Independent Bank Corporation (NASDAQ:IBCP) Q2 2021 Earnings Conference Call July 29, 2021 12:00 PM ET
Brad Kessel - President and Chief Executive Officer
Gavin Mohr - Executive Vice President and Chief Financial Officer
Joel Rahn - Executive Vice President, Commercial Banking
Conference Call Participants
Brendan Nosal - Piper Sandler
Damon DelMonte - KBW
Russell Gunther - D.A. Davidson
Good day and welcome to the Independent Bank Corporation Second Quarter Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to President and Chief Executive Officer, Brad Kessel. Please go ahead.
Good afternoon 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 2021 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.
Before we begin today’s call, I would like to direct you to the important information on Page 2 of our presentation, specifically, the cautionary note regarding forward-looking statements. If anyone does not already have a copy of the press release issued by us today, you can access it at the company’s website, independentbank.com. The agenda for today’s call will include prepared remarks, followed by a question-and-answer session and then closing remarks.
Slide 4 provides a good summary of our historical results. We continue to execute on our operating plan that we share each quarter. This plan is built around diversified and balanced growth, process improvement, cost controls, talent management and an enterprise-wide risk management framework. We believe following this plan will yield consistent and improving performance metrics over many quarters and many years.
Turning to Page 5, we are pleased to report continued strong financial performance for the second quarter of 2021. The highlights include an increase in net interest income of 3.1% over the second quarter of 2020. Net gains on mortgage loans of $9.1 million in total mortgage origination volume of $473.7 million. Net growth in portfolio loans of $30.3 million or 4.4% annualized, continued strong asset quality metrics, including net loan recoveries during the quarter and the payment of a $0.21 per share dividend on common stock on May 14, 2021.
Independent Bank Corporation reported second quarter 2021 net income of $12.4 million or $0.56 per diluted share versus net income of $14.8 million or $0.67 per diluted share in the prior year period. The decline in the second quarter 2021 earnings as compared to 2020 and primarily reflects a decrease in non-interest income and an increase in non-interest expense that were partially offset by an increase in net interest income and decreases in the provision for credit losses and income tax expense.
Listed on Page 6 are some of the more significant financial highlights year-to-date for 2021. These include increases in net income and diluted earnings per share of 75.8% and 77.3%, respectively. Annualized return on average assets and return on average equity of 1.6% and 18.06%, respectively. Net gains on mortgage loans of $21.9 million and total mortgage loan origination volume of $982.7 million. Net growth in portfolio loans of $80.9 million or 6% annualized. Net growth in deposits of $225.1 million or 12.5% annualized.
Finally, our credit quality continues to be real strong with net recoveries year-to-date, very low level of watch credits, past dues and non-performing assets. For the 6 months ended June 30, 2021, the company reported net income of $34.4 million or $1.56 per diluted share compared to net income of $19.6 million or $0.88 per diluted share in the prior year period. The increase in year-to-date 2021 earnings as compared to 2020 primarily reflects increases in net interest income and non-interest income, and a decrease in the provision for credit losses that were partially offset by increases in non-interest expense and income tax expense.
Significantly impacting comparable quarterly and year-to-date 2021 and 2020 results was the changes in the fair value due to price of capitalized mortgage loan servicing rights of a negative $2.4 million or $0.09 per diluted share after taxes and a positive $2.2 million or $0.08 per diluted share after taxes for the 3 and 6 months ended June 30, 2021, respectively, as compared to a negative $2.9 million or $0.10 per diluted share after tax and a negative $8.9 million or $0.31 diluted share after tax for the 3 and 6 months ended June 30, 2020, respectively. Our recent investments in new talent and in new technology had during the first half of 2021, elevated our overall non-interest expense run rate. I do believe it is reasonable to see us return to the higher end of our guided quarterly range for non-interest expense as we move forward. Page 7 provides a good snapshot of our loan and deposit metrics for our Michigan markets.
Turning to Page 8, we display several key economic statistics for the state of Michigan. Interestingly, we have moved from the pandemic peak period of a restricted economy to the current period of a constrained economy. Overall, we are seeing continued improvement in the unemployment rate for Michigan, now at 5%. Yet we have 300,000 less employed workers today in the state as compared to pre-COVID. Labor shortages are having a noticeable impact on many segments of our economy, including an increase in wages in our markets and reductions in business operating hours. Concurrently, supply chain shortages are also constraining many businesses in our markets. Regionally – regional average home sale prices continue to climb as inventory levels in many of our markets are at record lows and negatively impacting the overall volume of home sales.
