Earnings Call Transcript - IBCP Q3 2024

Operator, Operator

Hello everyone, and welcome to the Independent Bank Corporation Reports 2024 Third Quarter Results. My name is Ezra and I will be your coordinator today. I will now hand you over to your host, Brad Kessel, President and CEO to begin. Brad, please go ahead.

Brad Kessel, President and CEO

Thanks Ezra. 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 2024 results. I am Brad Kessel, President and Chief Executive Officer, and joining me is Gavin Mohr, Executive Vice President and our Chief Financial Officer; and Mr. Joel Rahn Executive President and Head of Commercial Banking. Before we begin today's call, I'd 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 third quarter 2024 net income of $13.8 million or $0.65 per diluted share versus net income of $17.5 million or $0.83 per diluted share in the prior year period. I am proud of our team and very pleased with our third quarter 2024 results, driving organic growth on both sides of the balance sheet. Overall loans increased 9.3% annualized while core deposits are up 8.9% annualized. We were able to generate net interest income growth on both a linked-quarter basis and a year-over-year quarterly basis. We believe that our expenses continue to be well managed and we continue to see improved operational scale from strategic investments we have made in recent years. Our credit metrics continue to be excellent with watch credits and non-performing assets near historic lows. These fundamentals continue to drive very strong growth in tangible book value per share, 22% in fact, compared to the prior year quarter. Based on a robust commercial pipeline, the past record of our core group of professionals and the ongoing strategic initiatives to add talented bankers to our team, we are optimistic about continuing these growth trends for the remainder of 2024 and into 2025. On page 5, total deposits, as of September 30, 2024, were $4.6 billion. Overall, core deposits increased $100 million during the third quarter of 2024. On a linked-quarter basis, retail deposits declined by $21.3 million. Business deposits increased by $16.7 million and our municipal deposits increased by $105.2 million for the quarter. Our existing customer base continues to exhibit a remix out of non-interest bearing and/or lower-yielding deposit products into our 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 funds spot rate and the Fed effective rate. For the quarter our total cost of funds increased by 8 basis points to 2.10%. At this time I'd like to turn the presentation over to Joel Rahn to share a few comments on the continued success we are having in growing our loan portfolios and to provide an update on our credit metrics.

Joel Rahn, Executive President and Head of Commercial Banking

Yes. Thanks, Brad, and good morning, everyone. On page 7, we share an update on loan activity for the quarter. Total loans increased $90 million in the third quarter, as Brad said, representing 9.3% annualized growth. We had a strong quarter of commercial loan activity with that portfolio increasing $93 million. Our mortgage portfolio grew $10 million while our installment loan portfolio declined by $12.5 million. Within the commercial loan activity, the mix of C&I lending versus investment real estate was approximately 60%, 40% with overall 35% coming from new customers to the bank. For the year, despite significant headwinds from unscheduled payoffs in the second quarter, our commercial portfolio has grown $145 million, representing an 11.5% annualized growth rate. Based upon a solid commercial pipeline, we see continued growth opportunity in the fourth quarter while maintaining our disciplined credit standards. As noted in the material in each portfolio, 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 6.78%. Page 8 provides additional detail on our commercial loan portfolio. As pointed out in prior quarters, C&I lending continues to be our primary focus, representing 67% of the portfolio. Manufacturing continues to be the largest concentration within the C&I segment, comprising approximately 9% or $172 million. The remaining 33% of the portfolio is comprised of investment real estate with the largest concentration being industrial at 8% or $153 million. It's worth noting that our exposure to the office segment stands at $86 million or 4.7% of the commercial portfolio at quarter end. Our office exposure consists primarily of suburban low-rise office space with medical comprising 19% of overall office exposure. The average loan size is $1.3 million, which points to the granularity of that segment of our portfolio. For additional insight on 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 as Brad remarked just a second ago. Total nonperforming loans were $5.1 million or approximately 13 basis points of total loans at quarter end, consistent with June 30. Past due loans totaled $4.8 million or 12 basis points similar to June 30. While not reflected on our slide, our commercial watch list remains low at 3.3% of the total portfolio, although up slightly from June 30th. 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 Mohr, Chief Financial Officer

