Independent Bank Corporation's (IBCP) CEO Brad Kessel on Q1 2022 Results - Earnings Call Transcript

Apr. 26, 2022 2:52 PM ETIndependent Bank Corporation (IBCP)
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Independent Bank Corporation (NASDAQ:IBCP) Q1 2022 Earnings Conference Call April 26, 2022 11:00 AM ET

Company Participants

Brad Kessel - President & CEO

Gavin Mohr - EVP & CFO

Joel Rahn - EVP, Commercial Banking

Conference Call Participants

Brendan Nosal - Piper Sandler

Manuel Navas - D.A. Davidson

Bryce Rowe - Hovde Group


Hello ladies and gentlemen thank you for joining and being present in the Independent Bank Corporation Q1 2022 Earnings Conference Call. My name is Irene and I will be coordinating today's call. [Operator Instructions].

I will now hand you over to your host, Brad Kessel, President and CEO to begin. Brad, please go ahead.

Brad Kessel

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 2022 results. I'm Brad Kessel, President and Chief Executive Officer. And joining me is Gavin Mohr, EVP and Chief Financial Officer, and Joel Rahn, Executive Vice President, 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

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. I am very pleased with our team's continued execution of our operating plan. In doing so, our first quarter 2022 performance generated strong core results with good growth in net interest income, stabilization of our net interest margin, and net growth in each category of loans and total deposits. We were also able to make progress in reducing our non-interest expenses.

During the first quarter inflation was reported at near four-year highs. And we witnessed a very dramatic increase in rates on the middle and long end of the yield curve with the expectation now for multiple Fed hikes through 2022 and into 2023. This recent increase in rates has slowed our mortgage refinance origination volume and decreased this quarter's net gains on mortgage loans sales. However, we have also structured our mortgage business to have an emphasis on supporting home purchase requests. And these volumes continue to be at solid levels.

Additionally, the increase in rates also significantly increased the value of our capitalized mortgage servicing rights, somewhat of a natural hedge providing a benefit with higher rates.

Over the years, we have shared our intentions and success in generating a diversified revenue stream through three lines of business: commercial banking, mortgage banking and consumer banking. During 2021, we made significant investments both in talent and technology, primarily in our commercial and consumer banking lines of business. We are seeing some of the early paybacks for these investments with a very strong commercial pipeline and some increased efficiencies in our consumer banking business.

Turning to Page 5, Independent Bank Corporation reported first quarter 2022 net income of $18 million or $0.84 per diluted share versus net income of $22 million or $1 per diluted share in the prior-year period. The decrease in the 2022 first quarter earnings as compared to the first quarter of 2021 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 a decrease in the provision for credit losses.

The first quarter 2022 highlights include an increase in net interest income of 9% over the first quarter of 2021, loan growth of $99 million, or 13.8% annualized and deposit growth of $88.4 million, or 8.7% annualized, a return on average assets of 1.54%, and a return on average equity of 19.38%. In addition, our asset quality continues to be very good, with very low net charge-offs in the first quarter, as well as commercial watch credits at just 2.44% of the portfolio, and a continued very low level of past due loans. These favorable asset quality metrics, combined with reduced reserves related to COVID-19, allowed us to record a negative provision for the first quarter.

Page 6 provides a good snapshot of our loan and deposit metrics for our Michigan markets. I would point out that our two loan production offices opened in Ottawa County and Macomb County during the third quarter of 2021 are off to a strong start. In 2020, we closed eight branch locations as part of our ongoing branch optimization reviews. During the second quarter of 2022, we will be closing an additional four locations, one each in Kent, Oakland, Lapeer and Saginaw counties. Annual expected cost savings from the combined closings is expected to be $1.5 million. These closings will reduce our branch network to 58 locations in total.

Turning to Page 7, we displaced several key economic statistics for the state of Michigan. Overall, we are seeing continued improvement in the unemployment rate for Michigan, now at 4.7%, slightly above the national average of 3.8%. However, the state of Michigan has 110,000 fewer workers employed today, 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. In addition, supply chain shortages also continue to constrain many businesses in our markets. Regional average home prices continue to climb as inventory levels in many of our markets, continue at record lows and negatively impact the overall volume of home sales.

On Page 8, 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.

At this time, I would like to turn the presentation over to Joel Rahn to share a few comments on our loan portfolio.

Joel Rahn

Thanks Brad.

