Independent Bank Q3 2024 Earnings Call Transcript

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October 24, 2024

There are 9 speakers on the call.

Operator

Hello, everyone, and welcome to the Independent Bank Corporation Reports 20 24 Third Quarter Results. My name is Ezra, and I will be your coordinator today. I will now hand you over to your host, Brad Kessel, President and CEO, to begin. Brad, please go ahead.

Speaker 1

Thanks, Ezra. 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 Q3 2024 results. I am Brad Kessel, President and Chief Executive Officer and joining me is Gavin Moore, Executive Vice President and our Chief Financial Officer and Mr. Joel Rahn, Executive Vice President, Head of Commercial Banking.

Speaker 1

Before we begin today's call, I'd 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 question and answer session and then closing remarks. Independent Bank Corporation reported Q3 2024 net income of $13,800,000 or $0.65 per diluted share versus net income of $17,500,000 or $0.83 per diluted share in the prior year period. I am proud of our team and very pleased with our Q3 2024 results driving organic growth on both sides of the balance sheet.

Speaker 1

Overall loans increased 9.3% annualized, while core deposits are up 8.9% annualized. We were able to generate net interest income growth on both a linked quarter basis 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 watch credits and non performing assets near historic lows. These fundamentals continue to drive very strong growth in tangible book value per share, 22% in fact compared to the prior year quarter.

Speaker 1

Based on a robust commercial pipeline, the past record of our core group of professionals and the ongoing strategic initiatives to add talented bankers to our team, we are optimistic about continuing these growth trends for the remainder of 2024 and into 2025. On Page 5, total deposits as of September 30, 2024 were $4,600,000,000 Overall core deposits increased $100,000,000 during the Q3 of 2024. On a linked quarter basis, retail deposits declined by $21,300,000 business deposits increased by $16,700,000 and our municipal deposits increased by $105,200,000 for 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.

Speaker 1

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 8 basis points to 2.10%. At this time, I'd like to turn the presentation over to Joel Ron to share a few comments on the continued success we are having in our growing our loan portfolios and to provide an update on our credit metrics.

Speaker 2

Yes. Thanks, Brad, and good morning, everyone. On Page 7, we share an update on loan activity for

Speaker 1

the

Speaker 2

quarter. Total loans increased $90,000,000 in the 3rd quarter, as Brad said, representing 9.3% annualized growth. We had a strong quarter of commercial loan activity with that portfolio increasing $93,000,000 Our mortgage portfolio grew $10,000,000 while our installment loan portfolio declined by $12,500,000 Within the commercial loan activity, the mix of C and I lending versus investment real estate was approximately 60%, 40% with overall 35% coming from new customers to the bank. For the year, despite significant headwinds from unscheduled payoffs in the Q2, our commercial portfolio has grown $145,000,000 representing an 11.5 percent annualized growth rate. Based upon a solid commercial pipeline, we see continued growth opportunity in the 4th quarter, while maintaining our disciplined credit standards.

Speaker 2

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 6.78%. Page 8 provides additional detail on our commercial loan portfolio. As pointed out in prior quarters, C and I lending continues to be our primary focus, representing 67% of the portfolio. Manufacturing continues to be the largest concentration within the C and I segment, comprising approximately 9% or $172,000,000 The remaining 33% of the portfolio is comprised of investment real estate with the largest concentration being industrial at 8% or $153,000,000 It's worth noting that our exposure to the office segment stands at $86,000,000 or 4.7 percent of the commercial portfolio at quarter end.

Speaker 2

Our office exposure consists primarily of suburban low rise office space with medical comprising 19% of overall office exposure. The average loan size is $1,300,000 which points to the granularity of that segment of our portfolio.

Speaker 3

And for additional insight on our office exposure, I refer you to Page 25 of the appendix to this presentation.

Speaker 2

Key credit quality metrics and trends are outlined on Page 9. Overall, credit quality continues to be excellent as Brad remarked just a second ago. Total non performing loans were $5,100,000 or approximately 13 basis points of total loans at quarter end, consistent with June 30. Past due loans totaled $4,800,000 or 12 basis points similar to June 30. While not reflected on our slide, our commercial watch list remains low at 3.3% of the total portfolio, although up slightly from June 30.

