Good morning, and welcome to the Independent Bank Corporation Third Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Brad Kessel, President and Chief Executive Officer. Please go ahead..

increases in net income and diluted earnings per share of 28.6% and 30.7%, respectively. Annualized return on average assets and average equity of 1.53% and 17.32%, respectively. Net gains on mortgage loans of $30.3 million and total mortgage loan origination volume of $1.44 billion.

Net growth in portfolio loans of $150.3 million or 7.4% annualized; and net growth in deposits of $374.7 million or 13.8% annualized. Page 7 provides a good snapshot of our loan and deposit metrics for our Michigan markets. Turning to Page 8, we display several key economic statistics for the state of Michigan.

Overall, we are seeing continued improvement in the unemployment rate for Michigan, now at 4.6%, slightly below the national average of 4.8%. However, we have 180,000 fewer workers employed today as compared to pre-COVID.

Labor shortages are having a noticeable impact in many segments of our economy, including an increase in wages in our markets and reductions in business operating hours. In addition, supply chain shortages are also constraining many businesses in our markets.

Regional average home sale prices continue to climb as inventory levels in many of our markets are at record lows and negatively impacting the overall volume of home sales. On Page 9, we provide a couple of charts reflecting the composition of our deposit base as well as the continued growth in this portfolio.

We're working to effectively manage our overall cost of funds. Extensive government stimulus continues to result in an increased deposit levels for many of our customers. Turning to Page 10, we have a few highlights relating to our -- the Independent Bank's digital transformation.

Following our second quarter whole bank conversion, we are seeing good utilization in growth rates of our ONE Wallet and Treasury ONE platform. At this time, I would like to turn the presentation over to Joel Rahn to share a few comments on our loan portfolio.

Joel?.

Thanks, Brad. On Page 11, we provide an update of our $2.9 billion loan portfolio. For the third quarter, commercial balances decreased by $21.7 million. However, excluding PPP activity, our commercial balances increased by $60 million for the quarter.

We're seeing a gradual increase in commercial working capital line usage, which was 36% in the third quarter. While it's up from prior quarters, this continues to lag the historical average. Our commercial pipeline is very strong, and we expect solid commercial loan growth in the fourth quarter.

Our residential mortgage balances increased by $55.9 million, and installment balances increased by $35.3 million.

Our mortgage pipeline, while down from peak levels, continues to display strength, and we remain optimistic about our ability to accelerate the earning asset rotation from lower-yielding investments to higher-yielding loans and continue to believe we are on track to grow loans, net of PPP, at the higher end of our original forecast.

On Page 12, we have an update of our loan modifications, which declined to $6 million or 0.2% of total loans at September 30, 2021. Moving to Page 13, we provide an update on the bank's administration of the SBA's Paycheck Protection Program.

As of September 30, 2021, we had $90.2 million in balances outstanding and $3.2 million in net unaccreted fees. We expect most of these fees to be accreted in the interest income in the next three to six months. Moving to Page 14, we displayed the concentrations of our $1.2 billion commercial loan portfolio.

You'll note that 63% of the portfolio is comprised of a variety of C&I categories, the largest of which is manufacturing at $132 million or 10.8%.

The largest concentrations -- or excuse me, the remaining 37% of the portfolio is comprised of commercial real estate, with the largest concentration being retail at $108 million or 8.8%; and office, the majority of which is medical, at $74 million or 6%. Our portfolio is very granular in nature.

Our credit metrics indicate this portfolio has held up very well through the pandemic. And at this time, I'd like to turn the presentation over to Gavin to share a few comments on our investments, capital, financials, credit quality and outlook for 2021..

increase in yield on securities available for sale of 1 basis point, increase in PPP accretion of 15 basis points and a decline in funding cost of 1 basis point. We will comment more specifically on our outlook for net interest income and the net interest margin for the remainder of '21 later in the presentation. Moving on to Page 19.

Noninterest income totaled $19.7 million in the third quarter of 2021 as compared to $27 million in the year-ago quarter and $14.8 million in the second quarter of 2021. Third quarter '21 net gains on mortgage loans totaled $8.4 million compared to $20.2 million in the third quarter of '20.

The decrease in these gains was due to decreases in mortgage loan sales volume and in the mortgage loan pipeline as well as lower loan sale profit margins. Mortgage loan applications remain solid, although refinancing applications slowed in the third quarter of '21. Our purchase market volume continues to be strong.

