Isabella Bank Corporation — 2016 Q2 Form 10-Q Summary
Business context and reporting period
Isabella Bank Corporation is a Michigan bank holding company whose principal subsidiary, Isabella Bank, serves customers primarily in central Michigan. This unaudited Form 10-Q covers the three and six months ended June 30, 2016. The company reported 7,833,893 common shares outstanding as of August 1, 2016.
The filing states that certain 2015 comparative amounts were restated for an accounting correction. The correction reduced reported loan interest and fee income and compensation expense but did not affect 2015 net income.
Key financial metrics
| Metric | Three months ended June 30, 2016 | Three months ended June 30, 2015 | Six months ended June 30, 2016 | Six months ended June 30, 2015 |
|---|---|---|---|---|
| Net interest income | $10.540 million | $10.241 million | $21.007 million | $20.506 million |
| Net income | $3.407 million | $4.098 million | $6.424 million | $7.771 million |
| Basic EPS | $0.44 | $0.53 | $0.82 | $1.00 |
| Diluted EPS | $0.43 | $0.52 | $0.80 | $0.98 |
| Cash dividend per share | $0.24 | $0.23 | $0.48 | $0.46 |
| Noninterest income | $2.752 million | $2.629 million | $4.975 million | $4.757 million |
| Noninterest expense | $9.218 million | $8.330 million | $18.298 million | $17.005 million |
| Provision for loan losses | $12 thousand | $(535) thousand | $168 thousand | $(1.261) million |
Net income declined 16.9% year over year in the second quarter and 17.3% for the first six months. Net interest income increased 2.9% for the quarter and 2.4% year to date, but the benefit was more than offset by higher operating expenses and the absence of the prior-year loan-loss provision reversals.
- Net interest margin yield on a fully taxable equivalent basis was 2.97% for both the second quarter and first six months, compared with 3.11% and 3.15%, respectively, in the comparable 2015 periods.
- Return on average assets was 0.81% for the quarter and 0.77% year to date; return on average shareholders’ equity was 7.05% and 6.71%, respectively.
- Total assets were $1.680 billion, up 0.73% from December 31, 2015. Gross loans were $919.594 million, up 8.12%, led by an 11.60% increase in commercial loans.
- Available-for-sale securities declined 8.74% from year-end to $602.463 million. Unrealized gains increased accumulated other comprehensive income to $7.567 million from $221 thousand at December 31, 2015.
- Deposits were $1.157 billion, down 0.66% from year-end. Borrowed funds increased 2.86% to $318.596 million.
- Shareholders’ equity increased 6.07% to $195.133 million. The equity-to-assets ratio was 11.61%.
- Loan quality remained strong overall: nonperforming loans were 0.13% of gross loans and nonperforming assets were 0.09% of total assets. The allowance for loan losses was $7.600 million, or 0.83% of gross loans.
Cash flow, debt and liquidity
| Six months ended June 30 | 2016 | 2015 |
|---|---|---|
| Cash provided by operating activities | $8.833 million | $7.544 million |
| Cash used in investing activities | $(1.658) million | $(28.110) million |
| Cash provided by financing activities | $(1.710) million | $30.641 million |
| Increase in cash and cash equivalents | $5.465 million | $10.075 million |
| Cash and cash equivalents at June 30 | $27.034 million | $29.981 million |
Loan growth used $69.186 million of cash through net loan originations and collections. Financing cash flow reflected a $7.693 million decline in deposits, $8.864 million of additional borrowings, $3.744 million of dividends, $1.462 million of share repurchases, and $2.489 million of common stock issuance.
Borrowed funds consisted primarily of $265.0 million of Federal Home Loan Bank advances and $53.596 million of repurchase agreements. The weighted average borrowing rate was 1.58%. Primary liquidity sources, consisting of cash and available-for-sale securities, totaled $629.497 million, or 37.46% of assets. The company reported additional borrowing capacity of $106.677 million based on pledged collateral.
Material changes versus prior comparable periods
- Loan growth increased interest income, but lower asset yields reduced the net interest margin from 3.15% to 2.97% year to date.
- Noninterest income increased 4.6% year to date, including a $245 thousand gain on sales of available-for-sale securities. Service charges declined 7.0%, and mortgage-loan sale gains declined 33.7%.
- Noninterest expense increased 7.6% year to date, driven by higher compensation and benefits, equipment costs, occupancy, consulting fees and other operating expenses. Management attributed part of the increase to two branches acquired in mid-2015 and outsourced trust and investment-service functions.
- The allowance for loan losses increased from $7.400 million at year-end 2015 to $7.600 million, while the allowance ratio declined because of loan growth.
- Total troubled debt restructurings declined to $19.430 million from $21.325 million at year-end 2015. Total impaired loans declined to $20.406 million from $22.338 million.
- The company began using a $10 million interest-rate swap during the quarter to hedge variable-rate borrowings and convert the exposure to an effectively fixed rate. The derivative had a fair value liability of $152 thousand at June 30.
- The company repurchased 51,911 shares for $1.462 million during the first six months and had authorization to repurchase an additional 106,748 shares at June 30.
Guidance, outlook, risks and unusual items
- Management expects only modest improvement in the net interest yield during the remainder of 2016 because of the persistent low-rate environment, with loan growth providing the principal support.
- Management expects continued commercial and agricultural loan growth and anticipates residential mortgage growth from new products, marketing initiatives and streamlined delivery channels.
- Management expects ATM and debit-card fees to continue increasing, NSF and overdraft fees to approximate 2015 levels, and mortgage-loan sale gains to improve as origination volumes increase.
- The company may sell additional low-yield available-for-sale mortgage-backed securities if attractive opportunities arise.
- Primary risks include interest-rate changes, economic conditions, credit quality, collateral values, deposit flows, competition, loan demand, liquidity and regulatory or accounting changes. The company identifies interest-rate and liquidity risk as its principal market risks.
- At June 30, modeled net interest income was projected to increase 1.34% over 12 months and 1.99% over 24 months under an immediate 100-basis-point rate increase; an immediate 100-basis-point decline was projected to reduce net interest income 1.77% and 1.46%, respectively.
- Off-balance-sheet credit commitments totaled $206.239 million, including $152.056 million of unfunded lines of credit, $53.187 million of loan commitments and $996 thousand of letters of credit. Management did not anticipate significant losses from these commitments.
- The company reported no material legal proceedings, no material changes to previously disclosed risk factors, and effective disclosure controls as of June 30, 2016.
- New credit-loss accounting guidance requiring an expected-loss methodology is expected to have a significant impact on the company and the banking industry, although it was not yet effective for this reporting period.
Important facts for investors to verify
- Whether continued loan growth can offset pressure from the 2.97% net interest margin and low interest-rate environment.
- Whether operating expenses, including branch-related and outsourced-service costs, normalize or continue to grow faster than revenue.
- The sustainability and credit concentration of commercial and agricultural loan growth, including the effect on the allowance for loan losses.
- Trends in nonperforming loans, troubled debt restructurings, past-due loans and collateral values.
- The effect of declining deposits and increased FHLB borrowings and repurchase funding on liquidity and funding costs.
- The impact of unrealized securities gains, future securities sales and interest-rate movements on comprehensive income and capital.
- The eventual implementation effects of the expected-credit-loss standard and the accounting correction affecting 2015 comparative disclosures.