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spk00: Good day and welcome to the Independent Bank Corporation fourth quarter 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 touchtone phone. To withdraw your 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.
spk05: 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 fourth quarter and full year 2020 results. I am Brad Kessel, President and Chief Executive Officer of 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 to the important information on page two 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 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. 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 frontline associates continue to do an outstanding job serving our customers, as do approximately 40% of our total staff who continue to work remotely. 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 in many years. As we continue to navigate the many challenges brought on by the COVID-19 pandemic, We are pleased to report very strong financial performance in the fourth quarter and full year of 2020. I am so proud of the job our associates did in persevering this past year, despite the extraordinary circumstances and challenges, all while staying focused on our purpose, that is assisting individuals and businesses to be independent. The highlights for our fourth quarter 2020 are shown on slide six and include the following. Independent Bank Corporation reported fourth quarter 2020 net income of $17 million, or 77 cents per diluted share, versus net income of $13.9 million, or 61 cents per diluted share in the prior year period. This represents increases in net income and diluted earnings per share of 22.4% and 26.2%, respectively, compared to 2019. Our return on average assets and return on average equity were 1.61% and 17.8%, respectively, compared to 1.56% and 15.9% in 2019. Our mortgage banking team generated net gains on mortgage loans of $15.9 million, up 149% over 2019, and total mortgage origination volume of $503 million for the fourth quarter. We were also pleased to see continued net growth in deposits of $39.6 billion, or 1.1% on a length quarter basis. Asset quality continues to be strong as evidenced by net loan recoveries during the quarter, a low level of non-performing loans and non-performing assets. We announced the payment of a 20 cent per share dividend on common stock on November 16th, 2020. And most importantly, we continue to effectively operate our business continuity plan to safely serve our customers and protect our employees. Page seven of our presentation provides a good snapshot of our historical financial performance and our efforts to produce consistent and improving operating performance year after year. For the year ended December 31, 2020, the company reported net income of $56.2 million or $2.53 per diluted share compared to net income of $46.4 million or $2 per diluted share in 2019. The increase in the 2020 fourth quarter and full year earnings as compared to 2019 primarily reflects increases in non-interest income that were partially offset by a decrease in interest income and an increase in non-interest expense and income tax expense. These full year results represent increases in net income and diluted earnings per share of 20.9% and 26.3% respectively compared to 2019. Our return on average assets and return on average equity were 1.43% and 15.7% respectively compared to 1.35 and 13.6 in 2019. Additionally, we were able to continue our annual trend of improving our efficiency ratio, this past year moving to 59.2% for all of 2020 versus 64.9% in 2019. Driving these results was strong net gains on mortgage loans. of $62.6 million, up 213% over 2019, and total mortgage origination volume for the year of $1.8 billion. Also for the year, we had deposit net growth of 600 million, or 19.8%. Finally, I am pleased to report our tangible common equity per share increased by 16% to $16.33 from $14.08 prior year end. Page eight provides a good snapshot of our loan and deposit metrics for our Michigan markets. On page nine, we display several key economic statistics reflecting the literal shutdown of the Michigan economy during the second quarter of 2020. However, since then, we have seen noticeable improvement and statewide employment. On the COVID-19 front, the Michigan Department of Health and Human Services had been closely monitoring three metrics for stabilization or declines over the past several months. Michigan continues to see improvements in these metrics, which has allowed for additional relaxing of protocols and reopening of activities. As a result, state government is opening up restaurants and bars on the 1st of February. Progress continues with the COVID-19 vaccine rollout. Healthcare workers, people over age 65, and other essential workers are currently eligible to receive the vaccine. On page 10, we provide a couple of charts reflecting the composition of our deposit bases. as well as the continued growth in this portfolio while working to effectively manage our overall cost of funds. On page 11, we provide an update on our $2.8 billion loan portfolio. For the fourth quarter, commercial balances declined by $109.4 million, mortgage balances declined by $8.1 million, and installment balances declined by $4.3 million. Despite the decline in commercial balances for the quarter, we are experiencing an increase in our commercial pipeline with the underlying economy showing strength, including the manufacturing sector. Additionally, the mortgage pipeline has continued to stay strong through the first three weeks into the new year. For the full year 2020, we did finish with net loan growth of $8.5 million over the prior year end. On page 12, we have an update on our loan modifications, which declined to $21.4 million or 0.78% of total loans at December 31, 2021. December 