Isabella Bank Corporation — 2020 Q2 Form 10-Q Summary
Business context and reporting period
Isabella Bank Corporation is a Michigan bank holding company whose principal subsidiary, Isabella Bank, serves customers primarily in central Michigan. This unaudited Form 10-Q covers the three and six months ended June 30, 2020, with comparisons to the corresponding 2019 periods. The filing reflects substantial operating and economic uncertainty from COVID-19, including the effects of business closures, government stimulus, the SBA Paycheck Protection Program (PPP), payment deferrals and lower interest rates.
Financial performance and condition
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net interest income | $12.3 million | $12.3 million | $24.3 million | $24.5 million |
| Provision for loan losses | $0.1 million | $(0.2) million | $0.9 million | $(0.1) million |
| Noninterest income | $3.2 million | $3.0 million | $6.2 million | $5.5 million |
| Noninterest expense | $10.7 million | $10.7 million | $21.6 million | $21.5 million |
| Net income | $4.2 million | $4.2 million | $7.3 million | $7.7 million |
| Diluted EPS | $0.52 | $0.52 | $0.90 | $0.95 |
- Margins and returns: Net yield on interest-earning assets was 2.92% in Q2 and 2.95% for the first six months, versus 3.06% and 3.04%, respectively, in the prior-year periods. Q2 return on average assets was 0.89%, and return on average shareholders’ equity was 7.63%; six-month figures were 0.78% and 6.67%.
- Balance sheet: Total assets were $1.913 billion at June 30, up 5.5% from December 31, 2019. Gross loans were $1.284 billion, up 8.2%, principally due to $99.5 million of PPP loans. Deposits were $1.441 billion, up 9.7%, while borrowed funds declined 14.4% to $236.3 million.
- Liquidity: Cash and cash equivalents were $109.4 million. Primary liquidity, consisting of cash and unencumbered available-for-sale securities, was $346.5 million, or 18.1% of assets. Total cash and liquidity, including available credit lines and estimated collateral capacity, was reported at $449.9 million.
- Debt and funding: Borrowed funds consisted primarily of $205.0 million of Federal Home Loan Bank advances and $31.3 million of repurchase agreements. The weighted-average rate on borrowed funds was 1.96% at June 30, 2020.
- Credit quality: The allowance for loan losses was $8.9 million, or 0.69% of gross loans, compared with 0.67% at year-end 2019. Nonperforming loans were $5.4 million, or 0.42% of gross loans, and nonperforming assets were $6.4 million, or 0.33% of total assets.
- Capital: The Bank remained well capitalized, with a 12.90% common equity tier 1 ratio, 12.90% tier 1 risk-based capital ratio, 13.60% total risk-based capital ratio and 8.86% tier 1 leverage ratio.
- Cash flow: Six-month operating cash flow was $6.6 million, investing cash flow was $(40.8) million and financing cash flow was $83.0 million, resulting in a $48.8 million increase in cash and cash equivalents.
Material changes versus prior comparable periods
- Six-month net income declined $0.4 million, or approximately 5.6%, primarily because the provision for loan losses increased by $1.0 million and net interest income declined by $0.2 million.
- Interest income declined $1.2 million for the first six months as a result of the lower-rate environment, partly offset by a $1.1 million reduction in interest expense.
- Noninterest income increased $0.8 million, primarily due to $0.9 million of gains from the redemption of corporate-owned life insurance policies and higher mortgage loan sale gains. These gains were partly offset by lower service charges and wealth management fees.
- The securities portfolio declined $49.4 million from year-end, primarily from maturities and sales. Unrealized after-tax gains increased accumulated other comprehensive income to $8.4 million from $2.0 million.
- Commercial loans increased $98.7 million from year-end, while agricultural loans declined $13.8 million. Management expects PPP-related commercial loan balances to decline as the loans are short term.
- Nonperforming loans and total past-due and nonaccrual loans improved from March 31, 2020, although management cautioned that COVID-19 payment deferrals and PPP lending may delay recognition of credit deterioration.
Guidance, outlook, commentary, risks and unusual items
- Management expects continued pressure on net interest yields from the flat yield curve and low interest rates; improvement may be gradual and may not occur during the remainder of 2020.
- Commercial loan balances are expected to decline as short-term PPP loans mature or are forgiven. Residential real estate and consumer loan growth is expected to continue.
- Deposit growth may continue because of government support programs and market instability. The company expects available-for-sale securities balances to remain subdued while excess funds are used to reduce higher-cost funding.
- Management expects mortgage loan sale gains to exceed 2019 levels, but wealth management fees may not exceed 2019 levels because of market uncertainty. Service charge income may be reduced by temporarily waived customer fees.
- The company funded more than 950 PPP loans totaling $99.5 million as of June 30, 2020. Customer payment-relief programs allowed eligible borrowers to defer full or partial payments for up to 180 days.
- COVID-19 could adversely affect borrower repayment capacity, collateral values, deposit flows, interest-rate sensitivity, operating results and capital. Payment deferrals and PPP loans may mask or delay deterioration in credit metrics.
- The company adopted a Restricted Stock Plan on June 24, 2020 and made initial grants to three senior executives. No compensation expense was recognized because achievement of the performance targets was not considered probable.
- Six-month corporate-owned life insurance redemption gains of $0.9 million and mortgage servicing-right impairment expense of $0.3 million were unusual or nonrecurring contributors to results.
- The company reported no material legal proceedings, no material changes to previously disclosed risk factors other than COVID-19-related risk, and no subsequent events requiring recognition or disclosure through the financial statement issuance date.
Important facts for investors to verify
- Whether PPP loan forgiveness, repayments or maturities cause the expected decline in commercial loan balances and how this affects net interest income.
- Whether COVID-19-related deferrals expire without significant increases in nonaccrual loans, charge-offs, troubled debt restructurings or the allowance for loan losses.
- Whether the allowance of $8.9 million remains adequate under changing economic forecasts and before adoption of CECL, which the company expects to implement in 2023.
- Whether low interest rates further compress the 2.95% six-month net interest yield and reduce earnings despite lower funding costs.
- How sustainable noninterest income is after the $0.9 million life-insurance redemption gains and the elevated mortgage loan sale gains.
- The company’s continued liquidity, capital ratios and ability to fund commitments if deposits decline or borrowing needs increase.
- The effect of mortgage prepayments on mortgage servicing-right values and the reported $0.3 million six-month impairment charge.