Independent Bank Corporation

Good day and welcome to the Independent Bank Corporation second quarter earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch-tone 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 President and Chief Executive Officer Brad Kessel. Please go ahead.

Good afternoon 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 second quarter 2021 results. I am Brad Kessel, President and Chief Executive Officer And joining me is Gavin Moore, Executive Vice President and our Chief Financial Officer, and Joel Rahn, Executive Vice President, in charge of 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 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. Slide four provides a good summary of our historical results. We continue to execute on our operating plan that we share each quarter. This plan is built around diversified and balanced growth, process improvement, 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. Turning to page five, we are pleased to report continued strong financial performance for the second quarter of 2021. The highlights include an increase in net interest income of 3.1 percent over the second quarter of 2020, net gains on mortgage loans of $9.1 million, and total mortgage origination volume of $473.7 million. net growth in portfolio loans of $30.3 million, or 4.4% annualized, continued strong asset quality metrics, including net loan recoveries during the quarter, and the payment of a 21 cent per share dividend on common stock on May 14th of 2021. Independent Bank Corporation reported second quarter 2021 net income of $12.4 million or 56 cents per diluted share versus net income of $14.8 million or 67 cents per diluted share in the prior year period. The decline in the second quarter 2021 earnings as compared to 2020 primarily reflects a decrease in non-interest income and an increase in non-interest expense that were partially offset by an increase in net interest income and decreases in the provision for credit losses and income tax expense. Listed on page six are some of the more significant financial highlights year-to-date for 2021. These include increases in net income and diluted earnings per share of 75.8 percent and 77.3 percent respectively. Annualized return on average assets and return on average equity of 1.6% and 18.06%, respectively. Net gains on mortgage loans of $21.9 million, and total mortgage loan origination volume of $982.7 million. Net growth in portfolio loans of $80.9 million, or 6% annualized. Net growth in deposits of 225.1 million, or 12.5 percent annualized. Finally, our credit quality continues to be real strong, with net recoveries year-to-date, very low level of watch credits, past dues, and non-performing assets. For the six months ended June 30th, 2021, the company reported net income of $34.4 million, or $1 dollar and 56 cents per diluted share compared to net income of 19.6 million dollars or 88 cents per diluted share in the prior year period the increase in year-to-date 2021 earnings as compared to 2020 primarily reflects increases in net interest income and non-interest income and a decrease in the provision for credit losses that were partially offset by increases in non-interest expense and income tax expense. Significantly impacting comparable quarterly and year-to-date 2021 and 2020 results was the changes in the fair value due to price of capitalized mortgage loan servicing rights. Of a negative $2.4 million, or 9 cents per diluted share after taxes, and a positive $2.2 million or $0.08 per diluted share after taxes for the three and six months ended June 30th, 2021, respectively, as compared to a negative $2.9 million or $0.10 per diluted share after tax and a negative $8.9 million or $0.31 per diluted share after tax for the three and six months ended June 30, 2020, respectively. Our recent investments in new talent and in new technology have, during the first half of 2021, elevated our overall non-interest expense run rate. I do believe it is reasonable to see us return to the higher end of our guided quarterly range for non-interest expense as we move forward. Page seven. provides a good snapshot of our loan and deposit metrics for our Michigan markets. Turning to page eight, we display several key economic statistics for the state of Michigan. Interestingly, we have moved from the pandemic peak period of a restricted economy to the current period of a constrained economy. Overall, we are seeing continued improvement in the unemployment rate for Michigan. now at 5%. Yet we have 300,000 less employed workers today in the state as compared to pre-COVID. Labor shortages are having a noticeable impact on many segments of our economy, including an increase in wages in our markets and reductions in business operating hours. Concurrently, supply chain shortages are also constraining many businesses in our markets. Regional average home sale prices continue to climb as inventory levels in many of our markets are at record lows and negatively impacting the overall volume of home sales. 