Independent Bank Corporation (NASDAQ:IBCP) Q2 2022 Earnings Conference Call July 26, 2022 11:00 AM ET
Company Participants
Brad Kessel – President and Chief Executive Officer
Joel Rahn – Executive Vice President and Head of Commercial Banking
Gavin Mohr – Executive Vice President and Chief Financial Officer
Conference Call Participants
Brendan Nosal – Piper Sandler
Matt Rank – KBW
Operator
Good morning. Ladies and gentlemen thank you for joining. Welcome to the Independent Bank Corporation Second Quarter 2022 Earnings Conference Call. My name is Irene and I will be coordinating this event.
I would like to turn the conference over to our host, Brad Kessel, President and CEO to begin. Brad, please go ahead.
Brad Kessel
Thanks, Irene. 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 2022 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, Head of Commercial Banking for Independent.
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.
I am pleased with our second quarter 2022 performance in which we generated strong core operating results with $3.1 million growth in net interest income, a 26 basis point expansion of our net interest margin on a linked quarter basis and a $255 million increase in loans, including growth in each category of loans, as well as a $48 million increase in total deposits. In addition, our asset quality metrics continue to be very good with a low level of past dues, low level of commercial watch credits, low level of non-performing assets and net loan recoveries for the quarter and an allowance for credit losses to total loans of 1.47%.
As we head into the second half of 2022, our focus will continue to be on the rotation of our earning asset mix out of lower yielding investments into higher yielding loans. Growing our deposit base, while managing our cost of funds and of course controlling our expenses. While there exists much uncertainty in the marketplace, we are excited about the momentum we have in our markets and we look forward to continuing these growth trends for the remainder of 2022.
Now turning to Page five, Independent Bank Corporation is reporting second quarter 2022 net income of $13 million or $0.61 per diluted share versus net income of $12.4 million or $0.56 per diluted share in the prior year period. The 4.9% increase in 2022 second quarter net income as compared to 2021 is primarily due to an increase in net interest income and a decrease in non-interest expense that were partially offset by a decrease in non-interest income and increases in the provision for credit losses and income tax expense.
For the six months ended June 30, the company reported net income of $31 million or $1.45 per diluted share, compared to net income of $34.4 million or $1.56 per diluted share in the prior year period. The decrease in the 2022 year-to-date results, as compared to 2021 is primarily due to increases in non-interest expense and the provision for credit losses and a decrease in non-interest income that were only partially offset by an increase in net interest income any decrease in income tax expense.
For the six months ended June 30 2022, our return on average assets and return on average equity is 1.32% and 17.63%, respectively. This compares to 1.60% and 18.06% for the same period in 2021.
Page seven provides a good snapshot of our loan and deposit metrics for our Michigan markets. I would point out that our two loan production offices, which opened in Ottawa County and Macomb County during the third quarter of 2021 continue their strong pace of new loan generation. Accordingly, we are excited to announce our intent to open a new full service branch in the Holland market during the third quarter of 2022.
During this past quarter, as part of our regular branch optimization review, we closed four branch locations, one each in Kent, Oakland, Lapeer and Saginaw counties. Annual cost savings from these combined foreclosings is expected to be $1.5 million. The closings along with the new branch opening will bring our branch network to 59 locations in total.
Turning to Page eight, we displayed several key economic statistics for the State of Michigan. Overall, we are seeing continued improvement in the unemployment rate for Michigan now at 4.3% slightly above the national average of 3.6%. However, the State of Michigan has 167,000 fewer workers employed today, as compared to pre-COVID. Labor shortages continue to have a noticeable impact on many segments of our local economies. In addition, supply chain shortages also continue to constrain many businesses in our markets. Regional average home sale prices continue to climb as inventory levels in many of our markets remain at low levels.
On Page nine, 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. Our total deposits have increased by $173.5 million or 8.5% since December 31, 2021 and are up $428 million or 11%, since June 30 of 2021.
On Page 10, we provide a historical view of our cost of funds as compared to the Fed Funds Spot rate and the Fed Effective rate from the last rate hike cycle through the most recent quarter end. It may or may not be indicative of what we will see prospectively, but it does provide a good historical view of our company and its cost of funds during a rising rate environment.