On Page 10, we provide an update on our $3 billion loan portfolio that I'll provide some insight on. For the first quarter, the commercial segment of the portfolio grew by $54 million. However, when you exclude PPP activity, our commercial balance has increased by $74.5 million. This falls on a strong fourth quarter of 2021 where we experienced commercial loan growth of $45 million, also excluding PPP activity.

Our annualized commercial growth rates over the past six months is 21% and based on strong pipeline, we expect strong commercial growth in the second quarter of 2022 as well.

In the first quarter our residential mortgage balances increased by $30.4 million and our consumer installment loan portfolio grew by $14.6 million. We remain optimistic about our ability to continue the earning asset rotation from lower yielding investments to higher yielding loans, and believe we're on track to grow loans at a low double-digit pace throughout 2022.

On Page 11, we display the concentrations of our $1.3 billion commercial loan portfolio. C&I lending continues to be our primary focus, representing 65% of the portfolio. Manufacturing is the largest single concentration within the C&I segment, comprising approximately 11% or $136 million. The remaining 35% of the portfolio is comprised of commercial real estate with the largest concentrations being Retail at a $112 million or 9%, and Industrial at $91 million or 7%. By design, this portfolio is very granular in nature. And our credit metrics, which Gavin will cover in a moment, reinforce that this portfolio is held up very well through the pandemic and resulting in supply chain pressures.

So at this time, I'd like to turn the presentation over to Gavin to share comments on our investments, capital, financials, credit quality, and our outlook for 2022.

Gavin Mohr

Thanks, Joel, and good morning, everyone.

I'm starting on Page 12 of our presentation. Page 12 contains details on our investment securities portfolio. Net unrealized losses increased in the second quarter of 2022 from year-end 2021 to $61.5 million net of swaps. Increasing rates in the first quarter of 2022 is primarily responsible for the increase in unrealized losses. These unrealized losses do not impact regulatory capital levels. The investment securities portfolio has a very strong credit profile, making credit losses unlikely excluding any credit impairment; the investment security will recapture the current unrealized losses as they mature. Approximately 30% of the portfolio has a variable rate structure including swaps.

Page 13 highlights our strong regulatory capital position. Reduction in the CET1 ratio, and the total risk-based capital ratios due to an increase in risk-weighted assets of $161.2 million in the first quarter of 2022.

Net interest income increased $2.7 million from the year-ago period. Our tax equivalent net interest margin was 3% during the first quarter of 2022, which was down 5 basis points from a year-ago period and down 13 basis points from the fourth quarter of 2021. I will have some more detailed comments on this topic in a moment.

Average interest earning assets were $4.49 billion in the first quarter of 2022 compared to $4.05 billion in the year-ago quarter and $4.43 billion in the fourth quarter of 2021.

Page 15 contains more detailed analysis of linked quarter decrease in net interest income and net interest margin. Our first quarter 2022 net interest margin was negatively impacted by two factors: decline in PPP loan balances had a negative 13 basis point impact and change in loan yield and mix excluding PPP decrease margin by 1 basis point. That was partially offset by an increase in investment yield of 2 basis points in the quarter. We will comment more specifically on our outlook for net interest income and the net interest margin for 2022 later in the presentation.

On Page 16, we provide details on the institution's interest rate risk position. The comparative simulation analyses versus first quarter 2022 and fourth quarter 2021 calculates the change in net interest income over the next 12 months. The base rate scenario assumes a static balance sheet and applies the spot yield curve from valuation date. The increase in the base rate forecast in net interest income in the first quarter 2022 compared to the fourth quarter 2021 is primarily due to an increase in rates, which resulted in higher forecasted earning asset yields as well as higher forecasted earning asset balances.

Most of the increase in the interest income was on term earning assets those pricing off the two to seven year part of the curve. The majority of the bank's funding basis consists of non-maturity deposits, which price off overnight fed funds rate, means that did not change non-maturity deposit rate after the first fed hike. Thus the spread between term earning assets and the banks non-maturity funding widened notably, resulting in the expansion of the forecasted net interest income. Currently, 17% of assets reprice in one month and 31.8% reprice in the next 12 months. The institution maintains an asset sensitive position primarily due to a federal funding base. And we'll continue to evaluate strategies to manage net interest income through hedging as well as product pricing and structure.

