Independent Bank Corporation

Good morning and welcome to the Independent Bank Corporation Q3 2020 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. If there is a question, please press star then two. Please note 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 third quarter 2020 results. I am Brad Kessel, President and Chief Executive Officer, and joining me is Gavin Moore. Gavin joined our team on September 14th as EVP and Chief Financial Officer. Also from our team, we have Jim Mack, Executive Vice President, Commercial Banking, and Rob Schuster, who, with the hiring of Gavin, has moved to a senior financial advisor role with the company. Before we begin today's call, I would like to direct you to the important information on page two of our presentation, specifically the cautionary note regarding forward-looking investments. 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, independentbank.com. The agenda for today's call will include prepared remarks, followed by a question and answer session, and then closing remarks. We continue to execute on our operating plan that we share each quarter. This plan is built around diversified and balanced growth, process improvement and cost controls, talent management, and an enterprise-wide risk management framework. We believe following this plan will yield consistent and improving performance metrics over many quarters and many years. As we continue to navigate the many challenges brought on by COVID-19 pandemics, We are pleased to report a very strong financial performance in the third quarter of 2020. In fact, I would say our associates were simply amazing. The highlights include the following. We closed over $1.5 billion of mortgage loans, helping our customers buy new homes or refinance existing mortgage loans. Total deposit balances grew by over $100 million. We assisted our customers in completing and submitting PPP forgiveness applications to the SBA with over 14% of outstanding balances submitted. We maintain solid asset quality metrics during the third quarter of 2020, including decreasing COVID-19 related loan modification balances by 80%. As part of our ongoing branch optimization efforts, We closed an additional six branch locations during the third quarter, bringing the year-to-date closures to eight, and our total branch footprint to 60 locations. We announced our fourth quarter planned opening of a new branch in the Brighton, Michigan market, where we have had much success with the existing loan production office. Behind the scenes, our teams continue to advance our 2021 digital transformation. which included the third quarter rollout of a new mortgage point of sale system that leverages artificial intelligence. And just last week, we were very pleased to announce the appointment of Dennis Archer Jr. to our board of directors. Dennis is a talented executive with a wide range of business and entrepreneurial experience. He will be a significant contributor to our company's ongoing success. Most importantly, we continue to effectively operate our business continuity plan to safely serve our customers and protect our employees. Page four of our presentation lists some of the actions that we have taken since the start of the COVID-19 pandemic to protect our employees, clients, vendor partners, and the communities we serve. Today, our frontliners continue to do an outstanding job serving our customers. as do the approximately 38% of our total staff who continue to work remotely. Page five of our presentation provides a good snapshot of our historical financial performance and our efforts to produce consistent and improving operating performance quarter after quarter, year after year. Turning to page six, we reported third quarter 2020 net income of $19.6 million, or 89 cents per diluted share, versus net income of $12.4 million, or 55 cents per diluted share in a prior year period. This represents increases in net income and diluted earnings per share of 57.4% and 61.8%, respectively, compared to 2019. The increase in third quarter 2020 earnings as compared to 2019 primarily reflects increases in net interest income and non-interest income that were partially offset by increases in the provision for loan losses, non-interest expense, and income tax expense. Our mortgage banking team continues to be a key driver in our strong operating results. producing net gains on mortgage loans of $20.2 million, up 256% over 2019, and total mortgage loan origination volume of $536.5 million. Additionally, we continue to produce net deposit net growth of $112.6 million, or 3.2%. I continue to be pleased with our asset quality metrics where we saw a low level of early stage 30 to 89 day loan delinquencies, 0.20% at September 30th, 2020. Net loan recoveries during the quarter, a low level of non-performing loans and non-performing assets, and a significant decline in the level of loan accommodations. Despite the continued strong performance of our loan portfolios, We recorded a $1 million provision during the third quarter, bringing our allowance for loan losses to $36 million, or 1.44% of portfolio loans, when excluding Traverse City State Bank acquired loan balances and our PPP loans. For the nine months ended September 30, 2020, the company reported net income of $39.2 million. or $1.76 per diluted share compared to net income of $32.6 million or $1.40 per share, diluted share in the prior year period. This represents an increase in net income and diluted earnings per share of 20.3% and 25.7% respectively compared to 2019. Year-to-date, we have produced a return on average assets and a return on average equity of 1.36% and 14.87% respectively, compared to 1.28% and 12.84% in 2019. Tangible book value per share increased by 5.6% for the quarter to $15.55 per share at September 30, 2020. Page seven provides a view of our Michigan markets. Turning to page eight, we display several key economic statistics