Independent Bank Q4 2022 Earnings Call Transcript

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January 26, 2023

There are 7 speakers on the call.

Operator

Welcome and thank you for joining the Independent Bank Corporation 2022 4th Quarter and Full Year Earnings Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. And for operator assistance at any point, it's star 0. Thank you.

Operator

Now let me turn the call over to Brad Chettle, President and CEO. Sir, Brad, You may begin.

Speaker 1

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 4th quarter and full year 2022 results. I am Brad Kessel, President and Chief Executive Officer. And joining me is Gavin Moore, EVP and Chief Financial Officer and Joel Rahn, Executive Vice President, Commercial Banking. Before we begin today's call, I would like to direct you The important information on Page 2 of our presentation, specifically the cautionary note regarding forward looking statements.

Speaker 1

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 4th quarter 2022 net income of 15,100,000 dollars or $0.71 per diluted share versus net income of $12,500,000 or $0.58 per diluted share in the prior year period. This represents increases in net income and diluted earnings per share of 20.6% and 22.4%, respectively, over the Q4 of 2021. For the Q4 of 2022, We generated an annualized return on average assets and return on average equity of 1.21% 17 point 9.4%, respectively.

Speaker 1

For the full year December 31, 2022, The company reported net income of $63,400,000 or $2.97 per diluted share compared to net income of $62,900,000 or $2.88 per diluted share in 2021. Our 4th quarter performance capped a very strong year as our entire organization executed extremely well despite a macroeconomic environment with many challenges and uncertainties. This past year with our successful expansion into new markets In addition of new banking talent, we were able to generate strong commercial loan growth and higher net interest income, which enabled us to offset a significant decline in mortgage banking revenue and deliver a higher level of earnings in 2022 than we did in 2021. These full year results generated a return on average assets return on average equity of 1.31 percent 18.41 percent respectively. Importantly, we have generated significant growth in our loan portfolio, while maintaining sound underwriting criteria, a low level of past dues and net recoveries credited to our allowance in 2022.

Speaker 1

We continue to see positive trends during the 4th quarter, Including double digit annualized growth in our commercial loan portfolio and further expansion in our net interest margin. Independent Bank has grown to $5,000,000,000 in assets as of year end 2022 as compared to $4,700,000,000 as of December 31, 2021. Our current position in our markets has had a positive impact on business development. As we consistently see more commercial clients wanting to do business with a local bank that offers superior level of responsiveness and customer service, while also having the size and scale to meet larger financing needs. Given the health of our loan portfolio and our high level of liquidity and reserves, we believe we are well positioned to continue effectively managing through the challenging and uncertain economic environment that we're presently in and delivering strong results for our shareholders as we continue to leverage the investments we have made in banking talent and technology over the last several years.

Speaker 1

During the Q4, our total deposits grew to $4,380,000,000 from $4,330,000,000 the prior quarter end. Of the $4,380,000,000 we consider $3,850,000,000 to be core. During the Q4, we did see a decline in our core balances of $91,700,000 We believe a good portion of the decline to be seasonal, but also some movement related to the competitive market conditions. For the quarter, total cost of deposits increased from 0.33% to 0.77%. For the full year, total deposits increased by $295,000,000 of which $53,000,000 is core.

Speaker 1

Stated another way, our core deposits increased for all of 2022 by 1.4%. We have included in our presentation 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 see prospectively, but does provide a good historical view of our company and its cost of funds during a rising rate environment. Through year end, our beta for the cycle to date is 16.2%. We are currently forecasting a 50 point hike in February, a 25 basis point hike in March And then 25 basis point cuts in September December of this year.

Speaker 1

Given the more competitive We are now seeing for deposit pricing, we estimate a higher beta with future rate hikes. At this time, I'd like to turn the presentation over to Joel Rahn to share a few comments on the success we're having in growing our loan portfolios as well as provide an update on our credit metrics.

Speaker 2

Thank you, Brad. On Page 7, we provide an update of our well diversified loan portfolio. Total loans increased $55,400,000 in the 4th quarter led by our commercial portfolio which increased $58,600,000 This continues our trend of strong quarterly commercial loan growth. For the year, our commercial portfolio increased 263,000,000 22% as a strategic expansion of our commercial banking team as well as marketplace disruption positively impacted growth. While moderating slightly in the Q4, we see low double digit commercial loan growth continuing into 2023 based on a solid pipeline and our continued focus on adding talent to our commercial banking team.

