ISABELLA BANK CORP quarterly report, Q1 FY2018

Isabella Bank Corporation: 2018 First-Quarter Form 10-Q Summary

Business Context and Reporting Period

Isabella Bank Corporation is a Michigan-based bank holding company whose principal subsidiary, Isabella Bank, serves customers primarily in central Michigan. This unaudited Form 10-Q covers the three months ended March 31, 2018, compared with the three months ended March 31, 2017, and balance-sheet comparisons are primarily to December 31, 2017. Dollar amounts are in thousands except per-share data.

Key Financial Metrics

Metric	Q1 2018	Q1 2017	Change
Total interest income	$15,121	$13,861	+$1,260
Net interest income	$11,720	$11,030	+$690
Provision for loan losses	$384	$27	+$357
Noninterest income	$2,487	$2,616	-$129
Noninterest expenses	$10,096	$9,951	+$145
Net income	$3,462	$3,136	+$326
Basic diluted earnings per share	$0.44 / $0.43	$0.40 / $0.39	Increased
Cash dividend per share	$0.26	$0.25	Increased

Return on average assets was 0.77%; return on average shareholders’ equity was 7.11%; and return on average tangible equity was 9.23%.
Net interest margin yield on a fully taxable equivalent basis was 2.95%, compared with 2.99% in Q1 2017 and 3.02% in Q4 2017.
Gross loans were $1.093 billion, including $643.6 million of commercial, $122.3 million of agricultural, $270.2 million of residential real estate, and $56.9 million of consumer loans.
Total assets were $1.800 billion, compared with $1.813 billion at December 31, 2017. Shareholders’ equity was $191.1 million, or 10.62% of assets.
The allowance for loan and lease losses was $8.2 million, equal to 0.75% of gross loans, compared with $7.7 million and 0.71% at year-end 2017.

Cash Flow, Funding, Debt, and Liquidity

Operating activities provided $5.8 million of cash, compared with $4.4 million in Q1 2017.
Investing activities used $9.6 million, primarily reflecting purchases of available-for-sale securities and net loan funding.
Financing activities used $10.3 million, as a $32.6 million increase in deposits was more than offset by a $41.8 million reduction in borrowed funds, $2.0 million of dividends, and share repurchases.
Cash and cash equivalents declined to $16.7 million from $30.8 million at December 31, 2017.
Total deposits increased 2.58% to $1.298 billion, while borrowed funds declined 12.11% to $303.1 million. Borrowed funds consisted primarily of $260.0 million of FHLB advances.
Primary liquidity, consisting of cash and unencumbered available-for-sale securities, was $285.7 million, or 15.87% of assets. The company reported available borrowing capacity of $153.3 million.
Off-balance-sheet credit commitments totaled $223.5 million, including $184.0 million of unfunded lines of credit, $37.8 million of commitments to grant loans, and $1.6 million of letters of credit.
The Bank exceeded applicable regulatory minimums and was considered well capitalized. Key March 31 ratios included an 8.69% Tier 1 leverage ratio, 12.34% common equity Tier 1 ratio, and 13.01% total risk-based capital ratio.

Material Changes Versus Comparable Periods

Net income increased approximately 10% year over year, primarily because of stronger interest income from loan growth and the lower federal corporate tax rate enacted by the Tax Cuts and Jobs Act.
Average loans increased to $1.077 billion from $997.4 million, and loan interest income increased $1.176 million. Loan balances increased $80.1 million over the prior 12 months.
Interest expense increased $570,000 year over year, reflecting higher costs for deposits and borrowings. The net interest margin nevertheless benefited from asset growth, although the reported yield declined modestly.
The provision for loan losses increased materially to $384,000 from $27,000 because of loan growth and an increase in nonperforming agricultural loans. Net recoveries were $116,000 in Q1 2018, compared with net recoveries of $73,000 in Q1 2017.
Nonperforming loans increased to $6.9 million, or 0.63% of gross loans, from $3.4 million, or 0.31%, at December 31, 2017. Nonperforming assets increased to $7.1 million, or 0.40% of assets.
Total past-due and nonaccrual loans increased to $14.1 million, or 1.29% of gross loans, from $9.8 million, or 0.90%, at year-end 2017. Management attributed the increase primarily to commercial and agricultural activity and stated that it was being closely monitored.
Noninterest income declined 4.9%, mainly because net mortgage servicing rights income fell to $12,000 from $201,000 and mortgage-loan sale gains declined to $81,000 from $155,000. Trust and brokerage advisory fees increased 15.2% to $658,000.
Accumulated other comprehensive loss increased to $8.7 million from $2.6 million at year-end 2017, primarily due to a $6.4 million after-tax unrealized loss on available-for-sale securities. The loss reduced comprehensive income to negative $2.8 million despite positive net income.
Borrowed funds declined and deposits increased during the quarter, allowing the company to fund balance-sheet needs with deposits rather than additional borrowings.

Guidance, Outlook, Commentary, Risks, and Unusual Items

Management expects continued loan growth in 2018, particularly in commercial lending, with additional expected growth in residential real estate and consumer loans.
Management anticipates marginal improvement in net interest yield as short-term rates rise, assets reprice faster than liabilities, and the asset mix shifts toward loans. However, persistent low rates and the substantial available-for-sale securities portfolio continue to pressure margins.
Management expects ATM and debit-card fee income, investment and trust services fees, mortgage originations, and possibly mortgage servicing income to improve during 2018, although some categories may not exceed 2017 levels.
Computer, network security, system-upgrade, and implementation costs are expected to remain above 2017 levels. Employee benefits are also expected to increase moderately.
The Tax Cuts and Jobs Act reduced the federal statutory corporate tax rate from 34% to 21%, materially reducing current-quarter tax expense to $265,000 from $532,000.
The company adopted ASU 2016-01, requiring changes in equity-security fair values to be recognized in earnings. Adoption had an insignificant operating impact. Adoption of the new revenue standard also had no significant impact.
The company is preparing for CECL credit-loss accounting, effective for the company in 2020. Management expects the standard could have a significant impact on operations and disclosures and plans to run parallel models during 2019.
Interest-rate sensitivity analysis projected that a parallel 100-basis-point rate decline would reduce 12-month net interest income by 2.11%, while increases of 100, 200, 300, and 400 basis points would increase it by 1.57%, 2.80%, 4.59%, and 5.82%, respectively. Management stated that sensitivity remained within Board-approved limits.
Principal risks include interest-rate and liquidity risk, credit quality and collateral values, local economic conditions, agricultural and commercial-loan performance, deposit flows, competition, regulatory requirements, and changes in accounting standards.
One municipal bond remained subject to a previously recognized $770,000 other-than-temporary impairment; no additional impairment was recorded in Q1 2018.
No material legal proceedings or material changes to previously disclosed risk factors were reported. Management concluded that disclosure controls were effective and that no material change occurred in internal control over financial reporting.

Important Facts for Investors to Verify

Whether the increase in nonperforming commercial and agricultural loans persists and leads to higher provisions, charge-offs, or allowance requirements.
Whether loan growth and Federal Reserve rate increases improve the net interest margin enough to offset higher deposit and borrowing costs.
The duration, credit quality, and unrealized-loss exposure of the $547.8 million available-for-sale securities portfolio.
The effect of CECL adoption in 2020 on the allowance, retained earnings, regulatory capital, and future earnings.
Whether liquidity remains adequate as cash declined to $16.7 million, despite $285.7 million of primary liquidity and $153.3 million of additional borrowing capacity.
The sustainability of the 21% tax-rate benefit and the company’s ability to maintain dividends and share repurchases while preserving capital.