Speaker 2

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.

Speaker 4

Thanks, Joel, and good morning, everyone. I'm starting on Page 10 of our presentation. Page 10 highlights our strong regulatory capital positions. All capital ratios increased from a linked quarter. Net interest income increased $2,400,000 from the year ago period.

Speaker 4

Our tax equivalent net interest margin was 3.37% during the Q3 of 'twenty four compared to 3.23% in the Q3 of 'twenty three and down 3 basis points from the Q2 of 2024. Worth noting, the accelerated fee accretion related to a large commercial loan payoff contributed 5 basis points to the margin in the Q2 of 2024. Excluding this accretion, the Q2 of 2024 net interest margin would have been 3.35% or 2 basis points lower than the Q3 of 20 24 margin of 3.37 percent. Average earning assets were $4,990,000,000 in the Q3 of 2024 compared to $4,800,000,000 in the year ago quarter and $4,800,000,000 in the Q2 of 2024. The linked quarter of 20 24 contains a more detailed analysis of the linked quarter increase in net interest income in the net interest margin.

Speaker 4

On a linked quarter quarter, our Q3 2024 net interest margin was positively impacted by 3 factors. Increase in yield on loans was 7 basis points, change in earning asset mix was 2 basis points and change in interest bearing liability mix was 2 basis points. These increases were more than offset by an increase in funding costs of 7 basis points, the reduction in loan fee accretion of 5 basis points and a decline in investment yield of 1 basis point. On Page 13, we provide details on the institution's interest rate risk position. The comparative simulation analysis for the Q3 of 2024 and Q2 of 2024 calculates the change in net interest income over the next 12 months under 5 rate scenarios.

Speaker 4

All scenarios assume a static balance sheet. The base rate scenario applies the spot yield curve from the valuation date. The shock scenario is considered immediate, permanent and parallel rate changes. The base case model NII is modestly higher during the quarter as asset yields were augmented by a shift in asset mix and liability costs also benefited from a shift in mix. The NII sensitivity profile shifted to a more asset sensitive position during the quarter largely due to slightly faster repricing on commercial loans, a modest increase in mortgage loan repricing due to additional pay fixed swaps and a shift in non maturity deposit beta assumptions.

Speaker 4

Currently, 35.6% of assets repriced in 1 month and 46.8% repriced in the next 12 months. Moving on to Page 14, non interest income totaled $9,500,000 in the Q3 of 24 as compared to $15,600,000 in the year ago quarter and $15,200,000 in the Q2 of 2024. 3rd quarter 2024 net gains on mortgage loans totaled

Speaker 1

$1,000,000 compared to $2,100,000

Speaker 4

in the 3rd quarter of $1,000,000,000 compared to $2,100,000 in the Q3 of 2023. The increase is due to increased profit margin as well as higher volume of loan sales. Negatively impacting non interest income was $3,100,000 loss on mortgage loan servicing net. This is comprised of $4,200,000 or $0.16 per diluted share after tax loss due to change in price and a $1,200,000 decrease due to pay downs that's partially offset by $2,200,000 of revenue in the Q3 of 2024. As detailed on Page 15, our non interest expense totaled $32,600,000 in the Q3 of 2024 as compared to $32,000,000 in the year ago quarter and $33,300,000 in the Q2 of 2024.

Speaker 4

Performance based compensation increased $500,000 due primarily to a higher expected incentive compensation payout for salaried and hourly employees. Data processing costs increased by $300,000 from the prior year period, primarily due to core data processor annual asset growth and CPI related cost increases as well as new solutions implemented during this time frame. Payroll taxes and employee benefits decreased $600,000 primarily due to lower health care related costs. Page 16 is our update for our 2024 outlook to see how our actual performance during the Q3 compared to the original outlook that was provided in January 2024. Our outlook estimated loan growth in mid single digits.