Positively impacting noninterest income was a $1.3 million gain on mortgage loan servicing due to a $0.6 million or $0.02 per diluted share after-tax increase in the fair value due to price and a $1.4 million decrease due to pay downs of capitalized mortgage loan servicing rights in the third quarter '21.

As detailed on Page 20, our noninterest expense totaled $34.5 million in the third quarter of 2021 as compared to $33.6 million in the year-ago quarter and $32.5 million in the second quarter of 2021.

Compensation increased $1.2 million compared to the prior year quarter due to ranges that were effective at the start of the year, the hiring of new lenders and increased overtime related to the data processing conversion. Performance-based compensation decreased $2.1 million due to a higher accrual catch-up in the third quarter of '20.

The third quarter of 2021 included $0.3 million of conversion-related expenses. We have more comments on our outlook for noninterest expenses later in the presentation. Page 21 provides data on nonperforming loans, other real estate, nonperforming assets and early-stage delinquencies.

Total nonperforming assets were $5.8 million or 13.13% of total assets at September 30, 2021. Loans 30 to 89 days delinquent decreased to $3.4 million at September 30, 2021, compared to $3.5 million ended June 30, 2021. Page 22 provides some additional asset quality data, including information on new loan defaults and unclassified assets.

I would highlight there were no new commercial loan defaults in the first nine months of 2021. Page 23 provides information on our TDR portfolio that totaled $37.9 million at September 30, 2021. This portfolio continues to perform well with 96.3% of these loans being current at September 30, 2021. Moving on to Page 24.

We recorded a provision for credit losses credit of $0.7 million in the third quarter of '21 compared to an expense of $1 million in the year-ago quarter and a provision credit of $1.4 million in the second quarter of 2021. The allowance for loan losses totaled $46.8 million or 1.62% of portfolio loans at September 30, 2021.

This ratio increases to 1.68% when excluding the PPP loans and the remaining Traverse City State Bank acquired loans. Page 25 is our update for our 2021 outlook to see how our actual performance during the year compared to the original outlook that we provided in January of 2021. Our outlook estimated loan growth in the low single digits.

Loans increased $69.4 million in the third quarter of 2021 or 9.8% annualized. Growth in mortgage and installment loans were offset by a decline in commercial loans due to a $81.7 million decrease in PPP loan balances in the third quarter of '21.

Excluding PPP loans, total portfolio loans grew at 10.8% annualized rate during the first nine months of 2021, above our forecasted range. During the first nine months of 2021, net interest income increased by 4.1% over 2020, which is higher than our forecast.

However, the net interest margin for the first nine months of 2021 was 25 basis points lower than the full year 2020 net interest margin of 3.34%, which is a steeper decline than our forecast. Higher-than-anticipated deposit growth that has largely been deployed into lower-yielding investment securities is the primary reason for these variances.

The third quarter '21 provision for credit losses was a credit of $0.7 million. This is below our forecasted 2021 full year provision range of 25 to 35 basis points of average total portfolio loans.

The primary drivers of the decrease in provision for credit losses were a decrease in adjustment to allocations based on subjective factors and an increase in recoveries of loans previously charged off. Current credit trends persist, we would anticipate that our provision for credit losses will be below our forecasted range for the full year of 2021.

Noninterest income totaled $19.7 million in the third quarter of '21 compared to our forecasted range of $13 million to $16 million. The mortgage loan pipeline continues to be solid, although refinance activity slowed down in the third quarter of 2021.

Excluding negative MSR value adjustments due to price, we generally would expect noninterest income to fall within the forecasted range in the fourth quarter of 2021. Noninterest expense was $34.5 million in the third quarter, outside our $28.5 million to $29.5 million targeted quarterly range.

Increases in compensation and employee benefits, data processing and conversion-related expenses were primary categories that caused noninterest expense to exceed the target range. We do expect that the additional costs we have been incurring related to core data processing system conversion will continue to contract through year-end.

Our effective income tax rate of 18.8% and 18.5% for the third quarter and first nine months of 2021, respectively, was a bit lower than our forecast. This is due in part to higher-than-expected levels of tax interest income. Lastly, the Company purchased 659,350 shares at an average cost of $20.89 in the first nine months of 2021.

That concludes my prepared remarks. And I would now like to turn the call back over to Brad..

