Independent Banks: High LTD Ratio Limits Growth Prospects (NASDAQ:INDB)

Independent Bank (NASDAQ:INDB) is a Michigan-based bank that operates 62 branches. In a previous article, I reviewed the third quarter of 2023 as generally positive, and indeed, despite some challenges, the stock is up 30% since then. The first few weeks. But today we will analyze it. 4th quarter 2023; EPS beat estimates, but revenue did not.

• GAAP EPS for the fourth quarter was $1.26, ahead by $0.02.
• Revenue of $177.16M (-11.5% Y/Y) decreased $0.18M.

Loan and Securities Portfolio

Starting with the loan portfolio, the first thing we will see in the fourth quarter of 2023 is that growth is gradually slowing.

The total loan growth rate compared to the previous quarter was only 0.40%, suggesting that credit demand is no longer the same as before. Total commercial loans were the weakest (down 0.30%), while residential real estate was the weakest. Considering that it grew by 3.70%, it is the country that suffers the least from rising interest rates. Based on this data, businesses are trying to avoid debt, while households needing a place to live are delaying interest payments.

In particular, on the commercial side, the construction industry is clearly struggling, with a plunge of 11.90%. That is, demand for loans at short-term prices has decreased. In current fixed interest rate advertisements, banks are asking for about 7%, which is higher than previous years but lower than the previous month. In any case, this small decline does not stimulate demand.

Another factor that explains why lending is not growing is that the bank has little financial flexibility. In fact, the LTD ratio is ​​96%, and management has no intention of raising it above 100%. This therefore means that INDB has somewhat limited room to maneuver and that new loans require new deposits. In fact, one of the main goals banks will pursue in 2024 is improving bank deposits.

We’re pretty close to where we want to be. I mean, we don’t have a bright line on that, but obviously we would very, very prefer to have a loan-to-deposit ratio of less than one. That’s why we’re focused on growing deposits in 2024.

CEO Jeff Tengel

In terms of loan quality, the delinquency rate is slightly increasing. Delinquent loans/total loans increased by 22bp compared to the previous month, which is not a level to worry about, but is still showing an upward trend.

CFO Mark Ruggiero was very clear about the reasons for this deterioration.

The biggest drivers are two factors that are new to non-performers as well. So, as of last quarter, our performance was good. They are now new to flight. And we have one more office loan that is basically an early stage delinquency that will mature in the first quarter of 2024. We’re working with those borrowers to see what the solution is, but we’re basically limited to three loans. I have one office and another that are not performing well.

So the much-discussed office loan began to creak. Although this is an unusual situation for the time being, it is best to wait and see what happens in the future. The possibility of further deterioration in coming quarters cannot be ruled out as office loans diversify. Ultimately, the federal funds rate will remain high throughout 2024 and $125 million in office loans will expire.

Lastly, there is no special news regarding the securities portfolio. This has not been discussed much as management’s current focus is on increasing deposits and thus generating new loans.

As you can see in this image, INDB is gradually reducing its securities portfolio as a percentage of its total assets. In practice, cash flows from maturing securities are not reinvested in new securities at current market rates. Rather, banks prefer to use this cash flow to make new loans. Unrealized losses on AFS and HTM securities amounted to $278 million.

Deposits and Net Interest Margin

As expected, the current focus is on deposit growth. That’s partly because bank deposits were somewhat disappointing last quarter.

• Total deposits reached $14.86 billion. -1.30% compared to the previous quarter. Therefore, the risk level of the loan-to-deposit ratio is mainly due to a decrease in deposits rather than excessive lending. Ultimately, credit demand is sluggish, and to increase the ratio, the denominator has no choice but to go down.
• Our deposit costs are significantly lower than our competitors but continue to rise rapidly. Today it is at 1.31%, up 24 basis points from last quarter.

But how long will the decline in deposits last? INDB’s deposits appear to have reached bottom, according to a statement from CFO Mark Ruggiero. In fact, this quarter’s performance may be affected by a variety of seasonal factors as account numbers have remained roughly the same.

Yes, as you said, it continues to decline. I think the situation will stabilize in the near future. And in fact, the decline that we experienced in the fourth quarter was mostly from business customers who still saw some level of excess liquidity. And we typically see year-end outflows, a lot of family-owned businesses, a lot of small businesses that have some pressure on their balances due to tax planning, tax distributions, year-end bonuses, and that’s going to see outflows in the first quarter as well. So I think there’s a little bit of that that we’ll continue to see. But overall, we’re growing our households and we’re not seeing any accounts being closed. So I think we’re reaching a point here where the downtrend should bottom out.

For INDB to grow in 2024, it is important to be able to attract new depositors without imposing too high interest rates. Granting CDs at 5-6% makes it easier to get new deposits, but of course this has implications for profitability. Finally, to conclude on the deposit issue, I believe this bank is in decline because it is unwilling to offer average interest rates. Although the overall accounts are largely the same, some depositors believe they have transferred their cash to other banks that offer better rewards. In the end, the total deposit cost is 1.31%, which is really low compared to most local banks. In some cases it can exceed 4%.

In the case of INDB, it is clear that the steady decline in net interest margin throughout 2023 is making it difficult for management to operate in the current macroeconomic environment. Interest rates will remain high for at least several quarters, so a continuation of this downward trend cannot be ruled out. These individual considerations are reflected in bank guidelines. In fact, net interest margin is expected to reach around 3.20% by mid-2024.

conclusion

INDB, like many other banks, has increased its LTD ratio to levels close to 100%. All of this limits operations, so I think 2024 will be a somewhat complicated year. The guidance cites low single-digit loan growth. Personally, I do not rule out stagnant growth. I think this is likely, especially if banks fail to improve bank deposits.

The biggest risk is that deposits may continue to decline, which could push the LTD ratio even higher. Granting a CD at a higher interest rate may improve the LTD ratio by a few percentage points, but may significantly worsen the net interest margin (NIM). Overall, the most interesting aspect to monitor in the coming months will be how INDB’s financial structure adapts to the macroeconomic environment. Potentially, the NIM estimate of 3.20% by mid-2024 may be too positive.