Speaker 4

Loans increased $90,400,000 in the Q3 of 2024 or 9.3 percent annualized, which is above our forecasted range. Commercial mortgage loans had positive growth, while installment loans decreased in the Q3 of 2024. Q3 of 2024 net interest income increased by 6.2% over 2023, which is within our forecast of mid single digit growth. The net interest margin was 3.3 percent, 3.37% for the quarter and 3.23 percent for the prior year quarter and down 3% 0.03% from the linked quarter. The Q3 2024 provision for credit losses was an expense of $1,500,000 or 15 basis points annualized of average loans, which is within our forecasted range.

Speaker 4

Moving on to Page 17, non interest income totaled $9,500,000

Speaker 3

in

Speaker 4

Q3 of 2024, which is below our forecasted range of $11,500,000 to $13,000,000 3rd quarter 2024 mortgage loan originations, sales and gains totaled $147,500,000 $117,000,000 $2,200,000 respectively. Mortgage loan servicing net generated a loss of $3,100,000 in the Q3 of 2024. Non interest expense was $32,600,000 in the 3rd quarter, within our forecasted range of $32,500,000 to $33,500,000 Our effective income tax rate of 20.1 percent for the Q3 of 2024 was in line with our forecast. Lastly, there were no shares repurchased in the Q3 or 1st 9 months of 2024. That concludes my prepared remarks, and I would like to now turn the call back over to Brad.

Speaker 1

Thanks, Gavin. I'm very pleased with another solid quarter 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 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 to the Q4 of 2024, our 160th year of serving the communities of Michigan and into 2025, our focus will be continuing to invest in our team, leveraging our technology and supporting our communities.

Speaker 1

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 very excited about our future. At this point in time, we'd like to open up the call for questions.

Operator

Thank you, Gavin. Our first question is from Brandon Nozzle with Hovde Group. Brandon, your line is now open. Please go ahead.

Speaker 5

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

Speaker 1

Good morning, Brandon.

Speaker 5

And just starting off here on mortgage gain on sale fees. I mean, it looks like it's the strongest quarter you guys have put up in quite some time. It looks like better gain on sale margins, better mix of saleable products. Just kind of curious what you folks are seeing at a ground level for that business and how you expect it to trend over the next few quarters? Thanks.

Speaker 4

Yes. Thanks, Brandon. This is Gavin. Yes, so we think that margin stable and but I do think we're going to see some headwinds in terms of production and that's primarily due to seasonality as well as just continued limited supply. So but overall, margins have been pretty stable and we think they're going to continue through year end.

Speaker 1

I think I'd add there, Brennan, it was interesting to sort of watch what was going on with application levels revolving around the Fed's move in September. And I think we had a lot of the client base, probably more than normal floating in anticipation of further drops in the mortgage rates. And obviously, short term rates are moved differently oftentimes than the longer term mortgage rates. So after the move and then we saw actually post quarter end, we're up now at the street level almost 100 basis points in the mortgage pricing. So customers I think were expecting it to go one way and then in fact went the other way.

Speaker 1

So we're going to, I think, again, dovetailing what Gavin said, sort of see what happens as we here in Michigan go into typically a softer season and see what happens. But hopefully that's helpful.

Speaker 5

Yes. No, I appreciate the comments there. One more for me. I'm just thinking about how the balance sheet is positioned for Fed reductions. I mean, I guess, the sheets may be a little bit asset sensitive, but you have the dynamic of rotating from securities into loans.

Speaker 5

I mean, if you kind of put those two pieces together, does that kind of lead to more or less a stable margin as we move ahead? Thanks.

Speaker 4

I actually would say the margin we should continue to see expansion. And just on what's disclosed, that's a 12 month forward look. So, we're showing some asset sensitivity and rates down in the model, but, that base model margin is higher than what we're actually at today. So just another way to say that I think we anticipate with the repricing of the assets and some ability to reprice on the liability side that the margin will grind higher.

Speaker 5

Thanks for taking the question, Gavin. Appreciate

Speaker 4

it. Thank you.

