Earnings Call Transcript - IBCP Q2 2024

Operator, Operator

Hello all, and welcome to Independent Bank Corporation Reports 2024 Second Quarter Results. My name is Ezra and I will be coordinating your call today. I will now hand you over to your host, Brad Kessel, President and CEO. Brad, 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 second quarter 2024 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 and Head of our Commercial Banking. Before we begin today's call, I would like to direct you to 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 second quarter 2024 net income of $18.5 million, or $0.88 per diluted share versus net income of $14.8 million, or $0.70 per diluted share in the prior year period. This represents a return on average assets of 1.44% and a return on average equity of 17.98% respectively. I am proud of our team and very pleased with our second quarter 2024 results, driving organic growth on both sides of the balance sheet. Overall loans increased 1.2% annualized despite a higher than normal level of commercial payoffs and pay downs. While core deposits are up 4.8% annualized. We were able to generate net interest margin expansion increasing to 3.40% from 3.30% on a linked quarter basis and net interest income growth on both a linked quarter and a year-over-year 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 drove good growth in both our earnings per share at 26% and tangible book value per share 16% compared to the prior year quarter. Based on a robust commercial loan pipeline, the past record of our core group of professionals and the ongoing strategic initiative to add talented bankers to our team, we are optimistic about continuing these growth trends for the second half of the year and into 2025. Total deposits at June 30, 2024, were $4.61 billion. Overall, core deposits increased $53.3 million, or 4.8% annualized during the second quarter 2024. On a linked quarter basis, retail deposits declined by $22.2 million, business deposits increased by $143.6 million, and municipal deposits declined by $68.1 million during 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 the presentation a historical view of our cost of funds, as well as compared to the Fed funds spot rate and Fed effective rate. For the quarter, our total cost of funds increased by 1 basis point to 2.02%. Through the second quarter of 2024, the cumulative cycle beta for our cost of funds is 38.8%. At this time, I'd like to turn the presentation over to Joel Rahn to share a few comments on the success we're having in growing our loan portfolios and provide an update on our credit metrics.

Joel Rahn, EVP and Head of Commercial Banking

Thanks, Brad, and good morning, everyone. On Page 7, we share an update of our $3.9 billion loan portfolio and quarterly activity. Total loans increased by $12 million in the second quarter, representing 1.2% annualized growth. Our mortgage portfolio grew by $10.9 million. Our installment portfolio increased by $3.9 million. Our commercial loan portfolio, as Brad mentioned earlier, declined $3 million in the quarter due to extraordinary payoff activity related to business sale as well as the sale of various real estate investment projects. It's worth noting that Q2 commercial loan origination was stronger than the first quarter but could not offset the approximate $82 million of unscheduled payoffs realized in the quarter. For the first half of the year, our commercial loan portfolio increased $52 million, representing 6.2% annualized growth. As noted in the material in each portfolio, the yield on new production is significantly higher than the respective portfolio yield. The commercial portfolio continues to be our highest yielding portfolio with a yield of 6.91%. Based upon a solid commercial pipeline, we see continued growth opportunity in the second half of the year while maintaining our disciplined credit standards. 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 69% of the portfolio. Manufacturing continues to be the largest concentration within the C&I segment, comprising approximately 10% or $173 million. The remaining 31% of the portfolio is comprised of investment real estate with the largest concentration being industrial at 7.9% or $123 million. It's worth noting that our exposure to the office segment stands at $84 million, or 4.8% of our commercial portfolio at quarter end. Our office exposure consists primarily of suburban low-rise office space with medical comprising 17% of overall office exposure. The average loan size is $1.3 million, which points to the granularity of the segment of our portfolio. For additional insight into our office exposure, I refer you to Page 25 of the appendix to this presentation. Key credit quality metrics and trends are outlined on Page 9. Overall, credit quality continues to be excellent. Total non-performing loans were $4.5 million, or approximately 10 basis points of total loans at quarter end consistent with March 31. Past due loans totaled $5.3 million, or 14 basis points, down slightly from March 31. While not reflected on the slide, our commercial watch list remains low at 2.2% of the commercial portfolio. 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, EVP and Chief Financial Officer

