Independent Bank Corporation. Q4 2008 Earnings Call Transcript

| About: Independent Bank (IBCP)

Independent Bank Corporation. (NASDAQ:IBCP)

Q4 2008 Earnings Call

January 27, 2009 10:00 am ET


Michael M. Magee Jr. – President and Chief Executive Officer

Robert N. Shuster – Executive Vice President and Chief Financial Officer

Stefanie M. Kimball – Executive Vice President and Chief Lending Officer


Stephen Geyen – Stifel Nicolaus & Co.

Brad Millsaps – Sandler O'Neill

Jason Werner – Howe Barnes Hoefer & Arnett Inc.



Hello and welcome to the Independent Bank Corporation Fourth Quarter 2008 Earnings Conference Call. (Operator Instructions) Please note this conference is being recorded. Now, I would like to turn the conference over to Michael Magee, President and CEO. Mr. Magee you may begin.

Michael M. Magee Jr.

Thank you. Good morning and welcome to our fourth quarter 2008 earnings conference call. I am Mike Magee, President and CEO of Independent Bank. Joining me on the call today, are Rob Shuster, our Chief Financial Officer, and Stefanie Kimball, our Chief Lending Officer.

Following my introductory comments, Rob will provide a detailed review of our financial performance during the fourth quarter. Following Rob’s comments, Stefanie will provide a progress report on the credit quality. We will conclude the call with a brief question-and-answer session.

Also, please note that an accompanied PowerPoint presentation will be referenced throughout today’s call. To access this presentation, please go to the investor relations section of our website at Furthermore, please also note that this presentation may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Please refer to our Safe Harbor Provision on slide two of the presentation for additional information on forward-looking statements.

I will begin today’s discussion with a review of our fourth quarter and year-end financial results, which are summarized on slide four of the accompanying slide presentation. For the fourth quarter ended December 31, 2008 we reported a net loss applicable to common stock of $86.5 million, or $3.80 per share, compared to net income from continuing operations of $2.3 million, or $0.10 per diluted share in the fourth quarter of 2007.

For a high level overview of the quarter, please turn to slide five of the accompanied presentation.

In discussing these results, I believe it'd be helpful to view the factors contributing to the results in three broad categories. Pre-tax pre-provision core earnings, provision for loan losses, and several one-time items that contributed to the vast majority of our reported losses. First, our pre-tax pre-provision core operating earnings remains strong, and showed improvement for both the fourth quarter and full year.

For the quarter, this measure rose 12.8% to $14.9 million from $13.2 million a year ago. For the full year, this measure rose 15.3% to $61.8 million from $53.6 million in 2007. These results were supported by a 5.9% quarterly increase in tax equivalent net interest income, and a net interest margin that increased nearly 60 basis points from the fourth quarter of 2007.

From this perspective, the fundamental operations of our bank remain strong and growing. We’ve recognized that pre-tax, pre-provision core operating earnings is a non-GAAP measurement, but we do believe that provides an important indication of the earnings power of our company and our ability to absorb credit related costs and weather this is very difficult economic cycle.

Second, let me address our loan loss provisions, which have been significantly impacted by the broad economic weakness in our nation and specifically in conditions in the Michigan economy where we operate. The current economic environment has created many challenges for us and our customers as we continue to experience increased levels of non-performing loans and the credit cost associated with managing that.

Given these challenges, our provision for loan losses rose substantially in the quarter and year, reaching $24.8 million in the fourth quarter, an increase of a 164% from the $9.4 million a year ago. The increase was result of the increase in non-performing loans and decreases in the underlying collateral values, particularly, commercial real estate loans and residential mortgages.

To help address these issues, we are working very closely with our borrowers to identify the best possible outcomes for both them and the bank. Our proactive efforts to manage our credits has resulted in our lowest commercial loans 30 to 89 delinquency levels since 2005 and our loan watch credits increased by less than 2% during the fourth quarter. Stefanie will speak to our efforts in greater detail shortly.

Finally, let me discuss the other items that made up the vast majority of our loss for the quarter and year, and which we do not anticipate will reoccur in the future. Our Board is never desirable to report such losses. We believe that by addressing these issues now, we can achieve greater transparency for our results going forward.

Largest of these items was a $50 million non-cash charge for impairment of goodwill. This impairment related to our Independent Bank Reporting Unit, however our remaining $16.7 million in goodwill relating to our Mepco Finance Corporation Reporting Unit was not determined to be impaired.

The second largest item was a non-cash charge of $26.8 million to establish valuation allowance for our deferred tax assets. Although this valuation allowance substantially reduced the carrying value of these assets, they remain available for us to use to offset future taxable income. The last of these items were $6.9 million in security losses and a $4.3 million non-cash charge for impairment of mortgage servicing rights. All told, these items reduced our results by $3.42 per share for the quarter and $3.65 per share for the full year in more than 90% of our reported losses for these periods.

While the external economic environment is expected to remain a challenge in the foreseeable future, we are not sitting idle in our efforts to navigate through these difficult times.

As we head into 2009, we will remain focused on controlling the one environment we can; improving our internal operations. We will continue to work diligently within our existing portfolio to improve asset quality, contain credit cost, and reduce non-performing assets. We will also continue to maximize our existing relationships and where it makes sense, partner with our customers to find creative and profitable solutions to these challenging times.

