Q1 2020 Earnings Call

And the retail side 325 mortgage loan customers with 69.4 million and balances are 6.5% of the mortgage loan portfolio and two hundred and fifty million installment loan customers with 7.2 million imbalances or 1.5% of the installment portfolio. We're under a forbearance agreement.

The retail for marriage plans are principally are primarily principal and interest for up to 90 days.

With regards to the paycheck Protection Program. We have built an effective process to manage the high volume of applications where receiving custard of customer demand for this purpose has been strong through April 17th. We had received 1473 applications for $238 million loan requests.

786 applications for $172 million accepted by the SBA prior to the completion of the initial funding off on April 16th or 7:00 this morning our totals now or up to about two hundred and fifty million in total SBA loan approved in about 1800 customers in total that that have an SBA loan number.

On page twelve we are displaying the concentrations or make up of our entire commercial loan portfolio the chart on the left segmented by industry catalog reflects our C&I portfolio, including owner-occupied commercial real estate loans the chart on the right side made a segmented by collateral type reflects our investor real estate loans off. The percentage shown percentage is showing on both of these charts aggregate to one hundred percent of the entire 1.18 billion commercial portfolio.

Portfolios very granular in nature with the largest concentrations in C&I being manufacturing at 10% construction at 7% and Retail at 7% within the cre port phone. Now. The largest concentration is retail at 8%

Our team did a complete review of the entire portfolio and assess each borrower's ability to withstand economic difficulty for the next couple of quarters or linen and credit team scored the portfolio first on risk to the borrowers industry in the current environment between high medium and low.

Second they looked at the underlying Financial strength of the company in all guarantors to carry the company for up to three to six months of economic shut down the analysis indicates that our credit underwriting standards requiring more stringent terms and conditions for higher-risk Industries in general as well as strong sponsor support and liquidity appears to serve us well and all these categories nearly every relationship of size.

Does indicate their ability to withstand the environment for the next several quarters the remainder of the portfolio across those Industries are composed of many smaller relationships with varying degrees of our financial strength.

A breakdown of our deferrals by principal amount and PPP loans approved for those Industries where we have the largest portfolio balances or identified them as being of higher risk is as follows.

Real real estate rental and leasing including all investor real estate 49.9 million or 30% of our deferrals in only two point six million or 2% of our home loans.

Manufacturing 29.2 million or 18% of our deferrals and 30.2 million or 18% of our PPP loans.

Accommodation and Food Services twenty six point five million dollars or 16% of deferrals and 10.6 million or 6% of our PPP loans.

Retail 10.3 million dollars or 6% of deferrals in nine point four million or 6% of our PPP loans construction five point six million dollars or 3% of deferrals and 29.5 million or 17% of our p p p loans and Healthcare 1.3 million dollars or 1% of deferrals off 12.9 million or 8% of the PPP loans General the industries where we see the most risk or have the highest exposure are also the industries were deployed resources to assist during this difficult time.

The total principal amount outstanding for those customers in those six industries that have received deferrals is 122.9 million or 13.1% of the total principal exposure of 936 million for PPP. The total loans to these industries is about 95.2 million or 10:10.

Investment Securities available for sale increase 75.9 million during the first quarter 2020 page thirteen provides an overview of our investments that quarter in fact only 72% of the portfolio is Triple A rated or backed by us by the US government.

Terms of Capital management or Capital levels continue to be strong with tangible common Equity to tangible assets of 8.4% at March Thirty One hundred twenty. This is slightly black or the bottom end of our target range of 8 and 1/2 to 9 and 1/2 as a result of larger than previously planned investment purchases during the first quarter combined with our plans to repurchase activity. We anticipate moving back into our targeted tce range in the second quarter of 2020.