31, 2020. On page 13, we are displaying the update on the bank's administration of the SBA's Paycheck Protection Program. As of December 31, 2020, we had $170 million in balances outstanding, and $3.2 million in unaccreted fees. We expect most of these fees to be accreted into interest income over the next six months. Additionally, since round two or phase two of the program was opened up, we have received 760 applications for a little over $100 million to date. Currently, we estimate phase two volumes to range between 40% to 50% of what was originated in phase one by our team. On page 14, 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 11%, construction at 8% and retail at 7.5%. Within the commercial real estate portfolio, the largest concentration is retail at 7.8%. Our credit metrics indicate this portfolio continues to hold up very well, including loans in those industry sectors whose business has been more negatively impacted by the COVID-19 pandemic. This includes the hospitality and food service industries. Page 15 provides an overview of our investments at December 31, 2020, as well as activity during the quarter. In terms of capital management, our capital levels continue to be strong with tangible common equity to tangible assets of 8.6% at December 31, 2020. We paid a quarterly cash dividend of 20 cents per share on November 16th, and recently declared a 21 cent cash dividend on January 25th, 2021 payable on February 16th. This represents a 5% increase over 2019, and it's the seventh consecutive year we increased our cash dividend. On December 18th, 2020, our board of directors authorized a 2021 share repurchase plan. Under the terms of the 2021 share repurchase plan, the company is authorized to purchase up to 1.1 million shares, or approximately 5% of the outstanding common stock. The repurchase plan is authorized to last through the end of December 31, 2021. At this time, I would like to turn the presentation over to Gavin to share a few comments on our financials, credit quality, CECL, the scorecard for 2020, and our outlook for 2021.
spk07: Thanks, Brad, and good morning, everyone. I am starting at page 17 of our presentation. Net interest income increased $0.3 million from the year-ago period. Our tax equivalents Net interest margin was 3.12% during the fourth quarter of 2020, which is down 58 basis points from the year-ago period and down 19 basis points from the third quarter of 2020. I will have some more detailed comments on this topic in a moment. Average interest earning assets were $3.98 billion in the third quarter of 2020 compared to $3.32 billion in the year-ago quarter and $3.89 billion billion in third quarter of 2020. Page 18 contains a more detailed analysis of the linked quarter decrease in net interest income and the decline in the net interest margin. Our fourth quarter 20 net interest margin was adversely impacted by three factors. Increase in interest expense related to the acceleration of amortization of loss on certain de-designated derivative instruments, accelerated premium amortization on securities, and a decline in earning asset yield. We will comment more specifically on our outlook for the net interest income and the net interest margin for 2021 later in the presentation. Moving on to page 19, non-interest income totaled $22.4 million in the fourth quarter of 2020 as compared to $15.6 million in the year-ago quarter and $27 million in the third quarter of 2020. Of course, the story here is our exceptionally strong mortgage bank revenues. Fourth quarter, 20 net gains on mortgage loans increased to $15.9 million compared to $6.4 million in fourth quarter 19. The increase in these gains was due to an increase in mortgage loan sales volume and in the mortgage loan pipeline as well as stronger loan sale profit margins. Mortgage loan application volume was strong in fourth quarter 19. and continues to be strong at the start of the first quarter in 2021 as we have both a solid purchase market and refinance volumes continue to be strong due to the lower interest rates. Partially offsetting these strong gains was a $384,000 loss on mortgage loan servicing due to an $892,000 or $0.03 per diluted share after tax decrease in the fair value due to price and a $1.3 million decrease due to pay downs of capitalized mortgage loan servicing rights in the fourth quarter of 20. As detailed on page 20, our non-interest expense totaled $32.7 million in the fourth quarter of 2020 as compared to $29.3 million in the year-ago quarter and $33.6 million in the third quarter of 2020. Performance-based compensation expense decreased $2.8 million over third quarter 20, primarily due to a decrease in the accrual for the annual management incentive compensation plan. The third quarter of 2020 included $1.5 million of conversion-related expenses. We will have more comments on the outlook for non-interest expense later in the presentation. Page 21 provides data on non-performing loans, other real estate, non-performing assets, and early-stage delinquencies. Total non-performing assets, $8.6 million, or 0.21% of total assets at December 31, 2020. Non-performing loans decreased by $2.3 million, or 23% during the fourth quarter. Loans 30 to 89 days delinquent increased to $13.2 million compared to $5.8 million in the third quarter of 20. Two commercial loans totaling $7.6 million make up this increase. Since December 31st, one of these loans has paid off and the other has become current. Page 22 provides some additional asset quality data including information on new loan defaults and on classified assets. Page 23 provides information on our TDR portfolio that totaled $48 million at December 31st, 2020. This portfolio continues to perform well with 94.2% of these loans performing and 87.3% of these loans being current at December 31st, 2020. Moving on to page 24, we recorded