As always, we will leverage our community banking groups and cultivate new lending relationships within the framework of our enhanced credit standards. IBC already operates in an efficient manner and while we do not foresee the need for staff reductions, we are constantly reviewing all non-interest expenses to control cost.

As part of this effort, we eliminated all executive officer cash bonuses for 2008. And all executive and senior officer salaries have been frozen at 2008 levels for 2009. During the fourth quarter, the company announced its participation in the Capital Purchase Program and the receipt of $72 million investment from the U.S. Treasury

The rules of this program are designed to help healthy banks shore up their financial position and IBC has been only one of the few banks in Michigan to apply for and receive these funds. The funds have had a positive impact on our balance sheet and further enhanced our capital position in order for us to provide lending in the markets we serve.

Looking back, 2008 will surely be remembered as the start of one of the most difficult economic and financial environments, and IBC was not immune to the challenges that have adversely impacted financial results across the banking sectors. As we begin 2009, we will likely continue to face significant challenges ahead.

However, our stronger regulatory capital position allows us to remain focused on the fundamentals of community banking, as well as our bank-wide directive to grow deposits, enhance asset quality, and improve operating efficiency, through disciplined expense management, so that we can emerge with solid footing for the eventual rebound in the market.

With that, I will now turn the call over to our Chief Financial Officer, Rob Shuster, for a review of our financial performance during the period. Rob?

Robert N. Shuster

Thank you Mike. Good morning everyone. I am starting at page seven of our PowerPoint presentation. I will focus my comments on adding more detail related to several of the unusual charges that impacted our fourth quarter and forward year results on capital and liquidity, net interest income in our margin, certain components of non-interest income and non-interest expense, and some very brief comments about asset quality, as Stefanie will cover this last topic in much greater detail.

As outlined on page seven, there were some positive factors evident in our fourth quarter ’08 results. Most notable was the continued strength of our net interest margin. However the positives were overshadowed by unusual non-cash charges, securities losses, and a rise in credit costs.

Page eight outlines several of the unusual items impacting the fourth quarter including the goodwill impairment charge, a charge to establish valuation allowance on deferred tax assets, an impairment charge on capitalized mortgage loan servicing rights, and securities losses. As Mike mentioned, collectively these four items totaled 90% of the total loss for the quarter.

Page nine outlines the factors leading to our $50 million goodwill impairment charge. Like many other banks who have reported goodwill impairment charges during 2008, the decline in our common stock price during the fourth quarter was the major factor in our assessment. As you know, this non-cash charge did not impact our regulatory capital ratios, liquidity, or financial resources.

As Mike mentioned, at year-end, we had $16.7 million of goodwill remaining on our books that is contained entirely in our Mepco Finance Corporation Reporting Unit. Because of Mepco’s level of profitability, we do not see any further risk for additional goodwill impairment charges at the present time.

Page 10 outlines the issues surrounding our decision to record valuation allowance on our deferred tax assets. To be clear, this was a judgment call that could have gone either way. Do not mistake our decision as being anything other than a conservative position, taking into account our loss in 2008 and the uncertainty of our near-term results, given the general outlook for credit costs and the continued potential for weak macroeconomic conditions. We would prefer to have the potential for this charge behind us, rather than hanging over our heads. We had more than sufficient regulatory capital to absorb this non-cash charge.

Our net deferred tax asset is not lost, it is available to offset future taxable income and the valuation allowance will be evaluated quarterly. As we look ahead in the near-term, it is likely that neither income nor losses will be tax effected, thus our book income tax expense or benefit will probably be zero for several quarters.

Page 11 covers our bank regulatory capital ratios, as you can see, all of the ratios are higher than the previous quarter end, or at year-end and we remain comfortably well capitalized. So now let’s take on the issue of the level of our tangible common equity, which stood at a $101.2 million at year-end or 3.45% of total tangible assets. Would we like more? You bet. In this environment you probably cannot have too much common equity. However, I do not think that our current level of tangible common equity will be an impediment in regards to the positive long-term future of the organization.

Let me offer two arguments from my position. First, between our preferred stock and our trust-preferred securities, we have an additional $158.6 million of regulatory capital. I recognize that this is not the same as common equity, because these instruments require a quarterly dividend that is cumulative.

However, the preferred stock is perpetual and the earliest maturity of any of our trust-preferred securities is 2032. So other than the quarterly dividends, they do not place any near-term pressure on our capital structure whatsoever. Further, with cash on hand at the parent company of $27.5 million at year-end, we have three years of dividend coverage.

My second argument relates to two potential additions to our common equity overtime that does not involve any issuance of new stock. At year-end, we had an accumulated other comprehensive loss of $23.2 million which is deducted from common equity.

This item is largely comprised of the amount by which the carrying value of available for sale securities currently exceed their fair value and the amount by which the carrying value of our interest rate swaps and caps currently exceed their fair value.

As long as we hold these items to maturity, which we intend to do, we would expect to recover the carrying value to fair value differences and this amount would be restored overtime to total common equity

The other potential addition to common equity is the possible further recovery of some or all of the valuation allowance on deferred tax assets that I discussed earlier. Collectively, these two items represent 1.72% of tangible assets, or about $2.19 per share. In my judgment, some consideration should be given for these two items when thinking about our common equity level.

