Good morning and welcome to the IDCP First Quarter 2021 Earnings Conference Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. Now I'd like to turn the conference over to Mr.
Brad Kessler, 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 Q1 2021 results. I am Brad Kessel, President and Chief Executive Officer and joining me is Gavin Moore, Executive Vice President 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 us today, you can access it at the company's website, independentbag.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 COVID-nineteen 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 38% 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 improvement 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-nineteen pandemic, we are pleased to report continued strong financial performance for the Q1 of 2021. I am so proud of the job our associates did in persevering this past year, despite the extraordinary circumstances and challenges. They stayed focused on our purpose, assisting customers, individuals and businesses to be independent. The highlights for our Q1 of 2021 are shown on Slide 6, include the following.
Independent Bank Corporation reported Q1 2021 net income of $22,000,000 or $1 per diluted share versus net income of 4 $800,000 or $0.21 per diluted share in the prior year period. The increase in 2021 Q1 earnings as compared to 2020 primarily reflects increases in net interest income, non interest income, as well as a decrease in the provision for credit losses that were partially offset by an increase in non interest expense. This represents increases in net income and diluted earnings per share of 3 58% and 3.76%, respectively, compared to 2020. Our return on average assets and return on average equity were 2.10 percent and 23.51 percent respectively. Our mortgage banking team generated net gains on mortgage loans of $12,800,000 up 45.1 percent over 2020 and a company record for mortgage loan origination volume of $509,000,000 for the quarter.
We were also pleased to see continued net growth in deposits of $221,200,000 or 6.1 percent on a linked quarter basis. Asset quality continues to be strong as evidenced by loan net recoveries during the quarter and no new commercial defaults during the quarter, a low level of non performing loans and non performing assets. On January 1, 2021, we adopted CECL recording an $11,700,000 increase in our allowance for credit losses. We announced the payment of a $0.21 per share dividend on our common stock on February 16, 2021. This represents a 5% increase over 2020 and is the 7th consecutive year we have increased our cash dividend.
Most importantly, we continued to effectively operate our business continuity plan to safely serve our customers and protect our employees. Page 8 of the presentation 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 5.2%. However, we still are still over 279,000 employed workers below the total number of employed workers pre COVID.
Regional average home sale prices continue to climb, yet inventory levels in many of our markets are at record lows and negatively impacting the overall volume of home sales. On the COVID-nineteen front, the Michigan Department of Health and Human Services continues to closely monitor vaccination rates, positivity cases, hospitalization rates and the deaths as a result of the virus. On the vaccination front through April 23, over 3,700,000 first doses and 2,300,000 second doses have been administered in our state. The daily positivity case rate continues to be at a concerning level in excess of 50 per 100,000. Michigan public health officials have begun identifying coronavirus outbreaks at schools, including preschool, K to 12 and higher institutions.
The 3rd wave of the coronavirus cases has spurred a rapid increase in the number of people being treated for COVID-nineteen in Michigan's hospitals. The cumulative deaths attributed to COVID in Michigan now exceeds 17,100. Our state government has held off on reactivating many of the previous restrictions. However, gathering limits and remote office work expectations are still in place. Despite this 3rd wave of the virus, I am optimistic and hopeful for a return to normal in the not too distant future.
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, while working to effectively manage our overall cost of funds. Like most in our industry, the extensive government stimulus continues to result in increased deposit levels for our customers. On Page 10, we provide an update on our 2 $9,000,000,000 loan portfolio. For the Q1, commercial balances increased by $58,800,000 mortgage balances declined by 15,900,000 and installment balances increased by $7,700,000 Excluding PPP activity, our commercial balances slightly declined by $5,600,000 for the quarter. Commercial line usage levels continued to be soft.
At quarter end, we were at 27.6% utilization rate, which is a historic low for our company. That said, the commercial pipeline is growing and our mortgage pipeline, well down from peak levels, continues to displace strength in demand. On Page 9 or on Page 11, we have an update on our loan modifications, which declined to just $15,800,000 or 0.62 percent of total loans at quarter end. On Page 12 is an update of the bank's administration of the SBA's PPP program. As of March 31, 2021, we had $234,200,000 in balances outstanding and $6,800,000 in unaccreted fees.
We expect most of these fees to be accreted into interest income over the next 9 months. On page 13, we display the concentrations or makeup of our entire commercial loan portfolio. The portfolio is very granular in nature with the largest concentrations in C and I being manufacturing with $146,000,000 or 11.2 percent construction at 8% and retail at 7.5%. Within the CRE portfolio, the largest concentration is retail with $98,000,000 or 7.6%. Our credit metrics indicate this portfolio continues to hold up well, including loans in those industry sectors whose business has been more negatively impacted by the COVID-nineteen pandemic.
