Independent Bank Corporation — Q1 2016 Form 10-Q
Business and period: Michigan-based bank holding company providing banking services primarily in Michigan’s Lower Peninsula, with a second reportable segment, Mepco, offering vehicle-service-contract payment plans. This unaudited report covers the three months ended March 31, 2016; comparisons are with Q1 2015 unless otherwise noted. Dollar amounts below are in millions unless stated otherwise.
Financial performance and position
| Metric | Q1 2016 / March 31, 2016 | Comparable period / prior year-end |
|---|---|---|
| Net interest income | $19.8 | $18.1 in Q1 2015 |
| Net interest margin, tax-equivalent | 3.61% | 3.57% in Q1 2015 |
| Non-interest income | $7.8 | $9.0 in Q1 2015 |
| Non-interest expense | $22.0 | $22.2 in Q1 2015 |
| Net income | $4.1; $0.19 per diluted share | $3.8; $0.16 per diluted share in Q1 2015 |
| Total assets | $2,487.1 | $2,409.1 at December 31, 2015 |
| Portfolio loans, gross | $1,539.0 | $1,515.1 at December 31, 2015 |
| Deposits | $2,154.7 | $2,086.0 at December 31, 2015 |
| Cash and cash equivalents | $144.7 | $85.8 at December 31, 2015 |
| Shareholders’ equity | $239.5 | $251.1 at December 31, 2015 |
- Net income increased about 8%; management attributed the improvement chiefly to higher net interest income and slightly lower operating expenses, partly offset by lower non-interest income and higher income tax expense.
- Net interest income grew 9.2%, supported by higher average interest-earning assets ($2.21 billion versus $2.06 billion) and a four-basis-point increase in tax-equivalent margin. The filing also cites $0.55 million of net loan interest recoveries, versus $0.05 million a year earlier.
- Non-interest income fell about $1.2 million. Mortgage loan gains declined to $1.6 million from $2.1 million, and mortgage servicing recorded a $1.0 million loss versus $0.4 million. Interchange income also fell $0.3 million, partly offset by higher securities gains.
- The provision for loan losses was a credit of $0.53 million, compared with a $0.66 million credit in Q1 2015. Net charge-offs were negative 0.12% of average portfolio loans, reflecting net recoveries, versus net charge-offs of 0.19% a year earlier.
- Operating cash flow was $5.0 million, investing cash flow was $2.0 million, and financing cash flow was $51.9 million. Financing included $68.7 million of deposit growth and $15.5 million of common-stock repurchases; cash increased $58.9 million during the quarter.
- Borrowings included $12.0 million of other borrowings and $35.6 million of subordinated debentures. Total deposits were $2.15 billion; management reported $534.3 million of uninsured deposits and $331.6 million of time deposits maturing within 12 months. Parent-company cash and time deposits were approximately $16.4 million.
- The Bank was categorized as well capitalized. At March 31, its total risk-based capital ratio was 14.83%, common equity Tier 1 ratio 13.57%, and leverage ratio 9.61%. Tangible common equity to tangible assets was 9.55%, down from 10.34% at year-end.
Material changes and asset quality
- Assets rose $78.1 million from year-end, primarily due to higher cash and loans; portfolio loans grew 1.6%, and deposits grew $68.7 million.
- Non-performing loans decreased to $10.6 million from $10.7 million; non-performing assets fell to $17.2 million from $17.9 million. The allowance was $22.5 million, or 1.46% of portfolio loans, compared with $22.6 million, or 1.49%, at year-end.
- Performing troubled debt restructurings were $80.6 million, or 5.2% of portfolio loans, down from $81.5 million, or 5.4%, at year-end. Management noted continuing defaults, particularly in commercial income-producing real estate and resort/vacation-property mortgage loans.
- Shareholders’ equity declined mainly because repurchases and dividends exceeded quarterly net income. The company repurchased 1,059,865 shares under its plan for $15.5 million, at an average $14.63 per share. The board later authorized a $5.0 million expansion of the plan.
Outlook, risks and unusual items
- No quantified earnings or revenue guidance was provided. Management said it expected short-term rate increases, if any, to be gradual and believed the company’s balance-sheet repricing characteristics would generally benefit net interest margin over the long term. Its simulations estimate next-12-month net interest income would rise 4.46% under an immediate 100-basis-point rate increase and decline 5.77% under a 100-basis-point decrease; these are scenario analyses, not forecasts.
- The company began using PIMCO to manage an approximately $150 million securities portfolio. Management anticipated about $0.5 million of additional annual interest income after fees once fully invested, while describing the segment’s expected risk weighting and duration as similar to the rest of the portfolio.
- Mepco settled its last significant remaining counterparty litigation matter during the quarter, receiving $4.0 million cash and a $1.5 million five-year promissory note. The note was fully reserved at quarter-end because of limited financial information and no payment history. Net counterparty receivables declined to $3.2 million from $7.2 million. Management cautioned that counterparties may fail to meet refund obligations and actual losses could exceed estimates.
- Other disclosed exposures include interest-rate, credit, liquidity, Michigan economic and real-estate risks; competition for deposits; and reliance on wholesale funding. Management estimated reasonably possible additional litigation losses of approximately $1.0 million beyond immaterial accrued amounts.
- The Bank had negative undivided profits of $5.7 million and was not permitted to pay dividends under Michigan rules. A regulator-approved $18.0 million return of capital to the parent was completed in February. The parent’s ability to fund shareholder distributions therefore depends in part on available parent-company resources and regulatory approvals.
- Mortgage servicing rights were subject to a $1.45 million quarterly valuation-allowance change, contributing to the higher servicing loss. The company also disclosed sensitivity of earnings to assumptions used for loan-loss reserves, servicing-rights valuations, deferred tax assets and Mepco counterparty losses.
Most important facts for investors to verify
- Whether loan growth, net interest margin, recoveries and credit quality remain supportive of earnings, and whether non-performing or restructured loans deteriorate.
- Whether Mepco collects its remaining counterparty receivables and the fully reserved $1.5 million note, and whether related losses or litigation exposure require further charges.
- Whether deposit growth continues and maturing time deposits renew, particularly given $534.3 million of uninsured deposits and stated reliance on wholesale funding sources.
- Whether mortgage production, mortgage servicing-rights valuations and non-interest income recover from the year-over-year declines.
- Whether capital remains adequate after repurchases and dividends, and how the Bank’s negative undivided profits and regulatory restrictions affect future parent-company distributions.
- Whether the anticipated PIMCO-managed portfolio income is realized without materially changing portfolio risk, and how actual interest-rate outcomes compare with management’s scenario analysis.