months ending June 30, 2025, versus a gain of $0.9 million or $0.03 per diluted share after tax for the same period in 2024. Additionally, there was a gain on equity securities at fair value of $2.7 million or $0.10 per diluted share after tax in the second quarter of 2024, attributed to the exchange of our Visa Class B-1 common stock. No gain or loss in equity securities at fair value was recorded in the second quarter of 2025. I'm very proud of our team and pleased to see us continue our positive trends with our second quarter results. Overall, loans increased by 9% annualized, while core deposits decreased by 1.4% annualized due to seasonality. We generated net interest income growth on both a linked-quarter basis and a year-over-year basis, resulting in 9 basis points of margin expansion from the prior quarter. Our expenses are well managed, and we are experiencing improved operational scale from strategic investments made in recent years. These fundamentals drove positive growth in tangible common equity per share, increasing 10.8% compared to the prior year quarter, alongside strong return metrics with a return on average assets of 1.27% and a return on average equity of 14.66%. Despite heightened uncertainty in the markets during the quarter, our credit metrics remained strong with low levels of watch credits, 16 basis points of nonperforming assets to total assets, and 2 basis points in net charge-offs to average loans for the quarter annualized. The allowance for credit losses was 1.47% of total loans. Our team has been effective in many areas during the first half of 2025, including business development from existing customers and onboarding new relationships, enhancing the geographic and product line diversification of our business. We continue to succeed in recruiting talented bankers to join the Independent Bank team. During the second quarter, we introduced several new technologies to make banking easier for our customers and associates. For all these reasons, I am optimistic about our prospects for growth for the rest of 2025 and into 2026. Moving to Page 5 of our presentation, total deposits as of June 30, 2025, were $4.7 billion. Overall, core deposits decreased by $15.7 million during the second quarter of 2025. On a linked-quarter basis, retail deposits dropped by $13.8 million, business deposits rose by $60.5 million, and municipal deposits fell by $64 million. Our sales team continues to establish new relationships well below our wholesale cost of funds. On Page 6, we have provided a historical view of our cost of funds compared to the Fed fund spot rate and effective rate. For the quarter, our total cost of funds declined by 4 basis points to 1.76%. 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?

Joel F. Rahn, EVP, Commercial Banking

Yes. Thanks, Brad, and good morning, everyone. On Page 7, we share an update on loan activity for the quarter. We continued to experience solid loan growth in the second quarter with total loans growing by $91.7 million or 9% annualized. Commercial loan generation was strong, resulting in $75.8 million of quarterly growth, 15.3% on an annualized basis. Our residential mortgage portfolio grew by $15.6 million, and our installment loan portfolio was up slightly for the quarter. Our continued strategic investment in commercial banking talent continues to supplement our loan growth. We added 3 experienced commercial bankers in the second quarter, bringing our team to 50 bankers across our statewide footprint. Our staff additions include launching a new LPO in Kalamazoo. We're very excited to have a commercial presence in that market. Looking ahead, we believe we will continue low double-digit growth of our commercial loan portfolio in the second half of the year based upon a strong pipeline. We continue to see market share opportunities from regional banks and are seeing some uptick in organic growth from our existing customers. As noted in previous quarters, our new loan production in all categories continues to come on at yields well above the respective portfolio yield. Looking at the commercial loan production activity on a year-to-date basis, the mix of C&I lending versus investment real estate is 59% and 41%, respectively. For our commercial portfolio, our mix is 70% C&I and 30% IRE. Page 8 provides detail on our commercial loan portfolio concentrations. There's not been any significant shift in our portfolio and the portfolio continues to be very well diversified. Our largest segment of the C&I category is manufacturing at $184 million or 8.9% of the total portfolio. It's worth noting that within the manufacturing segment is $157 million of automotive industry exposure that we're monitoring closely for any tariff-related impact. To date, the impact has been nominal. Key credit quality metrics and trends are outlined on Page 9. Overall, credit quality continues to be excellent, as Brad said. Total nonperforming loans were $8.2 million or 20 basis points of total loans at quarter end, up slightly from 17 basis points at 3/31. Past due loans totaled $6.6 million or 16 basis points, also up slightly from 10 basis points at 3/31. It's not reflected on the slide, and Brad mentioned it just a moment ago, but it's worth noting that our year-to-date charge-offs are $442,000 or 2 basis points of average loans on an annualized basis. At this time, I'd like to turn the presentation over to Gavin for his comments, including the outlook for the remainder of the year.