You paid a quarterly cash dividend of $0.20 per share on February 14th, 2020 in recently declared a dividend and April 21st is we believe that our Capital currently support the continuation of our dividend program during the first quarter 2020. We repurchased 678929 shares through Thursday 16th before suspending the buy back in response to the uncertain economic environment at this time. I would like to turn the presentation over to Steve to share a few comments and our financial credit quality Cecil and the outlook for the balance of twenty-twenty Steve. Thank you Brad. Good morning, everybody. I'm starting at a page fifteen of our presentation First Choice 20/20 net interest income declined by approximately $500,000 or 1.7% compared to the fourth quarter of 2019 due primarily to decline in our net interest month.

The decline in margin is partially offset by a thirty Point 1 million dollar increase in average earning assets are taxed equivalent net interest margin was 3.63% during the first quarter of 2020, which is down seven basis points from the fourth quarter of 2019 and down 26 basis points from the year-ago quarter average earning interest earning assets for $3,000 billion dollars in the first quarter of 2020 compared to 3.32 billion in fourth quarter of 1903 point one five billion dollars in a year ago quarter.

Turning to page 16. We have a bit more detail on the impacts the margin on a linked quarter basis. The primary factor in our margin change was the yield on average earning assets wage, which fell 14 basis points driven primarily by changes in yields on a commercial portfolio that portfolio is 49% variable with a reset frequency of 1 month for the for the majority of the variable rate Notes The Decline and asset yields was partially offset by improved funding costs as we responded quickly to the rate declines in the first quarter.

moving on

Page Seventeen non-interest income totaled $11 in the first quarter of 2020 as compared to $10 in a year ago quarter and 15.6 million dollars in the fourth quarter of 2018 the comparative quarterly changes. Were you having primarily by Mortgage Banking related activity namely change and net gains on mortgage loans and mortgage loan servicing income.

First quarter 2020 and that gains a mortgage loans increased to eight point eight million dollars compared to three point six million in the year-ago quarter and six point four million dollars into fourth quarter of 2012-13. The increase in these gains was due to increases in mortgage loan sales volume the mortgage loan Pipeline and our profit margin mortgage loan application volume continues to be very strong with birth rates driving significant refinancing activity. The application mix in the first quarter was 32% purchase and 68% refinance compared to all of 2019 where I am was 70% purchase and 30% refinance.

Red already discussed the changes in the fair value due to price of capitalized mortgage loan servicing rights are capitalized mortgage loan servicing rights asset of 14.8 million dollars at March 31st, 2020 represented a value of just fifty five basis points on our two point six billion dollars of mortgage loan servicing.

As detailed on page eighteen our non-interest expenses totaled twenty eight point seven million dollars in the first quarter of 2020 as compared to $28 in the year-ago quarter and $20,000 in the fourth quarter of 2019. First quarter not interest expenses were just above the high end of our projected range of 27 and 1/2 million dollars to twenty eight and a half million dollars.

Similar to the rest of the industry as we've expanded our suite of electronic banking products. We have experienced lower transaction counts across our Branch Network as we analyze the change in Branch traffic deposit growth and it needs of the communities. We serve we made the decision to consolidate eight branches as a community bank. It was important to us to make sure we considered the needs of our customers to still have physical access to a branch if they needed it in all cases. We have alternative branches very close to the closing facility with an average distance to the nearest alternative branch of less than five miles. Well, the furthest alternative branch is just over eight miles away. The cost savings are anticipated to be an excess of one point three million dollars annually and one time closing costs are anticipated to be approximately $800,000 with the majority of those expenses being realized in the second or third quarter.

Moving forward we will continue to be focused on expenses as opportunities exist to gain additional efficiencies as we optimize our delivery channels and focus on improving natural processes.

Page nineteen provides data on non-performing loans other real estate early stages delinquencies and non-performing assets total non-performing assets for eighteen point three million dollars or 5% of total assets at March 31st, 2020 non-performing loans increased by seven point two million dollars during the first quarter of 2020 driven primarily by the impact of one specific commercial loan relationship. This was watched credit at year-end. The migration from watched to non-performing was not directly related to covid-19. And we believe that we have books about fishing specific reserves related to this credit post quarter-end. We did receive full payoff on a retail rate relationship in non-accrual status of 1.2 million dollars.