a provision for loan losses credits. of $421,000 in the fourth quarter of 2020 compared to a credit of $221,000 in the year-ago quarter and a provision expense of $1 million in the third quarter of 2020. The single most significant factor driving the higher year-to-date provision for loan losses in 2020 was an $11.2 million or 128.3% increase in the qualitative or 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 $35.4 million or 1.3% of portfolio loans at December 31st, 2020. This ratio increases to 1.43% when excluding the PPP loans and the remaining Traverse City State Bank acquired loans. The adoption of CECL was delayed following the updated guidance included in the second COVID-19 relief bill passed in December of 2020. We expect to adopt CECL as of January 1, 2021 as allowed under the CARES Act extension. Page 25 provides an analysis of our allowance for loan losses under the incurred loss methodology and the CECL methodology at December 31, 2020. We estimate the increase to the allowance for loan losses to be in the range of $10.5 million to $12.5 million when CECL is adopted. The increase in the range over previously disclosed range is due to certain discounted cash flow model enhancements. Using the midpoint of our range are calculated as if CECL allowance at December 31st, 2020 was approximately $46.9 million or 1.72% total loans. Page 26 is our final update for our 2020 outlook to see how our actual performance during the year compared to the original outlook that we provided back in January of 2020. Our outlook estimated loan growth at approximately 7%, 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 $121.8 million in the first quarter, but increased 8.7 million or 0.3% from the prior year end. This growth is primarily due to PPP loans. The economic impact of the COVID-19 pandemic created challenges in our lending environment that were unforeseen at the beginning of the year. Net interest income grew by $1 million or 0.84% compared to a forecast of 5% for full year 2020. The original forecast assumed stable rates throughout the year, The rate environment for full year 2020 has been very different than the original forecast. Actual short-term rates declined 101.5% and long-term rates declined by approximately 1%. The net interest margin contracted by 46 basis points on an annualized basis. The growth in net interest income was generated by an increase and interest earning assets of $483.8 million and fee income accretion related to the Paycheck Protection Program. As a result of the CARES Act extension, we did not adopt CECL in 2020 as forecasted. The full year 2020 provision was $12.5 million or 0.43% of the annualized average total loans. This is outside the forecasted range of won 5% to 0.2% of average total loans. This provision includes an increase in the qualitative reserve of $11.2 million due to the shock from the COVID-19 pandemic. Non-interest income increased 69.2% in 2020 compared to the forecast of 3% to 4%. Higher than forecasted mortgage production combined with higher margins on sale of mortgages was a catalyst to our to our outperformance. Non-interest expense increased 9.56% for full year 2020, well above our forecasted range. The increase in 2020 compared to 2019 was driven primarily by an increase in performance-based compensation expenses related to the data conversion. Our effective income tax rate was 19.18% for full year 2020, which was generally in line with our forecast. After pausing the share repurchase activity on March 16th, 2020, the plan was reactivated effective October 30th, 2020. The company purchased 30,027 shares at an average cost of $14.90 in the fourth quarter of 2020. Total shares purchased in 2020 was 708,956 shares at an average cost of $20.07. Turning to page 27, This will summarize our initial outlook for 2021. The first section is loan growth. We anticipate loan growth in the low single-digit range and are targeting a four-year growth rate of 1% to 2%. Excluding PPP loans, our target growth rate range is 5% to 7%. We expect to see growth across all three of our loan portfolios. This outlook assumes an improving Michigan economy. Next is net interest income. where we are forecasting a slight increase of a half percent over full year 2020. We expect the net interest margin to trend lower compared to full year 2020 by 10 to 15 basis points, primarily due to declining yields on earning assets. This forecast assumes no change in target federal funds rate in 2021, with long-term rates up slightly by year end. We expect to adopt CECL as a 1-1-21. The initial CECL adjustment is expected to be approximately $10.5 to $12.5 million. This adjustment is subject to certain financial review procedures that will be completed in the first quarter of 2021. A four-year 2021 provision expense for the allowance for credit losses of approximately 0.25% to 0.35% of average portfolio loans would not be unreasonable. Related to non-interest income, we estimate a quarterly range of $13 million to $16 million. We expect mortgage loan origination volumes to decline by approximately 30% in 2021, combined with declining margins on loans sold. Our outlook for non-interest expense is a quarterly range of $28.5 million to $29.5 million, with the total for the year 4% to 6% below 2020 actuals. We expect total compensation employee benefits to be lower in 21 compared to 2020 due primarily to the reduction in incentive compensation. Our outlook for income taxes remains the same in 2021 as it was in 2020, an effective rate of approximately 20%. Assuming the statutory federal corporate income tax rate does not change during 2021. Lastly, we believe that the share repurchases Purchases will be at the midpoint of our authorization of approximately 5% of outstanding shares. That includes my prepared remarks. I would like now to turn the call back over to Brad.