Gavin A. Mohr, EVP and Chief Financial Officer

Thanks, Joel, and good morning, everyone. I'm starting on Page 10 of our presentation. Page 10 highlights our strong regulatory capital position. Turning to Page 11. Net interest income increased $3.3 million from the year ago period. Our tax equivalent net interest margin was 3.58% during the second quarter of 2025, compared to 3.40% in the second quarter of 2024, and up 9 basis points from the first quarter of 2025. Average interest-earning assets were $5.04 billion in the second quarter of 2025, compared to $4.89 billion in the year ago quarter, and $5.08 billion in the first quarter of 2025. 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 second quarter 2025 net interest margin was positively impacted by three factors: a decrease in funding costs contributed 3 basis points, change in earning asset yield and mix contributed 6 basis points, and a loan prepayment fee that contributed 1 basis point. These were partially offset by a change in funding mix that negatively impacted the margin by 1 basis point. On Page 13, we provide details on the institution's interest rate risk position. The comparative simulation analysis for second quarter '25 and first quarter '25 calculates the 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 the spot yield curve from the valuation date. The shock scenarios consider immediate, permanent and parallel rate changes. The base case modeled NII is slightly higher during the quarter, given earning asset growth and slight margin expansion. Asset yields were augmented by a shift in asset mix with good commercial loan growth partially funded by runoff of lower-yielding investments. Also, assets continued to reprice higher. This benefit was partially offset by an adverse shift in funding mix with an increase in wholesale funding to finance earning asset growth and a modest core deposit runoff. The NII sensitivity position shows slightly more exposure to a declining rate environment. Asset repricing increased due to strong growth in variable rate commercial loans and HELOCs. Some of the increase in asset repricing was offset by purchased floors and faster liability repricing given an increase in short duration wholesale funding. Currently, 37.1% of assets reprice in 1 month and 49.2% reprice in the next 12 months. Moving on to Page 14. Noninterest income totaled $11.3 million in the second quarter of 2025, compared to $15.2 million in the year ago quarter, and $10.4 million in the first quarter of 2025. Second quarter '25 net gains on mortgage loans totaled $1.6 million compared to $1.3 million in the second quarter of 2024. The increase is due to higher profit margins and higher volume of loan sales. No gain or loss on equity securities at fair value is recorded for the second quarter of 2025 compared to a $2.7 million gain in the prior year's quarter due to the exchange of Visa Class B-1 common stock. Positively impacting noninterest income was a $0.5 million gain on mortgage loan servicing net. This is comprised of a $0.2 million or $0.01 per diluted share after-tax loss due to change in price, a $0.9 million decrease due to paydowns and a $0.1 million loss on sale of originated servicing rights that was offset by $1.6 million of servicing revenue in the second quarter of 2025. The decline in servicing revenue compared to the prior year quarter is attributed to the sale of approximately $931 million of mortgage servicing rights on January 31, 2025. As detailed on Page 15, our noninterest expense totaled $33.8 million in the second quarter of 2025, as compared to $33.3 million in the year ago quarter, and $34.3 million in the first quarter of '25. Compensation expense decreased $0.1 million, primarily due to lower incentive-based compensation expense, lower health benefits-related costs and higher deferred loan origination costs due to higher commercial and mortgage loan production. Data processing costs increased by $0.6 million from the prior year period, primarily due to core data processor annual asset growth and CPI-related cost increases and increases in other software solutions. Page 16 is our update for our 2025 outlook to see how our actual performance during the second quarter compared to the original outlook that we provided in January 2025. Our outlook estimated loan growth in the mid-single digits. Loans increased $91.7 million in the second quarter of 2025 or 9% annualized, which is above our forecasted range. Commercial mortgage and installment loans increased in the second quarter of '25. Second quarter 2025 net interest income increased by 7.9% over 2024, which is slightly below our forecast of a high single-digit growth. The net interest margin was 3.58% for the current quarter, 3.4% for the prior year quarter and up 9 basis points from a linked-quarter perspective. The second quarter 2025 provision for credit losses was an expense of $1.5 million, which was within our forecasted range. Moving on to Page 17. Noninterest income totaled $11.3 million in the second quarter of 2025, which was within our forecasted range of $11 million to $12 million in the second quarter. Second quarter 2025 mortgage loan origination sales and gains totaled $147.8 million, $95.4 million and $1.6 million, respectively. Mortgage loan servicing net generated a gain of $0.5 million in the second quarter of 2025, which is below our forecasted target. Noninterest expense was $33.8 million in the second quarter, below our forecasted range of $34.5 million to $35.5 million. Our effective income tax rate was 18.4% in the second quarter of 2025. Lastly, there were 251,183 shares of common stock repurchased for an aggregate purchase price of $7.3 million in the second quarter of 2025. That concludes my prepared remarks, and I would like to now turn the call back over to Brad.

William Bradford Kessel, President and CEO

Thanks, Gavin. 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 through the second half of 2025, our focus will be continuing to invest in our team, leveraging our technology and supporting our communities. At this point, we'd like to open up the call for questions. Ezra?