On Page 9, we provide a couple of charts reflecting the composition of our deposit base as well as the continued growth in this portfolio while working to effectively manage our overall cost of funds. Like most in our industry, the extensive government stimulus continues to result in increased deposit levels for our customers.
Turning to Page 10, we have a few highlights relating to Independent Bank’s digital transformation. This major strategic initiative, which started in 2019 with vendor reviews and kicked off in early 2020 with the selection of our new partner moved significantly forward during the second quarter of 2021. With our successful conversion to a new modern core platform with flexible application processing interfaces, also known as APIs. This change now allows us faster integration with new technology, real-time processing capabilities and better access to our data and decision management using that data.
Initial feedback from our customer base includes much excitement about ONE Wallet, our new mobile and online platform for consumer and business clients. This platform provides customers with the ability to open new accounts and apply for loans online, along with enhanced transfer, bill pay and self-service capabilities. In addition, ONE Wallet+ enables our customers to monitor all their finances in one location and provides budgeting and spending analytical tools. ONE Wallet+ has experienced a very strong adoption rate. As we move forward during the second half of 2021, we will continue this digital transformation journey implementing numerous day 2 elements. A whole bank core conversion involves extensive planning and extraordinary effort by many individuals. I am very thankful to and proud of our team in undertaking this challenge in positioning us to compete and ultimately grow market share.
On Page 11, we provide an update on our $2.9 billion loan portfolio. For the second quarter, commercial balances decreased by $56.7 million. However, excluding PPP activity, our commercial balances increased by $5.6 million for the quarter. This was also net of several significant unexpected payoffs. Commercial line usage at 36%, while up from the previous quarters continues to be soft. That said, the commercial pipeline is very strong, and our mortgage pipeline while down from peak levels continues to display strength. Our mortgage balances increased by $45.1 million and installment balances increased by $41.9 million. Respectively, I am optimistic our – about our ability to accelerate the earning asset rotation from lower-yielding investments to higher-yielding loans. My optimism stems from the numerous talented additions to our sales team from across our markets during the first half of 2021. I do believe we are on track to grow loans net of PP at the higher end of our original forecast.
On Page 12, we have an update on our loan modifications, which declined to $12.7 million or 0.5% of total loans at June 30, 2021. Page 13 is an update on the bank’s administration of the SBA’s Paycheck Protection Program. As of June 30, 2021, we had $172 million in balances outstanding and $5.8 million in net unaccreted fees. We expect most of these fees to be accreted into interest income over the next 6 to 9 months.
On Page 14, we display the concentrations or makeup of our entire commercial loan portfolio. The portfolio continues to be very granular in nature, with the largest concentrations in C&I manufacturing with $139 million or 11%, construction at 9% and retail at 6%. Within the CRE portfolio, the largest concentration is retail with $102 million or 8%. Our credit metrics indicate the portfolio continues to hold up well, including those – including loans in those industry sectors whose business has been more negatively impacted by the COVID-19 pandemic. This includes the hospitality and food service industries.
Page 15 provides an overview of our investments at June 30, 2021, as well as activity during this past quarter. In terms of capital management, our capital levels continue to be strong with tangible common equity to tangible assets of 8.2% at June 30, 2021. We declared a quarterly cash dividend on our common stock of $0.21 per share. This dividend is payable on August 16, 2021 to shareholders of record on August 6. On December 18, 2020, the Board of Directors of the company authorized the 2021 share repurchase plan. Under the terms of the 2021 share repurchase plan, the company is authorized to purchase up to 1,100,000 shares or approximately 5% of our outstanding common stock. The repurchase plan is authorized to last through the end of this year. For the first 6 months of 2021, the company has repurchased 344,005 shares at a weighted average price of $21.18 per share.
At this time, I would like to turn the presentation over to Gavin to share a few comments on our financials, credit quality and our outlook for the balance of 2021.
Thanks, Brad and good afternoon everyone. I am starting at Page 17 of our presentation. Net interest income increased $0.9 million from the year ago period. Our tax equivalent net interest margin was 3.02% during the second quarter of 2021, which is down 34 basis points from the year ago period and down 3 basis points from the first quarter of 2021. I will have some more detailed comments on this topic in a moment.
