Isabella Bank Corporation — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2016. Financial amounts are in thousands, except per-share data. The interim financial statements are unaudited. Isabella Bank Corporation is a Michigan bank holding company whose subsidiary bank generated approximately 90% or more of consolidated assets and operating results.
Financial condition and performance
- Third-quarter net income: $3,593, down 11.6% from $4,063 in the comparable 2015 quarter. Basic and diluted EPS were $0.46 and $0.45, compared with $0.52 and $0.51.
- Nine-month net income: $10,017, down 15.4% from $11,834. Basic and diluted EPS were $1.28 and $1.25, compared with $1.52 and $1.49.
- Net interest income: Third-quarter net interest income increased to $10,860 from $10,387; nine-month net interest income increased to $31,867 from $30,893. The nine-month net yield on interest-earning assets declined to 3.00% from 3.12%.
- Noninterest income: Third-quarter income was $2,946, down from $3,101. Nine-month income was $7,921, slightly above $7,858, supported by higher trust and brokerage advisory fees and a $245 gain on AFS securities sales.
- Noninterest expense: Third-quarter expense increased 3.0% to $9,433; nine-month expense increased 6.0% to $27,731, primarily reflecting higher employee benefits, consulting, equipment, occupancy, audit, and loan-underwriting costs.
- Provision and credit costs: The third-quarter provision was $17 versus a $738 reversal in 2015. The nine-month provision was $185 versus a $1,999 reversal in 2015. Net recoveries were $183 in the third quarter and $215 for nine months, while the allowance for loan losses was $7,800, or 0.79% of gross loans.
- Balance sheet: Total assets rose 2.3% from December 31, 2015, to $1,706,498. Gross loans increased 16.3% to $989,366, led by 23.7% commercial-loan growth. Deposits increased 1.0% to $1,175,833, while borrowed funds increased 5.1% to $325,409. Shareholders’ equity increased 6.1% to $195,184.
- Investment portfolio: AFS securities declined 14.5% to $564,229 as securities were sold or allowed to mature to fund loan growth. The portfolio had $14,336 of net unrealized gains at September 30, 2016.
- Liquidity and cash flow: Cash and cash equivalents were $21,335. Primary liquidity, consisting of cash and AFS securities, was $585,564, or 34.31% of assets, down from $681,705, or 40.87%, at year-end 2015. Nine-month operating cash flow was $15,565; investing cash flow was negative $37,704, primarily from net loan growth; financing cash flow was $21,905.
- Debt and funding: Borrowed funds totaled $325,409, consisting mainly of $250,000 of FHLB advances, $54,809 of repurchase agreements, and $20,600 of federal funds purchased. The company had $15,173 of additional borrowing capacity based on pledged collateral.
- Capital: The Tier 1 leverage ratio was 8.59%, common equity Tier 1 and Tier 1 risk-based capital ratios were each 12.41%, and total risk-based capital was 13.10%. The company paid $0.25 per share in the third quarter and $0.73 per share during the first nine months.
Material changes versus comparable periods
- Loan growth materially increased interest income, but the absence of the prior-year $1,999 loan-loss provision reversal reduced earnings substantially.
- Commercial loans increased by $106,466 from year-end 2015. During the third quarter, the company began participating in short-term advances to mortgage brokers, contributing $27,832 of commercial loans.
- Net interest margin yield decreased year over year to 3.05% in the third quarter from 3.09%, and to 3.00% for nine months from 3.12%, reflecting the low-rate environment and lower asset yields.
- Trust and brokerage advisory fees increased 85.9% in the third quarter and 30.2% for nine months, while service charges and fees declined 13.1% and 9.2%, respectively.
- Nonperforming loans increased to $1,537, or 0.16% of total loans, from $792, or 0.09%, at December 31, 2015. Nonperforming assets were $1,821, or 0.11% of assets, versus $1,213, or 0.07%.
- The filing restated certain 2015 amounts due to an accounting correction. Loan interest and fee income and compensation expense were each reduced by $871 for the third quarter and $2,564 for the nine months of 2015; reported 2015 net income was not affected.
- The company repurchased 98,083 shares for $2,749 during the first nine months and had authorization to repurchase an additional 60,575 shares at September 30, 2016.
Outlook, commentary, risks, and unusual items
- Management expects continued loan growth, particularly in commercial, agricultural, residential mortgage, and consumer portfolios, supported by new products, marketing, and delivery-channel initiatives.
- Management did not expect a significant Federal Reserve short-term rate increase during the remainder of 2016 and therefore did not expect a near-term material improvement in net interest yield. The company expected only marginal improvement from loan growth.
- Management expected trust and brokerage fees to continue increasing, although not at the third-quarter rate. Mortgage servicing income was expected to improve as mortgage origination volume increased, but remained sensitive to mortgage rates and prepayment speeds.
- Primary risks include interest-rate risk, liquidity risk, credit quality, collateral values, deposit flows, competition, regional economic conditions, loan demand, and regulatory or accounting changes. Lending is concentrated primarily in Michigan markets, including commercial, agricultural, real estate, manufacturing, retail, gaming, tourism, and higher education exposures.
- Off-balance-sheet credit commitments totaled $212,094, including $166,007 of unfunded lines of credit, $44,981 of commitments to grant loans, and $1,106 of commercial and standby letters of credit. Management expected no significant losses from these commitments.
- The company began using a $10,000 interest-rate swap during 2016 as a cash-flow hedge for variable-rate borrowings. The swap had a fair value liability of $61 at September 30.
- The filing states that the allowance for loan losses was appropriate, no material legal proceedings were pending, and no material changes occurred in disclosed risk factors or internal control over financial reporting.
Important facts for investors to verify
- Whether rapid loan growth, particularly commercial lending and mortgage-broker advances, produces a commensurate increase in credit losses and allowance requirements.
- Whether the $15,173 of available borrowing capacity and reduced primary liquidity remain adequate as loan funding and deposit withdrawals fluctuate.
- Trends in nonperforming loans, past-due loans, TDRs of $20,522, and the allowance coverage ratio as the portfolio expands.
- The sustainability of the 3.00% nine-month net interest yield in a low-rate environment and under potential rate increases.
- Whether higher trust and brokerage fees offset weaker service charges, mortgage servicing results, and rising operating expenses.
- The effect of the disclosed 2015 accounting restatement and the implementation of pending accounting standards, particularly the expected-credit-loss standard, which management expected to have a significant future impact on banking-industry reporting.