IBCP - NASDAQ

Hello, everyone, and welcome to the Independent Bank Corporation Reports 2023 First Quarter Results. My name is Emily, and I'll be coordinating your call today. After the prepared remarks, there will be the opportunity for any questions [Operator Instructions]. I will now turn the call over to our host, Brad Kessel, President and CEO. Please go ahead.

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 2023 results. I am Brad Kessel, President and Chief Executive Officer, and joining me is Gavin Mohr, Executive Vice President and our Chief Financial Officer; and Joel Rahn, Executive Vice President in Charge of Commercial Banking for Independent. Before we begin today's call, I would like to direct you to the important information on Page 2 of our presentation, specifically, the cautionary note regarding forward-looking statements. If anyone does not already have a copy of the press release issued by us today, you can access it at the company's website, independentbank.com. The agenda for today's call will include prepared remarks, followed by a brief question-and-answer session and then closing remarks. Independent Bank Corporation reported first quarter 2023 net income of $13 million or $0.61 per diluted share versus net income of $18 million or $0.84 per diluted share in the prior year period. The decrease in the 2023 first quarter results as compared to the first quarter of 2022 is primarily due to a decrease in noninterest income, an increase in the provision for credit losses that were partially offset by an increase in the net interest income, and decreases in noninterest expense and income tax expense. For the first quarter of 2023, we generated an annualized return on average assets and return on average equity of 1.06% and 14.77%, respectively as compared to 1.54% and 19.38% in the first quarter of 2022. Significant items impacting the comparable first quarter 2023 results included the changes in fair value due to price of our mortgage servicing rights, the provision for credit losses on loans, and a provision for credit losses on securities held to maturity. I am pleased to report our deposit base remains stable throughout the recent troubles experienced in the banking industry and we have been able to remain focused on serving the needs of our customers and bringing in new relationships to the bank. Importantly, we generated core deposit growth of $93.1 million, 9.1% annualized for the first quarter of 2023. As a result, we are able to report another quarter of strong financial results. We grew total loans by $44.5 million or 5.2% annualized while maintaining a low level of past dues. Additionally, our team continues to be focused on efficiency and expense management. Independent Bank's operating strategy remains unchanged as we continue to add talented bankers to an already talented commercial banking team to assist in our goal of achieving greater loan and deposit market share across our footprint. We have a very granular deposit base with approximately 22.6% of our deposits uninsured and a high level of available liquidity with $2.4 billion in secured borrowing access and borrowing capacity on unpledged securities. With the loan-to-deposit ratio at 77.2%, we believe we have the capacity to continue to support ongoing growth of our loan portfolios. During the first quarter of 2023, our deposits grew to $4.5 billion. Of the $4.5 billion, we consider $3.85 billion or 84.8% to be core. In addition to generating $93.1 million in core deposit balance growth, we are also pleased to report net deposit account growth of more than 1,600 accounts for the quarter. We are including some additional information on the deposit base this quarter, showing the metrics behind the granularity of our funding. We have included in our presentation a historical view of our cost of funds as compared to the Fed fund spot rate and the Fed effective rate for the quarter. Our total cost of funds increased by 46 basis points to 1.25%. Through the first quarter of 2023, the cumulative cycle beta for our cost of funds is now at 24.1%. At this time, I'd like to turn the presentation over to Joel Rahn to share a few comments on the success we are having in growing our loan portfolios and provide an update on our credit metrics.

