Good day, and welcome to the Independent Bank Corporation Fourth Quarter 2020 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to Brad Kessel, President and CEO. Please go ahead.

Good morning, and welcome to today's call. Thank you for joining us for Independent Bank Corporation's conference call and webcast to discuss the company's fourth quarter and full year 2020 results. I am Brad Kessel, President and Chief Executive Officer, and joining me is Gavin Mohr, EVP and Chief Financial Officer; and Joel Rahn, Executive Vice President, Commercial Banking. Before we begin today's call, I would like to direct you to the important information on Page 2 of our presentation, specifically, the cautionary note regarding forward-looking statements. If anyone does not already have a copy of the press release issued by Independent today, you can access it at the company's website, IndependentBank.com. The agenda for today's call will include prepared remarks, followed by a question-and-answer session and then closing remarks. Page 4 of our presentation lists some of the actions that we have taken since the start of the COVID-19 pandemic to protect our employees, clients, vendor partners and the communities we serve. Today, our frontline associates continue to do an outstanding job serving our customers, as do the approximately 40% of our total staff who continue to work remotely. We continue to execute on our operating plan that we share each quarter. This plan is built around diversified and balanced growth, process improvements 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 the COVID-19 pandemic, we are pleased to report very strong financial performance in the fourth quarter and full year of 2020. I am so proud of the job our associates did in persevering this past year despite the extraordinary circumstances and challenges, all while staying focused…

Thanks, Brad, and good morning, everyone. I am starting on Page 17 of our presentation. Net interest income increased $0.3 million from the year ago period. Our tax equivalent net interest margin was 3.12% during the fourth quarter of 2020, which is down 58 basis points from the year ago period and down 19 basis points from the third quarter of 2020. I will have more, some more detailed comments on this topic in a moment. Average interest-earning assets were $3.98 billion in the third quarter of 2020 compared to $3.32 billion in the year ago quarter, and $3.89 billion in the third quarter of 2020. Page 18 contains a more detailed analysis of the linked quarter decrease in net interest income and the decline in the net interest margin. Our fourth quarter '20 net interest margin was adversely impacted by 3 factors: increase in interest expense related to the acceleration of amortization of loss on certain de-designated derivative instruments, accelerated premium amortization on securities and a decline in earning asset yield. We will comment more specifically on our outlook for the net interest income and the net interest margin for 2021 later in the presentation. Moving on to Page 19. Noninterest income totaled $22.4 million in the fourth quarter of 2020 as compared to $15.6 million in the year ago quarter and $27 million in the third quarter of 2020. The core story here is our actually strong mortgage banking revenues. Fourth quarter '20 net gains on mortgage loans increased to $15.9 million compared to $6.4 million in fourth quarter '19. The increase in these gains was due to an increase in mortgage loan sales volume and in the mortgage loan pipeline as well as stronger loan sale profit margins. Mortgage loan application volume was strong in fourth quarter…

2020 has been an extraordinary period of time for all of us. As I mentioned at the beginning of my remarks, our team continues to execute on the initiatives reflected on Slide 28 of the presentation. One of the most significant initiatives is our digital transformation, which began early in 2020 with our announced change in core processing partners and the planned move to a real-time core banking platform. Through 2020 and now into 2021, we have achieved numerous key milestones on this journey. Later in 2021, we are excited to provide to our customer base a unified and enhanced digital and mobile banking experience. A strong digital offering is essential to compete in today's fast-changing digital world. If we learned anything from 2020, it is the importance of PPP in today's world, and that is people, perseverance and purpose. At this point, we would like to open up the call for questions.

[Operator Instructions]. Our first question today will come from Brendan Nosal with Piper Sandler.

I just want to start off on the margin for this quarter. And I'm just trying to figure out what the appropriate way to think about the underlying core level is. So if I remove the $1.6 million of onetime interest expense that you guys took this quarter as well as the impact of PPP from both the numerator and denominator of the margin, I kind of get to a core underlying level of 306. Is that a reasonable way to think about kind of the true margin ex noise?

Yes, I would agree with that, Brendan.

Okay. Great. And then just a follow-up on that. Given that starting point and the outlook for 2021. So I guess you're looking for 10 to 15 bps of compression from the 334 level. So I guess that gets us to a 320 or 325, which is up a good bit from that 306 core level. So just kind of walk through the puts and takes of how you get from where the underlying margin ended the year to kind of how you're seeing it play out for 2021.

Yes. Sure. So a couple of things. I think at the end of the year, specifically for fourth quarter, for sure, we saw acceleration in the premium amortization on the investment portfolio. So one issue there. I think that's above what we're going to see on average for next year. So that slowdown should add some yield to the portfolio. And then secondly, as we see loan growth come on next year at a higher yield, it should be able to increase in the first quarter or so.

Got it. That's definitely helpful. And then just one final one for me. The NII outlook, 0.5% growth, that's off of the reported base of $123.6 million, correct?

Can you repeat that, Brendan, I'm sorry.

Yes, sure. The outlook for NII growth of 0.5%, that's off of the reported base of $123.6 million, correct?

That's correct.

Our next question comes from John Rodis with Janney.

Just I guess as a follow-up to the last question on your net interest income guidance, the plus 0.5%. Does that include any impact of the next round of PPP?

