Independent Bank Corporation — Q3 2017 Form 10-Q
Business context and reporting period. Michigan-based bank holding company serving primarily Michigan’s Lower Peninsula. This unaudited report covers the quarter and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods unless stated otherwise. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions.
Key financial results
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net interest income | $22.9 million | $20.0 million | $65.9 million | $59.4 million |
| Net interest margin, GAAP | 3.60% | 3.47% | 3.61% | 3.52% |
| Provision for loan losses | $0.6 million | $(0.2) million | $0.8 million | $(1.4) million |
| Non-interest income | $10.3 million | $11.7 million | $31.1 million | $29.1 million |
| Non-interest expense | $22.6 million | $22.5 million | $68.9 million | $65.5 million |
| Net income | $6.9 million | $6.4 million | $18.8 million | $16.9 million |
| Diluted earnings per share | $0.32 | $0.30 | $0.87 | $0.78 |
Financial position, cash flow and liquidity
- Balance sheet: Total assets were $2.753 billion at September 30, up $204.5 million from year-end 2016. Portfolio loans were $1.937 billion, up $328.8 million, or 20.4%. Deposits were $2.344 billion, up $118.0 million.
- Funding and debt: Other borrowings were $72.8 million, versus $9.4 million at year-end, and federal funds purchased were $3.0 million. Subordinated debentures remained $35.6 million. Deposit growth included $87.6 million of brokered time deposits; reciprocal deposits were $49.1 million. The company reported $557.9 million of uninsured deposits.
- Cash flow: For the first nine months, operating cash flow was $6.2 million, investing cash flow was $(219.4) million and financing cash flow was $177.6 million. Cash and cash equivalents declined $35.6 million to $47.6 million. Loan growth was a major use of investing cash; deposit growth and net borrowing activity funded part of the increase.
- Liquidity and capital: Management said bank liquidity was adequate, citing cash, available-for-sale securities and borrowing access. Parent-company cash and time deposits were approximately $23.4 million. The bank remained categorized as well capitalized; its September 30 ratios included 13.87% total capital, 12.76% Tier 1 and 12.76% common equity Tier 1 to risk-weighted assets.
Material changes versus comparable periods
- Q3 net income rose about 8% year over year, principally as higher net interest income more than offset higher credit provision and lower non-interest income. Nine-month net income rose about 11%.
- Net interest income increased 14.6% in Q3 and 10.9% year to date. Management attributed the growth to larger average interest-earning assets, particularly loans, and higher net interest margin, reflecting asset mix and higher short-term rates. FTE net interest margin was 3.66% in Q3 versus 3.51% and 3.65% year to date versus 3.55%.
- Q3 non-interest income fell $1.4 million, largely reflecting mortgage servicing income of approximately zero versus $0.9 million in the prior-year quarter and lower mortgage-loan gains. Year-to-date non-interest income increased, supported in part by expanded mortgage-banking activity.
- Non-interest expense increased $3.5 million year to date, primarily from compensation and employee benefits, including costs of the mortgage-banking expansion. The company opened additional loan production offices and reported higher mortgage staffing.
- Non-performing loans declined to $8.4 million from $13.4 million at year-end; non-performing assets fell to $10.6 million from $18.4 million. The allowance for loan losses rose to $21.5 million, while its ratio to portfolio loans declined to 1.11% from 1.26%, reflecting portfolio growth.
Outlook, commentary, risks and unusual items
- Outlook: The filing gives no specific earnings or revenue guidance. Management described Michigan economic conditions as generally improving, but noted uneven progress. It cautioned that interim results are not necessarily indicative of full-year results.
- Credit and rate risks: Management cited continuing defaults, particularly in commercial income-producing property and resort/vacation-property lending. It noted emerging commercial real estate risks, including retail closures and possible overdevelopment in some markets. Mortgage growth includes more fixed-rate loans with 15- to 30-year terms, increasing exposure to interest-rate changes; management said it was monitoring this exposure and may use longer-term funding or derivatives.
- Funding risks: Time deposits of $432.2 million mature within 12 months, and $1.81 billion of deposits are withdrawable on demand. Management cautioned that core deposits and wholesale funding may not remain available on current terms; brokered deposits may be difficult or costly to renew.
- Mortgage banking and servicing: Expansion supported originations and loan growth but raised staffing and occupancy costs. The Q3 loan sales margin was 2.46%, down from 3.98%; management attributed pressure, excluding fair-value adjustments, to competitive pricing and lower refinance activity. Fair-value changes in mortgage servicing rights reduced year-to-date results by $2.6 million; the company adopted fair-value accounting for these rights in 2017.
- Business sale and settlement: The payment-plan business sale closed effective May 1, 2017; the company received $33.4 million cash and recorded no 2017 gain or loss. The company had accrued a $2.3 million expense in Q4 2016 for a checking-account transaction-sequencing settlement and expected payment in Q4 2017 or Q1 2018. It also disclosed indemnification obligations related to the business sale, for which no liability was accrued because management considered payment remote.
- Accounting and other: The company expects the 2020 expected-credit-loss standard to increase its allowance, but had not quantified the impact. It reported no material changes to risk factors and no material internal-control changes during the quarter.
Important facts for investors to verify
- Whether rapid loan growth is sustained by stable, suitably priced deposits rather than greater dependence on brokered deposits, borrowings or other wholesale funding.
- Whether credit quality and allowance coverage remain appropriate as commercial real estate exposures and the loan mix evolve; review non-performing loans, TDRs, classified credits and charge-offs.
- Whether mortgage expansion produces durable earnings after compensation and occupancy costs, competitive loan-sale margins, and fair-value volatility in servicing rights.
- How interest-rate changes affect net interest income, the value of longer-term fixed-rate loans and securities, and deposit costs; scenario results are estimates, not forecasts.
- The timing and final cost of the accrued litigation settlement, any claims under sale-related indemnities, and the eventual effect of the expected-credit-loss accounting standard.