INDB - Independent Bank: High LTD Ratio Limits Growth Prospects

2024-01-21 04:10:02 ET

Summary

• Independent Bank's Q4 GAAP EPS beats estimates by $0.02.
• Q4 revenue of $177.16M misses estimates by $0.18M.
• Loan portfolio growth is slowing down, delinquency trend is increasing slightly and the focus is on deposit growth.

Independent Bank ( INDB ) is a Michigan-based bank where it operates with 62 branches. In my previous article , I assessed Q3 2023 as positive overall, and indeed the stock has risen 30% since then, albeit with some difficulties in the first few weeks. Today, however, I will analyze Q4 2023 ; EPS beat estimates but revenues did not.

• Q4 GAAP EPS of $1.26 beats by $0.02.
• Revenue of $177.16M (-11.5% Y/Y) misses by $0.18M.

Loans and securities portfolio

Starting with the loan portfolio, the first thing we can see in Q4 2023 is that growth is gradually slowing down.

Compared to the previous quarter, total loans increased by only 0.40%, suggesting that demand for credit is no longer the same. Total commercial loans are the most distressed (down 0.30%), while residential real estate is the one that is suffering the least from rising rates given it grew by 3.70 %. Based on this data, businesses are trying to avoid debt while households that need a home to live in are putting interest payments on the back burner.

Specifically, on the commercial side, construction is in clear trouble and has plummeted 11.90%: there is less demand for loans priced off the short end of the curve. Currently, on a fixed rate commercial, the bank is asking about 7%, a high rate compared to previous years but lower than previous months. Anyway, this small decline is not stimulating demand.

Another factor that would explain why loans are not increasing is due to the little financial flexibility this bank has. In fact, the LTD ratio is on 96%, and management has no intention of raising it above 100%. So, this implies that INDB has rather limited room for maneuvering and needs new deposits in order to make new loans. In fact, one of the main goals the bank will pursue in 2024 is to improve its bank deposits.

We're pretty close to being where we want to be. I mean, we don't have a bright line on it, but we definitely would have a very, very strong preference at having a loan to deposit ratio less than one, which is why we're very focused on growing deposits in 2024.

Jeff Tengel, CEO

Regarding the quality of loans, the delinquency trend is increasing slightly. Delinquent loans/total loans are up 22 basis points from the previous month, which is not too worrisome but still up.

On the causes of this deterioration, CFO Mark Ruggiero was quite clear:

The biggest drivers are the two new to non-performers as well. So those were performing as of last quarter. Those are now new to delinquency. And there's essentially one other office loan that is now early stage delinquency that'll be maturing here in the first quarter in 2024. We're working with that borrower to see what the resolution may be, but basically limited to three loans, the two that are non-performing and one other office.

So, the much-discussed office loans are beginning to creak. Although this is idiosyncratic for the time being, it is good to monitor the situation going forward. As diversified as office loans may be, further deterioration in the coming quarters cannot be ruled out. After all, the Fed Funds Rate will remain high in the entire 2024, and $125 million of office loans will expire.

Finally, there is no particular news for the securities portfolio. There has not been much discussion of this since management's focus is currently directed toward increasing deposits and consequent origination of new loans.

As we can see from this image, INDB is gradually reducing the weight of the securities portfolio relative to total assets. In practice, cash flow from maturing securities is not being reinvested in new securities at current market rates. If anything, the bank prefers to make new loans with this cash flow. Unrealized losses from AFS and HTM securities amount to $278 million.

Deposits and net interest margin

As already anticipated, the focus at the moment is on deposit growth, partly because bank deposits last quarter were rather disappointing:

• Total deposits amounted to $14.86 billion; -1.30% from the previous quarter. Thus, the risky level of LTD ratio comes mainly from declining deposits rather than excessive lending. After all, demand for credit is sluggish, and to increase the ratio, the denominator can only go down.
• The cost of deposits remains quite low compared to that of competitors but continues to rise rather rapidly. Today it is at 1.31%, up 24 basis points from the previous quarter.

But how long will the decline in deposits last? According to statements by CFO Mark Ruggiero , it would appear that INDB has reached the bottom in deposits. In fact, this quarter's results could be affected by various seasonal components since account numbers remained about the same.

Yes, it's been continuing to tick down as you suggest. It does feel like things will be stabilizing here in the very near term. And really, the decline we experienced in the fourth quarter was mostly business customers drawing on what appears to still be some level of excess liquidity. And we do see typically some year-end outflows, a lot of family owned businesses, a lot of small businesses where tax planning, tax distributions, year-end bonuses create some pressure on balances, that spills over into the first quarter as well. So I think there's a little bit of that we'll continue to see. But all in all, we're growing households, we're not seeing accounts close. So we do think we're getting to a point here where the decline should bottom out.

For INDB to grow in 2024, it is crucial that it can attract new depositors without granting a rate that is too high. It is easy to get new deposits if you grant CDs at 5-6%, but of course, this then has an impact on the profitability side. Finally, to conclude on the subject of deposits, I think this bank is experiencing a decline because it is not willing to give an interest rate that is about average. Although the total accounts are more or less the same, I believe that several depositors have transferred their cash to other banks that offered better remuneration. After all, a total deposit cost of 1.31% is really low compared to most regional banks. In some cases, it even exceeds 4%.

In the case of INDB, the net interest margin has been steadily declining throughout 2023, so it is clear that management has found it difficult to operate in the current macroeconomic environment. Since rates will remain high for at least a few quarters, I would not rule out that this downward trend may continue. This personal consideration is reflected in the bank's guidance; in fact, the net interest margin is expected to reach about 3.20% in mid-2024.

Conclusion

INDB is a bank that, like many others, has raised its LTD ratio to levels close to 100%. All this limits its operations, which is why I think 2024 will be a rather complex year. The guidance refers to low-single-digit loan growth: personally, I would not rule out a stall in growth. In particular, I consider it likely if the bank fails to improve its bank deposits.

The main risk is that deposits may continue to decline, and this would increase the LTD ratio even more. By granting CDs at high rates, the LTD ratio could improve by a few percentage points, but then the NIM could deteriorate substantially. All in all, the most interesting aspect to monitor in the coming months will be how INDB's financial structure adapts to the macroeconomic environment. Potentially, the estimate of a 3.20% NIM by mid-2024 may be too positive.

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