Independent Bank Corporation — Q3 2014 Form 10-Q
Business context and reporting period. The Michigan-based bank holding company reported unaudited results for the three and nine months ended September 30, 2014, with comparisons to the corresponding 2013 periods. Its reportable segments are Independent Bank and Mepco, a vehicle service contract payment-plan business.
Financial performance and condition
Amounts are in millions of dollars unless otherwise stated.
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net interest income | $18.2 | $19.5 | $55.2 | $58.6 |
| Net interest margin, tax-equivalent | 3.61% | 4.10% | 3.71% | 4.17% |
| Non-interest income | $10.5 | $9.8 | $29.6 | $33.9 |
| Non-interest expense | $22.1 | $25.9 | $67.0 | $79.1 |
| Income before tax | $7.3 | $3.8 | $19.8 | $16.5 |
| Net income | $4.9 | $3.5 | $14.1 | $72.7 |
| Net income per common share, diluted | $0.21 | $0.17 | $0.60 | $3.40 |
- Revenue and earnings drivers: Q3 net interest income fell 6.9% year over year as lower loan yields and a shift toward lower-yielding securities outweighed growth in average interest-earning assets. The nine-month decline was 5.8%. Lower non-interest expense and higher Q3 non-interest income supported quarterly pretax earnings.
- Cash flow: For the first nine months, operating cash flow was $6.3 million, investing cash flow was negative $76.0 million, and financing cash flow was $16.1 million. Cash and cash equivalents decreased $53.6 million to $65.5 million.
- Balance sheet: At September 30, total assets were $2.240 billion; portfolio loans were approximately $1.399 billion, up 1.8% from year-end 2013; and deposits were $1.896 billion, up $11.1 million. Available-for-sale securities rose to $533.2 million from $462.5 million.
- Credit quality: The allowance for loan losses was $27.5 million, or 1.97% of portfolio loans, versus $32.3 million, or 2.35%, at December 31, 2013. Non-performing loans were $17.5 million, and non-performing assets were $26.9 million, down from $36.2 million at year-end. Performing troubled debt restructurings were $106.4 million.
- Debt and liquidity: Other borrowings were $26.2 million and subordinated debentures were $40.7 million. The company reported $356.3 million in uninsured deposits and $257.7 million of time deposits maturing within 12 months. Management said the Bank had adequate liquidity; parent-company cash and time deposits were approximately $23.2 million.
- Capital: Shareholders’ equity was $247.1 million, compared with $231.6 million at year-end. Tangible common equity to tangible assets was 10.92%, up from 10.35%. The Bank was categorized as well capitalized; its reported total capital, Tier 1 risk-based capital, and Tier 1 leverage ratios were 16.57%, 15.31%, and 10.21%, respectively.
Material changes versus comparable periods
- Q3 net income increased from $3.5 million to $4.9 million, while nine-month net income fell sharply from $72.7 million to $14.1 million. The 2013 year-to-date comparison included a $57.6 million tax benefit from reversal of substantially all of the deferred-tax-asset valuation allowance. Q3 2013 common income also included a $7.6 million preferred-stock redemption discount benefit.
- Q3 non-interest expense declined $3.9 million year over year; the nine-month decline was $12.1 million. Lower credit-related costs were a major contributor, including vehicle-service-contract counterparty expense of $0.17 million year to date versus $3.40 million in 2013.
- Mortgage originations and sales declined year to date, and mortgage-loan gains fell to $4.1 million from $8.4 million. The company attributed weaker volumes primarily to higher mortgage rates and reduced refinancing activity.
- Non-performing assets declined, mainly reflecting sales of foreclosed real estate. The two largest ORE properties, with a combined book value of $8.6 million, were sold in Q3, generating $0.56 million in gains.
- The company resumed quarterly common dividends in 2014, declaring and paying $0.06 per share in Q2 and Q3. The Bank itself had negative undivided profits of $35.1 million and could not pay dividends under state rules; a separately approved $15 million return of capital to the parent was completed in April.
Outlook, commentary, risks, and unusual items
- Management said Michigan economic conditions and asset-quality trends had generally improved, while noting that progress was uneven and regional unemployment remained above the national average. The company had been profitable for 11 consecutive quarters.
- Management cited Federal Reserve announcements indicating short-term rates were expected to remain extremely low until at least mid-2015. It expects rising rates to benefit net interest margin over the longer term, subject to asset and liability repricing.
- No specific earnings or revenue guidance was provided. The filing says results for the nine months are not necessarily indicative of full-year results.
- Key risks include interest-rate and margin pressure, regional economic and real-estate conditions, loan-loss estimation, competition, deposit retention and wholesale-funding availability, and the ability to grow loans and deposits.
- Mepco’s collection exposure remains notable: net vehicle-service-contract counterparty receivables were $6.8 million, and recovery efforts include litigation. Some obligations are unsecured, and a major counterparty failure could cause significant losses. Management cautioned actual losses could exceed its estimates.
- Other contingencies include ordinary-course litigation, for which reasonably possible additional losses were estimated at up to approximately $0.5 million, and $0.7 million of reserves for sold-loan loss reimbursements. Management said accrued amounts were appropriate but future losses could exceed estimates.
- Available-for-sale securities had $3.48 million of gross unrealized losses at quarter-end. Management considered most losses temporary and reported $9,000 of credit-related impairment expense for the quarter and year to date.
- New U.S. banking capital rules apply beginning January 1, 2015. Management believed the company then exceeded their capital requirements. A new seven-year core processing contract was expected to reduce core processing and interchange costs by approximately $1 million annually; a new debit-card agreement was expected to add approximately $1 million in annual interchange net revenue, assuming similar transaction volumes.
Important facts for investors to verify
- Whether the improvement in non-performing assets, charge-offs, and allowance levels persists, and how the sizeable performing TDR portfolio performs.
- Whether low rates, loan mix, and securities growth continue to pressure net interest margin and net interest income.
- The collectability of Mepco’s $6.8 million counterparty receivables, the adequacy of related reserves, and exposure to concentrated or disputed counterparties.
- The stability of deposits, including uninsured balances and near-term time-deposit maturities, and continued access to wholesale funding.
- Whether deferred tax assets remain realizable and whether the Bank’s capital position and restrictions on upstream dividends affect parent-company liquidity or distributions.
- The sustainability of mortgage, interchange, and cost-saving trends, and whether management’s expected annual benefits are realized.