Business Context and Reporting Period
Isabella Bank Corporation is a Michigan bank holding company whose principal subsidiary, Isabella Bank, provides commercial, agricultural, residential real estate, consumer, investment, and trust services primarily in central Michigan. This unaudited Form 10-Q covers the three and six months ended June 30, 2019, compared with the corresponding 2018 periods. The filing was signed August 7, 2019.
Financial Highlights
| Metric | Q2 2019 | Q2 2018 | Six Months 2019 | Six Months 2018 |
|---|---|---|---|---|
| Interest income | $16.815 million | $15.713 million | $33.296 million | $30.834 million |
| Net interest income | $12.288 million | $11.972 million | $24.477 million | $23.692 million |
| Noninterest income | $3.011 million | $2.740 million | $5.490 million | $5.238 million |
| Noninterest expense | $10.749 million | $10.788 million | $21.538 million | $20.895 million |
| Net income | $4.188 million | $3.333 million | $7.684 million | $6.795 million |
| Diluted EPS | $0.52 | $0.41 | $0.95 | $0.84 |
- Q2 net income increased 25.7%; six-month net income increased 13.1%.
- Six-month net interest income rose 3.3%, while net interest margin on a fully taxable equivalent basis increased to 3.02% from 2.95%.
- Return on average assets was 0.93% in Q2 and 0.85% for the first six months. Return on average shareholders’ equity was 8.13% and 7.58%, respectively.
- The provision for loan losses was a benefit of $179 thousand in Q2 and $145 thousand for the six months, compared with provisions of $328 thousand and $712 thousand in the comparable 2018 periods.
Balance Sheet, Cash Flow, Debt, and Liquidity
- Total assets were $1.825 billion at June 30, 2019, down 1.0% from December 31, 2018. Gross loans increased 4.3% to $1.177 billion, led by commercial loans, while available-for-sale securities declined 4.9% to $470.4 million.
- Deposits declined 0.9% to $1.281 billion. Borrowed funds declined 5.8% to $320.5 million, consisting primarily of $295.0 million of FHLB advances and $25.5 million of repurchase agreements.
- Shareholders’ equity increased 6.4% to $208.1 million, aided by net income and an $8.452 million after-tax improvement in accumulated other comprehensive income. The AOCI balance improved from a $7.685 million loss at year-end to $767 thousand of income.
- Six-month operating cash flow was $12.112 million. Investing activities used $14.697 million, principally because of net loan growth, and financing activities used $34.924 million, primarily from reduced borrowings, lower deposits, dividends, and share repurchases. Cash and cash equivalents declined $37.509 million to $35.962 million.
- Primary liquidity, defined as cash and unencumbered available-for-sale securities, was $254.960 million, or 13.97% of assets. Available additional borrowing capacity was $153.006 million.
- The Bank remained well capitalized. June 30 ratios included a 9.03% Tier 1 leverage ratio, 12.43% common equity Tier 1 ratio, and 13.06% total risk-based capital ratio.
Material Changes Versus Prior Comparable Period
- Loan growth and improved loan yields increased six-month interest income by $2.462 million, partially offset by a $1.677 million increase in interest expense on deposits and borrowings.
- Commercial loans increased 6.4% from year-end to $702.0 million; residential real estate loans increased 2.9% and consumer loans increased 6.5%. Agricultural loans declined 5.4% to $120.4 million.
- Noninterest income increased 4.8% for the six months, supported primarily by investment and trust advisory fees and mortgage loan sale gains.
- Noninterest expense increased 3.1% for the six months, primarily from compensation and benefits, occupancy, loan underwriting, and employee incentive costs.
- Credit metrics improved from the first quarter but were weaker than a year earlier: nonperforming loans were 0.70% of gross loans versus 0.58% at June 30, 2018, while nonperforming assets were 0.48% of assets versus 0.37%. The allowance for loan losses declined to 0.68% of gross loans from 0.71%.
- Unrealized after-tax gains on available-for-sale securities drove most of the improvement in comprehensive income, which was $7.945 million in Q2 and $16.136 million for the six months, versus $1.822 million and a $993 thousand loss in the comparable periods.
Guidance, Outlook, Risks, and Unusual Items
- Management expects continued commercial, residential real estate, and consumer loan growth during the remainder of 2019, with modest change expected in agricultural loans.
- Management expects investment and trust fee income to exceed 2018 levels. Compensation and occupancy expenses are expected to exceed 2018 levels, while loan underwriting fees are not expected to exceed 2018 levels.
- The flat yield curve and rising deposit costs may pressure margins. Management stated that investment securities purchases are currently less attractive than lending or paying down higher-cost funding.
- Management identified agricultural industry conditions as a principal source of recent nonaccrual loan increases. Credit exposure also depends on regional real estate, manufacturing, retail, gaming, tourism, healthcare, higher education, and broader economic conditions.
- The company had $211.455 million of off-balance-sheet credit commitments, including $187.904 million of unfunded lines of credit, $21.821 million of commitments to grant loans, and $1.730 million of letters of credit.
- Management stated that no material losses were anticipated from these commitments and that the allowance was appropriate at June 30, 2019. The filing also states that no material legal proceedings were pending and that there were no material changes to previously disclosed risk factors.
- Adoption of the new lease standard resulted in a $72 thousand operating lease asset and liability. The pending current expected credit loss standard was expected to have a potentially significant effect on operations and disclosures, although the filing did not provide a quantified impact.
- A January 1, 2019 restructuring shifted employee compensation and benefit costs and most capital-asset-related expenses from the parent company to the Bank, with expected future operating and risk-management benefits.
Important Facts to Verify
- Whether commercial loan growth and agricultural credit quality remain consistent with management’s outlook.
- The sustainability of the 3.02% six-month net interest margin amid deposit repricing, the flat yield curve, and changing interest rates.
- Future allowance requirements and the impact of adopting CECL after December 31, 2019.
- The composition and liquidity of the $254.960 million primary liquidity position and the availability of the $153.006 million borrowing capacity.
- Whether nonperforming loans, agricultural nonaccrual loans, and TDR balances continue to increase; TDRs totaled $25.965 million at June 30, 2019.
- The effect of compensation, occupancy, and other growth-related expenses on future earnings.
- The potential impact of off-balance-sheet commitments, interest-rate sensitivity, cybersecurity, regional economic conditions, and collateral values.