Thanks, Joel, and good morning, everyone. I'm starting on page 10 of our presentation, which highlights our strong regulatory capital positions. All capital ratios increased from the previous quarter. Net interest income rose by $2.4 million compared to the same period last year. Our tax equivalent net interest margin was 3.37% in the third quarter of 2024, up from 3.23% in the third quarter of 2023, and down three basis points from the second quarter of 2024. It's worth noting that an accelerated fee accretion related to a large commercial loan payoff added five basis points to the margin in the second quarter of 2024. Excluding this accretion, the net interest margin for the second quarter of 2024 would have been 3.35%, which is two basis points lower than the margin of 3.37% in the third quarter of 2024. Average earning assets were $4.99 billion in the third quarter of 2024 compared to $4.89 billion in the same quarter last year and $4.89 billion in the previous quarter. Page 12 includes a more detailed analysis of the increase in net interest income and the net interest margin from the linked quarter. For the third quarter of 2024, the net interest margin was positively influenced by three factors: an increase in the yield on loans of seven basis points, a change in the earning asset mix contributing two basis points, and a change in interest-bearing liability mix adding another two basis points. These improvements were offset by an increase in funding costs of seven basis points, a reduction in loan fee accretion of five basis points, and a decline in investment yield of one basis point. On page 13, we provide details about the institution's interest rate risk position. The comparative simulation analysis for the third quarter of 2024 and the second quarter of 2024 estimates the change in net interest income over the next 12 months under five rate scenarios, all of which assume a static balance sheet. The base rate scenario applies the spot yield curve from the valuation date, and the shock scenarios account for immediate, permanent, and parallel rate changes. The base case modeled net interest income as modestly higher during the quarter, as asset yields were boosted by a shift in asset mix, and liability costs also benefited from a change in mix. The net interest income sensitivity profile shifted to a more asset-sensitive position during the quarter, largely due to slightly faster repricing on commercial loans, a modest increase in mortgage loan repricing due to additional pay fixed swaps, and a shift in non-maturity deposit beta assumptions. Currently, 35.6% of assets will reprice in one month, and 46.8% will reprice in the next 12 months. Moving on to page 14, non-interest income was $9.5 million in the third quarter of 2024 compared to $15.6 million in the same quarter last year and $15.2 million in the second quarter of 2024. The third quarter of 2024 net gains on mortgage loans were million dollars compared to $2.1 million in the third quarter of 2023. This increase was driven by higher profit margins and increased volume of loan sales. However, non-interest income was negatively impacted by a $3.1 million loss on mortgage loan servicing net. This included a $4.2 million or $0.16 per diluted share after-tax loss due to price changes and a $1.2 million decrease from paydowns, partially offset by $2.2 million of revenue in the third quarter of 2024. As detailed on page 15, our non-interest expense totaled $32.6 million in the third quarter of 2024, compared to $32 million in the same quarter last year and $33.3 million in the second quarter of 2024. Performance-based compensation increased by $25 million, primarily due to higher expected incentive compensation payouts for both salaried and hourly employees. Data processing costs rose by $0.3 million from the prior year period due to growth in annual assets and CPI-related cost increases, as well as new solutions implemented during this timeframe. Payroll taxes and employee benefits decreased by $0.6 million, mainly due to lower healthcare-related expenses. Page 16 provides an update on our 2024 outlook, comparing our actual performance in the third quarter to the original forecast provided in January 2024. We initially estimated loan growth in the mid-single digits. Loans increased by $90.4 million in the third quarter of 2024, or 9.3% annualized, which is above our forecasted range. Commercial and mortgage loans exhibited positive growth while installment loans decreased in the third quarter of 2024. The net interest income for the third quarter of 2024 grew by 6.2% over 2023, aligning with our forecast of mid-single-digit growth. The net interest margin was 3.37% for the quarter and 3.23% for the prior year, reflecting a 0.03% decrease from the previous quarter. The provision for credit losses for the third quarter of 2024 was an expense of $1.5 million, representing 15 basis points annualized of average loans, which is within our forecasted range. Moving on to page 17, non-interest income amounted to $9.5 million in the third quarter of 2024, which is below our forecasted range of $11.5 million to $13 million. Third quarter 2024 mortgage loan originations, sales, and gains totaled $147.5 million, $117 million, and $2.2 million respectively. The mortgage loan servicing net incurred a loss of $3.1 million in the third quarter of 2024. Non-interest expense was $32.6 million in the third quarter, within our forecasted range of $32.5 million to $33.5 million. Our effective income tax rate of 20.1% for the third quarter of 2024 was consistent with our forecast. Lastly, there were no shares repurchased in the third quarter or the first nine months of 2024. That concludes my prepared remarks, and I would now like to turn the call over to Brad.

Brad Kessel, President and CEO

Thanks, Gavin. I'm very pleased with another solid quarter for 2024, and it is very much in line with the strong results which our company has been delivering quarter-over-quarter, year-after-year for some time. This success is directly attributable to our talented team, who are focused on connecting with customers, investing in our communities and making banking easy. We 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 to the fourth quarter of 2024, our 160th year of serving the communities of Michigan and into 2025, our focus will be 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 very excited about our future. At this point in time, we'd like to open up the call for questions.

Operator, Operator

Thank you, Gavin. Our first question is from Brendan Nosal with Hovde Group. Brendan, your line is now open. Please go ahead.

Brendan Nosal, Analyst

Hey. Good morning, guys. Hope you're doing well.

