Independent Bank - Q2 2024
July 25, 2024
Transcript
Operator (participant)
Independent Bank Corporation reports 2024 second quarter results. My name is Ezra, and I will be coordinating your call today. If you would like to ask a question, please press star followed by one on your telephone keypad now. If you change your mind, please press star followed by two. 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 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 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 paydowns, 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 quarterly 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 large 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 30th, 2024, were $4.61 billion. Overall, core deposits increased $53.3 million or 4.8% annualized during the second quarter of 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 as compared to the Fed funds spot rate and Fed effective rate.
For the quarter, our total cost of funds increased by one basis point to 2.202%. Through the second quarter of 2024, the cumulative cycle beta for our cost of funds is 38.8%. 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 our Commercial Banking)
Yeah. Thanks, Brad, and good morning, everyone. On page seven, 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 $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 sale of various real estate investment projects. It's worth noting that Q2 commercial loan origination was stronger than 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, 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 eight 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 nine. 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 31st. Past due loans totaled $5.3 million or 14 basis points, down slightly from March 31st. 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 A. 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 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.
Change in earning asset mix equated to 3 basis points, 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 cost that was 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 scenarios consider immediate, permanent, and parallel rate changes.
The base case modeled NII is largely unchanged during the quarter, as asset yields benefits from a shift in asset mix, a shift in loan mix, and continued asset repricing was offset by liability repricing. The NII 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 repriced 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 B-1 Common Stock into a combination of Visa Class C Common Stock and Visa Class B-2 Common Stock. With the completion of this exchange, we're able to 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 B-2 Common Stock continues to be carried at zero. Positively impacting non-interest income was $2.1 million gain on mortgage loan servicing net.
This is comprised of $2.2 million of the 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 paydowns 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 the higher expected incentive compensation payout for salaried 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 the 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. Second quarter of 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 and up 10 basis points from the linked quarter. The second quarter of 2024, 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-$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 30th, 2024, which is attributed to the exchange over Visa Class B-1 common stock.
Non-interest expense was $33.3 million in the second quarter within our forecasted range of $32.5 million-$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 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 like to open the call for questions.
Operator (participant)
Thank you very much. To ask a question, please press star followed by one on your telephone keypad now. When prepping to ask your question, please ensure your device is unmuted locally. If you change your mind, please press star followed by two. Our first question is from Brendan Nosal with Hovde Group. Brendan, your line is now open. Please go ahead.
Brendan Nosal (Director)
Hey, good morning, guys. Hope you're doing well.
Gavin A. Mohr (EVP and CFO)
Morning.
Brendan Nosal (Director)
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 tell us on where the margin trends from here? Thanks.
Gavin A. Mohr (EVP and CFO)
Yeah, sure. So we did have some fee accretion that we equated to 5 basis points for the quarter, although that we do view that as part of a 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 end up in that forecasted range that we provided in January. The moving pieces is always there's a posit remix, and then we're able to see in terms of repricing of the asset book that's currently well below market rates. But yeah, I do believe we'll continue to see it drift higher.
Brendan Nosal (Director)
Okay, perfect. One more from 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 the M&A activity in the state.
Brad Kessel (President and CEO)
You know, Brendan, Independent Bank has a history of selective M&A, and I think prospectively we continue to where it would make sense would be interested in partnering with other institutions. But it's not a requirement. It doesn't 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. And if we can be a part of that and it makes sense for us, that would be great.
Brendan Nosal (Director)
All right, fantastic. Thanks for the thoughts, Brad.
Operator (participant)
Thank you very much. Our next question is from Damon Del Monte with KBW. Damon, your line is now open. Please go ahead.
Matt Renck (Director of Equity Research)
Hey, this is Matt Renck, filling in for Damon. Hope everybody's doing well today. My first question was just on loan growth. 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 paydowns 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 our Commercial Banking)
Yeah, this is Joel. I really do feel that our game plan, we were executing our game plan. Our originations, as I said, were slightly stronger in the second quarter than they were in the first quarter. 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 seller business and we had a number of real estate projects that sold, but they were all bunched within about a six-week time period.
