Good morning. Welcome to Independent Bank Corp’s Second Quarter 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. Please note that this event is being recorded. I’d 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 2020 second quarter results. I am Brad Kessel, President and Chief Executive Officer; and joining me is Rob Shuster, who rejoined Independent Bank Corporation as Chief Financial Officer last month. We are very appreciative to have Rob rejoin our team as we work to permanently fill the position vacated with the resignation of Steve Erickson. Also joining us today is Jim Mack, Executive Vice President and Head of Commercial Banking for our company. Before I 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 Web site, independentbank.com. 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 pause and recognize the very difficult period of time this past quarter has been for our country, our communities and our associates. Too many lives have been lost or negatively impacted by the coronavirus as have too many lives have been lost or negatively impacted by racism and social inequity. This period of crisis does hold opportunity for positive change. We are thankful to our customers, employees and our Board of Directors. The hope, patience and perseverance that all of you as the 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 difficult times. Our efforts to keep our customers…

Thanks, Brad, and good morning, everyone. I am starting at Page 15 of our presentation. Brad discussed the year-over-year slight decrease in our net interest income during his remarks, so I will focus on our net interest margin. Our tax equivalent net interest margin is 3.36% during the second quarter of 2020, which is down 51 basis points from the year ago period and down 27 basis points from the first quarter of 2020. I will have some more detailed comments on this topic in a moment. Average interest earning assets were $3.66 billion in the second quarter of 2020 compared to $3.19 billion in the year ago quarter and $3.35 billion in the first quarter of 2020. Page 16 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 second quarter 2020 net interest margin was adversely impacted primarily 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. 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 17, non-interest income totaled $20.4 million in the second quarter of 2020. This compared to $9.9 million in the year ago quarter and $11 million in the first quarter of 2020. Of course, the story here is our exceptionally strong mortgage banking revenues. 2Q '20 net gains on mortgage loans increased to $17.6 million compared to $4.3 million in 2Q '19. The increase in these gains is due to increases in mortgage loan sales volume and in the mortgage loan pipeline, as well as stronger loan sale profit…

Thanks, Rob. The first half of 2020 has been an extraordinary period of time for all of us. Our team continues to execute on the initiatives 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 initiatives while continuing 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.

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

Hi. Good morning, guys. How are you?

Hi, Brendan.

Just want to start off here on the net interest margin. So your guidance calls for a flat to up modestly for the rest of the year and it’s something that includes some acceleration of PPP fees as those loans are forgiven. Can you just give us a sense of what you expect the NIM to do for the remainder of the year outside of those accelerated fees?

Yes. I think outside of that, it would be relatively flat from the second quarter. And I think the other two factors that are influencing that that I mentioned was one, we did deploy much of that deposit surge in the month of June. So we’re getting a full impact from having done that whereas during the second quarter, that for a period of time, was just an overnight funds at the Fed [ph] remain very little. So I think that will be a boost. That would tend to offset some of the compression from some shrink in the loan portfolio that we anticipate taking aside the PPP loans. So where we see the boost is really from the acceleration in the accretion of those fees. And then the other comment that I made is we anticipate that rates would be relatively flat. Short-term rates really can’t come down much anymore unless we get into the negative territory and long rates seem to sort of be at a steady point. So we feel like much of the impact of the dramatic decline in rates occurred during the second quarter and it’s not going to continue to have a negative impact. In fact, I think we do have a little more room on the funding side as we move through the last two quarters. Not a lot, but a bit. Brad, I don’t know if you wanted to add anything.

No, that’s good.

All right, perfect. That’s very helpful. And then one more for me just on the charge-off this quarter. If I recall correctly that was the loan that moved from watch-list to nonaccrual last quarter. And just in relation to that, as you look at the broader portfolio, are there any other credits, whether they’re on deferral right now or nonaccrual that you see having enough issues because of COVID that you think could move to a loss position over the next three or six months?

I guess I’ll take first shot at that and then let Jim jump in or so. We did an increase in the TDRs for the quarter of about $5 million. That was a commercial real estate relationship. And while it bumped up TDRs, we do have – that borrower has a purchase and agreement for the sale of that property. And so I guess that was probably the one that would have been on my radar as I’m a little concerned about. And we still want to see that come to fruition, the eventual sale. But beyond that, Jim, I’m not really – anything’s popping off outside of one you mentioned – no other large ones that I see on the fence like that. And the one that did go sideways there was in the movie theater business. So that was in an asset category that we just decided to move aside as opposed to hold them. We don’t have any more – we do not have any more in that industry.

And the other thing I’d add is we’ve taken a pretty in-depth look at our top 50 credits within the commercial loan portfolio. So we really tried to evaluate all of those credits in relation to the kind of economic climate we’re dealing with, and we really find that that group of loans is still doing quite well.

All right, fantastic. Thank you for taking the questions.

Our next question comes from John Rodis with Janney. Please go ahead.

Good morning, guys.

Hi, John.

Rob, welcome back.

Hi. Thanks. Good to be back. Glad to hear your voice.