Well, thank you, Brad, and good morning, everyone. On Page 9, we provide an update on our well-diversified loan portfolio. Total loans increased $44 million in the first quarter, led by residential mortgage activity, leading to a $39 million increase in that portfolio. Our commercial loan portfolio grew $4.4 million and consumer installment lending was flat during the quarter. It's worth noting that our commercial loan growth reflected approximately $30 million of unplanned loan payoffs from sold businesses or refinanced projects, $9 million of these payoffs were watch list credits. So while commercial loan growth was soft in the first quarter, we believe this strategic expansion of our commercial banking team as well as marketplace disruption will provide creditworthy growth opportunity in 2023. Overall, we're pleased with our loan growth and believe that we are positioned to continue to gain market share in each market that we serve. On Page 10, we provide detail on our commercial loan portfolio. C&I lending continues to be our primary focus, representing 65% of the portfolio. Manufacturing continues to be the largest concentration within the C&I segment, comprising approximately 11% or $155 million. The remaining 35% of the portfolio is comprised of commercial real estate with the largest concentrations being retail at $134 million or 9.5% and industrial at $126 million or 8.6%. It's worth noting that our exposure to the office segment stands at $78 million or 5.3% of our commercial portfolio at quarter end, a slight decrease from 5.7% of our portfolio a year ago. We provide more insight into our office exposure on Page 11. The vast majority of our office exposure can be characterized as low-rise suburban office space with 28% being medical office space. This portfolio is also very granular, with the average loan size being $1.2 million. We did experience a charge-off on one office credit in the quarter, which was a credit that had a long and spotty history with the bank. That loss was $960,000 and was fully reserved during 2022. Aside from that credit, our credit quality for this segment of our portfolio continues to hold up very well with no office-related credits on our watch list at quarter end. Page 12 provides an overview of key credit quality metrics at March 31. Overall, credit quality continues to be excellent. Total nonperforming loans were $3.9 million or 0.11% of total loans at quarter end. In loans 30 to 89 days delinquent totaled $1.9 million or 0.05% at March 31, down slightly from year-end. 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.

