Independent Bank - Q1 2024

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by. Welcome to the Independent Bank Corporation Reports 2024 First Quarter Results. All lines have been placed on mute during the presentation portion of the call, with an opportunity for question-and-answer at the end. If you'd like to ask a question, please press star followed by one on your telephone keypad. I would now like to hand this conference 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 2024 results. I am Brad Kessel, President and Chief Executive Officer, and joining me is Gavin Mohr, Executive Vice President 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 two 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 first quarter 2024 net income of $16 million, or $0.76 per diluted share, versus net income of $13 million or $0.61 per diluted share in the prior year period. I am very pleased with our first quarter 2024 results, driving organic growth on both sides of the balance sheet, with loans up by 5.3% and core deposits up 9%. We were able to generate net interest margin expansion, increasing to 3.30% from 3.26% on a linked-quarter basis, and net interest income growth on both a linked-quarter basis and a year-over-year quarterly basis. Expenses continue to be well managed. Our credit metrics continue to be very good, with watch credits and non-performing assets near historic lows.

These fundamentals drove good growth in both our earnings per, earnings per share, 23% increase, and tangible book value per share is 16% increase compared to the prior year quarter. Our performance ratios for the quarter included a return on average assets of 1.24% and return on average equity of 15.95%. Leveraging our team's proven success in the integration of dynamic new professionals, we are optimistic about continuing these positive growth trends for the balance of this year and into 2025. Total deposits as of March 31, 2024, were $4.58 billion. Overall, core deposits increased $95.7 million or 9% annualized during the first quarter of 2024.

On a linked quarter basis, retail deposits increased by $23.5 million, business deposits increased by $25.4 million, and municipal deposits also increased by $46.9 million. Our existing customer base continues to exhibit a remix out of non-interest bearing and/or lower-yielding deposit products into higher-yielding product offerings, but the remix pace has slowed. Additionally, our sales team continues to bring in new relationships well below our wholesale cost of funds. We have included in our presentation a historical view of our cost of funds as compared to the Fed Funds spot rate and the Fed effective rate. For the quarter, our total cost of funds increased by 2 basis points to 2.01%. Through the first quarter of 2024, the cumulative cycle beta for our cost of funds is 37.3%.

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 of Commercial Banking)

Thanks, Brad, and good morning, everyone. On page seven, we share an update on our $3.8 billion loan portfolio and quarterly activity. Total loans increased by $49 million in the first quarter, representing 5.3% annualized growth. The strongest segment continues to be commercial lending, which grew by $55 million. We also realized growth in our mortgage business, with that portfolio growing by $4.6 million for the quarter. Our installment portfolio decreased by $11.1 million, with softness in demand, but also, a result of a strategic decision to pull back in that segment. As noted in the material, in each portfolio, yield on new production is significantly higher than the respective portfolio yield. The commercial portfolio continues to be our highest-yielding portfolio, with a yield of 6.83%.

We continue to see a return on our strategic expansion of our commercial banking team. The experienced talent that we continue to add has been a strong contributor to our commercial growth, which, on an annualized basis, was 13% in the first quarter, consistent with the pace of growth experienced in 2023. Based upon a solid commercial pipeline, we see continued growth opportunity while maintaining our disciplined credit standards. Page eight provides additional detail on our commercial loan portfolio. As I've pointed out in prior quarters, C&I lending continues to be our primary focus, representing 68% of the portfolio. Manufacturing continues to be the largest concentration within the C&I segment, comprising approximately 10% or $174 million.

The remaining 32% of the portfolio is comprised of investment real estate, with the largest concentration being industrial at 7.9% or $140 million. It's worth noting that our exposure to the office segment stands at $89 million, or 5% of our commercial portfolio at quarter end. Our office exposure consists primarily of suburban, low-rise office space, with medical comprising 25% of our overall office exposure. The average loan size is $1.2 million, which points to the granularity of this 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 $3.7 million, or approximately 10 basis points of total loans at quarter end, which is a slight decrease from 12/31/2023. Past due loans totaled $7.1 million or 19 basis points, up slightly from year-end 2023. At this time, I would like to turn the presentation over to Gavin for his comments, including the outlook for the remainder of the year.