This includes the hospitality and food service industries. Page 14 provides an overview of our investments at March 31, 2021 as well as activity during this past quarter. In terms of capital management, our capital levels continue to be strong with tangible common equity to tangible assets of 8.08% at March 31, 2021. As previously noted, we declared a cash dividend quarterly cash dividend on our common stock of $0.21 per share. This dividend is payable on May 14, 2021 to shareholders of record on May 5, 2021.
On December 18, 2020, the Board of Directors of the company authorized the 2021 share repurchase plan. Under the terms of the 2021 share repurchase plan, the company is authorized to purchase up to 1,100,000 shares or approximately 5% of our outstanding common stock. The repurchase plan is authorized to last through the end of this calendar year. Thus far in 2021, we have repurchased 180,667 shares at a weighted average price of $19.93 per share. At this time, I would like to turn the presentation over to Gavin to share a few comments on our financials, credit quality and our outlook for 2021.
Thanks Brad and good
morning everyone. I'm starting at Page 16 of our presentation. Net interest income increased $100,000 from the year ago period. Our tax equivalent net interest margin was 3.05 percent during the Q1 of 2021, which is down 58 basis points from the year ago period and down 7 basis points from the Q4 of 2020. I'll have some more detailed comments on this topic in a moment.
Average earning assets interest excuse me, average interest earning assets were $4,050,000,000 in the Q1 of 2021 compared to $3,350,000,000 in the year ago quarter and 3,980,000,000 dollars in the Q4 of 2020. Page 17 contains a more detailed analysis of the linked quarter decrease in net interest income and the decline in the net interest margin. Our Q1 2021 net interest margin was adversely impacted by 3 factors: decrease in PPP accretion, growth in liquid assets and a decline in earning asset yield. We will comment more specifically on our outlook for net interest income and net interest margin for the remainder of 2021 later in the presentation. Moving on to Page 18, non interest income totaled $26,400,000 in the Q1 of 2021, as compared to $11,000,000 in the year ago quarter and $22,400,000 in the Q4 of 2020.
Of course, the story here is our exceptionally strong mortgage banking revenues. 1st quarter 2021 net gains on mortgage loans increased $12,800,000 compared to $8,800,000 in the Q1 of 2020. 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 the Q1 of 2021 and continues to be robust at the start of the Q2 in 2021, but we are seeing a decline in refinance application volume as a result of the increase in rates. Our purchase market volume remains strong.
Contributing to our strong non interest income was a $2,500,000 gain on mortgage loan servicing due to a $4,600,000 or $0.17 per diluted share after tax increase in the fair value due to price and a $1,400,000 decrease due to pay downs of the capitalized mortgage loan servicing rights. As detailed on Page 19, our non interest expense totaled $30,000,000 in the Q1 of 2021 as compared to $28,700,000 in the year ago quarter and $32,700,000 in the Q4 of 2020. Performance based compensation expense decreased $1,200,000 over the Q4 of 2020, primarily due to a decrease in the accrual for the annual management incentive compensation plan. The Q1 of 2021 included $200,000 of conversion related expenses. We will have more comments on
the outlook for non interest expense later in
the presentation. Page 20 provides data on non performing loans, other real estate, non performing assets and early stage delinquencies. Total non performing assets were $7,400,000 or 17.17 percent of total assets at March 31, 2020. Non performing loans decreased by $1,200,000 or 14 percent during the Q1 of 2021. Loans 30 days to 89 days delinquent decreased to $3,900,000 compared to $13,200,000 in the Q4 of 2020.
Two commercial loans totaling $7,600,000 that either paid off or became current are primarily responsible for the decrease. Page 21 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 Q1 of 2021. Page 22 provides information on our TDR portfolio that totaled $42,000,000 at March 31, 2021. This portfolio continues to perform well with 94% of these loans performing and 93.3% of these loans being current at March 31, 2020.
Moving on to Page 23, we recorded a provision for credit loss credit of $500,000 in the Q1 of 2021 compared to an expense of $6,700,000 in the year ago quarter and a provision credit of $400,000 in the Q4 of 2020. The allowance for loan losses totaled for credit losses totaled $46,800,000 or 1.68 percent of portfolio loans at March 31, 2021. The ratio increases to 1.83 percent when excluding the PPP loans and the remaining Traverse City State Bank acquired loans. Page 24 provides information for adoption of CECL. We elected to adopt CECL on January 1, 2021.
The day one adjustment to the allowance for credit losses was $11,700,000 which fell within our previously disclosed range of $10,500,000 to $12,500,000 The day 1 adjustment increased the allowance for credit losses to $47,100,000 The increase in the reserve for unfunded lending commitments was $1,500,000 which fell within our previously disclosed range of $500,000 to $1,500,000 The after tax impact of the CECL adoption to retained earnings was a decrease of $10,300,000 Page 24 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 2021. Our outlook estimated loan growth in the low single digits. Loans increased $50,500,000 in the 1st quarter or 1.85%. This growth is primarily due to the origination of PPP Round 2 loans totaling $128,200,000 Loan balances net of PPP loans decreased $13,800,000 during Q1 of 2021. Net interest income grew by $300,000 or 0.31 percent compared to the Q1 of 2020, which was below our forecast of 0.5% for the full year 2021.