On Slide 11, we spotlight our ONE Wallet and Treasury ONE digital platforms for consumers and commercial clients. We continue to get very positive reviews on the One Wallet channel with an Apple app store rating of 4.4 and 4,517 reviews. I’m pleased to share we passed the 1,000 mark during this past quarter as our ONE Wallet customer base is now at 12,886 users, up from 86,994 users for an 8.2% increase from the same period one year ago. Also our bill pay customer base has increased significantly to over 28,500 users, which is up 71% from the same period one year ago.
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 12, we’ll provide an update of our $3.3 billion loan portfolio. In the second quarter, our commercial portfolio grew by $71.6 million or $77.3 million, when excluding PPP loan runoff. This follows on strong first quarter commercial loan growth of $74 million, also excluding PPP activity. Our annualized commercial growth rate excluding PPP runoff in the first half of 2022 is 24%. While we expect that pace of growth to moderate in the second half of the year, with a continued strong pipeline, we’re expecting a double-digit growth rate in the third and fourth quarters.
In terms of our residential mortgage activity, our balance has increased by $114 million as our originations shifted toward more portfolio lending. It’s worth noting that 33% of our mortgage portfolio is variable rate. Consumer installment lending remained strong during the quarter increasing by $59 million. Overall, we’re optimistic that we can continue the earning asset rotation from lower yielding investments to higher yielding loans and believe we’re on track to continue to grow loans at a double-digit pace for the remainder of the year.
On Page 13, 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 concentration within the C&I segment comprising approximately 11% or $140 million. The remaining 35% of the portfolio is comprised of commercial real estate, with the largest concentrations being retail at $111 million or 8.3% and industrial at $108 million or 8.1%. It’s worth noting that of the $342 million of new commercial loan volume generated in the first half of the year, $245 million or 71% is C&I versus $97 million or 29% investment real estate.
By design, the portfolio is very granular in nature and our credit metrics, which Gavin will cover in a minute reinforce that this portfolio has held up very well through the pandemic and the resulting 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 the outlook for the remainder of 2022.
Gavin Mohr
Thanks, Joel, and good morning, everyone. I’m starting at Page 14 of our presentation. Page 14 contains detail on our investment securities portfolio. On April 1 2022, approximately $392 million a securities available for sale were transferred to held the maturity to reduce our exposure to an increase in unrealized losses accounted for an AOCI. Net unrealized losses increased in the first half of 2022 from year-end 2021 to $122.3 million net of swaps.
The increase in rates in the first half 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 securities will recapture the current unrealized losses as they mature, approximately 27% of the portfolio has a variable rate including swaps. $66.4 million of securities were sold in the second quarter of 2022 to accelerate the asset rotation into higher yielding loans.
Page 15, highlights our strong regulatory capital position. The reduction in the CET1 ratio and the total risk based capital ratio is due to risk weighted asset growth.
Page 16, net interest income increased $4.7 million from the year ago period. Our tax equivalent net interest margin was 3.26% during the second quarter of 2022, which is up 24 basis points from the year ago period and up 26 basis points from the first quarter of 2022. I’ll have some more detailed comments on this topic in a moment. Average earning assets were $4.49 billion in the second quarter of 2022, compared to $4.22 billion in the year ago quarter and $4.49 billion in the first quarter of 2022.
Page 17, contains a more detailed analysis of the linked quarter increase in the net interest income and the net interest margin. Our second quarter 2022 net interest margin was positively impacted by three factors: declining cash and investments, totaling 6 basis points; change in loan yield and mix excluding PPP for 18 basis points; and an increase in investment yield equaling 10 basis points. These increases were partially offset by an increase in funding costs of 5 basis points and a decline in the PPP balances. We will comment more specifically on our outlook for net interest income and net interest margin for 2022 later in the presentation.
On Page 18, we provide details on the institution’s interest rate risk position. The comparative simulation analysis for second quarter 2022 and first quarter 2022 calculates the change in net interest income over the next 12-months. All scenarios assume static balance sheet. The base rate scenario applies to spot yield curve from the valuation date. The shock scenarios considered immediate, permanent and parallel rate changes.
