Welcome to the Independent Bank Corporation First Quarter 2020 Earnings Conference Call. [Operator Instructions] Please note, 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 2020 first quarter results. I am Brad Kessel, President and Chief Executive Officer; and joining me is Steve Erickson, Chief Financial Officer; and Jim Mack, Executive Vice President, Head of Commercial Banking. Before we begin today's call, it is my responsibility to direct you to the important information on Page 2 for 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 call for today the agenda for today's call will include prepared remarks followed by a question-and-answer session and then closing remarks. Before we begin reviewing our financial results, I'd like to take a moment to thank our customers, employees and our Board of Directors. The hope, perseverance and patience that all of you as Independent Bank Corporation community have demonstrated is simply amazing. To all of them and to you, our investors and analysts, I hope that you and your families are and remain safe and healthy during these very difficult times. Our efforts to keep our customers' employees safe in this environment began on March 3, 2020, when we enacted our business continuity plan to help prevent the spread of the coronavirus. On March 10, 2020, the Michigan Department of Health and Human services identified the first two positive cases of COVID-19 in Michigan. Since then, as of April 29, we the U.S. CDC reports Michigan with 38,210 cases and 3,407 deaths due to the coronavirus. While Ohio reports 16,325 cases and 715 deaths. Page 4 of our slide presentation lists some of the actions that we have taken over the last 60 days to protect our employees,…

Thank you, Brad, and good morning, everybody. I'm starting at Page 15 of our presentation. First quarter 2020, net interest income declined by approximately $500,000 or 1.7% compared to the fourth quarter of 2019 due primarily to a decline in our net interest margin. The decline in margin was partially offset by a $30.1 million increase in average earning assets. Our tax equivalent net interest margin was 3.63% during the first quarter of 2020, which is down seven basis points from the fourth quarter of 2019 and down 26 basis points from the year ago quarter. Average interest-earning assets were $3.35 billion in the first quarter of 2020 compared to $3.32 billion in the fourth quarter of 2019 and $3.15 billion in the year ago quarter. Turning to Page 16. We have a bit more detail on the impacts to margin on a linked-quarter basis. The primary factor in our margin change was the yield on average earning assets, which fell 14 basis points driven primarily by changes in yields on our commercial portfolio. That portfolio is 49% variable with a reset frequency of one month for the majority of the variable rate notes. The decline in asset yields was partially offset by improved funding costs as we responded quickly to the rate declines in the first quarter. Moving on to Page 17, non-interest income totaled $11 million in the first quarter of 2020 as compared to $10 million in the year ago quarter and $15.6 million in the fourth quarter of 2019. The comparative quarterly changes were driven primarily by mortgage banking-related activity, namely change in net gains on mortgage loans and mortgage loan servicing income. First quarter 2020 net gains on mortgage loans increased to $8.8 million compared to $3.6 million in the year ago quarter and $6.4…

Okay. Turning to Page 26. Thanks, Steve. As we began 2020, our team was focused on continuing to execute on the initiatives reflected on this page. We will continue to move forward on these initiatives. In addition, we will continue to work to protect the health and well-being of our employees, our customers and our community. At this point, we would now like to open up the call for questions.

[Operator Instructions] The first question is from Brendan Nosal of Piper Sandler.

First of all, thank you for all the detail that you provided. It's definitely been more than I've seen from most and was certainly helpful. So just to start off here, curious on the installment portfolios, how do you guys expect that to perform through this cycle? I get that it's a higher FICO book, so it should hold up relatively well. But at the same time, it feels like if borrowers come under stress, that's probably one of the first areas they look to kind of alleviate their financial situation.

That's a great question. And the team that oversees that area has been in place for many years. And in fact, they go back, many of them to pre-Great Recession. And that book, while it was smaller through the Great Recession, performed very, very well. Early again, as I said in my prepared remarks, the it's very granular, high FICOs, that's part of the business model with the dealer network that we have. We're really getting looks at only the best paper. And then really since the COVID-19 came through here, when we look at the forbearance activity, only a very small percentage has been requested so far. So it will be interesting to see if that changes here now as we come to another month end. But for the first month end, we really just had very little forbearance requests come in. So I feel good about that portfolio, and time will tell.

