Isabella Bank Corporation: Buying This High-Yielding Community Bank

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Summary

  • ISBA delivered record earnings last quarter, driven by a growing loan portfolio.
  • The company's average yield on loans continues to grow.
  • ISBA is yielding 4.7%; however, the company has not announced a dividend increase since 2017.
  • ISBA is trading at a discount compared to the market.

It is not a secret that we love community banks, especially the undervalued ones! The community bank sector offers a lot of attractively valued, capital heavy banks that pay a nice dividend. So today, we have another high-yielding, community bank based in Michigan that we are going to review: Isabella Bank Corporation (OTCQX:ISBA).

Isabella Bank was founded in 1903 and operates in the state of Michigan. The company offers a full suite of products, similar to most community banks, and has 30 locations across the state.

ISBA Financial Performance Review

The company released their Q2 earnings and Form 10-Q last month. So for this analysis, we have some nice, updated information to review this bank.

Reading the earnings release, management could not have set a more positive tone from the onset. The company reported record earnings for the quarter. Net income for the three months ended June 30, 2019, was $4,188,000 compared to $3,333,000 in the previous year. That is a 25.6% increase, for those that are counting, which is insane in the given environment.

Let's review the rest of the income statement to see if we can pinpoint the predominant drivers of the growth. The company's financials are pretty consistent. However, I've noticed two key items impacting their financial results that have led to the record earnings and continued strong financial performance for the bank.

Interest Income Growth - Starting at the top of the income statement, the company delivered strong interest income growth compared to last year. For the three months ended June 30, loan interest income was $13,785,000, a 12.5% increase compared to the same period last year. For the six-month period, the company's loan interest income was $26,748,000, a 13.3% increase. These growth rates are very strong, especially in a competitive industry going up against larger banks that may be willing to accept more risk or less competitive loan terms.

There are only two factors that could lead to growth (or a decline) in a bank's interest income: loans and the interest rate on the loans. Isabella benefitted from both factors, which is most likely why the company is seeing double-digit interest income growth on a regular basis.

In the company's 10-Q, the bank is required to disclose in their MD&A the average yield on all earning assets. I compiled the average yield on their loan portfolio for the following three-month periods below:

Look at that interest rate growth right there. In just over a year, the company's average yield on their loan portfolio increased 37 basis points. This isn't a small loan portfolio either, mind you. The bank has almost $1.2 billion of loans on their balance sheet! The one item we cannot see is the breakdown of loans, in terms of fixed or variable rates. So it is hard to tell if ISBA originated a lot of new loans at higher rates, or if they have a large percentage of variable rate loans that adjusted upwards once interest rates shot through the roof in Q4 2018. Regardless, it is easy to see how interest income grew so much when the company's average portfolio rate climbed so quickly.

But ISBA's growth wasn't simply due to interest rate growth. The company's loan portfolio has grown over the period as well. Total loans at 6/30/19 were $1,176,622,000 compared to $1,128,727,000 at 12/31/18, a 4.2% growth rate. Annualized, loans are on pace to grow 8.4%. An excellent mark for a community bank. The company has experienced the strongest loan growth in their commercial loans sector. Commercial loans can carry higher interest rates compared to mortgage loans due to increased risk. This could be another driver for their increased average loan yield.

Looking at the trend in the company's average portfolio yield and their loan growth, it is easy to see why Q2 produced a record setting earnings figure and double-digit interest income compared to last year.

Negative Provision for Loan Losses - Without getting too deep into the topic, each bank is required to maintain an Allowance for Loan Losses to estimate potential losses on their loan portfolio. The accounting team calculates the reserve. I won't get into the details in this article about how this number is calculated. However, if it is determined the reserve needs to increase, the bank records a provision for loan losses. This reduces the company's earnings. If it is determined that the bank has reserved too much, the bank records a negative provision, to bring the allowance down to the calculated amount. This increases the company's earnings. ISBA recorded a negative provision in the three months ended of ($168,000) compared to a positive provision of $328,000. That is a large swing compared to last year.