Thanks, Joel. Good morning, everyone. I'm starting at Page 13 of our presentation. In the first quarter, we took a provision of $3 million related to the charge-off on the Signature Bank subordinated debt security that was classified held to maturity. Additionally, we realized a $222,000 loss on the sale of a Silicon Valley Bank senior unsecured corporate securities to credit deterioration. Slide 13 quantifies our holdings and financial institution, corporate securities. We believe Signature Bank and Silicon Valley Bank's failures to be isolated events caused by unique liquidity characteristics of their balance sheet. Over 44% of our portfolio is rated investment grade by Moody's and/or S&P with an additional 44% rated investment grade by KBRA. We perform regular credit reviews of each security and are comfortable with our current holdings. Page 14 highlights our strong regulatory capital position. The tangible common equity ratio, leverage ratio, CET1 ratio, and the total risk-based capital ratio increased in the first quarter of 2023. Moving on to Page 15. Net interest income increased $5.4 million from the year ago period. Our tax equivalent net interest margin was 3.33% during the first quarter of '23, which is up 33 basis points from the year ago period and down 19 basis points from the fourth quarter of 2022. Average interest-earning assets were $4.7 billion in the first quarter of 2023 compared to $4.49 billion in the year ago quarter and $4.64 billion in the fourth quarter of 2022. Page 16 contains a more detailed analysis of the linked quarter decrease in net interest income and the net interest margin. On a linked quarter basis, our first quarter 2023 net interest margin was positively impacted by two factors: increase in yield investments and earning asset mix contributed 5 basis points, and change in loan yield and mix contributed 20 basis points. These increases were more than offset by an increase in funding cost of 44 basis points, 6 basis points of loss was due to changes in funding mix. We will comment more specifically on our outlook for net interest income and net interest margin in 2023 later in the presentation. On Page 17, we provide details on the institution's interest rate risk position. The comparative simulation analysis for first quarter '23 and fourth quarter '22 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 a spot yield curve from the valuation date. The shock scenarios consider immediate, permanent, and parallel rate changes. The decrease in the base rate forecasted net interest income in the first quarter of 2013 compared to the fourth quarter of '22 is primarily due to an adverse shift in the funding mix and higher than previously modeled betas on interest-bearing deposits during the quarter. These changes were partially offset by earning asset growth and a favorable change in earning asset composition. Sensitivity is largely unchanged during the quarter as the adverse impact from changes in the deposit mix were offset by additional hedging and term funding transactions. Currently, 30.9% of assets reprice in 1 month and 43.9% reprice in the next 12 months. Moving on to Page 18. Noninterest income totaled $10.6 million in the first quarter of 2023 as compared to $18.9 million in the year ago quarter and $11.5 million in the fourth quarter of 2022 and first quarter '23 net gains on mortgage loans totaled $1.3 million compared to $0.8 million in the first quarter of '22. The increase in these gains was due to an increase in the gain on sale margin and that's partially offset by a decrease in mortgage loan sales volume. The mortgage loan application mix continued to maintain a lower percentage of saleable loans in the quarter, highly impacting noninterest income, was a $0.6 million gain on mortgage loan servicing due to $2.2 million of revenue that was partially offset by a $0.6 million or $0.02 per diluted share after tax decrease 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. As detailed on Page 19, our noninterest expense totaled $31 million in the first quarter of 2023 as compared to $31.5 million in the year ago quarter and $32.1 million in the fourth quarter of 2022. Compensation increased $0.8 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 '23 as direct origination costs on lower mortgage loan origination volume and an increase in lending personnel. Performance-based compensation decreased $1.4 million due primarily to a decrease in mortgage lending volume and lower performance level within the corporate incentive compensation plan compared to the first quarter of '22. The first quarter of 2023 included a $0.5 million in credit to expense related to reserve for unfunded lending commitments to a decrease in the volume of such lending commitments as well as the expected loss rates. Data processing costs increased by $0.8 million from the prior year period, primarily due to a credit in the prior year quarter related to certain expenses that had been previously paid and expensed an increase in the expense related to asset growth. Page 20 is our update for our 2023 outlook to see how our actual performance during the first quarter compared to the original outlook that we provided in January 2023. Our outlook estimated loan growth in the low double digits. Loans increased $44.5 million in the first quarter of 2023 or 5.2% annualized, which is below our forecasted range. Commercial mortgage and installment loans had positive growth in the first quarter of '23. First quarter 2023 net interest income increased by 16.5% over 2022, which is higher than our forecast of a single-digit growth. The net interest margin for the first quarter of 2023 was 33 basis points higher than the first quarter of 2022. Net interest margin of 3%, which is in line with our original forecast. The first quarter 2023 provision for credit losses was an expense of $2.2 million or 0.25% annualized. The first quarter 23 provision expense as a result of an increase in provision for credit losses for securities held to maturity due to a $3 million loss incurred on a subordinate debt security during the quarter. The provision expense related to loans was a credit in the first quarter of '23, which is lower than our forecasted range. Noninterest income totaled $10.6 million in the first quarter of '23, which was below our forecasted range of $11 million to $13 million. First quarter 2023 mortgage loan originations, sales, and gains totaled $113 million, $106.9 million, and $1.3 million respectively. Mortgage loan servicing generated a gain of $0.7 million in the first quarter of '23. The $0.2 million loss on securities available for sale was related to the divestiture of a credit impaired corporate security. Noninterest expense was $31 million in the first quarter, below our forecasted range of $32 million to $33.5 million targeted quarterly. Our effective income tax rate of 18.2% for the first quarter of 2023 to slightly below where we had forecasted. Lastly, no shares were repurchased in the first quarter of 2023. That concludes my prepared remarks. I would like now to turn the call back over to Brad.

Thanks, Gavin. Each quarter, we share a high-level view of our key strategic initiatives. As we proceed through 2023, our focus will continue to be on the rotation of our earning asset mix out of all our yielding investments into higher-yielding loans, growing our core deposit base while managing our cost of funds, and controlling our noninterest expenses. While there is increasing concern about a potential economic slowdown, at this point, we continue to see good demand for loans, particularly in the commercial segment as well as a renewed interest in the strong value proposition offered by community banks like Independent Bank. Accordingly, we are excited about the opportunities we have to continue our growth trends. We've built a strong franchise on a talented team, a low-cost deposit base, and well-diversified loan portfolios, which we believe positions us well to effectively manage through a variety of economic environments and continuing to deliver strong and consistent results for our shareholders. At this point, we'd now like to open up the call for questions.

Thank you [Operator Instructions]. We will just take a brief pause to assemble the Q&A roster. Our first question comes from Brendan Nosal with Piper Sandler.

You folks did a really nice job of growing deposits this quarter. Nice to see core deposits flat and then you brought up time and broker to get the balance of the growth, which it looks like it allowed you to build cash quite nicely. I guess, looking forward, do you have a desire to build cash forever by bringing on more of those funding sources, or are you pretty happy at this point kind of matching the loan growth and keeping cash flat?

