Independent Bank Corporation — Q3 2018 Form 10-Q
Business context and reporting period
Independent Bank Corporation is a Michigan-based banking company. This unaudited report covers the quarter and nine months ended September 30, 2018, compared with the corresponding 2017 periods; balance-sheet comparisons are with December 31, 2017. Results include TCSB Bancorp from its April 1, 2018 acquisition, so comparisons are affected by the enlarged business.
Financial and operating metrics
Unless otherwise stated, figures are in millions of dollars.
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income | $29.7 | $22.9 | $82.6 | $65.9 |
| Provision for loan losses | $(0.1) credit | $0.6 expense | $0.9 expense | $0.8 expense |
| Non-interest income | $11.8 | $10.3 | $35.9 | $31.1 |
| Non-interest expense | $26.7 | $22.6 | $80.6 | $68.9 |
| Income before tax | $14.8 | $10.0 | $36.9 | $27.2 |
| Net income | $11.9 | $6.9 | $29.9 | $18.8 |
| Diluted earnings per share | $0.49 | $0.32 | $1.27 | $0.87 |
| FTE net interest margin | 3.91% | 3.66% | 3.86% | 3.65% |
- At September 30, total assets were $3.30 billion, up $507.8 million from year-end 2017. Portfolio loans were $2.56 billion, up $543.8 million; deposits were $2.80 billion, up $398.1 million.
- Cash and cash equivalents were $53.2 million. Other borrowings were $79.7 million and subordinated debentures were $39.4 million. Shareholders’ equity was $345.2 million.
- For the first nine months, operating cash flow was $20.6 million, investing cash flow was $(131.7) million, and financing cash flow was $109.5 million. Cash and cash equivalents declined $1.6 million to $53.2 million.
- The allowance for loan losses was $24.4 million, or 0.95% of portfolio loans (1.06% excluding acquired TCSB loans). Non-performing loans were $9.3 million, or 0.36% of portfolio loans; non-performing assets were $10.8 million.
- The Bank was categorized as well capitalized. Its reported capital ratios included total risk-based capital of 13.18%, Tier 1 risk-based capital of 12.19%, common equity Tier 1 of 12.19%, and Tier 1 leverage of 9.73%.
Material changes versus comparable periods
- Q3 net income rose about 74%; nine-month net income rose about 59%. Management attributed the improvement primarily to higher net interest income and non-interest income, partly offset by higher non-interest expense. Lower provision expense and income taxes also aided Q3 results.
- Net interest income increased 29.6% in Q3 and 25.4% year to date. Management cited larger average earning assets, a higher loan mix, market-rate increases, and the TCSB acquisition. FTE margin increased 25 basis points in Q3 and 21 basis points year to date.
- TCSB added approximately $343.5 million of assets, $295.8 million of loans, and $287.7 million of deposits at acquisition. Consideration was approximately $64.5 million in shares and converted options; the preliminary allocation included $28.3 million of goodwill and a $5.8 million core deposit intangible. Valuation remained provisional.
- Non-interest expense increased $4.1 million in Q3 and $11.7 million year to date, with merger-related costs of $0.1 million and $3.4 million, respectively. Management said it did not expect remaining TCSB merger expenses after Q3.
- Mortgage originations declined, which management attributed principally to higher rates suppressing refinancing. The mortgage loan sales margin fell to 1.85% in Q3 from 2.46%; excluding fair-value adjustments, it was 2.11% versus 2.68%.
- Available-for-sale securities fell $86.0 million from year-end, primarily to fund portfolio loan growth. Unrealized losses increased to $8.4 million from $3.8 million, largely attributed to interest rates and spread widening; the company reported no new credit-related impairment charges.
Outlook, risks, contingencies, and unusual items
- The filing provides no specific earnings or growth guidance. Management described Michigan economic conditions as generally improving, though uneven, and said it believed current bank and parent-company liquidity was adequate.
- Key stated risks include Michigan and local real-estate conditions, credit losses and allowance estimates, loan and deposit growth, competition, funding availability and cost, interest-rate movements, and realizing expected TCSB synergies and savings.
- Liquidity depends on deposits, FHLB advances, bank borrowing facilities, and brokered CDs. The company reported approximately $650 million of uninsured deposits, $506.9 million of time deposits maturing within 12 months, and wholesale funding—including reciprocal deposits—of approximately $380.4 million, or 13.2% of total funding excluding subordinated debentures.
- Interest-rate simulations estimated that a parallel 200-basis-point rise would increase next-12-month net interest income by 2.66% but reduce modeled portfolio equity value by 4.33%. These are scenario analyses, not forecasts.
- The company adopted revenue-recognition guidance in 2018, which changed gross presentation of interchange income and expense but did not affect net income. It expects the 2020 expected-credit-loss standard to increase the allowance, though the impact was not yet determined.
- Litigation accruals were described as immaterial, and management estimated additional reasonably possible losses as insignificant, while noting uncertainty. A mortgage-loan-sale indemnification reserve was $0.85 million; separate Mepco-sale indemnification exposure was considered remote and no liability was accrued.
- The federal corporate tax rate fell to 21% effective January 1, 2018. The company had recorded a $6.0 million deferred-tax-asset remeasurement expense in Q4 2017.
Most important facts for investors to verify
- How much reported growth and improved earnings reflect TCSB versus organic growth, and whether integration benefits and cost savings are realized.
- Final TCSB purchase accounting, acquired-loan performance, and the effect of acquisition-related goodwill and intangible amortization.
- Loan growth, deterioration in adversely rated commercial credits, non-performing loans, and adequacy of the allowance, particularly as the acquired portfolio seasons.
- Deposit retention and pricing, uninsured-deposit concentration, maturing time deposits, and continued access to wholesale funding at acceptable rates.
- Net interest margin sensitivity to rates, mortgage production and sales margins, and valuation sensitivity of mortgage servicing rights and securities.
- Capital and liquidity measures, including the effect of dividends, any share repurchases, and the eventual implementation impact of the expected-credit-loss accounting standard.