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ISABELLA BANK CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 8, 2014

ISABELLA BANK CORPORATION FINANCIAL REVIEW (Dollars in thousands except per share amounts) This section reviews our financial condition and results of our operations for the three and six month periods ended June 30, 2014 and 2013. This analysis should be read in conjunction with our 2013 Annual Report on Form 10-K and with the unaudited interim condensed consolidated financial statements and notes, beginning on page 4 of this report. Executive Summary During the three and six month periods ended June 30, 2014, we reported record net income of $3,565 and $6,874, respectively. In addition to record net income, we also posted record earnings per common share of $0.46 and $0.89 in the three and six month periods ended June 30, 2014, respectively. The primary driver for the increase in net income was a continued improvement in various credit quality indicators. These improvements continue to drive declines in the level of the ALLL in both amount and as a percentage of gross loans, resulting in a reversal of provision for loan losses of $442 for the six month period ended June 30, 2014. Net loans charged-off during the first six months of 2014 were $358 as compared to $751 in the first six months of 2013. Additionally, we continue to see reductions in loans classified as less than satisfactory. While we experienced reductions in net loans charged-off and in the level of loans classified as less than satisfactory, nonperforming loans have increased since December 31, 2013. This increase was primarily the result of two loans, which are well collateralized and closely monitored by management. While competition for high quality commercial loans continues to be intense, we were able to grow our commercial loan portfolio in the first six months of 2014 by $15,687 without relaxing our underwriting standards. This growth was partially offset by declines in both residential real estate loans of $11,386 and consumer loans of $1,103, resulting in a net increase in total loans of $8,270 for the period. The lack of demand for residential real estate loans continues to result in noticeable declines in loan fees and the gain on sale of mortgage loans. We anticipate that competition for commercial loans will continue to be significant, residential mortgage loan activity will remain soft, and growing our deposit base will be challenging throughout the foreseeable future. Despite these challenges, our unwavering commitment to core community banking principles and long term sustainable growth has, and will continue to, enable us to meet the needs of the communities we serve and increase shareholder value. 38



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Results of Operations

The following table outlines our quarterly results of operations and provides certain performance measures as of, and for the three month periods ended:

June 30 March 31 December 31 September 30 June 30 2014 2014 2013 2013 2013 INCOME STATEMENT DATA Interest income $ 13,391$ 13,364$ 13,603$ 13,505$ 13,440 Interest expense 2,468 2,500 2,683 2,736 2,781 Net interest income 10,923 10,864 10,920 10,769 10,659 Provision for loan losses (200 ) (242 ) 245 351 215 Noninterest income 2,434 2,249 2,130 2,862 2,736 Noninterest expenses 9,300 9,486 9,578 9,320 9,324 Federal income tax expense 692 560 303 674 643 Net Income $ 3,565$ 3,309$ 2,924$ 3,286$ 3,213 PER SHARE Basic earnings $ 0.46$ 0.43$ 0.38$ 0.43$ 0.42 Diluted earnings $ 0.45$ 0.42$ 0.37$ 0.42$ 0.41 Dividends $ 0.22$ 0.22$ 0.21$ 0.21$ 0.21 Tangible book value* $ 16.08$ 15.82$ 15.62$ 15.43$ 15.19 Market value High $ 23.50$ 23.94$ 24.84$ 25.50$ 26.00 Low $ 22.52$ 22.25$ 21.12$ 23.40$ 24.75 Close* $ 22.95$ 23.00$ 23.85$ 24.85$ 24.75 Common shares outstanding* 7,735,156 7,727,547 7,723,023 7,709,781 7,703,589 PERFORMANCE RATIOS (annualized) Return on average total assets 0.95 % 0.88 % 0.80 % 0.91 % 0.89 % Return on average shareholders' equity 8.43 % 8.04 % 7.18 % 8.27 % 7.76 % Return on average tangible shareholders' equity 11.59 % 10.92 % 9.78 % 11.16 % 11.10 % Net interest margin yield (FTE) 3.43 % 3.42 % 3.50 % 3.48 % 3.50 % BALANCE SHEET DATA* Gross loans $ 816,307$ 808,411$ 808,037$ 807,849$ 803,452 AFS securities $ 550,518$ 555,144$ 512,062$ 501,057$ 499,424 Total assets $ 1,522,135$ 1,513,371$ 1,493,137$ 1,459,341$ 1,451,415 Deposits $ 1,060,928$ 1,065,935$ 1,043,766$ 1,023,931$ 1,021,424 Borrowed funds $ 279,457$ 272,536$ 279,326$ 266,001$ 262,460 Shareholders' equity $ 171,099$ 165,971$ 160,609$ 161,305$ 159,288 Gross loans to deposits 76.94 % 75.84 % 77.42 % 78.90 % 78.66 % ASSETS UNDER MANAGEMENT* Loans sold with servicing retained $ 290,590$ 292,382$ 293,665$ 294,999$ 295,047 Assets managed by our Investment and Trust Services Department $ 374,092$ 358,811$ 351,420$ 351,505$ 336,132 Total assets under management $ 2,186,817$ 2,164,564$ 2,138,222$ 2,105,845$ 2,082,594 ASSET QUALITY* Nonperforming loans to gross loans 0.58 % 0.65 % 0.42 % 0.53 % 0.52 % Nonperforming assets to total assets 0.38 % 0.42 % 0.32 % 0.37 % 0.36 % ALLL to gross loans 1.31 % 1.37 % 1.42 % 1.44 % 1.46 % CAPITAL RATIOS* Shareholders' equity to assets 11.24 % 10.97 % 10.76 % 11.05 % 10.97 % Tier 1 capital to average assets 8.50 % 8.38 % 8.46 % 8.45 % 8.38 % Tier 1 risk-based capital 13.84 % 13.88 % 13.67 % 13.75 % 13.59 % Total risk-based capital 15.09 % 15.13 % 14.92 % 15.00 % 14.84 % * At end of period 39