Thanks, Gavin. Slide 26 displays a high-level view of our key strategic initiatives. And at this point in the call, we would now like to open it up for questions..

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

Maybe just to start off on the expense base, clearly running a little bit higher than had been sought year-to-date, but kind of with that comes stronger revenues.

Just trying to think out ahead as some of these mounting pressures for the bank space overall in terms of winning PPP, normalizing mortgage and eventually the end of reserve releases kind of move into the bottom line.

How much expense flex do you folks have from this higher level to counter some of those industry-wide headwinds?.

Yes. Thanks, Brandon. This is Gavin. So, we are running high currently for the third quarter. As we look at the longer-term run rate, we do have some flexibility there. And I'll let Brad talk a little more detail about the compensation piece of it, but the compensation piece is up.

We've brought on -- we've expanded our team in different areas strategically. And so that takes an investment. If I look at it more of the detail, Brandon, our data processing is up. We had some accrual catch-up this quarter that will run off. But ultimately, as the bank gets bigger, that expense will grow.

And then if I start to look at the interchange expense, we've just seen a real pickup in volume, so transaction volumes. So the nice part about that is the offset on the income side. And then I would point out, too, we saw an increase in the cost for unfunded commitments in the quarter, about $340,000 -- or $370,000, excuse me.

And that's due to increasing the level of commitments out. So, I think that's actually a positive as well. We are running still heavy in overtime as we continue to iron out here the conversion. I think we will see that anticipate. We'll see that wane. That being said, as you're aware, hiring in this market, it can be a challenge.

So that may be dependent just as we fill positions through the normal course of turnover. So Brad, do you want to talk any more about....

Yes, Gavin, I think that's hopefully helpful for Brendan, and just a little more clarity on the recruiting front. Year-to-date, we have added in our -- to our -- just our commercial team, we are up a headcount of 15, and 10 of which are sales side and another five are support. And that's -- we feel very good about who's joined our team.

And we think that, that's a good long-term investment for Independent Bank and our shareholders as we look to grow market share. This past quarter, we opened two new loan production offices, one on the West side of the state in Ottawa County, Michigan and the second office over on the East side of the state in Macomb County.

And so, we think that will contribute towards our efforts to accelerate the transfer or movement of earning assets from the lower-yielding securities into higher-yielding commercial loans. So probably we're just in the earlier stages of forecasting for 2022, Brendan.

But I think early on, the longer-term noninterest expense number needs to be probably $33 million and trending closer to the $32 million mark, all things being equal. But -- so hopefully, that gives you a little clarity there..

Yes. That's fantastic color. So thank you both for the comments there. Maybe kind of switching gears here and turning to the margin.

And if you strip out the noise of PPP, kind of that core underlying margin has been pretty stable for two quarters now, which I think is a win given some of the pressure we've seen elsewhere with just the exacerbated liquidity and rate base pressures.

So just kind of curious, in the near term, do you think you can hold the line on that core margin level, given that deposit costs are down to only 11 basis points? Or is there perhaps a bit of near-term pressure until we get the benefit, hopefully, at higher short-term rates?.

This is Gavin. I'll go first, and then Brad can share too. So the margin, I feel really good today about where it came, so net of PPP, around 3%. That was up three basis points from the prior quarter. So we've seen a little bit of lift in the securities portfolio. So we've seen rates back up a little bit.

So I think that favors us if we continue to have to deploy cash there, Brendan. But ultimately, we're going to get a nice pickup if we can just continue to rotate or attempt to rotate the liquidity into lows. So yes, I think we're in a pretty good place today. And I think the margin expected to be pretty stable for the year-end..

Very good, and I agree. And hey, we're going to continue to look and put pressure on maybe another basis point or two on the cost side, but there's not a lot of room to move where it's at today..

Next question is from Damon DelMonte with KBW. Please go ahead..

This is Matt Rank pinch-hitting for Damon. My first question, just with regards to the buyback, you have a little less than 500,000 shares left in the authorization.

Just wanted to get your thoughts going forward on that?.

Well, we -- at the start of the year, our Board had approved 1.1 million roughly in total shares. We had guided that for the year, we thought we'd be buying about half of that. Through three quarters, we're well beyond that pace. It's a function of, of course, capital levels, current share price trading level and alternative uses.

But I think you could probably expect us to continue to do what we've been doing, unless something else shakes out. So....

