Independent Bank Corporation (NASDAQ: IBCP) — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020; financial statements are unaudited. The company provides banking services primarily in Michigan’s Lower Peninsula, with two loan production offices in Ohio.
Financial performance and condition
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net income | $14.8 million | $10.7 million | $19.6 million | $20.1 million |
| Diluted earnings per share | $0.67 | $0.46 | $0.88 | $0.85 |
| Net interest income | $30.5 million | $30.8 million | $60.7 million | $61.0 million |
| Provision for loan losses | $5.2 million | $0.7 million | $11.9 million | $1.3 million |
| Non-interest income | $20.4 million | $9.9 million | $31.4 million | $19.9 million |
| Non-interest expense | $27.3 million | $26.6 million | $56.1 million | $54.6 million |
- Margins: Q2 net interest margin was 3.34% GAAP and 3.36% fully taxable equivalent (FTE), versus 3.86% and 3.87%, respectively, a year earlier. Six-month FTE margin was 3.49%, down from 3.88%.
- Balance sheet at June 30: Total assets were $4.04 billion, up $478.6 million from year-end 2019. Loans were $2.87 billion, up $141.6 million; deposits were $3.49 billion, up $448.4 million. Available-for-sale securities increased $337.9 million to $856.3 million.
- Credit: Allowance for loan losses rose to $34.5 million, or 1.20% of portfolio loans, from $26.1 million, or 0.96%, at year-end. Non-performing loans were $12.3 million (0.43% of portfolio loans), compared with $9.5 million (0.35%).
- Cash flow, first half: Operating activities provided $44.0 million; investing activities used $479.2 million; financing activities provided $425.8 million. Cash and cash equivalents decreased $9.5 million to $55.8 million.
- Debt and capital: Other borrowings were $50.0 million, down from $88.6 million at year-end. The company issued $40.0 million of subordinated notes in May; the June 30 carrying amount was $39.3 million. The bank was categorized as well capitalized; its CET1 ratio was 12.07%. Tangible common equity to tangible assets was 8.03%, versus 8.96% at year-end.
Material changes versus comparable periods
- Q2 net income increased year over year, principally because non-interest income rose, led by mortgage loan gains. This was partly offset by lower net interest income, a higher loan-loss provision, higher expenses, and higher tax expense. First-half net income declined slightly year over year as lower net interest income and higher credit provisions and expenses outweighed non-interest income growth.
- Mortgage loan gains were $17.6 million in Q2 and $26.5 million for the first half, versus $4.3 million and $7.9 million, respectively, in 2019. Higher refinancing volumes and wider loan-sale spreads contributed; management expects margins to decline toward more normal levels as refinancing activity abates.
- Mortgage servicing recorded losses of $3.0 million in Q2 and $8.3 million in the first half, largely from fair-value declines in servicing rights amid lower rates and higher expected prepayments. Servicing rights fell to $13.8 million from $19.2 million at year-end.
- Deposit costs declined substantially, but Federal Reserve rate cuts and lower market rates pressured asset yields and net interest margin. Loan growth was concentrated in commercial lending, including PPP loans.
Outlook, risks and unusual items
- COVID-19 and credit: Management said the pandemic’s ultimate impact was uncertain and could materially adversely affect results, asset values, and borrowers. COVID-related payment accommodations covered $299.2 million of portfolio loans, or 10.4%, at June 30; commercial accommodations were $210.5 million. The company identified retail, food service, and hotel lending, as well as certain commercial real estate exposures, as areas to monitor.
- PPP: The bank had 2,012 PPP loans outstanding totaling $259.4 million. These loans are federally guaranteed, and the allowance recorded on them was zero. The filing flags potential SBA-guaranty, compliance, and litigation risks. PPP fee accretion contributed $1.0 million of loan interest income in Q2 and the first half.
- CECL: The company deferred adoption of the current expected credit loss standard under CARES Act relief and continued the incurred-loss method. It estimated adoption could increase the loan allowance by $8–$10 million and the allowance for unfunded commitments by $1–$2 million; final effects depend on assumptions and economic conditions.
- Liquidity and funding: Management considered bank liquidity adequate, citing cash, securities, borrowing access, and brokered CDs. It also noted $658.0 million of uninsured deposits, wholesale-funding dependence, and the possibility that government stimulus-related loan and deposit balances could decline in the second half of 2020 and into 2021.
- Capital actions and operations: Share repurchases were suspended in March because of pandemic uncertainty. The quarterly dividend was $0.20 per share. Eight branches were closed or scheduled for closure (two in June and six in July); $0.4 million of closure costs were recorded. A core processing-system conversion was underway, with completion expected in Q2 2021; delays or implementation issues could affect operations and results.
- Other: A commercial loan relationship was charged down by $4.0 million in Q2; approximately $2.6 million was paid off through collateral auction proceeds in July, with the remaining $0.3 million fully reserved. No specific full-year earnings or revenue guidance was provided.
Important facts for investors to verify
- Whether COVID-related accommodations transition into delinquencies, defaults, additional provisions, or losses, especially in identified industry concentrations.
- Trends in non-performing loans, charge-offs, the allowance, and the eventual CECL adoption adjustment.
- How sustainable mortgage origination gains are as refinancing volumes and loan-sale margins normalize, and whether servicing-rights valuations stabilize.
- Deposit retention, uninsured-deposit concentration, wholesale-funding availability, and the liquidity effects of changing PPP and stimulus-related balances.
- Execution, timing, and cost of the core processing conversion, and the financial impact of branch closures and suspended repurchases.