Page 12 contains a new table. The concept for which we saw in another bank’s earnings release and that we believe has merit. We think this table demonstrates our ability to navigate through this difficult credit cycle and our capacity to absorb credit costs. This capacity has grown even stronger in 2008.

During the fourth quarter, we incurred securities losses of $6.9 million, which were comprised of a decline in the fair value of trading securities of $0.7 million, and a write-down of $6.2 million related to the dissolution of a money market auction rate security and the distribution of the underlying Bank of America preferred stock.

Page 13 provides details on what we have remaining in trading securities. As you can see, we sold most of these positions during the fourth quarter and now have very little exposure left. One closing comment on this slide. We originally purchased these securities long before the turmoil that has gripped the financial markets for the past year

Historically, these companies had very high credit ratings and were considered titans of the American financial system. We considered these investments to be conservative and safe. Obviously, the events of 2008 changed all of that.

Page 14 has details on our securities available for sale at year-end and provides both the cost basis and current market values. We discussed our ownership of the aforementioned money market preferred security last quarter and the fact there are evaluation of this security at that time did not result in any other than temporary impairment.

However, on November 17, the distribution event took place and the money market preferred security was dissolved and 400,000 shares of Bank of America preferred stock with a par value of $10 million were distributed to us. Because of this distribution event, GAAP required us to record the Bank of America preferred stock at its fair value on the date of distribution of $3.8 million, which led to the $6.2 million securities loss as mentioned above.

As you can see on page 14, at year-end, the fair value of these shares had moved up to $4.8 million.

Pages 15, 16, and 17 of our presentation provide information on our tax equivalent net interest margin, net interest income, and some unusual factors impacting the fourth quarter. I said in last quarter’s conference call that we would expect the margin to remain around 4.75% and we actually did a bit better than this at 4.8%

In particular, when looking at the linked quarter decline, and tax equivalent net interest income, I would encourage you to review the items outlined on page 17. We continue to exercise discipline in pricing both loans and deposits. Such discipline is a primary factor leading to our strong margins.

However, with respect to deposits, we continue to see nonsensical pricing by some competitors in many of our markets. We see some financial institutions offering one-year CD rates in excess of 3%, when similar term brokerage CD rates are just under 2% and FHLB borrowings are at 1.3%. In comparing deposit growth rates at various financial institutions, one must be mindful and understand the pricing tactics being employed on interest-bearing accounts such as CDs and money markets.

Page 18 provides information on our tax equivalent net interest income and margin sensitivity, based on our year-end balance sheet. As you can see in the base case, tax equivalent net interest income is $135.9 million, compared to an actual level of $134.7 million in 2008 and the tax equivalent net interest margin in the base case is 5.08%.

The potential improvement in tax equivalent net interest income is despite about a $170 million drop in total interest earning assets.

Moving on to some of the more significant categories of non-interest income on page 19 of our presentation, service charges on deposit accounts declined as we continue to see a decrease in NSF occurrences and related fees. Many banks are experiencing a similar decrease that I believe reflects belt-tightening on the part of consumers.

Mortgage loan servicing income declined sharply. As you are probably aware, mortgage loan interest rates plunged to record low levels in the last three weeks of the year. This led to a large decline in the fair value of our capitalized mortgage loan servicing rates at year-end, and a $4.3 million impairment charge.

Absent impairment charges or recoveries of such charges, this line item should run at about a positive $650,000 per quarter. Because of the record low mortgage interest rates, we are experiencing a big surge in refinancing volume. This should lead to increased gains on mortgage loan sales at least in the near-term.

Moving on to page 20 of our presentation, excluding the goodwill impairment charge non-interest expenses totaled $33.6 million in the fourth quarter of ’08. Most of the increase in total non-interest expense over the year ago quarter or linked quarter was credit driven, either in the form of higher loan and collection costs, or increased losses on other real estate owned.

Anecdotally, the increase in occupancy costs was all due to snow ploughing as we had record snowfall levels in Michigan in December.

Pages 21 through 25 of our presentation provide information on the provision and allowance for loan losses as well as net loan charge-offs. Because Stefanie is going to go over credit quality in detail, I would now like to turn the call over to her.

Stefanie M. Kimball

Thanks, Rob. My remarks will follow slides 27 through 43, and I will be discussing the credit quality results and our initiatives to enable us to weather this challenging credit and economic cycle.

First I will turn my comments to commercial lending. As Mike referenced in his comments, our management team continues to work diligently with our clients through this very difficult Michigan business climate. While national economic conditions deteriorated rapidly during the fourth quarter, our clients have been under stress now for several years. A number of them could not continue on during 2008 and defaulted on their loans.

Our commitment to relationship banking continues and our philosophy of working with our clients as long as they are working with us has been maintained. We continue to see the most severe stress with clients that depended in the past upon the sale of residential real estate to produce some cash flow for their business, as generally these clients were unable to produce sufficient volume to cover even the most basic of expenses.

Most of the clients that remain in this sector have alternative sources of income. As a community bank, our numbers reflect the story of individuals in the communities we serve and as I review the various credit metrics, I will share a few stories of clients that help illustrate these trends.