Operator, Operator

Our first question comes from Peter Winter with D.A. Davidson.

Peter J. Winter, Analyst

You guys had really nice strong margin expansion this quarter. And I was just wondering, could you talk about maybe the outlook for the margin in the second half of the year, especially if we get maybe 2 rate cuts based on the forward curve?

Gavin A. Mohr, EVP and Chief Financial Officer

Yes, Peter, this is Gavin. Thank you for joining today. We are still very confident in the margin forecast we provided in January. The two basis point cuts are included in that forecast. I would like to mention that given the current positioning of our balance sheet, a cut of 25 to 50 basis points does not have a significant impact on the margin, only affecting it by 1 or 2 basis points specifically.

Peter J. Winter, Analyst

Okay. That's helpful. You have done a nice job reducing deposit costs. Do you still see the potential to lower deposit costs without rate cuts? If so, what are some of the reasons for that?

Gavin A. Mohr, EVP and Chief Financial Officer

I think that right now, where we're at in the deposit costs, we're probably seeing a plateau, Peter. The longer we stay or the longer they hold flat and as asset growth continues, you can kind of feel the pressure build. If I look at where we're currently seeing our CDs reprice and where we're issuing new, those are at the same level. So I don't see, if we stay here, a lot of opportunity to reprice down from here.

Peter J. Winter, Analyst

And then, Brad, if I can ask just a question. Treasury Secretary, Scott Bessent, he seems very focused on bank regulation, trying to kind of level the playing field for the commercial banks. So the question is, have you seen anything that benefits you from a competitive standpoint against credit unions?

William Bradford Kessel, President and CEO

That's a great question. No, not specifically regarding credit unions. Since the administration change, several regulations have been reviewed, such as CRA, Dodd-Frank Section 1071, and small business data collection, and these have been paused or set aside. This is significant for banks, particularly community banks, because it would have been costly to implement those proposed regulations. Additionally, we are still looking for more relief and are encouraged by Fed Governor Miki Bowman, who is supportive of community banks in her compliance role. I believe there's more to come. However, in terms of a fair and equitable playing field with nonbanks, there has been no change.

Operator, Operator

Our next question comes from Brendan Nosal with Hovde Group.

Brendan Jeffrey Nosal, Analyst

Maybe just starting off here, kind of curious at a top-level walking through your local economies. Can you just kind of take us through your markets region by region and where you're seeing pockets of strength? And where, when you look at the footprint now, you see the biggest long-term opportunity?

Joel F. Rahn, EVP, Commercial Banking

Yes, Brendan, this is Joel. I would like to focus on the two largest metropolitan areas in our region, which are West Michigan and the Metro Detroit market. They are quite similar in many ways. The manufacturing base is largely the same, and while there is some diversity, it is still significantly reliant on the automotive sector. This is why I mentioned automotive earlier in my comments. Our exposure to the automotive industry from a supply perspective is relatively small, and they are performing well. Initially, there were concerns when the situation was first announced in early April about the implications. You could argue that the full impact has yet to be realized, which I think is a valid point. We continue to monitor closely, but overall, our economy appears to be holding up well. If I didn’t keep track of the news, based solely on customer feedback, I would say the economy is doing fine. Homebuilding remains strong, particularly in West Michigan, and manufacturing is also doing reasonably well. In our Northern Michigan offices, there is a robust tourism economy, and consumers are still spending. These are some high-level observations in response to your question.

Brendan Jeffrey Nosal, Analyst

That's super helpful color. Maybe moving on just to the competitive landscape. I'm just kind of curious how it's evolved over the past couple of months. I'm certainly hearing that some larger regionals are stepping back into certain asset classes like commercial real estate. So just kind of wondering how that's been impacting you and how you're seeing that on the ground?

Joel F. Rahn, EVP, Commercial Banking

Yes, I'll address that as well, and Brad can add his thoughts. Our situation hasn't really changed. A significant portion of our market share gains continues to come from larger banks. As a community bank, we perform strongly against them, and that remains consistent. Interestingly, there are opportunities arising because the large banks are being very cautious and may be completely uninterested in commercial real estate at this time, not just in the office sector but across all types of commercial real estate. We have been actively adding quality investment real estate to our portfolio while maintaining a balanced approach. As I previously noted, we prefer a mix of 70% commercial and industrial and 30% investment real estate in our overall portfolio. We are still pursuing deals. Notably, we have identified opportunities related to CMBS maturities, particularly in the medical office sector. We are selective, but we have had good success in revising deals from the CMBS market, which is currently less competitive than it has been in the past. So overall, while we are seeing opportunities from various sources, our overall mix and the sources of those opportunities have not changed significantly.