All right. Great. And then another one for me, just kind of on the reserve going forward. I get that larger provisions are quite potential in the quarters ahead. That makes complete sense to me. But just as I think about the reserve, I mean, is one way to think about it just to bring the reserve under the incurred loss methodology up toward that CECL level over the next few quarters as all of that forward-looking CECL information in the model kind of actually comes to pass and gets baked into the incurred loss model?

Yes. I think that's a great way to look at it. In the coming quarters, the gap between the two start to narrow. But I think that's fair.

The next question is from Damon DelMonte of KBW.

First question, just wanted to kind of circle back on the margin commentary. Steve, could you give a little perspective as to how much of that 150 basis point rate cut has been absorbed by the margin? And what you expect that could still come through here in the second quarter?

If you look at when rates fell from a timing point of view, much of the commercial portfolio had changed with it's reset midway through March. That being said, there still is, as you probably realize, a bit to go yet with the resetting of those rates. On the deposit side as well, we see that we have some more potential to get better cost on that side, too. So as we look to this quarter, we may see a little bit of pressure on the asset yield side, but we will also get that additional benefit on the deposit side with the cost of funds. And so that's why we guided to a very slight decline perhaps, but mostly flat relative to the first quarter. So we have a benefit on both sides coming down the pipeline.

Okay. And then as we look out a couple of quarters from here, if we assume that this low rate environment continues on, is it fair to assume that asset yield is just going to kind of continue to grind lower and just put modest pressure on the margin as we look out through 2020 and into 2021?

Yes. Obviously, excluding PPP, but yes, that's the way we're looking at it. It will be a very, very slow grind. We'll have some benefit on the cost of fund side but that'll ease up a little bit. And that's again why we're looking at a few basis points throughout the year going forward as far as potential decline.

Okay, great. And then with regards to the PPP, what are you expecting for total fees to be realized from your origination activity. And how do you kind of see that being realized over the coming quarters once those loans are forgiven?

So internally, the analysis we've put together obviously includes some assumptions, right? So as Brad said through this morning, we are at about $250 million of loans. The fees for that are going to be somewhere in the realm of $8 million to $10 million. Those will be accreted over the lifetime of loans. So what really ends up happening is it depends yield on those will depend ultimately on how soon they're forgiven and how much of the loan portfolio the PPP loan portfolio is forgiven. And so in our internal analysis, we made the assumption that 80% were forgiven within a six month period. So if we look at the fees on that, we look at the costs on that, and we say 80% are forgiven and repaid within six months, the yield on those loans are somewhere around the 5.25% to 5.5%. If we look on the other side and say, okay, from one extreme to the other, if all of those loans end up billing to term and last the full two years, the yield will be closer to 2.6%. So it's really difficult to look at it and forecast and say, this is where it's going to end up. But those are kind of the ranges as we're thinking from our assumptions point of view.

Got it. That's great color. I appreciate that. And then I guess just lastly, just to circle back on the increase in the non-performing loans this quarter, you referenced it was pretty much one credit that drove that $7 million increase, is that correct? Make sure I heard that right.

Yes, Damon. And actually, Jim Mack, who runs our Commercial Banking group is on the call with us today. And Jim, can give a little bit of insight into that credit, Jim?

Sure. So it was a movie-theater-related deal that has multiple locations to it. We had a pretty good plan in place to bridge the credit through to the summer season. COVID-19 obviously changed that plan. But we do have hard collateral on multiple locations in with very good facilities. So long term, we think we have a very good chance of substantial recovery on that loan. And as Steve, I think, mentioned earlier, we do think we're properly reserved at it now.

