Independent Bank Corporation

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.

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.

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.