Okay. Great. And then just one follow-up question.

On the reserve, do you have a target reserve level ex-PPP? And how much of the reserve is still related to COVID factors?.

So great question. And so, no, I don't have a targeted ACL necessarily. I do think that we've still got quite a bit in there for COVID and the COVID-related high-risk industries, forbearances and subjective. And so, when I check my notes here today -- and of course, this last quarter, we had quite a bit of loan growth, too.

So the subjective portion of our reserve today is down to 23 basis points. We were 25 basis points at the end of the second quarter. So the combined incremental for COVID and subjective reserves today is a little under $14 million, $13.7 million or 29% of the total reserve. And that's down from $14.2 million or 31% as of the second quarter.

So there's still some dollars in there. And hopefully, Matt, that gives you a little color..

[Operator Instructions] The next question is from Manuel Navas with D.A. Davidson. Please go ahead..

I'm on for Russell Gunther. I just want to ask a little bit more about the LPOs and how they're already helping the loan growth.

Can you add any color there? And kind of what are our expectations about possible further LPOs in the future?.

So, [Manuel], great question. We've been adding to the team now really going back first quarter, early second quarter. And this is actually -- since I've got Joel Rahn on the line, I'm going to let Joel talk a little bit about the success that we had there.

I'll just comment on -- I think we're pretty set on the existing offices that we now have in place. And if anything, at some point, I could see moving to full service branch locations in these two markets. But we're going to try to get the earning assets and deposit levels up a little bit. So we've got some momentum before moving to full-serve offices.

But Joel, do you want to comment a little bit about the team and the success and how much they've contributed to some of the production year-to-date?.

Yes. Sure. And I agree, Brad, with the overview that you just provided in terms of kind of our -- the strategy with the two new loan production offices that we want to ultimately turn those into full-service locations, kind of bootstrapping our way, starting with the commercial and residential mortgage side.

And I would just add that it's all very much a talent-led sort of an initiative when you're expanding like that. These were two locations that we had long desired to be in physically. And what really opened the door was just our ability to bring on some very top talent in both of those geographies.

In terms of new production, without getting into too much detail, yes, we've seen our new additions contribute very quickly, which is always very nice. You got to temper that and realize that it's -- we're making an investment here for the long term.

And certainly, that's helped to contribute to the -- some of the expense pressure that others were commenting on here just a few moments ago. But we are getting immediate lift.

And in rough numbers, I would say, in our third quarter, it was probably $30 million of contribution that we got from -- collectively from the two new LPOs, which is fantastic..

That's great.

Is -- how many of the new adds that you laid out a little bit earlier have gone to these two offices specifically?.

The vast majority of the revenue producers. So Brad talked about 10. There were eight of those that were attributable to the two new loan production offices..

Okay. Just shifting a little bit with the pipeline that's doing pretty well.

What kind of rates do you have in it, like loan yield expectations?.

You want me to take that? Brad and Gavin, I'll take a stab at it, and then you guys can fill in..

Sure..

But it's we're fighting. There's certainly pressure. There's no question that all institutions are looking for good, earning assets. So I don't want to misrepresent and say, there's not intense pressure, but we're fighting for yield. And I think so far, we've done a nice job of that in our commercial team.

So, I think that our expectation with the pipeline is very similar to what we've been doing here recently in the past few quarters..

Very good, Joel..

That's helpful. I appreciate that. Last question on buyback.

Are there any price sensitivities or TCE levels that -- and also with the great growth you're getting, that would kind of slow your pace at all?.

Slowing the pace relative to media for growth and/or capital lows, we -- in our deck and from quarter-to-quarter, we sort of outlined a targeted TCE range of 8.5 to 9.5. And Gavin, we're actually below that today. I think 8.02..

8.02..

8.02. So yes, I also feel like the balance sheet is inflated to some degree with the excess liquidity in the system. So, probably, the -- again, as we've talked about in the past, it's where we're trading at, and -- but I think it's fair to say our quarterly activity is a pretty good indicator of what you can expect going forward..

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

In closing, I would like to thank our Board of Directors and our senior management for their support and leadership. I also want to thank each of our associates. I continue to be so proud of the job being done by each member of our team.

Each team member, in his or her own way, continues to do their part toward our common goal of guiding our customers to be independent. Finally, I would like to thank each of you for your interest in Independent Bank Corporation and for joining us on today's call. Have a great day..

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