Earnings Call Transcript - IBCP Q1 2023

Operator, Operator

Hello, everyone, and welcome to the Independent Bank Corporation Reports 2023 First Quarter Results. My name is Emily, and I'll be coordinating your call today. After the prepared remarks, there will be the opportunity for any questions. I will now turn the call over to our host, Brad Kessel, President and CEO. Please go ahead.

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 2023 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 Joel Rahn, Executive Vice President in Charge of Commercial Banking for Independent. 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 brief question-and-answer session and then closing remarks. Independent Bank Corporation reported first quarter 2023 net income of $13 million or $0.61 per diluted share versus net income of $18 million or $0.84 per diluted share in the prior year period. The decrease in the 2023 first quarter results as compared to the first quarter of 2022 is primarily due to a decrease in noninterest income, an increase in the provision for credit losses that were partially offset by an increase in the net interest income, and decreases in noninterest expense and income tax expense. For the first quarter of 2023, we generated an annualized return on average assets and return on average equity of 1.06% and 14.77%, respectively as compared to 1.54% and 19.38% in the first quarter of 2022. Significant items impacting the comparable first quarter 2023 results included the changes in fair value due to the price of our mortgage servicing rights, the provision for credit losses on loans, and a provision for credit losses on securities held to maturity. I am pleased to report our deposit base remains stable throughout the recent troubles experienced in the banking industry and we have been able to remain focused on serving the needs of our customers and bringing in new relationships to the bank. Importantly, we generated core deposit growth of $93.1 million, representing 9.1% annualized for the first quarter of 2023. As a result, we are able to report another quarter of strong financial results. We grew total loans by $44.5 million or 5.2% annualized while maintaining a low level of past dues. Additionally, our team continues to be focused on efficiency and expense management. Independent Bank's operating strategy remains unchanged as we continue to add talented bankers to an already talented commercial banking team to assist in our goal of achieving greater loan and deposit market share across our footprint. We have a very granular deposit base with approximately 22.6% of our deposits uninsured and a high level of available liquidity with $2.4 billion in secured borrowing access and borrowing capacity on unpledged securities. With the loan-to-deposit ratio at 77.2%, we believe we have the capacity to continue to support ongoing growth of our loan portfolios. During the first quarter of 2023, our deposits grew to $4.5 billion. Of the $4.5 billion, we consider $3.85 billion or 84.8% to be core. In addition to generating $93.1 million in core deposit balance growth, we are also pleased to report net deposit account growth of more than 1,600 accounts for the quarter. We are including some additional information on the deposit base this quarter, showing the metrics behind the granularity of our funding. 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 46 basis points to 1.25%. Through the first quarter of 2023, the cumulative cycle beta for our cost of funds is now at 24.1%. At this time, I'd like to turn the presentation over to Joel Rahn to share a few comments on the success we are having in growing our loan portfolios and provide an update on our credit metrics.