Thanks, Joel, and good morning, everyone. I'm starting at Page 10 of our presentation. Page 10 highlights our strong regulatory capital position while capital ratios increased from the linked quarter. Net interest income increased $3 million from the year ago period. Our tax equivalent net interest margin was 3.4% during the second quarter of 2024, compared to 3.24% in the second quarter of 2023, and up 10 basis points from the first quarter of 2024. Average interest earning assets were $4.89 billion in the second quarter of 2024, compared to $4.76 billion in the year ago quarter and $4.91 billion in the first quarter of 2024. Page 12 contains a more detailed analysis of the linked quarter increase in net interest income and net interest margin. On a linked quarter basis, our second quarter 2024 net interest margin was positively impacted by four factors: changed earning asset mix equated to 3 basis points, an increase in yield on loans equated to 3 basis points, loan fee accretion equated to 5 basis points, and change in funding mix equated to 5 basis points. These increases were partially offset by an increase in funding costs that resulted in 6 basis points. On Page 13, we provide details on the institution's interest rate risk position. The comparative simulation analysis for the second quarter of 2024 and the first quarter of 2024 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 the spot yield curve from the valuation date. The shock scenario is considered immediate, permanent, and parallel rate changes. The base case model to NII is largely unchanged during the quarter as asset yields benefit from a shift in asset mix, a shift in loan mix, and a continued asset repricing that was offset by liability repricing. C&I sensitivity profile is largely unchanged during the quarter for smaller rate changes of plus or minus 100 basis points. The exposure to larger rising rate scenarios decreased modestly. Asset sensitivity increased slightly while liability sensitivity declined. Additionally, NII exposure to larger rate declines is largely unchanged. Currently, 34.3% of assets reprice in one month and 44.9% repriced in the next 12 months. Moving on to Page 14. Non-interest income totaled $15.2 million in the second quarter of 2024 as compared to $15.4 million in the year ago quarter and $12.6 million in the first quarter of 2024. Second quarter 2024 net gains on mortgage loans totaled $1.3 million, compared to $2.1 million in the second quarter of 2023. The decrease is due to decreased profit margins as well as lower volume of loan sales. Gain on equity securities at fair value totaled $2.7 million during the second quarter of 2024. This gain is a consequence of the exchange of our shares of Visa Class B1 common stock, into a combination of Visa Class C common stock and Visa Class B2 common stock. With the completion of this exchange, we will record the fair value of the Visa Class C common stock through income as it is convertible into publicly traded Visa Class A common stock, while the Visa Class B2 common stock continues to be carried at zero. Positively impacting non-interest income was a $2.1 million gain on mortgage loan servicing net. This is comprised of $2.2 million of revenue, $0.9 million or $0.03 per diluted share gain due to change in price that was partially offset by a $1 million decrease due to pay downs of capitalized mortgage loan servicing rights in the second quarter of 2024. As detailed on Page 15, our non-interest expense totaled $33.3 million in the second quarter of 2024 as compared to $32.2 million in the year ago quarter and $32.2 million in the first quarter of 2024. Performance-based compensation increased $0.7 million due to primarily higher expected incentive compensation payouts for salary and hourly employees. Data processing costs increased by $0.4 million from the year ago period, primarily due to core data processor annual asset growth and CPI-related cost increases, as well as new solutions implemented during this timeframe. Page 16 is our update for our 2024 outlook, to see how our actual performance during the second quarter compared to our original outlook we provided in January of this year. Our outlook estimated loan growth in mid-single digits. Loans increased $11.9 million in the second quarter of 2024, or 1.2% annualized, which is below our forecasted range. Mortgage installment loans had positive growth while commercial loans decreased in the second quarter of 2024. The second quarter 2024 net interest income increased by 7.8% over 2023, which is within our forecast of mid-single-digit growth. The net interest margin was 3.4% in the current quarter and 3.24% for the prior year quarter, up 10 basis points from the linked quarter. The second quarter 2024 provision for credit losses was an expense of $20,000 below our forecasted range. Moving on to Page 17. Non-interest income totaled $15.2 million in the second quarter of 2024, which was higher than our forecasted range of $11.5 million to $13 million. Second quarter mortgage loan origination sales gains totaled $142.6 million, $95.5 million, and $1.3 million, respectively. Mortgage loan servicing net generated a gain of $2.1 million in the second quarter of 2024, gain on equity securities at fair value of $2.7 million, or $0.10 per diluted share after-tax in the second quarter ended June 30, 2024, which is attributed to the exchange over Visa Class B1 common stock. Non-interest expense was $33.3 million in the second quarter within our forecasted range of $32.5 million to $33.5 million. Our effective income tax rate of 20% for the second quarter of 2024 was in line with our forecast. Lastly, there were no shares we purchased in the second quarter of 2024. That concludes my prepared remarks. I would like to now turn the call back over to Brad.