Page 27 provides highlight of some of the key metrics for the commercial lending business. During the fourth quarter, new and renewed commercial loan volume of $75 million was reported, which was consistent with our level in the third quarter. Overall, commercial loan demand has been weak in 2008 as it relates to new projects.

However we did see an increase in borrower applications who’ve met our lending criteria that were looking to move their relationships near the end of 2008. We think this pipeline will serve us well in 2009. The new loan volume did not completely offset repayments and a decline of $31 million in outstandings was experienced in the fourth quarter, which has slowed from the $50 million decline in the third quarter.

Our watch credits increased slightly to $210 million, primarily as a result of several relationships where the guarantor’s liquidity was severely impacted by declines in the stock market. Commercial loan delinquency continues to be at record low levels for our company at 1.2% for the 30 plus accruing loans.

Overall, our non-accruals increased, as a number of the real estate borrowers defaulted as they determined that they could not make it through the winter month given their weak liquidity position. Charge-off levels were elevated, as write-downs for the deterring collateral value are taken regularly. And our ORE levels increased nominally with the addition of less than $1 million in new properties in the fourth quarter.

Turning to page 28, commercial loan outstandings are highlighted. Outstandings declined at a slower rate than last quarter due to the trends, which I just outlined. We have basically seen two things in new application volume. The first is that borrowers who had existing loans at larger banks are conduits - those banks are now reluctant to renew them due to the Michigan locations. The second is there are clients that used to have a relationship manger at a larger bank and now their business is just too small to warrant that personal touch which they value and thus they are looking to move to a community bank where they can have personal service and the benefit of a banker’s advice at counsel during these very challenging financial times.

Turning to page 29, we continue our strategy to reshape our portfolio. Over the last 18 months we have seen significant declines in the high-risk categories of commercial real estate in the land, land development and construction categories and some nominal growth in our C&I and owner occupied loans This helps reshape our portfolio to reduce our reliance on real state related loans. Our remaining exposure on the high-risk areas of land and land development is now under a $100 million. These two segments have generated most of our losses during 2008.

Turning to page 30, our watch credits are displayed. Watch credits increased 1.4% or $2.8 million during the fourth quarter. As previously mentioned, several large relationships were either the borrowers or the guarantor’s liquidity were negatively impacted by the declines in the stock market. As reported in the media, about six years of profits were lost in the 2008 stock market, which now limits the potential sources of cash for many borrowers with either struggling projects or companies.

A good example of this is one of our clients who is an diversified investor who supports a small business, a well established hotel, and limited real estate investments with a sizable liquidity position. These investments in his portfolio dropped by 40% during the quarter and now the credit has been downgraded to internal watch to ensure that it is closely monitored. Shifts within the watch category also have taken place as the weak economy have placed continued stress on real estate related borrowers who could just not make it through the winter.

Turning to page 31, a continued bright spot is our strong early collection efforts and administrative discipline that is in place that resulted in continued low levels and improving delinquency rates.

Turing to page 32, the commercial non-accruals did increase during the quarter, due to the weakening of a number of watch credits. An example is one $4.3 million real estate development loan that moved to non-accrual from a substandard category - the quarter before. It moved into this non-accrual category because of sale of a planned commercial lot sell-through. The sale did not take place due to requirements and delays by the township, which then caused a subcontractor to file a lien on the project.

As this economic downturn continues, borrowers not only have to deal with creditors, but also local governments many of which that have specific timeframes for their development to be completed which are now have being surpassed.

Lack of support and understanding from these communities can add further stress to the borrowers in our portfolio. In this example, the subcontractor just became tired of the lengthy negotiations and filed a lien on the project, which increased the stress.

Now turning to page 33. The non-accrual loans reached $79 million at the end of the fourth quarter. Charge-offs and reserves are in place for 42% of the loan amount reflecting the collateral value declines experienced in our markets. Last quarter, we reported an overall 38% reserve on average.

Land and land development accounts for just under half of the non-accruals and adding in construction, they account for 57%. We have seen several income producing properties with tenant concentration struggle when one large tenant either vacates or fails. We are watching this segment of the portfolio carefully. Overall, the portfolio is fairly granular with 271 notes with many of which are under $250,000.

Turning to page 34, charge-offs for the commercial loans totaled just about $13.6 million for the quarter. A significant portion of this charge was a result of our continued write-down of appraisal values as the values continued to decline in this difficult market. Uncertainty as to when the real estate market will hit the bottom and when demand for real estate will start to increase has significantly impacted appraised value. Absorption rates for residential real estate projects in particular are being forecasted as very slow and far out into the future negatively impacting current values.

Turning to page 35, levels of other real estate owned increased $900,000 this quarter as several properties were replaced during the quarter or resolved and they were replaced by a few new loans this quarter. ORE has risen significantly during the second half of 2008 as several foreclosures have taken place and a number of deeds were negotiated with borrowers outside of foreclosure.

Turning to page 36, effective management of portfolios of troubled assets is a key challenge for our industry and our bank. While, government programs could relive some of the stress on banks, affected daily management of these loans and properties will be essential in 2009. As you look at the various stages of a troubled loan, it basically falls in just one of three categories. You’re either continuing to work with the borrower, or you’re involved in some kind of legal process such as foreclosure or bankruptcy and that process often ends in the bank owning the property.

