Good day, and welcome to the Independent Bank Corporation's 3Q '19 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. 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 2019 third quarter results. I am Brad Kessel, President and Chief Executive Officer, and joining me is Rob Shuster, Executive Vice President and Chief Financial Officer. Also joining us today is Steve Erickson, Executive Vice President and Treasurer. Before we begin today's call, it's my responsibility to direct you to the important information on page two regarding the cautionary note for 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 Web site, www.independentbank.com. The agenda for today's call will include prepared remarks followed by a question-and-answer session and then closing remarks. As previously announced, Steve Erickson will be taking on the role and responsibilities as Chief Financial Officer for IBC following Rob's retirement on January 31, 2020. There is no doubt we will miss Rob upon his retirement. However, I am very pleased that we are able to find and attract an individual like Steve, and that we are able to do so with a transition period allowing Rob and Steve to work together through a couple of quarter-ends and year-end in the budgeting process. Today, we are reporting third quarter 2019 net income of $12.4 million or $0.55 per diluted share versus net income of $11.9 million or $0.49 per diluted share in the prior year period. This represents year-over-year increases in net income and diluted earnings per share of 4.4% and 12.2% respectively. Overall, I'm very pleased with our third quarter as we were able to report strong results for the bottom line, both net income and earnings per share, fueled by growth in net interest income and increase in net gains on mortgage loans…

Thanks, Brad, and good morning everyone. I am starting at Page 13 of our presentation. Brad discussed the year-over-year increase in our net interest income during his remarks. So I will focus on our margins. Our tax equivalent net interest margin was 3.76% during the third quarter of 2019, which is down 15 basis points from the year-ago period and down 11 basis points from the second quarter of 2019. I will have some more detailed comments on this topic in a moment. Average interest earning assets were $3.29 billion in the third quarter of 2019 compared to $3.04 billion in the year-ago quarter and $3.19 billion in the second quarter of 2019. Page 14 contains a more detailed analysis of the linked quarter increase in net interest income. There is a lot of data on this slide but to summarize a few key points, the linked quarter tax equivalent yield on loans declined 13 basis points and the tax equivalent yield on investments declined 17 basis points. This primarily reflects lower market interest rates, particularly short-term rates. In addition, investment yields were negatively impacted by a $25.2 million increase in the average balance of lower yielding interest bearing cash balances due to a seasonal increase in deposits. We were generally able to offset the adverse impact of lower yields on earning assets by a $93.8 million increase in the average balance of earning assets. The average cost of funds declined by two basis points to 0.84% in 3Q 2019 from 0.86% in 2Q 2019. We'll comment more specifically on our outlook for the net interest margin and net interest income for the balance of 2019 later in the presentation. Page 15 compares our quarterly average cost of funds to the monthly average effective federal funds rate during the quarter…

Thanks, Rob. On October 22, 2019, we announced that our Board of Directors appointed Ronia Kruse to the Boards of the Corporation and the bank. She will also serve on the Corporation's Audit Committee. Ms. Kruse is the founder and CEO of OpTech, a talent development and solutions firm providing services to Fortune 1000 and government clients. OpTech provides innovative solutions for clients in the areas of analytics, cybersecurity, application development, and connected vehicles. Prior to founding OpTech, Ms. Kruse was a senior tax consultant for a Big 4 CPA firm, where she specialized in international tax planning. She is a Certified Public Accountant, is active in a variety of organizations, and has served on the investment committee of Belle Michigan to help evaluate potential emerging technology portfolio companies. We are delighted to and add Ronia to the Boards of Directors of both our parent company and the bank. She's -- is a dynamic executive, who brings us a unique ability to leverage technology, develop talent, and provide insight on the digital economy. In addition, her background with a big 4 CPA firm makes Ronia an important addition to our organization. Finally, we have listed our strategic initiatives on Slide 25. During the first nine months of 2019, we have made significant progress in each of these areas. We believe successful execution on these initiatives will continue to drive strong returns as a community bank at the center of all our strategies, staying focused on serving our customers and investing in our markets and in our people. At this point, we would know like to open up the call for questions.

We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Brendan Nosal with Sandler O'Neill and Partners. Please go ahead.

