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.