Independent Bank Corporation — Q2 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 six months ended June 30, 2017; balance-sheet comparisons are with December 31, 2016. Unless noted otherwise, amounts below are in millions of dollars.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net interest income | $21.5 | $19.6 | $43.0 | $39.4 |
| Provision for loan losses | $0.6 expense | $0.7 credit | $0.2 expense | $1.3 credit |
| Non-interest income | $10.4 | $9.6 | $20.8 | $17.4 |
| Non-interest expense | $22.8 | $20.9 | $46.3 | $42.9 |
| Net income | $5.9 | $6.4 | $11.9 | $10.5 |
| Diluted EPS | $0.27 | $0.30 | $0.55 | $0.48 |
| Dividends per share | $0.10 | $0.08 | $0.20 | $0.16 |
- Margins and earnings drivers: GAAP net interest margin was 3.56% in Q2 2017 versus 3.50% a year earlier, and 3.61% for the first half versus 3.55%. Fully tax-equivalent margins were 3.60% and 3.65%, respectively. Management attributed higher net interest income to larger average earning assets, loan growth and a more favorable loan mix, as well as higher short-term rates.
- Q2 net income declined year over year, reflecting higher credit provision, operating costs and taxes, partly offset by increased interest and non-interest income. First-half net income increased, led by higher net interest and non-interest income.
- Cash flow: First-half operating cash flow was $13.0, compared with $14.8 in 2016. Investing activities used $128.4, principally reflecting $202.2 of net portfolio loan growth, partly offset by securities cash flows and $33.4 received from the Mepco sale. Financing provided $91.9, including net deposit growth and net FHLB advances. Cash and cash equivalents declined $23.4 to $59.8.
- Balance sheet at June 30: Total assets were $2.665 billion, up $116.4 from year-end. Portfolio loans were $1.812 billion, up $203.4 (12.6%); deposits were $2.246 billion, up $20.5. Available-for-sale securities declined $26.9 to $583.7 as funds supported loan growth. Shareholders’ equity rose to $262.5 from $249.0.
- Credit quality: Allowance for loan losses was $20.6, or 1.14% of portfolio loans, versus $20.2, or 1.26%, at year-end. Non-performing loans declined to $8.5 from $13.4; non-performing assets were $10.9 versus $18.4. Net recoveries continued in the first half. Performing troubled debt restructurings totaled $66.7, down from $70.3.
- Debt and liquidity: Other borrowings, mostly FHLB advances, increased to $85.5 from $9.4; subordinated debentures remained $35.6. Brokered time deposits were $33.3, and wholesale funding including reciprocal deposits was approximately $165.4, or 7.1% of total funding. The company reported $494.5 of uninsured deposits and $357.4 of time deposits maturing within 12 months. Management stated liquidity was adequate; parent-company cash and time deposits were approximately $19.5.
- Capital: The Bank remained categorized as well-capitalized. At June 30, its total risk-based, Tier 1 risk-based, common equity Tier 1 and Tier 1 leverage ratios were 14.37%, 13.26%, 13.26% and 9.93%, respectively. Tangible common equity to tangible assets was 9.79%, up from 9.70% at year-end.
Material changes and unusual items
- Mortgage banking expanded, with additional employees and loan-production offices. First-half mortgage originations rose to $393.2 from $165.5, while loans sold increased to $184.4 from $126.1. Higher production supported gains, but the loan sales margin excluding fair-value adjustments narrowed year over year.
- The mortgage expansion contributed to higher compensation and benefits expense; average full-time equivalent employees increased 8.6% in the first half. Management expects the expansion to support mortgage gains and, over time, portfolio lending and servicing income, while cautioning that it raises costs and requires effective execution.
- Mepco’s payment-plan business and related assets were sold effective May 1, 2017; the company received $33.4 cash and recorded no gain or loss at closing. Management did not expect a significant effect on future overall financial condition or results.
- Effective January 1, 2017, the company adopted fair-value accounting for mortgage servicing rights. At June 30, rights totaled $14.5; fair-value changes contributed a $1.5 first-half loss. Adoption increased beginning equity by $0.35 net. The company also adopted the callable-debt premium amortization standard, with a $0.30 after-tax opening-equity adjustment.
- Available-for-sale securities had $2.0 of gross unrealized losses at June 30, down from $7.6 at year-end. Management considered the declines temporary; no credit-related impairment charges were recorded in the first half.
- A $2.2 settlement, plus approximately $0.1 of related costs, concerning historical checking-account transaction sequencing was accrued and expensed in Q4 2016. Payment was expected in Q4 2017 or Q1 2018. Other litigation was not expected by management to have a significant impact, though outcomes remain uncertain.
Outlook, risks and contingencies
The filing provides no quantified earnings or financial guidance. Management cited generally improving, though uneven, Michigan economic conditions and a longer-term decline in non-performing assets. Key exposures include Michigan and local real-estate conditions, loan growth and credit losses, competition for deposits, wholesale-funding availability and cost, and changes in interest rates. The company noted that its expanded mortgage business is more exposed to rate and margin volatility and that it is monitoring growth in longer-term fixed-rate portfolio mortgages.
Interest-rate simulations showed that an immediate 100-basis-point rate decline could reduce modeled next-12-month net interest income by 7.24% and market value of portfolio equity by 9.09%; a 100-basis-point rise was modeled to increase them by 2.78% and 2.90%, respectively. These are scenario analyses, not forecasts. The company expects the new credit-loss standard, effective in 2020, to increase its allowance for loan losses, but had not determined the amount. It reported no material changes to previously disclosed risk factors and no material changes in internal control over financial reporting.
Important facts for investors to verify
- Whether mortgage-banking growth produces durable revenue and servicing income sufficient to offset higher staffing and occupancy costs, particularly as refinancing activity and loan-sale margins face pressure.
- Whether rapid portfolio-loan growth, commercial real-estate exposures and the lower allowance-to-loans ratio remain consistent with subsequent credit trends and management’s loss assumptions.
- How the funding mix develops as time deposits mature, uninsured deposits and brokered funding are subject to outflow, and FHLB borrowings have increased.
- The sensitivity of earnings and servicing-right valuations to interest rates, prepayments and other valuation assumptions.
- Completion and payment timing of the checking-account settlement, and any claims under the Mepco sale indemnities; management said no Mepco indemnity liability was accrued because payment was considered remote.
- Reconcile the filing’s presentation of certain quarterly and six-month tax-equivalent net interest income figures with the GAAP statements; use the stated GAAP figures for reported financial results.