During 2008 our borrowers moved through these categories. We started the year with a large portion of these clients working with the bank and very little commercial ORE. We continue to have a large portion of our loans in the working with the bank category, but some have moved into the legal stage with approximately $33 million of loans in some legal proceedings such as litigation, foreclosure or the client filed bankruptcy.

We started the year with $2.5 million in ORE and we now have $12.5 million. In order to effectively manage properties in ORE, we have contracted the services of several expert property managers. Our properties are quite diversified and it is important to get the right assistance for each property. We are also looking at each to determinate highest and best use. If a project failed and ended up in our ORE department, we can’t assume that someone else just trying harder will work. Maybe an alternative use, given the changes in our economy is more appropriate.

We are working with real estate experts to determine that as well. Currently we are at discussions with a well-known expert property manager to manage most of our properties in one of our markets. We have started discussions with similar real estate experts in other markets to manage the other sizable properties.

We also continue to explore the market for sale of troubled loans. During the fourth quarter, we saw further significant declines in value of these loans with brokers that we work with due to some year-end sales at large institutions that saturated the market. We decided at that point to explore instead private placements and are now in discussions with an investment bank. We also are in discussion with several private investors working on individual sales. We believe that that approach will provide the best value for our shareholders.

Turning to page 37, in the past, we have gone over the numerous credit quality best practices that we have implemented. Over the past 18 months, we have put in place the best credit practices and we are confident that these serve as a good foundation for managing through this very difficult economic cycle. Managing credit in today's economic environment is very challenging, but the fundamental principles of credit have not changed.

We have a continuous improvement approach to these credit quality best practices, and we made further enhancements during the fourth quarter. We remain very committed to our training of our lending team to manage through the challenges and handle whatever comes their way with professionalism and care.

We also realize that this is an unprecedented time and we are looking at things differently like the ORE example that I gave. Only recently have we had sufficiently volume in ORE to merit this concerted approach. I will now turn my attention to retail, which starts on page 38.

Retail loan volumes during the fourth quarter, we did see an increase, as Rob mentioned, in refinance mortgage applications near the end of the quarter. New volume was $54 million with a10 million added to our portfolio during the quarter. Overall we had a net decline in balances of $29 million.

Turning to page 39, retail delinquencies increased during the quarter. Mortgage delinquency increased $2.5 million while consumer was up $1.4 million. The top reasons for delinquency are curtailment of up income and excess of obligations.

Turning to page 40. The retail non-accruals are shown. They also increased during the quarter. Non-performing assets for mortgage increased $4.6 million, while consumer increased just $1 million.

On page 41, our charge-offs are shown. Retail charge-offs in the fourth quarter were $5.4 million, of which $200,000 were overdraft losses. We continue to write-down our mortgages to current market values on average with a 83% value of the loan balance.

Turning to page 42, managing troubled assets is also a challenge for our retail businesses. We have a further breakdown on our non-performing asset portfolio, which shows 74% are currently residential properties that are the borrowers' primary residence. Another 9% are secondary homes or rental properties. We continue to work closely with borrowers with about 55% in some stage of renegotiation or workout and 45% having moved into a legal stage.

Foreclosures are running about 39% in the various stages. ORE continues to move with a 151 properties currently in inventory. Given the average balance of this portfolio, is about $50,000 after the write-downs, these properties are moving as they are attractive to first-time home buyers and investors at rental properties and sales in this end of the market are much more frequent than in other segments.

Turing to page 43, we have an outline of a number of retail initiatives to continue to manage through the credit cycle. We continue to underwrite loans at prudent industry standards. Our collections team, which was consolidated 18 months ago with our charters is working well together and has established a good process for working with our borrowers. Examples of some enhancements are our quality assurance function and our Loss Mitigation and Foreclosure Committee. The latter is a team of senior underwriting and collections expert that look at any alternative to foreclosure before we move forward.

We continue to have a number of channels for the sale of real estate to include the Internet, realtors, and our own Internet where employees can obtain information for interested clients. Overall, we have the processes and people in place to effectively manage through this credit storm.

Next I will turn the call over to Mike Magee, who will to conclude our presentation. Mike?

Michael M. Magee Jr.

Thank you Stef and thank you Rob. As one of the oldest and most well established banking brands in Michigan, we’ve been in business for more than 140 years and have weathered a variety of market cycles and business trends over those many decades. We will continue to face tough conditions, but I am confident that the substantial structural and operational changes we’ve implemented in the recent months, the commitment of our employees to continue to deliver the highest level of service will eventually begin to positively impact our business and position us for the improved performance over the long-term. That concludes our prepared comments. At this time, we will open the line for questions from investors and analysts.

Question-and-Answer Session


Thank you. (Operator Instructions) Our first question will come from Stephen Geyen from Stifel Nicolaus. Please go ahead

Stephen Geyen – Stifel Nicolaus

Yes, good morning. Rob just wondering that your deferred tax assets, just curious under what circumstances will that be realized in the future?