Joel Rahn, Executive Vice President - Commercial Banking

Well, thank you, Brad, and good morning, everyone. On Page 9, we provide an update on our well-diversified loan portfolio. Total loans increased $44 million in the first quarter, led by residential mortgage activity, leading to a $39 million increase in that portfolio. Our commercial loan portfolio grew $4.4 million and consumer installment lending was flat during the quarter. It's worth noting that our commercial loan growth reflected approximately $30 million of unplanned loan payoffs from sold businesses or refinanced projects, $9 million of these payoffs were watch list credits. So while commercial loan growth was soft in the first quarter, we believe this strategic expansion of our commercial banking team as well as marketplace disruption will provide creditworthy growth opportunities in 2023. Overall, we're pleased with our loan growth and believe that we are positioned to continue to gain market share in each market that we serve. On Page 10, we provide detail on our commercial loan portfolio. C&I lending continues to be our primary focus, representing 65% of the portfolio. Manufacturing continues to be the largest concentration within the C&I segment, comprising approximately 11% or $155 million. The remaining 35% of the portfolio is comprised of commercial real estate with the largest concentrations being retail at $134 million or 9.5% and industrial at $126 million or 8.6%. It's worth noting that our exposure to the office segment stands at $78 million or 5.3% of our commercial portfolio at quarter end, a slight decrease from 5.7% of our portfolio a year ago. We provide more insight into our office exposure on Page 11. The vast majority of our office exposure can be characterized as low-rise suburban office space with 28% being medical office space. This portfolio is also very granular, with the average loan size being $1.2 million. We did experience a charge-off on one office credit in the quarter, which was a credit that had a long and spotty history with the bank. That loss was $960,000 and was fully reserved during 2022. Aside from that credit, our credit quality for this segment of our portfolio continues to hold up very well with no office-related credits on our watch list at quarter end. Page 12 provides an overview of key credit quality metrics at March 31. Overall, credit quality continues to be excellent. Total nonperforming loans were $3.9 million or 0.11% of total loans at quarter end. In loans 30 to 89 days delinquent totaled $1.9 million or 0.05% at March 31, down slightly from year-end. 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. Good morning, everyone. I'm starting at Page 13 of our presentation. In the first quarter, we took a provision of $3 million related to the charge-off on the Signature Bank subordinated debt security that was classified held to maturity. Additionally, we realized a $222,000 loss on the sale of a Silicon Valley Bank senior unsecured corporate securities due to credit deterioration. Slide 13 quantifies our holdings in financial institution corporate securities. We believe Signature Bank and Silicon Valley Bank's failures to be isolated events caused by unique liquidity characteristics of their balance sheet. Over 44% of our portfolio is rated investment grade by Moody's and/or S&P with an additional 44% rated investment grade by KBRA. We perform regular credit reviews of each security and are comfortable with our current holdings. Page 14 highlights our strong regulatory capital position. The tangible common equity ratio, leverage ratio, CET1 ratio, and the total risk-based capital ratio increased in the first quarter of 2023. Moving on to Page 15. Net interest income increased $5.4 million from the year-ago period. Our tax equivalent net interest margin was 3.33% during the first quarter of '23, which is up 33 basis points from the year-ago period and down 19 basis points from the fourth quarter of 2022. Average interest-earning assets were $4.7 billion in the first quarter of 2023 compared to $4.49 billion in the year-ago quarter and $4.64 billion in the fourth quarter of 2022. Page 16 contains a more detailed analysis of the linked quarter decrease in net interest income and the net interest margin. On a linked quarter basis, our first quarter 2023 net interest margin was positively impacted by two factors: an increase in yield investments and earning asset mix contributed 5 basis points, and a change in loan yield and mix contributed 20 basis points. These increases were more than offset by an increase in funding cost of 44 basis points; 6 basis points of loss was due to changes in funding mix. We will comment more specifically on our outlook for net interest income and net interest margin in 2023 later in the presentation. On Page 17, we provide details on the institution's interest rate risk position. The comparative simulation analysis for first quarter '23 and fourth quarter '22 calculates the change in net interest income over the next 12 months under five-rate scenarios. All scenarios assume a static balance sheet. The base rate scenario applies a spot yield curve from the valuation date. The shock scenarios consider immediate, permanent, and parallel rate changes. The decrease in the base rate forecasted net interest income in the first quarter of 2023 compared to the fourth quarter of 2022 is primarily due to an adverse shift in the funding mix and higher than previously modeled betas on interest-bearing deposits during the quarter. These changes were partially offset by earning asset growth and a favorable change in earning asset composition. Sensitivity is largely unchanged during the quarter as the adverse impact from changes in the deposit mix was offset by additional hedging and term funding transactions. Currently, 30.9% of assets reprice in 1 month and 43.9% reprice in the next 12 months. Moving on to Page 18. Noninterest income totaled $10.6 million in the first quarter of 2023 as compared to $18.9 million in the year-ago quarter and $11.5 million in the fourth quarter of 2022 and first quarter '23 net gains on mortgage loans totaled $1.3 million compared to $0.8 million in the first quarter of '22. The increase in these gains was due to an increase in the gain on sale margin, and that's partially offset by a decrease in mortgage loan sales volume. The mortgage loan application mix continued to maintain a lower percentage of saleable loans in the quarter, highly impacting noninterest income, was a $0.6 million gain on mortgage loan servicing due to $2.2 million of revenue that was partially offset by a $0.6 million or $0.02 per diluted share after-tax decrease in the fair value due to price, and a $0.9 million decrease due to paydowns of capitalized mortgage loan servicing rights in the first quarter. As detailed on Page 19, our noninterest expense totaled $31 million in the first quarter of 2023 as compared to $31.5 million in the year-ago quarter and $32.1 million in the fourth quarter of 2022. Compensation increased $0.8 million compared to the prior year quarter due to raises that were effective at the start of the year, a decreased level of compensation that was deferred in the first quarter of '23 as direct origination costs on lower mortgage loan origination volume and an increase in lending personnel. Performance-based compensation decreased $1.4 million due primarily to a decrease in mortgage lending volume and lower performance level within the corporate incentive compensation plan compared to the first quarter of '22. The first quarter of 2023 included a $0.5 million in credit to expense related to reserve for unfunded lending commitments due to a decrease in the volume of such lending commitments as well as the expected loss rates. Data processing costs increased by $0.8 million from the prior year period, primarily due to a credit in the prior year quarter related to certain expenses that had been previously paid and expensed, and an increase in the expense related to asset growth. Page 20 is our update for our 2023 outlook to see how our actual performance during the first quarter compared to the original outlook that we provided in January 2023. Our outlook estimated loan growth in the low double digits. Loans increased $44.5 million in the first quarter of 2023 or 5.2% annualized, which is below our forecasted range. Commercial mortgage and installment loans had positive growth in the first quarter of '23. First quarter 2023 net interest income increased by 16.5% over 2022, which is higher than our forecast of a single-digit growth. The net interest margin for the first quarter of 2023 was 33 basis points higher than the first quarter of 2022. The net interest margin of 3%, which is in line with our original forecast. The first quarter 2023 provision for credit losses was an expense of $2.2 million or 0.25% annualized. The first quarter '23 provision expense as a result of an increase in provision for credit losses for securities held to maturity due to a $3 million loss incurred on a subordinate debt security during the quarter. The provision expense related to loans was a credit in the first quarter of '23, which is lower than our forecasted range. Noninterest income totaled $10.6 million in the first quarter of '23, which was below our forecasted range of $11 million to $13 million. First quarter 2023 mortgage loan originations, sales, and gains totaled $113 million, $106.9 million, and $1.3 million respectively. Mortgage loan servicing generated a gain of $0.7 million in the first quarter of '23. The $0.2 million loss on securities available for sale was related to the divestiture of a credit impaired corporate security. Noninterest expense was $31 million in the first quarter, below our forecasted range of $32 million to $33.5 million targeted quarterly. Our effective income tax rate of 18.2% for the first quarter of 2023 is slightly below where we had forecasted. Lastly, no shares were repurchased in the first quarter of 2023. That concludes my prepared remarks. I would like now to turn the call back over to Brad.

