Independent Bank Corporation — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. Independent Bank Corporation is a Michigan-based bank holding company with banking operations primarily in Michigan’s Lower Peninsula and a vehicle-service-contract payment-plan business through Mepco. Unless otherwise noted, amounts below are in millions of dollars.
Financial results and condition
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net interest income | $19.5 | $21.5 | $58.6 | $65.4 |
| Net interest margin, tax-equivalent | 4.10% | 3.95% | 4.17% | 4.06% |
| Non-interest income | $9.8 | $14.5 | $33.9 | $42.2 |
| Non-interest expense | $25.9 | $29.3 | $79.1 | $86.8 |
| Income before income taxes | $3.8 | $6.4 | $16.5 | $14.3 |
| Net income | $3.5 | $6.4 | $72.7 | $14.3 |
| Net income applicable to common stock | $10.3 | $5.4 | $77.3 | $11.0 |
| Basic / diluted EPS | $0.73 / $0.17 | $0.61 / $0.16 | $7.03 / $3.40 | $1.28 / $0.36 |
- Revenue and earnings: Q3 net interest income fell 9.0% year over year, mainly as average interest-earning assets declined following the 2012 branch sale; lower funding costs lifted net interest margin. Non-interest income decreased 32%, including lower mortgage-sale gains, deposit service charges and interchange income. Mortgage refinance activity weakened as rates rose. Expense reductions partly offset lower revenue.
- Unusual earnings items: Nine-month net income includes a $57.3 million income-tax benefit from reversing substantially all of the deferred-tax-asset valuation allowance. Q3 common-stock income includes a $7.6 million benefit from redeeming Series B preferred stock at a discount. These items materially affect reported earnings and per-share comparisons.
- Cash flow: For the first nine months, operating cash flow was $41.4 million, investing cash flow was negative $174.0 million and financing cash flow was positive $83.8 million. Cash and cash equivalents declined $48.8 million to $130.9 million.
- Balance sheet and funding: Total assets were $2.184 billion, up $159.6 million from year-end 2012, principally reflecting increased securities and deferred tax assets. Deposits rose $69.8 million to $1.849 billion, while portfolio loans declined 2.8% to $1.38 billion. Other borrowings were $17.3 million; subordinated debentures were $50.2 million.
- Liquidity and capital: Available-for-sale securities increased to $415.9 million from $208.4 million. Management stated liquidity was adequate, citing cash, securities and access to FHLB advances and brokered CDs. The Bank was categorized as well-capitalized; its total risk-based capital ratio was 16.01%, Tier 1 risk-based ratio 14.74%, and Tier 1 leverage ratio 9.88%. Common tangible equity was $223.2 million, or 10.24% of tangible assets.
- Asset quality: Non-performing loans were $20.4 million versus $32.9 million at December 2012; non-performing assets were $37.0 million versus $59.1 million. The allowance for loan losses fell to $34.4 million, or 2.50% of portfolio loans, from $44.3 million, or 3.12%. Annualized net charge-offs to average loans improved to 0.65% from 1.46% for the comparable nine-month period. Performing troubled debt restructurings remained significant at $118.9 million.
Material developments and outlook
- The company sold 13.225 million common shares in an offering and overallotment, receiving approximately $97.1 million net. It used $81.0 million to repurchase its Series B preferred stock and Treasury warrant on August 30, 2013, exiting TARP. The preferred-stock redemption and common offering substantially increased common equity and shares outstanding.
- Deferred interest payments on trust preferred securities resumed in August 2013. The company redeemed $9.2 million of 8.25% trust preferred securities on October 11, after quarter-end; management estimated this would reduce annual interest expense by about $0.8 million.
- The Federal Reserve and Michigan regulators terminated the prior MOU in March 2013 and later informed the company that related board resolutions were no longer needed; the resolutions were rescinded October 22, 2013. The Bank nevertheless had negative undivided profits of $55.3 million at quarter-end and could not pay dividends to the parent under state rules without applicable regulatory approval.
- Management cited improving Michigan economic and asset-quality trends, but noted local economic conditions, interest rates, credit performance and regulatory changes could affect results. It expected short-term rates to remain very low until late 2014 or early 2015 and said rising rates could benefit net interest margin over time. The filing gives no specific earnings or revenue guidance.
Risks, contingencies and unusual matters
- Mepco had $9.8 million of net vehicle-service-contract counterparty receivables at September 30, down from $18.4 million at year-end. Nine-month counterparty-contingency expense rose to $3.4 million from $1.1 million, reflecting second-quarter write-downs. Collection depends on counterparties, collateral and litigation outcomes; actual losses could exceed estimates. A $5.4 million insurer settlement payment was received in September.
- The mortgage-loan sold-loss reimbursement reserve was $3.5 million, up from $1.4 million at year-end. A proposed Fannie Mae resolution for specified 2000–2008 loans contemplated a payment of approximately $1.6 million, subject to final approval and adjustment; the amount was included in the reserve.
- Management estimated reasonably possible additional losses from ordinary-course litigation at up to approximately $0.5 million, beyond immaterial amounts accrued. It cautioned that the estimate may change.
- The company’s deferred-tax-asset realization depends on future taxable income. Approximately $1.0 million of valuation allowance remained, primarily for Mepco state tax assets. A shareholder ownership change could limit use of net operating loss carryforwards under Section 382.
- Interest-rate movements affect securities valuations and mortgage activity. Available-for-sale securities had $6.3 million of gross unrealized losses, which management generally attributed to rates, spreads or credit factors and considered temporary, while noting credit-related impairment on certain private-label mortgage securities.
Most important facts for investors to verify
- Separate recurring operating performance from the $57.3 million tax benefit and $7.6 million preferred-redemption discount benefit when assessing reported earnings and EPS.
- Track whether loan quality continues improving, particularly non-performing loans, charge-offs, allowance coverage and the large performing-TDR balance.
- Monitor Mepco counterparty collections, reserves, settlements and remaining litigation exposure, as well as mortgage-loan repurchase claims and the final Fannie Mae agreement.
- Confirm the effect of the common-stock issuance, TARP exit, resumed trust-preferred payments and subsequent $9.2 million redemption on capital, funding costs and future common-share dilution.
- Assess deposit stability and liquidity, including $333.5 million of uninsured deposits, upcoming time-deposit maturities and access to wholesale funding.
- Review actual realization of deferred tax assets and potential Section 382 limits, and compare subsequent results with management’s stated assumptions and rate outlook.