Q3 2020 Independent Bank Corp (Michigan) Earnings Call

We assisted our customers in completing and submitting PPP forgiveness applications to the SBA with over 14% of outstanding balance has submitted.

We we maintain solid asset quality metrics during the third quarter of 2020 including decreasing COVID-19 related mode loan modification balances by 50%

As part of our ongoing Branch optimization efforts, we closed an additional six branch locations during the third quarter bringing the year-to-date closures to 8 and our total Branchburg Sprint to 60 locations.

We announced our fourth quarter planned opening of a new branch in the Brighton, Michigan Market where we have had much success with the existing Loan Production Office.

Behind the scenes our teams continue to advance our 2021 digital transformation which included the third quarter roll out of a new mortgage point-of-sale system that leverages artificial intelligence.

Just last week. We were very pleased to announce the appointment of Dennis Archer Junior to our board of directors. Dennis is a talented executive with a wide range of business and entrepreneurial experience will be a significant contributor to our company's ongoing success.

Most importantly we continue to effectively operate our business continuity plan to safely serve our customers and protect our employees.

Page four of our presentation list some of the actions that we have taken since the start of the COVID-19 pandemic to protect our employees clients vendor partners and the communities we serve today our frontliners continue to do an outstanding job serving our customers as do the approximately 38% of our total staff who contribute to work remotely.

Page five of our presentation provides a good snapshot of our historical financial performance and our efforts to produce consistent and improving operating performance took after quarter year after year.

Turning a page six. We reported third-quarter 2020 net income of 19.6 million dollars or $0.89 per diluted share versus Net Income a twelve point four million dollars or $0.55 per diluted share in the prior year.

This represents increases in that income and diluted earnings per share of 57.4% and 61.8% respectively compared to 2019.

The increase in third-quarter earnings as compared to 2019 primarily reflects increases in net interest income and non-interest income that were partially offset by increases in the provision for loan losses, not interest expense and income tax expense.

Our mortgage banking team continues to be a key driver in our strong operating results producing net games on mortgage loans of 20.2 million dollars up 156% over 2019 and total mortgage loan origination volume of 536.5 million dollars. Additionally. We continue to produce net deposit deposit net growth of 112 point six million dollars or 3.2%

I continue to be pleased with our asset quality metrics where we saw a low level of early-stage 3289 day on delinquencies to 0% at September 30th, 2020 net loan recoveries during the quarter a low level of non-performing loans and non-performing assets and a significant decline in the level of like accommodations despite the continued strong performance of our loan portfolios. We recorded a $1000000 provision during the third quarter bring in our allowance for loan losses to $36 billion dollars or 1.44% of portfolio loans when excluding Traverse City State Bank acquired loan balances and our PPP loans.

For the nine months ended September 30th 2020 the company reported net income of 39.2 million dollars or $1.76 per diluted share wage compared to net income of thirty two point six million dollars or $1.40 per share diluted share in the prior year.

This represents an increase in net income and diluted earnings per share, 20.3% and 25.7% respectively compared to 2019 back today. We have produced a return on average assets and return on average Equity of 1.36% and 14.87% respectively compared with 1.28% and 12.84% in 2019.

Tangible book value per share increased by 5.6% for the quarter to $15.55 per share at September 30th 2012.

page seven provides a view of our Michigan markets

turning to page eight. We display several key economic statistics reflecting the literal shutdown of the Michigan economy during the second quarter of 2020.

In addition to a solid housing market we have seen noticeable Improvement in Statewide employment yet there continues to be elevated levels of unemployment and at the same time labor shortages for many Industries.

On page nine, we provide a couple of charts reflecting the composition of our deposit base as well as the continued growth in this portfolio while working to effectively manage our overall cost of life since December 30th, 2019 or deposits excluding brokered CDs have increased by $598 million dollars with 113 million of this increase wage taking place during the third quarter. However, it's very difficult to determine how much of the overall deposit increase will stay in the bank and for how long

On page twenty we provide an update on our two point nine billion dollar loan portfolio the commercial portfolio decreased by eleven point two million dollars during the court court mortgage loans decreased by 17.6 million any installment portfolio increased by 17.6 million.

On page eleven. We have an update on our loan modifications which declined to less than $60 million dollars for just 2.1% of total portfolio loans Thursday, September 30th 2020.

With regard to the paycheck Protection Program, we built an effective process to manage the high volume of applications for loans as well as the applications for loan forgiveness as of September 30th. We had 2117 PPP loans for $261 outstanding balances and wage only six point five million of remaining unaccredited net fees related to PPP. We expect most of these fees to be accreted into interest income over the next fifteen years.

On page thirteen, we are displaying the concentrations or make up of our entire commercial loan portfolio. The portfolio is very granular nature with the largest concentrations and seeing a high speed manufacturing at 12% construction at 9% and Retail at 7% within the cre portfolio. The largest concentration is retail at 15%

Our credit metrics indicate this portfolio is holding up. Well, including loans in those industry sectors whose business has been more negatively impacted by the COVID-19 demek.

Page fourteen provides an overview of our investments at September 30th 2020 as well as activity during the quarter. I'm very pleased with how well our finance team has been able to deploy The increased cash levels in very liquid high-quality relatively short duration assets generating high levels of cash payments.

In terms of Capital Management our Capital levels continue to be strong with tangible common Equity to tangible assets of 8.2% at September 30th 2025. We paid a quarterly cash dividend of $0.20 per share in August 14th and recently declared a dividend and October 20th available on November 16th, as we believe our Capital levels currently support the continuation of our dividend program.

In regards to share repurchases during the first quarter of 2020. Will you be purchased 678 thousand shares through March 16th before suspending the buy back in response to the economic uncertainty brought in by the COVID-19 kemik, however, primarily as a result of the company's strong financial performance and improving economic conditions wage and dependent upon market and other factors. We may begin to purchase our shares under the twenty-twenty share repurchase plan during the last two months of the year.

At this time, I would like to turn the presentation over to gather to share a few comments on our financials credit quality Cecil in our outlook for the fourth quarter of 2025. Thanks Brad can good morning everyone. I'm starting at page sixteen of our presentation. We had discussed a year-over-year increase in our net interest income during his remarks. I will focus on our margin tax-equivalent net interest margin was 3.31% during the third quarter of 2020, which is down forty five basis points from the year ago. And down five basis points from the second quarter of 12:20. I will have some more detailed comments on this topic in a moment average interest-earning assets for three point nine billion dollars in the third quarter of 2020 compared to three point nine billion dollars in the year-ago quarter and three point six billion dollars in the second quarter of 2020.

817 contains a more detailed analysis of the linked quarter increase in that interest income and the decline in the net interest margin like many other banks are third-quarter net interest margin was advised impacted by three factors a significant decrease in Market interest rates a surgeon deposits and liquidity and low relative yields on the PPP loan portfolio.

Yeah, we were able to overcome these challenges and post your over year and linked quarter increases in net interest income. We will comment more specifically on our outlook for net interest income in the net interest. Margin for the balance of twenty-twenty later in the presentation moving on to page eighteen not interest income totaled twenty seven million dollars in the third quarter of 2018 as compared to twelve point three million dollars in the year-ago quarter and twenty point four million dollars in the second quarter of 2020. Of course, the story here is are exceptionally Strong Mortgage Banking revenues third-quarter net gains on mortgage loans increased to twenty point two million dollars compared to five point seven million dollars in the third quarter of nineteen. The increase in wage gains was due to an increase in mortgage loan sales volume and the mortgage loan pipeline as well as stronger loan sale profit margins.

Mortgage loan application volume was very strong in the third quarter twenty and continues to be strong at the start of the fourth quarter as we have both a solid purchased market and refinance volumes continue to be strong do to lower interest rates partially offsetting. The strong gains is a $644,000 loss on mortgage loan servicing due to a 1.1 million dollar for $0.04 per month after tax decrease in the fair value price and a 1.3 million dollar decrease due to pay Downs of capitalized mortgage loan servicing rights in the third quarter 2018.

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On page nineteen or not interest expense total thirty three point six million dollars in the third quarter of 2020 as compared to twenty seven point eight billion dollars in the year-ago quarter and twenty seven point five million dollars in the second quarter of 2020 performance-based compensation expense increased 4.5 million dollars over the second quarter of twenty primarily due to an increase in the accrual for the annual management incentive Compensation Plan this increases the result a significant Improvement in performance metrics reflecting the strong third-quarter results the third quarter of 2012.

Point six million dollars of converging related expenses. We will have more comments or outlook for non interest expense later in the presentation.

Page twenty provide data on non-performing loans other real estate non-performing assets, early-stage delinquencies total non-performing assets were eleven point seven million dollars or down to 8% of total assets as September 30th, 2029 performing loans decreased by two point 1 million dollars or 17% during the third quarter of 2020 loans 30089 days delinquent decreased to 5.8 million dollars compared to eight point 1 million dollars in the second quarter of twenty. This marks the second consecutive quarter of improvement home 21, provide some additional asset quality data including information on new loan defaults and on classified assets page twenty-two provides information on RTD our portfolio that total 45.7 million dollars is September 30th, 2020 this portfolio continues to perform very well with ninety 3.7% of these loans performing ninety 2.7% of these loans being dead.

September 30th, 2020 moving on to page twenty-three. We recorded a provision for loan loss losses expanse on 1 million dollars in the third quarter $20 compared to add a credit of $300,000 in the year-ago quarter and a provision expense of five point two million dollars in the second quarter of 2020 the single most significant factor driving the higher year-to-date provision for loan loss in 2020 with a ten point seven million dollar increase in the qualitative subjective portion of the allowance for loan losses. This increased wages principally reflects the unique challenges and economic uncertainty resulting from the COVID-19 pandemic and the potential impact on the lone for

Allowance for loan losses totaled $35 or 1.25% of the loans at September 30th 2020 this ratio increases to 1.44% when when excluding the PPP loans and remaining Traverse City State Bank required loans.

Age 24 provides an analysis of our allowance for loan losses under the incurred lost methodology in the Cecil methodology of September 30th 2020 are calculated as if Cecil along the September 30th 2020 was approximately 44.8 million dollars this indicates that given the midpoint of our ads if Day One impact of nine million dollars. That's a provision for loan note in the first nine months of 2020 under Cecil would have been similar to what we recorded under the occurred loss methodology.

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Hi is our update or remain for a 2020 as well as comparison of our actual performance during the year to the original Outlook that we provided back in January 2020 if 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 decrease eleven point two million dollars in the quarter, but her up a hundred thirty point five million from the year-ago period due primarily to PPP balances.

The year-end total portfolio loan balance in the fourth quarter twenty activity will primarily reflect the pace of PPP loan forgiveness, despite the a prevention projected fourth quarter 2018 portfolio loan. We expect the net interest margin to be relatively steady over the last quarter of 2020 due to the following factors lessening the impact of lower interest rates and increasing my overall average yield of the PPP loan portfolio due to pay Downs resulting in acceleration in the accretion of net fees for the employment of excess liquidity from the deposit surged into security wage for sale during the third quarter.

We expect relatively steady interest rates in the last quarter of 2020 as compared to the third quarter of 2020. The provision for loan loss loss is a very difficult to forecast given the economic and took that we are facing. However, we have seen an 80% decline in total loan forbearance balances in the third quarter twenty compared to the second quarter 20, in addition asset-quality metronome personally remains solid current year-to-date provision is equal to 6% annualized of total portfolio loans are fourth-quarter provision will primarily depend on the level of net luggage charge off loan defaults and new forbearance activity, which were all low in the third quarter 20.

We expect non-interest income to average a bit above the high end of the original forecasted range in the fourth quarter, excluding any volatility associated with changes due to price in the fair value pack msrs.

Mortgage loan origination activity application volumes have remained strong in October but we do anticipate a seasonal slowdown and purchase activity and some cooling of the refinance activity to activity as we move towards the end of the year not interest expense was above the high end of the range in the third quarter of twenty as a result of an increase accrual for incentive compensation due to strong year-to-date through dating a performance and conversion related expense. We expect not interest expense to be slightly above the high end of the range of the quarterly rate high end of the quarterly range of 27.5 or 45 million dollars in the fourth quarter of 2020 are effective income tax rate was 19.6% third quarter twenty, which was generally in line with our forecast and last name refer more guidance for a 20% effective income tax rate.

Finally Brad mentioned after pausing the share repurchase activity on March 16th, 2020. We anticipate that repurchase activity will be reactivated subject to market conditions and other factors effective October 30th 2020 that concludes my prepared remarks and I would like to have to turn the call back over to Brad.

Thanks.

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and the first three quarters of twenty-twenty. They have been an extraordinary period of time for all of us as I mentioned at the beginning of my remarks. Our team continues to execute off any initiatives reflected on slide twenty-six of our presentation in addition to new initiatives as a result of the pandemic. We will continue to move forward both these plans wage unplanned Edition news while continuing to protect the health and well-being of our employees are customers in our community at this point. We would not like to open up the call for questions.

We will now begin the question on secession. Also question. You may press star then one on your telephone keypad. If you're using a speaker phone, please pick up your handset before pressing any keys to withdraw your question, please press * then two at this time. We will close momentarily to assemble our roster.

The first question comes from Brandon from Piper Santa please go ahead.

Hey, good morning. Everybody. Welcome together. How's everybody doing?

Good morning. Good morning. We're doing great. Thank you. Just want to start off on the outlook for you here appreciate the the guidance for a bit above the height of the Ring the next quarter off that implies a pretty substantial drop off in the fourth quarter. I'm assuming that that's on assumed lower mortgage activity. But you know, you guys did say that activities so far. It means pretty strong a date and I guess the outlook for origination the fourth quarter industry-wide is still pretty healthy. So just help us understand, you know, if there's something else that's driving that large expected decline or if you're just being conservative given how healthy mortgage has been so far this year.

Yeah. Yeah, I think you hit on it. They're point out first, you know that that expense is relative to the the performance of the mortgage book, but I think I would agree with you maybe being a little conservative. We do anticipate a Slowdown just season and seasonality of the mortgage production month coming coming in or coming to the end of the year. So I think you know, we would agree that if the pipeline systems like it did in in third-quarter we will be higher but we we are a little conservative on on uh, duplicating the third quarter.

Okay, perfect. And then one more for me just on the margin Outlook. I'm curious if the outlook for stable. Does that contemplate the five basis points benefit this quarter from accelerated paint accretion and then also how much PTP forgiveness and related accelerated fees is roughly baked into that outlook for stable margin.

Yeah.

With the Assumption in the stable margin would be that the ppp's continue to the accretion continued its current pace so clearly if we see a a significant pick up in those for the loan forgiveness, that would have a material impact and we we did factor in the the five basis points on the the the loan accretion.

Perfect. Thank you. Thank you my questions.

The next question comes from Damon Demonte from KBW, please. Go ahead.

Hey, good morning, guys. How's it going today?

Hi, David, good just to quickly follow up on the the margin question. So what was the the impact on the margin from from PPP this quarter?

It was five basis points.

Okay, and then the the impact from a credible yield was a similar level or no? Oh, I'm sorry. You were you were referencing the

Like I was there a dragon the margin from from the PPP loan because they were you know, generally lower-yielding than the rest of the portfolio.

Yeah, so yeah, if it's on page Seventeen the the accreted discount on Thursday.

So we were we were five basis points, you know Damon, let me let me locate that for you and come back to you on that. Yeah, no problem. No problem with you know with regards to loan growth or or lack of logo at this this quarter, you know installment was up. Could you talk a little bit about what was driving the growth in the installment walk-in kind of conversely. What was causing the commercial balances to to the client?

Okay, David. So the installment side we saw a very strong quarter in our indirect area. And that's an RV and that that momentum really continued out of the tail end of the second quarter off and I I would Envision that uh seasonally that will taper off as we close out the year and then when the the Dead shows begin in early January that that would pick back up over on the commercial side, you know.

It early earlier in the year. We were all focused on PPP as we moved to the third quarter. We sort of got past that money than we're still obviously very active on the TPP forgiveness, but we're starting to see some activity Improvement in the lifeline. The pipeline for the commercial book is up third quarter over second quarter and and and comment on mortgage then I turn it over to Jim because Jim Max and he could probably give a little bit more insight into terms of the the commercial book. And then finally on on the mortgage book well declined imbalances a small degree. Obviously what we had there was most of what we originated was Salem saleable product and I think one thing off

interesting in the last year

The Freddy Fannie definition of a jumbo mortgage increased substantially and now we're a little over $500,000 in what qualifies as a jumbo mortgage. So some of what in the past had been on the banks books as a portfolio mortgage has been reified out now into the secondary market so long and in Germany any further color on the commercial Pipeline and you know,

What part of the pay down which is good news? We did have some reduction on on the watch credits not cruel in July. So that was a good pay down the other good news Thursday September now through October. We basically remain flat and our commercial portfolio. So we are producing business to cover run off and extra pay off. But the challenge it continues to be there is a question you with our customers people being conservative. And so we're not seeing the same demand for loans within our customer base, but it is it has grown in the last three months.

Could you do you happen to have numbers on like line utilization the commercial portfolio and is very common to see those be paid down across the industry as you kind of went into the beginning part of the of the pandemic. Have you started to see a rebound and and people drawing back down on those line?

Yeah, we haven't really seen that happening yet. So there was a tremendous drop in the line usage from March through June and then we did see a little stick for a month or so that came back down to her line utilization stayed relatively flat here in the third quarter.

I said room at quarter. I'm excluding equipment and construction read about 30% if you add those interrupt about 40% less, correct?

Okay. All right, great. And then I guess you know with respect to the the provision and the outlook for you know, the the fourth quarter and kind of beyond what you feel comfortable with the reserve level just given the underlying credit Trends and you know, is there a way to kind of find out what you could expect for a provision in the fourth quarter?

Yeah, so, this is Gavin I think well, so if the trend continues we anticipate a relatively lower level of provision through your home, of course, that's you know, that can be impacted by by by different things emerging credit issues. But if the trend continues we anticipate that finishing out the year a bit of lower level.

Okay, great. All right. That's all that's all it adds. Thank you very much. Thanks.

The next question comes from Ryan Griffin from d a Davidson. She's go ahead.

Hey, good morning. This is Ryan on for Russell. I right.

I just had a quick question for the non interest expense guide going forward is the modestly higher expense guide, you know, primarily driven by the mortgage-related, or are there any other months pregnant factors driving that?

The the fourth quarter higher would be predominantly accruing at the higher levels for our annual management incentive Compensation Plan. So what we saw in the third quarter was a is a catch-up as we were both hitting. So if you go to our proxy Ryan, you can see that our plan has four categories for the incentive plan its EPS deposit growth and non-performing assets all four categories. We had quite a bit of catch-up here in the third quarter. And so I think we would again have month.

Just a higher level not so much catching up. But that's the driver in the fourth quarter see the higher expense of the mortgage production actually wage here to get run through games. Cuz most of that production is is sold in the secondary Market.

Great, and then just one more in the classified assets. It looks like you had a pretty meaningful drop quarter-over-quarter. Are you able to talk on some of the moving Parts there anything coming out of that bucket going forward?

So Jim, I don't know if you want to come out there.

I mean we continue to have good credit quality metrics and we have seen Improvement there. I really don't like to project things coming out of there necessarily in in fourth quarter, but we feel very comfortable on our credit metrics off to call this moment.

So so we dropped from 31 million to 21 million from the second quarter to third quarter and factors. That was probably just a handful of dry clean up a couple of credits. Yeah. So all in we I guess when you look at the chart, it looks like a a material amount. But the fact is we continue to have very low levels of classified assets at 6%

Okay, and then just one more touching back on the loan growth. I know you you gave some commentary on it earlier, but I was wondering if any other thoughts on, you know different pockets of strength heading into twenty twenty-one.

well, I I think

Yeah, first of all projections on 2021 at this point, we we haven't we're not really in a position to say what we think is going to happen. There's still a lot of uncertainty and I think in the in the coming weeks quarter will have a better field. I would say though, it feels like you know things are getting better in our in our markets say in the in the commercial side. You know, we're good things from our customer base gym. Yes, please were their performance so far. Yep. Yep, but it's very difficult at this point to

To project with the the the overall loan growth will be for 2021.

Got it. Thank you for taking my questions.

The next question comes from Kevin Swanson from the h d e group please. Go ahead.

I guess you know, I appreciate the the expense color and guidance just curious on the other side of that. Could you walk us through a digital or technology, you know initiatives or or pushes that you're you're doing for the franchise and and in particular which you know, some of the branch closures that you guys have done.

So that's a great question and I did reference our what we call digital transformation 20 21 in my prepared remarks month. So we we have a lot going on and I think in a nutshell at the end of 2019, we made the decision to change core providers and and move to a new partner. And that change over is in process easy as we speak so much of the first half of 2020. We we spent on really what we call the the system design and all the money all the systems interface with each other and and then we had a a couple of early applications going live here.

And uh twenty twenty one of those was a general ledger system a second one will be our call center and here in the third quarter. We are actually implemented a new mortgage point-of-sale system and under provided by a firm called blend and the black Knology really leverages artificial intelligence in enables us to streamline the the application process and and really reduce the number of touches and in short in the overall app to close time. So those are some of the the Hi-Life the core system actually will convert over in early second quarter of 2021. Yep.

We continue and we have them investing in our our Branch infrastructure, you know in terms of ATM technology. We've got some plans and she comes and you know that that it's it's an ongoing reinvestment in into our franchise. Hopefully that gives you a little color.

That's helpful. Thank you. And then, you know looking at the I guess in environment for lower rates for longer against them, you know strong success. You guys have had an adding deposit then, you know, maybe the the prospect for loan growth a little bit lighter in the past. Is there any change to I guess what the value of a core deposit relationship is in your mind.

You know that that that's a great question and and independent we have off and continued when we've always believed in gathering core deposits irregardless of where we're at in the cycle. I mean we had this coming out of a 20 2009 and and through fourteen fifteen when rates were really low and people in the market for backing off of corn and so of course deposits will continue to be an annual goal for us and there's there's no doubt that off.

It does impact the current Branch profitability formula if you will, but you know, we we think that I'm going forward the core deposit bases the true franchise value for CP.

Okay. Thanks. May I help you?

The next question comes from Bening and categorized please go ahead.

Good morning. Good morning. Good morning. Quick question one was on baseball analogy what inning of the refi boom bap. We're in right now.

Oh my well, that's a great question, you know just sort of formulating out loud, you know, we were very strong even before the pandemic and then we saw, you know, the FED take action game first name and drop rates to near zero and then you know continued to to roll, you know, I I think when I'm at 20 21, and I'll be it I said earlier it's difficult to forecast overall loan growth. When we look at twenty Twenty-One mortgage Nations. We think there will be some type of pullback from 2020, but we think we'll still be higher than you know,

on that

Maybe what?

Normal origination. Uh. It's so I don't know if that helps a little bit but I think there continues to be some level of of refi. Let me ask you if you refinanced yet only twice would you do it again song?

Not right now. No, okay. All right, but I think you're you're very difficult. People have done it. At least once maybe they're still are quite a few customers out there that have have hung on to their their current rates.

Got it. Thanks. And then other one I had another tough question. I missed an economy. What are the chances rods that there are more owners receive kind of reinstated on on the economy and businesses itself. And and how do you prepare for that? And I guess what what's your sense as far as the you know, the life is adding in in the in the in the give-and-take of that?

You know that that's a great question. So I I'm not sure if you're familiar, but

A few weeks back the Michigan Supreme Court ruled that the governor had over reached faith and some of the stay-at-home orders and and and so with that there's now took the position in in our state capitol where the governor needs to work with the legislature on sort of managing that black F or prospectively now the Michigan State Health Department as essentially laid out guidelines at home. I log in terms of you know, staying at home wearing masks social distancing and so on. So I I I'm hopeful that we don't go back to the club.

Dreams that we had before. I think the fast pass for us is if you know just each one of us is smart about you know, respecting the individual next to a so, I can't tell you for sure that we're not going to go back but I I I'm very hopeful that that we don't go go back like we were in the second quarter.

Appreciate that. Thank you.

The next question comes from Brendan also from Piper Sadler, please go ahead. Hey guys, just to follow up for me. So I believe that as a bank that I took the lead you guys need to adapt by by the end of the year. So if that is indeed the case, I mean if the best way to think about the impact where you guys just to look at the eight to ten million dollars in your ad this month scenario and run that through through retained earnings and then into the reserve or is there another way that we should be thinking about it? Oh you got it. Thanks God.

Yes.

Includes a question answer session like to turn the conference back over to Brad castle for any closing remarks.

I would like we would like to thank each of you for your interest in Independent Bank Corporation and for joining us on today's call and we wish each of you a great day.

A conference email concluded thank you for attending today's presentation. You may now disconnect.

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