So it was just very unusual. I look at our origination activity has been 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 our original plan, that we're right on our original plan. It's just 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 (Director of Equity Research)
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 kind of offset any expense growth?
Brad Kessel (President and CEO)
Well, I do, and Gavin, you can jump in here too. I think our range that was given early in the year back in January is still intact. I mean, we're continuing to look at every area of the bank and how we're using our resources. And so I think it is reasonable to still have that range in your estimates. Gavin, anything different too?
Gavin A. Mohr (EVP and CFO)
No, I think it's really well said. I 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 quarter over on a linked quarter basis was $500,000. So I agree with Brad.
Matt Renck (Director of Equity Research)
Okay, great. Thank you. I'll step back.
Operator (participant)
Thank you very much. As a reminder, to ask a question, please press star followed by one on your telephone keypad now. When prepping to ask your question, please ensure your device is unmuted locally. Our next question is from Nathan Race with Piper Sandler. Nathan, your line is now open. Please go ahead.
Nathan Race (Managing Director)
Hey, guys. Good morning. Thanks for taking the questions.
Gavin A. Mohr (EVP and CFO)
Good morning, Nathan.
Brad Kessel (President and CEO)
Good morning.
Nathan Race (Managing Director)
Curious, maybe, Gavin, if you can just update us on your margin expectations if the Fed were to cut in late September and if we were to get maybe 3-4 cuts as well into 2025. How do you kind of think about an exit margin coming out of the end of that year?
Gavin A. Mohr (EVP and CFO)
Yeah, so 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've kind of, again, as we're showing here in the deck, we're trying to manage to a fairly tight earnings profile. So overall positive, but not a big swing.
Nathan Race (Managing Director)
Okay, great. That's helpful. And just curious, with the Visa share gains that you guys recognized in the quarter, how do you guys kind of think about maybe redeploying some of those proceeds? Are you guys contemplating maybe a partial securities portfolio restructuring or just kind of thinking there just to build additional excess capital for maybe some acquisitions or share repurchases down the road?
Gavin A. Mohr (EVP and CFO)
Yeah, so we had that conversation. Part of the Visa transaction is there was gates on it. So at this point in time, we've actually only sold two-thirds of the shares that we're able to convert and became liquid. The other third won't become available until next month, we anticipate. So at this point in time, Nathan, management made a decision to just book the gains, and then we'll reevaluate going forward to see what opportunities are there for us, whether we want to retain the capital or restructure by year-end.
Nathan Race (Managing Director)
Okay, great. And then maybe just one last one on fee income. Levels in the quarter came in a little lower or towards the lower end of the range, excluding some of those one-time items around, or I guess maybe non-core items around the MSR adjustment, the Visa gains. Do you kind of think fee income will maybe be towards the middle to upper end of the range as we move into 3Q and 4Q based on what you're seeing?
Gavin A. Mohr (EVP and CFO)
I think we can get back to the middle. I'm hesitant to say high because 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. And then we also had some hedge and effectiveness that we've been able to tighten up on a go-forward basis. So I think working back to the middle. The other piece there is if we could see swap fee income increased, I think it'd be an opportunity for us as well.
Nathan Race (Managing Director)
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 reserves can maybe drift lower just given kind of the surplus reserves that exist today?
Gavin A. Mohr (EVP and CFO)
Yeah, 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 probably is a little heavy. It's something under that, but barring a credit event. I would expect us to have a greater provision than what we had this past quarter and directly related to loan growth. Now, having said that, we do have the ACL today, I think, at 1.46%, and probably 25% of that is in the subjective. So if the soft landing continues to materialize, 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 (Managing Director)
That's very helpful. I appreciate all the color. Thanks, guys.
Gavin A. Mohr (EVP and CFO)
Thank you.
Operator (participant)
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 so 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 (participant)
Thank you very much, everyone, for joining. This concludes today's call. You may now disconnect your lines.