And March 31st twenty twenty thirty two eighty ninety day commercial loan delinquencies were four basis points and mortgage and consumer loan delinquencies were 52 basis points off clear from the credit statistics at March 31st that we haven't begun to see the credit impact of covid-19 on our portfolio will discuss our approach to provision in a triple L shortly.

Page twenty provide some additional asset quality data including information on new loan defaults and unclassified assets for 9 and 1/2 million dollars or the date during 2012-13 driven primarily by the commercial loan relationship mentioned earlier.

Page twenty one provides information on RTD our portfolio that totalled fifty point five million dollars at March 31st, 2020 a decrease of $200,000 during the first quarter of this portfolio continues to perform very well with 95.3% of these loans performing and ninety 3.2% of these loans being current at March 31st, 2020. Am moving on the page twenty-two. We recorded a provision for loan losses of six point seven million in the first quarter of 2020 compared to $664,000 a year ago and a credit provision for loan losses of 221,000 in the fourth quarter of 2019. In addition. We recorded net loan charge-offs of $374,000 and $298,000 in the first quarters of 2020 and 2019, respectively.

The allowance for loan losses total 32 and 1/2 million dollars or 1.2% of portfolio loans at March 31st, 2020 all to provision and the allowance for loan losses were calculating wage calculated using are encouraged Los model.

Page twenty-three discusses our decision to stay with incurred until delay our adoption of Cecil until the end of the National Emergency or 12:31 2020. Whichever is earlier with our decision was driven primarily based on the lack of visibility into the impact of covid-19. Stay-at-home executive orders, increased employment unemployment eligibility and supplemental unemployment benefits on the economy are Cecil discounted cash flow model relies heavily upon a 2 year unemployment forecast and currently there's a wide range between the forecast that have been published by various economic sources in addition. The relationship between unemployment and its impact on credit is uncertain at this point. I'm like past economic Cycles in this event unemployment has been driven by stay-at-home executive orders unemployment benefits have been increased and the pool of recipients broadened.

this page discloses information

About both are incurred model and the assumptions that impact our allowance for loan loss calculation as well as our Cecil model its structure any assumptions. That would have driven our allowance for credit losses.

There's considerable considerable consistency in the assumptions between are encouraged and see some models that said it's prudent that we share some details of our Cecil model. So you can better understand our approach in our Cecil model. We're using a discounted cash-flow methodology with 14 loan segments are regression model uses a two-year forecast. With a two-year reversion to the long-term mean an employment is the primary driver.

Given the broad range of unemployment forecasts mentioned earlier we chose to use the median national unemployment rates from a collection of 55 analyst forecasts compiled by Bloomberg our first quarter 2020 Cecil calculation the median unemployment rates from the survey start at 12.8% in Q2 fall to 8.3% by the end of the year and reach 6% by the end of our projection. Then gradually fall to our long-term average of 5.9% over the reversion.

Please look at the chart on the lower left corner of the page for this following discussion under are incurred model on the left hand side of the chart our allowance increase by six point three million dollars off of 32 and 1/2 million dollars as of March 31st, 2020 this represented 1.2% of total loans while there was some significant movement in commercial related specific reserves, the four point nine million dollars of growth in a subjective allocation drove the majority of that change.

If we had adopted Cecil our day one adjustment has previously calculated and disclosed as of December 31st. 2019 would have been between $8 and $10 off using the midpoint of the Cecil range adoption would have increased our allowance at January 12020 by approximately 34.4% And total allowance for credit losses would have been 1.29% of total loans at March 31st. 2020 are Cecil allowance for credit losses would have been between 42 million and $45 implying an additional Reserve build under Cecil of between one and half million to 2 and 1/2 million dollars again, using the midpoint of that range.

In that instance the Cecil ACL would have been 33.9% higher than are incurred allowance. And the total Cecil allowance for credit losses would have been dead forty three and a half million dollars or 1.6% of loans.

