ISABELLA BANK CORP quarterly report, Q3 FY2021

Isabella Bank Corporation — Q3 2021 Form 10-Q Summary

Business context and reporting period

Isabella Bank Corporation is a Michigan-based bank holding company operating primarily through Isabella Bank in central Michigan. This unaudited Form 10-Q covers the three and nine months ended September 30, 2021, compared primarily with the same periods in 2020 and December 31, 2020 balance-sheet data.

Management continued to manage the effects of COVID-19, elevated deposits from government stimulus and PPP activity, low interest rates, and changing loan demand. The company is classified as a smaller reporting company and non-accelerated filer.

Financial performance and condition

Metric	Q3 2021	Q3 2020	9M 2021	9M 2020
Net income	$4.686 million	$4.357 million	$14.705 million	$11.608 million
Diluted EPS	$0.58	$0.54	$1.82	$1.43
Net interest income	$13.313 million	$12.497 million	$39.227 million	$36.803 million
Provision for loan losses	$(0.107) million	$0.516 million	$(0.599) million	$1.409 million
Noninterest income	$3.367 million	$4.060 million	$10.214 million	$10.304 million
Noninterest expense	$11.185 million	$10.950 million	$32.497 million	$32.595 million
Cash dividends per share	$0.27	$0.27	$0.81	$0.81

Net income increased 7.6% in the third quarter and 26.7% for the first nine months. Diluted EPS increased 7.4% and 27.3%, respectively.
Net interest income increased $2.424 million, or 6.6%, for the first nine months. Lower deposit and borrowing costs more than offset lower gross interest income.
The nine-month effective tax expense was $2.838 million versus $1.495 million in 2020, reflecting higher pretax income and the absence of certain 2020 tax benefits.
Net interest margin yield on a fully taxable equivalent basis was 2.85% in Q3 and 2.87% for the nine months, down from 2.89% and 2.93% in the comparable 2020 periods.
Return on average assets was 0.91% for Q3 and 0.97% for the first nine months; return on average equity was 8.35% and 8.82%, respectively.

Balance sheet, liquidity, debt, and capital

Total assets were $2.083 billion at September 30, 2021, up 6.4% from December 31, 2020.
Gross loans were $1.249 billion, up 0.8% from year-end. Residential real estate loans increased $14.077 million, while agricultural loans declined $6.679 million. PPP forgiveness reduced commercial loan balances.
Available-for-sale securities increased 45.7% to $494.384 million, primarily from purchases of U.S. Treasury securities.
Total deposits rose 8.0% to $1.692 billion, driven by demand and savings deposits. Certificates of deposit declined as customers shifted toward more liquid accounts.
Cash and cash equivalents were $206.482 million. Primary liquidity, consisting of cash and unencumbered AFS securities, totaled $584.135 million, or 28.05% of assets.
Available lines of credit totaled $260.815 million, and management reported total cash and liquidity of $807.297 million.
Borrowed funds totaled $156.655 million, including $60.000 million of FHLB advances, $67.519 million of repurchase agreements, and $29.136 million of subordinated debt.
On June 2, 2021, the company issued $30 million of 3.25% fixed-to-floating subordinated notes due 2031. The notes are intended to qualify as Tier 2 capital and reset after June 15, 2026, at three-month SOFR plus 256 basis points.
The Bank exceeded regulatory minimums and remained well capitalized. At September 30, common equity Tier 1, Tier 1 leverage, and total risk-based capital ratios were 13.07%, 8.37%, and 16.03%, respectively.