Speaker 2

In terms of residential activity, Despite the headwinds of higher interest rates, our mortgage portfolio increased by $13,500,000 in the quarter. For the year, our mortgage portfolio grew $228,000,000 Consumer installment lending softened in the quarter as we have strategically pulled back in that area. That portfolio declined $16,700,000 in the quarter. For the year, we grew our consumer loan portfolio $68,300,000 Overall, we are extremely pleased with our loan growth and believe we are on track to continue our planned asset rotation from the investment portfolio the higher yielding loans into 2023. On Page 8, we provide detail of our 1 point $7,000,000,000 commercial loan portfolio.

Speaker 2

C and I lending continues to be our primary focus, representing 64% of the portfolio. Manufacturing is the largest concentration within the C and I segment comprising approximately 11% or $157,000,000 The remaining 36% of the portfolio is comprised of commercial real estate with the largest concentrations being industrial at $124,000,000 or 8.5 percent and retail at $118,000,000 or 8%. It's worth noting that of the $662,000,000 of new commercial loan volume generated in 2022, $411,000,000 or 62 percent was C and I versus $251,000,000 or 38 percent investment real estate. By design, this portfolio is very granular in nature and we're maintaining our credit discipline to ensure that we maintain good diversity in this portfolio. Page 9 provides an overview of key credit quality metrics at twelvethirty one.

Speaker 2

Total non performing loans were 3 point $7,000,000 or 0.1 percent of total loans at year end. Loans 30 days to 89 days delinquent totaled 3,100,000 at twelvethirty one, up slightly from 3rd quarter, primarily due to an uptick in consumer loan delinquency. 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 3

Thanks, Joel, and good morning, everyone. I'm starting at Page 10 of our presentation. Page 10 highlights our strong regulatory capital positions. The CET1 ratio and the total risk based capital ratio increased in the Q4 of 2022. Net interest income increased $6,300,000 from the year ago period.

Speaker 3

Our tax equivalent net interest margin was 3.52% during the Q4 of 2022, which is up 39 basis points from the year ago period and up 3 basis points from the Q3 of 2022. I'll have some more detailed comments on this topic in a moment. Average interest earning assets were $4,640,000,000 in the Q4 of 2022 compared to $4,430,000,000 in the year ago quarter and $4,610,000,000 in the Q3 of 2022. Page 12 contains a more detailed analysis of the linked quarter increase in net interest income and the net interest margin. Our Q4 2022 net interest margin was positively impacted by 2 factors, Increase in yield on investments of 13 basis points and change in loan yield and mix of 36 basis points.

Speaker 3

These increases were partially offset by an increase in funding cost of 46 basis points. We will comment more specifically on our outlook for net interest income and net interest margin for 2023 later in the presentation. On Page 13, we provide details on the institution's interest rate risk position. The comparative simulation analysis Q4 2022 and Q3 2022 calculates the change And net interest income over the next 12 months under 5 rate scenarios, all scenarios assume a static balance sheet. The base rate scenario applies the spot yield curve from the valuation date.

Speaker 3

The shock scenario is considered immediate, permanent and parallel rate changes. The decrease in the base rate forecast and net interest income in Q4 2022 compared to Q3 2022 is primarily due to an adverse shift and the funding mix and higher than model 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. The shift in sensitivity is primarily due to faster liability repricing due to a shift in the funding mix With the decline in less sensitive DDA and savings deposit and an increase in wholesale funding, Currently, 28% of assets repriced in 1 month and 41.3% repriced in the next 12 months. Moving on to Page 14, non interest income totaled $11,500,000 in the Q4 of 2022 As compared to $15,800,000 in the year ago quarter and $16,900,000 in the 3rd quarter for 2022.

Speaker 3

4th quarter 2022 net gain on mortgage loans totaled $1,500,000 compared to $5,600,000 in the Q4 of 2021. The decrease in these gains was due to a decrease in mortgage loan sales volume and in the mortgage loan pipeline as well as lower loan sale profit margins. Mortgage loan applications have slowed and the mortgage production mix has rotated to a lower percentage of salable mortgages. Positively impacting non interest income was $700,000 gain on mortgage loan servicing due to $2,200,000 of revenue That was partially offset by a $500,000 or $0.02 per diluted share after tax decrease in the fair value due to price And a $1,000,000 decrease due to pay downs of capitalized mortgage loans servicing rights in Q4 2022. As detailed on Page 15, our non interest expense totaled $31,500,000 in the Q4 of 2022 as compared to 34 $1,000,000 in the year ago quarter and $32,400,000 in the Q3 of 2022.