Got it. Okay. And then just one quick final one. Did I hear you say that the line utilization on your C&I portfolio went from 41% to 48% this quarter?

It went from 40% to 44% and it stayed. For quarter-over-quarter, I believe, and that it stayed flat to post quarter end. I think I've got that right.

Yes, yes. I'm sorry. Yes, it went from 44% to 48%. 44% to 48%. And then it stayed flat at 48%.

Stayed flat at 48%?

Yes.

Okay.

Your next question is from John Rodis of FIG Partners Janney Montgomery Scott LLC.

I guess most of my questions have been asked and answered. But just one on the balance sheet, and maybe this is for you, Steve. Just we saw some buildup in the securities portfolio. How should we think about the level of that portfolio going forward?

So if you look at the movements on the balance sheet, we had some fairly significant growth in deposits without corresponding growth on the loan side. So the securities loan or the securities portfolio bulked up a bit. That is something that excess capacity is being utilized through PPP, will be utilized through, hopefully, some additional loan growth. That being said, it is not something that we're obviously targeting. But at this point, we're kind of in a wait-and-see mode to see what happens on the deposit portfolio. Don't know at this point what we're going to ultimately see based on both sides of the balance sheet. That level of investments is hopefully going to stay pretty stable then going forward.

The next question is from Russell Gunther of D.A. Davidson.

I wanted to follow-up on comments you guys made early in the presentation and just to make sure I understand it. So the six or seven kind of buckets you rattled off, whether it's manufacturing, accommodation, foodservices, retail, construction, et cetera. Are those the pockets of the loan portfolio that are kind of most concerning to you within the early innings of this COVID-19 situation and lack of visibility. And if I'm not understanding that right, perhaps you could just give us your thoughts in terms of maybe stack ranking sort of where that initial perceived risk might be?

Sure. Yes. And I'd like Jim to maybe take for a shot at that, Jim?

Yes. So if you go back to Page 12 maybe in the presentation, one of the things Brad mentioned is we have a very diversified and granular portfolio in total. So that gives me some level of comfort there. But if we look at the hotel portfolio or the foodservice industry that we have on the chart on the left, those will be high-risk industries today, certainly. And as we dug into those, we really look at how we've structured deals over the last eight or 10 years with lower loan to values, quicker amortizations. And we also look at the sponsors and guarantors to their liquidity levels to support that. So we feel pretty good about some of these higher risk industries that we have good structures, good loan to values to start out and good guarantor and the sponsor support.

Okay, great. And then just digging into that a little bit, if possible, kind of at quarter end. Are you able to share kind of where the LTV and debt service coverage stands within those portfolios. Or perhaps even more broadly, just maximum related criteria and then minimum as it relates to debt service?

Yes. I mean, I don't have it very specifically in each of those categories. Overall, we did take a look at that recently, and I think it was about a 67% overall loan-to-value on our real estate portfolios. Debt service coverage when we underwrite varies by the property type. On the hotels, it would typically be a 1.4 times debt service coverage. In foodservice and others may be closer to 1.2. And our amortizations that we look at in those industries are 15 to 20 years on the outside, we do not go longer than that. Does that help?

Okay, great, it does. Yes, quite a bit. I appreciate it. And then just switching gears for the final question I had. With regard to the updated loan guidance, could you share kind of where you would expect that loan growth to come from, if, in fact, the low single digits does materialize?

Well, I think it's like so up to this point, up to this quarter, we had 23 consecutive quarters of loan growth. And generally, through that period of time, it was fairly well balanced. And so I guess I would say at this point, it's probably the same kind of thing, Russell, it would be balanced. I would say this, we have tightened on the portfolio of mortgage underwriting at this point. And how quickly we ease up on that as things get clearer. I don't know. So but I think it'd be fair in the modeling to just sort of spread it evenly.

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

Very good. I would like to thank each of you for your interest in Independent Bank Corporation and for joining us on today's call. We do wish each of you peace and good health, and have a great day.

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