Business Context and Reporting Period
Isabella Bank Corporation, a Michigan bank holding company, filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2017. Its principal subsidiary, Isabella Bank, generated approximately 90% or more of consolidated assets and operating results. The company serves customers primarily in central Michigan through commercial, agricultural, residential real estate, consumer lending, deposit, mortgage, investment, trust and brokerage services.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2017 | Year-over-Year Change | Six Months Ended June 30, 2017 | Year-over-Year Change |
|---|---|---|---|---|
| Interest income | $14.5 million | +$1.3 million | $28.4 million | +$2.1 million |
| Net interest income | $11.5 million | +$0.9 million | $22.5 million | +$1.5 million |
| Noninterest income | $2.8 million | +$0.04 million | $5.4 million | +$0.4 million |
| Noninterest expense | $9.5 million | +$0.3 million | $19.5 million | +$1.2 million |
| Net income | $3.8 million | +12.8% | $7.0 million | +8.7% |
| Diluted EPS | $0.48 | +$0.05 | $0.87 | +$0.07 |
| Net interest margin, FTE | 3.03% | +6 basis points | 3.01% | +4 basis points |
- Return on average assets was 0.87% for the quarter and 0.80% for the six-month period; return on average shareholders’ equity was 7.85% and 7.21%, respectively.
- Gross loans were $1.048 billion at June 30, up $37.9 million, or 3.75%, from December 31, 2016. Commercial loans increased $24.9 million, while consumer loans increased 10.24%.
- Total assets were $1.777 billion, up 2.61% from year-end 2016. AFS securities were $567.9 million.
- Deposits were $1.210 billion, up $15.1 million, and borrowed funds were $360.9 million, up $23.2 million, from December 31, 2016.
- Shareholders’ equity was $195.1 million, compared with $187.9 million at year-end 2016. The company paid $0.50 per share in dividends during the first six months and repurchased 94,032 shares for $2.6 million.
- The allowance for loan and lease losses was $7.6 million, or 0.72% of gross loans. Net loan recoveries were $164,000 for the first six months, compared with net recoveries of $32,000 in the prior-year period.
Cash Flow, Debt and Liquidity
- Six-month operating cash flow was $8.7 million, compared with $8.8 million in 2016.
- Investing activities used $45.1 million, primarily because loan growth and purchases of AFS securities exceeded securities maturities, sales and other inflows.
- Financing activities provided $35.4 million, driven by a $15.1 million increase in deposits and a $23.2 million increase in borrowings.
- Cash and cash equivalents declined $1.1 million to $21.8 million at June 30, 2017.
- Primary liquidity, consisting of cash and unencumbered AFS securities, was $276.5 million, or 15.56% of assets, versus $307.1 million, or 17.73%, at year-end 2016. Available borrowing capacity was $119.5 million.
- Borrowed funds had a weighted-average rate of 1.57% and consisted principally of $310.0 million of FHLB advances, $50.0 million of repurchase agreements and $1.0 million of federal funds purchased.
- Regulatory capital remained above stated minimums: common equity Tier 1 capital was 12.43%, Tier 1 capital was 12.43%, total risk-based capital was 13.07%, and the Tier 1 leverage ratio was 8.50%.
Material Changes Versus Prior Comparable Period
- Net income increased primarily because interest income rose $2.1 million for the six months, reflecting strong loan growth. Average loan balances increased to $1.013 billion from $875.5 million.
- Net interest income increased despite a low-rate environment; the FTE net interest margin improved to 3.01% from 2.97% for the six-month comparison.
- Six-month noninterest income increased 8.62%. Service charges and fees rose 23.53%, mortgage loan sale gains rose 69.38%, and mortgage servicing income improved from a $329,000 loss to $184,000 of income.
- Noninterest expense increased 6.34%, led by higher employee salaries, new growth-oriented positions, higher audit and loan underwriting costs, and an early ATM/debit-card contract termination fee.
- Credit quality weakened from year-end but remained low by management’s historical standards. Nonperforming loans increased to $2.8 million from $1.7 million, and nonperforming assets increased to $3.0 million from $1.9 million. Total past-due and nonaccrual loans were $7.3 million, or 0.70% of gross loans.
- Total troubled debt restructurings increased to $26.3 million from $21.4 million. No loans modified within the preceding 12 months subsequently defaulted during the reported periods.
- Accumulated other comprehensive income improved to $86,000 from a $2.8 million loss at year-end, primarily due to higher unrealized gains on AFS securities.
Guidance, Outlook, Risks and Unusual Items
- Management expects continued loan growth in 2017, particularly in commercial, agricultural, residential real estate and consumer portfolios, while acknowledging strong competition.
- Management does not anticipate significant Federal Reserve short-term rate increases during the remainder of 2017 and expects only marginal near-term improvement in net interest margin.
- Management expects mortgage loan sale gains, mortgage servicing income, and trust and brokerage advisory fees to remain positive or increase during the remainder of 2017. Corporate Settlement Solutions income was temporarily lower because the sales cycle for several substantial customers took longer than expected.
- Employee salaries are expected to remain above 2016 levels, marketing expenses may increase modestly, and FDIC insurance expense is expected to remain lower because of changes in the premium calculation.
- The company identified no additional OTTI on AFS securities during the period. A $770,000 OTTI charge had been recognized on one municipal bond in 2016.
- Foreclosed assets were $229,000 at June 30, including a $28,000 impairment recognized during the first six months.
- Primary risks include interest-rate and liquidity risk, loan and collateral performance, regional economic conditions, deposit flows, competition, demand for financial services, and changes in accounting or regulatory requirements. Interest-rate sensitivity remained within board-approved limits.
- The company reported no material legal proceedings, no material changes to previously disclosed risk factors, and effective disclosure controls as of June 30, 2017.
Facts Investors Should Verify
- Whether loan growth can continue without further deterioration in nonperforming loans, impaired loans and TDR balances.
- Whether the $7.6 million allowance remains adequate as credit quality and regional economic conditions change.
- The sustainability of the 3.01% FTE net interest margin amid low rates, higher funding costs and the company’s large AFS securities portfolio.
- Liquidity trends, including the decline in unencumbered liquidity and greater reliance on FHLB advances, brokered deposits and other borrowings.
- Whether management’s expected increases in mortgage, trust and brokerage income materialize and offset higher personnel and operating expenses.
- The effect of future interest-rate movements on net interest income, AFS unrealized gains and losses, deposit pricing and borrowing costs.
- Remaining authorization to repurchase up to 105,875 shares as of June 30, 2017, and the effect of repurchases and dividends on capital.