Brad Kessel, President and CEO

Good morning, Brendan.

Brendan Nosal, Analyst

Maybe just starting off here on mortgage gain on sale fees. I mean looks like it's the strongest quarter you guys have put up in quite some time, looks like better gain on sale margins better mix sustainable product. Just kind of curious, what you folks are seeing at a ground level for that business, and how you expect it to trend over the next few quarters? Thanks.

Gavin Mohr, Chief Financial Officer

Thanks, Brendan. This is Gavin. We believe margins are stable. However, we anticipate some challenges in production primarily due to seasonality and continued limited supply. Overall, margins have remained stable, and we expect them to continue through the end of the year.

Brad Kessel, President and CEO

I think I'd add there, Brendan, it was interesting to sort of watch what was going on with application levels revolving around the Fed's move in September. And I think we had a lot of the client base probably more than normal floating in anticipation of further drops in the mortgage rates. And obviously, short-term rates move differently oftentimes than the longer-term mortgage rates. So after the move and then we saw actually post quarter end, we're up now at the street level almost 100 basis points in the mortgage pricing. So customers I think were expecting it to go one way and it in fact went the other way. So we're going to I think again dovetailing what Gavin said sort of see what happens as we here in Michigan go into typically a softer season and see what happens. But hopefully that's helpful.

Brendan Nosal, Analyst

Yeah. No, I appreciate the comments there. One more for me just thinking about how the balance sheet is positioned for Fed reductions. I mean, I guess the sheets may be a little bit asset-sensitive, but you have a dynamic of rotating from securities into loans. I mean, if you kind of put those two pieces together, does that kind of lead to more or less a stable margin as we move ahead? Thanks.

Gavin Mohr, Chief Financial Officer

I actually would say the margin we should continue to see expansion. And just on what's disclosed that's a 12-month forward look. So we're showing some asset sensitivity and rates down in the model, but that base model margin is higher than what we're actually at today. So just another way to say that I think we anticipate with the repricing of the assets and some ability to reprice on the liability side that the margin will grind higher.

Brendan Nosal, Analyst

Thanks for taking the question, Gavin. I appreciate it.

Operator, Operator

Our next question is from Peter Winter with D.A. Davidson. Peter, your line is now open. Please go ahead.

Peter Winter, Analyst

Thank you. You guys had nice annualized loan growth this quarter. Can you just talk about loan demand loan pipelines going forward? And secondly, do you think that there's a lot of pent-up loan demand once we get past this election and hopefully with lower rates that could lead to even stronger growth?

Brad Kessel, President and CEO

That's a great question, Peter. Joel, could you share your thoughts on what you're seeing there?

Joel Rahn, Executive President and Head of Commercial Banking

Yes. Right now, our commercial pipeline is solid. I think our fourth quarter and early 2025 look fine. It's hard to know about the potential pent-up demand. There could be some, but our growth has been really strong. So it's difficult for me to say definitively that we can outperform our current run rate, which is around 11 percent annualized. However, I can see that some business owners may have been waiting on the sidelines for the election outcome before making equipment or expansion decisions. It's just really hard to assess that.

Peter Winter, Analyst

Okay. And then, Joel, just you've had a lot of success with this location in your markets from acquisitions, bringing in teams or bankers. Just wondering if you could talk about maybe what the pipeline is for hiring new bankers with that dislocation in the market, how that's looking?

Joel Rahn, Executive President and Head of Commercial Banking

Yes. We are continuing to explore opportunities and have discussions. I don’t want to specify a number, but our strategy is to maintain our approach from the past few years, which involves bringing talented individuals onto our team, as this will benefit us in the long term.

Brad Kessel, President and CEO

All this past quarter, we added had some bankers in a couple of different markets. Is that right?

Joel Rahn, Executive President and Head of Commercial Banking

We did. Yes. We added two in Southeast Michigan and one up in our Northern Michigan region.

Peter Winter, Analyst

Got it. And just my final question. Credit quality is great. Last quarter, you slightly released reserves this quarter you added a little over $1 million. Is that addition just kind of to support loan growth and the thought is you want to keep the ACL ratio fairly steady from here?

Brad Kessel, President and CEO

This quarter's provision was primarily due to loan growth, and we are around $146 million overall. Included in that amount is about a 25% subjective reserve. We are still evaluating whether we will experience a soft or hard landing. I believe we will gain clarity on that by 2025. Currently, the reserves are quite healthy, and I anticipate that provisioning will remain consistent with our recent performance.

Peter Winter, Analyst

Got it. Thanks for taking my questions.

Operator, Operator

Our next question is from Nathan Race with Piper Sandler. Your line is now open.

Adam Kroll, Analyst

Hi. This is Adam Kroll on for Nathan Race. Thanks for taking my questions.

Brad Kessel, President and CEO

Hi, Adam.