Speaker 3

Compensation increased $1,300,000 compared to 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 Q4 of 2022 That's direct origination costs on lower mortgage loan origination volume and an increase in lending personnel. Performance based compensation decreased $300,000 due primarily to a decrease in mortgage lending volume and lower performance level within the corporate incentive compensation plan compared to Q4 2021. The Q4 $22,000,000 included a $700,000 credit to the expense related to the reserve for unfunded lending commitments due to a decrease in volume of such lending commitments as well as the expected loss rate. Other expenses decreased $6,000,000 compared to the prior year quarter, primarily due lower fraud related losses as well as contract termination costs incurred during the prior year quarter. We will have more comments on our outlook for non interest expense later in the presentation.

Speaker 3

Page 16 is our update for 2022 outlook to see how our actual performance during the Q4 compared to the original outlook that was provided in January of 2022. Our outlook estimated loan growth in the low double digits. Loans increased $55,000,000 in the Q4 of 2022 or 6.5 percent annualized and $560,300,000 or 19.3 percent for the full year 2022, which is above our forecasted range. Commercial mortgage loans had positive growth in the Q4 of 2022, while installment loans decreased. 4th quarter 2022 net interest income increased by 18.4% over 2021, which is higher than our forecast of low single digit growth.

Speaker 3

The net interest margin for the Q4 of 2022 was 39 basis points higher than the Q4 of 2021. Net interest margin of 3.13%, which is higher than our original forecast. Actual results benefited from a notable increase in interest rates during 2022. The Q4 2022 provision for credit losses was an expense of $1,400,000 or 16 basis points annualized. This is within our forecasted 2022 full year provision range of 15 to 20 basis points of average total portfolio loans.

Speaker 3

The primary driver of the increase in the provision for credit losses was an increase in subjective allocations related to general economic conditions. Non interest income totaled $11,500,000 in the Q4 of 2022, which below our forecasted range of $13,000,000 to $17,000,000 4th quarter 2022 mortgage loan origination sales And gains totaled $138,900,000 $80,600,000 $1,000,000 respectively. The decrease in net gains on mortgage loans sold was primarily due to lower sales volume and decreased profit margin on mortgage loan sales. Mortgage loans servicing generated a gain of $700,000 in the Q4 of 'twenty two. Non interest expense was 30 $1,500,000 in the 4th quarter within our forecasted range of $30,500,000 to $32,500,000 targeted quarterly.

Speaker 3

Our effective income tax rate of 18.9% for the Q4 of 2022 was at the lower end of our forecasted range. Lastly, we purchased 181,586 shares at an average cost of $22.08 for the year to date period in 2022. Turning to Page 17, this will summarize our initial outlook for 2023. The first section is loan growth. We anticipate loan growth in low double digit range and are targeting a Full year growth rate of 10% to 12%.

Speaker 3

We expect to see growth in commercial mortgage loans with installment loans remaining flat. This outlook assumes a stable Michigan economy. Next is net interest income where we are forecasting growth rate 7% to 9% over the full year 2022. We expect the net interest margin to be stable to slightly higher compared to full year 2022 by 5 to 10 basis points primarily due to increasing yields on earning This forecast assumes a 50 basis point increase in February, a 25 basis point increase in March followed by a 25 basis point decrease in both September December and the target Fed fund rate in 2023 with long term rates declining slightly by year end. A full year 2022 provision expense for allowance for credit losses of approximately 0.25 percent to 0.35 percent of average portfolio loans would not be unreasonable.

Speaker 3

Related to non interest income, we estimate a quarterly range of $11,000,000 to $13,000,000 We expect mortgage loan origination volumes to decline by approximately 20% in 2023. Our outlook for non interest expense is a quarterly range of $32,000,000 to $33,500,000 with the total For the year, 1.5% to 2.5% above the 2022 actuals. The primary driver is an increase in data processing and FDIC deposit insurance premiums. Our outlook for income taxes is an effective rate of approximately 18.8 percent assuming the statutory Federal corporate income tax rate does not change during 2023. Lastly, the Board of Directors authorized share repurchases of approximately 5% in 2023.

