Good morning, and welcome to the Independent Bank Corporation Second Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded.
I would now like to turn the conference over to Brad Kessel, President and CEO. Please go ahead..
Good morning. Thank you for joining Independent Bank Corporation's conference call and webcast to discuss the company's 2019 second quarter results. I am Brad Kessel, President and Chief Executive Officer. And joining me is Rob Shuster, Executive Vice President and Chief Financial Officer.
Before we begin today's call, it's my responsibility to direct you to the important information on page 2 regarding the cautionary note regarding forward-looking statements. If anyone does not already have a copy of the press release issued by Independent today, you can access it at the company's website www.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 very pleased with our second quarter results. To start off, we were again awarded the Forbes' Best-in-State Bank in 2019 taking first place.
Forbes partnered with market research firm Statista to survey more than 25,000 citizens throughout the United States. They were surveyed for their opinions and their current and previous banking relationships.
Banks were rated on overall recommendations and satisfaction as well as five subcategories including; trust, terms and conditions, branch services, digital services and financial advice. Nationwide financial institutions were excluded from the final rankings.
I know how hard each and every associate within our company works to serve our customers and it is great to have our team get the Best-in-State bank recognition. Moving on to our financial results. At a summary level, we had good growth in net interest income with only one basis point of margin compression.
We have strong fee income primarily through gain on mortgage loan sales and our expenses were well controlled coming in on the low end of our guidance. Team continues to do an excellent job of managing asset quality, enabling us to record only a small loan loss provision primarily related to new loan growth.
Our portfolio loan growth occurred through each business line in addition to a very strong quarter of mortgage loan originations and sales. Turning to slide 5 of our presentation.
With a little more detail on the quarter, we are pleased to report second quarter 2019 net income of $10.7 million or $0.46 per diluted share versus net income of $8.8 million or $0.36 per diluted share in the prior year period.
Impacting our second quarter results for both 2019 and 2018 is the acquisition of Traverse City State Bank which closed on April 1 2018 as well as the changes in the fair value due to price of our capitalized mortgage loans servicing rights.
For the three months ended June 30, 2019 a decline in the fair value of our capitalized mortgage loan servicing rights due to price decreased non-interest income by $2.7 million or $0.09 per diluted share after-tax. This compares to a $500,000 increase in fair value due to price or $0.02 per diluted share for the three months ended June 30, 2018.
Excluding the after-tax impacts of the MSR changes due to price and $3.1 million in merger-related expenses for the three months ended June 30, 2018 net income and diluted earnings per share increased by 18.4% and 25%, respectively.
For the second quarter of 2019, our return on average assets and return on average equity were 1.27% and 12.72%, respectively. These ratios increased to 1.52% and 15.22%, respectively when excluding the after-tax impact of the MSR change.
Driving these increases in net income and diluted earnings per share on a year-over-year quarterly basis was a $1.8 million or 6.1% increase in net interest income a $1 million increase in net gains on mortgage loans. During the second quarter we grew portfolio loans by $87.7 million or 13.4% annualized.
This represents the 21st consecutive quarter of loan growth. On the funding side during the second quarter total deposits were up $65.5 million or 4.5% annualized. And when excluding broker deposits the growth rate increases to 7% annualized.
For the six months ended June 30, 2019 the company reported net income of $20.1 million or $0.85 per diluted share, compared to net income of $18 million or $0.78 per diluted share in the prior year period. Slide 7 of our presentation provides a good view of our footprint.
Turning to slide 8, Michigan business conditions continued to be favorable, with low unemployment, some job growth affordable housing and continued good demand for commercial real estate. The May 2019 Michigan unemployment rate at 4.2% is unchanged from one year ago and 0.6% above the U.S. unemployment rate of 3.6%.
Regionally Grand Rapids unemployment is at 2.8%. Lansing is at 3.1%. And Detroit Livonia Dearborn is at 4.5%. Michigan's workforce is 4.44 million strong. And overall employment is up slightly from one year ago. The continuation of the positive economic trends can be seen in our regional portfolios shown on page 9.
Our two strongest growth regions are the Grand Rapids region up $110 million in loan balances. And our Southeast Michigan region up $61 million in loan balances. The next couple of slides cover our balance sheet.
Turning to page 9 we provide a couple of charts reflecting the attractive composition of our deposit base as well as the continued growth in this portfolio while working to effectively manage our overall cost of funds. Independent has $2.98 billion in total deposits of which 77% are non-maturity deposit accounts.
When comparing second quarter 2019 to the same quarter one year ago we increased deposits by $180.1 million. Our total cost of deposits is up three basis points on a linked-quarter basis and is up 34 basis points when comparing to the same quarter one year ago.
Our success in growing deposits while managing the overall cost of deposits has been primarily through the sale of our insured cash suite product, to public fund entities. Similar charts are also reflected on page 11. But in this case we are displaying our loan portfolios.