The growth in net interest income during the Q1 of 2021 compared to the prior year quarter was generated by an increase in interest earning assets of $697,000,000 in fee income accretion related to the Paycheck Protection Program. The impact of CECL adoption on January 1, 2021 was an increase due allowance for credit losses of $11,700,000 which was within our range of $10,500,000 to $12,500,000 The Q1 2021 provision for credit losses was a credit of $500,000 This is due to our forecasted 2021 full year provision range of 0.25 percent to 0.35 percent of average total portfolio loans. The primary drivers of the decrease in provision for credit losses were a decrease in the balance of loans at risk, a decrease in commercial watch credits and an improvement in the employment forecast that decreased the retail pool reserve. If current credit trends persist, it is likely our provision for credit losses will be below our forecasted range for the full year 2021. Non interest income totaled 26 $400,000 in the Q1 of 2021 compared to our forecasted range of $13,000,000 to $16,000,000 Higher than forecasted mortgage production with higher margin on sale in mortgages combined with higher than forecasted net gains on mortgage loan servicing drove our outperformance.
Non interest expense was $30,000,000 in the Q1, outside of our $28,500,000 to 29,500,000 dollars targeted quarterly range, an increase in the accrual for incentive based compensation due to a higher than anticipated payout levels, the primary driver of the increase in expense. Our effective income tax rate was 18.8 percent for the Q1 of 2021, which was generally in line with our forecast. Lastly, the company purchased 180,667 shares at an average cost of $19.93 in the Q1 of 2021. That concludes my prepared remarks. I would like to now turn the call back over to Brad.
Thanks, Kevin.
Let's turn to Slide 26 in the deck and which displays a high level view of our key strategic initiatives. And one of the most significant is our digital transformation initiative, much of which we completed during the Q2 here of 2021 or will be completed with the Q2 here of 2021. As I reported this time last year, we signed a core data processing agreement with a new partner Pfizer and will be converting to their DNA platform. The benefits of this change include moving to a modern core platform with flexible application processing interfaces, also known as APIs. This will allow faster integration with new technology, real time processing capabilities and better access to our data and decision management using our data.
This investment includes the introduction of 1 Wallet. That's our new mobile and online platform for consumer and business clients. This platform allows our customers to open new accounts and apply for loans online along with enhanced transfer, bill pay and self-service capabilities. In addition, One Wallet Plus enables our clients to monitor all their finances in one location as well as provides budgeting and spending analytical tools. This change will also serve as the foundation to create a unified customer experience through all channels, AKA the omni channel, from the mobile channel, the electronic banking channel, our branch channel and back office support, which we call the hub.
Our team has been working hard for over 16 months and we are excited to roll out this new technology to our clients. I think they will be pleased. At this point, we would now like to open up the call for questions.
First question comes from Brendan Nosel, Piper Sandler. Please go ahead.
Hey, good morning, Brad. Good morning, Gavin. How are you guys?
Good morning, Brendan. Doing well. Thank you. Good. Thanks, Brendan.
Good. Just want to start off here kind of a more top level question. There have been a number of deals announced in your markets over the past week or 2. Just kind of curious, I know it's early, but is any quick thoughts on kind of how those might shape up the competitive dynamics in your market? And then where, if anywhere, can you see yourself adding talent to your team if the opportunity presents itself as a result of these deals?
Well, yes. So that the M and A in the Michigan markets is a reoccurring thing. And of course, this past Monday with Flagstar and New York Community Bank partnering. And then earlier in the year, of course, Huntington and TCF, Not unique to independent, but for the remaining banks in the marketplace, of course, that disruption does create opportunity. I think it creates opportunity to add customers, it's opportunity to add talent.
And over the years, I think we have shown our ability to take advantage of the disruption in the marketplace. And I think you'll see us work to do the same thing going forward.
All right, perfect. Thanks for the color. And then maybe one more follow-up for me on a bit of a different note here. I look at Slide 17, just the margin changes from last quarter to this quarter. There's that 16 basis point benefit from accelerated amortization on loss of derivatives.
Is that a recurring piece of the margin that will kind of stick around or is that more of a transitory or one time benefit? In other words, should we pull it out and view the margin as 290?
That was a that's a one time quarter over quarter, Brandon. So we're just showing you the 3rd quarter. So we'll pick it up in the cost of funds is where you'll see the benefit, but the quarter over quarter impact is the one time adjustment
of 16 basis points last quarter. So what happened is we accelerated that in Q4. Yes. So you're not seeing it now in Q1. And you won't see it going forward other than we don't have that higher cost on those derivatives, respectively.