Robert N. Shuster

Well, just to kind of walk you through to the extent you have taxable book tax income, you can utilize it to offset that. I said, earlier on that at least for the next several quarters, if we have earnings they are not going to be taxed. Okay, so that’s how you are going to be utilizing it. And conversely if we have a loss you are not going to see a tax benefit, because in that instance what would happen is we would record a deferred tax asset but then we would increase our valuation allowance and the net of those would be zero. So to just answer your question directly the way you can realize it is by generating book taxable income in the future. At some point, if you’ve done that for many, it’s a judgment call, but if you have several consecutive quarters of having done that, you are always evaluating the need for that valuation allowance and you could restore it in its entirety, you know if you return to a period of profitability, and I would tell you other than where we started in 2008 historically the company always had generated taxable earnings. So, at some point in time it seems like it’s very difficult to know when this credit cycle is going to end, but at some point, certainly we’d expect there to be future taxable earnings, but in terms of the accounting, the establishment of the valuation allowance we have to look at a fairly narrow time band.

Stephen Geyen – Stifel Nicolaus

Okay, and Stefanie you said that the bank is working with managers to find use for OREO. It sounds like it’s a bit of change from the past. I’m just wondering do you have the staff in place to work through these problem loans and to work with these assets and get them into the position where they can generate income down the road?

Stefanie M. Kimball

Yes, two things with regard to that. First of all, we do have a couple of people in our special assets group that are managing the ORE properties, but in addition to that we’re really outsourcing some of the management by contracting with experts in each of our markets that could help us with each individual projects. For instance if we have a project that's a retail strip center, that needs different kind of maintenance and they could lend or then residential lots. And so, depending upon what that real estate is, we are finding someone who is expert in that management, since we don’t want to develop being a landlord of such a diversified amount of real estate.

Stephen Geyen – Stifel Nicolaus

So, I guess, to be more precise with my question, any incremental increase in costs is really dependent on the increase or where OREO may go in 2009, 2010?

Robert N. Shuster

You mean in loan and collection costs Steve?

Stephen Geyen – Stifel Nicolaus


Robert N. Shuster

Yeah, I mean there may be some, but in addition, you can also look at arrangements where maybe we would have some type of arrangement to share if they come up with a solution that generates a better result than where we are carrying the asset, you might provide them some upside. So I mean there is different ways of tackling that, but don’t necessarily increase our loan and collection costs.

Stephen Geyen – Stifel Nicolaus

Okay, thank you.

Stefanie M. Kimball

And those are all things that we are exploring with some third-party experts in each of the markets.

Stephen Geyen – Stifel Nicolaus

Got it. Thanks.


Our next question will come from Brad Millsaps from Sandler O’Neill. Please go ahead.

Brad Millsaps –Sandler O’Neill

Hi, good morning.

Unidentified Company Representative

Hi Brad.

Stefanie M. Kimball

Good morning Brad.

Brad Millsaps – Sandler O’Neill

Just maybe had a couple of questions on, kind of the watch list the data you provide I’m not sure the slide number, but Stefanie I wanted you to kind of talk about, I think at the beginning of the year, you had about a $186 million of land, land development construction loans, you finished at the end of the year with roughly 145 and then the charge-off data you provide for commercial loans, you charged off a total of about almost $38 million for the year and I know that encompasses other types of loans besides those three categories that I mentioned. But I’m curious if you can kind of talk about the decline in that loan category, how much of it was related to charge-offs? And just trying to get an idea, what other charges may be coming down the pike in terms of, some of your other commercial categories?

Stefanie M. Kimball

Well Brad, in terms of the remaining balances in the land, land development of $145 million that you mentioned, and you’re correct a good part of the decline during 2008 did come from a portion of that $38 million in commercial charge-offs. However, certainly, other segments had charge-offs as well, but the bulk of it would have been from land, land development and construction loans, mostly the land and land development categories.

Robert N. Shuster

And Brad just to sort of follow up on the second part of your question about remaining charge-offs, we have a chart at the end of the supplemental data that sort of breaks down those categories, and what is in watch credit, what’s performing, what’s not performing and then what’s not watch credit. You know, the one thing that I would say about, several of the credits and Stefanie said this in her remarks that remained performing is, they are performing not because they are selling anything. They are performing because the borrowers have alternative sources of cash flow and are dependent on sales to continue to service the deck. So, we still have, I guess some optimism that that will continue and so the level of charge-offs, overtime should diminish because the size of the portfolio has diminished and we are contemporaneously adjusting the carrying values based on updated analyses with the collateral values. In terms of the other sections, at least to-date and this is reflected in the delinquency data, they continue to hold up pretty well. Certainly, it’s very tough to project what’s going to happen as we move through ’09, but I think the delinquency data does sort of indicate that those portfolios are still hanging in there.

Stefanie M. Kimball

You know, the other thing I would add is that Rob was talking about the remaining loans in those categories. Certainly, those borrowers do have alternative sources of income. I mean, they’ve been holding on now for several years. As an example, one partnership, one of the partners is a surgeon and has over $1 million annual income and continues to support the project and believes in the project, along with his partner. So that, either that or individuals who have substantial liquidity have been able to hang on through this cycle and are not dependent on selling to real estate in order to make debt service payments.