spk05: 2020 has been an extraordinary period of time for all of us. As I mentioned at the beginning of my remarks, our team continues to execute on the initiatives reflected on slide 28 of the presentation. One of the most significant initiatives is our digital transformation, which began early in 2020 with our announced change in core processing partners and the planned move to a real-time core banking platform. Through 2020 and now into 2021, we have achieved numerous key milestones on this journey. Later in 2021, we are excited to provide to our customer base a unified and enhanced digital and mobile banking experience. A strong digital offering is essential to compete in today's fast-changing digital world. And if we learned anything from 2020, it is the importance of PPP in today's world. And that is people, perseverance, and purpose. At this point, we would like to open up the call for questions.
spk00: We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. Our first question today will come from Brendan Nosal with Piper Sandler.
spk06: Hey, good morning, Brad and Gavin. How are you folks?
spk05: Good, Brandon. Good morning to you. Good morning.
spk06: I just want to start off on the margin for this quarter and just try and figure out what the appropriate way to think about the underlying core level is. So if I remove the $1.6 million of one-time interest expense that you guys took this quarter, as well as the impacts of PPP from both the numerator and denominator of the margin, I kind of get to a core underlying level of 306. Is that a reasonable way to think about kind of the true margin X noise?
spk07: Yeah, I would agree with that, Brendan.
spk06: Okay, great. And then just a follow-up on that, given that starting point and the outlook for for 2021. So I guess you're looking for 10 to 15 bits of compression from the 334 level. So I guess that gets us to a 320 or 325, which is a good bit from that 306 core level. So just kind of walk through the puts and takes and how you get from where the underlying margin ended the year to kind of how you're seeing it play out for 2021.
spk07: Yeah, sure. So a couple of things. I think at the end of the year, specifically for fourth quarter, for sure we saw acceleration in the premium amortization on the investment portfolio. So one issue there, I think that's above what we're going to see on average for next year. So that slowdown should add some yield to the portfolio. And then secondly, as we see loan growth come on next year at a higher yield, it should increase the be able to increase in the first quarter or so.
spk06: Got it. That's definitely helpful. And then just one final one for me. The NII outlook, half a percent growth, that's off of the reported base of $123.6 million, correct?
spk07: Can you repeat that, Brent? I'm sorry.
spk06: Yeah, sure. The outlook for NII growth of half of a percent That's off of the reported base of $123.6 million, correct? That's correct. Great. Thanks for taking my questions. Thank you.
spk00: Our next question comes from John Rodas with Danny.
spk03: Good morning, guys.
spk05: Good morning, John. Good morning, John.
spk03: Hope you guys are doing well. Just, I guess, as a follow-up to the last question on your net interest income guidance, the plus 0.5%, does that include any impact of the next round of PPP?
spk07: Yeah, it does. We do have some revenue in 2021 regarding the second round, yeah.
spk03: So is, I think, in your perspective, prepared remarks. You said you thought round two could be 40 to 50% of round one. Is it, so are you sort of assuming that and taking the fees off of that into your guidance? Yeah. Okay. And okay. And then, you know, Brad, maybe just sort of big picture. What, what, what are you hearing from, you know, from your clients, from your borrowers today about, you know, how do they feel about the economy and so forth?
spk05: Well, that's a great question, and I'll give you an initial response, but we have Joel Ron with us today, and Joel heads up our commercial banking area, and I would say generally very optimistic about 2021 as we get past the first quarter and as the vaccine gets rolled out through the entire populations within our markets. Obviously, there are certain sectors of our economy that have been more negatively impacted than others. Coming out of a board meeting earlier this week and getting feedback from Just that group, which is representative of a number of different industries within the state, there was also that optimism for the second half of 2021. Joel, do you want to add?
spk02: I think you summed it up well. The obvious sectors that are struggling are the hospitality-related just because they just haven't been able to function at their full capacity, if at all. But core manufacturing, construction activity, it remains pretty solid. Very good, Joel.
spk03: Thanks, guys. Thank you for the color.
spk00: Our next question comes from Joe Plevelich with Benning and Scattergood.
spk04: Good morning. Good morning, Joe. Good morning, Joe. Good morning, guys. Question on the impact of the CECL adoption, the $10.5 million to $12 million, will that flow through the income statement or that will be all retained earnings? And then I think you hinted that the allowance might be $47 million or so, 1.7% of loans. Do you see that as where it will likely settle in over the longer term? And if not, what do you think a good number to use in the longer term is for allowance of loans?