Speaker 3

Currently, we are not modeling any share repurchases in 2023. That concludes my prepared remarks. And I would like now to Turn the call back over to Brad.

Speaker 1

Thanks, Gavin. Each quarter, we share a high level view of our key strategic initiatives as we head into 2023, 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 controlling our non interest expenses. While there is increasing concern about A potential economic slowdown. At this point, we continue to see healthy economic conditions and loan demand in Michigan. We're excited about the opportunities we have to continue to grow continue our growth trends into 2023.

Speaker 1

We've built a strong franchise based on a talented team, a low cost deposit base and well diversified loan portfolio, which we believe positions us well to effectively manage through a variety of economic environments and continuing to deliver strong results for our shareholders. At this point, we'd now like to open up the call for questions.

Operator

We'll have our first question from the line of Eric Zwick of Harvard Group. Please go ahead when you're ready.

Speaker 4

Good morning, everyone.

Speaker 3

Good morning.

Speaker 4

First, just wanted to start on the net interest margin. The guide for 'twenty three would imply some compression here from The 4Q 2022 level. So just curious how you might expect that to trend throughout the year, if it'd be some of that compression front loaded just as the deposit Cost catch up. And then if the Fed stops its hiking campaign towards the middle of the year, would the compression potentially be slower in the back half of the year or do you expect it to be kind of more even? Just curious, any thoughts on that topic.

Speaker 3

Yes, Eric, this is Gavin. That's You explained it very well. So, 1st part of the year, we do believe we'll see some compression. And then with The rate forecast we've utilized, there would be stabilization mid year, potentially slight expansion at the back end.

Speaker 4

Okay, great. Thanks. And then with respect to the investment securities portfolio, I think I heard you mention there's still opportunities Optimize the entire asset mix. So just curious how you would expect the size of the securities portfolio To trend throughout the year, either in terms of kind of dollar amount or percentage of total assets, how it could look at the end of 2023?

Speaker 3

Yes. Current modeling speeds, Eric, we're looking at about $170,000,000 of runoff next year.

Speaker 4

Okay. Thank you. Appreciate that. And then in terms of the Non interest expenses that you mentioned in the presentation, some opportunities to gain additional efficiencies as you optimize delivery channels. Curious if you could Talk to maybe any specific projects, either in that have been implemented today or others you might expect to initiate in 2023.

Speaker 1

Sure, Eric. This is Brad. And I point your attention back to when we did our core conversion in May of 2021. And here we are now Coming up almost on the 2nd year anniversary date post conversion. And we continue to See opportunities for efficiencies with that conversion.

Speaker 1

So in 2022, we had quite a bit of savings in the FTE count within In the branch network, and I think there's the opportunity there Also, just as we have vacancies, not having to replace those, as well as in the back room where we're Just not touching the paper like we did previously. So those are a couple of areas That we think there's opportunity.

Speaker 3

Okay.

Speaker 4

And then last one for me. You spoke to a little bit in terms of the Loan growth and the outlook for 10% to 12%, led primarily by commercial installment loans flat. I'm curious maybe from a geographic Perspective, if there's any particular markets that are stronger today that you would expect to drive that growth more relative to others in the coming year?

Speaker 1

I can take high level and then I probably Joel, why don't you go first? Go ahead.

Speaker 2

Yes. Well, I think it's pretty straightforward answer. I'll frame it up by saying in 2022, we had good growth In our entire footprint, all of our regions contributed. But there's no question that our 2 largest Market Southeast Michigan and West Michigan are driving a lot of our growth and we see that continuing. So Southeast Michigan and West Michigan are our 2 most active growth markets.

Speaker 4

Great. Thank you for taking my question today. Thank

Operator

you. Thank you. Your next question comes from the line of Matt Rangnick of KBW. Please go ahead when you're ready.

Speaker 5

Hi, guys. This is Matt Rink filling in for Damon Del Monte. I hope everybody is doing well. With respect to credit, I was just curious if you're seeing any signs of Stress within any of your loan categories. And then more specifically, with regards to the office portfolio, could you just provide some more color about what types of exposure you have to office And how those loans are performing?

Speaker 2

Yes. This is Joel. I in terms Just the overall credit quality. No broad trends that we're We're seeing a little bit of stress in the manufacturing sector With just upward rising prices, cost of manufacturing product due to increased wages and raw material Price inflation. But again, there's not a broad theme to it.

