First Internet Bancorp — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Amounts are in U.S. dollars; financial statement figures below are in millions unless stated otherwise.
Business context
First Internet Bancorp is an Indiana bank holding company operating First Internet Bank, a branchless bank offering nationwide online deposits, consumer and residential mortgage lending, and commercial, public finance, and healthcare lending. Its business model relies on deposits, wholesale funding and digital channels.
Financial performance and condition
- Q3 results: Net income was $6.3 million, up 28.5% from $4.9 million in Q3 2017. Diluted EPS was $0.61 versus $0.71, reflecting substantially more weighted-average shares after equity offerings. Net interest income rose 12.5% to $16.0 million; provision for loan losses fell to $0.9 million from $1.3 million. Noninterest income declined 36.4% to $2.0 million, while noninterest expense rose 6.9% to $10.0 million.
- Nine-month results: Net income was $18.3 million, up 56.2% from $11.7 million; diluted EPS was $1.98 versus $1.75. Net interest income increased 21.3% to $46.8 million. Provision expense declined to $2.4 million from $3.7 million; noninterest income decreased 16.1% to $6.7 million, and noninterest expense increased 12.7% to $30.4 million.
- Margins and returns: Q3 net interest margin was 2.06%, down from 2.31% a year earlier; nine-month margin was 2.16% versus 2.41%. Q3 return on average assets was 0.79% and return on average equity was 8.75%, compared with 0.78% and 11.20%, respectively, in Q3 2017. Nine-month figures were 0.83% and 9.83%, versus 0.71% and 9.61%.
- Balance-sheet growth: Assets were $3.20 billion at September 30, up 15.7% from December 31, 2017. Loans were $2.49 billion, up 19.2%; deposits were $2.45 billion, up 17.3%; shareholders’ equity was $287.7 million, up 28.4%. Loan growth was led by public finance, single-tenant lease financing, healthcare finance, and consumer lending.
- Funding and debt: Deposits included $530.9 million of brokered deposits, 21.7% of total deposits, compared with $76.7 million at year-end 2017. Federal Home Loan Bank advances were $425.2 million. Subordinated debt was $33.8 million net carrying value ($35.0 million principal); the company repaid a $3.0 million debenture in June.
- Credit quality: Nonperforming loans were $0.3 million, 0.01% of loans, versus $0.8 million and 0.04% at year-end. Nonperforming assets were $5.3 million, or 0.17% of assets. The allowance for loan losses was $16.7 million, 0.67% of loans, compared with $15.0 million and 0.72% at year-end. Nine-month net charge-offs were $0.7 million.
- Cash flow: For the first nine months, operating activities provided $23.3 million; investing activities used $411.7 million; financing activities provided $426.1 million. Cash and cash equivalents increased $37.8 million to $85.8 million.
- Capital and liquidity: At September 30, the consolidated common equity tier 1 ratio was 13.14%, total risk-based capital ratio 15.38%, and leverage ratio 9.40%. The company reported $554.8 million in cash and available-for-sale securities, plus $23.5 million in loans held for sale; the Bank had $586.6 million of additional borrowing capacity. Unconsolidated holding-company cash was $62.2 million.
Material changes versus comparable periods
- Higher loan balances drove interest income and net interest income growth, but funding costs rose: Q3 interest expense increased 67.6% year over year. Higher deposit costs and a greater mix of certificates and brokered deposits contributed to margin compression.
- Mortgage banking revenue declined to $1.4 million in Q3 from $2.5 million, primarily due to lower originations and gain-on-sale margins. Nine-month mortgage banking revenue was $4.6 million versus $6.3 million.
- The effective tax rate fell to 10.6% in Q3 and 11.5% for the nine months, from 25.7% and 26.3%, respectively, primarily due to the federal corporate tax rate reduction and growth in tax-exempt public finance assets.
- Available-for-sale securities had a $22.9 million gross unrealized loss at quarter-end, versus $9.1 million at December 31, 2017. Management attributed declines primarily to interest-rate changes and considered them temporary; accumulated other comprehensive loss increased to $14.4 million from $5.0 million.
- June 2018’s public offering generated $54.3 million net proceeds from 1,730,750 shares. Together with the September 2017 offering, added shares affected per-share comparisons and increased equity.
Outlook, commentary, risks and unusual items
- No specific earnings, growth, or margin guidance is provided. Management said it believes liquidity and capital resources are adequate for at least the next 12 months, but continued growth may require additional capital; unfavorable financing terms could constrain the growth strategy. The Board expects quarterly dividends to continue, subject to its discretion and applicable restrictions.
- Interest-rate risk is material. Management’s model estimated that a parallel 100-basis-point rate increase would raise year-one net interest income 2.02% and reduce economic value of equity 9.51%; a 200-basis-point increase was estimated to raise year-one net interest income 3.67% and reduce economic value of equity 18.51%. These are model estimates dependent on assumptions.
- Deposit pricing and retention are risks: brokered deposits expanded sharply, and the company lost one large money-market customer after a competitor offered a rate it chose not to match. Certificates and brokered deposits of $805.6 million were scheduled to mature within one year.
- Outstanding loan commitments, including unused lines and standby letters of credit, were $183.7 million. The filing identifies credit, market-rate, liquidity, technology, regulatory, competition, and execution risks; it reports no material change to previously disclosed risk factors.
- In Q3, a subsidiary acquired approximately 3.3 acres in Fishers, Indiana for about $10.2 million, including acquisition costs. The City agreed to reimburse specified acquisition costs by December 31, 2018, after which the property would be transferred to the redevelopment commission or a designated third party. The company was exploring possible use of part of the land.
- The company sold $25.2 million of single-tenant lease financing loans during the nine months, recognizing a $0.4 million gain. It also repaid the $3.0 million 2021 debenture. No material legal proceedings were reported, and management stated disclosure controls were effective as of September 30.
Important facts for investors to verify
- Whether loan and deposit growth can continue without further deterioration in net interest margin, particularly as deposit costs and brokered-funding reliance rise.
- Brokered deposit levels, renewal pricing and the $805.6 million of deposits scheduled to mature within one year.
- Performance and concentration risks in public finance, single-tenant lease financing, healthcare finance and consumer lending; monitor allowance adequacy as the portfolio grows.
- Whether mortgage originations and gain-on-sale margins recover, and the impact of further declines in mortgage banking revenue.
- Realization of the $10.2 million Fishers land reimbursement by the stated deadline, and any subsequent development or transfer obligations.
- Interest-rate sensitivity, including the assumptions underlying the reported net interest income and economic-value-of-equity scenarios, and the potential effect of securities losses if securities must be sold.
- Capital and liquidity needs under the growth strategy, including the effect of future equity issuance, funding costs, and dividend or subordinated-debt restrictions.