Brad Kessel, President and CEO

Thanks, Gavin. I'm very pleased with our first half performance 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, their focus on connecting with customers, investing in our communities, and making banking easy. We've built a strong community bank franchise, which positions us well to effectively manage through a variety of economic environments and continue delivering strong and consistent results for our shareholders. As we move into the second half of 2024, our 160th year of serving the communities of Michigan, our focus will be on continuing to invest in our team, leveraging our technology, and supporting our communities. In doing so, we will continue the rotation of our earning assets out of lower-yielding investments into higher-yielding loans. With the strong value proposition offered as a large community commercial bank, we believe we can continue to grow our customer base while managing our cost of funds and controlling our non-interest expenses. Accordingly, we are excited about our future. At this point in time, we'd now like to open up the call for questions.

Operator, Operator

Thank you very much. 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. Maybe just to start off on the net interest margin here, I mean, expansion was really quite healthy and probably stronger than I was looking for. Just as we move to the back half of the year, could you help us walk through the moving pieces over the next few quarters and thoughts on where the margin trends from here? Thanks.

Gavin Mohr, EVP and Chief Financial Officer

Yes, sure. So we did have some fee accretion that we equated to 5 basis points for the quarter, though we view that as part of the core of the business. I anticipate we'll continue to drift higher as we forecast. I think we'll end up within that range. I'm pretty confident we’ll be in that forecasted range that we provided in January. The moving pieces are always the deposit remix and what we're able to see in terms of repricing of the asset book that's currently well below market rates. But yes, I do believe we'll continue to see it drift higher.

Brendan Nosal, Analyst

Okay. Perfect. One more for me before I step back; it looks like M&A activity in Michigan continues to heat up with another in-market transaction announced this morning. Just curious at this point, what your own appetite is to participate in the kind of renewed activity in the state.

Brad Kessel, President and CEO

Brendan, Independent Bank has a history of selective M&A. I think prospectively we will continue to be interested in partnering with other institutions where it makes sense. But it's not a requirement. Our five-year forecast is not dependent on doing a deal. So I'm not surprised to see another announcement in the Michigan market, and we'll probably see more going forward. If we can be a part of that and it makes sense for us, that would be great.

Operator, Operator

Thank you very much. Our next question is from Damon DelMonte of KBW. Damon, your line is now open. Please go ahead.

Matt Renck, Analyst

Hey, this is Matt Renck filling in for Damon. Hope everybody's doing well today.

Brad Kessel, President and CEO

Hi, Matt.

Matt Renck, Analyst

My first question was just on loan growth. Hi. You guys mentioned strong origination activity, strong pipeline; but just looking forward to the second half of the year, how should we think about net growth? Do you think pay downs and payoffs will continue to weigh on overall growth, or will we get back to that mid-single-digit range?

Joel Rahn, EVP and Head of Commercial Banking

Yes. This is Joel. I really do feel that with our game plan, we were executing our game plan. Our originations, as I said, were stronger, slightly stronger in the second quarter than they were in the first quarter, and payoffs happened. But what was extraordinary was that $82 million of quarterly payoffs, which I would note we didn't lose any relationships, but we had a customer sell a business, and we had a number of real estate projects that sold. They were all bunched within about a six-week time period, so it was very unusual. I look at our origination activity as being solid and steady. Our pipeline is as strong as it's been since mid-last year. So it's actually been growing as we went through the first half of this year. We're expecting a good solid second half of the year and feel like we're right on our original plan. This quarter looks a little weird, but I think by the time we get to year-end, we'll be right on plan or slightly ahead.

Matt Renck, Analyst

Okay. Got it. Thank you. And then last one for me, just with expenses kind of pushing up on the higher end of the range, do you think you'll be able to maintain the range just given expected growth in the back half of the year? Are there any levers you can pull to offset any expense growth?