Brad Kessel, President and CEO

Thanks, Gavin. Each quarter, we share a high-level view of our key strategic initiatives. As we proceed through 2023, our focus will continue to be on the rotation of our earning asset mix out of all our yielding investments into higher-yielding loans, growing our core deposit base while managing our cost of funds, and controlling our noninterest expenses. While there is increasing concern about a potential economic slowdown, at this point, we continue to see good demand for loans, particularly in the commercial segment as well as a renewed interest in the strong value proposition offered by community banks like Independent Bank. Accordingly, we are excited about the opportunities we have to continue our growth trends. We've built a strong franchise on a talented team, a low-cost deposit base, and well-diversified loan portfolios, which we believe positions us well to effectively manage through a variety of economic environments and continue to deliver strong and consistent results for our shareholders. At this point, we'd now like to open up the call for questions.

Operator, Operator

Thank you. We will just take a brief pause to assemble the Q&A roster. Our first question comes from Brendan Nosal with Piper Sandler.

Brendan Nosal, Analyst

You folks did a really nice job of growing deposits this quarter. Nice to see core deposits flat and then you brought up time and broker to get the balance of the growth, which it looks like it allowed you to build cash quite nicely. I guess, looking forward, do you have a desire to build cash forever by bringing on more of those funding sources, or are you pretty happy at this point kind of matching the loan growth and keeping cash flat?

Gavin Mohr, Chief Financial Officer

So we did come through quarter end with an elevated level of cash that we were faced with. On-balance sheet cash will be lower, anticipate throughout the rest of the year. The growth we've seen in time and reciprocal; some of that was new deposit growth coming into the bank. Some of it is rotation as you could see from non-maturity. So I mean, I guess the answer I would have is we're continuing to grow deposits, and we expect to continue to grow deposits throughout the rest of the year.