Moving on to Page 17, non-interest income totaled $18.9 million in the first quarter of 2022 as compared to $26.4 million in the year-ago quarter and $15.8 million in the fourth quarter of 2021. First quarter of 2022 net gains on mortgage loans totaled $0.8 million, compared to $12.8 million in the first quarter of 2021. The decrease in gains was due to a decrease in mortgage loan sales volume and the mortgage loan pipeline, as well as lower loan sale profit margins. Margins were negatively impacted by approximately $3.8 million and the fair value adjustment on portfolio of saleable construction loans. Mortgage loan applications remain solid, although refinancing applications have slowed and the mortgage production mix is rotated to a lower percentage of saleable loans. Positively impacting non-interest income was a $9.6 million gain on mortgage loan servicing due to an $8.5 million or $0.31 per diluted share after-tax increase 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 of 2022.

As detailed on Page 18, our non-interest expense totaled $31.5 million in the first quarter of 2022 as compared to $30 million in the year-ago quarter and $33 million in the fourth quarter of 2021. Compensation increased $2.3 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 2022 has direct origination costs on lower mortgage loan origination volume and increase in lending personnel and higher health care insurance costs.

Performance-based compensation decreased $0.6 million due primarily to a decrease in mortgage lending volume compared to the first quarter in 2021. The first quarter of 2022 included $0.4 million of recoveries related to reserve for unfunded lending commitments, due to a decrease in unfunded lending commitments. We will have more comments on the outlook for non-interest expense later in the presentation.

Page 19 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 0.11% of total assets at March 31, 2022. Loans 30 to 89 days delinquent totaled $2.7 million at March 31, 2022 compared to $2.3 million at December 31, 2021.

Page 20 provides some additional asset quality data including information on new loan defaults and on classified assets. I would highlight there were no new commercial loan defaults for the first quarter of 2022.

Page 21 provides information on our TDR portfolio that totaled $36 million at March 31, 2022. This portfolio continues to perform well with 96.5% of these loans being current at March 31, 2022.

Moving on to Page 22, we recorded a provision for credit losses credit of $1.6 million in the first quarter of 2022 compared to provision credit of $0.5 million in the year-ago quarter, and a provision expense of $0.6 million in the fourth quarter of 2021. The allowance for loan losses totaled $45.6 million or 1.52% of the portfolio loans at March 31, 2022.

Page 23 is our update for 2022 outlook to see how our actual performance during the first quarter compared to the original outlook that we provided in January of 2022. Our outlook estimated loan growth in low-single-digits. Loans increased $99 million in the first quarter of 2022 or 13.8% annualized. Commercial mortgage and installment loans all experienced growth in the first quarter of 2022. Excluding PPP loans total loan portfolio grew at 16.7% annualized rate during the first quarter of 2022 above our forecasted range. First quarter 2022 net interest income increased by 9% over 2021, which is higher than our forecast. However, the net interest margin for the first quarter of 2022 was 5 basis points lower than the first quarter of 2021, net interest margin of 3.05%, which is less than our original forecast.

The first quarter 2022 provision for credit was $1.6 million. This is below our forecasted 2022 full-year provision range of 0.15% to 0.2% of average total portfolio loans. Primary drivers of the decrease in the provision for credit losses were a decrease in adjustments allocations based on subjective factors due in part to the expected reduction in risk related to COVID-19.

Non-interest income totaled $18.9 million in the first quarter of 2022, which is higher than our forecasted range of $13 million to $17 million.

First quarter 2022 mortgage loan originations sales and gains totaled $270.2 million, $221.7 million and $0.8 million respectively. The decrease in net gains on mortgage loans sold were primarily due to lower sales volume, decreased profit margin on mortgage loan sales, and a decrease in fair value adjustments on the mortgage loan pipeline. Mortgage loan servicing generated a gain of $9.6 million in the first quarter of 2022, due primarily to a positive $8.5 million fair adjustment -- value adjustment due to price.

The year-over-year decrease in non-interest income could be outside of our original forecast due to lower gain on sales mortgages in the coming quarter.

Non-interest expense was $31.5 million in the first quarter, in the middle of our $30.5 million to $32.5 million targeted quarterly range.

Our effective income tax rate of 18.6% for the first quarter of 2022 was at the lower end of our forecast.

Lastly, the company purchased 59,002 shares at an average cost of $23.46 for the first quarter of 2022.

That concludes my prepared remarks. I would like to turn the call back over to Brad.