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. Like most in our industry, the extensive government stimulus continues to result in increased deposit levels for our customers. Turning to page 10, we have a few highlights relating to independent banks' digital transformation. This major strategic initiative, which started in 2019 with vendor reviews and kicked off an early 2020 with the selection of our new partner moved significantly forward during the second quarter of 2021 with our successful conversion to a new modern core platform with flexible application processing interfaces, also known as APIs. This change now allows us faster integration with new technology, real-time processing capabilities, and better access to our data and decision management using that data. Initial feedback from our customer base includes much excitement about OneWallet, our new mobile and online platform for consumer and business clients. This platform provides customers with the ability to open new accounts and apply for loans online, along with enhanced transfer, bill pay, and self-service capabilities. In addition, OneWallet Plus enables our customers to monitor all their finances in one location and provides budgeting and spending analytical tools. OneWallet Plus has experienced a very strong adoption rate. As we move forward during the second half of 2021, we will continue this digital transformation journey, implementing numerous day two elements, A whole bank core conversion involves extensive planning and extraordinary effort by many individuals. I am very thankful to and proud of our team in undertaking this challenge and positioning us to compete and ultimately grow market share. On page 11, we provide an update on our $2.9 billion loan portfolio. For the second quarter, commercial balances decreased by $56.7 million. However, excluding PPP activity, our commercial balances increased by $5.6 million for the quarter. This was also a net of several significant unexpected payoffs. Commercial line usage at 36% while up from the previous quarters continues to be soft. That said, the commercial pipeline is very strong, and our mortgage pipeline, while down from peak levels, continues to display strength. Our mortgage balance has increased by $45.1 million, and installment balance has increased by $41. $45.1 million in installment balances increased by $41.9 million. Respectively, I am optimistic about our ability to accelerate the earning asset rotation from lower yielding investments to higher yielding loans. My optimism stems from the numerous talented additions to our sales team from across our markets during the first half of 2021. I do believe we're on track to grow loans net of PP at the higher end of our original forecast. On page 12, we have an update on our loan modifications, which declined to $12.7 million or 0.5% of total loans at June 30th, 2021. Page 13 is an update on the bank's administration of the SBA's Paycheck Protection Program. As of June 30th, 2021, we had $172 million in balances outstanding and $5.8 million in net unaccreted fees. We expect most of these fees to be accreted into interest income over the next six to nine months. On page 14, we display the concentrations or makeup of our entire commercial loan portfolio. The portfolio continues to be very granular in nature, with the largest concentrations in CNI being manufacturing with 139 million, or 11%, construction at 9%, and retail at 6%. Within the CRE portfolio, The largest concentration is retail with $102 million or 8%. Our credit metrics indicate the portfolio continues to hold up 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 June 30th, 2021, as well as activity during this past quarter. In terms of capital management, our capital levels continue to be strong with tangible common equity to tangible assets of 8.2% at June 30th, 2021. We declared a quarterly cash dividend in our common stock of 21 cents per share. This dividend is payable on August 16th, 2021 to shareholders of record on August 6th. On December 18th, 2020, the board of directors of the company authorized the 2021 share repurchase plan. Under the terms of the 2021 share repurchase plan, the company is authorized to purchase up to 1,100,000 shares or approximately 5% of our outstanding common stock. The repurchase plan is authorized to last through the end of this year. For the first six months of 2021, the company has repurchased 344,005 shares at a weighted average price of $21.18 per share. At this time, I would like to turn the presentation over to Gavin to share a few comments on our financials, credit quality, and our outlook for the balance of 2021.

Thanks, Brad, and good afternoon, everyone. I'm starting at page 17 of our presentation. Net interest income increased $0.9 million from the year-ago period. Our tax equivalent net interest margin was 3.02 percent during the second quarter of 2021, which is down 34 basis points from the year-ago period and down three basis points from the first quarter of 2021. I'll have some more detailed comments on this topic in a moment. Average interest earning assets were $4.22 billion in the second quarter of 2021 compared to $3.66 billion in the year-ago quarter and $4.05 billion in the first quarter of 2021. Page 18 contains a more detailed analysis of the linked quarter increase in net interest income and the decline in net interest margins. Our second quarter of 21 net interest margin was adversely impacted by two factors, growth in securities available for sale and a decrease in PPP accretion. We will comment more specifically on our outlook for net interest income and the net interest margin for the remainder of 2021 later in the presentation. Moving on to page 19, non-interest income totaled $14.8 million in the second quarter of 2021 as compared to $20.4 million in the year-ago period and $26.4 million in the first quarter of 2021. Second quarter, 21 net gains on mortgage loans totaled $9.1 million compared to $17.6 million in the second quarter of 20. A 