Average interest-earning assets were $4.22 billion in the second quarter of 2021 compared to $3.66 billion in the year ago quarter and $4.05 billion in the first quarter of 2021. Page 18 contains a more detailed analysis of the linked quarter increase in net interest income and a decline in net interest margin. Our second quarter ‘21 net interest margin was adversely impacted by 2 factors: growth in securities available for sale and a decrease in PPP accretion. We will comment more specifically on our outlook for net interest income and the net interest margin for the remainder of 2021 later in the presentation.
Moving on to Page 19, non-interest income totaled 14 – non-interest income totaled $14.8 million in the second quarter of 2021 as compared to $20.4 million in the year ago period and $26.4 million in the first quarter of 2021. Second quarter ‘21 net gains on mortgage loans totaled $9.1 million compared to $17.6 million in the second quarter of ‘20. The decrease in these gains was due to decreases in mortgage loan sales volume and in the mortgage loan pipeline as well as lower loan sale profit margins. Mortgage loan applications remained strong, although refinancing applications slowed in the second quarter of ‘21. Our purchase market volumes continue to be strong, negatively impacting non-interest income was a $2 million loss on mortgage loan servicing due to a $2.4 million or $0.09 per diluted share after tax decrease in the fair value due to price and a $1.4 million decrease due to pay-downs of capitalized mortgage loan servicing rights in the second quarter of ‘21.
As detailed on Page 20, our non-interest expense totaled $32.5 million in the second quarter of 2021 as compared to $27.3 million in the year ago quarter and $30 million in the first quarter of 2021. Compensation increased $1.5 million compared to the prior year quarter due to raises that were effective at the start of the year and increased over time related to the data processing conversion. Performance-based compensation increased $1 million due to an increase in the expected payout levels compared to the second quarter of ‘20. The second quarter of 2021 included $1.1 million of conversion-related expenses. We’ll have more comments on our outlook for non-interest expense later in the presentation.
Page 21 provides data on non-performing loans, other real estate, non-performing assets and early-stage delinquencies. Total non-performing assets were $5.4 million or 0.12% of total assets at June 30, 2021. Non-performing loans decreased by $2 million or 27.8% during the second quarter of 2021. Loans, 30 to 89, days delinquent decreased to $3.5 million at June 30, 2021 compared to $3.9 million at March 31, 2021.
Page 22 provides some additional asset quality data, including information on new loan defaults, on classified assets – and on classified assets. I would highlight there were no new commercial loan defaults in the first half of 2021.
Page 23 provides information on our TDR portfolio that totaled $41 million at June 30, 2021. This portfolio continues to perform well, 96.1% of these loans being current at June 30, 2021.
Moving on to Page 24, we reported a provision for credit losses, credits of $1.4 million in the second quarter of ‘21 compared to an expense of $5.2 million in the year ago quarter. And a provision credit of $500,000 in the first quarter of 2021. The allowance loan losses totaled $45.9 million or 1.63% of portfolio loans at June 30, 2021. This ratio increases to 1.75% when excluding PPP loans and the remaining Traverse City State Bank acquired loans.
Page 25 is our update for 2021 outlook to see how our actual performance during the year compared to the original outlook that we provided in January of 2021. Our outlook estimated loan growth in the low single digits. Loans increased $30.3 million in the second quarter of 2021 or 4.4% annualized. Growth in mortgage and installment loans were offset by a decline in commercial loans due to $62.3 million decrease in PPP loan balances in the second quarter of ‘21. Excluding PPP loans, total portfolio loans grew at a 6.2% annualized rate during the first 6 months for 2021 and was within our forecasted range.
During the first 6 months of 2021 net interest income increased by 1.7% over 2020, which is a bit higher than our forecast. However, the net interest margin for the first 6 months of 2021 was 30 basis points lower than the full year 2020 net interest margin of 3.34%, which is steeper decline than our forecast, higher-than-anticipated deposit growth has largely been deployed into lower-yielding investment securities are primary reason for these variances. As we were able to deploy more funds – as we are able to deploy more funds into the loan growth, we would expect the interest margin to stabilize.