Brad Kessel

Slide 24 displays a high-level view of our key strategic initiatives. In 2021, we made significant investments to our overall technology platform to improve the customer experience and increase productivity amongst other goals. We have already seen some very positive results with this investment and I believe we will see continued growth and improved productivity in 2022.

While the current operating environment contains numerous challenges and much uncertainty, it also provides many opportunities. We are excited about the momentum we have in our markets and look forward to continuing these growth trends for the remainder of 2022 and beyond.

At this point, we would now like to open up the call for questions.

Question-and-Answer Session


[Operator Instructions].

Our next -- our first question comes from Brendan Nosal from Piper Sandler. Brendan, your line is open.

Brendan Nosal

Hey, good morning folks. How are you doing?

Brad Kessel

Good, Brendan. Thank you.

Brendan Nosal

Okay. Just to start off here maybe on the mortgage piece, I was hoping you can provide a little bit more color on the dynamics that kind of drove the compression quarter-over-quarter particularly that fair value mark and then kind of tying your thoughts on mortgage for the rest of the year as it seems into the overall update in fee guidance. Thanks.

Gavin Mohr

Maybe I'll start Brendan; this is Gavin with the mark and we'll let Brad talk maybe about the more high-level mortgage operation for the rest of the year.

So Brendan, the biggest impact to the fair value mark for the quarter was a saleable construction portfolio. As you're aware the construction timelines are longer than they have historically been for completion as these loans are brought on, they are mark-to-market each quarter from the day that the loan closes to the end -- ultimate to the end mortgage. And so what we've seen was that we had an existing portfolio from 2021 origination with lower coupons in the current market. So we -- as rates increase the value -- the market value of that portfolio that was on hedge decreased because it's difficult to hedge a 12-month construction loan. So that $3.8 million for the fair value mark, the majority of it is related to that $3.8 million mark-to-market adjustment. And I would just point out; we have taken additional risk off the table of that portfolio. So there won't be any material mark-to-market adjustments regarding that going forward.

Brendan Nosal

All right. That's certainly helpful. Then maybe kind of turning to the expense side of things, certainly nice to see the run rate improve so much quarter-over-quarter. And then there's the additional savings from the closed branch locations later on in the year. Just kind of curious about the way that you're accruing for a comp at the start of the year meaning are you accruing at a level that reflects the potential revenue benefits of a higher short-term interest rate environment later on in the year?

Gavin Mohr

Yes. Yes.

Brendan Nosal

All right. Fantastic. Thanks for taking the questions.


Our next question comes from Damon DelMonte from KBW. Damon, your line is now open.

Unidentified Analyst

Hi, this is Matt Rank [ph] filling in for Damon DelMonte. I hope everybody's doing well today.

Brad Kessel

Hi, Matt.

Unidentified Analyst

First question as you remix -- hi -- as you remix the earning assets, you have a targeted range of or targeted percentage or proportion of securities to average earning assets?

Brad Kessel

I don't have a target, I would say this. The security is, I anticipate the security balances decline through 2022. So as we can, if we can redeploy those cash flows into loans, you will see dollar for dollar that move out of the securities portfolio. So obviously that the current allocation is much higher than it was historically targeted. We'd like to see it come down.

Unidentified Analyst

Okay. Got it. Got it. And then just one last question, if I can get your updated thoughts on share repurchases for the year. Thanks.

Brad Kessel

Sure, Matt. Good question. This is Brad and you could see from our report that we were in the market during the first quarter on a small scale. And I think prospectively our decision to continue to be in the market is a function of where we're trading, how we -- where our growth is or capital needs for growth, both organically and potentially inquisitively and also overall capital levels. So I think probably see a continuation of what our historical pattern has been.


Our next question comes from Russell Gunther from D.A. Davidson. Russell, you may go ahead.

Manuel Navas

Hi, this is Manuel Navas on for Russell. Good morning.

Brad Kessel

Good morning.

Manuel Navas

In looking at your loan growth performance for the -- and the outlook for the whole year, are you starting to get a sense for perhaps stronger growth in the first half year and a little bit more caution to the second half or you just see how loan growth comes in?

Brad Kessel

Joel you want to -- you want to answer [ph]?