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 remain strong, although refinancing applications slowed in the second quarter of 21. Our purchase market volumes continue to be strong. Negatively impacting non-interest income was a $2 million loss on mortgage loan servicing due to a $2.4 million or $0.09 per diluted share after tax decrease in the fair value due to price. and a $1.4 million decrease due to paydowns of capitalized mortgage loan servicing rights in the second quarter of 21. As detailed on page 20, our non-interest expense totaled $32.5 million in the second quarter of 2021 as compared to $27.3 million in the year-ago quarter and $30 million in the first quarter of 2021. Compensation increased $1.5 million compared to the prior year quarter due to raises that were effective at the start of the year and increased over time related to the data processing conversion. Performance-based compensation increased $1 million due to an increase in the expected payout levels compared to the second quarter of 20. The second quarter of 2021 included $1.1 million of conversion-related expenses. We have more comments on our outlook for non-interest expense later in the presentation. H-21 provides data on non-performing loans, other real estate, non-performing assets, and early-stage delinquencies. Total non-performing assets were $5.4 million, or 0.12% of total assets at June 30, 2021. Non-performing loans decreased by $2 million, or 27.8% during the second quarter of 2021. Loans 30 to 89 days delinquent decreased to $3.5 million at June 30, 2021. compared to $3.9 million at March 31, 2021. Page 22 provides some additional asset quality data, including information on new loan defaults on classified assets and on classified assets. I would highlight there were no new commercial loan defaults in the first half of 2021. Page 23 provides information on our TDR portfolio that totaled $41 million at June 30, 2021. This portfolio continues to PERFORM WELL, 96.1% OF THESE LOANS BEING CURRENT AT JUNE 30, 2021. MOVING ON TO PAGE 24, WE REPORTED A PROVISION FOR LOSSES CREDIT OF $1.4 MILLION IN THE SECOND QUARTER OF 2021 COMPARED TO AN EXPENSE OF $5.2 MILLION IN THE YEAR AGO QUARTER AND A PROVISION CREDIT OF $500,000 IN THE FIRST QUARTER OF 2021. THE ALLIANCE FOR LOAN LOSSES TOLD OF $45.9 MILLION or 1.63% of portfolio loans at June 30th, 2021. This ratio increases the 1.75% when excluding PPP loans and the remaining Traverse City State Bank acquired loans. Page 25 is our update for 2021 outlook to see how our actual performance during the year compared to the original outlook that we provided in January of 2021. Our outlook estimated loan growth in the low single digits. Loans increased $30.3 million in the second quarter for 2021, or 4.4% annualized. Growth in mortgage and installment loans were offset by a decline in commercial loans due to a $62.3 million decrease in PPP loan balances in the second quarter of 21. Excluding PPP loans, total portfolio loans grew at a 6.2% annualized rate during the first six months, 2021 and was within our forecasted range. During the first six months of 2021, net interest income increased by 1.7 percent over 2020, which is a bit higher than our forecast. However, the net interest margin for the first six months of 2021 was 30 basis points lower than the full year 2020, the interest margin of 3.34 percent, which is deeper decline than our forecast. Higher-than-anticipated deposit growth has largely been deployed into lower-yielding investment securities. The primary reason for these variances is we were able to deploy more funds. As we were able to deploy more funds into the loan growth, we would expect the interest margin to stabilize. The second quarter 21 provision for credit losses was a credit of $1.4 million. This is below our forecasted 2021 four-year provision range, 0.25% to 0.35% of average total portfolio loans. The primary driver of the decrease in the provision for credit losses were a decrease in the specific reserves, qualitative reserves, and improvement in the unemployment forecast. If current credit trends persist, we would anticipate that our provision for credit losses will be below our forecasted range for the full year of 2021. Non-industrial income totaled $14.8 million in the second quarter of 21 compared to our forecasted range of $13 million to $16 million. The mortgage loan pipeline continues to be strong, although refinance activity slowed down in the second quarter of 21. Excluding negative NSR value adjustments due to price, we generally would expect non-interest income to fall within the forecasted range for the last half of 2021. Noninterest expense was $32.5 million in the second quarter, outside our $28.5 to $29.5 million targeted quarterly range. Increases in compensation and employee benefits, data processing, and conversion-related expenses were the primary categories that caused noninterest expense to exceed the targeted range. We do expect that the additional costs we have been incurring related to the core data processing system conversion to abate by the fourth quarter of this year. Our effective income tax rate of 17.7 and 18.4 percent for the second quarter and first six months of 2021 respectively was a bit lower than our forecast. This is due in part to higher than expected levels of tax-exempt interest income. Lastly, the company purchased 344,005 shares at an average cost of $21.18 in the first six months of 2021. That concludes my prepared remarks. I would now like to turn the call back over to Brad.