Credit quality and allowance

Total past-due and nonaccrual loans were $3.498 million, or 0.28% of gross loans, down from $9.610 million, or 0.78%, at December 31, 2020.
Nonperforming loans were $3.077 million, or 0.25% of gross loans; nonperforming assets were $3.655 million, or 0.18% of total assets.
The allowance for loan and lease losses was $9.093 million, or 0.73% of gross loans, compared with $9.744 million, or 0.79%, at year-end 2020.
Net charge-offs were $52 thousand for the first nine months, compared with net recoveries of $158 thousand in the 2020 period.
Management attributed the allowance reduction and provision reversal to improved credit quality and economic conditions, while acknowledging that COVID-19-related risks remain.
Troubled debt restructurings totaled $28.682 million at September 30, 2021, compared with $24.930 million at year-end 2020. No loans modified within the prior 12 months subsequently defaulted during the reported periods.

Material changes versus prior comparable periods

Interest income declined $2.698 million for the first nine months, largely because of lower interest rates and a temporary pause in advances to mortgage brokers. PPP loan fees partially offset the decline.
Interest expense declined $5.122 million, primarily because of lower deposit costs and reduced FHLB borrowings and other higher-cost funding.
The provision for loan losses changed from $1.409 million of expense in the first nine months of 2020 to a $599 thousand benefit in 2021.
Noninterest income declined modestly by $90 thousand for the first nine months. Growth in service charges and wealth management fees was offset by lower mortgage loan sale gains and lower gains from corporate-owned life insurance redemptions.
Noninterest expense declined $98 thousand for the first nine months, although third-quarter expense increased $235 thousand, including higher audit, consulting, legal, ATM, and debit-card costs.
Accumulated other comprehensive income declined to $4.387 million from $7.698 million at year-end 2020, mainly because of $3.353 million of after-tax unrealized losses on AFS securities as intermediate- and long-term interest rates increased.
Assets under management increased to $2.860 billion from $2.665 billion at September 30, 2020, supported by growth in Isabella Wealth assets.

Guidance, outlook, commentary, and risks

Management expects residential mortgage and consumer loan growth to continue during the remainder of 2021, while PPP forgiveness and competition may pressure commercial loan balances.
Management expects service charge, ATM/debit-card, and wealth management revenue to exceed 2020 levels for the remainder of 2021. Mortgage loan sale gains are not expected to exceed 2020 levels, and mortgage servicing-rights income may remain volatile.
Management expects the low-rate environment and elevated cash position to continue pressuring asset yields and stated that improvement in net interest yield may be gradual.
COVID-19 remains a material uncertainty. Active loan payment deferrals totaled $20.291 million, or 1.6% of gross loans, at September 30, 2021. Management warned that payment relief, PPP loans, and government stimulus could mask or delay deterioration in credit quality.
Principal risks include interest-rate and liquidity risk, economic conditions, deposit flows, loan and collateral quality, competition, cybersecurity, regulatory and accounting changes, and the duration and effects of the COVID-19 pandemic and its variants.
The company is preparing for CECL adoption, which is delayed for smaller reporting companies until January 1, 2023. Management stated that the new standard could materially affect operations and disclosures.
On October 13, 2021, after quarter-end, the company completed a modified Dutch auction tender offer, repurchasing approximately 396,577 shares at $27.00 per share for approximately $10.708 million. Up to $9.292 million of the originally authorized $20 million remained available for general corporate purposes, including possible additional repurchases.
No material legal proceedings were reported, no material changes were made to previously disclosed risk factors, and management concluded that disclosure controls were effective.

Most important facts for investors to verify

Whether loan growth can continue after PPP forgiveness and amid commercial lending competition.
Whether the improvement in past-due and nonperforming loans persists after COVID-19 support programs expire.
The adequacy of the $9.093 million allowance under changing economic conditions and ahead of CECL adoption.
The effect of rising or falling interest rates on the 2.87% net interest margin, AFS securities valuation, deposit costs, and subordinated debt expense.
Liquidity after the large increase in AFS securities and the extent to which pledged collateral supports available borrowing capacity.
The sustainability of earnings growth given lower mortgage sale gains, volatile mortgage servicing income, and reliance on provision reversals and PPP fee income.
The final effect of the October 2021 tender offer and any subsequent share repurchases on capital, book value, and per-share earnings.