Independent Bank Corporation — Q3 2011 Form 10-Q
Business context and reporting period
Michigan-based bank holding company reporting for the quarter and nine months ended September 30, 2011; amounts below are consolidated and in millions of dollars unless noted. Its two principal segments are Independent Bank and Mepco, a vehicle service contract payment-plan business. The interim statements are unaudited.
Financial performance and condition
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net interest income | $23.8 | $27.0 | $71.6 | $85.6 |
| Net interest margin | 4.59% | 4.26% | 4.43% | 4.37% |
| Provision for loan losses | $6.2 | $9.5 | $21.0 | $39.2 |
| Non-interest income | $9.3 | $12.5 | $34.4 | $54.6 |
| Non-interest expense | $31.5 | $37.5 | $97.2 | $114.6 |
| Net loss | $(4.1) | $(6.6) | $(11.5) | $(12.6) |
| Net loss applicable to common stock | $(5.2) | $(7.7) | $(14.6) | $(15.9) |
| Loss per common share, basic and diluted | $(0.61) | $(1.03) | $(1.78) | $(3.71) |
- Q3 results improved year over year as lower loan-loss provisions and operating expenses more than offset lower net interest and non-interest income. Nine-month 2011 loss was narrower, but 2010 included an $18.1 million debt-extinguishment gain.
- Net interest income fell 11.9% in Q3 and 16.3% year to date, principally because average interest-earning assets declined as the company reduced higher-risk-weighted loans. Margin improved with lower funding costs, including fewer brokered CDs, and growth in non-interest-bearing deposits.
- At September 30, assets were $2.317 billion, down from $2.535 billion at December 31, 2010. Portfolio loans were $1.628 billion, down 10.2%; deposits were $2.079 billion, down $173.2 million, mainly from a planned $239.4 million reduction in brokered CDs.
- Cash and cash equivalents were $355.8 million, versus $385.4 million at year-end. Nine-month operating cash flow was $38.7 million, investing cash flow was $140.7 million, and financing cash flow was $(209.0) million. Financing outflows chiefly reflected deposit and FHLB advance reductions.
- Other borrowings were $35.7 million, versus $71.0 million at year-end; subordinated debentures remained $50.2 million. Shareholders’ equity was $110.8 million, down from $119.1 million. Tangible common equity was $24.0 million, or 1.04% of tangible assets.
- Non-performing loans were $50.9 million and non-performing assets $84.9 million, down from $67.6 million and $107.0 million, respectively, at year-end. The allowance was $58.8 million, 3.61% of portfolio loans and 115.56% of non-performing loans. Nine-month annualized net charge-offs were 2.35% of average loans, versus 3.13% in 2010.
- The Bank’s September 30 regulatory capital ratios were 11.57% total capital to risk-weighted assets and 7.07% Tier 1 capital to average assets. It was classified as well-capitalized under federal standards, but its leverage ratio was below the Board’s 8.00% internal target.
Outlook, management commentary, risks and unusual items
- Management expected a net loss for 2011 and projected a return to profitability in the second half of 2012, assuming credit costs abate and the Michigan economy does not deteriorate materially. These are forward-looking expectations, not guaranteed results.
- On October 25, 2011, after quarter-end, the company and Bank entered into a Memorandum of Understanding with the Federal Reserve and Michigan regulator. It requires a revised joint capital plan by November 30, 2011, quarterly reports on certain higher-risk assets, enhanced Mepco risk monitoring, and improved interest-rate risk modeling.
- Mepco recorded $5.0 million of counterparty-contingency expense in the first nine months of 2011. A bankrupt counterparty owed Mepco $50.9 million for cancelled plans; the company had a $23.4 million reserve for this counterparty and reported $27.5 million of net counterparty receivables from it. Recoveries depend on counterparties, collateral, litigation, and bankruptcy claims; actual losses could exceed reserves.
- The company continued to defer dividends on its Treasury-held Series B preferred stock and interest on subordinated debentures, and paid no common dividends. Preferred dividends in arrears totaled $5.6 million at September 30; the filing’s separate defaults disclosure reports $5.1 million in arrears. Verify the difference in those reported figures.
- Management cited uncertainty around wholesale funding access and deposit retention. Brokered CDs totaled $34.1 million, with $24.0 million maturing within 12 months; $124.7 million of deposits were uninsured, and $193.6 million of non-interest-bearing deposits had temporary unlimited insurance through December 31, 2012.
- Other key risks include continuing Michigan real-estate and credit weakness, further loan losses, potential forced transfer or loss of mortgage servicing rights if the Bank falls below well-capitalized status, Mepco industry and legal issues, and possible limits on tax-loss carryforwards from an ownership change. The company had approximately $71.9 million of federal loss carryforwards.
- Mortgage servicing rights produced a $3.2 million valuation-allowance charge in the first nine months; lower mortgage rates and expected prepayments affect the valuation. The 2011 year-to-date expense for Mepco counterparty contingencies was lower than 2010, but management cautioned that estimates rely on significant assumptions.
Most important facts for investors to verify
- Progress and regulator acceptance of the revised capital plan, particularly the gap between the Bank’s 7.07% leverage ratio and its 8.00% Board target.
- Subsequent non-performing asset, delinquency, charge-off, allowance, and TDR trends, including whether asset-quality improvement continues.
- Recoverability of Mepco’s counterparty receivables, adequacy of reserves, and any material new litigation, insolvency, or cancellation developments.
- Deposit stability, brokered-CD renewals and maturities, wholesale funding availability, and the company’s liquidity under stress.
- Actual operating results against management’s projected 2011 loss and second-half 2012 return to profitability, alongside net interest income and credit-cost trends.
- Preferred dividend arrears and the reported $5.6 million versus $5.1 million figures; also monitor the potential dilution from conversion of Treasury preferred stock.