Brad Kessel, President and CEO

Well, I do. And Gavin, you can jump in here too. I think the range that was given early in the year, back in January, is still intact. We are continuing to look at every area of the bank and how we're using our resources. So I think it is reasonable to still have that range in your estimates. Gavin, anything different there?

Gavin Mohr, EVP and Chief Financial Officer

No, no. I think it's really well said. Just maybe a little more focused on the driver this quarter was just the accrual for incentive catch-up. So is that the incentive compensation, this quarter, we had a really strong quarter, so we had some catch-up to do, and that was about a quarter over, on a linked quarter basis, with $0.5 million. So I agree with Brad.

Operator, Operator

Thank you very much. Our next question is from Nathan Race with Piper Sandler. Nathan, your line is now open. Please go ahead.

Nathan Race, Analyst

Curious, maybe, Gavin, if you can just update us on your margin expectations if the Fed were to cut in late September, and if you were to get maybe three to four cuts as well into 2025. How do you kind of think about an exit margin coming out of the end of that year?

Gavin Mohr, EVP and Chief Financial Officer

Yes. As you can see on our profile, in terms of the NII, we're running a pretty stable position. I do think that the Fed cuts could maybe lower the incentive or some of the pressure that the industry's feeling in terms of the deposit rotation. So that would be a positive. Additionally, if we could lose some of the inversion and we can see that new loans continue to go on at current levels, I think that's also positive long-term, but I don't. As we kind of, again, as we're showing here in the deck, we're trying to manage a fairly tight earnings profile, so overall positive, but not a big swing.

Nathan Race, Analyst

Okay. Great. That's helpful. And just curious with the Visa share gains that you guys recognize in the quarter, how you guys kind of think about maybe redeploying some of those proceeds that you guys contemplate maybe a partial securities portfolio restructuring or just kind of, what is the thinking there? Just to build additional excess capital for maybe some acquisitions or share repurchases down the road?

Gavin Mohr, EVP and Chief Financial Officer

Yes, we recently discussed this. Part of the Visa transaction has conditions attached. Currently, we've only sold two-thirds of the shares that are eligible to convert and become liquid. The remaining third should be available next month, as we expect. At this time, Nathan, the management decided to record the gains and will reevaluate in the future to explore potential opportunities, whether to retain the capital or restructure by year-end.

Nathan Race, Analyst

The fee income levels for the quarter were slightly lower, falling toward the lower end of the expected range, especially when excluding one-time items like the MSR adjustment and the visa gains. Do you believe that income will be closer to the middle or upper end of the range as we head into the third and fourth quarters?

Gavin Mohr, EVP and Chief Financial Officer

I think we can get back to the middle. Hesitant to say high because of the margin pressure we're seeing on the gain on sale for loans. We did have, what I would call, Nathan, unique events in the quarter that put additional pressure on that margin. I mean, there's general market pressure on the margin, but we had to move some saleable loans to portfolio that put some pressure on the margin. Then we also had some hedge ineffectiveness that we've been able to tighten up on a go-forward basis. So I think working back to the middle is feasible. The other piece there is if we could see swap fee income increase, I think it'd be an opportunity for us as well.

Nathan Race, Analyst

Okay. Great. And then just one last one from me. Just given it seems like you guys are expecting a pickup in loan growth in the back half of the year, do you guys see much in the way in terms of needing to provide for that growth from a provision perspective, or do you just feel like the reserve can maybe drift lower just given kind of the surplus reserves that exist today?

Gavin Mohr, EVP and Chief Financial Officer

Yes. That's a great question. I think that prospectively, our provisioning would be directly attributable to additional loan growth. So I think the guidance we gave at the start of the year on the provision is probably a little heavy, and so it's something under that. But barring some credit event, I would expect us to have a greater provision than what we had this past quarter directly related to loan growth. Now, having said that, we do have the ACL today at 1.46%, and probably 25% of that is in the subjective. If the soft landing continues to materialize, like it sure feels like it could drift lower, Nathan. So sort of a long answer, but hopefully, that tells you what's in our head on it.

Nathan Race, Analyst

That's very helpful. I appreciate all the color. Thanks, guys.

Gavin Mohr, EVP and Chief Financial Officer

Thank you.

Operator, Operator

Thank you very much. We have no further questions. So I will hand back to Brad and the management team to conclude.

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 proud of the job being done by each member of our team. Each 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 everyone for joining. This concludes today's call. You may now disconnect your lines.