Independent Bank Corporation — Q3 2012 Form 10-Q
Business context and period: Michigan-based bank holding company with banking operations concentrated in Michigan and Mepco, a nationwide vehicle service contract payment-plan business. This unaudited report covers the quarter and nine months ended September 30, 2012; balance-sheet comparisons are with December 31, 2011. Figures below are in millions unless stated otherwise.
Financial results and position
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net interest income | $21.5 | $23.8 | $65.4 | $71.6 |
| Net interest margin | 3.92% | 4.59% | 4.03% | 4.43% |
| Provision for loan losses | $0.3 | $6.2 | $6.4 | $21.0 |
| Non-interest income | $14.5 | $9.3 | $42.2 | $34.4 |
| Non-interest expense | $29.3 | $31.5 | $86.8 | $97.2 |
| Net income (loss) | $6.4 | $(4.1) | $14.3 | $(11.5) |
| Net income (loss) applicable to common stock | $5.4 | $(5.2) | $11.0 | $(14.6) |
| Basic EPS | $0.61 | $(0.61) | $1.28 | $(1.78) |
- Revenue and margins: Net interest income fell 9.8% year over year in Q3 and 8.7% for the nine months. Management attributed the margin decline largely to a shift from higher-yielding loans to lower-yielding cash and securities, alongside a shrinking payment-plan portfolio. Mortgage-loan gains rose to $4.6 million in Q3 and $12.0 million year to date, supporting non-interest income.
- Profit and costs: The return to profitability reflected lower loan-loss provisions and non-interest expenses, plus higher non-interest income. Year-to-date non-interest expense declined $10.4 million, although compensation and benefits increased, partly because improved results led to performance-compensation accruals.
- Credit and asset quality: Total loans were $1.432 billion, down 9.2% from year-end 2011; the allowance for loan losses was $48.0 million, or 3.35% of loans, versus $58.9 million, or 3.73%. Non-performing loans fell to $38.8 million from $59.3 million, and non-performing assets to $69.2 million from $93.9 million. Performing troubled debt restructurings increased to $132.5 million from $116.6 million. Annualized net charge-offs were 1.46% of average loans for the first nine months, compared with 2.35% in 2011.
- Cash flow and liquidity: Nine-month operating cash flow was $10.9 million, investing cash flow $23.1 million, and financing cash flow $85.5 million; cash and cash equivalents increased $119.4 million to $460.5 million. Cash included $403.6 million of interest-bearing deposits. Available-for-sale securities were $230.2 million.
- Funding and debt: Deposits totaled $1.765 billion, plus $405.9 million classified as held for sale in connection with the pending branch sale. Other borrowings were $17.7 million, down from $33.4 million; subordinated debentures remained $50.2 million. Brokered CDs were $48.9 million, with $32.1 million maturing within twelve months.
- Capital: Shareholders’ equity was $121.5 million. Tangible common equity was $31.6 million and tangible common equity to tangible assets was 1.32%, versus 0.66% at year-end. The Bank reported total risk-based capital of 13.22% and Tier 1 leverage of 7.29%; it met regulatory “well-capitalized” standards but was below its board’s 8.00% Tier 1 leverage target. Dividends on common and preferred stock and interest on trust preferred securities remained suspended or deferred.
Material changes versus prior periods
- Results shifted from losses in 2011 to net income of $6.4 million for Q3 and $14.3 million for the first nine months of 2012.
- Lower provisions, lower other-real-estate losses, and reduced Mepco counterparty-contingency expense helped results; the latter was $0.3 million for Q3 and $1.1 million year to date, versus $1.3 million and $5.0 million in 2011.
- Loan balances continued to contract while cash and securities increased. Available-for-sale securities rose to $230.2 million from $157.4 million at year-end.
- Non-performing loans and net charge-offs declined, but the balance of performing TDRs grew, and asset quality remained a central management and regulatory focus.
Outlook, risks, contingencies, and unusual items
- Branch sale: The company agreed to sell 21 branches to Chemical Bank, with approximately $408.6 million of deposits transferring and an estimated $11.8 million deposit premium. It estimated a net gain of about $5.8 million and expected completion by year-end 2012, subject to closing conditions. The transaction was expected to use approximately $330–$340 million of cash and short-term securities.
- Management outlook: Management expected reduced credit costs to support profitability, partly offset by lower net interest income as loans decline and lower-yielding securities increase. It believed the Bank could remain above regulatory well-capitalized standards, but cautioned that deterioration in Michigan’s economy, higher credit costs, or Mepco losses could undermine that outlook.
- Regulatory capital plan: The company and Bank were operating under an October 2011 Memorandum of Understanding and a capital plan. Management said it was generally in compliance but still needed to execute planned strategies, including the branch sale. Failure to meet capital requirements could lead to further restrictions, affect wholesale funding access, and threaten mortgage-servicing relationships.
- Mepco counterparty exposure: Net vehicle-service-contract counterparty receivables were $18.8 million, down from $29.3 million at year-end; the reduction included cash and real estate received from a former counterparty’s bankruptcy estate. Mepco was pursuing collections, collateral recovery, and litigation. Management warned actual losses could exceed recorded reserves.
- Other unusual items and risks: The company recorded a $0.9 million write-down of property and equipment held for sale following plans to close or consolidate branches. Three below-investment-grade private-label mortgage-backed securities had recognized other-than-temporary credit impairment. Ordinary-course litigation had an estimated maximum reasonably possible additional loss of approximately $0.4 million; management considered the accrued amount immaterial.
- Capital and shareholder effects: The U.S. Treasury held convertible preferred stock with accrued unpaid dividends; approximately 11.2 million common shares could result from conversion at September 30, 2012. The company also had a Dutchess equity-line facility, with additional potential proceeds dependent on share sales and market price. Capital-raising activity could limit use of tax-loss carryforwards.
Most important facts for investors to verify
- Whether the Chemical Bank branch sale closed on the expected terms and whether the estimated $5.8 million gain and capital benefits were realized.
- Whether improvement in non-performing loans and charge-offs continued, and how the growing performing-TDR balance performed.
- Whether the Bank met its 8.00% internal Tier 1 leverage target and remained above regulatory capital thresholds.
- How much of Mepco’s $18.8 million net counterparty receivables was ultimately collected, and whether litigation or future cancellations required additional reserves.
- Whether deposit retention, wholesale-funding availability, and liquidity remained adequate following the branch sale and the maturity of brokered CDs.
- The potential dilution and dividend obligations associated with Treasury preferred-stock conversion, the equity-line facility, and any future capital raise.