Brad Millsaps – Sandler O’Neill

Right, okay. And then Rob another question in terms of operating expenses. A big part of you guys getting back to that much higher pre-provision earnings number is getting some relief on maybe some of the loan and collection costs, some of the other real estate disposal costs. You talked a little bit about, some things you’ve done on the personnel side, anything else in your mind that if those costs do stay elevated, what you can do? I assume you’ve got, higher FDIC insurance premium as well that you will be filing in 2009?

Robert N. Shuster

Yeah, that’s certainly the case with the FDIC insurance is true. I mean, everyone is seeing a jump, at least for the first six months because of across the board increase and then the last six months are going to see probably changes too because of their, some of the other insurance changes they talk about. In terms of loan and collection cost, I will say that the fourth quarter is elevated and this is sort of technical, but one of the things that happens when you pay property taxes as we’ve actually accounted for those in the impairment analyses we do, but they sort of and you know, it’s really just a reclass between the provision in loan and collection. But, as those taxes are paid, they sort of come out of the FAS 114 impairment analysis and then get shifted into loan and collections. So I guess one way to think of it is, you got to look at the provision in loan and collection sort of collectively, but I think, longer term the way those costs come down is really, by disposing of the real estate and getting just the overall number of items in the portfolio down. I think the loss on ORE hopefully, we will see some abatement there as we find a bottom on home prices. I mean, we are finding on the one to four family, we continue to be able to sell, to sell those properties, but we certainly saw an adjustment of price points in the fourth quarter.

Michael M. Magee Jr.

Brad, this is Mike. I’d just like to add that, this has been an area of concern of mine because of over the last two years how fast and rapidly expenses increased in loan and collection. We are approaching close to $10 million on an annualized basis. And to this point it’s – and all the properties of course just spread out all over the State of Michigan. And to this point, our collection areas and our folks have been working with attorneys around the State of Michigan and firms to go through the foreclosure litigation process or workout or come to some type of a mediation agreement. I have made the decision to have one person within the corporation who will be responsible for negotiating and controlling all of our legal and collection expenses, because we feel based on the volume right now of the work that we’re requesting outside of the bank that we can negotiate prices down and receive substantial savings. I am not willing to put a dollar amount on that expense item right now, but I am quite confident that by having one individual manage and control who is performing legal work for Independent Bank Corporation and negotiating those prices will save a substantial amount of – of money in loan and collection expenses going forward

Brad Millsaps - Sandler O'Neill

Okay, and Rob just one final kind of housekeeping question. What tax rate did you use to get to $1.92 on that non-cash goodwill charge?

Robert N. Shuster

Boy! That’s a great question. The the way I get to it is, a bit of the goodwill was actually tax deductible.

Brad Millsaps - Sandler O'Neill


Robert N. Shuster

Some of the goodwill associated with our acquisition of the

TCF branches were tax deductible so there was roughly about $6 million of tax impact related to the goodwill tax benefit. And so that’s how you come to the $1.92, you have to take the 50 less the 6 and I think that will be come out or it should come out relatively close to the $1.92. Now the interesting thing is the flip side is, then we turnaround because of the deferred tax reserve and sort of reverse back out that $6 million, but if you are looking at the individual components, you still have to tax-effect them.

Brad Millsaps - Sandler O'Neill

Okay, okay yeah, doesn’t really matter, but just was curious. Thank you very much.

Robert N. Shuster

No, it’s a great question.


(Operator Instructions) Our next question will come from Jason Werner from Howe Barnes. Please go ahead.

Jason Werner - Howe Barnes Hoefer & Arnett

Good morning.

Robert N. Shuster

Hi, Jason.

Stefanie M. Kimball

Good morning Jason.

Jason Werner - Howe Barnes Hoefer & Arnett

I got on the call late. So if I ask any questions you already addressed I apologize. My first question was with regard to your tangible common equity ratio. Obviously that number did dip in the quarter went below 4% and I was curious what you guys are doing to address that. I know you have raised the TARP capital and that’s important but I think investors are still going to be looking at that common tangible number too. So what’s your thoughts on addressing that issue?

Robert N. Shuster

Well Jason, I spent a fair amount of my comments talking spot on to that point. And clearly, trying to raise common equity in this environment is extremely difficult and a challenge certainly from a dilution standpoint. But, the two comments I made, one I won’t repeat because you already addressed we have roughly $159 million of other capital contained within the preferred stock and our trust-preferred securities. But the other point I made was, there is a couple of components that are out of common equity right now that over time you know, there is at least the possibility of them being recovered, back into common equity. The one is, if you look at the amount of our accumulated other comprehensive loss, at the end of the year it was $23.2 million. That relates to carrying value, fair value differences in securities available for sale and on interest rates swaps and caps. And as long as we hold those positions, which we intend to do to maturity, that $23 million overtime will be recovered. The other thing I mentioned and this is, again no certainty here but you also have, the potential to recover the deferred tax valuation allowance. Of course that’s dependent on generating consistent future taxable book income. But collectively those two items represent about 1.72% of tangible assets or about $2.19 per share. So, they are very substantial and at least, in my judgment some consideration should be given to those, when at least thinking about our level. The last point I’d make is, and we under the TARP CPP program have responsibilities that we take very seriously regarding new lending and as you could see in the release in the 30 days, since receipt of the money roughly from December 15 through January 15, we had made $72 million in new loans, that’s not necessarily going to equate to dollar-for-dollar to growth in the balance sheet, because some of those loans on the mortgage side are going to be sold and we are going to have, pay-offs in the portfolio. So, I still do believe that there is opportunities for assets to come down. With the strength of our margin, I think we can still do that, without a material erosion in our net interest income. So, I think there is still that opportunity as well and so, I guess I’d point to those factors.

