Independent Bank Corporation — Q1 2021 Form 10-Q
Business context and period: Michigan-focused bank holding company with two loan production offices in Ohio. This unaudited report covers the three months ended March 31, 2021; income-statement and cash-flow comparisons are against Q1 2020, while balance-sheet comparisons are against December 31, 2020. Amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q1 2021 / March 31, 2021 | Comparable period / prior year-end |
|---|---|---|
| Net interest income | $30.3 million | $30.2 million in Q1 2020 |
| Net interest margin | 3.01% GAAP; 3.05% fully taxable equivalent (FTE) | 3.61% GAAP; 3.63% FTE in Q1 2020 |
| Provision for credit losses | $0.5 million credit | $6.7 million expense in Q1 2020 |
| Non-interest income | $26.4 million | $11.0 million in Q1 2020 |
| Non-interest expense | $30.0 million | $28.7 million in Q1 2020 |
| Income before taxes / net income | $27.1 million / $22.0 million | $5.8 million / $4.8 million in Q1 2020 |
| Diluted earnings per share | $1.00 | $0.21 in Q1 2020 |
| Annualized return on average assets / equity | 2.10% / 23.51% | 0.54% / 5.54% in Q1 2020 |
| Total assets | $4.43 billion | $4.20 billion at December 31, 2020 |
| Total loans, excluding allowance | $2.78 billion | $2.73 billion at December 31, 2020 |
| Total deposits | $3.86 billion | $3.64 billion at December 31, 2020 |
| Cash and cash equivalents | $130.5 million | $118.7 million at December 31, 2020 |
| Allowance for credit losses on loans | $46.8 million; 1.68% of loans | $35.4 million at year-end before CECL adoption |
| Shareholders’ equity | $387.3 million | $389.5 million at December 31, 2020 |
Earnings drivers and material changes
- Net income rose substantially year over year, reflecting higher non-interest income, a credit provision rather than the prior-year expense, and slightly higher net interest income. The comparison also reflects a $5.3 million mortgage-servicing loss in Q1 2020 versus a $5.2 million gain in Q1 2021.
- Mortgage loan gains increased to $12.8 million from $8.8 million. Originations were $509.0 million versus $311.1 million, and loans sold were $377.4 million versus $262.3 million. Management attributed increased activity primarily to refinancing demand. The reported loan-sale margin was 3.40%, versus 3.37%; excluding fair-value adjustments, it was 4.38% versus 2.59%.
- Mortgage servicing income included a $3.3 million increase in servicing-rights fair value, compared with a $7.0 million decrease in Q1 2020. Servicing rights were valued at $23.5 million at quarter-end, up from $16.9 million at year-end.
- Interest expense fell to $2.2 million from $5.4 million, but the FTE net interest margin contracted to 3.05% from 3.63%. Management attributed margin pressure to lower asset yields, partly offset by lower deposit costs and growth in average interest-earning assets.
- Compensation and benefits increased $2.0 million, largely due to higher performance-based compensation accruals. Total non-interest expense rose $1.3 million.
Cash flow, funding, debt, and capital
- Operating cash flow was $35.1 million; investing activities used $235.8 million, mainly reflecting $367.7 million of securities purchases, partly offset by sales and maturities. Financing activities provided $212.5 million, principally from a $221.2 million increase in deposits. Cash and equivalents increased $11.8 million during the quarter.
- Deposits grew $221.2 million. Non-interest-bearing, savings/checking, and reciprocal deposits increased, while time and brokered time deposits declined. The company reported $850.9 million of uninsured deposits.
- Quarter-end balance-sheet borrowings included $30.0 million of other borrowings, $39.3 million of subordinated debt, and $39.5 million of subordinated debentures. Management said bank liquidity was adequate, citing cash, available-for-sale securities, secured borrowing access, and brokered CDs; parent-company cash and time deposits were approximately $49.7 million.
- The Bank was categorized as well capitalized. At March 31, 2021, its total risk-based capital ratio was 13.99%, Tier 1 ratio 12.74%, common equity Tier 1 ratio 12.74%, and Tier 1 leverage ratio 8.95%. Tangible common equity was $355.0 million, and tangible common equity to tangible assets was 8.08%, down from 8.56% at year-end.
- The company declared a $0.21-per-share dividend. It repurchased 180,667 shares for $3.6 million during the quarter; the board’s plan authorized up to 1.1 million shares through December 31, 2021.
Outlook, risks, and unusual items
- No quantitative earnings guidance is provided. Management cautioned that Q1 results are not necessarily indicative of full-year results. It expects mortgage loan-sale margins to decline toward more normal levels when unusually high mortgage volumes ease.
- Management said stimulus and monetary actions contributed to deposit growth and PPP-related commercial loan growth, but the timing and effect of their eventual end are uncertain. Liquidity and funding plans consider possible significant declines in commercial loans and deposits during 2021.
- The company adopted CECL on January 1, 2021. Adoption increased the loan allowance by $11.7 million and the unfunded-commitment allowance by $1.5 million, and reduced retained earnings by $10.3 million. The Q1 2021 allowance and provision are therefore not directly comparable with prior periods prepared under the incurred-loss method.
- At March 31, 2021, 143 company-held loans totaling $15.8 million had COVID-19 accommodations, or 0.6% of portfolio loans. Mortgage and installment accommodations were 1.5% and 0.1% of those respective loan balances; there were no commercial accommodations outstanding. Separately, the company serviced $3.07 billion of mortgages for others and reported 205 accommodated serviced loans totaling $27.0 million.
- PPP loans outstanding totaled $234.2 million across 1,948 loans, including $128.2 million of Round 2 loans. The company recognized $2.1 million of PPP loan-fee accretion in interest income; $6.8 million of net fees remained unaccreted. Loans are SBA-guaranteed, but the filing identifies possible guarantee denial or recovery, compliance, litigation, and reputational risks.
- Management identified commercial exposures in retail, food service, hotels, office, and multifamily as potentially more exposed to pandemic disruption. It said it did not then foresee significant losses in these concentrations, while emphasizing substantial uncertainty about future credit performance. COVID-19 could also affect credit losses, collateral values, operations, cyber risk, and asset valuations.
- Available-for-sale securities increased to $1.25 billion from $1.07 billion; quarter-end unrealized losses were $4.1 million. A $5.7 million after-tax other comprehensive loss reduced accumulated other comprehensive income. Management reported no credit-loss allowance was required on these securities and attributed unrealized losses mainly to interest-rate and credit-spread movements.
- The core data-processing conversion was expected to be substantially complete by the end of Q2 2021. The filing reports $0.2 million of conversion-related expense in Q1. Litigation accruals were described as immaterial; the company said additional reasonably possible losses were currently estimated to be insignificant.
Important facts for investors to verify
- Whether the unusually strong mortgage banking and servicing contribution persists, especially given management’s expectation that loan-sale margins normalize and the sensitivity of servicing-rights value to rates and prepayments.
- How credit quality, criticized/watch loans, accommodations, and the CECL allowance evolve as pandemic effects and economic forecasts change; assess year-over-year credit comparisons on a consistent accounting basis.
- Whether deposit growth is durable, including the composition and stability of reciprocal and uninsured deposits, and the company’s ability to retain or replace wholesale funding at acceptable cost.
- PPP forgiveness and SBA guarantee performance, including any servicing or eligibility issues that could expose the Bank to losses or litigation.
- Interest-rate sensitivity, available-for-sale securities valuation, and capital ratios after the quarter’s decline in tangible common equity to tangible assets.
- Completion, cost, and operational impact of the planned core-system conversion.