The increase in the base rate forecasted net interest income in the second quarter of ’22, compared to the first quarter of ’22 is primarily due to the increase in range, which resulted in higher forecasted earning asset yields, lower betas on interest bearing deposits then bottled and earning asset growth. Most of the increase in net interest income consisted of higher yields on variable rate earning assets, which outpaced rate increases on deposits.
Secondarily, actual increases in deposit rates was less than previously modeled. The shift in sensitivity is due to a combination of faster liability repricing, due to higher deposit betas and slower asset repricing due to an increase in asset duration. Currently 24.3% of assets reprice in one month and 40.6% reprice in the next 12-months.
Moving on to Page 19, non-interest income totaled $14.6 million in the second quarter of 2022, as compared to $14.8 million in the year ago quarter and $18.9 million in the first quarter of 2022. Second quarter ‘22, net gains on mortgage loans totaled $1.3 million, compared to $9.1 million in second quarter of ’21. The decrease in these gains was due to a decrease in mortgage loan sales volume and the mortgage loan pipeline, as well as lower loan sale profit margins.
Mortgage loan refinancing applications have slowed and the mortgage production mix is rotated to a lower percentage of saleable mortgages positively impacting non-interest income was a $4.2 million gain on mortgage loan servicing, due to a $3.1 million or $0.12 per diluted share after tax increase in the fair value due to price and $1.1 million decrease due to paydowns of capitalized mortgage loan servicing rights in the second quarter of ‘22.
As detailed on Page 20, our non-interest expense totaled $32.4 million in the second quarter of 2022, as compared to $32.5 million in the year ago quarter and $31.5 million in the first quarter of 2022. Compensation increased $1.4 million, compared to the prior year quarter due to raises that were effective at the start of the year. The decreased level of compensation that was deferred in the second quarter 2022 as direct origination costs on lower mortgage loan origination volume and an increase in lending personnel.
Performance based compensation decreased $1 million, due primarily to a decrease in mortgage lending volumes, compared to the second quarter of ’21. The second quarter of 2022 included $1.6 million of expense related to the reserve for unfunded lending commitments due to an increase in unfunded lending commitment balances. We will 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 or $5 million or 0.1% of total assets at June 30, ’22, loans 30 to 89 days delinquent totaled $3.7 million at June 30, 2022, compared to $2.3 million at December 31, 2021.
Page 22, 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 year-to-date.
Page 23, provides information on our TDR portfolio that totaled $33.0 million at June 30, 2022. This portfolio continues to perform well with 96.5% of these loans performing at June 39, 2022.
Moving on to Page 24, we recorded a provision for credit losses expense of $2.4 million in the second quarter of ’22, compared to a provision credit of $1.4 million in the year ago quarter and a provision credit of $1.6 million in the first quarter of 2022. The allowance for loan losses totaled $47.9 million or 1.47% of portfolio loans at June 30, 2022.
Page 25, is our update for 2022 outlook to see how our actual performance during the second quarter, compared to the original outlook that we provided in January of 2022. Our outlook estimated loan growth in the low double-digits. Loans increased $254.8 million in the second quarter of 2022 or 34% annualized, which is well above our forecasted range. Commercial, mortgage and installment loans all experienced growth in the second quarter of 2022.
Second quarter 2022 net interest income increased by 14.9% over 2021, which is higher than our forecast of low single-digit growth. The net interest margin for the second quarter of 2022 was 24 basis points higher than the second quarter of 2021. Net interest margin of 3.02%, which is higher than our original forecast. The second quarter 2022 provision. The second quarter provision for loss was an expense of $2.4 million or 0.3% annualized. This is above our forecasted 2022 full-year provision range of 15.15% or 0.2% of average total portfolio loans. Primary drivers of the increase in provision for credit losses were an increase in the full reserve allocations due to loan growth.
Non-interest income totaled $14.6 million in the second quarter of 2022, which was within our forecasted range of $13 million to $17 million. Second quarter 2022 mortgage loan originations, sales and gains totaled $317.7 million, $143 million and $1.3 million, respectively. The decrease in net gains on mortgage loans sold is primarily due to lower sales volume and decreased profit margin on mortgage loan sales.
