Independent Bank Corporation (IBCP) — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Amounts are in U.S. dollars; financial statement amounts are generally in millions unless noted. The company provides banking services primarily in Michigan’s Lower Peninsula, with two Ohio loan production offices.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net interest income | $30.8m | $29.0m | $61.0m | $52.9m |
| Provision for loan losses | $0.7m | $0.7m | $1.3m | $1.0m |
| Non-interest income | $9.9m | $12.3m | $19.9m | $24.0m |
| Non-interest expense | $26.6m | $29.8m | $54.6m | $53.9m |
| Net income | $10.7m | $8.8m | $20.1m | $18.0m |
| Diluted EPS | $0.46 | $0.36 | $0.85 | $0.78 |
| FTE net interest margin | 3.87% | 3.93% | 3.88% | 3.83% |
Q2 net income rose 21.7% year over year, supported mainly by higher net interest income and lower expenses; lower non-interest income partly offset the gains. Six-month net income increased 11.9%. Annualized return on average assets was 1.27% in Q2 (1.12% prior year) and 1.20% for the first half (1.22% prior year). The Q2 margin eased six basis points, which management attributed to a flatter yield curve and rising funding costs; the first-half margin improved five basis points.
Non-interest income was pressured by mortgage servicing valuation losses: mortgage loan servicing, net, was a $1.9m loss in Q2 and a $3.1m loss for the first half, versus income of $1.2m and $3.5m in the comparable periods. Management attributed the change chiefly to fair-value effects from interest rates and expected prepayments. Mortgage loan gains increased, while deposit service charges declined. Q2 non-interest expense was lower in part because the prior-year quarter included $3.1m of merger-related costs.
Financial position, liquidity and capital
- Total assets were $3.44bn at June 30, up $85.0m from year-end 2018. Portfolio loans were $2.71bn, up $124.0m, or 4.8%.
- Deposits totaled $2.98bn, up $65.5m since year-end, primarily from reciprocal deposits. Reciprocal deposits increased to $326.3m from $182.1m. The company reported $491.9m of uninsured deposits.
- Cash and cash equivalents were $55.1m, down from $70.2m at December 31. For the first half, operating cash flow was $13.9m, investing cash use was $75.1m, financing cash provided was $46.0m, and cash declined by $15.1m.
- Other borrowings were $41.1m and subordinated debentures were $39.4m. Shareholders’ equity was $330.8m, down from $339.0m; the decline reflected repurchases and dividends, partly offset by earnings and improved accumulated other comprehensive loss. Tangible common equity to tangible assets was 8.72%, versus 9.17% at year-end.
- The Bank was categorized as well capitalized. At June 30, its total risk-based capital ratio was 12.81%, Tier 1 risk-based ratio 11.80%, common equity Tier 1 ratio 11.80%, and Tier 1 leverage ratio 9.50%.
- Management said Bank liquidity was adequate, citing cash, available-for-sale securities, FHLB access and ability to issue brokered CDs. Parent-company cash and time deposits were approximately $13.3m. About $556.2m of time deposits mature within 12 months; wholesale funding, including reciprocal deposits, was about 20.3% of total funding as defined by the company.
Asset quality, capital actions and material changes
- The allowance for loan losses was $25.9m, or 0.96% of portfolio loans, compared with $24.9m and 0.96% at year-end. First-half provision was $1.3m; net charge-offs were 0.02% of average portfolio loans on an annualized basis.
- Non-performing loans were $7.4m, or 0.27% of portfolio loans, compared with $8.6m and 0.33% at year-end. Non-performing assets were $9.4m. Performing troubled debt restructurings totaled $49.3m, down from $53.1m.
- Management noted an increase in adversely rated commercial loans, mainly in early watch categories and largely performing; it did not expect significant losses from this increase. It also cited continuing defaults, particularly in commercial income-producing property and resort/vacation mortgage lending.
- The company repurchased 1.18m shares in the first half for $25.8m, completing its original authorization to buy back 5% of outstanding shares. The board added authorization for up to 300,000 more shares through December 31, 2019. Quarterly dividends were $0.18 per share, compared with $0.15 in 2018.
- Comparability is affected by the TCSB acquisition completed April 1, 2018: TCSB results are included from that date, so the 2018 first-half period includes only the post-acquisition quarter. The company reported no merger-related expenses in 2019, versus $3.3m in the first half of 2018.
Outlook, risks and unusual items
- No specific earnings or revenue guidance was provided. Management identified loan and deposit growth, regional economic conditions, competition, credit losses, market interest rates and funding costs as factors that could affect results.
- The company expects to adopt the current expected credit loss standard (CECL) on January 1, 2020. Based on the June 30 loan portfolio and available forecasts, it estimated an initial loan allowance increase of $9.5m–$11.5m, plus $0.5m–$1.5m for unfunded commitments. These estimates remain subject to model refinement, portfolio changes and economic conditions. Management did not expect an allowance for available-for-sale securities at adoption.
- Fixed-rate mortgage growth may increase interest-rate exposure; management said it was monitoring portfolio mix and may use longer-term borrowings or derivatives, and may consider selling fixed-rate jumbo mortgages. Its interest-rate simulation showed a 1.55% increase in projected 12-month net interest income under a 200-basis-point rise, but a 1.71% decline under a 100-basis-point fall; the filing cautions that simulations are not forecasts.
- Mortgage servicing-rights fair value fell by $6.1m in the first half, contributing to the servicing loss. Fair value depends on estimates including discount rates, servicing costs, ancillary income and float rates.
- Litigation accruals were described as immaterial, and management estimated reasonably possible additional losses as insignificant, while noting outcomes remain uncertain. The company also valued its restricted-transfer Visa Class B shares at zero for accounting purposes; it estimated an indicative value of approximately $3.7m using the then-current conversion ratio and Class A share price.
- ASU 842 lease adoption resulted in approximately $7.7m of right-of-use assets and lease liabilities at January 1, 2019, with no material effect on results or financial condition expected. Other disclosed 2019 accounting-standard adoptions also had no material impact.
Key facts for investors to verify
- Whether net interest income growth can continue as deposit costs rise and the yield curve remains a pressure point.
- Mortgage servicing-rights valuation assumptions and whether further rate or prepayment changes could create additional non-interest income volatility.
- The quality and performance of watch-rated commercial loans, resort-related credits, non-performing loans and restructured loans.
- Actual CECL transition adjustments compared with the preliminary allowance estimates, including the unfunded-commitment impact.
- Deposit retention, uninsured and reciprocal deposit levels, upcoming time-deposit maturities, and the availability and cost of wholesale funding.
- Effects of the share repurchase expansion on capital, tangible common equity and per-share earnings.