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The following table outlines our quarterly results of operations and provides certain performance measures as of, and for the six month periods ended:

June 30 June 30 2014 2013 INCOME STATEMENT DATA Interest income $ 26,755$ 26,968 Interest expense 4,968 5,602 Net interest income 21,787 21,366 Provision for loan losses (442 ) 515 Noninterest income 4,683 5,183 Noninterest expenses 18,786 18,515 Federal income tax expense 1,252 1,219 Net Income $ 6,874$ 6,300 PER SHARE Basic earnings $ 0.89$ 0.82 Diluted earnings $ 0.87$ 0.80 Dividends $ 0.44$ 0.42 Tangible book value* $ 16.08$ 15.19 Market value High $ 23.94$ 26.00 Low $ 22.52$ 21.60 Close* $ 22.95$ 24.75 Common shares outstanding* 7,735,156 7,703,589 PERFORMANCE RATIOS (annualized) Return on average total assets 0.91 % 0.88 % Return on average shareholders' equity 8.24 % 7.63 % Return on average tangible shareholders' equity 11.17 % 10.98 % Net interest margin yield (FTE) 3.42 % 3.52 % BALANCE SHEET DATA* Gross loans $ 816,307$ 803,452 AFS securities $ 550,518$ 499,424 Total assets $ 1,522,135$ 1,451,415 Deposits $ 1,060,928$ 1,021,424 Borrowed funds $ 279,457$ 262,460 Shareholders' equity $ 171,099$ 159,288 Gross loans to deposits 76.94 % 78.66 % ASSETS UNDER MANAGEMENT* Loans sold with servicing retained $ 290,590$ 295,047 Assets managed by our Investment and Trust Services Department $ 374,092$ 336,132 Total assets under management $ 2,186,817$ 2,082,594 ASSET QUALITY* Nonperforming loans to gross loans 0.58 % 0.52 % Nonperforming assets to total assets 0.38 % 0.36 % ALLL to gross loans 1.31 % 1.46 % CAPITAL RATIOS* Shareholders' equity to assets 11.24 % 10.97 % Tier 1 capital to average assets 8.50 % 8.38 % Tier 1 risk-based capital 13.84 % 13.59 % Total risk-based capital 15.09 % 14.84 % * At end of period 40



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Average Balances, Interest Rate, and Net Interest Income The following schedules present the daily average amount outstanding for each major category of interest earning assets, nonearning assets, interest bearing liabilities, and noninterest bearing liabilities. These schedules also present an analysis of interest income and interest expense for the periods indicated. All interest income is reported on a FTE basis using a 34% federal income tax rate. Nonaccrual loans, for the purpose of the following computations, are included in the average loan balances. FRB and FHLB restricted equity holdings are included in accrued income and other assets. The following tables display the results for the: Three Months Ended June 30, 2014 March 31, 2014 June 30, 2013 Tax Average Tax Average Tax Average Average Equivalent Yield / Average Equivalent Yield / Average Equivalent Yield / Balance Interest Rate Balance Interest Rate Balance Interest Rate INTEREST EARNING ASSETS Loans $ 808,541$ 9,799 4.85 % $ 805,812$ 9,751 4.84 % $ 780,909$ 10,280 5.27 % Taxable investment securities 353,878 1,993 2.25 % 353,013 1,998 2.26 % 341,232 1,798 2.11 % Nontaxable investment securities 194,307 2,376 4.89 % 189,000 2,332 4.94 % 162,626 2,024 4.98 % Trading account securities 172 2 4.65 % 524 8 6.11 % 1,156 14 4.84 % Other 21,421 112 2.09 % 26,604 153 2.30 % 23,533 109 1.85 % Total earning assets 1,378,319 14,282 4.14 % 1,374,953 14,242 4.14 % 1,309,456 14,225 4.35 % NONEARNING ASSETS Allowance for loan losses (11,208 ) (11,634 ) (11,889 ) Cash and demand deposits due from banks 17,403 17,690 17,157 Premises and equipment 25,960 26,018 25,917 Accrued income and other assets 97,187 94,704 99,729 Total assets $ 1,507,661$ 1,501,731$ 1,440,370 INTEREST BEARING LIABILITIES Interest bearing demand deposits $ 192,798 39 0.08 % $ 197,776 41 0.08 % $ 181,044 40 0.09 % Savings deposits 257,628 91 0.14 % 252,979 94 0.15 % 242,247 90 0.15 % Time deposits 455,592 1,459 1.28 % 451,350 1,481 1.31 % 460,379 1,692 1.47 % Borrowed funds 263,606 879 1.33 % 270,010 884 1.31 % 243,936 959 1.57 % Total interest bearing liabilities 1,169,624 2,468 0.84 % 1,172,115 2,500 0.85 % 1,127,606 2,781 0.99 %


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Source: Edgar Glimpses


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