reflecting the literal shutdown of the Michigan economy during the second quarter of 2020. In addition to a solid housing market, we have seen noticeable improvement in statewide employment. Yet, there continues to be elevated levels of unemployment, and at the same time, labor shortages for many industries. On page nine, we provide a couple of charts reflecting the composition of our deposit base, as well as the continued growth in this portfolio while working to effectively manage our overall cost of funds. Since December 30th, 2019, our deposits, excluding brokered CDs, have increased by $598 million. with 113 million of this increase taking place during the third quarter. However, it's very difficult to determine how much of the overall deposit increase will stay in the bank and for how long. On page 20, we provide an update on our $2.9 billion loan portfolio. The commercial portfolio decreased by $11.2 million during the quarter. Mortgage loans decreased by $17.6 million, and the installment portfolio increased by $17.6 million. On page 11, we have an update on our loan modifications, which declined to less than $60 million, or just 2.1% of total portfolio loans as of September 30, 2020. With regard to the Paycheck Protection Program, we built an effective process to manage the high volume of applications for loans, as well as the applications for loan forgiveness. As of September 30th, we had 2,117 PPP loans for $261 million outstanding balances, and there was approximately $6.5 million of remaining unaccreted net fees related to PPP. We expect most of these fees to be accreted into interest income over the next 15 months. On page 13, we are displaying the concentrations or makeup of our entire commercial loan portfolio. The portfolio is very granular in nature, with the largest concentrations in C&I being manufacturing at 12%, construction at 9%, and retail at 7%. Within the CRE portfolio, the largest concentration is retail at 7%. Our credit metrics indicate this portfolio is holding up well, including loans in those industry sectors whose business has been more negatively impacted by the COVID-19 pandemic. Page 14 provides an overview of our investments at September 30, 2020, as well as activity during the quarter. I'm very pleased with how well our finance team has been able to deploy the increased cash levels in very liquid, high-quality, relatively short-duration assets generating high levels of cash payments. In terms of capital management, our capital levels continue to be strong with tangible common equity to tangible assets of 8.2% at September 3, 2020. We paid a quarterly cash dividend of 20 cents per share on August 14th and recently declared a 20-cent dividend on October 20th, payable on November 16th, as we believe our capital levels currently support the continuation of our dividend program. In regards to share repurchases, during the first quarter of 2020, we repurchased 678,000 shares through March 16th. before suspending the buyback in response to the economic uncertainty brought on by the COVID-19 pandemic. However, primarily as a result of the company's strong financial performance and improving economic conditions, and dependent upon market and other factors, we may begin to purchase our shares under the 2020 share repurchase plan during the last two months of the year. At this time, I would like to turn the presentation over to Gavin to share a few comments on our financials, credit quality, CECL, and our outlook for the fourth quarter of 2020.

Thanks, Brad, and good morning, everyone. I'm starting at page 16 of our presentation. Brad discussed the year-over-year increase on our net interest income during his remarks. I will focus on our margin. Our tax equivalent net interest margin was 3.31% during the third quarter of 2020. which is down 45 basis points from the year ago period and down five basis points from the second quarter of 2020. I will have some more detailed comments on this topic in a moment. Average interest earning assets were $3.89 billion in the third quarter of 2020 compared to $3.29 billion in the year ago quarter and $3.66 billion in the second quarter of 2020. Page 17 contains a more detailed analysis of the linked quarter increase in net interest income and the decline in the net interest margin. Like many other banks, our third quarter net interest margin was adversely impacted by three factors, a significant decrease in market interest rates, a surge in deposits and liquidity, and low relative yields on the PPP loan portfolio. Yet, we were able to overcome these challenges and post year-over-year and linked quarter increases in net interest income. We will comment more specifically on our outlook for net interest income and the net interest margin for the balance of 2020 later in the presentation. Moving on to page 18, non-interest income totaled $27 million in the third quarter of 2020 as compared to $12.3 million in the year-ago quarter and $20.4 million in the second quarter of 2020. Of course, the story here is our exceptionally strong mortgage banking revenues. Third quarter 20 net gains on mortgage loans increased to $20.2 million compared to $5.7 million in the third quarter of 19. The increase in these gains was due to an increase in mortgage loan sales volume and the mortgage loan pipeline, as well as stronger loan sale profit margins. Mortgage loan application volume was very strong in the third quarter 20. and continues to be strong at the start of the fourth quarter as we have both a solid purchase market and refinance volumes continue to be strong due to lower interest rates. Partially offsetting these strong gains was a $644,000 loss on mortgage loan servicing due to a $1.1 million or $0.04 per diluted shares after tax decrease in the fair value due to price and a $1.3 million decrease due to paydowns. of capitalized mortgage loan servicing rights in the third quarter of 20. As detailed on