Transitioning to page twenty-five. I'd like to share a few comments on our Outlook update for the first quarter of 2020 staying with the theme of the day. This is very difficult page due to the fact of certainty surrounding the economic and social toll that the covid-19 pandemic has created. I'm sure you'll understand that we caveat these comments and really the entire presentation with a reminder of these are estimates based on what we know today and ultimately all of these outcomes discussed may be greatly impacted depending upon the depth and duration of the covid-19 events. The first section is a long while we had modest loan growth of 3.2% annualized excluding loan securitizations and sales we can no longer be certain of continued portfolio growth excluding loans related to the program. We believe that loan growth will be flat too low single-digits.

We're net interest income.

We were targeting a full year twenty-twenty increase of approximately 1 to 2% over 2019. Obviously, we're in a very different interest rate environment than we were when we initially provided guidance our net interest margin for the first quarter of 2020 was 3.63% We would anticipate excluding again the impact of PPP and given that the current interest rate environment that margin will be relatively stable to a slight decline from our first quarter level for the rest of the year.

For provision or Outlook is based on incurred model instead of Cecil this line item more than most will depend on the depth and duration of the covid-19 events will be watching the economic environment and the portfolio were very closely to ensure that we provide appropriate allowance levels.

For not interesting come we estimated a quarterly range of 11 to 13 and 1/2 million dollars. We will keep that range in place for now higher volumes and mortgage loan refinance activity is boosting gains on mortgage loans in the near-term, which should offset slowing Point of Sales volumes on debit cards as stay-at-home orders persists as well as lower-than-expected home purchase activity as economic uncertainty and unemployment office potentially way on home sales. This is also caveat added by an assumption that we don't experience additional significant changes in the value of msrs due to price.

That interest expense for the first quarter of 2020 was just outside of the top end of our range at twenty eight point seven million dollars. We're still comfortable with this original range and believe that expenses wage will fall closer to the bottom end of the range do specifically to the branch closures impacting the second half of the year as well as select expense reductions in marketing and travel given the new economic environment that we're in

our outlook for income tax remains unchanged and lastly. We repurchased 670929 shares of the one point. One two million dollar or 1.12 million Chef authorization and additional repurchases are on hold at this time. Then concludes my remarks with today, and I'd like to turn the call back over to Brad Brad. Okay turning to page twenty-six. Thanks Steve as we began twenty-twenty. Our team was focused on continuing to execute on the initial initiatives reflected on this page. We will continue to move forward on these initiatives. In addition. We will continue to work to protect the health and well-being of our employees or customers in our community off at this point. We would now like to open up the call for questions.

We will now begin the question-and-answer session to ask a question. You may press * then 1 on your touchtone phone. If you are using a speaker phone, please pick up your handset before pressing the key to withdraw from the Quad you please press star then to the first question is from Brenda Nestle of Piper Sam, please go ahead.

Hey, good morning. How are you?

Morning briefing Brennan.

First of all, thank you for all the detail you provide. It's definitely been more than anything from most and was certainly helpful. So just to start off here curious on a installment portfolio. How do you guys expect that to perform through this cycle? You know, I get that. It's a higher FICO book, so it should hold up relatively well, but at the same time, you know it feel like if Farmers come under suggest, that's probably one of the first areas they look too kind of alleviated financial situation.

You know, that's a great question and the the team that over seas in that area has been in place for many years. And in fact, they they go back many of them to pre Great Recession and that book when she was smaller through the Great Recession performed very very well early again. Um, as I said in my prepared remarks the it's very granular Hi-Fi cose that that's part of the the business model with with the dealer Network that we have. We're really getting looks at only that that the best paper and and and then really dead.

Uh, you know, since the uh, uh covid-19 came through here, when we look at the birth parents activity only a very small percentage is has been requested so far so it'll be interesting to see if that changes here now as we come to each other month end, but for the the first month and we really just had very little for forbearance request come in. So I I feel good about that portfolio and and and in time we'll see what time will tell.

all right great thanks and then another one for me just kind of on the reserve going forward I get that you know larger Provisions are you know quite potential quarters ahead that makes complete sense to me but just as I think about the Reserve I mean as long way to think about it just to bring the reserve under the incurred loss methodology up toward that age level over the next few quarters as all of that forward-looking Cecil information in the model kind of actually comes to pass and gets baked Into The Incredibles model yeah I I I think that's a great way to look at it in in the coming quarters the gap between the two you know start to start to narrow but I think I think that's fair wage

All right. Great. Thank you for taking the question.