Hey, good morning, guys. How are you?

Good morning.

Good morning, Brendan.

I just want to start off on the margin. I appreciate all the color you gave on some of the things you're doing to pushback on the cost of funds, as well as trying to maintain on the asset side. If you could just kind of wrap up those moving pieces into what you think it means for the NIM in the fourth quarter that would be helpful, and then, what each incremental rate cut thereafter you think would mean for the margin?

Well, for the fourth quarter, I don't expect to see the same magnitude of drop that we had in the third quarter, the 11 basis points. I think it would be somewhere maybe in between, so in that six to seven basis point range. I think a lot of it is just going to depend on asset mix a bit and then just some timing on the cost of funds side. Longer term in part of why I gave that sort of long-term data point of 352 that was when rates were down, and not they had come up from zero, but not much. So, I kind of feel like that sort of a low watermark for us. So I would see maybe a bit of a drift down, but not toward that kind of levels. So we're at 376, so maybe a bit of a drift down, but hopefully all of our efforts will result in stabilizing it not too far away from where we're at right now, and the other real goal is to continue to drive earning asset growth. So, the dollars of net interest income continue to grow.

Understood, that's definitely helpful. And then if I can sneak one more in there, just moving onto the C side of things, obviously a very, very good number here in this third quarter after you remove the MSR noise, and I appreciate the outlook for the fourth quarter to be above the high end of the range, but as I look at things, given continued strength in the mortgage market and then the $1.1 million gain you expect to take, it seems like fees could be meaningfully above the high end of that $11 million to $12 million range next quarter. So I guess just one, want to make sure I'm thinking about that correctly, and then two, if you could give a finer point on how much above that $12 million mark you think you could be?

Well, that's a great question. I think given where the pipeline is and new application volume and as you mentioned, the million dollar gain on the $36.6 million that moved into held-for-sale, I would certainly see a number approaching as strong as we were in the third quarter. I think the one caveat I will give you is with the way we record the fair value adjustments, the pipeline is likely to be lower at December 31 versus where it was in September 30. So that's going to cause us to have a downward adjustment, and it's really going to be the magnitude of how much does that pipeline drop because actual loan sales are going to be as strong or stronger. So, the wildcard is kind of the change in fair value related to the pipeline, and to the extent that that holds up, in app volumes hold, it could be again a number very similar to where we were in the third quarter if the app volumes have a more of a seasonal decline, then it could be off a bit, but I certainly would expect it to be lead to us being meaningfully above the high end of the range.

Rob, I would add to that. In the third quarter 2019, we had a very strong swap fee income quarter to about half a million dollars.

Yes. That's another non-interest income. So we may not be quite at that level in the fourth quarter, but the gains I would expect to be pretty strong in the fourth quarter. I know I'm not giving you an exact number because it's tough to project the one item on the pipeline, but I would be surprised if we are meaningfully above.

No, that's very helpful color. So, thanks for walking me through the moving pieces, and thanks for taking the questions.

You're welcome.

[Operator Instructions] Our next question comes from John Rodis of Janney. Please go ahead.

Hey guys, good morning.

Good Morning, John.

Good Morning, John.

Rob, it's been great working with you over all these years. I guess you'll have a little extra time to play some golf next year.

Yes, hopefully…

You won't have to worry about interest rates and all that exciting stuff in the yield curve, but just…

I'll be a shareholder, so I'll still worry about it.

Don't worry about it too much. Hey, just a quick question, just on your thoughts on the buyback, obviously, you've still got -- what about 270,000 shares remaining between now and year end and then just thoughts on re-upping the buyback plan for 2020?

Yes. So I guess, John, I'll jump in there. So we had through the second quarter a very, very strong buyback activity. In fact, we completed the full initial authorized amount of 5% and then our board re-upped an additional 300,000 shares. And in the third quarter we had a small amount of purchases for the third quarter. I would say going forward, we will continue to have the program in place and so it would expire at the end of 2019. I would think that our board would re-up that for 2020. And we continue to look at all the opportunities that we have to put our capital to work. And it's a balancing act, and so the pace that we were buying at through the first half of the year obviously is slowed down, but perspectively, we could do some purchasing, but not probably not nearly at the pace that we were at before.