We continue to target a diversified loan mix with the largest portfolio being our commercial book of business. At June 30 2019, our loan mix included 43% commercial, 39% mortgage, 16% installment and 2% held for sale. Total loans outstanding now aggregate to $2.77 billion excluding -- or including $62.9 million of loans held for sale.
The commercial portfolio grew by $7.6 million or 2.6% annualized during the quarter. Consumer installment loans were up by $37.6 million or 37.1% annualized, for the quarter, primarily through our indirect lending line of business which targets Michigan Marine, Power Sports and RV dealers.
Total mortgage originations for the quarter increased to $241 million up from the first quarter's $138 million and up from the second quarter one year ago, of $226 million. Portfolio mortgage loans increased by $42.6 million or 16% annualized for the quarter.
In terms of capital management, our capital levels continued to be strong with tangible common equity to tangible assets moving from 9.26% at March 31 2019 to 8.72% at June 30 2019. This is well within our targeted TCE range of 8.5% to 9.5%.
Our Board of Directors increased the 2019 quarterly cash dividend by 20% to $0.18 per share effective February 15 2019. During the first six months of 2019, the company completed the repurchase of 5% of its outstanding shares. Specifically, 1179688 shares were repurchased at a weighted average purchase price of $21.85 per share.
On June 18 2019, the Board of Directors of the company supplemented the 2019 share repurchase plan and authorized the repurchase of up to 300,000 additional common shares. At this time I would like to turn the presentation over to Rob Shuster, to share a few comments on our financials credit quality, CECL and our outlook for the balance of 2019..
Thanks Brad and good morning everyone. I am starting at page 13 of our presentation. Brad discussed the year-over-year increase in our net interest income during his remarks. So I will focus on our net interest margin.
Our tax equivalent net interest margin was 3.87%, during the second quarter of 2019, which is down six basis points from the year ago period, but down just one basis point from the first quarter of 2019. I will have some more detailed comments on this topic in a moment.
Average interest-earning assets were $3.19 billion in the second quarter of 2019 compared to $2.96 billion in the year ago quarter and $3.15 billion in the first quarter of 2019. Page 14 contains a more detailed analysis of the linked quarter increase in net interest income. There is a lot of data on this slide, but to summarize a few key points.
Overall, we felt that the net interest margin held up very well in the second quarter despite a rather challenging environment. The amount of average loans increased $77.8 million and average loans represented 84.6% of total earning assets in the second quarter of 2019 as compared to 83.2% in the first quarter of 2019.
This change in mix helped push our average yield on earning assets up by three basis points. The average cost of funds was up four basis points to 0.86% in the second quarter of 2019 from 0.82% in the first quarter of 2019. We experienced a $7.7 million decline in average non-interest-bearing deposit balances in the second quarter of 2019.
However, this compares to a $27 million decline in the first quarter of 2019. Finally, one more day in the second quarter of 2019 increased net interest income by $159,000 compared to the first quarter. We'll comment more specifically on our outlook for net interest income for the balance of 2019 later in the presentation.
Page 15 compares our quarterly average cost of funds to the monthly average effective federal funds rate during the quarter and the spot federal funds rate during the quarter.
As you all know, there has been an amazing change in sentiment as we have moved from considering the impact of additional fed funds rate increases on cost of funds to now considering the impact of lower interest rates on our net interest margin. Moving on to Page 16.
Non-interest income totaled $9.9 million in the second quarter of 2019, as compared to $12.3 million in the year ago quarter and $10 million in the first quarter of 2019. Mortgage loan servicing caused most of the quarterly comparative and year-over-year variability in non-interest income and Brad covered these numbers in his remarks.
Second quarter net gains on mortgage loans increased to $4.3 million compared to $3.3 million in the second quarter of 2018. The increase in these gains was due to increases in mortgage loan sales volume and in the mortgage loan pipeline.
Mortgage loan application volume was very strong in the second quarter of 2019 and continues to be very strong at the start of the third quarter as we have both a healthy purchase market and refinanced volumes have been increasing due to lower interest rates.
As detailed on Page 17, our non-interest expenses totaled $26.6 million in the second quarter of 2019 as compared to $29.8 million in the year ago quarter and $28 million in the first quarter of 2019. The second quarter of 2018 included $3.1 million of merger-related expenses.
The decrease from the first quarter of 2019 is primarily concentrated in the compensation and employee benefits, occupancy and other real estate line items. We will have more comments on our outlook for non-interest expenses later in the presentation. Investment securities available for sale decreased $31.2 million during the second quarter of 2019.
Page 18 provides an overview of our investment portfolio at June 30, 2019. Approximately 31% of the portfolio was variable rate and much of the fixed rate portion of the portfolio is in maturities or average lives five years or less.
