ISABELLA BANK CORP annual report, FY2018

Isabella Bank Corporation — Form 10-K Summary

Business context and reporting period

Isabella Bank Corporation is a Michigan financial services holding company whose primary subsidiary, Isabella Bank, operates 30 banking offices across seven mid-Michigan counties. The company provides commercial, agricultural, residential real estate and consumer lending, deposit services, investment management and trust services. The filing covers the fiscal year ended December 31, 2018; fourth-quarter figures are included as unaudited supplemental information. Retail banking represented approximately 90% or more of consolidated assets and operating results, and the company reported one operating segment.

Key financial metrics

Metric	2018	2017	Change
Net income	$14.0 million	$13.2 million	+5.9%
Basic/diluted EPS	$1.78/$1.74	$1.69/$1.65	Improved
Net interest income	$48.2 million	$45.9 million	+5.0%
Provision for loan losses	$1.0 million	$0.3 million	+ $0.7 million
Noninterest income	$10.9 million	$10.8 million	+1.2%
Noninterest expense	$42.8 million	$40.2 million	+6.4%
Net interest margin, FTE	2.97%	3.03%	Down 6 bps
Return on average assets/equity	0.77%/7.26%	0.75%/6.75%	Improved

• Total assets increased 1.3% to $1.84 billion. Gross loans rose 3.4% to $1.13 billion, led by commercial and consumer lending; agricultural loans declined slightly.
• Deposits increased 2.2% to $1.29 billion. Borrowed funds declined 1.3% to $340.3 million, including $300.0 million of FHLB advances.
• Shareholders’ equity was $195.5 million, or 10.64% of assets. Consolidated Tier 1 leverage was 8.72%, common equity Tier 1 was 12.58%, and total risk-based capital was 13.26%. The Bank was categorized as well capitalized.
• Net cash provided by operating, investing and financing activities was $22.0 million, $6.5 million and $14.1 million, respectively. Cash and cash equivalents increased to $73.5 million from $30.8 million.
• Primary liquidity, consisting of cash and unencumbered available-for-sale securities, was $256.6 million, or 13.97% of assets. Additional borrowing capacity was $150.2 million.
• Cash dividends increased to $1.04 per share from $1.02. The company repurchased 248,017 shares for $7.0 million and had authorization to repurchase 167,654 additional shares at year-end.

Material changes versus the prior comparable period

• Net income increased primarily because of higher loan balances and the 21% federal corporate tax rate enacted by the Tax Cuts and Jobs Act.
• Interest income increased $5.5 million, principally from loan growth and higher loan yields. Interest expense increased $3.1 million because of higher deposit and borrowing costs, limiting margin expansion.
• The provision for loan losses increased to $978,000 from $253,000, reflecting loan growth, higher charge-offs and increased criticized assets, particularly in the agricultural portfolio.
• Noninterest expense increased $2.6 million due to compensation, loan-related costs, technology upgrades and network-security spending. The 2017 comparison benefited from an insurance settlement.
• Available-for-sale securities declined 9.8% to $494.8 million as maturities and principal payments helped fund loan growth and reduce higher-cost borrowings. Unrealized losses increased, producing a $5.8 million after-tax reduction in accumulated other comprehensive income.
• Asset quality weakened modestly: nonperforming loans increased to $7.4 million, or 0.65% of gross loans, from $3.4 million, or 0.31%. Total past-due and nonaccrual loans rose to $11.4 million, or 1.01% of gross loans.

Guidance, outlook, commentary, risks and unusual items

• Management expected loan growth in 2019, with commercial growth consistent with 2018, modest agricultural change, and increases in residential real estate and consumer loans. Management also expected investment and trust advisory fees and Corporate Settlement Solutions income to increase.
• Management expected 2019 compensation expense to exceed 2018 because of merit increases, technology-related expenses to approximate 2018 levels, and loan underwriting expenses not to exceed 2018 levels.
• Management anticipated possible incremental improvement in net interest yield over the next several years from a greater loan mix, strategic loan growth and market-driven loan pricing. However, the flat yield curve and rising deposit costs were pressuring margins.
• Interest-rate sensitivity modeling indicated that a 100-basis-point immediate increase could increase net interest income by 1.06% over 12 months and 1.83% over 24 months; a 100-basis-point decline could reduce it by 2.85% and 4.04%, respectively. Results were within Board-approved limits.
• The allowance for loan losses was $8.4 million, or 0.74% of gross loans. Management stated that credit quality remained strong, but noted deterioration in certain indicators and agricultural criticized assets. The higher 2018 charge-off level was described as largely related to one borrower.
• The company reported no material legal proceedings, no regulatory actions as of March 12, 2019, effective disclosure controls and internal control over financial reporting, and unqualified audit opinions.
• Key risks include concentration in mid-Michigan markets, agricultural and commercial credit exposure, interest-rate and liquidity risk, deposit competition, cybersecurity and infrastructure disruption, regulatory changes, goodwill impairment, mortgage-loan repurchase exposure and estimation risk in the allowance and fair-value measurements.
• The company expects adoption of the current expected credit loss standard, CECL, to potentially have a significant effect on operations and disclosures. It planned parallel processes during 2019; the filing does not provide a quantified expected impact.
• Unusual items included a $5.8 million after-tax unrealized AFS securities loss in other comprehensive income, no 2018 AFS securities sales gains compared with $142,000 in 2017, and no new other-than-temporary impairment charge. A previously recorded $770,000 impairment on one municipal bond remained outstanding.

Important facts for investors to verify

• Whether the increase in nonperforming, past-due and agricultural loans persists and requires additional provisions or charge-offs.
• The effect of deposit repricing, the flat yield curve and loan pricing competition on the 2019 net interest margin.
• The implementation impact of CECL on the allowance, retained earnings, regulatory capital and reported earnings.
• The maturity and refinancing requirements of the $340.3 million borrowed-funds balance, including $100.0 million of FHLB advances due in 2019.
• Whether projected loan growth can be funded through deposits and liquidity without increasing reliance on higher-cost borrowings or brokered deposits.
• The sustainability of the 2018 tax benefit, noninterest income growth and expense trends, including technology, cybersecurity and compensation costs.
• The market value and credit performance of the $494.8 million AFS securities portfolio and the potential effect of further rate increases on accumulated other comprehensive income.