Thank you.

The next question is from Damon Del Monte, please go ahead.

Hey, good morning, guys. Hope everybody's doing well during these challenging times. First question. Just wanted to kind of circle back on the on the margin commentary, you know, Steve took a little perspective as uh, how much of that hundred fifty basis point rate cut has has been absorbed by the margin and and what you expect that could still come through here in the second quarter.

If you look at it, when rates fell from a timing point of view much of the commercial portfolio had changed with its reset Midway through March that being said there still is as you as you probably realize a bit to go yet. I'm resetting of those rates.

I need the positive side as well. We see that we have some more potential to get get better cost on that side is an outside too. So Thursday look to this quarter. Um, we may see a little bit of pressure on the asset yield side, but we will also get that additional benefit on the deposit side with the cost of funds wage. And so that's why we guided to a very slight decline perhaps but mostly flat relative to the first quarter.

So we have we have benefit on both sides coming down the pipeline.

Okay, and then you know as we look out a couple of quarters from here if we assume that, you know, this low-rate environment continues on is it fair to assume that? They're just going to come kind of like need to grind lower and um, you know, just put Midas pressure on the margin as we look out through 2020 and into twenty Twenty-One. Yeah, obviously excluding PPP but yes, that's the way I'm looking at it that it it'll be a very very slow grind we'll have some benefit on on the cost of fun side, but that'll ease up a little bit and that's why we're looking at a few basis points throughout the year going forward as far as potential decline.

Okay, great. And then with regards to the the p p p p what are you expecting for total fees to be realized from the your origination activity and how do you kind of see that being realized, you know over the coming quarters once those bones are forgiven.

Internally the analysis we've put together obviously includes some assumptions, right? So as Brad said through this morning, we're about two hundred fifty million dollars of of loans the fees for that are going to be somewhere in the realm of eight to ten million dollars. Uh, those will be uh a created over the lifetime of the loans. So what really ends up happening is it depends yield on those will depend ultimately on how soon they're forgiven and how much of the loan portfolio the PPP loan portfolio Is Forgiven and so in our internal analysis, we made the assumption that 80% were forgiven within a six-month. So if we look at the facts on that we look at the cost on that and we say 80% are forgiven or repaid within six months the yield on those loans are somewhere around the five to five to five and half percent.

if we

Look on the other side and say okay from one extreme to the other if all of those loans end up going to term and last the full 2-years the yield to be closer to 2.6% So it's it's really difficult to to look at it and forecast and say this is where it's going to end up but those are kind of the ranges as we're thinking from our assumptions point of view.

Got it. That's that's great color. I appreciate that thanx. Yep. And then I guess just lastly just the circle back in the the increase in the non-performing loans this quarter you referenced it was pretty much 1001 credit that that drove that $7 increase. Is that correct? Make sure I heard that right? Yeah, and actually Jim Mack who took our Commercial Banking group is on the call with us today and Jim could give a little bit of insight into that credit Jim sure. Good morning. So it was a good movie theater related deal with that has multiple locations to it. We had a pretty good plan in place to bridge the credit through to the summer season covid-19. Obviously change that plan, but we do have hard collateral on multiple locations in with very good facilities. So long term we think we have a very good chance of substantial recovery on that birth.

It has Steve. I think mentioned earlier. We do think we're properly reserved at it now.

Got it. Okay, and they just one quick final one. Did I hear? You said that the line utilization on your seen my portfolio went from 41% to 48% this quarter.

Went from 40 to 44 and it's stay for quarter-over-quarter. I believe in that it stayed flat post quarter in I think ever got them. Yeah.

I'm sorry. Yeah, we went from 44 to 48 and 48. It's let it for you. Okay?