Jason Werner - Howe Barnes Hoefer & Arnett

Okay. What about shrinking the balance sheet further obviously, when you are trying to lend out you are going to have some pay-offs also, but what about securities portfolio? Do you envision, continue to delever a little bit or with the TARP capital you don't need to do that now?

Robert N. Shuster

Well, I will say this, I think, we had talked about the possibility of levering some of the TARP proceeds to offset some of the preferred dividend, but I think our view is to put, in securities, I think our view right now is to put that on hold. I think, we believe there is still enough upside in the margin, the one slide I think it’s page 18, sort of gives you a snapshot of where at least our asset liability margin modeling has us, if we look at the balance sheet at the end of the year. So, we still think there is upside, there. So, we don’t feel the pressure to leverage that through buying securities and with that I do think then you will get some deleverage in assets just through normal paydowns and alike. So, I think again that will provide some additional opportunity to bring those tangible capital levels up.

Jason Werner - Howe Barnes Hoefer & Arnett

Okay. And could you tell me what the discount was on the TARP preferred, and what timeframe will you be accreting that over?

Robert N. Shuster

The discount would be, it’s the $72 million less the $68.456 million and then we already accreted I think $35,000 at the end of the year. So, the gross discount was I think $3.6 million and we are accreting it over five years. And I think most banks are doing that same type of thing. There were some different options on how you do it, but most of the releases I’ve seen have that being accreted over 5 years. And then, the difference between the $72 million and the $68.4 million was, what was allocated to the warrants and that’s in capital surplus and that will just remain there, but the preferred stock, the $68.456 million will be accretive up to $72 million over a five-year timeframe.

Jason Werner - Howe Barnes Hoefer & Arnett

Okay, and my last question just to kind of go back to what you just said about the margin, you think you have some upside. Obviously that chart on table, the page 18, has that going up in a declining rate environment, but quite honestly we can’t have a much of a declining rate environment when rates are where they are right now. What are your thoughts and how much margin improvement you can have, just where we are today just kind of having things flow through?

Robert N. Shuster

Well I agree with the concept that you had that, rates, they are so low that they’re not likely to come down very much, but I do think the one thing that you have is you still have repricing of liabilities to lower rates that haven’t repriced yet. And the other thing I would say is, one of the things we’ve done is we often have floors on many of our commercial loans, variable rate commercial loans. So, they have hit those floors and they are not, the rates aren't going down further, while we still have some liabilities that may reprice lower. So I do think there is some opportunity there. The other thing that the fourth quarter was very unusual. In the first 30 days of the quarter, LIBOR rates were really high. And we had some repricing that was on some debt or swaps that, really at least for that 30 or 3 month period, because they reprice every 90 days, but those high LIBOR rates just in that first 30 days of the quarter really spiked up some, some interest costs. So, I don’t think the fourth quarter in terms of the cost of interest-bearing liabilities is a good reflection of where they will sort of graduate to, because of that and then the other item was and it’s on I think page, there is a page in – it’s page 17. The other unusual thing in that fourth quarter is we had - we have a few interest rate swaps and caps that are hedging Federal Reserve Bank borrowings and we can’t take hedge accounting treatment on those because the discount rate is a managed rate rather than a market rate. So, we have to mark those to market. And what happened is at the end of the year or in the last two months of the quarter, LIBOR rates really declined. So we had to take some mark-to-market hits there that I don’t think will be recurring at that level rates. Again – because you said, you don’t think short-term rates are going to fall much below where they are already at. So, just a couple of unusual things in that fourth quarter again that are necessarily reflective and that’s why I think that 508 on slide 18, is where we are forecasting our base case given the year-end balance sheet, and where rates were at that point in time. And the last thing I would say is I think you will see some shifts in the loan portfolio, where we’ll have some growth and maybe higher yielding types of loans and we are seeing better pricing opportunities for lending people I think are understanding that you have to get better returns there.

Michael M. Magee Jr.

Yeah and several of the commercial loans that we are renewing currently, some of them did not have floors, some are implementing floors those loans were tied to prime and so we are taking advantage of. Right now, as Rob pointed out, the competitive environment is such where is the availability of credit that’s important to our borrowers not the cost of credit. And so it’s allowing us to basically receive a very decent return on all the new lending opportunities that we’re looking at

Jason Werner - Howe Barnes Hoefer & Arnett

Great. Thank you guys.


This does conclude today’s question-and-answer session. I would like to turn the conference back to Mike McGee for any closing remarks.

Michael M. Magee Jr.

Okay, thank you. With that, this concludes our call today. Thank you for your interest in Independent Bank and we look forward to speaking with you again next quarter. For an archived webcast of today’s call, please go to the Investors Section of our website at The webcast will be archived on our website for approximately 90 days from date of today’s call. If you do have any questions in the interim, please don’t hesitate to give Rob Shuster or myself or Stefanie a call. Thank you and we all hope you have a great day. Thank you.


The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: Thank you!