Independent Bank Corporation — 2013 Second-Quarter Form 10-Q
Business context and reporting period. This unaudited filing covers the three and six months ended June 30, 2013, with comparisons to 2012. The Michigan-focused banking company reports two principal segments: Independent Bank and Mepco, its vehicle service contract payment-plan business. Amounts below are in U.S. dollars; financial statement figures are in millions unless otherwise indicated.
Financial performance and position
| Metric | Q2 2013 | Q2 2012 | First half 2013 | First half 2012 |
|---|---|---|---|---|
| Net interest income | $19.5 | $21.8 | $39.1 | $43.9 |
| Net interest margin | 4.16% | 4.06% | 4.20% | 4.12% |
| Non-interest income | $13.0 | $13.0 | $24.1 | $27.6 |
| Non-interest expense | $27.7 | $29.5 | $53.2 | $57.5 |
| Pre-tax income | $6.9 | $4.3 | $12.7 | $7.8 |
| Net income | $63.4 | $4.3 | $69.2 | $7.8 |
| Net income applicable to common stock | $62.2 | $3.2 | $66.9 | $5.7 |
Reported 2013 net income includes a $57.6 million tax benefit from reversing substantially all of the deferred-tax-asset valuation allowance; it is not a measure of recurring operating earnings. The reported income tax benefit was $56.5 million after related tax expense. Basic/diluted EPS was $6.56/$2.64 for Q2 and $7.14/$2.90 for the first half, versus $0.38/$0.11 and $0.66/$0.19, respectively, in 2012. No common dividends were declared or paid.
- Balance sheet at June 30: Total assets were $2.135 billion, up $110.8 million from year-end 2012. Total loans were $1.386 billion, down from $1.419 billion; net loans were $1.349 billion. Available-for-sale securities increased to $353.8 million from $208.4 million, while cash and cash equivalents fell to $140.4 million from $179.8 million.
- Funding and debt: Deposits were $1.816 billion, up from $1.780 billion. Other borrowings were $17.5 million and subordinated debentures were $50.2 million. The company continued to defer interest on trust preferred securities; accrued unpaid interest was $7.7 million at June 30. Preferred-stock dividends were also in arrears.
- Cash flow, first half: Operating activities provided $36.4 million; investing activities used $111.8 million; financing activities provided $36.0 million. Cash and cash equivalents decreased $39.4 million to $140.4 million.
- Credit quality: Non-performing loans were $20.1 million, or 1.45% of portfolio loans, versus $32.9 million, or 2.32%, at December 31, 2012. Non-performing assets were $37.9 million, or 1.78% of assets, versus $59.1 million, or 2.92%. The allowance for loan losses was $36.8 million, or 2.65% of portfolio loans, down from $44.3 million, or 3.12%. First-half annualized net charge-offs were 0.68% of average loans, compared with 1.69% in 2012.
- Capital: The Bank was categorized as well-capitalized. Its total risk-based capital ratio was 16.35% and Tier 1 leverage ratio was 10.35%, above both regulatory well-capitalized thresholds and the company’s higher internal minimums. Tangible common equity was $118.8 million, or 5.58% of tangible assets, versus $46.8 million, or 2.32%, at year-end.
Material changes versus comparable periods
- Net interest income declined 10.6% in Q2 and 11.0% in the first half, primarily because average interest-earning assets fell after the 2012 branch sale. The higher net interest margin, supported by lower funding costs, partly offset the decline.
- Non-interest expense fell 5.9% in Q2 and 7.5% in the first half, largely reflecting the branch sale, branch consolidations, and lower credit-related costs. Compensation and benefits also declined with lower staffing.
- Provision for loan losses was a credit of $2.1 million in Q2 and $2.8 million for the first half, compared with expenses of $1.1 million and $6.2 million, respectively, in 2012. Management cited lower problem-loan balances and net charge-offs.
- First-half non-interest income fell $3.5 million. Lower deposit service charges, interchange income, mortgage gains, and securities gains were partly offset by improved mortgage servicing income. Q2 non-interest income was essentially flat.
- Mepco reported a $1.8 million Q2 loss and $1.3 million first-half loss, compared with profits in the 2012 periods. Lower payment-plan receivables and increased counterparty contingency expense were cited factors.
Outlook, management commentary, risks and unusual items
- Management cited improving Michigan economic and asset-quality trends, but noted that the state’s unemployment rate remained above the national average. It said low short-term interest rates were expected to persist until late 2014 or early 2015, while rising longer-term rates could benefit the company over time. The filing provides no specific earnings guidance.
- Management said liquidity was adequate, citing cash, securities, borrowing access and deposit funding. Risks include uninsured deposits of approximately $264.9 million, $250.1 million of time deposits maturing over the next 12 months, and uncertainty about renewing wholesale funding.
- Following the March 2013 termination of the regulatory MOU, board resolutions still require prior regulatory approval for Bank dividends to the parent and for specified parent-company payments, borrowing and stock transactions. The Bank had negative undivided profits of $59.3 million, restricting dividends absent regulatory action.
- After quarter-end, on July 26, the company agreed to purchase the U.S. Treasury’s Series B preferred stock, including accrued dividends, and warrant for $81.0 million. Closing requires at least $86.0 million in gross common-equity proceeds, regulatory approval, payment of deferred trust-preferred interest and other conditions; either party may terminate if closing has not occurred by October 31, 2013. Completion is not assured.
- Mepco’s counterparty receivables, net of reserves, were $15.1 million, down from $18.4 million at year-end. Counterparty contingency expense rose to $3.1 million in Q2 and $3.3 million for the first half, following receivable write-downs and tentative litigation settlements. Collection outcomes and counterparty failures remain material uncertainties.
- Other notable items include termination of the last interest-rate swap, with a $0.6 million fee, and reclassification of the Treasury warrant to equity at a $1.5 million fair value. The company estimated reasonably possible additional losses from ordinary-course litigation at up to approximately $0.4 million; accrued probable litigation losses were immaterial.
- New U.S. capital rules are scheduled to apply beginning January 1, 2015, with the capital conservation buffer phased in from 2016. The company also identified risks relating to loan-loss estimates, mortgage-loan repurchase claims, deferred tax asset realization, interest rates, and Mepco’s vehicle-service-contract industry exposure.
Important facts for investors to verify
- Whether the proposed $86.0 million-or-more equity offering and $81.0 million Treasury transaction closed, and whether required regulatory approvals and trust-preferred interest payments were obtained.
- How much of reported earnings is recurring after excluding the $57.6 million deferred-tax valuation-allowance reversal, and whether future profitability supports realization of deferred tax assets.
- Subsequent changes in Mepco counterparty receivables, reserves, settlements, and collections, including outcomes of the referenced litigation.
- Trends in non-performing loans, TDRs, charge-offs, allowance coverage, and loan-loss provisions as the portfolio continues to run off or change mix.
- Liquidity and capital effects of uninsured deposits, upcoming time-deposit maturities, deferred preferred dividends and trust-preferred interest, and the planned capital transactions.