Brendan Nosal, Analyst

One more from me. Can you maybe walk us through how deposit pricing evolved kind of month-to-month over the quarter and kind of give us some insight as to what period you felt the most pressure?

Gavin Mohr, Chief Financial Officer

The environment clearly changed after March 10. We were increasing deposits in the first two months. Ultimately, it was the deposit rotation that was driving up costs. However, we were still increasing throughout the quarter. We managed to hold back for as long as possible, but we had to make some adjustments to catch up a bit.

Operator, Operator

Our next question comes from Erik Zwick with Hovde Group.

Erik Zwick, Analyst

I wanted to discuss the net interest margin. If the margin remains at this level for the rest of the year, it aligns with your previous guidance suggesting it would be flat or slightly higher compared to the full year 2022. I'm interested in your thoughts on the potential to shift into higher earning assets, as you've mentioned, and how you perceive the funding environment, which appears to be becoming more competitive based on what you said earlier. How do you foresee the margin outlook in the upcoming quarters?

Gavin Mohr, Chief Financial Officer

In our outlook, I want to remind everyone that we used a forward curve that included two rate cuts toward the end of the year, which was certainly advantageous. Moving forward, we are experiencing deposit pressure, which increased in the first quarter. I wouldn't say it's necessarily continuing to grow, but it is present. The major question that complicates this is the nature of the deposit rotation. Looking back at our model, we underestimated the level of rotation of non-maturities within this timeframe.

Erik Zwick, Analyst

I appreciate the additional insight. Moving on to fee income, the first quarter results for noninterest income were slightly below the lower end of your expected range. I'm curious about the interchange and service charges on deposits that seemed to come in lighter. Was there some seasonality involved? I’ve noticed other banks have made adjustments to their deposit service charges and non-sufficient funds fees, so I’m interested in understanding what factors might have influenced the first quarter results and how we should approach reaching that expected range for the remainder of the year.

Brad Kessel, President and CEO

Yes, Eric, I have a few thoughts on that. We are noticing a lower-than-expected halt in sales. Typically, by this time of year, we would expect to see an increase in mortgage activity. Last week, we experienced the highest number of applications per week since the beginning of the year, but we have been facing unusually cool weather, which might be contributing to this slowdown. In terms of noninterest income, I think that is a significant factor. We remain optimistic about the interchange fees and deposit service charges we have. We've made some adjustments, such as changing our approach to charging for statements, but those are the main factors, right, Gavin?

Gavin Mohr, Chief Financial Officer

Yes, I agree.

Erik Zwick, Analyst

I have one last question before I step back. Most bank stocks have decreased in value this year, and you did not repurchase any shares in the first quarter. I'm curious about your thoughts on capital utilization since loan growth remains strong. Given the current trading price of the stock, has this affected your strategy at all, and are you considering becoming more active in share buybacks throughout the year?

Brad Kessel, President and CEO

Our capital will primarily support our organic loan growth. Currently, our AOCI marks are below our target range on TCE, which affects our willingness to repurchase shares. However, considering our current stock price in relation to the intrinsic value we anticipate, we may engage in some share repurchases, but it is unlikely to be significant at this time.

Operator, Operator

Our next question comes from Damon DelMonte with KBW.

Matt Renck, Analyst

This is Matt Renck filling in for Damon. I hope everybody is doing well. My first question is on provisions. So the core provision, so to speak, was lower than the range. Do you think provision expense will pick back up to that 0.25% to 0.35% as commercial loans come back online or commercial loan growth starts to pick up? Or is there like economic deterioration built into that forecast?

Gavin Mohr, Chief Financial Officer

So I would agree with you, it will be driven by loan growth. So right now, as Joel had highlighted in his commentary or we had one commercial note that we wrote down, but we had already addressed that in 2022. So we did come out of the gate a little slower on growth than forecasted indicated for the full year. So maybe in totality, everything held the same. We may come in a little lighter than the 25 basis points for the year regarding loans. But obviously, given the HTM write-down that we took was right in line. I don't anticipate that happening again. But so if loan growth comes back, yes, I think we can get close to where we forecasted maybe a little lighter.