Got it. Okay. That's all I had. Thanks a lot guys. Appreciate it. You're welcome.

The next question is from John. Roseth of big Partners, please go ahead. Good morning guys. Hope you're doing well.

You too, I guess most of my questions have been asked and answered but just one of the balance sheet. Maybe this is for you Steve this we saw some build up in the Securities portfolio. How should we think about the level of the portfolio going forward?

So if you look at the movement on the balance sheet, we had some fairly significant growth in deposits without corresponding growth on the loan side. So the Securities loan or the security guard folio booked up a bit, you know, that is something that that excess capacity is being utilized through PPP utilize through hopefully some additional loan growth. Uh, you know, that being said, it is not something that we're obviously targeting but at this point we're we're kind of in a wait-and-see mode to see what happens on a deposit portfolio don't know at this point what what we're going to ultimately see based on both sides of balance sheet, but that that level of of Investments is hopefully going to stay pretty stable then going forward.

Okay, super.

I understand I understand a lot of moving parts so okay got you thank you thank you and be well thank you you too Jaan

the next question is from Russell gandharva Davidson please go ahead

hi good morning guys

Wayne l so

I wanted to follow up on comments you guys made early in the presentation and just to make sure I understand it so the the six or seven kind of buckets you you rattled off wage you know manufacturing accommodation Food Services retail construction et cetera are those the pockets of the loan portfolio that are kind of most concerning to you within the early Innings of of this co-ed nineteen situation and and lack of visibility and if I if I'm not understanding that right perhaps you could just give us your thoughts in terms of thought maybe you stack ranking sort of whether that initial perceived risk might be sure yeah and I'd like I'd like Jim to maybe take for a shout at that gym so you know if you go back to page twelve maybe in in the in the presentation you know one of the one of the things Brad mentioned is we have a very Diversified granular portfolio in total so that gives me you know some level of comfort there but if

We look at the the hotel portfolio or the food service industry that we have on the chart on the left. Those are be High Risk Industries today. Certainly. It has we've dug into those dead. We really look at how we've structured deals over the last eight or ten years with lower loan-to-value is quicker and reservations. And we also look at the sponsors and in in guarantors to their liquidity wage levels to support that so we feel pretty good about some of these higher risk industries that we have good structures good Lona values to start out and good guarantor and in the sponsor support,

Okay, great. And then just digging into that a little bit if possible kind of at quarter-end are able to share kind of where the LTV in debt service coverage stands within a portfolios or you know, perhaps even more broadly just um maximum related criteria and and and minimum as it relates to get service off. Yeah. I mean, I don't have it very specifically each of those categories overall. We did take a look at that recently and I think it was about a 67% overall loan-to-value at a realistic art folios that service coverage when we underwrite varies by by the property type and hotels, it would typically be a 1.4 times that service coverage if Food Service in others, maybe a month or 1.2 and R&B reservations that we look at in those Industries are 15 to 20 years on the on the outside. We do not go longer than that.

Okay, great that it does. Yeah quite a bit. I appreciate it. And then just Switching gears for the final question. I had with regard to the updated loan guidance office. Could you share kind of where you would expect that loan growth to come from? You know, if in fact the low single-digits doesn't materialize

Well, I I think it's like so up to this point up to this quarter. We have 23 consecutive quarters of wage growth and and generally through that period of time it was fairly well-balanced. And so I guess I I would say at this point. It's probably the same kind of thing Russell it would be balanced. Um, I would say this we have tightened on the portfolio mortgage underwriting at this point and you know how quickly we I you know, he's up on that as things get clear. I don't know so but I think it'd be fair in the modeling to just sort of spread it even even lie.

Okay, great. I appreciate it guys. Thanks for the help. That's all I had.

This concludes our question-and-answer session. I would like to turn the conference back over to Brad castle for closing remarks.

Very good. I would like to thank each of you for your interest in Independent Bank Corporation and for joining us on today's call. We do wish like each of you peace and good health and have a great day.

The conference has now concluded thank you for attending today's presentation. You may now disconnect.