It’s been a long time. No, not really, but a lot has changed. But guys, thanks for all the detail. And I guess Rob or Brad, one of you, just your comments about the loan outlook looking for loans to be down. I think you said 1% to 2% year-over-year. What are you sort of assuming though for the PPP loans, the level of forgiveness and then how much in the second half of this year versus next year?

Why don’t you take first shot on the PPP?

Yes, with all the changes that went on with the PPP forgiveness piece so far, which we’re waiting for that to fully be finalized. But with the 24-week timeframe now, we look to have a much higher percent forgiven than I initially thought. So I think it will be up in the 90% to 95% range for the forgiveness piece. We had modeled out about two-thirds of the forgiveness process to be collected by the end of this year.

Okay. Thank you.

John, I’m looking at it going from about $250 million down to a bit over $100 million I think by the end of the year.

Okay.

That assumes that everything is moving along with the SBA and processing forgiveness applications run into big delays there.

And obviously, Rob, that would be more heavily weighted in the fourth quarter versus the third quarter?

Yes. We’re assuming that we get a bit of a chunk in September once the portal opens up. So there is a chunk in September as well. But the bigger paydown is in the fourth quarter too.

Okay. And then just one other question on the securities portfolio. So it’s roughly 21% of assets today. And given you still have some excess liquidity and so forth and then I guess depending on what happens on the deposit side, how high would you take that I guess in the current environment as a percent of assets from the current 21%?

I don’t really think there is a ratio there. I think what we look – one is, if it’s going to be driven by what’s going on in the deposit portfolio and then kind of the rate of paydown in the PPP portfolio. I don’t think we’re going to see big changes in the installment loan portfolio or the mortgage portfolio. Mortgage portfolio may drift down a little bit because of refinancing activity, but I don’t think that’s going to change. And I think outside of PPP, commercial loans will be reasonably steady. So given that, I think a lot of it is just going to depend on the deposit surge and we do have potentially another wave of money is going to consumers with the federal government aid package that is being discussed. So it’s hard to tell the length of time that those deposits will remain here. And as a result, we’ve sort of taken an approach to investing in really either relatively short duration assets that flow off a lot of cash or investments that could easily be liquidated or variable rate, so sort of a combination of those three things. But I think if it moves up relative to total assets, it’s largely going to be because of what’s going on with the deposit base. Again, I don’t think we’re going to set some kind of limit there.

Okay. That makes sense, Rob. Thank you.

[Operator Instructions]. Our next question comes from Russell Gunther of D.A. Davidson. Please go ahead.

Good morning, guys.

Good morning, Russell.

I appreciate the commentary on deferral activity, especially within the migration in retail. Is there any incremental color you could provide on the commercial deferrals, roughly 15%? I know you mentioned things were heading lower in July, but just kind of a point to point update there, if it’s at all possible?

Sure. This is Jim Mack. So as shown in the presentation, we had 259 loans and $210 million of deferrals that were done. Right now, we’re getting close to the end of that timeframe. A lot of those were done in mid to late April, some even in May. So August will be the first period where those payments will resume to the normal schedule. Also keep in mind that over 90% of what we did were simply principal deferrals. Interest payments continued on the bulk of that portfolio. And then we’ve seen very few for second round additional requests. There have been five so far to ask us for another three months. And that remains to be seen how many more. But it’s been low activity at the moment.

Okay. And then would your expectation then be for the originals as they roll off the overwhelming majority it sounds like when we speak next quarter, we would not be talking about much in the way of deferrals?

That’s the expectation. Again, it remains to be seen.

Yes, understood. Okay. I appreciate the clarification there. And then another minor one in terms of the provision guidance. The 55 to 60 basis point of average total loans, does that include PPP loans on the balance sheet or should we adjust for that?

I just took the total average loans. So I didn’t really adjust for that in coming up with that number. That’s why I kind of gave you a dollar amount to 8 million to 8.5 million in total for the last six months. So that just sort of clarifies what that ratio range means.

Perfect. I appreciate the clarification there. And then bigger picture, and this maybe a few quarters out but in terms of PPPs off the books, as you think about what '21 might hold from a budgeting perspective around organic loan growth. Obviously a lot can change from now to then, but do you have a view as to where Independent might shake out from an organic loan growth perspective into '21?

Russell, that’s a good question. So you’re asking me to see 12 months when I’m having a hard time seeing three months. I would say this. We continue to position the company to be competitive within our markets and we’re still knocking on doors, we’re recruiting, we’re adding talented staff even this past quarter as there continues to be remnant disruption from past announced MOEs. And so we will – our loan activity in 2021 will be very much driven by what’s happening with the overall economy, but we will field the team that will be very, very competitive in our markets. Sorry, that doesn’t give you a percentage for the --

No, not at all. I would think there is a lot of market share for grab. So I appreciate your thoughts there. Thank you both for taking my questions.

You’re welcome.

This concludes our question-and-answer session. Now, I’d like to turn the conference back over to Mr. Brad Kessel. Please go ahead.

We’d like to thank each of you for your interest in Independent Bank Corporation and for joining us on today’s call, and wish everyone a great day. Thank you.

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