The second quarter ‘21 provision for credit losses was a credit of $1.4 million. This is below our forecasted 2021 full year provision range of 0.25% to 0.35% of average total portfolio loans. The primary driver of the decrease in the provision for credit losses were a decrease in the specific reserves, qualitative reserves and improvement in the unemployment forecast. If current credit trends persist, we would anticipate that our provision for credit losses will be below our forecasted range for the full year of 2021.
Non-interest income totaled $14.8 million in the second quarter of ‘21 compared to our forecasted range of $13 million to $16 million. The mortgage loan pipeline continues to be strong, although refinance activity slowed down in the second quarter of ‘21. Excluding negative MSR value adjustments due to price, we generally would expect non-interest income to fall in the forecasted range for the last half of 2021. Non-interest expense was $32.5 million in the second quarter outside our $28.5 million to $29.5 million are targeted quarterly range increases in compensation and employee benefits, data processing conversion related expenses were the primary categories that caused non-interest expense to exceed the targeted range. We do expect that the additional costs we have been incurring related to the core data processing system conversion to abate by the fourth quarter of this year.
Our effective income tax rate of 17.7% and 18.4% for the second quarter and first 6 months of 2021, respectively, was a bit lower than our forecast. This is due in part to higher-than-expected levels of tax-exempt interest income. Lastly, the company purchased 344,005 shares at an average cost of $21.18 in the first 6 months of 2021.
That concludes my prepared remarks. I would now like to turn the call back over to Brad.
Thanks, Gavin. Slide 26 displays a high-level view of our key strategic initiatives. And at this point in the call, we would now like to open it up for questions.
[Operator Instructions] The first question comes from Brendan Nosal with Piper Sandler. Please go ahead.
Hey, good morning everybody. How are you doing?
Hi, good, Brendan.
Good. Maybe just to start off on loan growth, I mean certainly nice to see growth return after a year or so of softer trends. I was just hoping you could kind of walk through what changed in the underlying environment that drove the inflection this quarter and drives your expectation for continued growth through the balance of the year?
Well, I’m going to let Joel Rahn, who heads up our commercial banking take first stab at that. Joe, why don’t you.
Yes, two primary things that I would say. First, Brendan, is the – just the pace of the economy, certainly, we’re seeing a lot of demand. Our customers are doing well. Biggest issue for manufacturers and a lot of companies are supply chain issues that really is restraining growth to some degree. So we’re seeing some organic growth in that sense. And then Brad mentioned our investment in talent. We have strategically added many new commercial bankers in the first half this year, 9 to be exact. And we’re seeing opportunities come through those talent additions. So it’s really twofold, continuing improvement opening up with the economy and then obtaining greater market share with an expanded commercial force.
Alright. Fantastic. That’s certainly helpful. And then maybe one more for me, just turning to kind of the reserve level, I guess even with this quarter’s negative provision, you still have quite a robust level of reserves ex-PPP. So can you just help us think about how much COVID-related reserves you still hold today? And what a normalized level of the allowance might look like for you folks now that you’re under CECL?
Yes, Brendan, so approximately $14 million is still COVID related in terms of the allowance today. So to answer your question there, as we look at the subjective factors and how they are related to COVID, it’s going to depend on – as we progress, we’re cautious about releasing those two quickly, given some of the data that’s coming out regarding variance. But also, what you’re going to see is we’ve seen loan growth, and we think that there is probably going to be a meeting point where we will see the COVID continue to release and we anticipate it will be absorbed with loan growth.
Understood. That’s a helpful way of thinking about it. Alright, thank you for taking my questions.
The next question comes from Damon DelMonte with KBW. Please go ahead.
Hey, good afternoon guys. First question, just wanted to circle back on the expense outlook. So obviously, this quarter came in above the guided range. Is the commentary that you expect to get back into that guided range in the third quarter or is it by the end of the fourth quarter?
Well, I think we’ve had a lot of change, Damon. And I’ve got – our team has a pretty detailed understanding of where the increase has been year-to-date. And so high level, I think we should move to the high end of that range here in the third quarter now and then be consistent with that in the fourth quarter. The wildcard a little bit there is – and I mentioned the whole bank conversion. We have actually – we have temporary staff and sort of kept people on and there is over time and so on, all related to the digital transformation effort. And I’m a little – we do not want to – we’d rather have a little higher expense run rate and do that right and take good care of our customer base as opposed to get a little – pull the trigger early and sort of not have the hours being worked either temporary employees or over time. So I think it’s reasonable to expect us to get back there in the third quarter, but it may move into the fourth quarter.
