Independent Bank Corporation — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are to December 31, 2016 unless noted. The unaudited consolidated company provides banking services primarily in Michigan’s Lower Peninsula, alongside mortgage banking and the Mepco payment-plan business, which was held for sale.
Financial performance and condition
Amounts below are in millions of dollars unless otherwise indicated.
| Metric | Q1 2017 / March 31, 2017 | Comparable period / prior date |
|---|---|---|
| Interest income | $23.4 | $21.4 in Q1 2016 |
| Net interest income | $21.5 | $19.8 in Q1 2016; up 8.6% |
| Net interest margin | 3.69% FTE; 3.67% GAAP | 3.61% FTE; 3.60% GAAP |
| Non-interest income | $10.3 | $7.8 in Q1 2016 |
| Net income | $6.0; diluted EPS $0.28 | $4.1; diluted EPS $0.19 |
| Non-interest expense | $23.6 | $22.0 in Q1 2016 |
| Provision for loan losses | Credit of $0.36 | Credit of $0.53 in Q1 2016 |
| Assets | $2,596.5 | $2,549.0 |
| Portfolio loans | $1,670.7 | $1,608.2; up 3.9% |
| Deposits | $2,263.1 | $2,225.7; up $37.3 |
| Cash and cash equivalents | $69.8 | $83.2 at December 31, 2016 |
| Other borrowings / subordinated debentures | $9.4 / $35.6 | Both unchanged from year-end |
| Shareholders’ equity | $255.5 | $249.0 |
| Operating cash flow | $3.2 | $5.5 in Q1 2016 |
- Net income rose approximately 46% year over year. Higher net interest income and non-interest income were partly offset by higher expenses and taxes; the loan-loss provision remained a credit but was a smaller credit than in Q1 2016.
- Net interest income benefited from higher average interest-earning assets ($2.37 billion versus $2.21 billion) and an 8-basis-point increase in FTE margin. Non-interest income growth included stronger mortgage loan gains and a swing in mortgage servicing income.
- Compensation and benefits increased 19% to $14.1 million, primarily reflecting mortgage-banking expansion, staffing growth and incentive accruals. Total non-interest expense increased about 7%.
- Net cash used in investing activities was $51.4 million, principally reflecting $61.0 million of net portfolio loan growth. Financing cash flow was $34.8 million, including deposit growth and $2.1 million in dividends paid.
- Bank regulatory capital remained well above minimums: the Bank reported a 13.65% common equity Tier 1 ratio and a 9.96% Tier 1 leverage ratio. Consolidated total capital to risk-weighted assets was 15.71%.
Material changes and asset quality
- Non-performing loans declined to $9.0 million from $13.4 million at year-end; non-performing assets fell to $14.3 million from $18.4 million. Non-performing loans were 0.54% of portfolio loans, versus 0.83%.
- The allowance for loan losses decreased to $20.0 million from $20.2 million, or 1.20% of portfolio loans versus 1.26%. Net recoveries continued, although the annualized net recovery ratio was lower than in Q1 2016.
- Performing troubled debt restructurings totaled $67.8 million, down from $70.3 million. Management cited paydowns and payoffs; it also identified ongoing defaults, particularly in income-producing commercial real estate and resort/vacation-property mortgage lending.
- Available-for-sale securities were $609.0 million, slightly below year-end. Gross unrealized losses declined to $4.2 million from $7.6 million; management reported no Q1 2017 credit-related other-than-temporary impairment charges.
- The Board authorized a plan in January 2017 to repurchase up to 5% of outstanding shares through year-end. The filing says no shares were repurchased under the plan in Q1. A separate disclosure reports 46,538 shares purchased during February, comprising employee stock ownership plan purchases and shares withheld for tax obligations, not purchases under the public plan.
Outlook, management commentary, risks and unusual items
- No formal earnings or financial guidance was provided. Management said it expects future short-term rate increases to be gradual and believes rising rates may benefit net interest margin over the longer term. It cautioned that deposit outflows could require borrowing or securities sales and adversely affect earnings.
- Mortgage-banking operations expanded, including new employees and six loan-production offices; another office was in development. Management expects the expansion to support mortgage gains and longer-term portfolio and servicing growth, but acknowledged higher operating costs and anticipated lower industry-wide refinance volume as rates rise. Execution is a stated risk.
- The Mepco asset sale to Seabury covers its payment-plan processing business, receivables and certain other assets, with certain liabilities assumed by the buyer. The transaction was expected to close May 5, 2017. Mepco reported Q1 net income of $0.14 million, compared with a $0.24 million loss in Q1 2016. The company did not expect the sale to materially affect overall results.
- A $2.3 million settlement expense for litigation concerning historical checking-account transaction sequencing was recorded in Q4 2016. The settlement had preliminary court approval in Q1; payment of approximately $2.2 million plus costs was expected in the second half of 2017.
- Management highlighted liquidity exposure from $566.1 million of uninsured deposits and $350.3 million of time deposits maturing within 12 months. It cited parent-company cash and time deposits of approximately $16.8 million and stated that bank and parent liquidity were adequate.
- Mepco counterparty receivables and related indemnification obligations in the pending sale remain judgment-sensitive. The filing warns that actual counterparty losses could exceed recorded charges; no indemnification liability was accrued because management considered payment remote.
- Accounting changes included adoption of fair-value accounting for mortgage servicing rights, increasing the opening carrying value by $0.54 million and equity by $0.35 million net of tax, and early adoption of callable-securities premium amortization guidance. The new expected-credit-loss standard is expected to increase the allowance, but the impact had not been determined.
- Key risks identified include Michigan and local real-estate conditions, credit-loss estimates, loan and deposit growth, competition, interest-rate movements, liquidity, and regulatory or legislative changes. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether the Mepco transaction closed on the anticipated date and the final sale proceeds, accounting effects, and any indemnification claims.
- Whether loan growth, commercial real-estate exposures, non-performing loans and the allowance remain consistent with management’s credit assumptions.
- Whether mortgage-banking expansion delivers expected revenue and servicing growth without expense growth or weaker refinance demand eroding returns.
- Deposit retention, uninsured-deposit behavior, time-deposit renewals and access to wholesale funding as interest rates change.
- How the fair-value measurement of mortgage servicing rights and future expected-credit-loss accounting affect reported earnings, equity and reserves.
- Repurchase-plan activity and the distinction between plan repurchases and employee-plan purchases or tax-withholding shares.