Speaker 2

We're just seeing isolated cases of that. But we continue to watch that carefully. And then in terms of office exposure, We've got about $81,000,000 It's shown on Page 8. It's about About 5.5% of our portfolio in office. And I would characterize our office exposure as primarily suburban, Low rise and with a fair amount of medical office usage.

Speaker 2

So we actually feel Very good about our office exposure in our portfolio. It's held up extremely well.

Speaker 1

Yes, Joel, I'd add then over on the consumer side, we continue to Watch closely, but are not seeing any early signs of stress there.

Speaker 5

Got it. Great. Thank you for the color. And then just one follow-up to Eric's question about loan growth. Are you Planning any new additions of commercial bankers or expansions into new markets?

Speaker 2

Yes. We are continually Recruiting additional commercial banking talent, probably the best why I would answer that. So that will just be an ongoing strategy for us or focus. And that's what we've got built into the 2023 plan.

Speaker 5

Got it. Great. Thank you for taking my questions.

Speaker 4

Thanks, Matt.

Operator

Thank you. We now have Brendan Nosal of Piper Sandler. Your line is now open.

Speaker 6

Hey, good morning guys. Hope you're doing well. Maybe just to start off on kind of the equation between loan growth and funding in the year ahead. Thanks for the comments on the securities book. I think you said $170,000,000 of cash flow there.

Speaker 6

I guess that kind of funds about half of roughly 10% loan growth for the year. Just kind of thinking about the balance of that growth, how much would come from core funding ideally versus the need for more wholesale funding?

Speaker 3

Yes. Well, we want to grow deposits and we're Still low single digit deposit growth for next year and then the balance would come Through wholesale or potentially, yes, I guess I'd say wholesale.

Speaker 6

Got it. Got it. Okay. And then maybe one more for me. You may have kind of addressed this in a prior question already, but Just conceptually, I'm wondering what would be a better outcome for the margin at this point, whether it's stability after the Fed wraps up its tightening program Or a more rapid pivot to rate cuts?

Speaker 3

Yes. So it's the more rapid cuts rate cuts, but The caveat I'd give you there Brendan is that assumes that we're able to achieve the betas going down that we've seen historically. And so that is you get a less inverted curve, Which we do benefit from.

Speaker 6

Okay, understood. With the prospect For rate cuts, I mean, do you think like the first couple cuts allows you to start pushing back on deposit pricing or maybe not so much given that Fed funds will still be so far ahead of the industry's cost of funds at that point most likely.

Speaker 1

I think that's a great

Speaker 4

question. I think

Speaker 1

what it does is we're Then you could sort of stop the catch up, right? And so It then you don't have the large gap between your deposit base and maybe alternative money market and U. S. Treasuries. And so I think that's where the benefit comes in.

Speaker 6

All right. Fantastic. Thanks for your thoughts.

Operator

Thank you. We have had no further questions on the line. So I'd like to hand it back to Brad for any closing remarks.

Speaker 1

Very good. In closing, I would like to thank our Board of Directors and our senior management for their support and leadership. I 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

Speaker 6

of

Speaker 1

getting 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 all of you a great day.

Operator

Thank you all for joining. That does conclude today's call. Please have a lovely day, and you may now disconnect

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Key Takeaways

  • Independent Bank reported 4Q22 net income of $15.1 million ($0.71 EPS), up 20.6% year-over-year, and full-year 2022 net income of $63.4 million ($2.97 EPS) with a return on average assets of 1.31% and return on average equity of 18.41%.
  • The loan portfolio grew by 19.3% in 2022 (up $560 million), led by a 22% increase in commercial loans and continued double-digit annualized growth in 4Q, helping assets reach $5 billion at year-end.
  • Net interest income rose 18.4% in 4Q22 versus 4Q21, with a net interest margin of 3.52% (up 39 basis points), despite funding costs increasing by 46 basis points and a funding beta of 16.2% for the rate cycle to date.
  • Credit quality remained strong with nonperforming loans at just 0.1% of total loans, low 30-89 day delinquencies, and net recoveries, reflecting disciplined underwriting and robust reserves.
  • For 2023, the bank is targeting 10%–12% loan growth, 7%–9% growth in net interest income, a stable to slightly higher margin (+5–10 bps), provisions of 0.25%–0.35% of loans, controlled non-interest expenses, and up to 5% in share repurchases.
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Earnings Conference Call
Independent Bank Q4 2022
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