page 19, our non-interest expense totaled $33.6 million in the third quarter of 2020 as compared to $27.8 million in the year-ago quarter and $27.3 million in the second quarter of 2020. Performance-based compensation expense increased $4.5 million over the second quarter of 20, primarily due to an increase in the accrual for the annual management incentive compensation plan. This increases the result of significant improvements in performance metrics reflecting the strong third quarter 20 results. The third quarter of 2020 included $.64 million of conversion related expenses. We will have more comments on our outlook for non-interest expense later in the presentation. Page 20 provides data on non-performing loans, other real estate, non-performing assets, early-stage delinquencies. Total non-performing assets were $11.7 million, or 0.28% of total assets, at September 30, 2020. Non-performing loans decreased by $2.1 million, or 17% during the third quarter of 2020. Loans 30 to 89 days delinquent decreased to $5.8 million, compared to 8.4%. $1 million in the second quarter of 20. This marks the second consecutive quarter of improvement. Page 21 provides some additional asset quality data, including information on new loan defaults and on classified assets. Page 22 provides information on our TDR portfolio that totals $48.7 million as of September 30, 2020. This portfolio continues to perform very well with 93.7% of these loans performing, 92.7% of these loans being current at September 30, 2020. Moving on to page 23, we recorded a provision for loan losses expense of $1 million in the third quarter of 2020 compared to a credit of $300,000 in the year-ago quarter and a provision expense of $5.2 million in the second quarter of 2020. The single most significant factor driving the higher year-to-date provision for loan loss in 2020 was a $10.7 million increase in the qualitative subjective portion of the allowance for loan losses. This increase principally reflects the unique challenges and economic uncertainty resulting from the COVID-19 pandemic and the potential impact on the loan portfolio. The allowance for loan losses totaled $35.8 million. for 1.25% of portfolio loans at September 30th, 2020. This ratio increases to 1.44% when excluding the PPP loans and remaining Traverse City State Bank acquired loans. Page 24 provides an analysis of our allowance for loan losses under the incurred loss methodology and the CECL methodology at September 30th, 2020. Our calculated as-if CECL allowance at September 30, 2020, was approximately $44.8 million. This indicates that given the midpoint of our as-if day one CECL impact of $9 million, that the provision for loan losses in the first nine months of 2020 under CECL would have been similar to what we recorded under the incurred loss methodology. Page 25 is our update for the remainder of 2021. as well as comparison of our actual performance during the year to the original outlook that we provided back in January, 2020. As you can appreciate many of the factors that shaped our original outlook have changed dramatically given the economic upheaval from the COVID-19 pandemic. Loans decreased $11.2 million in the quarter, but are up 130.5 million from the year ago period due primarily to PPP balances. The year-end total portfolio loan balance and the fourth quarter 2020 activity will primarily reflect the pace of PPP loan forgiveness. Despite the aforementioned projected fourth quarter 2020 decline in portfolio loans, we expect the net interest margin to be relatively steady over the last quarter of 2020 due to the following factors. Lessening impact of lower interest rates, an increase in the overall average yield of the PPP loan portfolio due to paydowns resulting from an acceleration in the accretion of net fees, the deployment of excess liquidity from the deposit surge into securities available for sale during the third quarter. We expect relatively steady interest rates in the last quarter of 2020 as compared to the third quarter of 2020. The provision for loan losses is very difficult to forecast given the economic uncertainty that we are facing. However, we have seen an 80% decline in and total loan forbearance balances in the third quarter of 20 compared to the second quarter of 20. In addition, asset quality metrics presently remain solid. Current year-to-date provision is equal to 0.6% annualized of total portfolio loans. Our fourth quarter provision will primarily depend on the level of net loan charge-offs, loan defaults, and new forbearance activity, which were all low in the third quarter of 20. We expect non-interest income to average a bit above the high end of the original forecasted range in the fourth quarter, excluding any volatility associated with changes due to price and the fair value of the MSRs. Mortgage loan origination activity and application volumes have remained strong in October, but we do anticipate a seasonal slowdown in purchase activity and some cooling of the refinance activity as we move towards the end of the year. Non-interest expense was above the high end of the range in the third quarter of 2020, as a result of an increased accrual for incentive compensation due to strong year-to-date financial performance and conversion-related expense. We expect non-interest expense to be slightly above the high end of the range of the quarterly range of $27.5 to $28.5 million in the fourth quarter of 2020. Our effective income tax rate was 19.6%, third quarter of 20, which was generally in line with our forecast and thus we reaffirm our guidance for a 20% effective income tax rate. Finally, as Brad mentioned, after pausing the share repurchase activity on March 16, 2020, we anticipate that repurchase activity will be reactivated, subject to market conditions and other factors, effective October 30, 2020. That concludes my prepared remarks, and I would like now to turn the call back over to Brad.