Dividend Diplomats Dividend Stock Screener

Let's run Isabella through the Dividend Diplomats' Dividend Stock Screener.

The Dividend Diplomats Dividend Stock Screener examines the following metrics and is what we use to determine whether a company is considered an undervalued dividend growth stock.

  • P/E Ratio (Valuation)

  • Dividend Payout Ratio (Safety)

  • Dividend Growth Rate and History (Longevity)

For this analysis, I will use the company's 9/13/19 close price of $22.20/share, annualized EPS of $1.94/share, and an annual dividend of $1.04/share.

1.) Price-to-Earnings (P/E) - This metric is used to see if the company is undervalued. According to my source, the S&P 500 P/E ratio is 22.37. ISBA's 11.44X ratio is much lower than the broader market. Further, we performed an analysis over another community bank, Citizens & Northern (CZNC). In our screener, CZNC's P/E ratio was 11.93X. So, ISBA's P/E ratio is in line, and even slightly lower, than another community bank we monitor.

2.) Payout Ratio - We use a 60% target payout ratio in our analysis, as we believe 60% provides a strong blend of yield and ability to continue growing their dividend going forward. ISBA's payout ratio is 53.6%. ISBA passes this metric, and man, would we love to see some more dividend growth from the company.

3.) Dividend Yield - The current dividend of $1.04/share equates to a yield of 4.68%. That's a very high yield and is very appealing for a company with a dividend payout ratio of only 53.6%.

4.) Dividend Growth Rate - This has been a frustrating point when analyzing the company. Isabella Bank has paid a dividend since the 1990s. For the last decade, the company has been steadily increasing their quarterly dividend... until this last year. The last time ISBA increased their quarterly dividend was in September 2017. There has not been much information disclosed about why the company has not announced a dividend increase yet; however, we are eagerly awaiting to learn why. ISBA has a strong history of paying and increasing their dividend based on their history; however, I would like to see another dividend increase announced sooner, rather than later. Their streak of increasing dividends may come to an end if one isn't announced before the year is over.

Summary

ISBA has been performing very well. I like the growth the company has exhibited and it is encouraging to see that the company is producing record earnings using growth in their core operations (growing loans). The company also pays a very nice dividend yield and has plenty of room to continue growing their dividend. The one frustrating thing is that the company has not announced a dividend increase for several years now. I wonder why! Is an acquisition coming? Is the company planning on a major capital deployment elsewhere?

There is one other thing to note about ISBA that is making the company very attractive. Their current valuation. In addition to their low P/E ratio, ISBA is trading at a low Price to Book Value level. As of today, the company's Price to Book Value ratio is 89.5% and their Price to Tangible Book Value is 108.5%. In the banking sector, these are very low. For comparison's sake, CZNC's P/B and P/TBV are 149.5% and 171.0%, respectively. Based on this metric alone, ISBA is flashing that it is trading at a discount compared to other banks.

With low valuations, strong performance, loan growth, and a strong dividend yield, I am long ISBA and will most likely add to my position in the company before their ex-dividend date on September 25, 2019.

What are your thoughts about the bank? Are you familiar with them? What metrics do you use to analyze community banks?

This article was written by

Dividend Diplomats profile picture
14.78K Followers
Two guys who love Investing, Dividends, Frugality, Passive Income & attempting to Reinvest Our Dividends to one day achieve Financial Freedom! Follow us on your journey towards a work-free life! We share EVERY ASPECT of our journey on our blog, social media, and YouTube Channel. Make sure to follow us so you don't miss an update. Updates include the stocks we are watching, buying, selling, and our overall thoughts about the the marketBlog: http://www.dividenddiplomats.comYouTube Channel: www.youtube.com/dividenddiplomatsTwitter: https://twitter.com/DvdndDiplomats

Disclosure: I am/we are long ISBA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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