Independent Bank Corporation — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; balance-sheet comparisons are with December 31, 2012. The company is a Michigan-based bank holding company with banking operations and Mepco, a vehicle service contract payment-plan business. Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions.
Financial performance and position
| Metric | Q1 2013 / March 31, 2013 | Comparable period / prior date |
|---|---|---|
| Net interest income | $19.6 million | $22.1 million in Q1 2012 |
| Non-interest income | $11.1 million | $14.6 million in Q1 2012 |
| Provision for loan losses | Credit of $0.7 million | Expense of $5.1 million in Q1 2012 |
| Non-interest expense | $25.5 million | $28.0 million in Q1 2012 |
| Net income | $5.8 million; $4.7 million applicable to common stock | $3.5 million; $2.4 million applicable to common stock in Q1 2012 |
| Common earnings per share | $0.51 basic; $0.27 diluted | $0.29 basic; $0.07 diluted in Q1 2012 |
| Net interest margin | 4.21% | 4.14% in Q1 2012 |
| Cash from operating activities | $18.5 million | $13.3 million in Q1 2012 |
| Cash and cash equivalents | $221.6 million | $179.8 million at December 31, 2012 |
| Total assets | $2.105 billion | $2.024 billion at December 31, 2012 |
| Total loans | $1.391 billion | $1.419 billion at December 31, 2012 |
| Total deposits | $1.851 billion | $1.780 billion at December 31, 2012 |
| Allowance for loan losses | $40.8 million, or 2.93% of portfolio loans | $44.3 million, or 3.12%, at December 31, 2012 |
| Non-performing assets | $51.5 million; 2.45% of assets | $59.1 million; 2.92%, at December 31, 2012 |
| Subordinated debentures / other borrowings | $50.2 million / $17.6 million | Both substantially unchanged from December 31, 2012 |
Net cash used in investing activities was $47.6 million and net cash from financing activities was $70.9 million. Common and preferred dividends were not paid during the quarter.
Material changes versus comparable periods
- Net income increased to $5.8 million from $3.5 million, principally because the loan-loss provision shifted from a $5.1 million expense to a $0.7 million credit and non-interest expense declined. Lower net interest and non-interest income partly offset the improvement.
- Net interest income fell 11.5% year over year. Management attributed the decline mainly to a $267.6 million reduction in average interest-earning assets following the sale of 21 branches in December 2012; a lower cost of funds partly offset the impact.
- Non-interest income declined by $3.5 million year over year, including lower deposit service charges and interchange income, partly reflecting the branch sale, and a larger adverse change in the fair value of the U.S. Treasury warrant.
- Non-interest expense decreased by $2.6 million, primarily due to the branch sale, branch consolidations, lower staffing and reduced credit-related costs.
- Asset quality improved against year-end: non-performing loans declined to $27.9 million from $32.9 million, and other real estate and repossessed assets declined to $23.6 million from $26.1 million. Net charge-offs were 0.82% of average portfolio loans annualized, versus 2.07% in Q1 2012.
- Deposits grew $71.3 million from year-end, mainly through checking and savings balances. Portfolio loans declined 2.0% from year-end.
Outlook, capital, risks and unusual items
- Outlook: No specific earnings guidance was provided. Management said Michigan conditions had generally improved into 2013, though more slowly, while remaining weaker than national conditions. It expects low interest rates to continue weighing on interest income. Results for the quarter are not necessarily indicative of full-year results.
- Capital and regulatory oversight: The Bank was categorized as well-capitalized. At March 31, its total capital-to-risk-weighted-assets ratio was 15.78% and Tier 1 capital-to-average-assets ratio was 9.62%, above the board’s respective minimums of 11% and 8%. Regulators terminated the 2011 MOU on March 26, 2013, but board resolutions require regulatory approval for specified dividends, distributions, borrowing increases and stock repurchases, and require quarterly reporting on certain problem assets.
- Parent-company liquidity and deferred payments: Management reported approximately $5.6 million of parent-company cash and expected it, together with the equity line, to cover parent operating expenses until the fourth quarter of 2014. It intends to have funds to bring subordinated-debt interest current by then, but cautioned success is not assured. Interest on trust preferred securities and dividends on Treasury-held convertible preferred stock are deferred; $11.2 million of preferred dividends were in arrears at quarter-end. The company said it had no current plan to resume preferred or common dividends.
- Equity and dilution: The company sold 168,941 common shares to Dutchess during Q1 under an equity line, at a 5% discount to market; approximately $10.8 million remained available under the facility at March 31. Treasury-held Series B preferred stock and accrued dividends could convert into approximately 9.4 million common shares at quarter-end. The company warns a large equity issuance could limit use of tax-loss carryforwards.
- Tax assets: A $62.5 million valuation allowance was maintained against deferred tax assets; federal loss carryforwards were approximately $110.8 million. Management said it had achieved five consecutive profitable quarters and identified six quarters, along with forecasts of profitability and stable or improving asset quality, among its criteria for reassessing the allowance.
- Credit and contingent exposures: Mepco had $18.3 million of net vehicle-service-contract counterparty receivables, with collection dependent on counterparties, collateral and legal remedies; management cautioned actual losses could exceed reserves. The company also had a $2.0 million reserve for mortgage-loan sale reimbursements amid increased investor review activity. Ordinary-course litigation had an estimated maximum reasonably possible additional loss of approximately $0.4 million.
- Investment securities: Available-for-sale securities increased to $283.9 million from $208.4 million at year-end. Unrealized losses totaled $1.9 million; management reported no Q1 impairment charge, while three below-investment-grade private-label mortgage securities continued to carry previously recognized credit impairment.
- Unusual warrant accounting: The U.S. Treasury warrant’s fair-value increase reduced Q1 earnings by $1.0 million. Its relevant anti-dilution provision expired April 16, 2013, after quarter-end, and the warrant was then reclassified to shareholders’ equity.
Important facts for investors to verify
- Whether improving credit trends persist and whether the $40.8 million loan-loss allowance remains adequate, particularly given $143.5 million of total troubled debt restructurings.
- Whether Mepco can collect its counterparty receivables and whether counterparty failures, cancellations or litigation produce losses beyond current reserves.
- The parent company’s ability to meet deferred interest obligations by the fourth quarter of 2014, given limited parent-level cash, regulatory restrictions and reliance on equity financing.
- The effects of preferred-stock conversion, further equity-line draws and related dilution, including any impact on the use of tax-loss carryforwards.
- The sustainability of earnings after branch-sale effects, reduced loan balances, lower fee income and the quarter’s loan-loss-provision credit.
- The filing reports the Bank’s March 31 total capital-to-risk-weighted-assets ratio as 15.78% in its regulatory capital table and 15.84% in a later MD&A discussion; verify the applicable reported figure.