Operator

Our next question is from Peter Winter with D. A. Davidson. Peter, your line is now open. Please go

Speaker 6

ahead. Thank you. You guys had nice annualized loan growth this quarter. Can you just talk about loan demand, loan pipelines going forward? And secondly, do you think that there's a lot of pent up loan demand once we get past this election and hopefully with lower rates that could lead to even stronger growth?

Speaker 1

That's a great question, Peter. Joel, why don't you share your thoughts on what you're seeing there?

Speaker 2

Yes. Right now, our pipeline on the commercial side, Peter, is solid. It's so I think our Q4 and early in 2025 look fine. Hard to know on the it's a really interesting question on the pent up demand. There could be some, but our growth has been really good.

Speaker 2

So it's difficult for me to sit here and say, oh yes, we can outperform our current run rate, which is 11% -ish annualized. So but there certainly could be some business owners that have been sitting on the sidelines just waiting to make an equipment or expansion decision pending the outcome of the election. I could certainly see some of that, but it's really hard to gauge that.

Speaker 6

Okay. And then, Joel, just you've had a lot of success, with the dislocation in your markets from acquisitions, bringing in teams, or bankers. Just wondering if you could talk about maybe what the pipeline is for hiring new bankers with that dislocation in the markets, how that's looking?

Speaker 2

Yes, we're just continuing to look and talk. So I don't want to put a number on it, but our plan is to continue to do what we've been doing in the last few years and that is continue to where we can put good talent on our team and that pays off in the long run for us.

Speaker 1

Joel, this past quarter, we had some bankers in a couple of different markets, is that right?

Speaker 2

We did. Yes, we added 2 in Southeast Michigan and 1 up in our Northern Michigan region.

Speaker 6

Got it. And just my final question. Credit quality is great. Last quarter, you slightly released reserves. This quarter, you added a little over $1,000,000 Is that addition just kind of to support loan growth?

Speaker 6

And the thought is you want to keep the ACL ratio fairly steady from here?

Speaker 1

Yes. I would say, yes. This quarter's provision was directly attributable to loan growth. We're at a 146 ish to overall, plus or minus. And but built into that is about a 25% subjective.

Speaker 1

And I think we're still sitting on a subjective reserve with the question out there, is this a soft landing or a hard landing? So I think we'll get clear post election and into 'twenty five. So the reserves are very healthy today and I think going forward you'll see provisioning consistent with how our recent record has been.

Speaker 6

Got it. Thanks for taking the questions.

Operator

Our next question is from Nathan Race with Piper Sandler. Nathan, your line is now open.

Speaker 3

Hi. This is Adam Kroll on for Nathan Race. Thanks for taking my question. Hi Adam. So just starting on deposit costs, I noticed the pace of increase was a bit higher this quarter than in prior ones.

Speaker 3

Is it fair to assume that deposit costs have peaked? And I was just wondering if you could provide any color on what you're seeing in terms of deposit pricing competition within your markets?

Speaker 4

Yes. Thank you. So a lot of that has to do with mix. But in terms of spot rate, yes, I do believe that we have seen a peak with the recent Fed move. But again, we did continue to see some runoff in the non interest going and then it was rotating into interest bearing.

Speaker 4

So from a spot rate perspective, I do agree that I think we're at a peak.

Speaker 1

And in terms of what we're seeing in the marketplace, I think it's still aggressive. I think and watchful. So looking at your neighbor down the street and seeing what they're doing and who's going to blank first. So it's going to be interesting to see here through the balance of the year who does what. But our pricing strategy, I think, continues to work well.

Speaker 1

We're going to take very good care of our customer base. And based on what our overall wholesale borrowing costs that really drives the overall pricing strategy. So I feel good where we're at, particularly with just a very strong deposit growth here in the Q3.

Speaker 3

Thanks. I appreciate all the color on that. Just switching to expenses, it was nice to see them come in lower this quarter. And I saw in the release yesterday about using AI to kind of streamline IT processes and couple that with ongoing initiative to add additional bankers. I was just wondering how you guys are thinking about the expense run rate in 2025?

Speaker 1

On 2025, Adam, we haven't provided any guidance at this point. Our sort of timing would be following the Q4. We'll give you a full look at 2025. And so at that time, that we'll share that. But I would say, hey, expense management is a focus for us.

