Independent Bank Corporation — Q2 2018 Form 10-Q
Business context and reporting period
Michigan-based bank holding company reporting the quarter and six months ended June 30, 2018. Results include TCSB Bancorp, acquired effective April 1, 2018; therefore, Q2 includes three months of TCSB operations, while the six-month comparison includes only the post-acquisition period. Unless noted, amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income | $29.0 million | $21.5 million | $52.9 million | $43.0 million |
| Provision for loan losses | $0.65 million | $0.58 million | $0.97 million | $0.22 million |
| Non-interest income | $12.3 million | $10.4 million | $24.0 million | $20.8 million |
| Non-interest expense | $29.8 million | $22.8 million | $53.9 million | $46.3 million |
| Net income | $8.8 million | $5.9 million | $18.0 million | $11.9 million |
| Diluted EPS | $0.36 | $0.27 | $0.78 | $0.55 |
| Net interest margin, fully tax-equivalent | 3.93% | 3.60% | 3.83% | 3.65% |
- At June 30, total assets were $3.23 billion, loans $2.47 billion, deposits $2.78 billion, and shareholders’ equity $337.1 million. Compared with December 31, 2017, assets increased $445.2 million, loans 22.2%, and deposits $380.0 million; the TCSB acquisition contributed materially to these increases.
- Cash and cash equivalents were $58.7 million. For the first half, operating cash flow was $13.3 million, investing cash flow was negative $65.2 million, and financing cash flow was positive $55.9 million; cash increased $4.0 million.
- Other borrowings were $40.6 million and subordinated debentures $39.4 million. Wholesale funding, including reciprocal deposits, was approximately $333.5 million, or 11.8% of deposits and borrowings excluding subordinated debentures. The filing reports $598.3 million in uninsured deposits and $534.2 million of time deposits maturing within 12 months.
- The Bank was categorized as well capitalized. At June 30, its common equity Tier 1 ratio was 12.53%, total risk-based capital ratio 13.52%, and Tier 1 leverage ratio 9.93%. Consolidated common equity Tier 1 was 11.97%.
- Non-performing loans were $9.1 million, or 0.37% of portfolio loans; the allowance for loan losses was $23.5 million, or 0.95% of portfolio loans. The allowance ratio was 1.12% at year-end 2017.
Material changes versus prior periods
- Q2 net income rose about 49% year over year; first-half net income rose about 51%. Management attributed the increases mainly to higher net interest and non-interest income and lower income tax expense, partly offset by higher loan-loss provisions and operating expenses.
- Q2 net interest income increased 34.8%. Management cited higher average earning assets, a 33-basis-point increase in the net interest margin, loan growth, higher short-term rates, and TCSB. First-half margin increased 18 basis points.
- Non-interest expense increased $7.0 million in Q2, including $3.1 million of merger-related costs. First-half merger costs were $3.3 million. Expense growth also reflected the larger post-merger operation and higher compensation.
- Q2 non-interest income increased $1.9 million. Mortgage servicing income was $1.2 million versus a $0.2 million loss a year earlier, including favorable fair-value movements; mortgage loan sale margins were lower. The adoption of revenue standard ASC 606 moved certain network costs from netting against interchange revenue to separate expense, increasing both lines by $0.4 million in Q2 and $0.7 million year to date, with no net-income impact.
- Unrealized losses on available-for-sale securities increased to $7.5 million from $3.8 million at year-end, primarily attributed to higher rates and wider spreads. The company reported no new credit-related impairment charges on these securities.
Outlook, commentary, risks and unusual items
- The filing provides no specific full-year earnings or revenue guidance. Management said it expected quarterly data-processing costs to decline by approximately $0.2 million to $0.3 million from Q2’s $2.25 million after the TCSB systems conversion, and expected minor merger costs in Q3, principally for further systems conversion.
- The April 1 TCSB acquisition had preliminary consideration of $64.5 million and generated $29.0 million of goodwill and a $5.8 million core deposit intangible. Purchase accounting remained provisional, with valuation adjustments possible through the one-year measurement period. Management cited anticipated synergies and cost savings, but cautioned that expected benefits might not be realized on schedule or in full.
- Management described Michigan economic conditions as generally improving, while emphasizing risks from regional economic and real-estate conditions, credit losses and allowance assumptions, competition, deposit and loan growth, interest-rate movements, liquidity, and regulatory or legislative changes.
- Management said it believed current Bank and parent-company liquidity was adequate. It also cautioned that uninsured deposits and wholesale funding may be difficult to retain or replace at attractive rates. Its interest-rate simulation estimated that a 100-basis-point rate decline would reduce next-12-month net interest income 3.66%; a 100-basis-point rise would increase it 1.02%. These are model scenarios, not forecasts.
- Non-accrual loans increased $0.9 million in the first half, principally from one commercial relationship entering non-accrual; management said it did not expect a loss because of collateral. Performing troubled-debt restructurings were $58.1 million. Management noted that additional loan-loss provisions may be needed if economic or borrower conditions worsen.
- Litigation accruals were described as immaterial, with reasonably possible additional losses estimated as insignificant, though outcomes remain uncertain. The filing reported no material changes to previously disclosed risk factors and stated that disclosure controls were effective.
Important facts for investors to verify
- How much of reported growth and earnings improvement is attributable to TCSB, and whether projected synergies and cost savings are achieved.
- Final TCSB purchase-price allocation, acquired-loan performance, and any resulting goodwill or intangible-asset adjustments.
- Deposit mix, uninsured-deposit retention, brokered and other wholesale funding needs, and the cost of funding as rates change.
- Credit quality trends, especially the new non-accrual commercial relationship, watch-rated loans, performing TDRs, and adequacy of the allowance as the portfolio expands.
- Whether mortgage servicing-rights valuations, securities unrealized losses, mortgage sale margins, and interest-rate exposures materially affect future earnings or capital.
- The consistency of cash generation and reported earnings, and the effects of merger costs, tax changes, and nonrecurring fair-value movements.