Mortgage loan servicing generated a gain of $4.2 million in the second quarter of ’22, due primarily to a positive $3.1 million fair value adjustment due to price. Non-interest expense was $32.4 million in the second quarter, within our forecasted range of $30.5 million to $32.5 million targeted quarterly. Our effective income tax rate of 18.1% for the second quarter of 2022 was at a lower end of our forecast. Lastly, we purchased 181,586 shares at an average cost of $22.08 for the year-to-date period in 2022.
That concludes my prepared remarks. And I would now like to turn the call back over to Brad.
Brad Kessel
Slide 26, displays a high level view of our key strategic initiatives. In 2021, we made significant investments in growing our commercial sales team in addition to investments in our overall technology platform to improve the customer experience and increased productivity amongst other goals. 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 into 2023.
At this point, we would now like to open up the call for questions.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from Brendan Nosal from Piper Sandler. Brendan, your line is open.
Brendan Nosal
Hey, good morning folks. How are you?
Brad Kessel
Very good, Brendan. Good morning.
Brendan Nosal
Maybe just a couple of questions on the interest rate management Slide 18. Just want to make sure that I’m interpreting this correct. So the updated SIM base rate NII of like $62 million, I mean, that’s quite a bit above the current quarter’s run rate. Is the correct interpretation that if spot rates held throughout the third quarter, you will be doing roughly $45 million in net interest income? I’m sorry, $40. 5 million.
Brad Kessel
Can you give me to your number, Brendan? I’m sorry, I was having a little bit trouble hearing you.
Brendan Nosal
Yes. No problem.
Brad Kessel
Are you just dividing [Multiple Speakers]
Brendan Nosal
Yes. $40.5 million, you know, spot rates stay where they are? Is that what that implies through the third quarter based on this?
Brad Kessel
Yes, on that math, yes. So this is a 12-month scenario, so yes. I think it gets recent.
Brendan Nosal
Okay. And then a follow-up on that. I mean, it looks like thereafter, you know, relatively rate neutral whereas previously a little bit asset sensitive. So just help us understand how the margin would perform as short-term rates continue to rise given this updated simulation?
Brad Kessel
Yes. So the margin as you can see from now plus [100 to 200] (ph) stays relatively the same, and that’s due to the increase of beta assumption within the model from where we’re previously at. So as the spot rate gets further and further away from what our current cost of funds is, our analysis indicates there’s going to be pressure to increase those betas.
Brendan Nosal
Understood. All right, thanks for taking the questions.
Operator
Thank you. Our next question comes from Damon DelMonte from KBW. Damon, your line is open.
Matt Rank
Hi, everybody. Good morning. This is Matt Rank filling in for Damon DelMonte. Just one question on the provision with higher expected loan growth, do you expect to provide outside of the 15 basis points to 20 basis points from the remainder of the year? Or do you think it’ll pull back to that range?
Brad Kessel
I think will be we could — it’s likely to be within that range, maybe over the high side of the range?
Matt Rank
Okay, great. And then, sorry, one follow-up to the deposit question. With the increased data assumptions, is there a level of conservatism built in, where you think you could maybe provide [outside] (ph) for those numbers?
Brad Kessel
I apologize, we’re having a little bit trouble in hearing. Can you repeat the last part of that question? I got most of it.
Matt Rank
Yes. Sorry, hiring you did. With the beta assumptions increasing in your margin outlook, you think there’s any upside from those numbers still built in? I think you said you finished your last data has performed better in this current rate cycle?
Brad Kessel
Yes. I think that is — there’s potential there. We’re trying — we’re doing everything we can to stratify the products in terms of pricing. But again, I don’t think that we’re way off here by any means.
Matt Rank
Okay, great. Thank you.
Operator
Thank you. [Operator Instructions] It seems that we currently have no further questions. Therefore, I would like to hand back to Mr. Brad Kessel for any closing remarks.
Brad Kessel
Thank you, Irene. 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 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. We wish each of you a great day.
Operator
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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