Adam Kroll, Analyst

So just starting on deposit costs. I noticed the pace of increase was a bit higher this quarter than in prior ones. Is it fair to assume that deposit costs have peaked? And I was just wondering if you could provide any color on what you're seeing in terms of deposit pricing competition within your markets?

Brad Kessel, President and CEO

Yes, thank you. A lot of this relates to the mix, but regarding spot rates, I believe we have reached a peak following the recent Fed actions. We are continuing to see some runoff in non-interest accounts, shifting towards interest-bearing accounts. From a spot rate perspective, I agree that we appear to be at a peak. In terms of the market, it remains active and cautious, with an eye on competitors and their movements. It will be interesting to see how things unfold for the remainder of the year. Our pricing strategy is working effectively, and we are committed to taking excellent care of our customers. Our overall wholesale borrowing costs significantly influence our pricing strategy, and I feel optimistic about our position, especially with strong deposit growth in the third quarter.

Adam Kroll, Analyst

Thanks. I appreciate all the color on that. Just switching to expenses. It was nice to see coming lower this quarter. And I saw in the release yesterday about using AI to kind of streamline IT processes and couple that with ongoing initiatives to add additional bankers. I was just wondering how you guys are thinking about the expense run rate in 2025?

Brad Kessel, President and CEO

In 2025, we haven't provided any guidance yet. We'll assess this following the fourth quarter and share a comprehensive outlook at that time. However, I can say that expense management remains a priority for us. We've maintained our expenses within the $32 million to $33.5 million range for some time. This has mainly involved resource allocation and reallocation. While we've significantly expanded our commercial banking team, our overall headcount has actually decreased to just over 800 full-time equivalents. This reduction has come from our branch system and the mortgage support area, where volumes have remained low, along with implementing automation in mortgage processing. As we look ahead, we are enthusiastic about leveraging AI and application processing interfaces, along with bots. Our technology team is performing excellently, yielding positive results with some internal use cases that help our staff serve clients more effectively by providing easier access to information. In 2025, we are optimistic about progressing with AI to enhance revenue generation. It's an exciting time for us in banking and as a community bank. Thank you.

Adam Kroll, Analyst

Thanks for all the color. That's it for me.

Operator, Operator

Thank you. Our next question is from Damon DelMonte with KBW. Damon, your line is now open.

Matt Renck, Analyst

This is Matt Renck filling in from Damon DelMonte. Hope everybody is doing well. Just a follow-up to the last question on AI. Has there been any regulator pushback? Or anything extra you had to do to make sure they're okay with how you're using the systems? Or is that more for later on in 2026 when you move it to the more of the revenue side?

Brad Kessel, President and CEO

No, I think it’s still early. Everyone is trying to understand what AI can do and then act on it. It all begins with governance. We're not waiting for regulators to guide our governance around AI; we are establishing it based on what we believe are best practices in risk management. So, I don't think we're overextending ourselves in this area. I believe we're in a good position. As of now, there hasn't been any pushback from regulators.

Matt Renck, Analyst

Okay. Got it. And then just last one on deposit growth. Has the lowering of rates made it easier to kind of garner the whole relationship from a loan perspective? Or has it not really affected that? I was just curious if we could see a step-up in growth there.

Joel Rahn, Executive President and Head of Commercial Banking

There may be some opportunities there. This is Joel. There have been certain chances that were missed over the past year or so because they were tied to attractive fixed rates. As time passes, we expect some of that to correct because those loans will eventually need to be refinanced. So, yes, we might see a bit of an increase in areas where we haven't been able to engage with customer relationships due to refinance activity. That's a very good question.

Matt Renck, Analyst

Okay. Great. Thank you. That’s all for me.

Operator, Operator

Our next question is from John Rodis with Janney. John, your line is now open.

John Rodis, Analyst

Good morning, guys.

Brad Kessel, President and CEO

Hey, John.

Gavin Mohr, Chief Financial Officer

Yes. So we're looking at about $25 million in the fourth quarter and then next year is going to be in that current speeds 120-ish, $120 million-ish.

Brad Kessel, President and CEO

For the full year.

John Rodis, Analyst

Okay. Is that $120 million next year, is that weighted heavily towards any one quarter? Or is it fairly even?

Gavin Mohr, Chief Financial Officer

It's fairly even. I mean a lot of it is amortization of the MBS portfolio.

John Rodis, Analyst

Okay. And I think maybe a quarter or two ago you had said you sort of longer term targeting securities to assets of around 12% to 13%. Is that sort of still the case?

Gavin Mohr, Chief Financial Officer

12% to 15%. But yes, you're right there, John.

Brad Kessel, President and CEO

Thank you, guys.

Operator, Operator

Thank you. That ends our Q&A session. I will hand back to Brad for any closing remarks.

Brad Kessel, President and 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 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 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 everyone for connecting. You may now disconnect your lines.