Isabella Bank Corporation 10-Q Summary
Business context and reporting period
Isabella Bank Corporation, a Michigan-based bank holding company, filed its unaudited Form 10-Q for the three and nine months ended September 30, 2020. The company’s principal subsidiary is Isabella Bank, which represented approximately 90% or more of consolidated assets and operating results. Results were materially affected by the COVID-19 pandemic, the CARES Act and SBA Paycheck Protection Program (PPP), a low interest-rate environment, and related economic uncertainty.
Financial performance and condition
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Net income | $4.4 million | $4.4 million | $11.6 million | $12.1 million |
| Diluted EPS | $0.54 | $0.55 | $1.43 | $1.50 |
| Net interest income | $12.5 million | $12.6 million | $36.8 million | $37.1 million |
| Provision for loan losses | $0.5 million | $0.2 million | $1.4 million | $0.05 million |
| Noninterest income | $4.1 million | $3.3 million | $10.3 million | $8.8 million |
| Noninterest expense | $11.0 million | $10.6 million | $32.6 million | $32.2 million |
- Revenue and margins: Nine-month interest income decreased $2.7 million, primarily because of lower rates. Lower interest expense offset much of the decline, but net interest income still decreased $0.3 million. Net interest margin on a fully taxable equivalent basis declined to 2.93% from 3.07% for the nine-month period and to 2.89% from 3.13% in Q3.
- Noninterest income: Nine-month noninterest income increased $1.5 million, driven mainly by a $1.2 million increase in mortgage-loan sale gains and an $0.9 million gain from corporate-owned life insurance redemptions. Wealth-management fees decreased $0.3 million.
- Credit costs: The nine-month provision for loan losses increased to $1.4 million from $0.05 million, primarily reflecting increased economic and environmental risk associated with COVID-19. The allowance for loan losses rose to $9.5 million, or 0.73% of gross loans, from $7.9 million, or 0.67%, at December 31, 2019.
- Balance sheet: At September 30, 2020, total assets were $2.0 billion, gross loans were $1.3 billion, deposits were $1.5 billion, borrowed funds were $238.3 million, and shareholders’ equity was $222.5 million.
- Loan growth: Gross loans increased $116.7 million, or 9.8%, from year-end 2019, primarily due to PPP loans and advances to mortgage brokers. Commercial loans increased $120.2 million, while agricultural loans declined $14.7 million.
- Deposits and liquidity: Deposits increased $181.2 million, or 13.8%, largely due to PPP proceeds and government stimulus funds. Cash and cash equivalents increased to $165.7 million from $60.6 million. Management reported total cash and liquidity of approximately $494.6 million, including $150.8 million of available lines of credit.
- Debt: Borrowed funds declined $37.7 million from year-end 2019 to $238.3 million, consisting principally of $205.0 million of FHLB advances and $33.3 million of repurchase agreements.
- Cash flow: Nine-month operating cash flow was $10.9 million, investing cash flow was negative $43.4 million, and financing cash flow was $137.6 million. Cash and cash equivalents increased $105.2 million during the period.
- Asset quality: Nonperforming loans were $4.9 million, or 0.38% of gross loans, and nonperforming assets were $5.8 million, or 0.30% of total assets. Active COVID-related payment deferrals totaled $98.7 million, or 7.6% of gross loans, down from $306.1 million, or 23.8%, at June 30, 2020.
- Capital: The bank remained well capitalized. At September 30, 2020, common equity tier 1 and tier 1 risk-based capital ratios were each 12.90%, total risk-based capital was 13.64%, and the tier 1 leverage ratio was 8.76%.
Material changes versus comparable periods
- Net income declined 4.3% for the first nine months and 1.9% for the quarter; diluted EPS declined from $1.50 to $1.43 for nine months and from $0.55 to $0.54 for the quarter.
- The lower-rate environment reduced asset yields and compressed net interest margin, although funding costs also fell because of lower rates and reduced higher-cost borrowings.
- COVID-19 drove a substantial increase in the loan-loss provision and allowance, despite reported improvements in past-due and nonaccrual loans.
- Loans, deposits, cash and equity increased significantly from year-end 2019, while the securities portfolio declined $66.8 million and borrowings declined $37.7 million.
- Quarterly noninterest income benefited from a 420.6% increase in mortgage-loan sale gains. Nine-month results also included $873,000 of insurance-redemption gains, which did not recur in 2019.
- FDIC insurance expense was higher than in 2019 because the prior-year period included a $440,000 FDIC assessment credit.
Outlook, commentary and risks
- Management expects the low-rate environment and flat yield curve to continue pressuring net interest margin; improvement may be gradual or may not occur during the remainder of 2020.
- Commercial loan balances could decline as short-term PPP loans are forgiven or repaid. Management expects continued consumer-loan growth and does not expect further significant residential real-estate loan declines during the remainder of 2020.
- Mortgage-loan sale gains were expected to exceed 2019 levels, while wealth-management fees might not exceed 2019 levels because of stock-market uncertainty.
- COVID-19 assistance programs and PPP loans may mask or delay deterioration in credit quality. Future credit losses remain dependent on the duration and severity of the pandemic, unemployment, business closures, collateral values and borrower performance.
- Other principal risks include interest-rate and liquidity risk, deposit flows, economic conditions in Michigan, cybersecurity, competition, vendor risk, litigation and changes in accounting or regulatory requirements.
- The company adopted a Restricted Stock Plan in June 2020. No compensation expense had been recognized because achievement of the specified performance targets was not considered probable as of September 30, 2020.
- The filing reports no material legal proceedings, no material control deficiencies and no subsequent events requiring recognition or disclosure through the financial-statement issuance date.
Important facts for investors to verify
- Whether PPP loan forgiveness, repayment timing and related fee recognition affect future commercial-loan balances, interest income and liquidity.
- Whether COVID-19 payment deferrals and government support programs continue to suppress reported delinquencies and nonperforming loans.
- Whether the $9.5 million allowance for loan losses adequately covers future losses under changing economic conditions.
- Whether net interest margin stabilizes or continues to decline as loans and investments reprice in the low-rate environment.
- The sustainability of elevated mortgage-loan sale gains and the nonrecurring $873,000 insurance-redemption gain.
- Future trends in wealth-management assets and fee income, given market volatility and the 2020 rebranding and restructuring of Isabella Wealth.
- Progress toward adoption of CECL, which is delayed for this smaller reporting company until January 1, 2023 and may significantly affect earnings, capital and disclosures.