Independent Bank Corporation (NASDAQ: IBCP) — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020; unaudited. The company provides banking services primarily in Michigan’s Lower Peninsula, with two loan production offices in Ohio. Dollar amounts below are in millions unless noted.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income | $32.0 | $30.9 | $92.6 | $91.9 |
| Provision for loan losses | $1.0 | $(0.3) credit | $12.9 | $1.0 |
| Non-interest income | $27.0 | $12.3 | $58.4 | $32.1 |
| Non-interest expense | $33.6 | $27.8 | $89.7 | $82.4 |
| Net income | $19.6 | $12.4 | $39.2 | $32.6 |
| Diluted earnings per share | $0.89 | $0.55 | $1.76 | $1.40 |
| Net interest margin, fully tax-equivalent | 3.31% | 3.76% | 3.42% | 3.83% |
Annualized return on average assets was 1.90% for Q3 and 1.36% year to date, versus 1.42% and 1.28% in 2019. Annualized return on average equity was 21.36% and 14.87%, versus 14.64% and 12.84%.
Q3 earnings improved mainly on higher net interest and non-interest income, partly offset by increased credit provision, expenses and taxes. Mortgage loan gains were a major driver: $20.2 million in Q3 and $46.7 million year to date, compared with $5.7 million and $13.6 million in 2019. Refinance activity and wider mortgage pricing spreads supported gains; management expects the sales margin to decline toward more normal levels if refinancing subsides. Mortgage servicing recorded a net loss of $0.6 million in Q3 and $9.0 million year to date, principally reflecting lower servicing-rights valuations and paydowns.
Financial condition, funding and capital
- At September 30, 2020, assets were $4.17 billion, up $604 million from year-end 2019. Portfolio loans were $2.86 billion, up $130 million; commercial loan growth was partly offset by lower mortgage balances. Securities available for sale were $985 million, up $467 million.
- Deposits were $3.60 billion, up $561 million from year-end. Non-interest-bearing, savings/checking and reciprocal deposits grew, while time and brokered time deposits declined. Cash and cash equivalents were $46.6 million.
- Other borrowings were $30.0 million, compared with $88.6 million at year-end. The company also reported $39.3 million of subordinated debt and $39.5 million of subordinated debentures. It issued $40 million of fixed-to-floating subordinated notes in May, initially bearing 5.95% fixed interest for five years.
- Shareholders’ equity was $373.1 million. The bank was categorized as well capitalized; its September 30 ratios included 13.82% total capital, 12.57% Tier 1 capital and 12.57% common equity Tier 1 to risk-weighted assets.
- The allowance for loan losses was $35.8 million, or 1.25% of portfolio loans, versus $26.1 million and 0.96% at year-end. Non-performing loans were $10.2 million, or 0.36% of portfolio loans, versus $9.5 million and 0.35%. The allowance increase primarily reflected a $10.7 million increase in subjective reserves tied to COVID-19 uncertainty.
- Cash from operations was $38.2 million for the first nine months, compared with $6.1 million in 2019; investing used $570.9 million and financing provided $513.9 million. Cash and equivalents decreased $18.7 million over the period.
Material changes and unusual items
- Q3 net interest margin declined 45 basis points year over year (fully tax-equivalent), despite higher average interest-earning assets. Lower market rates pressured asset yields; lower deposit costs partially offset the effect.
- Year-to-date provision for loan losses rose to $12.9 million from $1.0 million. Net charge-offs were $3.3 million after recoveries; the filing cites pandemic-related economic uncertainty as a reason for higher qualitative reserves.
- The bank had 2,117 PPP loans outstanding totaling $261.2 million at quarter-end; $37.2 million of forgiveness applications had been submitted. PPP fee accretion contributed $1.3 million to Q3 interest income and $2.3 million year to date.
- COVID-19 payment accommodations on company-held commercial, mortgage and installment loans totaled $59.8 million across 311 loans (2.1% of portfolio loans). Accommodations on serviced loans for others totaled $66.3 million. Subsequent extensions covered $29.9 million of company-held loans.
- Non-interest expense increased, including higher performance-based compensation. Year-to-date costs also included $1.0 million for core-system conversion and $0.4 million for branch closures; eight branches were closed in 2020.
- Mortgage servicing rights declined to $15.4 million from $19.2 million at year-end; the year-to-date fair-value change was a $14.0 million loss. Securities unrealized losses totaled $1.9 million; the company reported no current-period credit-related impairment charges on available-for-sale securities.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management said liquidity and funding contingency plans account for the possibility of significant reductions in commercial loans and deposits during 2021. It expects various Michigan restrictions to continue through Q4 2020 and potentially beyond. COVID-19 could adversely affect borrower repayment, collateral values, credit losses, operations and asset valuations; the eventual impact remains uncertain. Higher-risk commercial exposures identified included retail, food service and hotel lending, as well as retail, office and multifamily commercial real estate.
The company delayed CECL adoption under the CARES Act and continued using the incurred-loss method. It estimated that eventual adoption could increase the allowance by $8–$10 million and the allowance for unfunded commitments by $1–$2 million; actual effects may differ. Other risks include PPP eligibility, processing, forgiveness and SBA-guarantee disputes; deposit outflows and dependence on wholesale funding; interest-rate and mortgage-servicing valuation changes; cybersecurity and vendor disruptions; and the planned core-system conversion, expected in Q2 2021. Management said litigation accruals were immaterial and estimated reasonably possible additional losses as insignificant, while noting uncertainty.
Share repurchases under the 2020 plan were suspended in March because of economic uncertainty; management said repurchases might resume late in 2020 depending on conditions. The company paid $0.60 per share in dividends during the first nine months.
Important facts for investors to verify
- Whether elevated mortgage gains and refinance volumes persist, and how servicing-rights valuations respond to rates and prepayments.
- Whether pandemic-related accommodations, PPP forgiveness and economic conditions lead to higher delinquencies, charge-offs or reserve needs.
- The assumptions and final allowance impact when CECL is adopted, including unfunded commitments.
- Deposit stability, uninsured deposits ($741 million reported), wholesale-funding availability and liquidity under stress.
- Execution, timing and costs of the core-system conversion expected in Q2 2021, and any related operational disruption.
- Whether share repurchases resume and whether dividend distributions remain supported by earnings, liquidity and regulatory capital.