Got it. Okay. That’s helpful. Thank you. And then the buyback, your approach to the buyback is, given capital levels and where the stock is trading, you clearly had some capacity last year. So should we expect kind of a similar amount of buyback here in the back half of the year as we saw in the first half?
Yes. I think that’s very reasonable, the pace. Of course, we’ve shared in the past, our activity there is a function of some modeling of what we see future earnings being with the current stock prices, the earn-back period being within adorable range. And so yes, if all those things sort of stay where they have been, I think we will continue on the current path.
Okay, great. And then just one last question, obviously, there has been three larger transactions that have occurred with – across your footprint in the last 3 to 6 months or so. Can you talk a little bit about opportunities to capitalize on market disruption? Do you see opportunities in the way of the human capital side of hiring lenders or teams of lenders? And then also on the customer acquisition side, do you see opportunities to win over customers that you may have been calling on but never had the opportunity to actually bank? Thanks.
Yes and yes. I think there is opportunity in adding to the team, which we have done. I think Joel outlined what we’ve done on the commercial side. We’ve also added in other areas. On the sales side, we’ve also added in some support roles because, of course, you’ve got to be able to get that new business through the – through our processing areas in a timely manner. So we are very active in that effort. And the story of our company is being very well received in the marketplace. Independent on a deposit base is now the largest – will be the largest bank headquartered in the state of Michigan. And so we’ve got size and we’ve got a terrific platform. We’ve talked about the technology investments we’ve made. It’s still a people business. And we’re very excited about continuing to capitalize on all the market disruption.
Excellent. Appreciate the color. Thank you very much.
[Operator Instructions] Our next question is from Russell Gunther with D.A. Davidson. Please go ahead.
Hi, good afternoon guys.
Just had a couple of follow-ups, right, thank you. I just had a couple of follow-ups. The first on the loan growth side, so I appreciate all the color you’ve given on the trends for the quarter and the back half. Just focusing on the core C&I, ex PPP, could you talk about those trends intra-quarter and how the back half of the year is shaping up for that lending vertical?
This is Joel, Russell. Very, very strong. So our pipeline is the strongest it’s been in a number of years. And that goes back to my comments earlier. We’re seeing the demand from our customers as the economy continues to open up. But really more importantly, it’s the impact of our expanded commercial team that’s out in the marketplace helping to find opportunities. So we think that we will see solid loan growth in the second half of the year. It got masked a little bit in the second quarter with some extraordinary payoffs. But yes, we’re very confident based on our pipeline that, that will show good growth in the commercial portfolio in the second half of ‘21.
Okay, great. I appreciate the comments there. And then just one more for me, a follow-up on the expense conversation, so I hear you in terms of getting back down to the high end of the range for the back half of the year and what the wild cards are there, that kind of $29.5 million quarterly run rate. But how should we think about that going forward? Is that a base off of which you expect to grow in the normal course of business or as some of those temporary hires and overtime goes away there can be some benefit to a potentially lower run rate going forward?
Yes, great question. I think the – with our core conversion change, we knew and we have been benefiting from just the lower core contract for some time now. But what was very difficult to forecast, and I think it’s still difficult is with all the automation and the removal of much of what paper still move within the company, it’s very difficult to tell what the additional savings will be prospectively. I think, as we move through the second half of the year, we’re going to have a much better feel for that. So I think the key point is we think – we believe to be a high-performing community bank in today’s operating environment, you need to continue to have a good efficiency ratio and be smart about how you’re spending your money and watching every cost. So we’re going to continue to work that and try to push that down. So I’m not necessarily – we’re not necessarily accepting of that current $29.5 million level. We’re going to continue to try to push that down. But at the same time, hey, you got to spend money to make money. So there is that part of it, too.
Understood. Okay, great. Well, that’s it for me guys. Thanks for taking my questions.
Okay. I don’t believe there is any more questions. So 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 of our associates. I continue to be so proud of the job being done by each member of our team. Each team member in his or her own way continues to do their part 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. We wish each of you a great day. That concludes today’s call.