Independent Bank Corporation — Q3 2016 Form 10-Q
Business context and reporting period
Michigan-based bank holding company serving primarily Michigan’s Lower Peninsula, with banking subsidiary Independent Bank and vehicle-service-contract payment-plan business Mepco. This unaudited report covers the quarter and nine months ended September 30, 2016; balance-sheet comparisons are with December 31, 2015. Dollar amounts below are in millions unless stated otherwise.
Financial results and key metrics
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net interest income | $20.0 | $18.8 | $59.4 | $55.6 |
| Non-interest income | $11.7 | $10.1 | $29.1 | $30.1 |
| Non-interest expense | $22.5 | $21.9 | $65.5 | $65.6 |
| Net income | $6.4 | $5.0 | $16.9 | $14.4 |
| Diluted earnings per share | $0.30 | $0.22 | $0.78 | $0.62 |
| Tax-equivalent net interest margin | 3.51% | 3.58% | 3.55% | 3.59% |
Net income rose about 26% year over year in Q3 and 17% for the nine-month period. Q3 improvement reflected higher net interest and non-interest income, partly offset by higher expense and taxes. Year-to-date earnings benefited from higher net interest income, a larger credit to the loan-loss provision, and slightly lower expenses; lower non-interest income and higher taxes partly offset those gains. The loan-loss provision was a credit of $0.2 million in Q3 and $1.4 million year to date.
- Balance sheet: Total assets were $2.538 billion, up $129.3 million from year-end 2015. Portfolio loans were $1.607 billion, up $92.3 million (6.1%); total deposits were $2.207 billion, up $121.0 million.
- Liquidity and funding: Cash and cash equivalents were $114.3 million and available-for-sale securities were $603.1 million. Cash from operations was $13.1 million for the nine months, compared with $19.6 million in 2015; investing used $82.3 million and financing provided $97.7 million. Cash increased $28.5 million to $114.3 million.
- Debt and capital: Other borrowings were $11.5 million and subordinated debentures $35.6 million. Shareholders’ equity was $250.9 million, nearly unchanged from year-end. The Bank remained well capitalized: total risk-based capital ratio 15.39%, Tier 1 risk-based 14.14%, common equity Tier 1 14.14%, and Tier 1 leverage 10.09%.
- Credit quality: Non-performing loans were $10.8 million, or 0.67% of portfolio loans; non-performing assets were $15.8 million, or 0.62% of assets. The allowance was $22.0 million, equal to 1.37% of portfolio loans and 204% of non-performing loans. Performing troubled debt restructurings totaled $74.9 million.
Material changes versus comparable periods
- Net interest income increased 6.1% in Q3 and 6.8% year to date, mainly from growth in average earning assets. Margin narrowed by 7 basis points in Q3 and 4 basis points year to date, as loan yields fell in the prolonged low-rate environment and funding costs rose modestly.
- Q3 non-interest income rose $1.6 million, led by mortgage-loan gains and servicing results. Nine-month non-interest income declined $1.0 million; 2015 included a $1.2 million gain on a branch sale.
- Mortgage loan sales margin increased to 3.98% in Q3 and 3.59% year to date, versus 2.55% and 2.58% in 2015. Compensation and benefits rose $1.3 million year to date, partly due to higher performance-based compensation; overall non-interest expense was nearly flat.
- Asset quality measures generally improved: non-performing assets declined from $17.9 million at year-end, and net loan charge-offs were net recoveries of 0.08% of average portfolio loans on an annualized year-to-date basis, versus net charge-offs of 0.03% in 2015.
Outlook, risks, contingencies, and unusual items
- Management reported generally improving Michigan economic conditions and continued improvement in asset quality, but noted ongoing defaults, particularly in commercial income-producing property and resort/vacation mortgage lending. The filing gives no formal earnings guidance.
- Management expected short-term rates to remain very low until at least late 2016 or 2017 and said rising rates could benefit net interest margin over the longer term. It did not expect the unusually strong mortgage loan sales margin of the first nine months to continue into Q4 2016 or 2017.
- Mepco’s counterparty collection risk remains significant: recoveries may be affected by cancellations, counterparties’ ability to pay, collateral, and enforceability of contractual obligations. A Q1 settlement produced $4.0 million cash and a $1.5 million promissory note; the remaining $1.39 million note balance was fully reserved at September 30, despite six payments received. Net counterparty receivables fell to $2.6 million from $7.2 million at year-end.
- Ordinary-course litigation accruals were immaterial; the company estimated additional reasonably possible losses of up to approximately $1.0 million. Management cautioned this estimate may change.
- Uninsured deposits were approximately $572.4 million. Management said liquidity was adequate but warned that deposit outflows or reduced access to wholesale funding could raise funding costs and adversely affect results.
- The company repurchased 1.153 million shares for $16.9 million during the first nine months under its repurchase plan. The Board increased the quarterly dividend to $0.10 per share in October; Q3 dividends were $0.08 per share. The tax-benefits preservation plan was not renewed and was scheduled to expire November 15, 2016.
- Adoption of share-based-payment accounting guidance added $1.247 million to opening equity. The company had not determined the impact of the new expected-credit-loss accounting standard, effective for it in 2020.
Most important facts for investors to verify
- Whether loan growth and deposit funding can continue without further net interest margin compression, particularly if rates or deposit pricing change.
- Trends in non-performing loans, TDRs, charge-offs, and allowance adequacy as the portfolio expands.
- Mepco’s collections, counterparty concentrations, fully reserved note, and adequacy of contingency reserves.
- Reliability of mortgage gain and servicing income, including management’s expectation that elevated mortgage sales margins may not persist.
- Uninsured-deposit levels, liquidity access, regulatory capital headroom, and the remaining authorization and execution of share repurchases and dividends.