Independent Bank Corporation — Q2 2012 Form 10-Q
Business context and period. Michigan-based bank holding company with banking operations and Mepco, a vehicle service contract payment-plan business. This unaudited report covers the quarter and six months ended June 30, 2012; balance-sheet comparisons are to December 31, 2011. Amounts below are in millions unless otherwise stated.
Financial performance and position
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net interest income | $21.8 | $23.4 | $43.9 | $47.8 |
| Net interest margin | 4.02% | 4.36% | 4.08% | 4.35% |
| Provision for loan losses | $1.1 | $4.2 | $6.2 | $14.9 |
| Non-interest income | $13.0 | $12.5 | $27.6 | $25.2 |
| Non-interest expense | $29.5 | $31.9 | $57.5 | $65.8 |
| Net income (loss) | $4.3 | $0.04 | $7.8 | $(7.4) |
| Net income (loss) applicable to common stock | $3.2 | $(1.0) | $5.7 | $(9.4) |
| Basic earnings (loss) per common share | $0.38 | $(0.12) | $0.66 | $(1.16) |
Balance sheet and liquidity. Total assets were $2,403.5, up from $2,307.4 at year-end. Cash and cash equivalents were $419.8, including $358.9 of interest-bearing deposits. Portfolio loans were $1,457.4, down 7.6%; the allowance for loan losses was $51.3, or 3.52% of portfolio loans, versus $58.9 and 3.73% at year-end. Reported deposits were $1,765.3; another $417.5 was classified as deposits held for sale for the pending branch sale. Including those deposits, balances increased $96.7 during the half-year. Other borrowings were $17.9, and subordinated debentures were $50.2.
For the first six months, operating cash flow was $22.4, investing cash flow was negative $28.7, and financing cash flow was $85.0. Cash and cash equivalents increased $78.7 to $419.8. Wholesale funding (brokered CDs and FHLB borrowings) totaled approximately $66.8, or 3.0% of funding.
Credit and capital. Non-performing loans were $45.1, down from $59.9 at year-end; non-performing assets were $74.6, or 3.10% of assets, versus $93.9 and 4.07%. Annualized net charge-offs were 1.69% of average loans, compared with 2.58% in the prior-year half. Performing troubled debt restructurings increased to $131.9 from $116.6. Bank capital ratios at June 30 were 12.48% total capital to risk-weighted assets and 6.98% Tier 1 capital to average assets. The bank exceeded the federal “well-capitalized” thresholds, but its Tier 1 leverage ratio remained below the company’s 8.00% board-plan target. Tangible common equity to tangible assets was 1.01%.
Material changes and unusual items
- Profitability improved markedly year over year, principally because loan-loss provisions and non-interest costs declined. Lower net interest income partly offset the improvement.
- Net interest income fell 6.6% in Q2 and 8.2% for the half. Management attributed the margin pressure to a mix shift from higher-yielding loans, including Mepco receivables, toward lower-yielding cash and securities.
- Mortgage-loan sale gains rose to $3.6 in Q2 and $7.4 for the half, compared with $1.8 and $3.7, respectively, in 2011. Mortgage servicing recorded a $1.1 Q2 loss, reflecting servicing-rights valuation and amortization effects. Securities impairment charges were $0.3 for the half, relating to private-label mortgage-backed securities.
- Mepco counterparty-contingency expense declined to $0.3 in Q2 and $0.8 for the half, from $1.3 and $3.7. However, net vehicle-service-contract counterparty receivables remained $28.9, and collection efforts include collateral recovery, bankruptcy claims and litigation.
- On May 23, 2012, the company agreed to sell 21 branches to Chemical Bank. The transaction is expected to transfer approximately $417.5 of deposits, with an estimated $12.4 deposit premium, and may include approximately $53.2 of loans sold at a discount. Completion was expected by the end of Q3, subject to approvals and other conditions.
Outlook, risks and contingencies
Management expected the branch sale, continued asset reduction and lower credit costs to support capital and profitability. It anticipated some further decline in net interest income from the branch sale and continued loan-mix changes. Management believed the bank could remain federally well-capitalized without additional capital under its forecasts, but cautioned that this depended on economic conditions, credit costs and Mepco collections. It expected adequate liquidity after the branch sale, while noting the transaction would use approximately $330–$340 of cash or short-term securities.
- The company and bank were subject to a regulatory Memorandum of Understanding and capital-restoration plan. Dividends, certain debt, repurchases and other actions were subject to regulatory restrictions or approval. The bank’s 6.98% Tier 1 leverage ratio was below its 8.00% board target.
- The company had suspended cash dividends on common and preferred stock and deferred interest on subordinated debentures. It reported $8.6 of accrued unpaid preferred dividends in the notes; Part II separately reported $8.1 in arrears—figures investors should reconcile.
- Mepco’s counterparties may fail to reimburse refunds due on cancelled service contracts. The company stated actual losses could exceed recorded reserves; receivables are not generally fully collateralized.
- Other key risks include Michigan economic and real-estate conditions, loan-loss estimate uncertainty, access to wholesale funding and deposit outflows, possible loss of mortgage servicing rights if capital weakens, and potential limits on tax-loss carryforwards after an ownership change.
- The company had a pending equity-line facility with Dutchess through November 2013; approximately $7.6 of potential proceeds were available based on the June 30 stock price. Management was evaluating the timing and size of any common-stock offering. The U.S. Treasury preferred stock could convert into approximately 11.0 million common shares based on June 30 terms, creating potential dilution.
Most important facts for investors to verify
- Whether the 21-branch sale closed on schedule, its final premium and loan-transfer terms, and the resulting liquidity and capital effects.
- Whether the bank can reach and sustain the 8.00% board Tier 1 leverage target, not merely the federal well-capitalized threshold.
- Trends in non-performing loans, performing TDRs, charge-offs, reserve adequacy and Michigan collateral values.
- Recoverability of the $28.9 of Mepco counterparty receivables and any further losses, litigation outcomes or reserve changes.
- The preferred-dividend arrears and accrual disclosures, potential Treasury conversion dilution, and the amount and terms of any new equity issuance.