So we did come through quarter end with an elevated level of cash that we were faced with. On balance sheet cash will be lower anticipate throughout the rest of the year. The growth we've seen in time and reciprocal; some of that was new deposit growth coming into the bank. Some of it is rotation as you could see from non-maturity. So I mean, I guess the answer I would have is we're continuing to grow deposits, and we expect to continue to grow deposits throughout the rest of the year.

One more from me. Can you maybe walk us through how deposit pricing evolved kind of month-to-month over the quarter and kind of give us some insight as to what period you felt the most pressure?

So I do think the environment clearly changed after March 10. We were increasing deposits in the first 2 months. And ultimately, at the end, we just -- it's really the deposit rotation that was pushing the costs up. But we were increasing throughout the quarter. I think we've been able to hold back as long as we could, and we had to make some adjustments to maybe catch up a little bit.

Our next question comes from Erik

I wanted to just start a little bit on the net interest margin. The first quarter result would -- if the margin was to hold here for the rest of the year, we kind of fit with your prior guidance for it to be flat to up slightly relative to the full year '22. So just curious, you mentioned the opportunity to remix into some higher earning assets. But just curious about the funding certainly seems to be a little bit more competitive -- that you talked to that just in your last comments. Just curious how you continue to view the outlook for the margin going forward here over the next quarter or two?

In our outlook, I'd just remind everybody on the call did use a forward curve that had two rate cuts and on the back end of the year that obviously was beneficial. I would say, going forward, we are feeling, again, as we just talked about, deposit pressure. It did build in the first quarter. I don't know that I would necessarily say it's continuing to build, but it's there. And the big question that makes this challenging is what does the deposit rotation look like. So that was -- if we go back to our model, that was one area where we were light. We did not anticipate this level of rotation of those non-maturities in this time frame. So I think…

…a good point.

Go on.

Go ahead.

So I think we could -- I think we're in a reasonable range right now for the quarter, could drift a little lower, but it's really going to depend on how our deposit mix shakes out.

Yes, I'd agree. I think we'll probably see a little drifting lower, respectively. I think that would be good in your assumptions.

I appreciate the additional color there. And just moving to the fee income, the 1Q result for noninterest income was maybe a little bit below kind of the bottom end of your expectation range there. Just curious about -- I guess, as I look at my expectations, it was maybe the interchange and service charges on deposits that came out a little bit lighter. So curious if there was just some seasonality there? Or I know some other banks have made changes to their deposit service charges, nonsufficient fees charge things of that. So curious what might have been at play in the first quarter and how to think about getting into that range for the rest of the year?

Yes. Eric, a couple of thoughts there. We continue to see lighter-than-expected halt in on sale. Generally, by this point in the calendar year, we'd see a pickup on the mortgage side. And now we did just last week, take probably the -- I think it was the largest apps per week since the start of the year, but we've had an unseasonably cooler weather environment here, and that may be part of it. So when you translate it over to noninterest income, I think that's the big one. We continue to feel very good about the interchange and deposit service charges that we have. We have made some tweaks in terms of charging for statements and so on. But I think that those are the big movers in there, right, Gavin?

Yes, I agree

Okay.

And just one last one for me, and I'll step back. The majority of the bank stocks have sold off here, year-to-date, you didn't repurchase any shares in the first quarter. So just curious how you think about the opportunity to utilize capital for -- loan growth continues to be strong. But just given kind of where the stock is trading today, if that's changed your thought process at all and whether you'd like to become more active in buying back shares throughout the year.

I think, first off, our capital will be used for our organic loan growth. And we are today with the AOCI marks below our targeted range on TCE. So that does put some pressure on our maybe appetite for share repurchases. But there's -- as you point out, the aspect of our current price relative to maybe what we -- the intrinsic value we see going forward. So you may see us with some repurchases, but it probably is not going to be that material at this point.

Our next question comes from Damon DelMonte with KBW.

