Business Context and Reporting Period
Isabella Bank Corporation, a Michigan bank holding company, filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2017. Its banking subsidiary represented approximately 90% or more of consolidated assets and operating results. The company serves customers primarily in central Michigan through commercial, agricultural, residential real estate, consumer, investment and trust services.
Financial Performance and Key Metrics
Dollar amounts are in thousands except per-share data.
| Metric | Three Months Ended September 30, 2017 | Change vs. 2016 | Nine Months Ended September 30, 2017 | Change vs. 2016 |
|---|---|---|---|---|
| Total interest income | $14,976 | +$1,369 | $43,335 | +$3,429 |
| Net interest income | $11,776 | +$916 | $34,276 | +$2,409 |
| Noninterest income | $2,698 | -$248 | $8,102 | +$181 |
| Noninterest expenses | $10,139 | +$706 | $29,597 | +$1,866 |
| Net income | $3,536 | -$57 | $10,516 | +$499 |
| Diluted EPS | $0.44 | -$0.01 | $1.31 | +$0.06 |
- Net interest margin on a fully taxable-equivalent basis was 3.08% for the quarter and 3.03% year to date, compared with 3.05% and 3.00%, respectively, in the prior-year periods.
- Return on average assets was 0.79% for the quarter and year to date; return on average shareholders’ equity was 7.11% for the quarter and 7.18% year to date.
- Total assets were $1.792 billion, up 3.45% from December 31, 2016. Gross loans increased 6.62% to $1.078 billion, led by commercial loans up 7.73% and consumer loans up 24.81%.
- Deposits rose 1.76% to $1.216 billion, while borrowed funds increased 8.69% to $367.0 million. The gross-loans-to-deposits ratio was 88.61%.
- Shareholders’ equity increased 4.56% to $196.5 million. The company paid $0.76 per share in dividends during the first nine months and repurchased 143,117 shares for $4.0 million.
- The allowance for loan and lease losses was $7.7 million, or 0.71% of gross loans. Nine-month net recoveries were $215 thousand, and the provision for loan losses was $85 thousand.
- Nonperforming loans were $2.3 million, or 0.21% of total loans; nonperforming assets were $2.5 million, or 0.14% of total assets. Troubled debt restructurings totaled $27.3 million.
- Nine-month operating cash flow was $13.7 million. Investing activities used $60.6 million, primarily reflecting net loan growth and securities purchases, while financing activities provided $45.1 million. Cash and cash equivalents ended at $21.1 million.
- Primary liquidity, consisting of cash and unencumbered available-for-sale securities, totaled $269.7 million, or 15.05% of assets, down from $307.1 million, or 17.73%, at year-end 2016. Available borrowing capacity was $114.8 million.
- Borrowed funds consisted primarily of $310.0 million of FHLB advances, $55.0 million of repurchase agreements and $2.1 million of federal funds purchased. The weighted-average borrowing rate was 1.57%.
- Regulatory capital remained above stated minimums: common equity Tier 1 and Tier 1 risk-based capital were each 12.20%, total risk-based capital was 12.84%, and the Tier 1 leverage ratio was 8.50%.
Material Changes Versus Comparable Period
- Nine-month net income increased 5.0%, primarily because loan growth increased interest income by $3.8 million, partially offset by higher interest expense and operating expenses.
- Third-quarter net income declined modestly despite higher net interest income because noninterest income fell 8.4% and noninterest expense increased 7.5%.
- Nine-month noninterest income increased 2.3%. Service charges and fees rose 19.7%, while trust and brokerage advisory fees, Corporate Settlement Solutions income and securities gains declined.
- Nine-month noninterest expense increased 6.7%, including a 10.1% increase in compensation and benefits. The company cited new positions, merit increases and incentive compensation as drivers of higher salaries.
- Credit metrics remained low but deteriorated from year-end in certain areas: nonperforming loans increased from $1.7 million to $2.3 million, nonperforming assets increased from $1.9 million to $2.5 million, and TDRs increased from $21.4 million to $27.3 million.
- Accumulated other comprehensive income improved from a $2.8 million loss at December 31, 2016 to a $51 thousand gain, primarily due to unrealized gains on available-for-sale securities.
Guidance, Outlook, Risks and Unusual Items
- Management expected continued loan growth through the remainder of 2017, particularly in commercial, residential real estate and consumer lending, while acknowledging strong competition for commercial loans.
- Management did not anticipate significant near-term Federal Reserve rate increases and expected only marginal improvement in net interest yield. Interest-rate sensitivity analysis indicated that a 100-basis-point immediate increase could raise projected net interest income by 1.90% over 12 months and 2.37% over 24 months; a 100-basis-point decrease could reduce it by 1.48% and 1.57%, respectively.
- Management expected mortgage loan sale gains and net originated mortgage servicing rights income to improve during the remainder of 2017, while trust and brokerage fee income was expected to remain below 2016 levels for the year.
- Management expected salaries, consulting fees and loan underwriting fees to remain above 2016 levels, while FDIC insurance premiums were expected to remain lower.
- The filing identifies interest rates, economic conditions, monetary and fiscal policy, loan and investment portfolio quality, collateral values, deposit flows, competition, loan demand and accounting changes as principal risks.
- The company reported no material legal proceedings, no material changes to previously disclosed risk factors, and effective disclosure controls as of September 30, 2017.
- Unusual or notable items included a $2 thousand foreclosed-asset impairment during the first nine months, a prior-year $770 thousand other-than-temporary impairment on a municipal bond with no additional impairment recognized in 2017, and a 2017 ATM/debit-card contract termination fee included in expenses.
- The company expected no significant impact from pending revenue recognition, lease, stock compensation or hedge accounting standards, although implementation reviews were ongoing.
Important Facts for Investors to Verify
- Whether rapid loan growth, particularly in commercial and consumer lending, is sustained without a meaningful increase in charge-offs, nonaccrual loans or TDRs.
- Whether the $7.7 million allowance remains adequate as impaired loans and TDRs increase.
- Funding and liquidity trends, including reliance on FHLB advances, brokered deposits and repurchase agreements as the loans-to-deposits ratio rises.
- The effect of future interest-rate changes on net interest margin, deposit costs, securities values and borrowing costs.
- Whether management’s expected improvement in mortgage-related income and continued loan growth offsets higher compensation, compliance and other operating expenses.
- The composition and duration of the $552.9 million available-for-sale securities portfolio, including unrealized gains and losses and potential interest-rate or credit exposure.