Gavin Mohr (EVP and CFO)

Thanks, Joel, and good morning, everyone. I'm starting at page 10 of our presentation. Page 10 highlights our strong regulatory capital position. All capital ratios increased from a linked quarter basis. Net interest income increased $1.8 million from the year ago period. Our tax equivalent net interest margin was 3.3% during the first quarter of 2024, compared to 3.32% in the first quarter of 2023, and up 4 basis points from the fourth quarter of 2023. Average interest-earning assets were $4.91 billion in the first quarter of 2024, compared to $4.7 billion in the year ago quarter, and $4.93 billion in the fourth quarter of 2023.

Page 12 contains a more detailed analysis of linked-quarter increase in net interest income and the net interest margin. On a linked-quarter basis, our first quarter 2024 net interest margin was positively impacted by 3 factors: increase in yield on loans and investments of 2 basis points, change in earning asset mix of 3 basis points, change in funding mix of 4 basis points. These increases were partially offset by an increase in funding costs of 5 basis points. On page 13, we provide details on the institution's interest rate risk position. The comparative simulation analysis for the first quarter of 2024 and the fourth quarter of 2023 calculates the change in net interest income over the next 12 months under 5 rate scenarios. All scenarios assume a static balance sheet. The base rate scenario applies the spot yield curve from the valuation date.

The shock scenarios consider immediate, permanent, and parallel rate changes. The increase in the base rate forecast of net interest income in the first quarter of 2024 compared to the fourth quarter of 2023, is primarily due to a shift in the asset mix, with an increase in loans and a decline in securities. The loan growth was centered in variable rate commercial loans. Additionally, a modest increase in term rates during the quarter increased modeled asset yields related to fixed rate lending products. Sensitivity is largely unchanged during the quarter, with the exposure to rising rates decreasing modestly for larger rate increases. Currently, 33% of assets reprice in one month and 43.8% reprice in the next 12 months.

Moving on to page 14, non-interest income totaled $12.6 million in the first quarter of 2024, as compared to $10.6 million in the year-ago quarter, and $9.1 million in the fourth quarter of 2023. First quarter 2024 net gains on mortgage loans were $1.4 million, compared to $1.3 million in the first quarter of 2023. The increase is primarily due to increased profit margins that was partially offset by lower volume of loan sales. Positively impacting non-interest income was $2.7 million dollar gain on mortgage loan servicing net. This is comprised of $2.2 million of revenue, $1.3 million or $0.05 per diluted share after-tax gain due to change in price.

That was partially offset by a $0.8 million decrease due to pay downs of capitalized mortgage loan servicing rights in the first quarter of 2024. As detailed on page 15, our non-interest expense totaled $32.2 million in the first quarter of 2024, as compared to $31 million in the year ago quarter, and $31.9 million in the fourth quarter of 2023. Performance-based compensation increased $1.2 million, due primarily to higher expected incentive compensation payouts for salaried and hourly employees, and salary increases effective at the beginning of the year. Data processing costs increased by $0.3 million from the prior year period, primarily due to core data processor, annual asset growth, and CPI-related cost increases, as well as the purchase of a new lending solutions software.

Page 16 is our update for our 2024 outlook to see how our actual performance during the first quarter compared to the original outlook that was provided in January of 2024. Our outlook estimated loan growth in the middle single digits. Loans increased $49.1 million in the first quarter of 2024, or 5.3% annualized, which is below our forecasted range. Commercial and mortgage had positive growth, while installment loans decreased in the first quarter. First quarter of 2024 net interest income increased by 4.6% over 2023, which is lower than our forecast of mid-single digit growth. The net interest margin was 3.3% for the current quarter and 3.32% for the prior year quarter, but was up 4 basis points from the linked quarter.

The first quarter of 2024 provision for credit losses was an expense of $0.7 million and below our forecasted range. The first quarter of 2024 provision expense was primarily a result of provision expenses on loans that was partially offset by a credit provision on securities held to maturity. Moving on to page 17, non-interest income totaled $12.6 million in the first quarter of 2024, which was within our forecasted range of $11.5 million-$13 million. First quarter of 2024 loan originations, sales and gains totaled $94 million, $80.8 million and $1.4 million, respectively. Mortgage loan servicing net generated a gain of $2.7 million in the first quarter of 2024.

Non-interest expense was $32.2 million in the first quarter, below our forecasted range of $32.5 million-$33.5 million. Our effective income tax rate of 19.3% for the first quarter of 2024 was lower than our original forecast. Lastly, there were no shares repurchased in the first 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 how we started 2024, and it is very much in line with the strong results which our company has been delivering quarter-over-quarter, year-over-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 forward in 2024, our 160th year of serving the communities of Michigan, our focus will be continuing to invest in our team, leveraging our technology, and supporting our communities.