Joel Rahn

Yes, I will attempt to answer that one. I wish I had a crystal ball to tell you. Right now, we're seeing very strong growth. And it's a good mix of new customers to the bank as well as organic growth that would label it to existing customers. That was a very nice split in our first quarter growth. We're seeing that based on our pipeline into the second quarter certainly not naive to what, we can't expect to slow later in the year, it's hard to predict that. But at this point I can tell you is based on our pipeline where we're seeing good demand, we're seeing businesses expand. We're not seeing signs of pullback yet. But certainly we're following the economic conditions closely. It's difficult to say what the second half of the year will look like. Right now we don't see a slowing up, but the world's changing rapidly to deal with the economic news.

Manuel Navas

Definitely understandable. What do you see right now in terms of pricing competition, both on the lending side like, what do you see on new loans here in April? And on the deposit side as well is anyone stepping up deposit competition yet?

Joel Rahn

This is Joel again; I'll answer the loan side. We've seeing a lot of pricing pressure, yield pressure, really starting in the second half of last year, as all banks were hungry to grow earning assets. And that has changed. So there's still a lot of pressure on yields. And I expect that that's going to continue here through throughout this year. And I'll turn it over to Brad or Gavin on thoughts on deposit rates?

Brad Kessel

Well, I think we're not seeing a lot of pressure on the deposit side at this point. And that's going to be very interesting to watch here with each fed rate hike. And on the mortgage side, I would say it just feels like the market is slow to adjust to what's happening with the yield curve. And so it's, I think, then a lot of discussion internally about being disciplined in our pricing. But it is very aggressive on all the home funds today.


[Operator Instructions].

Our next question comes from Bryce Rowe from Hovde Group. Bryce your line is open.

Bryce Rowe

Thank you. Good morning. Wanting to kind of follow-up on that last comment about one competition, I'm curious where you're seeing new loans pricing in this environment relative to the portfolio yield as of -- as for the first quarter?

Joel Rahn

We've -- yes, I am proud of our Group, in terms of the discipline that we've shown to hit our projected or our pro forma yields on the commercial side. It has been, it's been very difficult because as rates are rising, especially fixed rates, conventional fixed rates. As the yield curve is rising rapidly, not all of our competitors seem to be, as Brad just alluded to a second ago, seem to be on top of that or passing that along in terms of their quoted rates. And so I think we were more proactive, and it kind of means we lost business. And yet we're still able to show the growth that that that we showed that's the best. That's the best answer I can give you on. Gavin, do you have anything to add to that?

Gavin Mohr

Well, I would, I guess, I'm joking. Obviously, going to highlight the spread aspect of it in the specific crusher. I do think too, we're seeing a rotation into a higher allocation of variable loans, which obviously is carrying a lower yield as well. If you're just looking at the consolidated portfolio yield.

Bryce Rowe

Yes, yes, okay. And the asset sensitivity, interest rate risk management slide you have in the deck obviously highlights that asset sensitive position. Curious what deposit data you are assuming in that analysis?

Joel Rahn

Yes. So we took a look back, Bryce at the current early last rate hike, and we have very low betas through the first, say, plus 75 hikes. And then they come back to a more long-term historical, I guess, what we would call adjustment. So in this up another 50 to 75 debate assumptions is low, yes.

Bryce Rowe

Okay. Okay. The last one for me, we've seen pressure on tangible common equity from the fair value market on the securities portfolios, really across the industry here this quarter. Does that compression in tangible common equity ratio, does that change your outlook from a repurchase perspective? And just trying to gauge how you all see that compression? And just any, any views around? It would be helpful. Thanks.

Joel Rahn

Yes, great question. And we've had a lot of discussion about it. Internally, we have run multiple stress scenarios, in terms of further depreciation with additional rate hikes. Of course, where we've seen the bulk of the move today in the curve has been right in that belly portion, which is right, where the -- our asset or security duration is. So we're hopeful that we're sort of passed the worst part of it, but we -- you don't know. And so, we're watching it closely. We continue to -- we have conversations with all the stakeholders, of course, from the investment community, to regulators, which of course are focused on regulatory capital. This is not impact regulatory capital, and so on. So it's a consideration, but it's not necessarily going to be the ultimate yes or no, we're out of the market, or we're just going to keep doing what we're doing.


Currently, we have no further questions. Therefore, I will hand back to Brad Kessel, President and CEO for any closing remarks.

Brad Kessel

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 for 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.


Ladies and gentlemen, this concludes today's conference call. Thank you for being with us today. Have a lovely day ahead. You may disconnect your lines now.

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