Okay. Fair enough. Thanks for it.

Yes, I think that covers it well. I think the other thing is it's a good lever if organic growth and earning assets and loans slows a bit maybe its economic factors in the marketplace, but it's a good lever to try and continue to produce growth in earnings per share, if there is some slowdown in asset growth.

Yes. And I expect the stock will probably -- stocks will -- bank stocks will probably remain volatile. So, just one other question, you guys sort of addressed it a little bit just as far as the GM strike and you know, maybe it's going to be over soon, but just your comments, it doesn't sound like you've seen any meaningful negative impact yet from the strike? Is that correct?

Yes, it's a - so we internally consult with our client base and there is no doubt that, this has as impacted, the Michigan markets and the national markets. If you go back to pre-strike, there was some positioning by both parties that I think they had set themselves up so that for a short period of time they could, survive without maybe being too negative. And so, while this has gone on, I think longer than what people expected and anybody really wanted it, it appears that they're, they're close. And so, hey, in our markets, on the supplier side there have been layoffs, as production has slowed or ceased. But when we canvas our portfolio of clients, really they are looking longer-term and quite frankly, they're bullish on 2020. I mean, there's a lot of uncertainty in the market, but there are definitely optimistic about 2020.

Yes, so…

Yes. I was going to add, we haven't seen anything impact wise either in the retail portfolio mortgages or consumer loans or on the commercial portfolio where, you know, it's affected someone's ability to make their payments.

Okay. Thanks, guys. Thanks for the comments.

Our next question comes from Kevin Reevey with D.A. Davidson. Please go ahead. Good morning.

Good morning.

Good morning, Kevin.

Good morning, Kevin.

Rob, congratulations on your retirement, well deserved. And Steve, I'm looking forward to working with you again.

Thank you, Kevin.

Okay. So first question is, I was just curious, were there other - are there any other levers on the asset side of the balance sheet that you can pull in order to mitigate margin compression in a lower rate environment?

I think the thing that we're just working the hardest on is trying to, where we can hold the line in - maybe expand margins a little bit on new lending. I kind of went through the fact that floors are not going to prevent on the variable rate loans a downward drift there. But I think those are the two key elements is just trying to expand margin a little bit. And other than that, I think earning asset growth and getting more dollars of net interest income is the other key.

Okay.

And the other thing I would say, and we have a slide on it. We do have a decent amount of the portfolio that is fixed rate now to the extent to get prepayments. You can still have some drift down there as well, but we're reasonably balanced in those portfolios between fixed rate and variable rates. So we may not have quite as much pressure as maybe someone who has a vast percentage of their commercial portfolio with variable rates.

And then your fixed rate loans and most of them structured such that if there is an early prepayment that there is a prepayment fee that you can capture to kind of to better fit a bit from the last of the higher yield asset?

That is correct on commercial. So, virtually all of the commercial loans that are fixed rate would have some form of yield maintenance or prepayment penalty that is not the case on retail loans. So that on retail loans, that's just not acceptable in the marketplace. So those loans there is know the ability to refinance without penalty. But again, the one thing I would say is margins have kind of improved in the mortgage banking space. So that what we call the primary secondary spreads have widened down a bit. So hopefully that will help on the mortgage side.

Okay. And then lastly, given CECL and then your focus on consumer lending, do you expect to see any changes on your focus given the impact of CECL?

That's a great question. I would say that we would be -- as we have been this year, I think we would be active in doing some portfolio, loans sales without a recourse to try and moderate the growth rate there. I think longer-term, the performance it's more of a timing thing than anything else. So, the credit losses are whatever they ultimately are. And I think over time we'll probably refine where provisioning levels are. I think when - at the start everyone is sort of in the same bucket of maybe being a bit on the conservative side as you start down the path with CECL in terms of the modeling, and I think over time you'll get better on that. So I think over time it's not going to affect our desire to do consumer financing both mortgage and the RV Power Sport Marine. But I think we'll try to maybe regulate those growth rates through sales.

Great, thank you. Appreciate the color.

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

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 you all a great day.

The conference is now concluded. Thank you for attending today presentation. You may now disconnect.