In doing so, we will continue the rotation of our earning assets out of lower yielding investments into higher yielding loans. With the strong value proposition offered as a large community commercial bank, we believe we can continue to grow our customer base while managing our cost of funds and controlling our non-interest expenses. Accordingly, we are excited about our future. At this point, we'd now like to open up the call for questions.

Operator (participant)

Thank you, Brad. If you'd like to register a question, please press star followed by one on your telephone keypad, ensuring you are unmuted locally. If you'd like to withdraw your question at any time, you can do so by pressing star followed by two. As a reminder, it's star followed by one to ask your question. So our first question comes from the line of Brendan Nosal of Hovde Group. Your line is now open. Please go ahead.

Brendan Nosal (Analyst)

Hey, good morning, folks. Hope you're doing well.

Brad Kessel (President and CEO)

Good morning.

Brendan Nosal (Analyst)

Maybe to start off here, there was a pretty meaningful transaction announced in your neck of the woods last week. I know that it's early days, but any preliminary thoughts on how Independent might be impacted and where you might like to capitalize on any talent dislocation, if those opportunities arise?

Brad Kessel (President and CEO)

Brandon, you know, great question. You know, Macatawa has always been a good competitor in our market, and we view their sale as an opportunity for us here in Kent County and Ottawa County and in related markets. So we think it's an opportunity for both customer acquisition and talent acquisition. And it's really a continuation of, you know, within the Independent Bank markets, M&A disruption. And so we're viewing the event as a very positive event for our franchise.

Brendan Nosal (Analyst)

All right. That's, that's helpful color. Maybe turning over to the margin, continue to move in the right direction for another quarter. Just kind of curious, if you have any updates to the guidance or the margin you laid out early in the year, whether you're kind of still on track there or, you know, performing better or worse based on what you say.

Gavin Mohr (EVP and CFO)

Yeah, Brandon, this is Gavin. I think we're right on track, and from what we've forecasted. Yeah, just leave it at that.

Brendan Nosal (Analyst)

Yeah. Perfect. Perfect. All right. Thank you for taking the questions.

Gavin Mohr (EVP and CFO)

Thank you.

Operator (participant)

Thanks. The next question comes from the line of Damon DelMonte of KBW. Your line is now open. Please go ahead.

Damon DelMonte (Analyst)

Hey, good morning, guys. Hope you're both doing well, or the three of you guys are doing well. Just a quick follow-up-

Brad Kessel (President and CEO)

Thanks. Good morning

Damon DelMonte (Analyst)

... on the margin. Good morning. Just a quick follow-up on the margin comment. You know, Gavin, should there be some rate cuts in the back half of the year and given some of the more asset-sensitive portions of your balance sheet, how would you expect the margin to react? Do you feel you have some leverage on the funding side that could reprice? ... kind of in step with the asset side and kind of keep the margin stabilized? Or what are your thoughts on that?

Gavin Mohr (EVP and CFO)

Yeah, Damon, I would come back to our January guidance that we gave. We do have some rate cuts built into that. So, within that back half, I don't know how much pricing, repricing, leverage we'll have on the deposit side. I think that's a big question mark. But the forecast we gave with the increase in NIM of 10-15 did have Fed rate cuts in May and June, August and October.

Damon DelMonte (Analyst)

Okay, so that's three cuts. Okay. Okay, great. And then, you know, with regards to the loan growth, you know, the first quarter growth was on the low end of the kind of the full-year guide. As you kind of look out over the next few quarters, do you still feel good for that 6%-8% growth for the year? And, you know, is that being primarily driven by the C&I side as well?

Joel Rahn (EVP of Commercial Banking)

Yeah, this is Joel. I would, I think we're right on track, right where we plan to be. And, as I said in my comments, our pipeline is looking solid, very, very comparable to how we were positioned last year. And, yeah, we're still seeing opportunity on the C&I side, as well as, you know, we're still making some real estate loans, where obviously, we're cautious there in certain segments, office being the most notable. But, yeah, I feel like we're positioned well to hit our plan. And, part of that is also we continue to add talent.

We added some commercial bankers in the first quarter, capitalizing on some disruption in the marketplace throughout the state, in all of our footprint. And it positions us real well.

Gavin Mohr (EVP and CFO)

Very good, Joel.