Does that make sense?
Yes, I think so. Right. So there is a kind of a permanent help to the cost of funds. But next quarter, if nothing else changes, the NIM would look closer to $2.90, correct?
That's fair. Yes. That's 16 basis points just as compared to quarter over quarter.
All right, fantastic. Thanks for the help there.
Thank you. Next question is from Russell Gunther, D. A. Davidson. Please go ahead.
Hey, good morning guys.
Good morning, Russell. Good morning.
I wanted to follow-up on your comments on loan growth. It looks like reiterated expectations for that kind of 5% to 7% ex PPP. And prepared remarks suggest that will come from commercial mortgage and consumer. But just hoping you could elaborate a little bit more on whether you expect that to be fairly even contributions from the 3 verticals or how you're thinking about that kind of core non PPP organic growth mix?
Yes. So again, what we saw for the quarter was a slight decline excluding PPP and commercial. We saw a slight decline in mortgage and we had a little bit of an increase in consumer. I think generally, we view it as across the board evenly. As a company, we really are working to have the commercial book continue to be the largest book of business for us.
And I think as the economy returns to stable more stable footing, we'll see more commercial demand. What's been interesting on the mortgage front in a headwind is of course the lower rates has accelerated prepayment rates on the existing mortgage book. And what previously was in our mortgage book as a result of size only were jumbo loans. And over the last few years, the GSEs have of course materially raised their conforming loan limit level. So what we've experienced over the last few quarters is loans that were previously portfolio are now being sold into the secondary market.
I think we'll probably still continue to see some of that, but it'll wane as refis are reduced. We are seeing very good demand for residential construction. We're seeing very good demand for the RV and marine areas of financing too. So again, back to your original high level, I think our goal and we still think that loan growth should be in that mid single digits and across the board.
I appreciate all the color there. Next question relates a bit, appreciate your comments on the margin and the glide path that you provide in the deck, a big chunk was the excess liquidity that weighed on the quarter. And so could you give us a sense for when you think you might be able to get that to put to work? And so that piece of it, that excess liquidity drag, when you would anticipate that to stop weighing on the margin?
Yes. Good question. And so we view this as we're putting it to work in terms of the investment portfolio versus letting it set overnight in cash. So although not a wide or a very high raw yield, that 170 is much better than 10 basis points. So we do feel like we're putting it to work in an appropriate manner to that should deposits either exit or loans pick up to absorb it, we can quickly roll the mix into either fund the outflows or more preferably fund the loans.
But our deposits just continue to grow. And so I just think that's a common here and it gives you an indication of the amount of liquidity that's out there.
Thanks, Gavin. I appreciate that. Last question, guys, is on the anticipated P and L impact from the systems conversion. So something that's been in the works, as you mentioned, 16 months, exciting to see it unveiled. Do you have any bigger picture projections around what this could mean for revenue growth or expense declines, just how you're thinking about the impact?
So that's a great question. And let's go to the expense side first. So on the expense side, part of the new contract was an agreement to capture contractual savings immediately even before conversion. So really going back to a year ago, at this time, you would have seen or did see a reduction in our overall data processing expense. And we carried that forward each quarter through last year.
And you'll see that here into 2021. The second component to cost saves, and this is the one essentially to be garnered by just really doing the business operating more efficiently. And its processes are that were in place for a long, long time are no longer there and we have new processes in place. And it's very difficult at this point. We've got an idea.
We haven't necessarily shared it publicly, but we think there are opportunities to capture significant efficiencies just through leveraging the new technology. And the account opening, as an example, the account opening, new account opening process, We can do today in a fraction of the time and digitally what previously involved human beings taking a lot more time. And that's just one way one example or account maintenances or and so on. So there prospectively will be material cost savings and I can't quantify it. I'm not in a position to share that today.
On the revenue side, also very difficult. We do believe that one of our core objectives within the company, actually 2. One is to make it easier for our associates to service our clients. And the second is to make it easier for our clients to bank with us. And that make it easier to bank with us, we think will drive more revenue.
And but it's very difficult to quantify. So Russell, I know you're looking for X percent on the revenue side and X percent on the cost side, but at this point, it's just very difficult to put down on a spreadsheet. But I hope that gives you some insight into how we're looking at it.
Yes, quite a bit. Brad, it's very helpful. And guys, that's it for me. Thank you both for taking my questions.
Welcome. Thank you.
This concludes our question and answer session. I'd like to turn the conference back over to Mr. Kessel for any closing remarks. Please go ahead.
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 all of our associates. I continue to be so proud of the job being done by each member of our team. Despite a very difficult operating environment, our team continues to adapt to the circumstances, leverage the opportunities to go the extra mile for our customers and our communities. 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.