ISABELLA BANK CORP quarterly report, Q3 FY2019

Isabella Bank Corporation 10-Q Summary

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 nine months ended September 30, 2019, compared with the corresponding 2018 periods. Dollar amounts are in thousands except per-share data.

Financial performance and position

Metric	Q3 2019	Q3 2018	9M 2019	9M 2018
Interest income	$17,161	$16,419	$50,457	$47,253
Net interest income	$12,611	$12,188	$37,088	$35,880
Noninterest income	$3,274	$2,878	$8,764	$8,116
Noninterest expense	$10,620	$11,087	$32,158	$31,982
Net income	$4,442	$3,696	$12,126	$10,491
Diluted EPS	$0.55	$0.46	$1.50	$1.30

Net interest margin yield on a fully taxable equivalent basis was 3.13% in Q3 and 3.07% for the first nine months, compared with 2.97% for both comparable 2018 periods.
Return on average assets was 0.98% in Q3 and 0.89% year to date; return on average shareholders’ equity was 8.37% and 7.85%, respectively.
Net income increased 20.2% in Q3 and 15.6% for the first nine months. Diluted EPS increased 19.6% and 15.4%, respectively.
Gross loans were $1,191,804 at September 30, 2019, up 5.6% from December 31, 2018. Commercial loans increased 7.5%, residential real estate loans increased 6.2%, and consumer loans increased 8.4%; agricultural loans declined 6.8%.
Total deposits were $1,308,773, up 1.2% from year-end. Borrowed funds declined 18.5% to $277,386.
Total assets were $1,813,684, down 1.6% from December 31, 2018, primarily because cash and available-for-sale securities declined as management used liquidity to fund loans and reduce borrowings.
Shareholders’ equity increased 8.6% to $212,376. The equity-to-assets ratio was 11.71%.
The allowance for loan losses was $8,169, equal to 0.69% of gross loans. Net charge-offs were $61 in Q3 and $254 for the first nine months.

Cash flow, liquidity and debt

For the first nine months, operating activities provided $17,083 of cash, investing activities used $3,875, and financing activities used $52,348.
Cash and cash equivalents declined $39,140 to $34,331, largely reflecting a $62,913 reduction in borrowed funds and continued loan growth.
Primary liquidity, consisting of cash and unencumbered available-for-sale securities, totaled $267,167, or 14.73% of assets, at September 30, 2019.
The company reported $137,016 of additional borrowing capacity based on pledged collateral.
Borrowed funds consisted primarily of $245,000 of Federal Home Loan Bank advances and $32,386 of repurchase agreements. Total borrowed funds carried a weighted-average rate of 2.08%.
Off-balance-sheet credit commitments totaled $219,909, including $192,385 of unfunded lines of credit, $23,026 of commitments to grant loans and $4,498 of commercial and standby letters of credit.

Material changes versus the prior comparable period

Loan yields and loan balances drove a $4,293 increase in loan interest income for the first nine months, while higher deposit and borrowing rates increased interest expense by $1,996.
Noninterest income increased 8.0% year to date, led by higher service charges, mortgage loan-sale gains, joint venture income and gains on foreclosed assets.
Noninterest expense increased only 0.6% year to date. Higher compensation and benefits expense was largely offset by lower audit and consulting costs and lower FDIC insurance premiums, including a $440 assessment credit in Q3.
Available-for-sale securities declined $49,305 from year-end to $445,529. Unrealized gains improved substantially, producing $9,831 of net other comprehensive income for the first nine months versus a $9,774 loss in 2018.
Nonperforming assets were $7,470, or 0.41% of assets, compared with $7,728, or 0.42%, at year-end. Nonperforming loans were $7,002, or 0.59% of gross loans.
Troubled debt restructurings declined to $24,699 from $26,951 at December 31, 2018. Six TDR modifications totaling $2,043 were made during the first nine months, compared with 34 modifications totaling $7,671 in the prior-year period.
The company repurchased 92,256 shares for $2,140 during the first nine months, compared with 215,427 shares for $6,212 in 2018. Authorization remained for 75,398 additional shares at September 30.

Guidance, outlook, commentary and risks

Management expects commercial loan balances to remain broadly stable for the remainder of 2019, agricultural loans to continue their recent decline, and residential real estate and consumer loans to continue growing.
Management does not expect the investment securities portfolio to rise significantly in the near term because of the flat yield curve and limited opportunities to purchase securities at acceptable yields.
Management expects 2019 service-charge income and Corporate Settlement Solutions joint venture income to exceed 2018 levels. Compensation and benefits and community-relations expenses are expected to exceed 2018 levels, while FDIC insurance expense is not expected to exceed 2018 levels.
Management stated that credit quality remained strong and that the allowance was appropriate, but noted agricultural-sector challenges and fluctuations in nonaccrual loans.
The company’s primary market risks are interest-rate and liquidity risk. At September 30, management’s simulation indicated that a 200-basis-point decline in rates could reduce projected net interest income by 2.76% over 24 months, while a 200-basis-point increase could increase it by 8.98%; actual results may differ materially.
CECL accounting under ASU 2016-13 was delayed for this smaller reporting company to January 1, 2023. The company is developing implementation processes and does not expect to adopt early on January 1, 2020.
Forward-looking results remain exposed to interest rates, economic conditions, credit quality, collateral values, deposit flows, competition, cybersecurity, demand for financial services, tax law and accounting changes.
The company reported no material legal proceedings, no material changes to previously disclosed risk factors, effective disclosure controls, and no material changes in internal control over financial reporting.

Important facts for investors to verify

Whether loan growth, particularly commercial lending, can continue without deterioration in agricultural and other credit quality metrics.
Whether higher deposit costs and the flat yield curve pressure future net interest margin despite improved loan yields.
The impact of the planned CECL adoption, including the eventual change to the allowance for credit losses and regulatory capital.
The sustainability of nonrecurring or variable items, including the $440 FDIC assessment credit, gains on foreclosed assets and securities-sale gains.
Liquidity and funding trends as cash declined, loan-to-deposit ratio reached 91.06%, and additional borrowing capacity depended on pledged collateral.
Future share repurchases, dividend coverage and the effect of capital deployment on tangible book value and regulatory capital.