Damon DelMonte (Analyst)

Okay, great. And then lastly, you know, the credit trends remain very strong. And as you kind of look, you know, at the prospects for loan growth, and you look at where the loan loss reserve is now at, I think it's 147 basis points. Do you feel that you need to maintain that level? Or do you feel that there's enough cushion where you can kind of let that drift down a little bit?

Brad Kessel (President and CEO)

You know, that's a great question. You know, if we do realize the soft landing that, you know, it feels like we're heading into, we may see that come down a little bit. You know, I think we've got, again, help me, a quarter of the total reserve today is in the subjective.

Yep.

And some of that, I think, could be released with a soft landing. So, that's what we're sort of thinking, Damon. So really, future provisioning is going to be driven by loan growth.

Damon DelMonte (Analyst)

Okay. Great. That's all that I have for now. Thanks.

Brad Kessel (President and CEO)

Thank you.

Joel Rahn (EVP of Commercial Banking)

Thank you, Damon.

Operator (participant)

As a reminder, if you'd like to ask a question, please press star followed by one on your telephone keypad. We now have a follow-up question from Brendan Nosal of Hovde Group. Your line is open. Please go ahead.

Brendan Nosal (Analyst)

Hey, just one more for me. But not to beat a dead horse in the margin, especially considering how nicely it's performed over the past few quarters. But let's say we don't get any of the 4 rate cuts that you've baked into the guide at the start of the year. Just kind of curious how that might impact that margin outlook. I know you're, you know, fairly rate neutral at this point, but curious how that impacts the margin.

Gavin Mohr (EVP and CFO)

Yeah, it, it'd be beneficial, moderately. But again, I just keep coming back to the question mark is the deposit remixing. So if you-- if that trend continues, what we're currently seeing and rates stay flat, we would be a little better off in margin.

Brendan Nosal (Analyst)

Perfect. Perfect, that's helpful. Thanks again.

Operator (participant)

The next question comes from the line of John Rodis of Janney. Your line is now open. Please go ahead.

John Rodis (Analyst)

Hey, good morning, guys.

Gavin Mohr (EVP and CFO)

Um, morning.

John Rodis (Analyst)

A question, and maybe for Gavin, on the securities portfolio. How should, I assume, it's going to continue to trend down, but can you just talk about, you know, just as far as cash flows and, you know, whether you decide to reinvest any going forward?

Gavin Mohr (EVP and CFO)

Yeah, so this quarter, we start from the top. Cash flow projection for the year is $145 million of amortization, assuming no repurchases or reinvestment into the securities book. We were able to pull some of that forward. We sold $28 million in the first quarter. You see a small loss of about $300,000. Earn back will be by year-end a break even on that loss. So, that being said, I think, you know, I don't think what we're targeting for a portfolio to total asset is around 12%. So, when you look at the current cash flows and the current size, it will be some time before we anticipate reallocating capital into the securities portfolio.

John Rodis (Analyst)

Okay. And Gavin, you said so cash flows this year, $140 million, and then you pulled forward $28 million in the first quarter with the sale. Do you have what cash flows are next year, roughly?

Gavin Mohr (EVP and CFO)

Yeah. It's around $130 million.

Brad Kessel (President and CEO)

Pretty similar.

Gavin Mohr (EVP and CFO)

Yeah, it's similar for the 24-month period.

John Rodis (Analyst)

Okay. So to get down to that 12% area, I mean, it, it'll take you a couple of years or a few years without reinvesting, correct?

Gavin Mohr (EVP and CFO)

That's correct, John. Yep.

John Rodis (Analyst)

I assume if deposit growth would remain pretty solid, if loan growth were to slow, then maybe you decide to reinvest a little bit in the securities portfolio at higher rates. Does that make sense?

Gavin Mohr (EVP and CFO)

Yeah, absolutely. So, I mean, if we have liquidity and loan, you know, at greater than our loan growth, with the count, that would be an excellent option for capital. Yeah.

John Rodis (Analyst)

Okay. Okay. Thanks, guys.

Gavin Mohr (EVP and CFO)

Thank you.

Operator (participant)

As there are no additional questions waiting at this time, I'd like to hand the conference back over to Independent Bank Corporation's President and CEO, Brad Kessel, for closing remarks.

Brad Kessel (President and CEO)

In closing, we would like to thank our board of directors, our senior management for their support and leadership. We would also like 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. Have a great day.