The estimated average duration of the portfolio is about 2.7 years with a weighted average tax equivalent yield of 3.12%, which is down five basis points from March 31, 2019. Page 19 provides data on non-performing loans, other real estate, non-performing assets and early-stage delinquencies.
Total non-performing assets were $9.4 million, or just 0.27% of total assets at June 30, 2019. Non-performing loans decreased by $0.9 million during the second quarter of 2019. You may have noticed that we began to deduct government-guaranteed loans from total non-accrual loans to arrive at total non-performing loans. This is a common practice.
And as our Ginnie Mae mortgage loan servicing portfolio has grown, we may elect to purchase defaulted mortgage loans out of pools during the pendency of the claims process. At June 30, 2019, 30 to 89-day commercial loan delinquencies were just 0.02% for commercial loans, and mortgage and consumer loan delinquencies were just 0.43%.
Moving on to page 20, we recorded a provision for loan losses of $652,000 and $650,000 in the second quarters' 2019 and 2018 respectively. We recorded loan net charge-offs of just $3,000 in the second quarter of 2019 compared to loan net charge-offs of $217,000 in the second quarter of 2018.
The allowance for loan losses totaled $25.9 million or 0.96% of portfolio loans at June 30 2019. Page 21 provides some additional asset quality data, including the information on new loan defaults and unclassified assets. New loan defaults were just $2.5 million during the first half of 2019.
Page 22 provides information on our TDR portfolio that totaled $52.1 million at June 30, 2019, which is a decline of $1.2 million during the second quarter. This portfolio continues to perform very well with nearly 95% of these loans performing and 93.1% of these loans being current at June 30, 2019.
Page 23 provides a detailed time line for our implementation of the CECL accounting standard. We are on track to publicly disclose the estimated impact of CECL on our allowance for loan losses when we file our second quarter 2019 Form 10-Q on or about August 2, 2019.
Page 24 is our update for 2019, where we compare our actual performance during the year to our original outlook that we provided back in January 2019.
Overall, we believe that our actual performance in the second quarter of 2019, when factoring out the negative fair value adjustment due to price on capitalized MSRs was better than our original outlook. We achieved actual annualized loan growth of 13.4% in the second quarter of 2019.
Typically our second and third quarter loan growth is the strongest due to seasonal factors. We remain comfortable with our full year expectation of 8% to 9% or slightly better loan growth. With the current shape of the yield curve and the now expected cuts in the federal funds rate, we do expect some downward pressure on our net interest margin.
As a result, we reduced our original forecasted growth rate of 10% to 11% for net interest income for all of 2019, down to 8% to 9%. This updated forecast assumes 25 basis point cuts in the federal funds rate in July, September and December. We had a loan loss provision, as mentioned earlier, of $652,000 in the second quarter.
This was below our anticipated level, because of better than expected asset quality metrics. We expect generally stable asset quality metrics during the remainder of 2019, so loan growth is anticipated to be the main driver of our loan loss provision.
Excluding, again, the negative fair value adjustment due to price on MSRs, our adjusted second quarter 2019 non-interest income would have been a bit above the high end of our forecasted range, due primarily to higher net gains on mortgage loans.
We continue to expect non-interest income to be within our forecasted range in the next two quarters, excluding any volatility associated with changes due to price and the fair value of the MSRs.
As I discussed last quarter, we expected actual second quarter 2019 non-interest expenses to move back within our forecasted range, due primarily for lower expenses and compensation and employee benefits, occupancy and credit-related items, which are comprised of ORE, costs related to unfunded lending commitments, and the provision for loss reimbursement on sold loans.
These declines resulted in actual second quarter total non-interest income being a bit below the lower end of our range. We expect to generally be within our forecasted range in the last half of 2019. Finally, our effective income tax rate was 20% in the second quarter of 2019, which is exactly in line with our forecasts.
Just a couple of supplemental comments probably the two areas where I believe we could do a bit better than my comments that I just made would be in the provision for loan loss area particularly in the third quarter and in non-interest income if our mortgage loan pipeline holds up at September 30.
That concludes my prepared remarks and I would now like to turn the call back over to Brad..
Thanks, Rob. We have listed our strategic initiatives on slide 25. During the first half of 2019, we made significant progress in each of these areas.
We believe successful execution on these initiatives will continue to drive strong returns as community bank at the center of all our strategies is staying focused on serving our customers and investing in our markets and in our people. At this point, we'd now like to open up the call for questions..
We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Brendan Nosal of Sandler O'Neil and Partners. Please go ahead..
Hey, good morning, everybody.
How are you?.
Great. Thank you. .
Good. Just want to start-off here on the NII outlook. I definitely appreciate the clarity on guidance that the revision back to 8% to 9% in aggregate for the year is due to the outlook for a couple of fed cuts. Just hoping you can put a finer point on what each fed cut means for the NIM in terms of basis points as you sit here today..