spk07: So regarding the adjustment to CECL, that will run through retained earnings. And then that calculation of where we're at is inclusive of, so the 1.7 is inclusive of PPP. So ex-PPP, you're over 1.8 to maybe 1.85. I think our forecast, you know, I know our forecast says, you know, longer term, given the economy approves, some of that qualitative reserve will probably ease up. although we are anticipating maybe a more normalized charge-off environment. So having said all that, we believe that is an appropriate level to begin.
spk05: Yeah, I think that's good. And the other thing, again, the one-time adjustment, those are pre-tax.
spk07: Yes.
spk04: Thanks, Brian. And then the buyback. Do you expect to be kind of programmatic and do a certain amount each quarter or more opportunistic? And what gives you confidence that, you know, two and a half is the right number versus, say, trying to use it all?
spk05: Well, great question, first of all. And I would say we would probably see ourselves as being more consistent with the buyback as opposed to maybe opportunistic. Really, over time, quarter after quarter, with an understanding of delivering on our forecasts, cognizant of capital levels, cognizant of cash at the holding company, cognizant of growth rates as well as other, you know, growth opportunities. So I think, again, we're going to probably be more consistent with the share repurchase as opposed to opportunistic.
spk01: Thanks.
spk00: And if you have any further questions, please press star and then 1 to join our queue. Our next question will come from Russell Gunther with DA Davidson.
spk01: Hey, guys. This is Ryan on for Russell Gunther. I just had a quick question on the expense guide for 2021. You know, in addition to the reduction in incentive comp in the new year, are there any other meaningful levers to drive that expense ratio down?
spk05: Ryan, this is Brad. Dan, have you got a quick answer to that?
spk07: In terms of, are you saying outside of the compensation piece? Ryan, can you maybe ask the question again?
spk01: Yeah, sure. So I was just wondering, you know, outside of that compensation piece, are there any other plan reductions and expense that will drive down to that lower range that you had guided to?
spk07: Yeah, so the big one, obviously, is going to be the expense. The comp expense, correct, yeah. And then, obviously, we're ongoingly evaluating the expense structure. If you're talking non-interest specifically, I do anticipate there'll be some savings in interest expense relative to the de-designation, too. I should have mentioned that earlier.
spk05: I don't know, Brad, if you want to do any more. Yeah, you know, so in 2020, $19 million was recorded in performance-based compensation. And probably half of that related to our annual incentive plan. And then the balance was for various other programs, I'd say a good chunk of it relative to our uh, mortgage banking unit and, um, and hitting some milestones there. So, um, I, I think we feel like in, in that category, um, we've got a lot of, uh, um, variability based on, on how the overall company is, is doing after that, you know, uh, we're going to, as we have been year after year, uh, uh, you know, uh, hone in on each category. We closed eight locations in 2020 and achieved some material cost saves. Our branch optimization team, if you will, is continuing to look at other opportunities. The really tough one, Ryan, to nail down right now is We have spent almost two years on this effort to change core partners and core processing platforms. And there were material contractual savings, which we're realizing at this point. But the backroom efficiencies, which we know will be there, are very difficult to quantify right now. And if anything, we're to get the conversion done in a manner that is, you know, at least negative impact to our customers, we have been running with a higher cost structure intentionally. And so I think there are some areas for improvement, but they're difficult to just quantify for you today.
spk01: Got it. Thank you very much.
spk00: And our next question is a follow-up from John Rodas with Jannie.
spk03: Hey, Brad. Just one follow-up. Just the recent announced acquisition between TCF and Huntington. Just your thoughts, potential opportunities for you guys, you know, within your Michigan footprint.
spk05: Well, John, thanks for the question. And it's a material event, obviously, within our markets. Between the two financial institutions, we compete with them in almost every one of our markets. And obviously, well, they announced here in the last week the closure of almost 200 locations So, that just will be opportunities for talent acquisition and will be opportunities for customer acquisition. I would point to our track record. We've had this disruption going on in our marketplace as the industry continues to consolidate for a number of years. You know, as we've shared with you and others, you know, we have, I think, been very successful in adding talent and customers to our company.
spk03: Yep, I think it could be a real opportunity. So thanks, guys.
spk02: Thanks, Ken.
spk03: Thanks.
spk00: This concludes our question and answer session, and I'd like to turn the call back over to Brad Kessel for any closing remarks.
spk05: 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 everybody a great and safe day.
spk00: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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