Matt Renck, Analyst

And then just lastly, on noninterest expense. You guys hired a new commercial team. What's the appetite like for new hires? And then conversely, should we enter a more recessionary environment? Do you have opportunities to cut costs? Or will cost savings more come from optimization of delivery channels?

Joel Rahn, Executive Vice President - Commercial Banking

So our appetite for talent is ongoing. We're always in all areas, particularly the sales side, continuing to look for talented people to add to our team. So this past quarter, we added three commercial salespeople and as well as a strong person on the credit support side. And they were not a team. They were spread out in our markets. So one in Southeast Michigan, one in West Michigan, and one in Northwest Michigan. And we're constantly also looking at the expense structure. Over on the retail side, we've reduced the FTE count by about 11 here through the first quarter. We sort of see through the third quarter, probably an opportunity for another 12 or 13. Much of that is simply not filling some of the lower-paid positions that we're able to still meet customer demand because of technology that we've put in place as well as reduced traffic in the branches. So we have a number of initiatives also to leverage additional technology. I'll give you an example. I think with the slowdown on the mortgage side, the support team for that group has been very, very busy automating more and more of our mortgage process. And we've seen the benefit of using robotic automation to perform what was previously done manually by people. So we're going to continue to push down on the expense side. And that is one of the areas we do have probably the most control over, Matt.

Brad Kessel, President and CEO

Okay. On our end, we're not hearing any more questions. It sounds like actually, maybe we do have one more question.

Manuel Navas, Analyst

Can you guys hear me?

Brad Kessel, President and CEO

We can now. Go ahead.

Manuel Navas, Analyst

This is Manuel Navas from Davidson. I wanted to follow up on the operational expenses discussion. They were slightly lower due to variable compensation. I'm wondering if you expect operational expenses to stay near the lower end of the range or even drop below it, especially if fees do not return to previous levels.

Brad Kessel, President and CEO

I think we'll probably be on the lower end of the range prospectively.

Manuel Navas, Analyst

Just looking over to the margin for a second. Do you have like a March-end NIM or a deposit cost at the end of the period to kind of compare to as we enter the second quarter?

Gavin Mohr, Chief Financial Officer

I do. March NIM was 3.28%. Deposit costs were $151 million.

Manuel Navas, Analyst

And what kind of are you assuming on the deposit beta side with kind of the shifts to your expectation for deposit account migration? And any kind of update on how you're thinking about deposit betas during the cycle?

Gavin Mohr, Chief Financial Officer

We spent a lot of time talking about that in the last few weeks. We're still modeling at low to mid-30s for the cycle.

Manuel Navas, Analyst

You mentioned that the situation seemed to be more focused earlier in the quarter, and then there was less pressure on deposit rates as the quarter progressed. Is that a correct understanding? It's still present, you noted, but it was...

Gavin Mohr, Chief Financial Officer

So we were...

Manuel Navas, Analyst

In January and February.

Gavin Mohr, Chief Financial Officer

This quarter, the pressure from rate changes was quite significant, more so than in previous quarters. We adjusted our strategies in response to this. The events in early March accelerated the changes, prompting us to make further pricing adjustments. However, there isn't a specific date for when we increased prices; we make adjustments continuously. We hold regular meetings to assess the market conditions and our deposit base, and we modify our approach as needed.

Manuel Navas, Analyst

And just especially on loan growth. You already indicated it's more than that last three quarters weighted to growth. I might have missed it, but how are pipelines looking into the second quarter and beyond?

Joel Rahn, Executive Vice President - Commercial Banking

Our pipeline actually is stronger now than it was at the end of last year. We had a very active fourth quarter, really the second half of last year. And I think the combination of having to rebuild our pipeline during the first quarter and just the market kind of digesting the higher rate environment caused the slowness from my viewpoint. But now our pipeline is stronger than it's been in several quarters. And we're feeling very confident about good solid growth for the remainder of the year.

Operator, Operator

At this time, we have no further questions. So I will hand the call back to Brad.

Brad Kessel, President and CEO

Thanks, Emily. 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 toward 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. We wish each of you a great day.

Operator, Operator

Thank you, everyone, for joining us today. This concludes our call, and you may now disconnect your lines.