Speaker 1

We've been in that $32,000,000 $33,500,000 range for some time. And it's we've been able to keep it there. We're really just resource allocation or reallocation. So, while we've grown the commercial banking team significantly, we actually our overall headcount is down significantly. We're a little over 800 FT feet feet feet feet feet feet feet feet feet feet feet feet feet feet Es.

Speaker 1

And that's been pulled out of the branch system through the use of tele recycler machines. It's been pulled out of the mortgage support area as volumes stayed low and did not as they stayed lower and as we've implemented automation on the mortgage side. So we are excited as we go forward about our positioning with AI and application processing interfaces and as well as bots. Our technology leadership guys are doing a great job there and we're seeing some real benefits with some use cases today internally in terms of helping our staff better serve our client base by just accessing information. And I think in 2025, what we're hopeful for is really to move that AI and leverage it on the revenue generation side.

Speaker 1

So it's an exciting time to be in banking and a community bank. Thanks.

Speaker 3

Thanks for all the color on that. That's it for me.

Operator

Thank you, Adam. Our next question is from Damon DelMonte with KBW. Damon, your line is now open.

Speaker 7

Hey, everybody. This is Matt Rank filling in from Damon DelMonte. Hope everybody is doing well. Just a follow-up to the last question on AI. Has there been any regulator pushback or anything extra you've had to do to make sure they're okay with how you're using the systems?

Speaker 7

Or is that more for later on in 2026 when you move it to more of the revenue side?

Speaker 1

No, I think, first off, this is early and I think everybody's trying to figure out what it can do and then execute on it. But it all starts with governance. And so we're not waiting to develop the governance around AI based on what regulators tell us. I mean, we're building the governance on what we think are risk management best practices. So I think we're not necessarily over our skis on that.

Speaker 1

And I think we're in a good spot. But at this point, no, there hasn't been any pushback by regulators.

Speaker 7

Okay. Got it. And then just last one on deposit growth. Has the lowering of rates made it easier to kind of garner the whole relationship from a loan perspective or has it not really affected that? I was just curious if we could see a step up in growth there.

Speaker 2

There could be some of that. This is Joel. There were some opportunities that really were just kind of boxed out over the past year or so, year and a half because they were locked in on a fixed rate that was very attractive. So yes, we will see time, correct a portion of that because those loans will ultimately come up for refinance. But yes, there certainly could be

Speaker 1

a little bit of lift

Speaker 2

that we see with some pieces that we haven't been able to pull on customer relationships just with the refinance activity. That's a really good question.

Speaker 7

Okay, great. Thank you. That's all for me.

Operator

Our next question is from John Rodis with Janney. John, your line is now open.

Speaker 1

Good morning, guys. Good morning, John.

Speaker 8

Gavin, a question for you just on the balance sheet, the securities portfolio. Could you remind us what sort of maturities you're expecting in the Q4 and then next year?

Speaker 4

Yes. So we're looking at about $25,000,000 in the Q4 and then next year is going to be in that current speeds $120,000,000 ish $120,000,000 ish. For the full year? For the full year, that's correct.

Speaker 6

Yes. Yes. Okay.

Speaker 8

Is that $120,000,000 next year, is that weighted heavily towards any 1 quarter or is it fairly even?

Speaker 4

It's fairly even. I mean a lot of it's amortization off the MBS portfolio.

Speaker 8

Okay. And I think maybe a quarter or 2 ago you had said you sort of longer term targeting securities to assets of around 12% to 13%. Is that sort of still the case?

Speaker 4

12% to 15%, but yes, you're right there, John.

Speaker 6

Okay. Okay. Okay. That's it

Speaker 8

for me. Thank you, guys.

Speaker 6

Thank you.

Operator

Thank you. That ends our Q and A session. I will hand back to Brad for any closing remarks.

Speaker 1

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.

Speaker 1

Have a great day.

Operator

Thank you very much, Brad, and thank you everyone for connecting. You may now disconnect your lines.

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