This is Matt Renck filling in for Damon. I hope everybody is doing well. My first question is on provisions. So the core provision, so to speak, was lower than the range. Do you think provision expense will pick back up to that 0.25% to 0.35% as commercial loans come back online or commercial loan growth starts to pick up? Or is there like economic deterioration built into that forecast?

So I would agree with you, it will be driven by loan growth. So right now, as Joel had highlighted in his commentary or we had one commercial note that we wrote down, but we had already addressed that in 2022. So we did come out of the gate a little slower on growth than the forecasted indicated for the full year. So maybe in totality, everything held the same. We may come on a little lighter than the 25 basis points for the year regarding loans. But obviously, given the HTM write-down that we took was right in line. I don't anticipate that being happening again. But so if loan growth comes back, yes, I think we can get close to where we forecasted maybe a little lighter.

And then just lastly, on noninterest expense. You guys hired a new commercial team. What's the appetite like for new hires? And then conversely, should we enter more of a recessionary environment? Do you have opportunities to cut costs? Or will cost savings more come from optimization of delivery channels?

So our appetite for talent is ongoing. We're always in all areas, particularly the sales side, continuing to look for talented people to add to our team. So this past quarter, we added three commercial sales people and as well as a strong person on the credit support side. And they were not a team. They were spread out in our markets. So one in Southeast Michigan, one in West Michigan, and one in Northwest Michigan. And we're constantly also though, looking at the expense structure. Over on the retail side, we've reduced the FTE count by about 11 here through the first quarter. We sort of see through the third quarter, probably an opportunity for another 12 or 13. Much of that is simply not filling some of the lower paid positions that we're able to still meet customer demand because of technology that we've put in place as well as reduced traffic in the branches. So we have a number of initiatives also to leverage additional technology. I'll give you an example. I think with the slowdown on the mortgage side, the support team for that group has been very, very busy automating more and more of our mortgage process. And we've seen the benefit of using robotic automation to perform what was previously done manually by people. So we're going to continue to push down on the expense side. And that is one of the areas we do have probably the most control over, Matt.

Okay. On our end, we're not hearing any more questions. It sounds like actually, maybe we do have one more question...

Can you guys hear me?

We can now. Go ahead.

This is with Davidson. Manuel Navas. Just a follow-up on the OpEx conversation. It was also a little bit down because of variable comp. With these also the channel savings a little bit -- do you kind of expect OpEx to be more in the low end of the range or even below the range, especially if fees don't bounce back up?

I think we'll probably be on the lower end of the range in prospectively.

Just looking over to the margin for a second. Do you have like a March end NIM or a deposit cost at the end of the period to kind of compare to as we enter the second quarter.

I do. March NIM was 3.28%. Deposit costs were $151 million.

And what kind of are you assuming on the deposit beta side with kind of the shifts to your expectation for deposit account migration. And any kind of update on how you're thinking about deposit betas during the cycle?

We spent a lot of time talking about that in the last few weeks. We're still modeling at low to mid-30s for the cycle.

And you did indicate that it was -- I think I heard this right, that it was kind of more focused earlier in the quarter and then it's less deposit rate pressure as the quarter went along. Is that the right way to think about it? It's still there, you said, but it was...

So we were...

…In January and February.

So this quarter, I would say the pressure in terms of rate moves was really noticeable. It was more than in prior quarters. So we were making adjustments along the way. And then with March -- the events in early March, that accelerated the rotation, and we did make some adjustments to pricing then, too. But there's not a definitive date that we adjusted prices up, right? We do it along. We meet regularly and review the landscape and what's going on with our deposit base and then adjust as necessary.

And just especially on loan growth. You already indicated it's more that that last three quarters weighted to growth. I might have missed it, but how are pipelines looking into the second quarter and beyond?

Our pipeline actually is stronger now than it was at the end of last year. We had a very active fourth quarter, really the second half of last year. And I think the combination of having to rebuild our pipeline during the first quarter and just the market kind of digesting the higher rate environment caused the slowness from my viewpoint. But now our pipeline is stronger than it's been in several quarters. And we're feeling very confident about good solid growth for the remainder of the year.

At this time, we have no further questions. So I will hand the call back to Brad.

Thanks, Emily. 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'd 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.