As we sit here today the impact -- and again some of this would be dependent on timing. So what we have forecast is a 25 basis point cut in late July this coming -- or next week a cut in September and a cut in December. So the December cut really does not have that dramatic an impact.
And over time when you get a full year impact it could be a bit greater. But in general over the course of the six months assuming those cuts we're looking at a downward move in the net interest margin cumulatively of about 10 basis points. And how that spreads out between the two quarters I'm not as certain on that.
But that -- on an overall basis that's about what we're looking at. .
Got it..
We hope to hold the line on loan pricing as much as we can and push hard on deposits to try and mitigate some of that..
Okay. Great.
And then just to clarify that will be a kind of a point-to-point from 2Q 2019 levels through the full impact of those three cuts correct?.
Yes. But again as I said the December cut you really -- that doesn't have that big of an impact. It's only for a part of a month during that 6-month period..
Understood. Okay. And then moving on to the funding side. I mean you guys held the line really nicely on overall deposit cost this quarter.
Just curious as your thoughts on and how much you can push back on deposit pricing with these expected fed rate cuts?.
Well, I think in the public funds arena, I think, we could move fairly quickly. And there are a number of accounts where we model them with a beta of 100%. In other words they're -- and they may not be under their terms linked to a particular driver rate, but the way we price them is pretty much linked to a driver rate.
So with respect to those dollars I think we could get an immediate move if we get a fed rate cut. Now those dollars are not as great as what we would see with an immediate cut on the prime rate with commercial loans et cetera. So that's where I think we could push immediately.
On the balance of deposits that are smaller and balanced there we've tried to hold the line as we've moved up. So I don't know that there is as much push on the other way on the way down. So that kind of gives you a little bit of a mix on the funding cost.
The other area I do think though that over time we'll get an immediate impact would be the wholesale funding side of things. So broker deposit rate should come down and borrowing cost should come down. And I think all of that into account in that sort of forecast for the NIM.
But again to the extent we could hold the line on loan pricing get a little bit better earning mix there and push on deposits. I'm optimistic. We can do a bit better..
All right, thanks for taking my questions..
[Operator Instructions] Our next question comes from Damon DelMonte of KBW. Please go ahead..
Hey, good morning, guys.
How are you doing?.
Hi, David, good thanks..
Great, quick question on the margin, just a quick follow-up, Rob what are you forecasting for accretable yield for the next couple of quarters?.
I think it was about five basis points. I can get to that slide. Yeah about I think four to five basis points. Yeah, 5.1 basis points, I don't -- I mean that's going to drift down over time as that portfolio shrinks. Now to the extent you get more payoff activity it could accelerate it a bit. But I don't see a material change there..
Okay..
… at least in the third quarter..
Okay.
And then kind of switching over to loan growth, good to see that the outlook remains positive there, could you talk a little bit about what's driving the installment loan growth? Is that -- was that more seasonal here in the second quarter and that carries into the third quarter, or is it just greater demand for those types of loans, whether it be Marine or Power Sport or RVs?.
Well, Damon I think that the strong performance for us here in the second quarter is directly related to continued consumer optimism in the marketplace. And, a majority of that production for consumer growth came through our indirect lending desk, which focuses specifically on RV, Marine and Power Sport.
And the production that we have had through six months, out of that area, is slightly over what it was a year ago. But very similar to what we saw in 2018. And we continue to have a high expectation for credit quality there. Probably we give a little on yield to accomplish that.
But we work extremely hard with the dealer network to be the preferred provider, for that high credit quality source of financing. I would imagine that we'll see it still continue into the third quarter. And then typically fall off in the fourth quarter and then early 2020..
Got it, okay..
…Rob is there anything you want to add?.
Nope..
Okay. That's helpful.
And then, I guess, could you just give us some thoughts on M&A and kind of what you're seeing as opportunities across your footprint in Michigan and your appetite to participate in any possible deals?.
Well, there has been year-to-date in 2019, several announced deals. And we continue to see a shrinking population of banks within our immediate footprint. I would say that, we have said and we'll continue to run the independent plan focused on organic growth. And supplement it with acquired growth where it makes sense.
I am pleased with the opportunity to be included where appropriate. But our game plan continues to be focused on organic growth. David, we've had, I think -- again as I mentioned our organic growth has come from the West Michigan portion of our footprint as well as Southeast Michigan.
And in both those markets, we've been able over the last 12 months to 18 months add a number of new talented lenders, from the market disruption that's been taking place. And that has really been a nice source of our organic growth..
Great, okay, thanks for the color. That’s all that I have. Thank you..
This concludes our question-and-answer session. I would like to turn the conference back over to Brad Kessel for any closing remarks. Please go ahead..
We would like to thank each of you for your interest in Independent Bank Corporation. And for joining us on today's call. We wish everybody a great day..
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect..