Good morning. And welcome to Independent Bank Corporation Q3 2020 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that 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. Thank you for joining Independent Bank Corporation’s conference call and webcast to discuss the company's third quarter 2020 results. I am Brad Kessel, President and Chief Executive Officer. And joining me is Gavin Mohr. Gavin joined our team on September 14, as EVP and Chief Financial Officer. Also from our team, we have Jim Mack, Executive Vice President, Commercial Banking, and Rob Schuster who with the hiring of Gavin has moved to a senior financial adviser role with the company. 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. 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 and many years. As we continue to navigate the many challenges brought on by COVID-19 pandemic, we are pleased to report a very strong financial performance in the third quarter of 2020. In fact, I would say our associates were simply amazing. The highlights include the following: We closed over one half billion dollars of mortgage loans, helping our customers buy new homes or refinance existing mortgage loans. Auto deposit balances grew by over $100 million. We assisted our customers in completing and submitting PPP forgiveness applications to the SBA with over 14%…

Thanks, Brad. And good morning, everyone. I'm starting at page 16 of our presentation, Brad discussed the year-over-year increase in our net interest income during his remarks I will focus on our margin. Our tax equivalent net interest margin was 3.31% during the third quarter of 2020, which is down 45 basis points from the year ago period and down five basis points from the second quarter of 2020. I will have some more detailed comments on this topic in a moment. Average interest earning assets were $3.89 billion in the third quarter of 2020 compared to $3.29 billion in the year ago quarter, and $3.66 billion in the second quarter of 2020. Page 17 contains a more detailed analysis of the linked quarter increase in net interest income and the decline in the net interest margin. Like many other banks, our third quarter net interest margin was adversely impacted by three factors; the significant decrease in market interest rates, a surge in deposits and liquidity and low relative yields on the PPP loan portfolio. Yet, we were able to overcome these challenges and post year-over-year and linked quarter increases in net interest income. We will comment more specifically on our outlook for net interest income and the net interest margin for the balance of 2020 later in the presentation. Moving on to page 18, non-interest income totaled $27 million in the third quarter of 2020 as compared to $12.3 million in the year ago quarter, and $20.4 million in the second quarter of 2020. Of course, the story here is our exceptionally strong mortgage banking revenues. Third quarter 2020 net gains on mortgage loans increased to $20.2 million, compared to $5.7 million in the third quarter of 2019. The increase in these gains was due to an increase in…

Thanks, Gavin. In the first three quarters of 2020, 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, and the initiative is reflected on slide 26 of our presentation. In addition to new initiatives as a result of the pandemic, we will continue to move forward both these planned and unplanned additions, while continuing to protect the health and wellbeing of our employees, our customers and our community. At this point, we would now like to open up the call for questions.

We’ll now begin the question-and-answer session. [Operator Instructions] The first question comes from Brendan Nosal from Piper Sandler. Please go ahead.

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

Good morning.

Good morning. We're doing great. Thank you.

Just wanted to start off on the outlook for Steve here. Appreciate the guidance for a bit above the high end of the range next quarter. But that implies a pretty substantial drop off in the fourth quarter. I'm assuming that's on assumed lower mortgage activity. But you guys did say that activity so far remains pretty strong quarter to date. And I guess the outlook for originations in the fourth quarter industry wide is still pretty healthy. So just help us understand 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.

Yes, thanks. Yes, I think you hit on it there. Just point out first, you know that expenses relative to the performance of the mortgage book. But I think I would agree with you maybe being a little conservative, we do anticipate a slowdown this season and seasonality of the mortgage production coming in, or coming to the end of the year. So I think, we would agree that if the pipeline performs like it did in third quarter will be higher. But we are a little conservative on 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 discount accretion? And then also, how much PPP forgiveness and related accelerated fees is roughly baked into that outlook for stable margin?

Yes, so if the assumption the stable margin would be that the PPPs will continue to, the fee accretion continued at its current pace. So clearly, if we see a significant pickup in those for the loan forgiveness, that would have a material impact. And we did factor in the five basis points on the loan accretion.

Thank you for taking my questions.

The next question comes from Damon DelMonte from KBW. Please go ahead.

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

Hi, Damon. Good.

Just quickly follow up on the margin question. So what was the impact on the margin from PPP this quarter?

It was five basis points.

Okay, and then the impact of a credible yield was a similar level. Or no?

Oh, I'm sorry. You were you were referencing the…

Like, was there a drag in the margins from the PPP loans, because they were, generally lower yielding than that the rest of the portfolio?

Yes, so yes, it's on page 17. The accreted discount on Tuesday. So we were we were five basis points. Damon, let me let me locate that for you and come back to you on that.

Yeah, no problems, no problems. With regards to loan growth or lack of loan growth this quarter, you know installment was up? Could you talk a little bit about what was driving the growth in the installment? And then kind of conversely, what was causing the commercial balances to decline?

Okay, Damon. So on the installment side, we saw a very strong quarter in our indirect area, and that's marine in our [Indiscernible]. And that that momentum really continued out of the tail end of the second quarter. And I, I would envision that seasonally that will taper off as we close out the year. And then when the show's begin in early January, that that would pick back up. Over on the commercial side, it early, earlier in the year, we were all focused on PPP. As we move to the third quarter, we sort of get past that other than we're still obviously very active on the PPP forgiveness. But we're starting to see some activity improvement in the pipeline, the pipeline for the commercial book is up, third quarter over second quarter and now come at a mortgage and then I turn it over to Jim, because as Jim mentioned, he could probably give a little bit more insight in terms of the commercial book. And then finally on the mortgage book, well it declined in balances a small degree, obviously, what we had there was most of what we originated was sale more saleable product. And I think one thing that's interesting in the last year, the Freddie 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 refied out now into the secondary market. So and then Jim, any further color on the commercial pipeline, and you know…

Well part of the paydown, which is good news is we did have some reduction on the watch credit snack rolls in July. So that was a good pay down. The other good news, August, September now through October, we basically remain flat in 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 just liquidity 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.

So do you happen to have numbers on like line utilization and commercial portfolio? I know it’s very common to see those be paid down across the industry. As you kind of went into the beginning part of the pandemic, have you started to see a rebound and, and people drawing back down on those lines?

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 last tick for a month or so and that came back down, so our line utilization stayed relatively flat here in the third quarter. I said Jim, we were at quarter end, excluding equipment, and construction, we're about 30%. If we add those in, we're up to about 40%?

That’s correct.

Okay. All right. Great. And then I guess, with respect to the provision in the outlook for the fourth quarter and kind of beyond, if you feel comfortable with the reserve level, just given the underlying credit trends, and is there a way to kind of plan out what you could expect for 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 year end. Of course, that's that can be impacted by different things, emerging credit issues, but if the trend continues we anticipate that finishing out the year at a lower level.

Okay, great. All right. That's all that I had. Thank you very much.

Thanks, Damon.

The next question comes from Ryan Griffin from D.A. Davidson. Please go ahead.

Good morning. This is Ryan on for Russell.

Hi, Ryan.

I just had a quick question. For the non-interest expense guide going forward? Is the modestly higher expense guide, primarily driven by the mortgage related comp? Or are there any other pertinent factors driving that?

The fourth quarter higher would be predominantly accruing at the higher level for our annual management incentive compensation plan. So what we saw in the third quarter was a -- is a catch up as we were getting. So if you go to our proxy, Ryan, you can see that our plan has four categories. For the incentive plan, its EPS positive growth efficiency 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 just a higher level not so much catching up. But that's the driver in the fourth quarter. The higher expense on the mortgage production actually is going to get run through gains because most of that production is sold into the secondary market.

Great. And then just one more in the classified assets. It looks like you had a pretty meaningful drought 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 wanted to comment there.

We 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 the fourth quarter, but we feel very comfortable on our credit metrics and credit quality at the moment.

So we dropped from 31 million to 21 million from third -- second quarter to the third quarter. And I think there's probably just a handful of cleanup, a couple of credits. So all-in we, I guess, when you look at the chart, it looks like 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. Bill, I know you gave some commentary on it earlier. But I was wondering if any other thoughts on different pockets of strength heading into 2021?

Well, I think first of all, projections on 2021 at this point. 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 coming weeks, quarter we’ll have a better feel. I would say though, it feels like things are getting better. In our in our markets, I’d say in the commercial side, we're hearing good things from our customer base, Jim.

Yes, please with their performance so far, through the pandemic.

Yeah. But it's very difficult at this point to, to project with the overall loan growth would be for 2021.

Got it? Thank you for taking my questions.

Sure.

The next question comes from Kevin Swanson from the Hovde Group. Please go ahead.

Hi guys.

Hi, Kevin.

You know, I appreciate the expense, color and guidance. Just curious on the other side of that, could you just walk us through any digital or technology initiatives or pushes that you're doing for the franchise? And in particular, what are some of the branch closures that you guys have done?

So, that's a great question. And I did reference what we call digital transformation 2021 in my prepared remarks. So, 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 move to a new partner and that changeover is in process as we speak. So, much of the first half of 2020 we spent on really what we call the system design and all the systems integrate -- interface with each other. And then we had a couple of early applications going live here in 2020. One of those was a general ledger system. A second one will be our call center. And here in the third quarter, we actually implemented a new mortgage point of sale system and under provided by a firm called blend and the blend technology really leverages artificial intelligence and enables us to streamline the, the application process and really reduce the number of touches and shorten the overall app to close time. So those are some of the highlights that the core system actually will convert over in early second quarter of 2021. Beyond that, we continue and we have been investing in our branch infrastructure. In terms of ATM technology, we've got some plans and items. And that it's an ongoing reinvestment into our franchise. Hopefully that gives you a little color.

That's helpful. Thank you. And then looking at the, I guess an environment for lower rates or longer. Again some of us, strong success you guys have had at adding deposits. And maybe the prospects 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?

Hey, that's a great question. And at Independent, we have and continue. And we've always believed in gathering core deposits here, regardless of where we're at in the cycle. I mean, we had this coming out of 22,009 [ph]. And through 14, 15, when rates were really low, and people in the market are backing off of core, and so core deposits will continue to be an annual goal for us. And there's, there's no doubt that it does impact the current branch profitability formula, if you will. But we think that going forward, the core deposit basis, the true franchise value for IBCP.

Okay, thanks. That’s helpful.

The next question comes from Joe Plevelich from Boenning & Scattergood. Please go ahead.

Good morning.

Good morning.

Got quick questions. One was on baseball analogy, what inning of the refi boom do you think we're in right now?

Oh, my. Wow. That's a great question. Just sort of formulating out loud here. We were very strong even before the pandemic. And then we saw, the Fed take action, loosening and drop rates to near zero. And then it continued to roll. I think when we look at 2021 and albeit I said earlier, it's difficult to forecast overall loan growth. When we look at 2021 on mortgage origination suite, we think there will be some type of pullback from 2020. But we think we'll still be higher than, maybe what a normal origination period is. So that, 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.

Okay. Would you do it again?

Not right now, no.

Okay. All right. But I think you're very typical people have done it at least once, maybe. But there still are quite a few customers out there that have hung on to their term range.

Got it. Thanks. And then other one I had another tough question. The Michigan economy. What are the chances Rob if there are more onerous restrictions, kind of reinstated on the economy and businesses itself? And how do you prepare for that? And I guess what, what's your sense as far as the likelihood of that, and the give and take of that?

You know, that's a great question. So I am not sure if you're familiar, but a few weeks back, the Michigan Supreme Court ruled that the governor had overreached in some of the stay at home orders. And, and so with that, there's now really this position in, in our state capitol where the governor needs to work with the legislature and sort of managing that effort, prospectively now. The Michigan State Health Department has essentially laid out guidelines at a high level in terms of staying at home, wearing mask, social distancing, and so on. So I am hopeful that we don't go back to the extremes that we had before. I think the best path for us, as you know, just each one of us is smart about, respecting the individual next to us. So I can't tell you for sure that we're not going to go back. But I'm very hopeful that that we don't go back like we were in the second quarter.

Perfect. Thanks.

The next question comes from Brendan Nosal from Piper Sandler. Please go ahead.

Hey guys, just a follow up for me on CECL adoption. So I believe that as a bank that has delayed you guys need to adopt by the end of the year. So if that is indeed the case, I mean, the best way to think about the impact for you guys is just to look at the $8 million to $10 million and your add this as if scenario and run that through to retained earnings and then into the reserve, or is there another way that you should be thinking about it?

No you got it.

Perfect. Thanks.

This concludes our question and answer session. I’d like to turn the conference back over to Brad Kessel 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. We wish each of you a great day.

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