Yes, it does. We do have some revenue in 2021 regarding the second round. Yes.

So I think in your prepared remarks, you said you thought Round 2 could be 40% to 50% of Round 1. So are you sort of assuming that and taking the fees off of that into your guidance?

Yes.

Okay. Okay. And then Brad, maybe just sort of big picture. What are you hearing from your clients, from your borrowers today about how do they feel about the economy and so forth?

Well, that's a great question. And I'll give you an initial response, but we have Joel Rahn with us today. And Joel heads up our commercial banking area. And I would say generally very optimistic about 2021 as we get past the first quarter and as the vaccine gets rolled out through the entire populations within our markets. Obviously, there are certain sectors of our economy that have been more negatively impacted than others. But coming out of a Board meeting earlier this week and getting feedback from just that group, which is representative of a number of different industries within the state, there was also that optimism for second half of 2021. Joel, you want to add?

I think you summed up it well. The obvious sectors that are struggling are the hospitality-related just because they just haven't been able to function at their full capacity, if at all. But core manufacturing, construction activity remains pretty solid.

Our next question comes from Joe Plevelich with Boenning and Scattergood.

A question on the impact of the CECL adoption. The $10.5 million to $12 million, will that flow through the income statement or that will be all retained earnings? And then I think you hinted that the allowance might be $47 million or so, 1.7% of loans. Do you see that as where it will likely settle in over the longer term? And if not, what do you think a good number to use in the longer term is for allowance to loans?

Yes. So regarding the adjustment to CECL, that will run through retained earnings. And then that calculation of where we're at is inclusive of, so the 1.7% is inclusive of PPP. So ex PPP, over 1.8% to maybe 1.85%. I think our forecast -- I know our forecast says, longer term, given the economy improves, some of that qualitative reserve will probably ease up. Although we do, we are anticipating maybe a more normalized charge-off environment. So having said all that, we believe that is a appropriate level to begin.

Yes. I think that's good, Gavin. And the other thing, again, the onetime adjustment, those are pretax, too.

Yes. Thanks, Brad.

Okay. And then the buyback, do you expect to be kind of programmatic and do a certain amount each quarter or more opportunistic? And what gives you confidence that 2.5% is the right number versus, say, trying to use it all?

Well, great question, first of all. And I would say, we would probably see ourselves as being more consistent with the buyback as opposed to maybe opportunistic really over time, quarter after quarter with an understanding of delivering on our forecast, cognizant of capital levels, cognizant of cash at the holding company, cognizant of growth rates as well as other growth opportunities. So I think, again, we're going to probably be more consistent with the share repurchase as opposed to opportunistic.

[Operator Instructions]. Our next question will come from Russell Gunther with D.A. Davidson.

This is Ryan on for Russell Gunther. I just had a quick question on the expense guide for 2021. In addition to the reduction in incentive comp in the new year, are there any other meaningful levers to drive that expense ratio down?

Ryan, this is Brad. And Gavin, do you have a quick answer to that or I can?

In terms of -- are you saying outside of the compensation piece? Ryan, can you maybe ask the question again?

Yes, sure. So I was just wondering, outside of that compensation piece, are there any other planned reductions in expense that will drive down to that lower range that you had guided to?

Yes. So the big one obviously is going to be the expense...

Comp expense.

The comp expense, correct. Yes. And then obviously, we're ongoingly evaluating the expense structure. If you're talking noninterest specifically, I do anticipate there'll be some savings in interest expense relative to the de-designation, too. I actually mentioned that earlier. I don't know, Brad, if you want to add any more comment?

Yes. So in 2020, $19 million is recorded in performance-based compensation. And probably half of that related to our annual incentive plan. And then the balance was for various other programs, I'd say, a good chunk of it relative to our mortgage banking unit and hitting some milestones there. So I think we feel like in that category, we've got a lot of variability based on how the overall company is doing. After that, we're going to, as we have been year after year, hone in on each category. We closed 8 locations in 2020 and achieved some material cost saves. Our branch optimization team, if you will, is continuing to look at other opportunities. And the really tough one, Ryan, to nail down right now is, we have spent almost two years on this effort to change core partners and core processing platforms. And there were material contractual savings, which we're realizing at this point. But the back room efficiencies, which we know will be there, are very difficult to quantify right now. And if anything, to get the conversion done in a manner that is least negative impact to our customers. We have been running with a higher cost structure intentionally. And so I think there are some areas for improvement, but they're difficult to just quantify for you today.

And our next question is a follow-up from John Rodis with Janney.

Brad, just one follow-up. Just the recent announced acquisition between TCF and Huntington. Just your thoughts, potential opportunities for you guys within your Michigan footprint?

Well, John, thanks for the question. And it's a material event, obviously, within our markets. Between the two financial institutions, we compete with them in almost every one of our markets. And obviously, well, they announced here in the last week the closure of almost 200 locations. So that just will be opportunities for talent acquisition and will be opportunities for customer acquisition. I would point to our track record. We've had this disruption going on in our marketplace as the industry continues to consolidate for a number of years. And as we've shared with you and others, we have, I think, been very successful in adding talent and customers to our company.

Yes. I think it could be a real opportunity.

Thanks, John.

Thanks.

This concludes our question-and-answer session, and I'd like to turn the call back over to Brad Kessel for any closing remarks.

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

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