Isabella Bank Corporation — Q2 2023 Form 10-Q Summary
Business context and reporting period
Isabella Bank Corporation is a Michigan-based financial services 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, 2023, compared primarily with the same periods in 2022 and December 31, 2022 balance-sheet data.
Key financial metrics
| Metric | Q2 2023 | Q2 2022 | Change |
|---|---|---|---|
| Net income | $4.6 million | $5.3 million | Down 12.6% |
| Diluted EPS | $0.61 | $0.69 | Down $0.08 |
| Net interest income | $14.7 million | $14.9 million | Down 1.7% |
| Net interest margin, FTE | 3.11% | 3.16% | Down 5 basis points |
| Noninterest income | $3.6 million | $3.6 million | Essentially flat |
| Noninterest expense | $12.5 million | $11.7 million | Up 7.5% |
| Provision for credit losses | $0.2 million | $0.5 million | Down $0.3 million |
| Metric | June 30, 2023 | December 31, 2022 | Change |
|---|---|---|---|
| Total assets | $2.042 billion | $2.030 billion | Up 0.6% |
| Gross loans | $1.334 billion | $1.264 billion | Up 5.6% |
| AFS securities | $530.5 million | $580.5 million | Down 8.6% |
| Total deposits | $1.715 billion | $1.744 billion | Down 1.7% |
| Borrowed funds | $121.4 million | $87.0 million | Up 39.5% |
| Shareholders’ equity | $188.4 million | $186.2 million | Up 1.2% |
For the six months ended June 30, 2023, net income was $10.0 million versus $10.0 million in 2022, while diluted EPS was $1.31 versus $1.31. Net interest income increased 5.7% to $30.0 million, but interest expense increased to $8.1 million from $2.5 million as deposit and borrowing costs rose sharply. The six-month net interest margin, FTE, improved to 3.17% from 3.01%.
Cash flow from operating activities was $14.9 million. Investing activities used $22.3 million, primarily because net loan originations and collections used $70.4 million, partly offset by security maturities, principal payments, and sales. Financing activities used $1.6 million, reflecting a $29.3 million decline in deposits, reduced repurchase-agreement funding, $55.0 million of new FHLB advances, $4.1 million of dividends, and $2.4 million of share repurchases. Cash and cash equivalents declined to $29.9 million from $38.9 million at year-end.
Liquidity sources included cash and cash equivalents plus unencumbered available-for-sale securities of $410.7 million, available credit lines of $312.2 million, and estimated unencumbered lendable Federal Reserve collateral of $360.0 million. Management reported total cash and liquidity of approximately $702.1 million.
The allowance for credit losses was $12.8 million, or 0.96% of gross loans, versus $9.85 million, or 0.78%, at December 31, 2022. Nonaccrual loans were $0.4 million, nonperforming loans were $0.5 million, and nonperforming assets were $1.0 million, or 0.05% of total assets.
At June 30, the securities portfolio had net unrealized losses of $44.2 million, equal to 7.69% of portfolio fair value. Management attributed the losses primarily to higher market interest rates, stated that it did not expect to sell the securities before recovery, and recorded no credit-loss allowance on the securities in unrealized-loss positions.
Capital remained strong. The Bank’s common equity tier 1, tier 1 risk-based, total risk-based, and tier 1 leverage ratios were 12.39%, 12.39%, 15.37%, and 8.70%, respectively, exceeding regulatory well-capitalized thresholds.
Material changes versus comparable periods
- Loan balances increased $70.2 million from year-end, led by commercial and industrial loans, advances to mortgage brokers, residential real estate, and consumer loans. Agricultural loans declined.
- Deposits declined $29.3 million from year-end, with noninterest-bearing and interest-bearing demand deposits and savings balances falling while certificates of deposit increased $61.7 million.
- Borrowed funds increased $34.4 million, primarily because of $55.0 million of short-term FHLB advances used to fund loan growth amid deposit pressure.
- Q2 net interest income declined despite higher loan yields because deposit and borrowing costs rose faster. The Q2 net interest margin declined to 3.11% from 3.16%.
- Six-month noninterest income declined $0.2 million, mainly because net originated mortgage servicing rights income fell $554,000 and net gains on mortgage-loan sales fell $271,000. Wealth management fees increased $229,000.
- Six-month noninterest expense increased $1.8 million, driven primarily by compensation and benefits, furniture and equipment, occupancy, and FDIC insurance premiums.
- The company adopted CECL, ASC 326, on January 1, 2023. The adoption increased the combined allowance for credit losses and unfunded commitments by $3.1 million and reduced retained earnings by $2.4 million after tax.
- Accumulated other comprehensive loss improved to $36.4 million from $37.2 million at year-end, but Q2 comprehensive income was a loss of $1.5 million because of after-tax unrealized securities losses of $6.1 million.
Guidance, outlook, commentary, and risks
- Management expects interest rates to remain high during 2023. Higher deposit rates are expected to continue pressuring the net interest margin, and further margin improvement may occur at a slower pace.
- Commercial loan demand is expected to continue. Residential mortgage growth is expected to continue more slowly, and mortgage-loan sale gains are not expected to exceed 2022 levels because of reduced originations and higher rates.
- Consumer loan growth is expected to continue. Agricultural growth is also expected but at a slower pace because of competitive lending conditions.
- Compensation, equipment expense, and FDIC insurance expense are expected to exceed 2022 levels for the remainder of 2023. Management expects other losses to approximate 2022 levels after recognizing a Q2 loss related to settlement of a business matter, with no further losses anticipated from that matter.
- Key risks include interest-rate and liquidity risk, deposit outflows, reliance on short-term borrowings, credit and collateral deterioration, regional economic conditions, competition, cybersecurity, regulatory changes, and volatility in the value of available-for-sale securities.
- The filing states that no material legal proceedings, material changes to previously disclosed risk factors, or reportable subsequent events occurred. Disclosure controls were deemed effective, and no material change in internal control over financial reporting was identified.
Investor verification points
- Verify the sustainability of loan growth and whether deposit outflows require continued use of higher-cost FHLB or other borrowings.
- Monitor deposit mix migration into certificates of deposit and the resulting effect on funding costs and net interest margin.
- Review the $44.2 million unrealized AFS securities loss, duration and collateralization of the portfolio, and management’s ability to avoid forced sales.
- Assess CECL assumptions, the increase in the allowance to 0.96% of loans, and whether credit quality or regional economic conditions warrant additional provisions.
- Track mortgage originations, servicing-rights valuations, wealth management growth, and other noninterest-income trends.
- Reconcile reported liquidity sources with pledged collateral, short-term FHLB maturities, available credit lines, and depositor withdrawal needs.
- Review the authorization for an additional 319,248 share repurchases and the effect of repurchases and dividends on capital and per-share results.