William Bradford Kessel, President and CEO

Yes, Joel, I think that was excellent. I would just add, I mean, we were on a call with a prospect last week, whereby sort of that dollar size between $10 million and $20 million, which I'd say is sort of a sweet spot for us, was considered too small by the entity's incumbent bank. And so that is a terrific opportunity for us. So we're in a good spot. Great question, Brendan.

Brendan Jeffrey Nosal, Analyst

That's really great color. I'm going to sneak one more in here. Maybe just turning to capital M&A activity. It certainly feels like deals have picked up not only across the country, but in the Midwest specifically. So just kind of curious how you're viewing the M&A landscape at the moment, whether you're seeing signs of pickup in activity on your end and just updated thoughts on your own appetite for any inorganic opportunities right now.

William Bradford Kessel, President and CEO

I believe we've observed several positive deals in Michigan this year, indicating that there is definitely ongoing activity and discussions taking place. In Michigan, we still have around 80 chartered banks remaining. For Independent, organic growth will continue to be the main driver of our growth, although we are open to acquired growth when it makes sense. Determining what makes sense involves factors such as culture, size, geography, and price. I am optimistic that we can enhance our organic growth with some strategic acquired growth as we move forward.

Operator, Operator

Our next question comes from Adam Kroll with Piper Sandler.

Adam Kroll, Analyst

This is Adam Kroll on for Nathan Race. Yes. So maybe just a question for Gavin, going back to the margin. If the Fed were to remain on hold through the remainder of the year, do you think the margin can just grind higher with new loans still coming on at a higher rate than the portfolio yield? And maybe could you remind us how much cash flow is coming off the bond book and maybe in terms of what your fixed rate loan repricing looks like over the next couple of quarters?

Gavin A. Mohr, EVP and Chief Financial Officer

Yes. To answer your first question, I am confident that if rates remain stable, we can expect our margins to gradually improve, as long as there are no disruptions in the funding market. Over the next 12 months, we anticipate around $110 million in securities will be repriced. Regarding your question about fixed rate loans repricing, we expect $121 million to reprice in the next year, with an exit rate of 6.15.

Adam Kroll, Analyst

Okay. That's super helpful. And then maybe switching to fees. You had really solid mortgage loan volume during the quarter. And obviously, the loan sale margin saw a drop with all the rate volatility during the quarter. But I was just wondering if you have any visibility on how you see mortgage trending so far this quarter?

Gavin A. Mohr, EVP and Chief Financial Officer

Yes, the gain on sale margin came in lower than we expected. Several factors contributed to this. Firstly, the market remains very competitive, which affected our anticipated rates and gains. Additionally, in some sectors of the market, the premiums being paid, particularly in the secondary market by GSE, have decreased significantly and we didn't foresee this shift. This also impacted our results. Furthermore, we conduct an annual review of origination costs, which were higher this year, leading to a further reduction in margin. Overall, the primary factor has been the competitiveness in the mortgage market today.

Operator, Operator

Our next question comes from Damon DelMonte with KBW.

Matthew James Renck, Analyst

It's Matt Renck filling in for Damon. My first question is just a follow-up to the capital management. As you guys look for that inorganic opportunity, do you think you'll still be active with buybacks? Or should we expect you guys to kind of put those on pause in the meantime?

Gavin A. Mohr, EVP and Chief Financial Officer

Yes, this is Gavin. We evaluate it daily. As we've explained before, we approach buybacks similarly to M&A opportunities, and we believe they need to fall within a price range that provides a reasonable earnback for our shareholders. The current price is outside of that comfortable earnback range. However, as we move forward and build capital, we may adjust those parameters. In the short term, if the stock continues to trade at current levels, the buybacks will be limited.

Matthew James Renck, Analyst

Okay. Great. And then last one for me. You guys mentioned you implemented some new technologies to help customers and associates. Just kind of curious what those technologies are and if you have any other planned investments coming up.

William Bradford Kessel, President and CEO

Yes, that's a great question. In the second quarter, we introduced an AI chat function on our website and banking platform that is being well-utilized by our customers. This feature allows customers to get answers to their questions more quickly. We are employing numerous AI applications across the company that assist our staff in responding to customers more efficiently, especially in our call center. Additionally, we are using AI to determine the best product opportunities for our customers. We have also implemented technology in the loan processing and underwriting areas to significantly reduce time. These are just a few examples, and we are really excited about our progress and the potential for further advancements as we continue to leverage our technology.

Operator, Operator

Thank you very much. We currently have no more questions. So I will hand back over to Brad for any closing remarks.

William Bradford Kessel, President and CEO

Thanks, Ezra. In closing, I'd like to thank our Board of Directors and our senior management for their support and leadership. I also want 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 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.

Operator, Operator

Thank you very much, Brad, and thank you to all our speakers on today's call. We appreciate everyone for joining. You may now disconnect your lines.